Charitable-remainder trusts have grown in popularity at universities that control the trusts using their own investing strategies, but financial advisers are often loath to hand over control to the schools, as the strategies are sometimes risky.
CHICAGO — Charitable-remainder trusts have grown in popularity at universities that control the trusts using their own investing strategies, but financial advisers are often loath to hand over control to the schools, as the strategies are sometimes risky.
Many universities tend to invest aggressively in hedge funds and other alternative strategies, which can produce fabulous results one year but paltry results the next year. That can deeply hurt a donor who is counting on an annual income stream from the trust.
Some donors simply feel more comfortable with less aggressive strategies, advisers said.
Many people wrongly assume that universities generally use relatively safe strategies, said Jim Hardesty, president of Hardesty Capital Management in Baltimore.
“The superior returns do regress to the mean eventually,” he said. “If you make a gift to the fund of a university that’s employing these alternative-investment vehicles, you could potentially be exposed to the darker side of risk, having enjoyed the brighter side of it for many years.”
Schools that offer charitable remainder trusts to donors include Harvard University and the Massachusetts Institute of Technology, both in Cambridge; the University of California, Los Angeles; the University of Michigan in Ann Arbor; and the University of Notre Dame in South Bend, Ind.
In a charitable-remainder trust, the donor transfers cash, stock or other appreciated property to a trust. The trust pays a percentage of its principal to the income beneficiaries, and when the trust is terminated, the remainder is passed on to the university.
In most cases, the income beneficiary receives about 5% or 6% annual income. The donor usually receives an immediate income tax deduction and doesn’t have to pay upfront capital gains tax on the appreciated assets donated.
Universities use their marketing materials to tout their investment records, saying that donors who let them manage their money will gain access to some of the best money managers in the nation.
MIT’s endowment fund had about a 15% annualized return over the 10-year period ended June 30, 2006.
Meanwhile, in a 2006 report, Harvard said that it had produced annualized total returns for its endowment fund of 13.5% for the previous five years and 15.2% over the previous 10 years.
But universities don’t always have great track records, according to Peter Valente, a lawyer with Blank Rome LLP in New York.
“It sounds good on the surface to invest along with universities,” he said.
“Generally, they do well, but they don’t always do well,” Mr. Valente said. “The thought is, you invest with them and get the benefit of great money managers, and they make mistakes, too.”
However, one adviser thinks that working with universities is a good idea, noting Harvard’s long-term high returns.
“I’m in the investment business, and I can’t do [those returns], said Seth Pearson, an adviser with Pearson Financial Services in Dennis, Mass.
Advisers are most concerned, however, about universities’ overseeing these accounts when the market is volatile, such as was the case recently as a result of the subprime woes. Harvard reportedly lost $350 million last month from a hedge fund investment.
“Some of these endowments, they’ve gotten into derivatives and some funky investments because they were doing such spectacular returns, but with spectacular returns usually means increased volatility,” said Vaughn Henry, an adviser with Henry & Associates in Springfield, Ill. “I’m always a little concerned when charities start chasing big returns.”
Most universities are investing the charitable-remainder trusts alongside their endowments, but Yale University in New Haven, Conn., operates the charitable-remainder trusts outside its endowment, using many of the same asset management strategies from the endowment, according to an online report from the university.
Even if the university controls the charitable-remainder trust outside its endowment, Dave T. Phillips, an adviser and chief executive of Phillips Financial LLC in Chandler, Ariz., tells his clients not to let a non-profit manage the money.
“I always recommend people set up their own personal foundation and do not do it with institutions,” he said. “I want to control where my money is invested.”
Unique approach
UCLA has taken on a unique approach for its endowment fund, according to Judith Pillon, executive director of planning. The university no longer manages the fund, and instead, it is managed by Kaspick & Co., a subsidiary of New York-based TIAA-CREF.
UCLA chose Kaspick because it specializes in operating and managing non-profit trusts, and the university realized that another company could better manage the assets, Ms. Pillon said. She said that it is a juggling act to ensure that the fund grows adequately but is also aware of tax ramifications for donors, as well as their income needs.
“It’s really hard to balance the interests. It’s a precarious place, and we’re mindful of it,” Ms. Pillon said.
“If there’s any tilt at all, it tends to benefit the income beneficiary,” she said. “You tend to want to increase the income to the benefit of the beneficiary.”
UCLA is more conservative about its investments than other schools, and focuses mostly on mutual funds, Ms. Pillon said. A 65-year-old donor who was earning between 5% and 7% annual income would likely be in a growth portfolio of 71% equities and 25.5% fixed income, she said.
“Our donors who previously grumbled are all accolades now,” Ms. Pillon said. “We came to the decision that we don’t run a trust office. Why don’t we go to someone who really has that expertise?” she said.
But other universities aren’t thinking of the tax considerations of donors, Mr. Henry said.
“Their motives are to preserve and grow the value of the trust to benefit them. They may not think about tax issues inside [the trust] which influences the beneficiary,” said Mr. Henry, who sets up about 60 to 100 of these documents a year.
