Foundation Payout Decisions and the Folly of One-Size-Fits-All Mandates

Faced with the coronavirus health crisis, the economic decline caused by the resulting lockdowns, and an increased focus on racial justice, private foundations have responded generously and creatively in their grant-making. A third-quarter 2020 report issued by Foundation Source reported that of over 100 client foundations surveyed, 42% had increased the dollar amount of their grant-making beyond what they had planned, and the same percentage intended to increase grant-making in the final quarter of the year.

Despite such evidence of a fulsome voluntary increase in grant-making by private foundations, there are continued calls to force such foundations to do more. The Patriotic Millionaires, for example, are pushing Congress to enact the Emergency Charity Stimulus bill, which would mandate that private foundations double the current required payout of 5% and distribute at least 10% for three years. The Initiative to Accelerate Charitable Giving uses a carrot rather than a stick, suggesting a zero excise tax for any year in which a private foundation’s payout is 7% or more.

Many foundation leaders in favor of increased payout are opting for persuasion over legislation, as demonstrated in a fascinating set of 11 opinion pieces in Stanford Social Innovation Review: “Up for Debate: Should Foundations Increase Their Payouts During Big Crises?” Hewlett Foundation CEO Larry Kramer kicked off and closed the series, noting in his final piece that the spending decision is always “a tradeoff between resources to help people in the present and resources to help people in the future.” Kramer was the only author to cite the most recent report on the impact of long-term endowment returns on foundation payout—a report that noted that “historical and projected investment returns struggle to consistently deliver more than 5 percent annual real returns” and that “a mandated payout rate above 5 percent would be difficult to sustain on an inflation adjusted (that is, real) basis.”

The report in question—An Evaluation of Private Foundation Model Portfolios, Investment Returns, & Payout Rates—was commissioned from the Dorothy A. Johnson Center for Philanthropy and Plante Moran Financial Advisors by the Council of Michigan Foundations (CMF). It is an update of prior reports commissioned by CMF from Cambridge Associates in 2000, 2004, 2013, and 2016. While the older reports were based on data from a sample of 48 Michigan foundations, the 2020 report uses a database of private foundations that file electronic returns that represent 84% of the 80,322 private foundations in the United States.

The 2020 report also utilizes an investment strategy model that included global equity in order to project investment returns. Finally, the report accounts for both the historical returns documented by the three Cambridge studies and the returns from 1989-2019—what the report calls the “internet era.” As Kramer noted in his payout opinion piece cited above, the report concludes that “if the public policy goal is to set a payout threshold at the point where there is a 50/50 chance of investments maintaining an inflation-adjusted grant payout in perpetuity, then the existing payout rate of 5 percent is in line with projected investment returns based on assumptions using internet-era returns from the last 31 years.”

Private foundations are, of course, free to spend more than the mandated minimum and may certainly choose to do so in response to a sudden disaster or a long-term crisis. In fact, the CMF report notes, “Nearly a quarter of foundations across the nation paid out 15% or more of their corpus in each of the study years 2013-2018.” It is reasonable to anticipate that 2020 data will also include many payout rates higher than 5%. The report confirms that such decisions are indeed tradeoffs. Using a model in which a foundation with assets of $1,000,000 chooses (or is mandated) to pay out 7% for three years, the analysis shows that it will take a decade before that foundation returns to its starting asset base on an inflation-adjusted basis. At a 10% payout rate over three years, it will take two decades. 

As the report concludes, “Increasing payout rates in the short term can be the equivalent of choosing to decrease grants for 17 years (years 4-20) for the opportunity to increase grants in the first 3 years.” How might such a decision affect grantees and the community a foundation serves? How might it weaken a foundation’s effectiveness in pursuit of its mission? And how might it threaten a foundation’s ability to respond to another crisis? These are difficult questions and ones best left to a foundation’s own leaders.

  • Both historical and projected investment returns struggle to deliver more than 5%

    annual real returns on a regular basis.

  • If mandatory payout rates were increased, it may take private foundations up to 20 years for assets to return to their current inflation-adjusted balance.

  • Private foundations are free to choose payout levels above 5% and—despite the long-term tradeoffs involved—a sizable number choose to do so.

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