What Drives a Payout Decision?
March 07, 2016
At the beginning of each year, the Foundation Board meets to review investment performance and decide on the payout percentage. This determines the actual income arts organizations holding endowments with the OAF will receive. What does the Board consider in making this decision?
The majority of endowments we administer are permanent. The original capital can never be paid out and income is based on returns (cash income and market appreciation). So rule # 1 is to invest the portfolio so that annual returns increase each fund’s value, which creates income available to pay out. Our investment objectives are to earn consistent returns that support annual distributions, to preserve the capital in real dollar terms (protect against inflation) and cover investment management and our administration expenses. We invest for the long term, and aim to be able to pay out 3 to 5% returns consistently. We seek returns that exceed 5% over a 5 year period.
The Board looks at investment returns for the past year ( 2015, 7.2% ) and returns for 5 years ( 9.0% ) and 10 years ( 6.7%). This confirms that market growth is well in excess of our policy objective and that the difference between the original endowed value and current market is growing. We want that difference to be going up each year. As that happens, the board can with confidence strike a payout percentage that is stable and consistent.
A consistent income year over year is helpful for arts organizations in setting their operating and program budgets. We believe that consistency is more important than maximizing a payout in a given year then having to lower it in a future year. We recognize that arts organizations need the income from their endowments, and we try to pay as much as we can while being mindful of the long term.
Another way we look for stability is to base the distribution rate on the average market value of the funds over the previous three years. This is helpful both as markets grow year over year or experience a decline.
The Board is mindful of future return expectations, which is reflected in the asset mix strategy and decisions on investment managers. As a long term investor, our investment strategy has a bias towards equities, and we choose managers having a long term investment focus. That focus examines economic themes emerging across the world, and identifies businesses that will benefit from these themes and are well managed to excel in their particular business and marketplace. These strategies mitigate short term volatility and position the Foundation for sustained long term growth. We believe we are achieving success in this regard. The OAF investment portfolio has achieved higher long term returns with lower volatility than most managers following a similar strategy. The OAF annualized 5 year returns are approximately 10% vs a 7.6% from a universe of comparable balanced portfolio managers.
Lastly, we seek returns that are decent versus excessive as we strive for that long term continuity, and avoid significant year over year variations in returns.
The debate at the Board is always lively, as it seeks to balance a sustained, increased amount each year, while also marshaling resources for the long term in order to deliver stability. For 2016, all factors resulted in a decision to maintain a 4.5% payout. Ontario arts organizations will receive just over $3.0 million in endowment income this year.