Cambridge University Reporter


Report of the Council on distributions from the Amalgamated Fund

The COUNCIL beg leave to report to the University as follows:

1. The Council on the recommendation of the Finance Committee, propose that the policy under which distributions from the Amalgamated Fund are made should be changed from an income-only distribution policy to a total return distribution policy. The proposed change will require amendment of Statute F, III, 6.


2. In March 2004 the Investments Sub-committee of the Finance Committee established a working party to examine the issues involved in moving to a total return distribution policy for the Amalgamated Fund. In establishing the working party, the Sub-committee had regard to changes in capital market practices over the past decade and to the decision of the Charity Commission to approve the adoption of total return distribution policies by charitable trustees specifically empowered to operate under those policies.

3. Until the Charity Commission issued its new guidance on distribution policy for charities in 2001, charity law drew a clear distinction between income and capital in the hands of charitable trustees, and required distributions by charities to be made exclusively from income. Total return distribution does not observe the traditional distinction between income and capital, but requires the trustees to follow a distribution policy that is sustainable, appropriate to the purposes of the charitable fund, and even-handed in its effect on present and future beneficiaries of the fund.

4. The Amalgamated Fund has operated under an income-only distribution policy since its inception in 1958.

Income-only distribution policy

5. Under an income-only distribution policy the distribution is paid exclusively from the dividends, interest, and rentals earned by the fund's investments in the course of the year (accounted for on an accrual basis). For the first 35 years of the Amalgamated Fund's existence, that is until the 1990s, income-only distribution sat comfortably with the investment conditions and practices of the time. There was a broad consensus among institutional investors in favour of equities and corporate dividend policies responded to expectations of steady income growth, underpinned by the knowledge that investment ratings would be damaged by dividend cuts.1 Charitable fund trustees accordingly enjoyed an income stream that facilitated income-only distribution and investment policy accommodated the income/capital distinction without undue constraint. Even so, the distinction between income and capital was not as sharp as is sometimes claimed. By changing their asset allocation, trustees could vary their income stream and funds that sought high income through fixed-interest investments in effect converted fund capital into income.

6. The report of the working party noted that the conditions just described disguised a number of rigidities that are inherent in income-only distribution policy, and that these rigidities have become more apparent and troublesome as capital market theory and taxation and accounting practices have shifted in recent years.

(i) Distribution volatility: A smooth income stream is important to charitable funds, but equity investment offers no inherent income stability. In earlier years, many funds dealt with the volatility of the business and dividend cycle by creating income reserves to smooth their distributions between good and bad years. Modern accounting practice, however, has made it more difficult to operate such reserves, and has exposed funds pursuing an income-only distribution policy to the risk of income instability.
(ii) Absolute dividend level: Capital market theory has reduced the importance of dividends in equity valuation, leaving companies under less pressure to maximize dividends or even to pay them at all. At the same time, UK taxation has become more hostile following the withdrawal of Advance Corporation Tax relief. This has reduced the value of dividends in the hands of charities and put downward pressure on their income. The impact of these changes on the Amalgamated Fund is clear. Its net income has declined from £27.8m in 1998-99 to £21.8m in 2003-04.
(iii) Constraining investment decisions: The pressure on absolute dividend levels has been exacerbated by two other trends: globalization and the emergence of alternative investments. Globalization, allowing the free movement of investment capital around the world, has increased the importance of geographic asset allocation in maximizing investment returns. However, in most overseas markets capital appreciation plays a larger role in expected investment returns and income yields are lower than in the UK. Similarly, but to a more extreme degree, alternative investments (venture capital, private equity, hedge funds) focus on capital growth and typically give no income yield at all. As a result, asset allocation and investment choice under an income-only distribution policy are increasingly constrained by concern about income loss and the need to avoid putting the fund's sustainable distribution at risk.

Total return

7. Under total return investment, trustees invest for maximum gain through capital appreciation and income, without regard to their respective contributions. They distribute from total return, again without regard to the respective contributions of capital appreciation and income (thus abandoning the distinction between income and capital). The determinant of distribution policy under total return is no longer the income received during the year, but a consistently applied distribution formula with the characteristics already referred to: sustainability, appropriateness to the purposes of the fund, and even-handedness between present and future beneficiaries.

8. Total return distribution gives trustees more control over these variables than was possible under income-only distribution. Achieving even-handedness between present and future beneficiaries nevertheless remains an exercise of principle and judgement rather than determinable fact. Broadly speaking, an even-handed policy will seek to ensure that, net of distributions, the value of the investment fund is maintained in real terms over time; an even-handed policy giving weight to future uncertainties may target some increase in the real value of the fund.

9. At the heart of total return distribution policy is the formula used to determine the distribution. Much empirical evidence is available from the US, where charitable funds (including all the major university endowment funds) have operated under total return principles for over 30 years. The working party reviewed practice among US endowment funds. These typically work to a fixed percentage of the fund that the trustees judge can be expended over time (i.e. treated as consumable income) without impairing the real long-term value of the fund. In addition, the formula will typically apply a smoothing function to the distribution. This is to avoid large year-to-year fluctuations in distributions caused by market movements and their effect on the fund's valuation.

Total return distribution and the Amalgamated Fund

10. The working group reviewed simulations for the Amalgamated Fund on the assumption of a varied range of total return distribution formulae. In its definition of maintained real value, it adjusted for inflation using an annual rate of inflation of RPI+1%. Using a 5% distribution rate averaged over three years, fund units held since 1958 preserved their 'real value' over the 45-year period, plus a small surplus (defined as real reserve), but the end-period unit value was below the actual 2004 unit value. Given that this simulation ended shortly after the 2000-02 market collapse (before which the real reserve was substantial) the simulation could be seen as a robust demonstration of the long-term effect of the model. Using a 4.25% average distribution rate, the element of real reserve was significantly greater at the end of the 45-year period and the simulated unit value was above the 2004 actual unit value.

11. Given the considerable changes in investment background over the period, the working party found that a consistently applied total return distribution policy, with rates in the range 4.25%-5%, would have given long-term results equally satisfactory to or better than the income-only distribution policy. On most distribution assumptions, the rate of distribution followed at least as stable an upward course under total return as had been the case under income-only distribution. At some periods the simulated distribution lagged the actual dividend for a number of years, but in all simulations it finished at a higher level from the late 1990s onwards.

12. Having regard to future uncertainties, the working party thought it right to err on the side of caution in proposing a distribution rate for use by the University in a total return distribution policy for the Amalgamated Fund. It recommended a rate of 4.25%. This was accepted by the Investments Sub-committee and the Finance Committee and is incorporated in the distribution formula contained in this Report.

The way forward

13. The Investments Sub-committee advised the Finance Committee that, while an income-only distribution policy had served the University well through much of the Amalgamated Fund's history, the conditions supporting that policy no longer pertained and in its view would not return. A change to a total return distribution policy for the Amalgamated Fund was therefore now needed. The Finance Committee have accepted this advice and have recommended to the Council that Statute F, III, 6 be amended to allow a total return distribution policy.

14. In weighing the recommendation of the Finance Committee, the Council took note of the fact that the University of Oxford, in respect of its Trusts Pool, has recently moved from an income-only to a total return distribution policy, and that the Board of Scrutiny in their Ninth Report (Reporter, 2003-04, p. 1082) recommended that the 'University should seek statutory authority to enable it to use, as appropriate, a total return policy for investment of its permanent capital'.

15. The Council also noted the Investment Sub-committee's view, in the context of total return distribution, that where a fund operates in perpetuity or is of indefinite duration the trustees should concern themselves with the long term and their policy decisions should not be subject to frequent review and amendment, even in the face of large market movements in the short term. The Sub-committee proposed that the rules governing the total return distribution formula should be formulated in such a way that there is a bias against change and that proposals for change should always be subject to careful scrutiny and the possibility of challenge. They recommended that the total return distribution formula should be embodied in University Ordinances, and that any future amendment of the Ordinance should require a recommendation of the Finance Committee to the Council for submission to the Regent House for approval.

16. For the current financial year (to 31 July 2005) the Investments Sub-committee have recommended to the Finance Committee that, subject to the approval of the amendment to Statute F, III, 6, 110.5p should be distributed to each unit in the University's Amalgamated Fund. In the event that the amendment to the Statute is not approved before the end of this financial year, they have recommended that the distribution be 110.5p per unit except as limited by income for the year.


17. The Council accordingly recommend

I. That the policy under which distributions from the Amalgamated Fund are made be changed from an income-only to a total return distribution policy.

II. That, subject to the approval of Her Majesty in Council, the Statutes of the University be amended as set out below and that these amendments be submitted under the Common Seal of the University to Her Majesty in Council for approval:

Statute F


Chapter III


Section 6.

By amending subsections (b)-(e) so as to read:

(b)An amalgamated fund shall be held on behalf of the constituent funds in shares as nearly as may conveniently be proportionate to their respective capital values upon the first constitution of the amalgamated fund; such shares shall be fixed by resolution of the Council on the recommendation of the Finance Committee of the Council.
(c)The Council, on the recommendation of the Finance Committee of the Council, may at any time increase any amalgamated fund by adding thereto new constituent funds and upon any such increase shall fix the share of such new constituent funds in the resulting amalgamated fund.
(d)The Council may at any time wind up any amalgamated fund and divide the investments thereof between the constituent funds in proportion to their respective shares therein or may bring all or any of the shares into a new or other amalgamated fund in accordance with the provisions of this section.
(e)The Council may appropriate and distribute for expenditure as much of the fair value of any amalgamated fund as prescribed by Ordinance as it considers in its absolute discretion is prudent having regard to the total return achieved and reasonably to be expected in the long term of the amalgamated fund and distribute in proportion to the constituent funds at the time of the distribution.

III. That, subject to the approval of Recommendations I and II, the regulations for University Funds (Statutes and Ordinances, p. 904) be amended to include regulations for the distribution formula to be used under a total return policy as set out in the Annex to this Report, such regulations to come into effect on the date on which the change in Statutes set out in Recommendation II is approved by Her Majesty in Council or on 1 August 2005 whichever date is the later.

IV. That, subject to the approval of Recommendations I and II, the appropriation and distribution for expenditure of the fair value of any amalgamated fund for the twelve months to 31 July 2005 be 110.5p distributed to each unit in the University's Amalgamated Fund, provided that if the amendments to Statute F, III, 6 have not received the approval of Her Majesty in Council by 31 July 2005 the sum distributed to each unit in the University's Amalgamated Fund shall be 110.5p per unit except as limited by income for the year.



University Funds

Distribution from the Amalgamated Fund

1. The appropriation and distribution for expenditure of the fair value of any Amalgamated Fund under Statute F, III, 6 shall be determined as set out in Regulation 2. The Council, on the advice of the Finance Committee, may from time to time recommend amendment of the formula set out in Regulation 2 to the Regent House for approval by Grace.

2. The sum distributed to each unit shall be calculated according to the following formula:

(PYD × 0.7) + (0.0425 × BMV × 0.3)


(i)PYD is the previous year's distribution per unit in the Amalgamated Fund uplifted by an inflation factor taken as the retail price index plus one per cent or such other inflation factor as the Council may from time to time determine,
(ii)BMV is the capital value of one unit in the Amalgamated Fund taken as the mean of the starting capital values of the most recent six half-years, including the first half-year of the current financial year (i.e. the closing value of the Fund on 31 July of that year, plus the two previous 31 July closing values and three previous 31 January closing values).

1 The discussion here and in much of what follows focuses on UK investment practice. Similar considerations have influenced practice elsewhere, but the taxation and legal backgrounds have been different, as has the time-scale of events.