The value of university endowments

Rachel Tonkin, Senior Associate at VWV, explains how to adopt a total return approach to investment of university endowments

Faced with substantial funding cuts over the last few years, and with further threat of reductions in government support, it has perhaps never been more important for those universities which benefit from endowment funds to maximise their value.

New regulations (The Charities (Total Return) Regulations 2013 (the ‘Regulations’)), which came into force in January 2014, give universities more flexibility to invest their endowment by allowing their governing bodies to adopt a ‘total return’ approach to investment more easily. In this article, we look at some of the practicalities of operating a total return strategy and consider the central question that total return poses: how does one balance the needs of a university and its students now with preserving the value of the endowment for the benefit of future generations? 

Why total return?

Total return investment is a solution to a restriction many charities with permanent endowment (in other words, funds whose capital and capital gains cannot be spent) must engage with when it comes to taking investment decisions. Restrictions on the expenditure of capital can lead trustees, quite rightly, to invest in assets that produce the ‘right’ mix of income (for spending now) and capital growth (to invest for future beneficiaries). This may not always be in line with an investment approach which is more likely to produce the best overall investment return. 

A total return approach offers all charities the ability to invest permanent endowment in a way which is focused on the best overall financial return, regardless of how it is made up between income and capital gains. A charity’s trustees can then decide how much of the endowment’s overall investment return – including capital gains as well as income – should be spent on current operations. The balance remains in a fund that the Regulations call the ‘Unapplied Total Return’ (UTR), which must be treated as permanent endowment until the trustees decide to spend it as income. 

The Regulations allow charity trustees to adopt a total return approach to investment by passing a resolution. Previously, it was often necessary for universities to obtain Privy Council approval to include a specific authorisation in their statutes.

Striking the right balance

A total return approach therefore gives universities greater flexibility over both how funds are invested and how the investment returns can be applied. There is also a limited power to ‘borrow’ from the endowment, provided the funds are recouped over time.  

But inherent in this flexibility there is a tension – how to balance the competing objectives of providing a stable investment return to meet financial demands now while also protecting the real value of the endowment over time. As the Charity Commission says in its guidance on the Regulations: ‘The total return approach is not just about spending resources which under the standard rules would be capital gains. It can also be about retaining resources as unapplied total return for the protection of the interests of future beneficiaries.’

This tension is recognised in the Regulations, which impose a duty on trustees to make decisions in a way which does not adversely affect their charity’s ability to further its aims both now and in the future. The Regulations also go part of the way to providing a solution by giving trustees the power to allocate part of the UTR to capital (what the Regulations call the ‘trust for investment’) in line with inflation, in order to maintain the real value of the endowment over time.

But the key question for university governing bodies will be how to ensure that the rate at which they spend is sustainable and appropriate in the long term. And for that, it is likely that some sort of ‘spending rule’ is needed.

There are precedents for this in the US. Varying forms of well-developed spending policies are used by US universities, including those which employ a formula based on the average value of the endowment over past successive periods and inflation-based rules. Some of the larger endowed institutions, including Stanford, Yale and Harvard, use a policy which is a hybrid between these two methods and which combines a long-term spending rate target with a ‘smoothing’ rule. This approach reduces volatility in spending by adjusting the amount that can be spent in any given year gradually, in response to changes in the market value of the endowment.

A number of Oxbridge Colleges and other charities in the UK operate modified versions of this hybrid spending rule (see for example the Harpur Trust: Whether this or another approach is adopted, it is likely that any university adopting total return investment for the first time will need to review its spending and investment policies to ensure they provide for both short and long-term needs to be catered for.

Some practicalities

The Regulations are complex and the devil is in the detail when it comes to using the new power. The Charity Commission has published some helpful advice for trustees which sits alongside the Regulations:

There are a number of specific duties attached to total return investment, including a duty to take ‘proper advice’ about the way in which any of the new powers under the Regulations should be exercised (unless the conclusion is that advice is not necessary). In practice, the advice is likely to be similar to that which governing bodies are required to obtain on investment matters generally; is total return in the best interests of the university and the endowment in terms of the university’s particular investment objectives and spending requirements? What are the investment risks of adopting a total return approach?

There is also some potentially difficult work to do at the outset around establishing an initial value of the endowment in order to determine the initial value of the UTR. Helpfully, the Charity Commission takes a pragmatic approach here, confirming that trustees won’t be expected to carry out an elaborate tracing exercise, but should make a ‘reasonable estimate’ of which part of an endowment represents the UTR on the original endowment. 

The importance of the original valuation becomes clear if one looks at the UTR as an investment reserve to smooth out spending between good and bad years (ie in ‘good’ years, surplus investment returns grow the UTR, to be drawn on in years where returns are poor). On the one hand, too small an initial UTR may leave a university with an insufficient ‘cushion’ for bad years. On the other hand, the Commission’s guidance confirms that trustees must be able to justify the balance of funds remaining in the UTR, similar to their approach in relation to reserves. Too large a UTR becomes difficult to justify as an investment reserve and (in the absence of a prudent spending rule) potentially also risks over spending. 

The key point in relation to decisions about total return – as with all their decisions – is that a university’s governing body can demonstrate how they have reached their decision and that it is one which a reasonable body of trustees would make, having regard to the overriding duty we have mentioned above of balancing current and future interests.


Total return investment can free investment of university endowments from constitutional constraints which may cause investments to be skewed towards particular asset classes. Overall investment return may be maximised and capital gains can be utilised to meet immediate financial requirements. The key point is that the policies and mechanisms in place as part of a total return strategy allow the important balance between current and future beneficiaries to be managed properly.

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