How Endowment Works at UCSD

1. How Endowment Works at UCSD March 14, 2008

2. 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 • Both The Regents of the University of California and the UCSD Foundation hold endowment • Endowment generates a permanent expendable income stream (by using a portion of the annual investment return on the gift) for the purpose the donor desires. This is called “endowment spending” and is discussed later. • Endowed gifts may be for restricted or unrestricted purposes and are particularly important due to their permanency. These gifts permit planning for programs into the far future.

3. How is an endowment invested? • The Regents and the Board of Trustees of the UCSD 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

4. “Total Return” and Long Term Philosophy • The Regents and the Foundation, like many large educational and non-profit organizations, invest their endowment for total return 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 = • cash earnings on investments (such as dividends and interest) + • realized or unrealized appreciation (or depreciation) in the market value of those investments

5. Endowment Buy-In Using Unitization • 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 the 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.

6. Unit Values Over the Last 20 Years

7. Example of a Buy-in Today Pool Market Value: $10,000,000 Units in Pool: 100,000 Mkt Value per Unit $100 Buy in of new $10,000 Smith endowment: $10,000 / $100 unit = $100

8. Buy-in and Unitization, cont • The Smith endowment received 100 units today for $10,000. • The Jones endowment was created five years ago at a beginning value of $10,000, when the market value of a unit was only $50. That endowment bought in at 200 units, and is worth $20,000 today due to the appreciation of the pool.

9. How does endowment “spending” work? • This is the amount made available to each endowment fund holder to “spend” from the annual endowment earnings • It is generally a computation, predetermined by the institution, taking into account the best practices of other institutions, the investment mix, the age of the endowment pool and the amount of appreciation in it, as well as the market return environment.

10. How does endowment “spending” work? cont • Most use an averaging of the unit value of the pool over say five years, to smooth out fluctuations in any one year • This smooths the spending and allows for a fairly steady, and growing rate of spending.

11. Spending Rates • 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. • Both entities spending policies include a fee of 0.25% that is recovered for annual endowment administration costs incurred internally.

12. Endowment Spending Calculation Example The actual spending for any individual endowment is computed annually using the following information: • the average value of a unit in the pool as computed over the averaging period; • the number of units EACH endowment owns in the pool; and • the spending policy rate as set by the institution

13. Spending Calc cont • Using the Jones and Smith Endowments above, let’s compute the spending that would be made available to each endowment for 2008. • 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 2008 would be as follows: Jones Endowment: • 200 units X $74.60 (5 yr. avg. unit value) X 4.75% = $708.70 of endowment spending, • less $37.30 (at .25% annually) of admin management fee • = net spending of $671.40

14. Spending Calc cont Smith Endowment: • 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 for a net of $335.73 • Note that the spending calculation is NOT a pure 4.75% of the ending market value of the fund.

15. Spending Calc cont • 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.

16. Growth of Market Value

17. Growth of Spending

18. Other information • Note that endowed gifts are assessed • 6% on the original gift as the UCSD gift fee • Investment management fees – which are netted from the market value and are about 10 to 50 basis points per annum (.10 to .50 %) • Administrative fees of 25 basis points per annum (.25%) taken from spending.

19. Endowment Stewardship Endowment must be monitored annually to ensure the funds make available for spending are spent UCOP Policy: • http://www.ucop.edu/ucophome/coordrev/policy/PP091106-Guidelines.pdf • http://www.ucop.edu/uer/instadv/fundraising/principles.pdf

20. Questions?