Endowment Strategy

(English) This is an essay. It expresses the opinions and ideas of some Wikimedians but may not have wide support. This is not policy on Meta, but it may be a policy or guideline on other Wikimedia projects. Feel free to update this page as needed, or use the discussion page to propose major changes.

Why its needed

For financial Sustainability. We don't need lofty goals or any sense of social responsibility to establish an endowment. In the simplest terms, we need an endowment for better financial planning and independence. It is exercising the same modicum of financial responsibility we all practise in our daily lives, and carrying it over to an organisation, a common goal and projects we love.

Saving and investing are important life lessons we are taught as individuals - some people establish a nest egg, a rainy day fund, individual and family savings. We put them in an account to accrue interest or in a retirement plan or invest in other investment products - whether managing it ourselves or having a third party do it. We do so, to plan for a future unforeseen, to better utilise the present resources to reduce and better manage our finances. We save and invest.

WMF needs a similar strategy to be a responsible financial manager. A responsibility it owes to its donors, supporters, the community and everyone who believes in its mission. Merely, holding certain amount of liquid assets in reserve is not a good strategy, it is certainly not an evolved strategy that keeps up with the growth and aim WMF has enjoyed in the last decade. We need a more comprehensive strategy and a long term vision, one in which we don't merely focus on saving the most but also utilising every dollar to its full potential value. The larger strategy can be evolved as things mature through a stage-wise plan. The shortest most achievable goal at the first stage however, should be about achieving financial independence and being self sustaining. This should be the simplest goal at this stage for WMF - Nothing more, nothing less.

A more conservative and less exciting way of looking at the endowment is to look at it as a retirement plan, where WMF is the pensioner or beneficiary. It needs to accumulate funds for its retirement, what happens beyond that goal, is a long-long way away.

Risks to WMF financial sustainability

Single mode of fundraising - Annual fundraiser is the sole source of WMF revenue and all other organisations and projects dependent on it. A banner based campaign that is exposed to a multitude of risks-
- Macro-economic factors- A recession, financial meltdown.
- Prioritisation - Donations tend to get prioritised by need and urgency. Charities focused on war zones, or homeless immigrant take precedent over an online encyclopedia.
- Law of diminishing return - Fundraising will plateau out at some point whether the top has been breached is a matter of debate but it will eventually happen and will always fall afterwards.

Purpose

An endowment should ideally be viewed as a retirement fund for a non-profit. The minor difference there should be in case of an individual, it should be self-sustaining. An individual's life is finite, a non-profit can and do exist in perpetuity, for decades, even centuries. Hence, the principal amount has to maintained forever and only returns from investments (rent, profit, dividends or other gains) are expended.

The first purpose of an endowment fund would have to be to maintain and hold the principal indefinitely. This would be accrued from years and decades of savings that would go to form the principal amount. The highest priority is protecting the principal - from bad financial decisions and any form of risks.
The second priority is returns. They have to be maximised while limiting the risk exposure. Finding a careful balance of the two and regularly evaluating the options.
The third priority should be being movement aligned and socially responsible. Our movement principals and ethos has to be respected when making these decisions. If a movement aligned option offers lesser returns, it should be evaluated with our goals in mind. Just chasing higher returns should not be the only goal.

What would the endowment cover

What should the endowment cover? As beneficiaries of a fixed return instrument, like retirement beneficiaries or regular pensioners, expenses would have to be prioritised between essential and non-essential. So, the question becomes, What do we absolutely need every year?

A hierarchy of needs

A large discussion happened about this a few years ago. It was about Core vs non-core expenses of WMF. A better idea would be to look at it in terms of essentials and non-essentials, and create a hierarchy of needs. Again, What do we absolutely need every year -

Tier 1
- Hosting cost - Without this there is no Wikipedia
- Administrative and compliance cost - no departments, no staff just the absolute bare minimum cost of running WMF, the organisation with a legal existence.

Tier 2
- Essential staff - ops, executives, retain a legal representative, administrative staff.
- Mobile and app dev related expenses
- Further hosting expenses that relate to improved performance, limited projects or research. Future essential hardware or software needs.

Tier 3
- Fundraising abilities - related staff. Essential component to raising more funds.
- Further staff
- Minimal grant and support capacity for other organisations and individuals

The strategy

Wmf needs a consistent long term strategy. Aiming 10 years or more down the line. A long term goal and a short term way of getting there. The long term mission is achieving our movement goal, the financial vision hence is having enough funds to achieve our set goal. And since there is no finite time known to achieve such a vision, we have to achieve financial sustainability whereby WMF can pursue its goal indefinitely.

The true aim of financial sustainability would be that WMF can hurry or be tardy, it can make mistakes, stumble, or leap or even jump across towards it mission - an endowment should be there constantly to provide a stable backing not just to WMF but the entire movement and similar entities who have mission aligned goals.

Components

The first and foremost step to looking at a larger long term financial vision for WMF is to look at our needs in terms of two components-

A constant return from an endowment
A variable return from the annual banner based fundraiser
An unforeseen contingency sum i.e. reserve

All 3 component should ideally be kept separate. The annual banner based fundraising would be the primary contributor in the accumulation phase of the endowment i.e. the fundraiser will pay in to the endowment. WMF should also consider keeping a limited sum in liquid assets for any short term emergency needs.

Endowment Rule

It is imperative to understand, the endowment is looked at as a constant. It would be the byproduct of careful planning and yield evaluation. It can and should not be treated as a piggy bank or a rainy day fund. It can not be offset one year, raided another and paid back the next. Its principal has to remain untouched and only added to every year. In an inherent sense, it is a promise the endowment holds to its benefactors that it will not be spent, only invested. There are historical laws across states that recognise this ancient covenant, and it should indeed be looked at as a promise to our donors.

Endowment invasion, as it is called, is the practise of raiding from the principal of an endowment to pay off debts and expenses - it is an act that requires court intervention and permission in some states. It is one of the argument, the endowment itself deserves its own legal existence so that it can't be raided in a bad year or to achieve a short term goal. It is cannibalising the savings to pay off excess expenses. This is something that has to be avoided in the strongest possible terms.

Endowment can not be treated as emergency funds for unforeseen contingencies. Ideally, a larger future vision should incorporate those funds separately.

I propose this as a rule to a future financial vision. Endowment can and should only accrue, increase year over year. Returns would be disbursed separately, never withdrawn from the principal.

Annual Fundraising

Another component to understand here is the annual fundraiser. It should go on, as it always has. The endowment expenses and operations should have no direct relation to the fundraising campaign. The fundraising campaign can be limited in future, to smaller targets but WMF has a complete discretion and control over the annual fundraiser. The fundraising is the stop gap, the variable that can be revised up or down, limited or expanded based on goal based needs.

The fundraising target has to cover any short term expenses.

Approach

A careful consideration of pros and cons needs to be taken about what is the most suitable option for WMF. Arguably, an endowment needs a legal existence and independence to limit its liability from WMF and vice versa. As an investment vehicle it also needs the freedom of making quick financial decisions that can be caught in bureaucracy or needless red-tape. Which in turn, would argue against a separate financial entity but handing the money to a third party money manager. So the decision to make first of all is -

Hands on approach - WMF sets up a foundation or trust, hires its own fund managers, establishes a separate board to oversee the endowment. A DIY (Do it yourself) approach.

Pros-
- All the large endowments follow this structure - Harvard, Yale etc.
- Control - WMF retains absolute control over management
- Accountability - Movement and socially aligned investment practises rather than just for-profit decisions
- Returns - Just as lower returns are a risk, higher returns are also a possibility.

Cons-
- Higher cost of operation- separate staff, back-office work, management expenses
- Returns - Rate of return directly dependent on investment managers and their skills
- Risk - Bad decisions or slow reaction by fund managers can risk the principal.

Hands off approach -WMF hands off a certain amount of funds to a third party portfolio or fund manager and expects returns in line with their historical return rate.

Pros-
- Professional management - Third party managers have years, even decades of experience in money management. For better or worse, they are the professionals.
- Lower cost of operations - Little or no dedicated staff needed. Limited overhead in terms of management.
- Larger pool - Our funds are accrued with others, maximising impact and lowering the exposure to risks.

Cons-
- Little control - fund managers limit withdrawals(lock-in period) and return rate and generally, offer limited control over their decisions.
- Mission aligned, or socially responsible practises would be hard to adopt.
- Risks- Scams, Recession and exposure to macro-economic conditions

Both the approach have merits and demerits. A hand-off approach might be ideal for a time or composition based approach. For example, it might be smart to try it initially until the fund reaches a certain level where its operation and management cost is justified, or for a limited size of the endowment i.e. handing off 35-40% to a portfolio manager while retaining the rest to manage internally.

Management cost

A big consideration needs to be made about the management expense or the operational cost of the endowment itself. While this cost scales with the fund, there is a certain minimum cost in back-office and dedicated staff that would have to be justified. This can be a small or a large factor depending upon the view that is taken.

Management cost for the fund would have to include -

Dedicated staff
Compliance work
Investment managers
Board and meeting related expenses

Legal structure

Even if a decision is made to limit its independence or have a third party manage, a legal existence would have to be considered. The fund can be incorporated as a foundation, trust or several variations thereof. The most suitable option would only be arrived at after extensive discussion with a tax and non-profit experts. The laws would differ from state to state in the US or even country to country, suggesting a particular option over another would be premature and highly ill advised - a job left to professionals.

Annuity or return based approach

The return to aim for from an endowment would be higher than 5%, ideally 8% is the comfortable level while 10% or higher might be risky. This might seem aggressive but standard interest rates across the world range from 7-12%, so such a figure is relative depending upon the country. The true balance has to be struck between

our current and future financial needs (see hierarchy for how expenses should be prioritised)
the inflation rate
a small growth rate (2% or more to offset cost of living adjustment and allow for relevant growth in all areas)
a small amount to over budget as discretionary spending yearly

The benchmark to follow, is 2-3% for inflation and 2% for the growth of the fund itself. In other words, the fund would have to generate 2% or more return at a minimum to not lose value every year. Anything giving short of a 3% return would not qualify as an endowment or a growth fund, it would be better held in a savings account to be used for regular checking and expenses. A return up to 2-3% would be growth neutral, unless it is higher, the principal would get cannibalised. The 2% growth rate during the accumulation phase might not be needed, but it will eventually have to be taken in consideration.

The target to aim for here is between 6-8% return rate.

The fund

The fund has to have no close target set i.e. a number at which the endowment "is done". It should only be prioritised and de-prioritised. The entire time it takes for the fund to achieve its stage wise goals would be the accumulation period. It is important to consider this an on-going exercise, one that goes on in perpetuity. The first true target to achieve self-sustaining goal would be $250 million where this endowment can cover its own expenses and WMF core tier 1/tier 2 expenses. Beyond those goals it can be de-prioritised and pursued less aggressively.

The fund should be held openly and in perpetuity with no set targets after the second stage is achieved. After achieving $250 million in funding, it can grow slowly and expand at its own speed. It can take a lower priority, with future surplus and large donations going to WMF budget rather than the endowment.

First stage

Initially, a target should be set for $100 million in fundraising. Anything up to the first target, would be the non-performing phase of the endowment. Any returns might not yield sizeable return to offset its cost and management operations. This target if pursued aggressively is achievable in less than 5 years. This would give us Tier 1 sustainability.

Second Stage

The second target to aim for is $250 million. Ideally, achieved in 10 years or more. This would give us Tier 2 sustainability and true financial independence.

Re-evaluation

Anything beyond the second stage goal, is not a priority. It would go back to discretionary spending to WMF that can choose to direct funds as it sees fits. WMF can choose to expand the fund to cover more expenses or use the funds directly. A decision that should be taken again when we arrive.

This is the fork in the road where we can decide where to go when we get there. In 10 years or more, we can pose a question to ask the community and the movement players to decide together what should the next goal be. We can re-evaluate the performance of the endowment, come up with future goals, abandon old ones, help other non-profits. But these are all things to talk about when we get there.

How we get there

Certain steps and resource investment would be needed to achieve this target. Initial steps to consider -

All large donations above $200,000-250,000 should directly go to the endowment.
10-15% of annual fundraising proceeds should go directly to the endowment ($6 million or more check written annually from WMF).
Any surplus leftover after annual expenditure should either be directed to the reserve or the endowment
Aggressively pursue large donations from foundations, charities who are mission aligned to pay directly in to the endowment (with the benefit of their gift living in perpetuity)
Find mission aligned fundraising opportunities from private companies like Google and Facebook who have donate to similar causes

These steps should only be considered temporary. Once the target for the endowment is achieved, future surplus and large donations should be directed back to WMF budget.

Resource Investment -

Staff - An endowment sub-department with minimal dedicated staff. The goal here is Long term, hence ideally kept separate from fundraising, different skill sets would be required.
- An Endowment manager
- A financial liaison to liaise with investment managers and WMF staff, board
- A large donations manager with part-time or full-time support staff to pursue fundraising opportunities and focus on large gifts

All these staff members would require a very strong financial background, possibly years/decades of experience. Our structure doesn't offer a large pool to choose from, given the nature of Wikimedia, a non-profit and a SF based IT company, while the relevant pool of hires with endowment experience generally comes from Universities, institutes, theatres etc., there would be hard to find little to no overlap between the three.

There is also the problem no large endowment like this has been formed in the last decade or two. Either large universities with billions already in management or small firms, non-profit with $10 million or less raised in the short term. The experience there would find little overlap with our needs, hence it is highly advisable to forego endowment experience all together and instead focus on a strong financial background, fundraising and relationship management.

Fund manager - Either we choose to have a third party manage the firm or hire in-house managers later, regardless, this is perhaps the most important relation and the most important decision to make. A good fund manager will work best invisibly and keep the foundation running for decades without a hiccup and a bad manager can ruin the endowment in 5 year or less. This needs constant vetting and evaluation.

Board to oversee the endowment - Depending on the structure we chose, we can have WMF board oversee the endowment temporarily but ideally, it should be overseen by a dedicated board. The required skill sets and experience are different between the WMF board and an endowment board - a financial background is compulsory and highly relevant. A non-elected board filled with financial planners and managers with relevant experience in financial management. It is what larger endowment choose to do.

Financial management choices

The strategy to aim for here is a conservative and robust investment portfolio. We have to forego higher return options for stronger more reliable return options and balance out between medium and low risk grade investments.

A right balance needs to be struck between investing in fixed assets and liquid assets. Any change in strategy or market consideration would require moving the funds, a fixed investment would limit such an option but is also a necessary cornerstone to build upon from the first stage.

The first tier to consider should be composed of rents, high grade secure debt instruments/securities, interest, limited exposure to dividends from blue chips through mutual fund or third party. One consideration is investing in real estate through purchasing rented office property, this can be done through a management/investment firm or directly. Liquidating funds in fixed assets is a long process and any market slowdown can increase this time and return rate, hence it is ideal to have a capital expenditure view on the investment and just focus on the rental yield. Interest and dividend payout, are the second thing to consider, these would be more liquid options that can be moved to another option at a later date.

Risks to the Endowment

Cannibalising - endowment invasion.
Poor management - a bad fund manager can destroy the entire endowment in 5 years
Risk aversion - Investment is a risky process, limiting risk is a high priority
Macro economic factors - the fund will have some exposure to the large economic factors, it is impossible to avoid. Harvard university, Yale, Stanford and Brown university all declared major losses following the 2008 recession to the tune of 20-30% in their values, which translated anywhere from $1.5 to as much as $11 billion in case of Harvard. It is hard to be completely risk averse when investing in certain areas. A recession can be national or global, the intent there is to balance the return vs the risk. To limit exposure to a particular area or financial product to curtail losses at an acceptable level.

Plan of action

To sum up, we have a goal for the next 10 years to raise $250 million ($100 million in 5). To be managed by either third party investment managers or ourselves, with dedicated staff. The return to aim for is 6-8% from a conservative investment portfolio, risk averse and limited in exposure to macro-economic, high risk investment grade options. The $100 million goal allows WMF to have minimal financial independence, the tier 2 allows for minimal staff support and other incremental improvements to tech structure, tier 3 affords us fundraising staff and operations and minimal grant and support for other organisations. Anything beyond Tier 3 would cover more and more of WMF expenses and even provide for additional capacity and future expansion.

All this is separate from our annual fundraising operations which should cover the bulk of our expenses. The endowment has to be expanded in tiers to cover more and more of our expenses on the road to financial independence.

Next steps

Board resolution to start off the consultation process.
Hiring a dedicated Endowment manager, someone to pursue this primarily.
Consultation and planning phase to arrive at an actionable report by the next quarter.
Legal consideration and movement wide communication about our stated goals.

Glossary

Principal - The original amount invested
Annuity - A fixed amount paid annually
Accumulation period - Time to build up the savings
Inflation - Buying power of currency, increasing level of inflation means lower buying power