Cumberland Advisors has received a growing number of inquiries about managing charitable trust and foundation funds. We will introduce some history and use a FAQ (frequently asked questions) format to describe some of our observations.
By way of background, Cumberland Advisors has been involved in managing assets and charitable funds for decades. We do that in many US states and handle various account sizes ranging from the low six figures to $100 million foundations. Our primary goal is to assist charities in an unbundled and fully transparent manner with no conflicts of interest, either perceptual or actual. Over decades, we have encountered several different conflicts of interest. Some of those will be enumerated in occasional installments in our series on the subject.
Our firm has special fee arrangements for charities that are discounted and thus may be attractive. We apply those fee arrangements to all of our managed asset classes. We often waive minimum account sizes to charities because we want to encourage the growth of smaller charities as well. As principals in Cumberland Advisors, we personally use charitable funds. Many of us contribute to them. I personally have two donor-advised funds at community foundations and have used a third through a major distribution channel.
Let’s get to some FAQs.
(1) How much does it cost to administer a donor-advised fund?
In our survey of US foundations, we found costs from 40 (0.40%) to 125 (1.25%) basis points. The costs vary by location, services, and the built-in overhead at a charitable foundation or community enterprise. Those fees and their range are solely for the administration of the fund and do not usually include custody of assets (although some are included), investment advice, or independent consulting services. Typically those charges are processed against the fund as a cost. Essentially the fund director grants a gift to the foundation from the fund in order to defray the charges that the foundation itself levies for its services. We find most of those charges are levied on a quarterly schedule.
(2) What are the rendered services?
The services rendered vary by fund and foundation; however, the basic structure is predicated on the fact that the servicing foundations screen charitable requests to make sure they are legitimate charitable entities that have filed appropriately and are properly identified as acceptable charitable organizations. Those organizations are able to receive funds.
Some foundations have restrictions, including directives, percentage tests, or other guidelines, depending on their board policies. When we are asked to review foundations, Cumberland Advisors recommends that donors and philanthropists seek the most easily available and readily administered structure in accordance with their personal charitable wishes. We strongly suggest that the procedures within the foundation be reviewed in detail. When we manage charitable fund assets, we act as an independent, fee-for-service-only investment advisor. We review the objectives of the fund and how those objectives are met and should be met. We respect the wishes and desires of the philanthropist and the processes that are in place to obtain the desired outcomes.
(3) What about the conflict of interest issue?
Our firm has always believed in a separate-silo approach. We recommend that investment advice, custody, and transactional activities be separated so that they do not overlap. It is the overlapping and the lack of transparency in bundled situations that expose the philanthropist and the foundation to risk. Given that Cumberland Advisors is a fee-for-service, separate-account investment advisor, avoiding conflicts of interest is easy. We do not take custody of funds. We have charitable funds in custody at various places. In those places, we suggest that the custody fees are separately identified and billed. The trustees, advisors, and philanthropists may ascertain the value of each service. And they may evaluate each price or cost separately and distinctly from the investment advisor’s result. The third piece is the transactions, which are also done separately. All parties are able to see what the transactions are, who did them, what they cost, and how they were implemented. In our view, separating the three elements is the safest way to advance charitable purposes while insulating the philanthropist, foundation, and all interested parties, including the recipient charities, against any inadvertently unlawful or intentionally deceptive activity.
(4) How is the proper investment objective determined for a charity?
This is a more precise question and depends on the uses of the charitable fund. In my personal structure, with two donor-advised funds, I expect to fund them over time and to continue funding them while using them to disburse charitable gifts that I will recommend to the prospective foundation. I expect my endowment funds to be long-lived. Therefore the endowment and more-permanent foundation funds are invested with long-term investment objectives.
A risk tolerance has to be determined for each fund. That is why Cumberland seeks to avoid the classic pie-chart approach. From our decades of experience, we have observed that that approach leads to poor performance of the funds. Poor charitable fund performance reduces the money flowing to the recipient charities to fulfill their philanthropic purposes. We find many donor-advised funds showing poor performance. Unfortunately, donors often do not hold charitable foundations to a high level of accountability for that poor performance. We also notice that charitable organizations sometimes fail to report their performance results with GIPS (Global Investment Performance Standards) methodology.
(5) What is an example of such poor performance?
We compare long-term structure in live accounts with consultant-driven funds that use “cookie-cutter” models. Those models are designed through regressions and therefore look backwards to attempt an asset allocation. They are not forward-looking. In one case we compared the results of two foundations versus a structured approach that was similar to the consultant’s recommendations. Over 10 years of live-account results, we found that the difference between the backward-looking, regression-oriented model and the forward-looking structure, based upon serious investment literature and asset allocation, averaged 200 basis points (2%) per year.
Here is an example of this opportunity cost. The philanthropist puts $1 million in the fund with charitable intentions to support various organizations that seek to do good deeds and improve the quality of life in their communities or the world. Each year the net performance result is permitted to be gifted to the charities. There are also the prospects of principal donations, subject to applicable rules. If one fund returns 2% more than another, in the case of the lower-performing fund $20,000 per year out of that $1 million never reaches the intended charities. It is the charities that are punished by poor performance.
There is a peculiarity when it comes to philanthropists. We have found that donors feel good about doing charitable deeds. They give the money to the foundation, endowment, or charity and feel good about the result. Sometimes those gifts are honored personally, and others are anonymous. In all cases there is goodwill in charitable giving. We see it constantly among our client base and throughout the US.
At the same time, that donor stops looking at the investment results. Donors seem to treat their funds differently than they do their own personal investments. The philanthropists have a tendency to examine their own portfolio returns in greater depth than the portfolio returns of the charities to which they have directed their wealth. Maybe this is just the nature of the human being, or maybe donors need to assume greater responsibility after they make the gift. Among Cumberland’s clients, where we are involved in those funds, we constantly assist the donor in reviewing the charity’s or foundation’s activities.
(6) What about specific conflicts of interest?
There are two types of conflict of interest. The first type is actual conflicts of interest involved in criminal cases when guilty parties are caught. The organizational activities of Bernard Madoff and the way in which charitable funds lost monies placed with Madoff afford a stark example of how things can go awry. In that particular case, boards of charities placed monies with Madoff, and investment committees concurred with the decisions. One should ask what the roles of investment committees, directors, auditors, and supervisors are under such circumstances. How could they make the decisions they made if they were doing what they were supposed to be doing in their fiduciary capacity?
The answers were revealing. There have been changes since that now apply to investment advisors like me. I cannot manage my own donor-advised fund; I must personally use some other management structure. In my case I use the default general fund in my two donor-advised funds. That structure also gives me an opportunity to watch both of those funds in operation and see how well or how poorly they perform and how they deliver both services and investment returns.
The second issue is the perception of conflict of interest. If someone is the philanthropy’s vendor and sits on its board, it appears that there is a conflict of interest whether or not one exists in actual decision making. By virtue of being in an influential position, any individuals seated on a charitable board or investment committee, whether they are recusing themselves on votes or distancing themselves from particular decisions, appear to have a conflict of interest. Using the buffer of an investment committee separate from a board seat does not eliminate the appearance of a conflict.
At Cumberland Advisors we recommend against utilizing any charitable structure in which a person seated on the board or the investment committee supplies a service for a fee or vends a product for commission. Over the years we have watched members of investment committees participate in commissions on products that were sold to the charitable foundation. We were part of a process that discovered such participation after it had been ongoing for years.
The distinction between a board and an investment committee is often used as an attempt to create a barrier or the appearance of a barrier in order to allay concerns about conflict of interest. This is understandable, in that philanthropies like to have prominent, wealthy board members so they can evidence themselves to the community as being well-organized and efficiently run, with skills that include financial, economic, and ministerial professionalism.
We have no problem with that structure; however, if there is any overlap of business, the notion of an indifferent and unconflicted supervision is immediately defeated by the relationship with the vendor. In our firm, no person is permitted to function on a board or investment committee if he has a role in our firm as a vendor of services or a prospective vendor of services. I currently sit on the Global Interdependence Center (GIC) board. During my tenure GIC has engaged in foundation and charitable activities. The largest single gift was $1 million. Under no circumstances would I sit on the committee that directs the investments or proffer investment advice in any way. Furthermore, Cumberland Advisors would not participate in the vending of services to GIC. The conflict of interest issue is simple: you either are one or you’re not one.
Sum this ethical stance up as the responsibility of the donor versus that of the charity. The charity’s responsibility, in our view, is very straightforward. Run it as efficiently as possible at the lowest possible cost needed to administer its purposes. Make sure funds are directed to charities that are legitimate, that have filed appropriately with the government, and that have reported their budgets, approaches, and purposes to ensure that they are saying and doing the same things.
For the donors, the responsibilities are up to them. I know donors who write checks and then put the matter out of their minds. They give funds to “feel good” and do not spend any energy determining how effectively those funds are used, how they are deployed, how they are invested, or the final administrative outcome. There are other donors who view charitable giving with a greater sense of responsibility. We encourage the latter. We encourage donors to think about ways in which they can enhance their charitable activity for the benefit of the receiving charities. We are happy to help those donors who agree with us on that approach.
The management of Cumberland Advisors has a bias in favor of philanthropy. Our firm is a community of 34 people. Many of us are active in charitable causes. Some of us tithe. Most of us participate in communal and global charitable activities. We find that the investment world tends to look at the cover of the book of charitable giving instead of reading its pages. We find that the investment performance of foundations that is not computed under Global Investment Performance Standards (GIPS) is sometimes deficient.
While we cannot change the world, we can change what we do. We have now expanded our determined effort to improve investment efficiency and distribute the results to charities. I am personally intensifying my efforts in this area. I am personally available to discuss charitable giving, foundations, and structures in detail.
Thank you for your time in reading this first note in a series about charitable giving and investing.
David R. Kotok, Chairman and Chief Investment Officer