Similar Yet Distinct
Many people think of foundations and endowments as interchangeable entities, and for good reason, as they have a fair amount in common. But if you peel back even the first layer of the onion, you will see structural differences between the two that can have important implications on their investment strategies.
To be clear, we are discussing specifically the distinctions between private foundations and college endowments.
|They are the Same||They are Different|
From an investment perspective, there is a lot be said for the first two similarities listed in the table, tax exemption and 5% payout. Most investment strategies for individuals need to consider the impact of taxes, hence the lower yields of municipal bonds or the preference of long term capital gains versus short term gains. Both foundations and endowments can largely ignore taxes in considering investment opportunities, unlike the common 5% payout requirement restraint that can’t be ignored. Both foundations and endowments need to provide for the cash outflow every year or suffer tax consequences or worse.
A major distinction between foundations and endowments is the simple fact that endowments are attached to large operating organizations. Colleges have students paying tuition, development officers hitting up alumni for gifts, and may get public assistance from government sources. Offsetting these revenue sources are the operating costs of the college, employee salaries, facility maintenance, and scholarship support to name a few.
Most foundations, on the other hand have no source of income other than investment returns and no fixed expenses, just the mandate to provide 5% of assets to charity.
Why this Difference Matters
The knee jerk reaction is that foundations should invest more conservatively than endowments as there will be no new money coming in. However, the opposite argument can also be made – that foundations can invest more aggressively because they can accept higher volatility (while the 5% payout ratio is common to both, colleges typically rely on a set dollar amount each year – while foundations’ grants can ebb and flow with performance). In addition, foundations may have different investment time frames, the $50 billion Gates foundation wants to contribute all its money in the 10 years following Bill Gates’ death. Imagine Harvard saying they want to have everything wrapped up in 40-50 years. Foundations also have more latitude in choosing their investments – think of the $14 billion Eli Lily Foundation, which is all in shares of the company of the same same name (NYSE:LLY). Imagine Stanford’s endowment in a single company!
One of the similarities we put in the table is that both foundations and endowments are pursuing investment returns to fund their charitable missions. At the end of the day both endowments and foundations use their investment returns to fund their missions. For colleges, the endowment’s mission broadly stated is to provide financial aid to students, for foundations it is much the same except the financial aid that they provide might go to fighting poverty or eradicating disease. For both foundations and endowments, the better they do investing, the more money is available for important causes.
There are a lot More Foundations than Colleges
There are about 2,000 colleges in the US, compared to about 100,000 foundations. FoundationMark tracks all foundations over $1 million, close to 45,000. So there are over 20 foundations for each college. Imagine 180 colleges in the Ivy League!
Different Tax Forms
From Foundation Advocate’s point of view the most important distinction between endowments and foundations is that they file different tax forms. The tax form that colleges file is the same one that all operating charities file, like the United Way or your local library. Foundations are subject to far greater disclosure requirements. Foundations must report the fair market value of their holdings, report on capital gains and interest income and many other line items that endowments do not. The reason this matters is that it provides FoundationMark with the ability to estimate performance.
Sample Endowment Form
Sample Foundation Form