Lucy Rhodes, partner in the Charity and Social Enterprise team at Bates Wells, reflects on a resurgence of interest in endowment funds and the options available to charities.
Endowments are back in focus
What springs to mind when you hear the term endowment? A prestigious university scholarship? A shiny new museum wing? A source of stability or a legal headache?
The endowment has its roots in Roman history when emperor and philosopher Marcus Aurelius created an endowed chair for each of the major schools of philosophy in Athens. In the medieval period, endowments became the financial underpinning for many universities, hospitals and religious institutions and, later, a cornerstone of Victorian society’s approach to social welfare. In early Islamic history a similar concept – waqf – emerged as a central pillar of Islamic philanthropy, eventually supporting vast infrastructure development across the Ottoman Empire.
Today, endowments are back in focus again, as charities look to future-proof their finances and align their money with their mission.
Setting up a new endowment
Historically, many endowments would have been initiated by donors through a lifetime gift or legacy, often given for specific purposes. Now, many charities are adopting an approach, championed by universities, of establishing their own endowment and setting out to raise funds for it. This can open up a new channel of giving, particularly among HNW donors who respond enthusiastically to the concepts of legacy, permanence and stability that endowments embody. Once the endowment achieves scale, it has the potential to provide a steady stream of income for the charity, enabling the charity to reduce reliance on more volatile income streams and seasonal cash flow pressures. This approach can also facilitate a more strategic approach to fundraising. It puts the charity on the ‘front foot’, raising funds for purposes which are aligned with its goals, rather than reacting to donor-driven priorities.
When we advise charities on the structure of a new endowment fund, one of the first questions we explore with them is whether they are looking to establish a permanent endowment fund where the charity can only spend the income and cannot access the capital or an expendable endowment fund,a more flexible type of endowment where the trustees have the ability to spend the capital, if needed. This often throws up a tension between the priorities of the charity (to have flexibility in relation to how it spends its funds) and potential donors (who may be more concerned about the preservation of the capital). Generally, these different priorities can be accommodated through a hybrid fund structure but carefully designing the structure of the fund from the outset can avoid the charity tying itself in knots.
Besides legal advice on the structuring and establishment of an endowment fund, it is essential to spend some time running the numbers, particularly if the aspiration is to achieve a particular level of income from the investment of the fund.
Unlocking existing endowments
As a former classicist and ongoing history enthusiast, I’ve found that advising on endowment funds can provide a fascinating window into the concerns of the past. Memorable endowments that we’ve advised on from the Victoria era, for example, include funds which provided ransoms for sailors enslaved by North African pirates and dowries to assist women in getting married.
Not all endowment funds will have purposes which are so blatantly due an upgrade as these funds. Yet many charities still hold restricted and endowment funds which have purposes which are out-of-date or difficult to fulfil, or where a fund doesn’t produce enough income to further its purpose effectively or at all. Updating purposes and/or releasing permanent endowment restrictions using the powers in the Charities Act 2011 can free up funds to be used more strategically and efficiently.
Charities with permanent endowment now have an additional tool in their endowment toolbox thanks to the Charities Act 2022. Under the new power a charity can borrow up to 25% of the total value of a permanent endowment fund without the need for Charity Commission consent, provided the trustees are satisfied that the charity has arrangements to repay the borrowing within 20 years. It’s a useful option if your charity has a short-term need for funds, but ultimately wants to preserve the capital of their permanent endowment, as the charity in this case study found.
Using endowments to make social investments
An increasing number of charities are widening the focus of their endowment investments beyond financial return. This includes a variety of approaches ranging from aligning investments with their mission and values, engaging actively as shareholders or making social investments. The latter have become easier for permanently endowed charities as a result of new rules which allow charities which have formally adopted a total return approach to make investments which have an uncertain or potentially negative return. This should give a confidence boost to any charities which were concerned about their ability to make such investments due to the anticipated level of return.
Establishing an endowment generally means taking a long view. But flexible models and new and updated powers for spending, borrowing from and investing endowments mean that charities can now combine longevity with agility. With the right structure, an endowment can preserve capital, support innovation and stay aligned with mission, proving that one of philanthropy’s oldest tools remains one of its most adaptable.
About the author
Lucy Rhodes is a partner in the Charity and Social Enterprise team at Bates Wells and wrote the permanent endowment chapter of The Charities Acts Handbook: A Practical Guide to the Charities Acts.
