In addition to the significant effect on people’s health and wellbeing, the shutdowns, social isolation and overall uncertainty caused by the coronavirus have created economic challenges and stock market volatility. This may leave you wondering how market changes will affect distributions from your fund. The answer, in the short term, is that it will have minimal impact: MCF’s spending policy is designed to mute the short-term effects of market volatility.
Careful Stewardship Evens Out Volatility
As steward for more than 1,100 funds, of which 750 are endowments, MCF manages the charitable resources for individuals, families, businesses and nonprofit organizations – all of whom rely on MCF to shepherd their funds through good and bad economic times. These endowments are intended to be available both today and for future generations, and one of the tools MCF uses to help ensure their longevity is its spending policy.
Stock market fluctuations from quarter to quarter, or even year to year, are smoothed out by MCF’s “total return” spending policy. The amount available for distribution each year is based on a percentage (historically between 4% and 5%) of the fund’s average value over the past 20 quarters.
Using a total return policy is considered a best practice among foundations and endowments because it maintains more balanced and sustainable distributions. Policies that spend out a fund’s earnings each year can produce much higher income streams when the market is strong, but much lower distributions when the market is weak – and perhaps none when the market is in recession and the resources are needed most.
“The predictability of the distributions is such an important part of the model, particularly in uncertain times,” says Bob Sorge, MCF President and CEO. “This provides support to organizations and allows them to plan and respond rather than react to immediate changes.”
MCF holds a position of trust and responsibility for both donors and beneficiaries, and focuses to ensure the endowments it stewards are stable and enduring.
For donors, this may mean striving to maintain inter-generational equity so future generations have the same giving capacity as today’s generation. For organizations relying on distributions from these funds, this means having a steady source of resources available, regardless of where the stock market is in its cycle.
How Distributions Are Calculated
Each year, the MCF Board of Governors determines the annual distribution percentage and applies it to all endowed funds at MCF (including those that support MCF operations). The distribution rate is currently at 4.25% of a fund’s average value over the prior 20 quarters (five years). The long window means the market’s peaks and valleys moderate each other.
Here’s a hypothetical fund, opened with a $40,000 initial donation and no subsequent donations. In the table, you’ll see hypothetical investment returns for each quarter, along with the fund’s value at the end of that quarter.
Hypothetical Fund Spending Policy Calculation
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Hypothetical 2020 Results |
| Quarter Ending |
Fund Balance |
Quarter Ending |
Fund Balance |
Quarter Ending |
Fund Balance |
| 3/31/2015 |
$41,440 |
9/30/2017 |
$40,491 |
3/31/2020* |
$39,164 |
| 6/30/2015 |
$40,779 |
12/31/2017 |
$39,782 |
6/30/2020* |
$35,248 |
| 9/30/2015 |
$41,990 |
3/31/2018 |
$42,407 |
9/30/2020* |
$37,010 |
| 12/31/2015 |
$42,980 |
6/30/2018 |
$42,445 |
12/31/2020* |
$41,451 |
| 3/31/2016 |
$43,276 |
9/30/2018 |
$42,495 |
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|
| 6/30/2016 |
$44,102 |
12/31/2018 |
$43,268 |
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|
| 9/30/2016 |
$43,418 |
3/31/2019 |
$43,250 |
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|
| 12/31/2016 |
$43,235 |
6/30/2019 |
$43,457 |
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| 3/31/2017 |
$42,482 |
9/30/2019 |
$44,295 |
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|
| 6/30/2017 |
$41,589 |
12/31/2019 |
$46,075 |
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| Average balance over 20 quarters through the end of 2019 |
$42,663 |
| 2020 spending policy percentage |
x 4.25% |
| Funds available to distribute in 2020 |
$1,813 |
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| Hypothetical average balance over 20 quarters through the end of 2020 |
$42,138 |
| 2021 spending policy percentage |
x 4.25% |
| Funds available to distribute in 2021 |
$1,791 |
*2020 results are hypothetical and included for illustration only.
Looking at our illustration, during the 20 quarters ending on December 31, 2020, the fund had a high balance of $46,075, a low balance of $39,782, and an average balance of $42,663. In 2020, the fund would be able to distribute $1,813. Extending our example out over a hypothetical market drop in 2020, the fund’s value drops by nearly 10% to $41,451 at the end of 2020, but the amount available for distribution in 2021 is only reduced by 1.2%, to $1,791.
Obviously, we have no way of knowing how the market will behave in 2020, nor the effect it will have on our investment portfolio, this is just to provide an illustration of how even a dramatic reduction in a fund’s value is evened out by the policy.
Committed to the Community
MCF has a long history of serving the Madison area, and we intend to continue that service long into the future. MCF’s prudent spending policy safeguards the financial health of the endowments in our care so that they are able to provide ongoing support for the community we love, even in challenging times such as these.
MCF's portfolio, collectively designed by Commonfund and the MCF Investment Committee, is aligned with MCF’s long-term objectives. It is well-diversified to account for our return needs, risk tolerance, and liquidity requirement (to provide steady income to support annual distributions). As such, our portfolio contains four primary components: equities, fixed income, diversifying strategies, and real assets.
Equities (Growth Assets): The role of equities in the portfolio is to provide long-term growth and capital appreciation in support of our return needs.
MCF executes equities through both public and private strategies and, collectively, they represent the largest allocation in our portfolio. Prior to to 2019, MCF had been carrying a tactical overweight to equities in the portfolio, which has served us well in recent years. Recognizing that we were in the late stages of a long growth cycle, we decided to tactically reduced this overweight and changed the portfolio allocation to a neutral position by the end of 2019.
Relative to our peers, MCF has a higher allocation to private investments and these investments have been one of the primary drivers behind our strong investment performance over the past several years.
Fixed Income (Deflation Hedge): The role of fixed income in the portfolio is to provide a source of income and liquidity, while also providing potential downside protection from negative volatility in the equity markets.
While fixed income has not offered attractive returns in the past few years, we’ve maintained an allocation close to our targets for the very reason that unfolded: an unforeseen drop in the equity markets. The fixed income portfolio has served its purpose and helped dampen the impact of the recent equity market volatility.
Diversifying Strategies (Diversification Benefits): The role of diversifying strategies in our portfolio is to provide a source of return that does not rely on the broad direction of either the equity or fixed income markets.
Over the past year or so, our portfolio has carried a slight overweight to diversifying strategies. Given a desire to add more flexibility and liquidity to the portfolio, we reduced the allocation to target weights coming into 2020. Not all diversifying strategies are priced daily, so we do not have a full comparative picture of how the strategies are faring relative to benchmarks. But the portfolio has provided much needed diversification away from traditional asset classes during this volatile period.
Real Assets (Inflation Hedging Strategies): The role of real assets in the portfolio is to serve as a hedge against inflation, and, for select strategies, to drive long-term capital appreciation.
Our real assets portfolio is diversified and includes both public and private natural resources, as well as both public and private real estate. While inflation has been modest over the past several years, we do believe having a component of the portfolio that can provide inflation protection characteristics will be beneficial over the long-term.