Endowments need to be more fee conscience
It’s been a hard year to fundraise. Traditional methods like galas or in-person donor appreciation events are limited. Virtual events aren’t the same. Yet, the mission of not-profits is more important now than ever. What can board members do about this? A simple solution is control what you can control, and that’s your endowment investment advisor fees.
When I review an endowment, I usually find the performance of the endowment looks good at first glance, but that is before fees. When fees are factored into the mix – fees from the advisor and fees for the underlying mutual fund – sadly the performance mirrors the index. If a $1MM endowment pays 1% or $10,000 annually to mirror the benchmark, what’s the point of paying the fee? Why not own the index and keep the $10,000 in the endowment? The figure below illustrates this point. Assume a $1MM endowment grows at 5% over 5 years. Also, assume three fee schedules: 1%, .5%, and .3%. The difference over 5 years is a savings of $41,499 in the lower Fee 3 proposal. That is a substantial savings. The $41k in savings can translate into additional donations, additional services for those you serve, or additional money for a special project, all of which are better uses of endowment money.
Lower fees also translate into less risk to get the same result. This is important. For example, the advisor using the Fee 1 portfolio must earn 5.7% versus the advisor who using the Fee 3 portfolio only needs to earn 5%. A lower fee puts less pressure on the endowment to earn a target rate of return.
Some may say a higher advisor fee is justified because active management can be tactical and lose less in a bad market. Evidence of that claim is usually mixed. Some years the endowment may lose less, other years more. On average over time I’d say an active manager usually performs about the same or worse as a buy and hold strategy. And that makes me wonder, if the research shows market timing doesn’t work for individual investors why should it work for endowments? And why should endowments be market timing? If the time horizon of the endowment is long like the mission of the organization, there is greater risk that trying to time the market will keep the endowment on the sidelines, in low-yielding cash as the stock market recovers, hurting future growth.
Some board members may point to the years the active manager produced outsized performance as justification for the fee. In other words, they’ll say the performance has been very good, or we are really happy with the growth. To which I respond, “How are you measuring that? Are you comparing the returns to the right benchmark? Are you measuring the returns on risk-adjusted basis?” It’s important to ensure the manager’s performance is compared to the appropriate benchmark so you are comparing apples to apples.
It’s also important to understand whether or not you are being rewarded for the risk you take. If Manager A grows the endowment by 100% compared to Manager B who only grows it by 20%, Manager A looks great! Until you find out later Manager A took 20x the amount of risk to get that return. Analyze the returns on the risk-adjusted basis, your manager should provide you this information. You may be surprised to find you are not being rewarded for the risk you take.
Board members should have a process to review fees and performance. Having a review process and using an experienced professional can help fulfill your fiduciary duty. Board members should not manage the endowment themselves, that is a conflict of interest. But they should not overpay either. For this reason, board members need to be proactive in managing endowment costs. A good first step is by putting out a “Request for Information” to other endowment managers and asking what their fee would be for a xyz size endowment. That information will help you determine whether your current fee is in the ballpark or if there is room for renegotiation. In these difficult times, every little bit helps.
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