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Distributions
11. What is the spending (distribution) policy of the LTF?
The LTF utilizes what is often called a "constant growth" spending policy in determining annual distributions. Under a constant growth spending policy, distributions in a year are equal to the distributions in the prior year (in dollars) plus an increase to offset actual inflation in the particular year. Thus, distributions grow at a steady rate equal to the rate of inflation, which provides a stable stream of "real" resources to the beneficiaries of the endowments in the LTF. The constant growth spending policy is particularly suited to endowments in which current distributions are large relative to the total budget for the program being served by the endowment, as is the case for many of the endowments in the LTF. An unfortunate effect of the constant growth spending policy is that the volatility of financial markets, which is typically much greater than the volatility of inflation, is transferred to the value of the endowment funds from which distributions are made. To moderate potential negative effects on the value of endowments, which could endanger the ability of the endowments to meet the needs of future beneficiaries, a smoothing formula is used to calculate the inflation rate at which distributions are increased year to year and limits are placed on the distributions to protect the endowments under the most adverse capital market environments.
12. How is the distribution rate determined?
Distributions are increased annually at the three year average rate of inflation, provided that the distributions remain within a range of 3.5% and 5.5% of the three year average net asset value of the LTF. All calculations are done on a per-share (or per-unit) basis, to adjust for flows into and out of the LTF. For example, the 2004 distribution rate of $.2645 per unit was increased to $.2697 for fiscal year 2005 because the average three year increase of the consumer price index was 2.0%. Distributions based on the new rate of $.2697 were equal to 5.2% of the three year per-unit asset value of the LTF, within the allowable range of 3.5% to 5.5%. The long-term target distribution rate for the LTF is 4.75%.
13. Who determines the distribution rate for the LTF?
Following the Spending Policy established by the UTIMCO Board, UTIMCO staff recommends the annual distribution rate to the UTIMCO Board of Directors. Upon approval by the UTIMCO Board, the rate is recommended to the UT Board of Regents. Final authority over the distribution rate rests with the UT Board of Regents.
14. What is the current payout of the LTF?
The payout for the LTF for the fiscal year ended August 31, 2004, was $.2645 per unit. The UT Board of Regents has approved a payout rate of $.2697 per unit for the fiscal year ending August 31, 2005. The 2004 payout or distribution rate amounted to 5.0% of the LTF's twelve-quarter average net asset value.
15. How does the distribution rate convert into dollars distributed to the individual endowment beneficiary?
All endowments which invest in the LTF purchase units based on the LTF's market value per unit as of the date of purchase. The endowment beneficiary receives distributions on the last day of each fiscal quarter from the LTF based on the number of units owned at that time multiplied by the current distribution rate.
16. How has the distribution policy in the past affected the internal growth of the LTF?
The LTF's investment and distribution policy has been positioned to balance the needs of present and future beneficiaries by distributing only a portion of the market value of the endowment each year. For the five and ten year periods ended August 31, 2004, the LTF's distribution rate has averaged 4.77% and 4.63% of trailing three year average net assets, respectively, while the average annual net total return for the same time periods have been 5.81% and 10.32%, respectively. Consequently, reinvested earnings, the difference between the total returns and the distribution rates over the time periods, provide the cushion to support the endowments' educational programs in the future, while still meeting the needs of current beneficiaries.
A physical analogy might be helpful in explaining how the LTF's constant growth spending policy has affected its growth over time. Dams have been built on rivers throughout Texas for the dual purpose of flood control and water conservation. In years with heavy rain, the dams reserve water for the future and prevent downstream damage from flows too large and intermittent to be useful to farmers. In periods of drought, water sufficient to meet the needs of downstream users is released, even if it means that the level of the lake drops from prior rain-swollen levels. In any case, the objective of the dam operator is to meet the current needs of downstream users for a stable and predictable source of water while still maintaining reserves to meet future needs. Using very long term statistics on rainfall, dam operators adopt a cautious water discharge strategy, but allow the lake level to drop by permitting water to flow downstream, realizing that rainfall is unpredictable in the short term, but much more predictable over the long term. The dam is the instrument that allows short term unpredictability to be overcome for the long term benefit of both current and future downstream water users. Under this analogy, the dam operator is clearly using a strategy equivalent to the constant growth distribution policy.
In previous years when investment markets were strong, UTIMCO adhered to the constant growth distribution philosophy. Distribution rates were previously targeted at 4.5% while the LTF's investment return was well above that level. Those excess returns were held within the LTF in order to provide for periods, such as the 2001 through 2002 period, when investment returns fell below the 4.5% distribution rate target.
17. What effect does the target distribution (spending) rate have on an endowment's value in the long term?
One of the two objectives required to preserve the purchasing power of the endowment is to increase the market value of the endowment (after the annual distribution) at a rate at least equal to the rate of inflation. Over the long term, a higher spending rate will produce a lower long term endowment market value when compared to a lower spending rate. The effect that the distribution (spending) rate will have on the endowment's value is shown graphically in Figure E.
18. What effect does the target distribution (spending) rate have on the amount of the distribution (the dollar payout) paid to the endowment beneficiaries in the long term?
One of the two objectives required to preserve the purchasing power of the endowment is to increase the amount of the annual distribution to endowment beneficiaries at a rate at least equal to the rate of inflation. Over the long term, a higher spending rate will produce a lower spending amount because the endowment's ability to grow has been compromised by the higher spending rate. The effect the distribution (spending) rate has on the dollar payout is shown graphically in Figure F.
19. How does the current distribution rate of the LTF compare to other colleges and universities?
The LTF's distributions, when compared to the 2003 NACUBO Endowment Study, are near the distribution rates for large endowment funds, as reflected in Figure G.
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