June 8, 2022

How MCF's Spending Policy Helps Stabilize Distributions

While the stock markets closed out 2021 with strong returns, by mid-May the S&P 500 was flirting with bear market status (a drop of 20% or more from its last peak) and investors are watching both interest rates and inflation closely. Adding to investors’ unease is the war in Ukraine and the ongoing COVID-related supply chain disruptions. All of this has added up to a period of high market volatility.

Helping Mitigate Inflation’s Bite

Inflation in the United States is rising at a higher annual rate than we’ve seen in decades. Periods of rapidly increasing inflation often cause volatility in the markets as investors try to discern which sectors may benefit from rising prices, and which will be hurt by them.

Inflation affects nonprofit organizations just like it affects individuals, eroding an organization’s spending power as the cost of goods and services increases. Some organizations may also experience fluctuations in giving, as donors adjust to the effects of inflation on their own finances.

Nonprofits that rely on distributions from an endowment as part of their operating budget have an advantage during these periods of uncertainty – they have a consistent, relatively predictable stream of income to rely on. Even though a sudden increase in inflation, like we’re experiencing now, can cause an increase in market volatility, MCF's spending policy helps minimize the impact of that volatility on your endowment and distributions.

Stewardship Focused on the Long Term

MCF manages endowments through good and bad economic times. These endowments are intended to provide distributions today and for generations to come. To make this happen, MCF takes a long-term approach to managing the endowments we steward.

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 maintains more balanced and sustainable distributions, minimizing the impact of market fluctuations on a nonprofit’s operating budget or an individual fundholder’s annual distribution amount. Policies that spend out a fund’s earnings each year can produce much higher distributions 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 distributions is an important part of the model, particularly in uncertain times,” says Bob Sorge, MCF President and Chief Executive Officer. “This provides support to organizations and allows them time to project and adjust rather than react to immediate changes.”

Calculating Annual Distributions

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.

The table below shows a hypothetical fund, opened for a nonprofit organization with a $100,000 initial contribution at the end of 2016. Our hypothetical fund has received no subsequent contributions and has made an annual distribution to the nonprofit every year in March. In the table, you’ll see investment returns for each quarter, along with the fund’s value at the end of that quarter.

Looking at our illustration, during the 20 quarters ending on December 31, 2022, you’ll see the annual distributions have risen from $4,712.72 in 2018 to $5,011.68 in 2022. Even with the large drop in the endowment’s value in the quarter ending March 31, 2020 – caused by market volatility at the start of the COVID pandemic – the annual distribution from the endowment only decreased $8 from 2021.

Committed to the Community

MCF has a long history of serving the Madison area. Our prudent spending policy safeguards the financial health of the endowments in our care so they can provide ongoing support for the community, even in challenging times.