During the continuous documentation and review work conducted by the research and translation team at The Third Bank | Encyclopedia of Knowledge Enrichment for the Non-Profit Sector, the team reviewed a policy paper issued by the Criterion Institute, a prestigious American research entity concerned with reimagining the role of money as a tool for social change and transformation in economic systems.

The team found that the content of this paper touches on core issues that intersect with the challenges and aspirations experienced by the endowment and non-profit sectors in the Kingdom of Saudi Arabia.

Consequently, efforts were made to translate and edit it in a way that aligns with the local context and considers regulatory and cultural privacy, while maintaining the original spirit of analysis and presenting it in a cognitive framework that serves policymakers, practitioners, and researchers in this vital area.

The non-profit sector plays a fundamental role in supporting community development and enhancing national solidarity by filling gaps that may not be covered by government agencies or the market, and providing initiatives that contribute to improving quality of life and empowering different groups.

Despite this vital role, many entities operating in this sector work with limited resources, rely on volunteer efforts, and manage their activities with utmost efficiency within the available capacities.

Resource limitations are among the most prominent challenges that restrict these entities' ability to achieve their long-term goals and mission.

From this perspective, the Criterion Institute presents this paper to support non-profit organizations, grantmakers, and all stakeholders in analyzing how endowments can transform from just a traditional funding tool into a strategic lever for maximizing impact and enhancing sustainability in line with the goals of Saudi Vision 2030.

What is an endowment?

An endowment is an asset dedicated usually in the form of a donation, gift, or permanent financial allocation, aimed at supporting an entity with sustainable and long-term funding that aids its activities related to its community or developmental mission. An endowment is managed as a permanent fund, where the principal capital—referred to as "Principal"—is invested while only the returns from this investment, such as profits, interest, or capital gains, are used to finance programs and initiatives.

The principal remains intact to ensure the continuity of the endowment and its impact across generations. The pivotal importance of the endowment lies in its being a regular and predictable financial source, which grants the beneficiary entity—whether it is a non-profit organization, a university, or a charitable organization—the necessary financial stability for strategic planning, effective implementation, and the ability to withstand economic and financial fluctuations.

How do endowments work?

Endowments are typically managed as restricted funds, meaning they are subject to conditions and regulations that determine how they are invested and how the returns are spent, often set by the endower or grantor at the time of establishment. In most cases, it is prohibited to dispose of the principal or withdraw it; instead, it remains in place to continue generating investment returns that are used to support the targeted activities.

Endowment funds—according to a specified policy—are invested in various financial instruments such as stocks, bonds, and real estate, aiming to achieve sustainable capital growth. Expenditures are limited to the profits, interest, or capital gains generated by these investments, which are in turn used to finance programs, provide grants, or support initiatives related to the beneficiary entity’s mission.

Management of the endowment is usually overseen by an authorized fiduciary or a board of trustees, which possesses legal and administrative powers to ensure compliance with the original conditions of the endower, and implements financial distribution in alignment with local regulations and the strategic goals of the endowment institution.

Components of an endowment

Endowments typically consist of four basic components that represent the foundation upon which their sustainability and financial stability are built:

1. Principal:

This is the initial financial asset usually provided through donations, bequests, or major grants, designated to remain intact. This asset is invested—permanently or for the long term—to create a stable source of financial returns that finance the activities of the endowed entity.

2. Investment Returns:

The endowment funds are employed in diversified investment portfolios including stocks, bonds, and real estate, aiming to generate a regular income from profits, interest, or capital gains. These returns serve as the primary resource upon which the entity relies to finance its programs and activities.

3. Use of Funds Policy:

Endowment entities set clear expenditure policies based on withdrawing a limited annual percentage of the returns—usually between 4% and 5%—to finance operational costs or programs. Meanwhile, the remaining returns are reinvested to enhance capital and balance the effects of inflation.

4. Restrictions:

Some endowments come with binding conditions from the grantor or endower outlining how the returns should be used, such as designating them for educational, environmental, or social purposes. Unrestricted endowments provide the endowed entity with broader flexibility to direct resources according to emerging circumstances and actual needs.

Mechanism of Endowment Fund Operation

Endowment funds operate on a financing model that balances the protection of principal and maximization of long-term impact. The main stages of endowment operation can be summarized in three interconnected steps:

1. Gift:

The endowment process begins with the provision of a donation or financial gift that establishes the principal capital for the fund, often coming from individuals, institutions, or endowers seeking to support a specific goal sustainably.

2. Invest:

The principal capital is managed under an investment strategy designed to grow it over the long term, while keeping it intact without direct withdrawals. Funds are typically invested in diverse financial instruments, in line with the level of acceptable risk and endowment objectives.

3. Grant:

A specific percentage of the investment returns is annually allocated to support the programs or activities specified in the endowment policy, while the remaining returns are reinvested to enhance future growth of the fund and ensure its sustainability.

This model reflects the endowment philosophy that relies on permanent capital, enabling organizations to carry out their activities with stability and independence, without continuously depending on emergency or seasonal funding sources.

Why are endowments important?

Endowments are strategic tools that many entities operating in the non-profit sector resort to for enhancing their long-term financial stability. They enable organizations to establish a permanent funding source, decreasing reliance on seasonal donations or short-term grants, empowering them to implement their missions and programs in the face of economic and political fluctuations.

Recent data indicates a tangible impact of endowments in enhancing financial stability; a study published in 2023 by the National Bureau of Economic Research in the United States showed that organizations with endowments face income fluctuations that are 40% lower compared to organizations without endowments.

From this perspective, endowments are no longer merely an alternative funding method, but have become an institutional pillar that enhances the resilience of organizations and their long-term planning capabilities, granting them greater independence in directing their resources towards achieving sustainable impact.

Key features: Types of endowments according to UPMIFA classification

According to the Uniform Prudent Management of Institutional Funds Act (UPMIFA) adopted in the United States, endowments are categorized into three main types, differing in the degree of restrictions imposed on the use of principal and returns:

1. True Endowment:

This is a permanent or perpetual endowment typically presented as a restricted gift from a donor, requiring the maintenance of a fixed part of the assets (usually a specific amount or percentage) as principal that cannot be encroached upon. Only the returns generated from the investment of this principal are allowed to be spent on the purposes specified in the endowment's terms.

2. Quasi-Endowment:

This is also known as a "Funds Functioning as Endowments" and consists of unrestricted funds or reserves designated by a decision of the board of directors. The endowed entity has the authority to use part of the endowment principal when necessary, making it more flexible, but it is not classified as a permanent endowment in the strictest technical sense.

3. Term Endowment:

This is an endowment defined for a specific period or until a pre-condition is fulfilled (such as the beneficiary reaching a specific age or completing a specific project). After the term ends or the condition is met, it may be converted into a permanent endowment or liquidated as agreed upon at the time of establishment.

Although this classification provides a useful framework for analyzing endowments based on the level of restrictions and flexibility, it is not binding or applicable in the Saudi regulatory environment, where endowments are governed by the regulations of the General Authority of Endowments, based on the provisions of Islamic law and Saudi law.

The difference between "endowment" and "reserve fund"

Although an endowment and a reserve fund share the characteristic of being financial instruments used to support the stability of non-profit organizations, there are substantial differences related to function, liquidity, time horizon, and limits on asset disposal.

First: Reserve Fund

A reserve fund is a type of "emergency fund" designated to meet unexpected obligations or expenses. It is a financial vessel characterized by high liquidity, often kept in cash or as assets that can be quickly liquidated.

This fund can be utilized fully or partially, and the board of directors or supervisory body has broad discretionary authority in how and when to use it, including the possibility of drawing from the principal fund itself. It may or may not be invested, depending on the organization's policies.

Second: Endowment

In contrast, an endowment is established to achieve sustainable long-term funding. Its assets are bound by strict conditions that prevent their disposal or liquidation, whether those conditions are stipulated by the endower or under the regulations governing the endowment.

The principal of the endowment (the basic asset) is invested, and only the returns generated from it are utilized to cover specified expenditures while adhering to the maintenance and growth of the principal over time to ensure continuity across generations.

Brief Comparison:

Element | Endowment | Reserve Fund

Liquidity | Low (principal cannot be liquidated) | High (cash or liquidable)

Usage Limits | Only returns are used | Both principal and returns can be used

Time Horizon | Long-term or permanent | Short or medium-term

Purpose | Sustainable and stable funding | Meeting emergencies and unexpected expenses

Discretionary Authority | Restricted by endowment conditions | Discretionary for the board or supervisory body

Summary:

A reserve fund is akin to a temporary "safety cushion" used when necessary.

On the other hand, an endowment is a long-term institutional commitment aimed at securing permanent and stable income sources that contribute to achieving sustainable impact.

Understanding endowments in the context of the non-profit sector

First: Impact on operational operations

Endowments are among the most prominent tools that contribute to enhancing the financial stability of non-profit organizations through providing a steady and reliable cash flow. This financial sustainability is reflected in reducing reliance on external funding sources and alleviating the pressures of continuous fundraising, which can exhaust the executive teams and sometimes lead to what is known as "mission creep," where funding requirements overshadow the core focus of programs and essential goals.

The endowment enables beneficiary entities to build long-term strategic plans, enhancing their predictive ability and preparedness in facing economic crises and market fluctuations, thus supporting institutional decision-making resilience and granting them greater operational independence.

Second: Investment strategies

To ensure achieving developmental goals and the desired sustainability, organizations need to adopt balanced and carefully studied investment policies. Among the most effective practices in managing endowment funds are:

• Asset Diversification: By spreading investments among stocks, fixed-income instruments like bonds, and alternative assets such as real estate and private equity funds.

• Sustainable Investment (Environmental, Social, and Governance – ESG): By integrating environmental, social, and governance standards into financial employment decisions to align them with institutional values.

• Periodic Portfolio Rebalancing: Through periodic reviews of portfolio distribution to align with market changes and the approved risk level.

It is noteworthy that endowments are not limited to financing programs only; they also provide organizations an opportunity to direct their resources towards investment strategies aligned with their mission, in what is known as "impact-aligned investing."

A study published by the Council on Foundations in 2023 indicated that impact-linked investment portfolios achieve returns close to those generated by traditional investment strategies.

This affirm that endowments can simultaneously achieve two main objectives: financial sustainability and enhancing social impact, without compromising either.

Spending Policies from Endowment Returns

Spending policies from investment returns are one of the core organizational pillars in managing endowments, aiming to achieve a balance between meeting the current financial needs of the organization and maintaining the principal to ensure funding continuity across generations.

Foundation institutions often adopt a financial approach known as the "4–5% Rule," which allows for withdrawing an annual percentage ranging from 4% to 5% from the average endowment value over a period typically extending from three to five years. This amount is used to cover operational costs or finance programs based on the objectives of the beneficiary entity.

This rule aims to provide a predictable income source without affecting the principal, targeting investment returns that exceed the annual withdrawal rate. For instance, if a non-profit organization has an endowment worth 10 million dollars with an annual return rate of 7%, the total returns are estimated to be 700 thousand dollars. According to the rule, 400 to 500 thousand dollars (4%–5%) are allocated for direct expenditure, while the remaining amount (200–300 thousand dollars) is reinvested to enhance long-term growth of the endowment.

To strengthen funding stability, many institutions rely on what is known as smoothing mechanisms, where annual spending is based on a moving average of the endowment value over several preceding years instead of relying on a single year assessment.

This methodology helps reduce financial fluctuations caused by market volatility and prevents harsh budget cuts during recession periods, enabling organizations to plan strategically with greater confidence.

This model—which combines financial caution with sustainability—has become an adopted standard among major institutions, especially in higher education and philanthropy, and is viewed as one of the best practices in endowment management. It enables organizations to align between maintaining social impact and committing to long-term financial sustainability.

Endowments as a tool for sustainability in developmental work

Since the beginning of the new millennium, a notable decline in donation rates has been observed in many communities, where the number of households contributing to charitable work has decreased by more than 20 million households in some countries. At the same time, certain funding tools such as donor-advised funds have seen significant growth in their assets, reaching 251.5 billion dollars in 2023. However, this growth has not necessarily been accompanied by an increase in the actual support for field organizations, contributing to rising financial pressure on entities operating in the developmental sector.

In light of these challenges, endowments stand out as a strategic tool ensuring non-profit organizations a stable and sustainable funding source, allowing them to continue their work without being hostage to the fluctuations of donor priorities or shifts in the funding environment. Unlike short-term donations, endowments provide long-term funding that aligns with the core goals of the organization.

Many major institutions worldwide have moved to strengthen their endowments to serve long-term developmental goals, such as supporting education, caring for the most needy groups, or empowering local communities. These international experiences demonstrate how endowments, when managed under sound governance and effective investment, can contribute to financial stability and enhance developmental impact for entities working in the field.

Considerations regarding endowments in supporting sustainability and community empowerment

There are compelling arguments affirming the pivotal role that endowments can play in enhancing the capacity of non-profit organizations to achieve their developmental goals:

• Sustainable funding: Endowments are a reliable source of long-term funding for programs, providing non-profit entities with greater flexibility and independence, and reducing excessive reliance on seasonal donations or short-term grants. A suitably-sized endowment can cover a substantial part of operational or programmatic expenses, ensuring the entity continues to fulfill its mission efficiently.

• Hedging against funding fluctuations: Endowments help protect organizations from the effects of annual contribution fluctuations from donors, especially during economic downturns or changing priorities. However, it should be noted that the effectiveness of endowments in this regard remains linked to the performance of financial markets, making the hedging not guaranteed in all cases.

• Enhancing institutional trust: The presence of an endowment sends a clear signal to donors that the organization is committed to a long-term vision and seeks to build a stable financial structure. This enhances its standing within the community and may encourage major donors to support it as an endowment can solidify impact and leave a sustainable legacy.

• Balancing community inclusion: One of the challenges associated with endowment growth is that some individuals may feel that their small donations are no longer impactful, which may affect community engagement. Therefore, organizations should continue to engage all community segments and communicate effectively with them, even as institutional funding sources expand.

Strategic discussions on the viability of endowments in non-profit organizations

Despite the vital role that endowments can play in enhancing financial sustainability, there are strategic challenges that require serious reflection by decision-makers in non-profit organizations:

• The effectiveness of endowments correlates with market performance

The returns of endowments cannot be separated from the state of financial markets. While historical returns in the 1980s and 1990s ranged between 6% and 7%, they are now estimated at only 3% to 4% according to recent estimates. A study from the Sloan Management Institute at MIT indicates that the average net return on endowment investments after deducting administrative expenses was about 5.3%, which is lower than the historical average for stock returns. Also, individual donations to non-profit organizations are often tied to market performance, meaning that an endowment does not always offer an effective safety barrier against funding fluctuations.

• High management costs require high organizational efficiency

Maximizing the benefits of endowments requires competent financial and human resources in investment and management fields. Small or mid-sized endowments may lack the capacity to employ professional investment managers or build effective governance structures, which could lead to erosion of returns or suboptimal investment performance. Furthermore, managing an endowment demands different communication with donors, moving beyond conventional fundraising to establishing relationships founded on long-term impacts.

• A shift in funding and communication strategies

Endowments are often funded through a limited number of large donations, which may result in a reduction in engagement with the traditional network of supporters who contribute small amounts. Therefore, this trend should be balanced with maintaining community involvement and diversity in support sources to preserve the organizational identity.

• Concerns about resource freezing against immediate needs

One of the major criticisms aimed at endowments is that they freeze funds for an uncertain future while communities face urgent immediate needs. Therefore, organizations should have a clear strategic vision and transparent communication with their audience to explain the rationale behind the endowment and how it is managed to strike a balance between the present and the future.

• Erosion of purchasing power over time

Due to inflation and fluctuations in investment returns, the actual value of endowed funds may decline over time, requiring the adoption of flexible financial policies to enhance real asset growth and ensure the longevity of impact.

• An endowment is not always the best solution

The suitability of endowments depends on the organization's size, the nature of its mission, and the level of its institutional maturity. Some entities with short-term or changing objectives may find an endowment an inappropriate organizational burden. Therefore, an endowment should be viewed as one of the tools for sustainability, not as a standalone alternative.

Practical Recommendation:

In light of the aspirations of