Revisions to University Board of Governors Common Trust Fund statute section University Endowment Fund Policy

Transcription

1 Submitted by: John L. Davis, Vice President for Finance and Facilities Management Revisions to University Board of Governors Common Trust Fund statute section University Endowment Fund Policy Recommendation The Administration recommends the approval of the attached revised Code Annotated statute , the Common Trust Fund, as presented in the attached document Exhibit I with changes becoming effective October 1, Background The Common Trust Fund (CTF) statute established the University policy for the distribution of endowment fund earnings. A critical object ive of this policy is to balance support for the spending needs of current endowment fund beneficiaries, and the need to maintain the purchasing power of the endowment fund in order to be able to support the spending needs of the endowment fund beneficiaries in the future. At the January 30, 2008 Budget and Finance Committee meeting, the Administration presented last year's Annual Report on the Long Term Investment Program. During the discussion regarding this agenda item, the Administration indicated that it would be evaluating the University's current endowment distribution or spending policy and bring any recommendations for change to the July 2008 Board of Governors meeting. As a result of this review, it is proposing several changes to the related statute. These proposed changes are highlighted in the attached Exhibit II and the proposed revised statute is attached as Exhibit I. The revised statute would be effective for the quarter beginning October 1, The significant proposed changes to the statute are discussed below. Change in the amount of the endowment spending/distribution rate The statute's investment objective is to generate an annual total rate of return for the fund sufficient to produce the following results on average, over long periods of time: (1) Provide periodic distributions as determined by the Board of Governors; (2) Inclusive of (1), grow the value of the corpus of the Common Trust Fund over longer periods of time equal to the rate of inflation (Consumer Price Index); and (3) Inclusive of (1) and (2), preserve the corpus of the Common Trust Fund with the goal of growing the real value of the Common Trust Fund. Among the most critical factors in determining the total distribution rate are the expected long-term investment return for the endowment fund's investment program and long term inflation expectations. The present distribution policy as authorized in the current statute provides for an annual total distribution rate of 4.75%. This distribution rate has been in effect since April, Of the 4. 75% distribution rate, 4.25% is transferred to beneficiary or program accounts and.5% is used to fund the administrative fee assessment. Prior to the April 2005 distribution rate change, the total annual distribution rate had been 5% for many years. At that time in 2005, the previous University /Foundation investment advisor, EnnisKnupp, had projected long term annual endowment fund investment returns of 7.3% and long term annual inflation of 2.5% which would provide an estimated long term annual inflation adjusted return of 4.8% (please see attached Exhibit III). Based upon these projections, the Administration recommended and the Budget and Finance Committee Agenda July 30, 2008

2 Submitted by: John L. Davis, Vice President for Finance and Facilities Management 2 Board of Governors approved a change in the distribution rate from 5% to 4.75% to better position the endowment fund to achieve the statute's investment objective. Since that time, th e Foundation changed investment advisors. The present investment advisor is New England Pension Consultants (NEPC). Working with NEPC, the Foundation completely revised the endowment portfolio's asset allocation and hired a number of new investment managers. With these changes, and a few more changes that are coming, we asked NEPC to look at projected long term annual investment returns. The Administration reviewed NEPC's projected long term annual endowme nt fund investment returns and inflation with the Foundation Investment Committee. At this tim e, NEPC projects endowment fund long term (five to seven years) annual investment returns of 8.2% and long term annual inflation of 3%. This, if achieved, would result in an estimated long term annual inflation adjusted return of 5.2% (please see attached Exhibit IV). We expect that the changes that are being made to the investment portfolio will help further solidify NEPC's inveshnent performance expectations over the longer term. While future investment returns cannot be known with certainty, this NEPC information suggests that a small increas e in the distribution rate would be appro priate, in order to ensure that the present endowment fund beneficiaries receive a reasonable portion of the anticipated investment gains, while at the same time maintaining the real purchasing power value of the endowment fund for future ben eficiaries. Based upon the above information, there is support for the endowment fund mainta ining its real purchasing power if the total distribution rate is increased to 5.0%. These are NEPC's projected long term annual investment returns and inflation rates, even though investment market performance over the short term has been difficult. Therefore, the Administration recommends a one-quarter-point increase in the total distribution rate from 4.75% to 5.0%. It further recommends that this one-quart er-point increase be added to the existing 4.25% which is transferred to the beneficiary or program accounts. Implementation of this recommendation would require several changes to CTF statute sections and Of the 5.00% total distribution rate recommended, 4.50% would be transferred to the beneficiary or program accounts and.5% would continue to be used to fund the administrative fee assessment. An extension of the administrative fee was approved at the March 19, 2008 Board of Governors meeting with the stipulation that it would be used to support the fund raising activities of the Division of Development and Alumni Affairs. Given that financial markets change over time, we will periodically review the long term expected annual investment market returns and inflation expectations with the investment advisor in order to determine if any adjustments to the distribut ion policy are necessary. We will perform such a review no less frequently than every three years. Also attached are summaries of endowment fund distribution rates for the State of Michigan Public Univer sities (Exhibit V), "Big Ten" Public Universities and Selected Public Urban Universities (Exhibit VI) and Average Annual Calculated Distribution Rates from the 2007 NACUBO Endowment Study (Exhibit VII). Budget and Finance Committee Agenda July 30, 2008

3 EXHIBIT I Proposed Common Trust Fund The University w ill maintain a pooled fund through its endowment fund held by the Foundation. This fund will be known as the Common Trust Fund, and it will be for the purpose of pooling all liquid assets of endowment funds (true endowments, funds functioning as endowments, term endowments, living trusts, and similar assets) for investment purpo ses, unless a donor of an endowment specifies that such assets be maintained and invested separately and the President or his/her designee agrees to such special arrangement The investment objective of is to generate an annual total rate of return for the fund sufficient to produce the following results on average, over long periods of tim e: (1) Provide periodic distributions as determined by the Wayne State University Board of Governors; (2) Inclu sive of the above, grow the value of the corpus of the Common Trust Fund over longer periods of tim e equal to the rate of inflation (Consumer Price Index, CPI) and (3) Inclu sive of (1) and (2), preserve the corpus of the Common 1

4 EXHIBIT I Proposed Trust Fund with the goal of growing the real value of the Common Trust Fund The above financial results should be sought without incurring a level of rate-of-return vo latilit y materially greater than that generally associated with peer institution assets. Since the University has transferred its endowment funds to the Foundation, the University expects that the Foundation wi 11 adopt an investment policy that incorporates these objectives Generally, new endowment fund cash and/or securities will be placed in the Common Trust Fund as of the first day of the next quarter unless a significant ly large endowment is received. Then the assets wil l be placed in the Common Trust Fund at the earliest possible date. The value of the Common Trust Fund wil l be appraised as of the first day of the quarter, or an earlier date in the case of significant ly large endowments, and units of participation will be assigned to the new endowment fund(s) on the basis of the total market value of the Common Trust Fund and the total outstanding units of participation before the inclusion of the new fund Subtractions from the principal, when necessary and allowable, will 2

5 EXHIBIT I Proposed be made on the first day of the calendar quarter, at which time a reappraisal is to be made as described above Income and capital gains from the Common Trust Fund will be distributed quarterly to each participating endowment fund on the basis of the number of units of participation The annual amount of the distribution will be 5.0% of a moving average of the market value of the endowment fund. Of this annual distribution, 4.5% will be transferred to the beneficiary or program account and.5% will be transferred to an administrative account as a fee to support the Divi sion of Development and Alumni Affairs fund raising activities Unless there are different requirements based upon exceptions in existing memorandums of agreement, there will be a quarterly distribution from each endowment fund to: (1) Its beneficiary or program account of a sum equal to % of a moving average of the market value of the endowment fund. (2) An administrative account for the support of the Division of Development and Alumni Affairs fund raising activities of a sum equal to.125% of a moving average of the market value 3

6 EXHIBIT I Proposed of the endowment fund The moving average is to be determined by dividing the twelve most recent quarterly market valuations by twelve. If there is no beneficiary or program account, the distribution will be added to the principal. Additionally, if the funds are not needed in the beneficiary or program account, then, upon the request of the University official who has signature authority on the beneficiary or program account, they will be added back to the principal, unless the donor specifies otherwise. 4

7 EXHIBIT II Proposed - With Changes Common Trust Fund The University w ill maintain a pooled fund through its endowment fund held by the Foundation. This fund will be known as the Common Trust Fund, and it wil l be for the purpose of pooling all liquid assets of endowment funds (true endowments, funds functioning as endowments, term endowments, liv ing trusts, and similar assets) for investment purposes, unless a donor of an endowment specifi es that such assets be maintained and invested separately and the President or his/her designee agrees to such special arrangement The investment objective of Wayne State Univers ity is to generate an annua l total rate of return for the fund sufficient to produce the following results on average, over long periods of time, to the extent allowed by returns in the broad markets: (1) Provide periodic distributions as determined by the Wayne State University Board of Governors; (2) Inclu sive of the above, grow the value of the corpus of the Common Trust Fund over longer periods annually by at least the annual rate of tim e equal to the rate of inflation (Consumer Price Index, CPI) for that year; and

8 EXHIBIT II Proposed - With Changes (3) Inclusive of (1) and (2), preserve the corpus of the Common Trust Fund with the goal of growing the real value of the Common Trust Fund The above financial results should be sought without incurring a level of rate-of-return vo lati I ity materially greater than that generally associated with peer instituti on assets. Since the University has transferred its endowment funds to the Foundation, the University expects that the Foundation will adopt an investment policy that incorporates these objectives Generally, new endowment fund cash and/or securities will be placed in the Common Trust Fund as of the first day of the next quarter unless a significantly large endowment is received. Then the assets will be placed in the Common Trust Fund at the earli est possible date. The value of the Common Trust Fund will be appraised as of the first day of the quarter, or an earlier date in the case of significantly large endowments, and units of participation wi II be assigned to the new endowment fund (s) on the basis of the total market value of the Common Trust Fund and the total outstanding unit s of participation before the inclusion of the new fund Subtractions from the principal, when necessary and allowable, will 2

9 EXHIBIT II Proposed - With Changes be made on the first day of the calendar quarter, at which tim e a reapp raisal is to be made as described above Income and capital gains from the Common Trust Fund will be distributed quarterly to each participating endowment fund on the basis of the number of units of participation The annual amount of the distribution will be 4.75% 5.0% of a moving average of the market value of the endowment fund. Of this annual distribution, 4.25% 4.5 % will be transferred to the beneficiary or program account and.5% will be transferred to an administrative account as a fee to support the Foundation/University Capital Campaigns Division of Development and Alumni Affairs fund raising activities Unless there are different requirements based upon exceptions in existing memorandums of agreement, there will be a quarterly distribution from each endowment fund to: (1) Its beneficiary or program account of a sum equal to % 1.125% of a moving average of the market value of the endowment fund. (2) An adm ini strative account for the support of th e Foundation/University Capital Campaigns Division of Development and Alumni Affairs fund raising activities of a 3

10 EXHIBIT II Proposed - With Changes sum equal to.125% of a moving average of the market value of the endowment fund. The moving average is to be determined by dividing the twelve most recent quarterly market valuations by twelve. If there is no beneficiary or program account, the distribution will be added to the principal. Additionally, if the funds are not needed in the beneficiary or program account, then, upon the request of the University official who has signature authority on the beneficiary or program account, they will be added back to the principal, unless the donor specifies otherwise. 4

11 EXHIBIT IJI EnnisKnupp Wayne State_ University Fou ndation Endowment Fund Asset Allocation and _Expected Returns.~'i!):,G:/.-...,,,~ '~.k.j!'""~~~~~.l~~?: ': ~!. ~~...!.'\ ~f~~... r..,...,.,~.,,-r r ~ Asset Class U.S. Equity Non-U.S. Equity Fixed Income Real Estate Hedge Funds ertv. Eqty I Venture Cap. Expected Return (a).actual 55.0% o.o % NACUBO Peers Adopted 48.8% 55.0% , o:o 42 o:o. 72% 7.3% * Note: Average Annual Speocf ingll)is1rl>ulion Ra1es in Higher Education The_ FY 2004 average speflooyil rate for all putb:: institutions was 4.3% aoo for all private institutions was 5.3%. This Information Study, not EnnisKnupp. was from the 2004 NACUBO Endowment ',J (a) Expected total investment return Is based on the prqected investment re1ums of the As.set aasses held in the proportions noted. Provided by 1he University Foundation Endowment Investment Advisor, EnnisKnupp. *Assumes 2.5% expected l ong tetid. inflation rate. ENNISKNUPP Foundation

12 EXHIB IT IV NEPC - Expected Return s Asset Allocation - 5 to 7 Year Risk and Return Assumptions WAYNE STATE UNIVERSITY Foundation Portfolio 5-7 Year Forecast Expe~d.Expected {Basoo on NB"C 2008 Capitli Mai<a s Assurptlons) Return Risk. ;. (Median Expected Return) 8.2 % 10.0 % Expected Inflation,, % 1.5 % - Asset Class Assurq>tions 5-7 Year Forecast.Expected.:.~~cted Target {NEPC2008 assurptl ors) ~tum _'. -.)' Ri'sk Allocation,,, Large c.ap Ecµties 8.50 % % 10.0 %., L..a-ge c.ap(patable Alpha) Small/Md 03p,Eqlitres International Equities~, Total Equities,' 45.0 % Core Bonds 5.00 % 6.75 % 18.0 % Opportunistic Rxed Income** Total Fixed Income,. 25.0% Hedge Ft.nd of FLJ"lds 6.50 % 7.00 % 10.0 % Real Estate Global Asset Allocation "'** % * Internatio nal equities includes develope d (65%) and emerging (35%) countries ** Opportunistic Fixed Income return is targeted at its benchmark weights (1/3 emerging market debt, 1/3 global bonds, 1 /3 high yield) *** NEPC uses an 8% return assumption and 12% risk estimate for global asset allocation products 2

13 Exhibit V Summary of Endowment Fund Distribution Rates and Assets State of Michigan Public Unive rsities June 2008 ENDOWMENT STATED DISTRIBUTION RATE FUND ASSETS BENEFICIARY ADMINISTRATIVE AS OF JUNE 2007 (bl NAME OF INSTITUTION ACCOUNTS PURPOSES TOTAL ($ - IN MILLIONS) Eastern Michigan University Ferris State University Michigan Techno logical University 4.00% 4.00% 4.00% 2.00% 1.00% 2.00% 6.00% 5.00% 6.00% Western Michigan University 4.50% Range of 1.0% to 1.5% Range of 5.5% to 6.0% - Current 4.25% 0.50% 4.75% - Proposed 4.50% 0.50% 5.00% $ 49 $ 36 $ 79 $ 198 $ 237 $ 237 (d) (di (d) Central Michigan University 4.50% 0.00% 4.50% Grand Valley State University 5.00% 0.00% 5.00% Lake Superior State University 4.50% 0.00% 4.50% Mi chigan State University 5.75% 0.00% 5.75% Northern Michigan University 5.00% 0.00% 5.00% Oakland University 4.50% 0.00% 4.50% Saginaw Valley State Univ ersity 4.00% 0.00% 4.00% Univer sity of Mic higan 5.00% ( ) $ 82 $ 62 $ 8 $ 1,248 $ 36 $ 42 $ 40 $ 7,090 (c) (d) (di 1 ' 1 U-M's distribution rate was obtained from the university's finan cial statements and confirmed fr om other university documents. From these documents, it was not possible to determine conclusively if the University used endowment earnings to fund any of their administrat ive costs. lbl Endowment fund assets were obtained from the most recent NACUBO Endowment Study, which reported information as of June 30, ' 1 Lake Superior State University did not participate in the 2007 NACUBO Endowmen t Study. This university's endowment fund asset amount was obtained fro m the university 's financial statements for the fiscal year ending June 30, Id) Endowment fund assets reported in the 2007 NACUBO Endowment Study for these inst it utions include both the university and Its related foundation. N/ A - Not available V:\Vice President Office\JLD\Board or Governors Documents\2008 Board Documents\July 08 - Revisions Exhibit S - Summary of Endowment Fund Page 1 of 1

14 Exhibit VI Endowment Fund Distribution Rates and Assets 'Big Ten' Public Universities and Selected Public Urban Universities June 2008 ENDOWMENT STATED DISTRIBUTION RATE FUND ASSETS BENEFICIARY ADMINISTRATIVE AS OF JUNE 2007 NAME OF INSTITUTION ACCOUNTS PURPOSES TOTAL ($ - IN MILLIONS) (b) University of Illinois University of Minnesota 'BIG TEN' PUBLIC UNIVERSITIES 4.75% 1.20% 4.60% 0.75% 5.95% s 5.35% s 1,515 2,804 Indiana University Michigan State University Ohio State University Pennsylvania State University Purdue University University of Iowa University of Michigan University of Wisconsin University of Wisconsin Foundation 5.75% 0.00% 5.00% (a) s 5.75% s 4.00% (a) $ 5.00% (a) $ 4.00% (a) $ 5.00% (a) $ 5.00% (a) $ 4.00% (a) $ 4.75% (a) s 1,557 1,248 2,338 1,590 1, , ,645 (c) (c) (c) SELECTED PUBLIC URBAN UNIVERSITIES University of Houston System 5.00% 2.00% 7.00% (d) $ 522 Temple University University of Alabama - Birmingham University of Pittsburgh 4.50% (a) $ 5.00% (a) $ 4.25% (a) $ ,254 - Current - Proposed 4.25% 4.50% 0.50% 0.50% 4.75% 5.00%! I These distribution rates were obtained from university financial statements or other university documents. From these documents, it was not possible to determine conclusively if these universities used endowment earnings to fund any of their administrative costs. $ $ !bl For all universities except for the University of Alabama - Birmingham, the endowment fund assets were obtained from the most recent NACUBO Endowment Study, which reported information as of June 30, The University of Alabama - Birmingham's total endowment fund assets were obtained from the university 's financial statements for the fiscal year ended September 30, ' 1 Endowment fund assets reported in the 2007 NACUBO Endowment Study for these institutions include both the university and its related foundation. (di The University of Houston System's distribution rates were obtained from university policy documents, which indicate that the rates are review ed annually. N/ A - Not available V:\Vice President Office\JLD\Board of Governors Documents\2008 Board Documents\July 08 Revisions Exhibit 6 Endowment Fund Distribution Rates - Big 10 Page 1 of 1

15 Exhibit VII Endowment Distribution Rates from the FY 2007 NACUBO Endowment Study Average Annual Calculated Distribution Rate, Endowment Assets % % % % % % N=770 N=766 N=756 N=738 N=720 N=702 Greater Than $1 Billion >$500 Million to ~$1 Billion >$100 Million ~$500 Million >$50 Million to ~$100 Million >$25 Million ~$50 Million Less Than or Equal to $25 Million Public Independent Full Sample % N= (1.) The Average Annual Calculated Distribution Rate is computed by dividing the actual amount of dollars distributed for spending to the beneficiary accounts for a given fiscal year by the market value of the endowment fund at the beginning of that fi scal year. This Average Annual Calculate d Distribution Rate is differen t than the stated distri bution rate. The latter is the rate which is applied to the calculated endowment fund market value in order to derive the amount of dollars to be distributed for spending. The calculated endowment fund market value used can be either a point in time or the average value of selected point s in time. Usually, the distributions are done on a quarterly basis using the average quarterly market values for a twenty four to a thirty six month time period. uses the average quarterly market values for a thirty six month time period. Note: 770 institutions provided distribution rate information for the 2007 fiscal year. Table data are equal-weighted.