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How Endowment Works
UC Regents and the UCSD Foundation
What is an endowment?
An endowment is created by a donor from a gift containing a legal stipulation that the
original gift may never be expended. These gifts are held and invested in perpetuity by
The Regents of the University of California and the UCSD Foundation for the purpose of
generating a permanent expendable income stream from the return on the gift for the
purpose the donor desires.
Endowed gifts may be for restricted or unrestricted purposes and are particularly
important to UCSD due to their permanency. These gifts permit planning for programs
into the far future.
How is an endowment invested?
The Regents of the University of California (“The Regents”) and the Board of Trustees
of the UCSD Foundation (“the Foundation”) each have fiduciary responsibility for
investment of their respective endowments. Both The Regents and the Foundation are
guided by basic principles in endowment management as follows:
Maximizing long-term total return
Preserving and enhancing the real purchasing power of the endowment
Maximizing the stability and predictability of the endowment spending
allocations from the return generated
To accomplish this goal, both The Regents and the Foundation, like many large
educational and non-profit organizations, invest their endowment using diversified
portfolios of assets comprised of primarily of equity, fixed income, and alternative asset
classes (most of which are equity based). Most larger institutions recognize that while
the equity markets can be volatile in short runs, over the long-term they produce the
greatest total return. Total return in any given period is defined as the sum of cash
earnings on investments, such as dividends and interest, plus the realized or unrealized
appreciation or depreciation in the market value of those investments for that period.
The Regents have received and manage endowed gifts directly for the benefit of each
campus, including UCSD, and those funds are invested by the Treasurer’s Office of the
Regents in their General Endowment Pool (GEP). The Treasurer’s Office has achieved
good long-term returns on the endowment, with an investment management fee of only
.09% per annum.
The Foundation’s endowment is separate from that of The Regents, and is invested based
on a policy approved by its Board of Trustees, and carried out by its Investment
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Committee. All ten UC campus foundations have the option of hiring the Treasurer’s
Office of the Regents as a manager and of investing in the UC Pools, including the GEP,
or of hiring completely external managers, making their own determination of
investments, or a combination of them all. As of November 2007, the Foundation uses
the GEP as a core investment in its endowment investment strategy, and has added
additional vehicles as well. The Foundation has achieved good long-term returns similar
to that of the GEP, at a low cost.
Endowment Buy-In and Unitization Example
The actual mechanics of endowment investment and management are very similar to that
of a mutual fund. Endowment, whether held by The Regents, or by a campus foundation,
is accounted for using a unitized investment pool. Each individual endowment owns
units in the pool, revalued at each month-end. Only at month-end periods, using the
month-end value of a unit, may new endowments enter the pool. New endowments “buy
into” and receive a certain number of units in the pool given the amount being invested
and the value of a unit on the buy-in date. As the value of a unit in the pool grows, new
endowments purchase fewer units in the pool.
For example, an entire endowment pool may have a market value at December 31, 2006
of $10,000,000, and have 100,000 units in the pool. The market value is therefore $100
per unit. Let’s assume the Jones Endowment began with a $10,000 gift and bought into
the pool five years ago when the unit value was only $50, obtaining 200 units in the pool
at that time. Given the unit value at December 31, 2006, the market value of the Jones
Endowment would be $20,000 at December 31, 2006. If the Smith Endowment gift of
$10,000 were received during the month of December 2006, the Smith Endowment
would buy units in the pool as of January 1, 2007 at the rate of $100 per unit. Therefore,
the Smith Endowment would obtain 100 units in the pool. The same gift five years ago
bought 200 units in the pool at the unit value at that time, versus the 100 units it can
purchase now, due to the appreciation of the value of a unit in the pool.
What is the policy on the expenditure of the return earned on endowed funds?
Since the principal of an endowed gift may never be expended, then a very significant
aspect of any institution’s endowment policy is the question of how much of the total
return earned on those gifts may be expended annually. Typically, this is referred to as
an institution’s endowment “spending policy”.
Most institutions invest to maximize long-term total return of their endowment, but have
very conservative spending policies. That is, in order to ensure the spending made
available from the endowment is equal to, or better yet, outpaces the rate of inflation,
most institutions set annual spending policies at rates less than their expected total
rate of return. By retaining a portion of return in the principal, rather than spending it,
the fund will grow. If this inherent conservatism were not in place, an endowed
scholarship fund that provided a full scholarship from the spending the first year might
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only provide one-half a scholarship in its tenth year, due to the effects of inflation and the
higher cost of education. Eventually, its value would erode to nothing.
According to an endowment study conducted nationally each year by the National
Association of College and University Business Officers (NACUBO), approximately
75% of all institutions set a spending policy rate using an average value of the
endowment, generally computed over a three to five year period, to compute annual
spending. The use of an averaging mechanism to compute spending helps ensure the
amounts are not widely fluctuating, and most likely are slightly increasing, each
year. The equal-weighted average spending rate of all institutions in the NACUBO
Study was approximately 4.7% of the average fund value.
The Regents and the Foundation have very similar spending policies to each other. The
Regents policy is set at 4.75% of the 60-month average unitized market value. The
Foundation’s policy is the same, but uses a five-year average rather than a 60 month
average. Both entities spending policies include a fee of 0.25% that is recovered for
annual endowment administration costs incurred internally.
Endowment Spending Calculation Example
The actual spending for any individual endowment is computed annually using the
a) the average value of a unit in the pool over the averaging period (for the
Regents, the average of the past 60 months of unit values of the pool, and for
the Foundation the average of the past five-year calendar year-end unit values
of the pool)
b) the number of units EACH endowment owns in the pool; and
c) the spending policy rate as set by the institution
Using the Jones and Smith Endowments above, let’s compute the spending that would be
made available to each endowment for 2005. The value of a unit in the pool today is
$100 per unit, and the value of a unit five years ago was $50 per unit. The overall total
return earned on the pool over that five years has been positive. Let’s assume the 60 -
month average value of a unit in the pool is $74.60. The computation for endowment
spending for 2005 would be as follows:
200 units X $74.60 (5 yr. avg. unit value) X 4.75% = $708.7 of endowment spending,
less $37.30 (at .25% annually) of admin management fee is a net of $671.4
(Note: if the market value of the endowment is $20,000 now, it is easy to see that the
endowment spending is NOT calculated on the ending value of the endowment at any
point in time, but on the unitized value. Taking the gross spending of $708.7 divided by
the $20,000 current value, that is a rate of 3.5% on the most recent market value. This
illustrates the important effect of the averaging mechanism on spending.)
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100 units X $74.60 (5 yr. avg. unit value) X 4.75% = $354.35 of endowment
spending, less $18.65 in admin management fee.
(Note: if the market value of the endowment is $10,000, the gross spending of $354.35
divided by the $10,000 current value, that is a rate of 3.5% on the most recent market
Five years ago, the Jones Endowment calculation for endowment might have looked
something like this:
200 units X $28.50 (5 yr. avg. unit value) X 4.75% = $270.75 of endowment spending
Comparing the Jones Endowment spending five years ago versus now, one can see that a
conservative spending policy, coupled with a sound investment policy that achieves long-
term maximized returns, will preserve and enhance the value and purchasing power of
endowment spending in perpetuity. While it is true that there may be short-term
fluctuations in both value, over the long-term, endowments will grow and achieve the
donor’s purposes, and the averaging mechanism will provide a smoother increase in
spending, and smooth any decreases, should market value be affected by significant
changes in overall market value of the fund as whole.