A national church organization has two significant investment pools. One investment pool holds various gifts and endowment funds that have been given to the church over many years. The other pool holds retirement plan assets for church personnel, both lay staff and clergy.
Managing the two pools separately was inefficient both from an investment management standpoint, and all fees and expenses associated with the portfolios – custody accounts, trading costs, investment advisory fees paid to outside managers.
Accounting for the separate pools and all of the underlying subaccounts had become an administrative burden to the church financial staff.
By utilizing unitized accounting, an accounting methodology used by mutual funds in the U.S., the two portfolios were combined, and the church financial group is able to accurately track the original investment, accrued income and dividends, and realized and unrealized gains.
Combining investment pools typically requires either an offering memorandum or registration of the investment pool with the SEC. The issue is particularly acute when combining qualified retirement plan assets, and non-retirement plan assets, because private funds available to institutional shareholders like a large church organization cannot take advantage of that exemption for retirement plan assets.
There is an exemption, however, for church and fraternal organizations with a legitimate common bond. Private letter rulings issued in the 1950s make clear that a church or fraternal organization has an exemption from registration for an investment pool limited to the use of that church or fraternal organization.
The church’s goal is to be as efficient as possible in structuring the investment management program for both pools. With both pools the church administrative team wants to focus on asset allocation appropriate for each pool, and subaccounts within the pool.
The subaccount issue was of particular importance. Not all the gifts to the church are on the same terms, in fact there is typically very little that is standard about the gifts and endowment funds. Gifts may be made to the local church, or to the diocese, or to the national church. Some gifts are split, for example a donor might make a donation to a church and designate 70% of the fund for the general fund of that parish, and the other 30% to provide ongoing endowment funds for the parish music program.
From a reporting standpoint, a parish treasurer may want to look at the endowments for which his parish is the beneficiary. A regional subdivision of the church, whether it be a diocese or the northwestern section of Iowa depending on how the church is administered may want to look at all the funds in that subdivision or region. The national church finance team might want to view the southeastern U.S., or all endowments in the mid-Atlantic region, or retirement assets by state.
In a nutshell, the ability to sort the underlying data in any number of ways is important. By coding each shareholder/participant with the appropriate “tags”, or sorting by zip code, or by name, that data can be utilized in an infinite number of subaccount levels, although there is clearly a point of diminishing return. Drilling down 3-4 levels is typically all that is necessary.
Charitable remainder trusts also generate some particular issues. A donor may set up a CRT to provide lifetime income for the donor and spouse, with the principal going to the church or sub entity of the church at the death of the second spouse. During the donor’s lifetime, reporting is required to the IRS to show the income and capital gains generated by the gift.
Combining thousands of subaccounts with differing reporting requirements, and assets that are both qualified retirement assets and non-qualified endowment assets (qualified or non-qualified referring to whether the assets are retirement plan assets and subject to those special accounting treatments) creates a monstrous accounting and reporting issue if each account is handled separately.
Combining the assets together into a single pool, and creating subaccounts and subaccounts of subaccounts for tracking the principal, income and gains, and ending balance of each, is the typical goal.
As Will Rogers said, “I am not so much interested in the return on my money as the return of my money”. A treasurer at the parish level wants to be assured that participating in a pool does not mean forgoing any accuracy in the original principal amount, and the income and capital gains attributable to that investment balance. Mutual fund style, unitized accounting is singularly without parallel in its ability to provide that accuracy. The value of the portfolio, interest and dividend income, and realized and unrealized capital gains and losses are accrued on a per share basis. By carrying these items on a share level, shareholder/participants can purchase or redeem shares on a daily basis, and their portion of the total fund will always be tracked accurately.
Investment pools using partnership or trust accounting are typically only valued at the end of each period, with the fund allocated as a percentage of ownership. Accrued income and accrued realized capital gains are much more difficult to allocate accurately, which can have an impact especially on the tax reporting for a charitable remainder trust.
The benefit of this method of handling investment pools is not limited to churches. Any foundation or endowment, social brother or sisterhood like Masonic Foundations, cooperative utility agencies, administrative groups of hospitals, college and university endowments can all benefit from unitization of their investment program to gain efficiencies and accuracy.