What is the Uniform Prudent Management of Institutional Funds Act?
Historically, nonprofits’ endowments were governed by the Uniform Management of Institutional Funds Act, a law enacted in 47 states in the 1970s. Under that law, endowments were subject to the historic value requirement, which mandated that an endowed fund always had to maintain its initial value, referred to as the historic dollar value. Organizations could only spend a fund’s dividends; but when the equity funds holding these endowments declined during the Great Recession, such that many endowments depreciated below the original gift amount, organizations couldn’t legally access the money despite its usefulness in balancing budgetary shortfalls.
To fix the problem, the law was tweaked to create the Uniform Prudent Management of Institutional Funds Act, which replaces the quantitative historical dollar value standard with a qualitative prudence standard that requires managers to preserve the purchasing power of a fund’s principal according to a set of investing guidelines, rather than the specific amount. UPMIFA allowed for context to factor into investment decisions, with the idea being that the law would inject flexibility into endowment spending such that a manager could withdraw as much as an “ordinarily prudent person.”
In 2009, Illinois adopted UPMIFA with no payout rate spending restriction, a seven percent caveat that some states implemented. Now, when setting a payout rate, endowment managers should weigh factors such as the purposes of the institution and its endowment fund, the general economic conditions and the expected total return from investments. Under the factors designated in the prudence standard, [graduate student Andrew] Hull believes it’s appropriate for the University to spend more of the endowment.
Most large endowments are mainly illiquid.
Another potential limit on increasing endowment spending is the way in which the funds are held. The University is not sitting on a pile of cash, but rather managing a range of investments in different asset classes subject to different redemption terms and market changes. The largest percentage of funds are held in private investments, absolute returns and real assets, which combine to constitute 60.4% of the endowment. Private investments and real asset holdings are relatively illiquid and ineligible for redemption, and absolute return investments range in liquidity.
Large universities typically hold endowments in long-term investments because they get a better rate of return, a sensible strategy considering they don’t need to spend them. Funds that are held in more liquid asset classes make up a smaller portion of the endowment — Northwestern’s holdings in US and international equity combine to constitute 28.9% of the endowment, and are redeemable daily to annually, depending on the equity, with notice periods ranging from one to 180 days.
If the Board wanted to liquidate more funds for spending, these are the asset classes they would likely draw from. Of course, those are the funds that have depreciated due to the stock market crash associated with the pandemic, although markets have more recently seen rapid improvement.
Post by Marcelino Pantoja