Investing for Forever: Considerations When Investing for Endowments and Foundations

October 27, 2022
We discuss factors that come into play when investing for endowments and foundations.

At Brown Brothers Harriman (BBH), we frequently speak and write about investing with a long-term time horizon: As a more than 200-year-old partnership, we manage assets for numerous multigenerational families, and our proprietary investment teams and external partners spend their days seeking out high-quality businesses that can compound intrinsic value for many years.

Few entities have longer time horizons than endowments and foundations (E&Fs). Some of the largest E&Fs in the United States include colleges and universities, philanthropic organizations, and hospital systems. Such institutions, built to outlast their mortal stakeholders and stewards, operate on timescales denominated in centuries. In an ideal world, their intended time horizons are nothing short of infinite.

One might think that the natural long-term orientation of E&Fs makes their approach to investing even more straightforward. After all, what does quarterly or yearly volatility matter to an endowment focused on 20- or 30-year returns? Despite this distant time horizon, however, E&Fs also bear a variety of unique organizational characteristics and financial obligations, including annual spending to support the operating budgets of their parent institutions. The primary purpose of a typical E&F investment portfolio is therefore twofold in nature: providing a stable stream of funds to support near-term operations while preserving (and ideally growing) institutional capital in perpetuity. These twin priorities are inherently difficult to balance, and satisfying both requires a thoughtful and differentiated investment approach. At BBH, we are constantly pondering these important nuances in investment for E&Fs. Not only do we have E&Fs as direct clients, but our taxable clients, Partners, and employees also often serve as advisors, donors, and trustees to many more E&Fs.

Stable Funding vs. Purchasing Power Preservation

All tax-exempt entities rely to some extent on endowment assets to execute their missions. These institutions include schools, museums, foundations, and a wide variety of other nonprofits. Such institutions are also generally characterized by their regular spending mandates and investment programs overseen by a formal investment committee (IC), typically populated by investors and other knowledgeable financial services professionals who collectively bear fiduciary duty for protecting the assets of the organizations they serve.

For certain institutions, these spending requirements are mandatory. To maintain their tax-exempt status, U.S. private foundations must make annual distributions1 that often amount to 5% or more of investment asset value; endowments, while not subject to the same laws, typically spend at least 4% to 6% of a rolling average of asset values each year to support their operating budgets. In addition to these minimums, state laws such as the Uniform Prudent Management of Institutional Funds Act (UPMIFA) contain optional subsections (adopted by New York and California, among others) that require ICs to monitor their spending rates based on a combination of expected returns, expenses, and inflation. Spending formulas differ across institutions, but almost all E&Fs base some portion of their spending on the value of their investment portfolios. E&Fs also vary in the degree to which the organizations they serve depend on them for operational support: Whereas some E&Fs are often treated as “rainy day” funds and provide minor budgetary smoothing, others fund as much as half or more of their institutional operating budgets.

Due to the reliance on investment portfolios to support operations, tax-exempt institutions must ensure that their assets can predictably and consistently support annual outlays. While short-term, unrealized portfolio depreciation can usually be ignored in a long-term-oriented portfolio, significant downturns in investment portfolios can substantially affect endowment spending, even if that portfolio depreciation is never realized. When an endowment’s asset value declines, the organization can either maintain its spending in absolute dollars or percentage terms; the former risks spending a much larger portion of the endowment than is prudent, while the latter risks absolute underspending that fails to meet budgetary needs.

To illustrate this trade-off, consider the example of a $100 million endowment that spends roughly 5% per year, or $5 million, to support its institutional budget. In the event of a major downturn during which the endowment temporarily loses 30% of its value (bringing net asset value to $70 million), continuing to spend 5% would only provide $3.5 million for the budget, creating a material shortfall.2 On the other hand, if the institution in question decides to continue spending $5 million to stabilize its budget, it will spend over 7% of the endowment’s new value and may need to realize less-liquid investments at a loss to fund operations. Neither situation is ideal and can only be prevented through a combination of more sophisticated spending formulas and a portfolio that is intentionally sensitive to drawdowns. Ordinarily, lower-volatility, income-paying assets like fixed income would be one potential solution to such needs.

At the same time, however, most E&Fs are designed to function in perpetuity. Thus, without investing in assets that deliver returns beyond the rate of spending plus inflation (which is estimated to be considerably higher in the education sector, often reaching 3% to 4%), the funds that an institution accumulates today will lose purchasing power and become gradually less effective in supporting future constituents. In contrast with stable, predictable assets like fixed income, the investments that are best-suited to growing over time in excess of inflation include various forms of equity – which can be less liquid and more volatile.

Reconciling these conflicting needs and the assets available for investment is central to the role of any E&F IC. For an institution to execute its mission successfully and consistently over the long term, its portfolio managers must avoid mortgaging the future to fund the present – and vice versa.

Reconciling these conflicting needs and the assets available for investment is central to the role of any E&F IC. For an institution to execute its mission successfully and consistently over the long term, its portfolio managers must avoid mortgaging the future to fund the present - and vice versa. 

BBH’s Approach

At BBH, we seek to balance the competing priorities of stability and growth by allocating a larger portion of E&F portfolios to equity-related assets, including private assets and marketable alternatives. We define marketable alternatives as those strategies that can generate investment returns that are independent of overall public equity market performance, including event-driven, long/short, and turnaround/distressed investments. Such strategies are well-suited to E&F portfolios due to their intended ability to generate a different return pattern regardless of market conditions, supporting the stable spending policies previously discussed while ideally also generating equity-like returns. Due to their tax-exempt nature, E&Fs are typically better able to invest effectively in such strategies, which can be higher turnover and tax inefficient.

We believe the inclusion of private investments also merits some additional explanation. One potential advantage conferred by a typical E&F’s unique time horizon is that of the illiquidity premium. In exchange for locking up capital for longer periods of time – which endowments can often afford to do in ways that individuals cannot – E&Fs can extract higher returns than those offered by shorter-term, more liquid alternatives. Examples of such illiquid, higher-return asset classes include private equity and private real estate (although as with any investment, manager access and selection within these asset classes can make all the difference).

In determining how much to invest in private markets, however, it is important to recognize that an overreliance on private equity and other illiquid investments is not without risk. Even with a multigenerational timeframe, tax-exempt institutions occasionally do face unexpected and near-term liquidity demands. During the 2008 recession, some illiquid-heavy endowments were forced to liquidate high-performing public equities to meet the contractually obligated capital calls of their private equity managers. Others were forced to take on debt to backstop institutional budgets, and nearly all endowment portfolios emerged materially off-model and overweight to private equity.

In general, we believe this approach to liquidity – sacrificing some near-term flexibility for the sake of returns and predictability – is appropriate given the time horizon advantage of most E&Fs. That said, we also believe that the ideal liquidity profile for any endowment or foundation is highly institution-specific and should be chosen with several different considerations.

  • How reliant is the institution on its endowment to fund operations? Some nonprofit institutions rely primarily on fundraising, grants, and other revenue sources to pay their operating expenses, allowing their endowments to accrue as long-term rainy day funds that supply only a small percentage of their annual budget. Other institutions rely more heavily on endowment spending to support operations, with the majority of annual spending derived from endowment payouts. In the latter case, liquidity is far more important; in the event of a downturn or externally triggered budget crisis, locked-up capital will be inaccessible to serve as a stopgap, forcing the institution to consider debt or severely underfund its operations.
  • How easily can spending be adjusted in a downturn? In addition to being less reliant on their endowments for budgetary needs, some institutions are more flexible than others in their ability to temporarily reduce spending without disrupting their core missions. Those that can afford to cut costs during a downturn – whether by trimming staff or paring back programming – or to lean on additional grants or fundraising to cover shortfalls, as described earlier, can likewise afford less liquidity.
  • What are the institution’s liquidity sources? With the aforementioned qualitative considerations in mind, institutions should conduct a full accounting of their current sources of liquidity, project their future distributions and commitments, and stress test their projected liquidity in a variety of scenarios. How much liquidity is derived from grants vs. operations? Lines of credit? What are the expected distributions from and commitments to private investments? Institutions should be comfortable that they can maintain enough liquidity, even in a market downturn, to service all their commitments.

Ironically, very few for-profit entities operate with the same permanence of the endowments and foundations they serve. However, at BBH, where we have just celebrated our 204th birthday, we consider a permanent time horizon to be one of our founding principles, and we invest our nonprofit clients’ capital accordingly. Unsurprisingly, this approach is driven by the same equity-biased portfolios and multidecade focus on capital preservation that we pursue for our taxable clients. At the same time, however, effective endowment investing also requires thoughtful attention to near-term concerns like spending, liquidity, and stability – which often vary on an institution-by-institution basis. BBH seeks to balance both as we steward our E&F clients to their own bicentennials and beyond.

1 The minimum “distributable amount” is calculated by the Internal Revenue Service based on the minimum investment return of the foundation, reduced by the sum of any income taxes and increased by certain other adjustments.
2 This is a simplified spending model based on end-of-year values; most institutions “smooth” spending by utilizing three- or five-year averages.

Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries. This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners. © Brown Brothers Harriman & Co. 2022. All rights reserved. PB-05771-2022-09-29

As of June 15, 2022 Internet Explorer 11 is not supported by

Important Information for Non-U.S. Residents

You are required to read the following important information, which, in conjunction with the Terms and Conditions, governs your use of this website. Your use of this website and its contents constitute your acceptance of this information and those Terms and Conditions. If you do not agree with this information and the Terms and Conditions, you should immediately cease use of this website. The contents of this website have not been prepared for the benefit of investors outside of the United States. This website is not intended as a solicitation of the purchase or sale of any security or other financial instrument or any investment management services for any investor who resides in a jurisdiction other than the United States1. As a general matter, Brown Brothers Harriman & Co. and its subsidiaries (“BBH”) is not licensed or registered to solicit prospective investors and offer investment advisory services in jurisdictions outside of the United States. The information on this website is not intended to be distributed to, directed at or used by any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Persons in respect of whom such prohibitions apply must not access the website.  Under certain circumstances, BBH may provide services to investors located outside of the United States in accordance with applicable law. The conditions under which such services may be provided will be analyzed on a case-by-case basis by BBH. BBH will only accept investors from such jurisdictions or countries where it has made a determination that such an arrangement or relationship is permissible under the laws of that jurisdiction or country. The existence of this website is not intended to be a substitute for the type of analysis described above and is not intended as a solicitation of or recommendation to any prospective investor, including those located outside of the United States. Certain BBH products or services may not be available in certain jurisdictions. By choosing to access this website from any location other than the United States, you accept full responsibility for compliance with all local laws. The website contains content that has been obtained from sources that BBH believes to be reliable as of the date presented; however, BBH cannot guarantee the accuracy of such content, assure its completeness, or warrant that such information will not be changed. The content contained herein is current as of the date of issuance and is subject to change without notice. The website’s content does not constitute investment advice and should not be used as the basis for any investment decision. There is no guarantee that any investment objectives, expectations, targets described in this website or the  performance or profitability of any investment will be achieved. You understand that investing in securities and other financial instruments involves risks that may affect the value of the securities and may result in losses, including the potential loss of the principal invested, and you assume and are able to bear all such risks.  In no event shall BBH or any other affiliated party be liable for any direct, incidental, special, consequential, indirect, lost profits, loss of business or data, or punitive damages arising out of your use of this website. By clicking accept, you confirm that you accept  to the above Important Information along with Terms and Conditions.

1BBH sponsors UCITS Funds registered in Luxembourg, in certain jurisdictions. For information on those funds, please see

captcha image

Type in the word seen on the picture

I am a current investor in another jurisdiction