In 1997, Porter, White & Company was asked to advise a private, non-profit secondary school on its investments and capital financing. The school's board of directors makes policy, which is implemented in the financial area with oversight from the finance committee of the board. The firm assisted the school in developing an integrated capital financing and investment policy, formulated on the foundation of a long term financial plan.
Issues Since operating expenses exceed tuition, the school needs income from its endowment, and it is important that over time withdrawals from the endowment not exceed income, capital appreciation and additional contributions. The amount of operating subsidy required of the endowment is a function of the schoolıs program, which is being expanded at the direction of the board with the anticipated result that the endowment will be called upon for additional support of operations. Matching anticipated withdrawals from the endowment (i.e., the "spend rate") to anticipated income, capital appreciation and contributions is a complex but important planning process. From time to time the school has a need to spend money to upgrade its physical plant and faces the decision of whether to borrow or spend money from its endowment. This decision also requires analysis in the light of the resources and long term objectives of the school.
Solutions Porter, White & Company assisted in the preparation of a multi year financial plan projecting income and expenditures and anticipated capital expenditures, as well as analysis of the existing financial resources and likely increases in these resources. PWCO then prepared a policy recommending an asset allocation for the endowment and a debt financing appropriate to the school's circumstances to cover needed capital expenditures. This policy was tested using simulation and sensitivity analysis. The recommended asset allocation consisted of a mix of fixed income and equity investments. Low cost variable rate tax exempt debt was recommended on the liability side after analysis showed that the risk of fluctuation in the debt interest rate was hedged by interest earned on the fixed income component of the investment portfolio.
Results The results of this investment policy have been attractive. The fixed income portion of the Porter, White advised portfolio has exceeded the borrowing cost. Over time the investment strategy has produced a positive variance in return as compared to established market benchmarks, with a lower standard deviation (a measure of risk). The fixed income portion of the investment allocation has been invested in short to medium term securities, thereby avoiding the volatility of long term bonds and permitting a larger equity allocation without subjecting the school to investment risk beyond its tolerance. Equity investments are broadly diversified (42% domestic and 18% international, with a tilt to small cap and value stocks).
