Investment Returns and Distribution Policies of Non-Profit Endowment Funds

Investment Returns and Distribution Policies of Non-Profit Endowment Funds

Sandeep Dahiya, David Yermack

January 03 2019

Endowment funds are repositories for gifts and operating surpluses generated by non-profit organizations.  Often described by their parent organizations as “nest eggs” or “rainy day funds,” endowments invest in stocks, bonds, and alternative asset classes, and they pay income to their parents to subsidize operating costs and capital expenditures.  In recent decades, many endowments have grown rapidly.  Probably the best-known example is Yale University, which in 2018 reported having grown to $29.4 billion with an annualized return of 11.8% per year over the prior 20 years.  There is an old joke that describes Harvard as a “$37 billion hedge fund with a university attached.”  

This fixation on university endowments has meant that up to now, nearly all research on endowments has focused on a small, self-selected sample of major research universities, using self-reported survey data from these organizations.  Our paper, in contrast, focuses on the entire non-profit sector rather than a small number of university endowments and we present a comprehensive survey of endowment returns and distribution policies for the period 2009-2016 in all U.S. non-profit sectors.  We use data provided by non-profit organizations in annual Form 990 filings with the Internal Revenue Service (IRS), and our download of these filings yields a sample of 167,675 annual endowment observations reported by 28,696 organizations in all non-profit sectors.  Within the universe of non-profits, we find that the subclass of higher education institutions significantly under-performs the community of other non-profit endowments that support organizations in diverse areas such as the arts, human services, health care, and religion. The disappointing returns reported by educational institutions to the IRS appear to belie those touted in commercial surveys that have made their way into the press and academic papers.

Overall the funds in our study earn negative abnormal investment returns.  The median annual investment return for endowments is 3.75% between 2009 and 2016.  Weighting our observations by the time periods in which they occur, the benchmark returns on ten-year Treasury bonds are 4.89% per year and the equity market index returns 12.21% per year over the same measurement periods.  In other words, the typical endowment fund under-performs a 60-40 combination of the equity and Treasury bond market indexes by about 5.53 percentage points annually.  When we employ a more sophisticated model that adjusts for risk (the standard Fama-French-Carhart four factor model) we estimate that the non-profit endowments on average have an alpha of -1.01%.

We also study the distribution policies of non-profit endowments to their parent organizations.  We find that most endowments have conservative distribution policies that imply payouts below their long-run expected returns, and well below the actual returns realized during the sample period for our study. For example, while the median endowment return is 3.75%, the median distribution is only 2.37%.  For the very largest endowments, those with asset values above $100 million, distributions occur almost every year, with mean and median distribution rates near 4.5%, which appears to have become a heuristic that enjoys wide acceptance in the non-profit sector without theoretical justification.

Finally, we examine if (and how big) a role the endowment performance plays in future donations to the parent organization. In other words, do donors respond to successful years in which funds earn strong investment returns? Our results indicate a modest but significant positive relationship between investment performance and the willingness of donors to contribute in future periods.  If a fund out-performs the equity market benchmark by 10%, for instance, donations would grow by about 1.3% in the following year, all else equal. 


Real name:
Sandeep Dahiya