The Power of Spend-Down Funds
Written By: John Walsh and Christian O’Dwyer, CFA
Endowment funds have long been a cornerstone of philanthropy as they provide sustained financial support for various causes across generations. While endowments traditionally focus on perpetuity, a growing number of donors are opting for time-limited or spend-down funds. These funds, designed to disburse their assets within a set period, offer distinct benefits for addressing urgent challenges and achieving more immediate impact. When carefully structured and governed, spend-down strategies can provide targeted financial support to causes that need it most. They allow donors to be actively involved and avoid the risks of perpetuating dynastic wealth.
One of the main reasons to set up a spend-down fund is to address causes that require more immediate attention. Some donors are opting to reap the fruits of their gifts while experiencing their impact. Other causes require larger grants or investment to see meaningful change. Immediate funding allows organizations to scale quickly and address pressing issues effectively. The short-term focus of these funds allows the capital to multiply its impact by leveraging early interventions, as opposed to compounded financial return.
While the immediate effect of time-limited funds may increase the short-term impact and provide more resources for organizations in need, donors and stakeholders should consider the following variables:
Governance: Construction of the policy, goals, and objectives is always important when building a portfolio, and shorter time horizons raise the stakes. The funding and distribution phases of limited life endowments require more drastic changes in the asset allocation policy. It is vital for decision makers to be consistent and adhere to the policy.
Sequence of Returns Risk: This risk occurs when a portfolio experiences negative market returns at the same time as large distributions. This combination reduces the original value of the portfolio. To a degree, the phenomenon is hastening the goal of distributing the assets. However, the total dollars granted will be reduced, meaning risk management will take priority during the distribution process.
Adverse Cause Selection: While it might be compelling to bet on immediate impact, it is important to consider mistakes, such as giving grants to unworthy charities. Additionally, funding a solution to an unsuccessful cause leaves little room for error when selecting beneficiaries and strategies.
Spend-down funds offer an interesting dichotomy to the perpetual family foundation. Numerous families have created intergenerational, philanthropically-inclined heirs that lead, distribute, and manage the foundation for good. However, other donors prefer not to pass significant wealth to their children, believing that it can lead to complacency. Warren Buffett encapsulates this philosophy with his famous quote: "Leave the children enough so that they can do anything but not enough that they can do nothing." Spend-down funds ensure that wealth is deployed for meaningful causes rather than sitting in trusts or foundations that primarily benefit heirs.
It should be noted that spend-down funds are subject to timing risks. As illustrated in the graph below, macroeconomic conditions can significantly impact the foundation's timeline goals. A poor sequence of returns, particularly in the early stages of the fund, can severely diminish available capital for distribution and potentially accelerate the depletion of the fund. In contrast, favorable returns early on can extend the fund's longevity. This sequence of returns risk underscores the importance of careful planning and risk management. Market fluctuations can lead to unpredictable outcomes, potentially jeopardizing long-term objectives.
Spend-down strategies are a powerful tool for donors looking to make an immediate and lasting impact by allowing targeted giving, active donor involvement, and avoidance of dynastic wealth accumulation. While perpetual endowments remain valuable for long-term support, spend-down funds provide a focused and timely approach to philanthropy. In the current era of urgent world challenges, spend-down funds have become an increasingly relevant and effective way to direct wealth toward meaningful change while simultaneously facing unique challenges.