Tuesday, 18 January 2005. A Discussion was held in the Senate-House of the following Reports:
Report of the Council, dated 13 December 2004, on distributions from the Amalgamated Fund (p. 282).
STATEMENT BY THE BOARD OF SCRUTINY (read by Professor D. W. PHILLIPSON):
Mr Deputy Vice-Chanceller, the Board of Scrutiny welcomes the proposal from the Council to change the policy for distributions from the Amalgamated Fund from an income-only policy, to one based on total return, subject to amendment of the Statutes. The Board has advocated this change, in line with revised guidance from the Charity Commission to reflect the structural changes in the investment environment in the twenty-first century. The proposed level of draw-down appears to have been prudently assessed and, provided that the mechanism for review of this level is properly applied and the formula regularly updated, the Board commends this proposal to the Regent House.
Mr C. LARKUM:
Mr Deputy Vice-Chancellor, I speak as a member of the Finance Committee and its Investments Sub-committee in support of the proposal, recommended in the Report on distributions from the Amalgamated Fund, that the Statutes be changed to enable the Amalgamated Fund to operate under a total return distribution policy. The arguments behind this recommendation are, to a large extent, technical and have been well covered in the Council's Report. I will limit my comments to the timing rather than the substance of the proposed change. Although charitable funds in the United States have operated under total return policies for over 30 years, it was not possible to do so in the UK until the Charity Commission became convinced that its rigid distinction between the income and capital of charities was unfairly hampering the management of endowed funds and issued guidance that opened the door to change. That was three years ago, and a number of large funds have since moved to meet the criteria laid down for such a change. For the Amalgamated Fund, that requires our Statutes to change and you have an appropriate proposal before you. The change is eminently sensible. It was supported by the Board of Scrutiny in its most recent Report and I hope the Regent House will give it a swift passage.
Dr J. FAIRBROTHER:
Mr Deputy Vice-Chancellor, this Report contains two proposals. The first is a change from an income-only distribution policy to a total return distribution policy, requiring a change to the Statutes. The case is set out well and I would like to support it. It might be preferable to replace the words 'for expenditure' by the words 'as income' in the proposed amendment to Statute F, III (e), since certain funds holding Amalgamated Fund shares may not wish or be able to spend such distribution immediately. However, this is a minor quibble.
The second proposal is to move from a distribution policy determined at the discretion of the Finance Committee to one determined by a formula. Neither the case for so doing, nor the particular formula recommended is discussed in detail and I would like to raise concerns about each.
The position in Cambridge is not quite the same as that for a US endowment fund, where the university is the beneficial owner of the assets. We are here speaking of the Amalgamated Fund which, as its name suggests, amalgamates the beneficial interests of both the University and of trusts for which it is trustee. The University is therefore not quite so free to determine a 'spending rule' as it would be with an endowment fund. I am not at all clear that by adoption of a formulaic approach, which looks like a spending rule tailored to the requirements of the University, the University can properly discharge its obligations as trustee for the many funds holding Amalgamated Shares. As the Report says in paragraph 8, achieving even-handedness between present and future beneficiaries remains an exercise of principle and judgement rather than determinable facts. On these grounds, it might be preferable to leave the determination of distribution, under a total return policy, to the judgement of the Finance Committee, advised as at present by its Investments Sub-committee and professional external advisers. That judgement might well be illuminated by reference to a formula, but it would remain flexible and responsive to factors which cannot readily be incorporated in a formula. The University may, of course, wish to adopt a slightly different, and perhaps more predictable, spending policy from the distribution policy of the Fund; this it can do at any time by simply purchasing or selling additional units in the Fund.
Turning to the mechanics of the proposed formulaic approach, the Report recommends a distribution rate of 4.25%, which, we are told, having regard to future uncertainties, errs on the side of caution. That may be appropriate at present: it is a matter of judgement for the Finance Committee and its advisers. It looks unambitious in comparison with comparable endowments in the United States, and it may be a mistake to lock this figure in stone in case returns prove to be better than currently anticipated.
The proposed formula itself combines two different types of smoothing. The first part of the formula involves linkage with the previous year's distribution (adjusted for inflation); if we assume that previous distributions have been calculated using the same formula, this is a convenient way of applying diminishing weightings to earlier valuations. However, we are not told if that is the intention here. The second part of the formula uses a three-year moving average of semi-annual valuations.
The net effect of combining these approaches to smoothing is to reduce the weighting of the most recent valuation to only 5% (i.e. 0.3 x 1/6 of BMV) and to give the greatest weighting to valuations that are three years out of date. This does not seem sensible. In effect the two parts of the formula involve double-counting of the smoothing, making the result quite unresponsive to changes in valuations in both directions.
In addition, there is no inflation adjustment in the calculation of the three-year moving average, which seems illogical and inconsistent with the application of an inflation adjustment to the previous year's distribution in the first part of the formula.
These concerns would be met by simply defining BMV as the most recent (31 July) valuation. In due course, the use of the previous year's distribution in the formula would ensure the application of steadily reducing weights to the valuations of earlier years, adjusted for inflation, in the determination of the base to which the proposed 4.25% distribution rate is applied (usually described as simple exponential smoothing).
This brings us to the initial application of the formula and the question of this year's distribution. I would have assumed that if the theory underlying the proposed formula were thought to be sound (indeed sufficiently sound to make a point of proposing that future changes can only be made with difficulty), then the proposed distribution this year would be close to that which would have prevailed had the formula been in place for a number of years. It is fairly easy to calculate, using my revised formula and figures published in the Reporter that that figure would be at around 122p, giving a distribution rate of about 4.7% on the most recent valuation of about £26. The figure using the proposed formula is even higher. However, the Council is, instead, recommending a lower distribution of 110.5p based, I assume, on applying the proposed distribution rate of 4.25% to the unsmoothed valuation of £26, without taking any account of the higher valuations in previous years. There may well be a good case for adopting the more conservative figure of 110.5p but I think we should be told why the Council is not proposing to adopt the principles of the proposed formula in setting this initial rate, which will affect distribution levels for some years to come. At the very least, PYD for 2005-06 should be deemed to have been 110.5p in 2004-05 rather than the actual figure, should that turn out to be lower because of income constraints and delays in approving the necessary statutory changes. I hope the Council will review the proposals contained in Recommendations III and IV of this Report in the light of these comments.
Mr A. M. REID:
Mr Deputy Vice-Chancellor, I speak as a member of the working party of the Investments Sub-committee of the Finance Committee established to look into a move to a Total Return Distribution Policy for the Amalgamated Fund. As previous speakers have agreed, the case for such a move is clear and requires no further comment.
I now turn to the detail of the formula to determine the annual distribution. The group believes that a formula should be set out clearly with a bias against change to avoid the temptation to over-distribute when things look very good (as in the latter part of the 1990s), and to under-distribute when things turn down (in the first part of this decade).
Our aim is to give a smoothed and predictable distribution, allowing the trust funds making up the Amalgamated Fund to be able to plan expenditure funded by this distribution with a reasonable degree of certainty. We must do this whilst ensuring that in the long term permanent capital is maintained in real terms.
We looked at the practices of the major US and UK endowments and carried out much analysis of different formulae against the historical performance of the Fund. We sought the help of Cambridge Associates, who specialize in investment analysis and advice to university endowment funds and foundations. (The Cambridge in this respect is in Massachusetts, not the UK.)
The proposed formula fits the 47-year experience of the Amalgamated Fund well. Looking forward, Cambridge Associates' analysis compared the proposed formula over the simple three-year moving average alternative. The outcomes are similar over the long term, and the 'most-likely' case is that capital is maintained in real terms. The distribution is also maintained in real terms. However, volatility of distribution is lower for our proposed formula compared to the alternative considered. That gives us smoothing and predictability, which we consider important. Cambridge Associates supported the proposed formula.
Of course, no one knows what will happen to investment returns in the future. There is an element of judgement in setting the starting point for the formula, and in setting the 4.25% long-term rate (although this has been the average distribution over the life of the Amalgamated Fund). But we believe the formula has been properly tested against past performance and analysed against future scenarios. If we err, it is on the conservative side. The formula should be reviewed from time to time, but not as knee-jerk reaction to market movements. The working group was content to leave such reviews to the good sense of future Investment Committees.
Report of the General Board, dated 8 December 2004, on senior academic promotions (p. 286).
No comments were made on this Report.