Question

Explain why an endowment as a long time horizon and low liquidity?

Answer 1

Endowment funds are long-term funds of non-profit institutions, such as universities, colleges, schools, museums, theatres, opera companies, hospitals, and clinics. These organisations use their endowment funds to provide some services to their students, patrons, and patients. Foundations are grant-making institutions funded by gifts and by the investment income that they produce. Most foundations do not directly provide services. Instead, they fund organisations that provide services in such areas as the arts or charities. Foundations often own endowment funds, which invest the foundation’s money.

Endowment funds and foundations typically have a charitable or philanthropic purpose and receive gifts from donors interested in supporting their activities. In many countries, donations to these organisations are tax deductible for the donors. That is, donations reduce the income on which the donors have to pay taxes. Investment income and capital gains that these organisations receive from investing these funds may also be tax-exempt.

Endowment funds are usually intended to exist in perpetuity and, as such, are regarded as very long-term investors. But they are also typically required to spend annually on the charitable or philanthropic purpose for their existence, so money needs to be drawn from their funds. Many endowment funds and foundations establish spending rules; for example, they may set spending goals of a percentage range of their assets. Often, their challenge lies in balancing long-term growth with shorter-term income or cash flow requirements.

Each endowment fund or foundation has its own specific circumstances. Some are able to raise money on an ongoing basis, whereas others are restricted from raising more money. Some endowment funds and foundations are required to spend a fixed portion of the portfolio each year, whereas others have more flexibility to vary spending. These differences have implications for how the institutional investor’s assets are invested. An endowment client that is restricted from fundraising has to meet its financial needs from income or the sale of assets, but an endowment client that has no restriction on fundraising may also raise money to meet its financial needs. Most organisations with endowment funds hire professional investment managers to manage the funds. Some manage portions of their funds internally, in some cases through an investment management company that they own.