Endowments provide an ongoing source of income to support the university's teaching and research mission. They are a collection of gift and reserve funds which are invested primarily in the university's Merged Pool (MP). With few exceptions, these funds are intended to be invested and drawn upon in perpetuity by preserving the principal and spending only the investment income authorized by the Board of Trustees.
An endowment has two components: the Principal Fund-EN set of books and the Income Fund-SU set of books. The principal fund cannot be spent. It generates payouts which are transferred to the income fund where it can be spent. Each set of books has its own balance.
Refer to Topic Overview: Fund Types for information about all types, including Endowments, which are a version of donor gift funds. For information on donor gifts, including how gifts should be received, when and how gifts should be used and who is responsible for them, see Topic Overview: Donor Gifts.
The Glossary of Endowment Related Terms contains definitions of the large number of endowment concepts. The following narrative uses the terms for a simple high-level description of how endowments work.
Endowment amounts are stored in two sets of books or journal ledger codes:
- SU for income value
- EN for book and market value
The book value is how much money was initially placed in the endowment and the market value is how much that investment is worth today. The book value is considered principal and cannot generally be spent.
However, as the market value increases, some of the increase (called appreciation) is moved from the EN set of books as payout to the SU set of books where it can be spent. Both the EN and SU sets of books have balances and they use the same award or fund number, so it is important to keep them straight.
The dollar amount credited to income funds (SU set of books) monthly, based on the number of shares held by each fund at the beginning of the month, is the payout. Payout not funded by actual earnings comes from appreciation. For funds created using gifts, payout must be spent in accordance with donor wishes (as opposed to other sources such as royalty income, patent income and budget surpluses).
If donor terms explicitly do not allow endowment payout when the market value falls below the book value, the endowment is invested in either Pool A or Pool B Limited. In those cases, payout may be limited during market downturns.
Budget planning requires that the spending rate for endowment funds be set prior to the start of the fiscal year. The proposed spending rate for the MP is derived from the application of the university's smoothing rule. Generally, the smoothing rule is used to dampen the impact on the budget of annual fluctuations in the market value of the endowment, thereby providing stability to budget planning.
Note: Most of the smoothing rule parameters were changed at the October 2021 Board of Trustees Committee on Finance. View a comparison table of the previous and newly approved methodologies.
Stanford's smoothing rule generally uses a weighted average of the current payout per share and the target payout per share - increased by a long-term growth factor to account for expense cost rise - to determine the proposed payout per share for the upcoming fiscal year. The specific calculations for the proposed payout per share are detailed below.
Calculate the current year payout rate: Current Fiscal Year (CFY) payout per share divided by the December 31 share price.
If the payout rate is below the lower boundary of 4.25%:Multiply the December 31 share price by 4.75%, then add the long term growth factor of 4%.
If the payout rate is between the boundaries of 4.25% and 6.25%:
If the payout rate is above the upper boundary of 6.25%:
Multiply the December 31 share price by 5.75%.
Endowment funds are a type of donor gifts that are recognized as having an Award Type that starts with “END.” Endowments are gifts where the donor has required the perpetual investment of the principal. Only the income and appreciation from the endowment gift may be spent. The income and appreciation are maintained in an Endowment Income Fund, which is maintained separately from the endowment principal.
Endowments are either true endowments (including term endowments) or funds functioning as endowment (FFE).
- True endowment, the most common, is created by a donor gift to be used in perpetuity by preserving the principal and spending the earnings or appreciation.
- Term endowment is very similar, but is intended to be spent down to zero over a specified term of years by spending its principal along with its earnings.
- Funds functioning as endowment (FFE) can be created by a donor request, or use gift funds as well as other university money to act like an endowment to produce earnings over time that can be spent.
More information is available in Administrative Guide Policy 3.1.2: University Funds and on the Stanford Management Company website.
There are two types of shares, called pure and quasi:
- Pure shares are created by original donor gifts and normally are not sold.
- Quasi shares are created either by an original donor gift or by a department reinvesting unspent payout, and can be sold.
An endowment can have both pure and quasi shares.
An additional distinction for pure shares is whether they are limited or unlimited. While principal is not normally intended to be spent, it is possible for an endowment to be underwater, which means the market value is less than the book value. In that situation, for an endowment to produce payout it would have to use principal. If the donor allows borrowing against future market value to produce payout when the endowment is underwater, then the shares are considered unlimited. If payout is not allowed when a fund is underwater then the shares are considered limited.
Use these links to additional resources to learn about share value, including the definition of interim versus ending-share value, and the effects of new gifts and withdrawn shares on share value and payout.
- Share Value Calculations
- Understanding Share Value Video (6 min)
- Understanding Share Value PPT
Presentations include animation that must be viewed in Slide Show or Play mode.
To learn the details of the monthly payout process, click on the resource links below and/or read the four-step summary further below.
Tutorial: Basic Mechanics of Endowment Payout Process(15 min)
- Basic Mechanics of Endowment Payout Process and Commonly Used Reports PPT
Presentation includes animation that must be viewed in Slide Show or Play mode.
- EXAMPLE: Endowment Payout Process Steps 1 - 4 by Share Type
An automated process evaluates each fund that is invested in the MP, and calculates the maximum monthly payout amount using the BoT approved annual payout per share, divided by 12, and multiplied by the number of shares held at the beginning of that given month.
An automated process evaluates each fund that holds MP shares, by share type, to determine how much the fund has in available earnings and appreciation, referred to as payout resources. Note that some funds are only eligible for the earnings portion of payout (e.g., Pool A funds and non-endowment funds invested in the MP). The amount of payout not covered by earnings is taken from available appreciation, quasi shares and/or, when allowed by the donor, from the fund's corpus (in effect, borrowing against future market appreciation).
Once the maximum payout and available payout resources are calculated for a fund, payout is allocated and posted mid month as follows:
- If payout resources are greater than or equal to (≥) the maximum payout amount, the fund receives full payout (earnings and appreciation components, as eligible by fund type). The vast majority of endowment funds have sufficient resources to cover full payout.
- If payout resources are less than (<) maximum payout amount, the fund receives earnings and any available appreciation. Undistributed payout is reinvested into the fund.
The MP share value declines as payout is distributed. The monthly calculation to determine fund/share value also incorporates market fluctuations (appreciation/depreciation) and earnings, thus share value also increases or decreases with market performance. Learn more about Share Value Calculations.
The only funds at risk of receiving less than the maximum allowable payout are Pure B Limited funds that do not have enough appreciation to cover full payout. As of July, 2013, this is a very small number of funds (~1% to 2% across the university). These underwater or partially underwater Pure B Limited funds will receive payout of earnings and any available appreciation. Note that Pool A funds are eligible for earnings only.
Any missed payout cannot be made up later, as the monthly amount distributed to the income fund represents actual payout based upon the fund's available resources that month. However, university policy gives fund holders the option in July of each year to liquidate any available quasi shares to fund any payout that was not received during the year because of underwater Pure B Limited shares.
Payout Resources, the amount of earnings and available appreciation to cover payout, are evaluated and distributed at the share type level, including if a fund consists of both pure and quasi shares. This means that payout for Pure B shares must come from the available resources from those shares. Likewise, payout for Quasi shares is made from the resources available from the quasi shares in the fund. Total payout for the fund is made proportionally to the share types held.
Refer to Oracle Business Intelligence (OBI) Revenue and Fund Management Dashboard: Endowment Investment Summary by Pool Tab to see a breakdown of fund value by share types to assess the health of any Pure B Limited shares.
Fund holders may spend the full anticipated annual payout amount at any time during the fiscal year, although they must cover any deficit at year-end if the actual payout is less than anticipated.
Funds that do not receive full payout for the month have the undistributed payout portion automatically reinvested in the fund to purchase new shares. The purchase of new shares offsets the decrease in share value that results from the distribution of payout.
Payout that is distributed but remains unspent may be reinvested. Contact your fund accountant to learn about policy and process. Refer to Contacts for Non-Sponsored Funding by School/Department for more information.
Conditions of investment and withdrawal vary by fund type as described below.
Quasi shares can be decapitalized (sold) to make up for missed payout when Pure B Limited shares in a fund do not have adequate payout resources. Refer to Policy: Withdrawal Guidelines for True Endowments, which has a link to the withdrawal form.
Schools and departments may have restricted or unrestricted funds for which a near-term use has not been identified. In order to earn a return and preserve the value of the funds, these funds may be invested as FFE in the university's MP. However, any unit considering this option should acknowledge the incremental risk associated with the commensurate return. Unlike funds within the Expendable Funds Pool (EFP), no guarantee of principal exists for the FFE. To optimize investment returns, the university takes a long term perspective of its investments in the MP, which requires minimal unplanned cash flow volatility in the portfolio. Thus, the MP should not be used by individual fund holders to support short-term needs. Under circumstances where these funds have to be withdrawn, they are subject to the policy Investment and Withdrawal Guidelines for Funds Functioning as Endowment (FFE), which has a link to the investment and withdrawal form.
The IP is an attractive investment alternative to the MP for university capital that requires liquidity. The IP is designed for investors to take principal risk in pursuit of higher returns, but may also require liquidity from time to time. Investors with an intermediate term investment horizon should consider this investment pool.
Investors with time horizons more than 7 years that are able to accept illiquidity should consider investing in the MP, which has a somewhat higher expected rate of return. Investors with a very short-term time horizon should be cautious of taking principal risk associated with either the IP or MP. Unlike funds within the EFP, no guarantee of principal exists for the IP or MP. Refer to Policy: Investment and Withdrawal Guidelines for the Intermediate Pool, which has a link to the investment and withdrawal form.
Donors may have expectations that expendable gifts will be used within a certain period of time and that payout from endowed funds will generally be used on an annual basis. Units may access the OBI Revenue and Fund Management Dashboard: Endowment Financial Dashboard Tab to identify funds that are accumulating income, perhaps because of restrictions that make it difficult to spend, or endowments that are underwater because of market fluctuations. Schools and units can work with the Restricted Funds group in the Office of Development to determine the appropriate steps. See Topic Overview: Donor Gifts for information on how to distinguish different types of donor gifts, how gifts should be received, when and how gifts should be used and who is responsible for them.
For information about revenue and fund management reporting for endowments, type and number of shares held, amount and dates of payout, anticipated remaining payout and anticipated remaining balance, as well as detail on fund statement, journals, transfers, fund trend and pledge, refer to:
- OBI Dashboard: Revenue and Fund Management (RFM)
- Oracle Funds Functioning as Endowment – Merged Pool Tracking Tool
For information about OBI, refer to OBI Financial Reporting.