This line from schweser in page 20 of book2 under “Managing Institutional portfolio” is confusing - " Most endowments (and foundations) have spending rules. In the United States, foundations have a minimum required spending rule but endowments can decide their spending rate, change it, or just fail to meet it"
My understanding is that foundations MUST meet spending rules to retain tax exempt status. Why does endowment need spending rule?
Please someone explain. I’m not able to grasp this.
There’s no “minimum” requirement which makes it a quasi endowment however it has its own liquidity and spending needs…
Wait which is a quasi-endowment?
Can you spell out the diff in spending requirements for Endowments and Foudnations separatenyl?
Foundations have a minimum spending requirement (5%) then you have to add up the expenses + inflation to get the final required rate of return.
Endowments have no minimum spending requirement (which is meant by quasi endowment) but it doesn’t mean that they have no spending rates. They can set it can 4, 5 or even 6 …
the spending requirements of an endowment are not in place for tax purposes, they are in place as the purpose of the endowment. As an example, the endowment may be expected to provide a certain % of the operating budget of the university, or a dollar amount for an expansion or something…this essentially feeds into what the spending rate.
Endowment - University needs money to make a business school. They dip into the endowment which has built up over time from small donations by alumni. (and probably also get funded by some fat cat with lots of money that gets to be on the name of the business school …)
BUT…the endowment CAN’T lose principal, so whatever you have to fund from the endowment for the B-school, you can’t errode your principal and you need to have a return to exceed your spending rate. Because the endowment funds activities and projects over time, it’s best to get a stable estimation of how much it can spend out each year rather than have a high variance and have a shortfall of some expected project, or worse, can’t pay staff or something.
They are not explicitly required to spend anything, but endowments fund stuff, so they have to have a return and it’s best if they smooth that spending rate/return target over time.
Foundation - Required spending of 5% for Independent and Corporate foundations. Rich guys have 'em so come from one source of funds (Bill and Melinda Gates) and they HAVE to spend since it’s private so they issue grants however they want. Being tax-free, they shouldn’t be allowed to just accumulate returns without being required to fund something, so that’s why they require a spending rate.
COMMUNITY FOUNDATION DO NOT HAVE A SPENDING REQUIREMENT
OPERATING FOUNDATION - 85% of interest/dividends + sometimes 3.33% of assets