Here’s the world’s simplest math problem.
My wife, Pat, and I often meet a pair of friends for a movie. If there’s a risk that the show will sell out, I run over to the theater ahead of time and buy all four tickets in advance. When our friends arrive, we hand them their tickets and they pay us back.
So the question is this: How many movie tickets were sold?
Four, of course.
But in the parallel universe of donor-advised funds, where double-counting comes as naturally as breathing and dissembling, the answer would be six.
Let me try to explain the inexplicable.
As The Economist wrote this spring, when it delved into the phenomenon of donor-advised funds: Which nonprofit has received the most in grants from Fidelity, Schwab, and Vanguard Charitable, the three largest commercial gift funds? Was that lucky grantee the Salvation Army? Doctors Without Borders? No. The largest recipient of charitable grants from those three commercial gift fund giants in the period studied was ... Fidelity Charitable.
Double-counting is commonplace in the donor-advised world, because transfers from one fund to another count as grants.
Huh?
If this makes no sense to you, let me tell you about a friend of mine I’ll call Leah. She had a donor-advised fund at Organization A, a donor-advised fund sponsor. She was annoyed with Organization A, concluding that its fees were too high. So she transferred her $250,000 DAF to create a donor-advised fund at Organization B.
The transfer of Leah’s $250,000 was essentially an administrative action akin to shifting bank accounts from one financial institution to another. She was not “giving” the money to Organization B. But Organization B, like all donor-advised fund sponsors, is legally a charity, so consequently the transfer was considered a $250,000 grant from Organization A, the same as if the money had gone to a soup kitchen or a college.
The large grant dollars flooding into Fidelity from rival commercial gift funds are essentially transfers of accounts. These transfers probably result from people like Leah hunting for low fees and high investment returns. The donors’ financial advisers also seem to play an influential role in these DAF-to-DAF transfers. I say that because the third-largest grantee from the three megafunds, according to The Economist, was the American Endowment Foundation, a donor-advised fund sponsor I wrote about several years ago in The Chronicle.
The American Endowment Foundation promotes itself heavily to financial advisers. In fact, its hook is to tell financial advisers that if their clients open DAFs at the American Endowment Foundation, the financial advisers can retain a “management role,” which is to say, they receive fees for managing the investments. Moreover, American Endowment Foundation pays financial advisers management fees for funds of any size, while Fidelity and Schwab require a minimum fund size of $250,000 for that kind of fee-generating arrangement, and Vanguard pays nothing to financial advisers. I suspect that many financial advisers are persuading their clients to move their established DAFs from the Big Three (Fidelity, Schwab, and Vanguard) to AEF so they (the advisers) can begin to draw a management fee.
But whatever the cause of this migration of DAF funding from one sponsor to another, the findings of The Economist demonstrate that double-counting is commonplace in the donor-advised world, because DAF-to-DAF transfers count as grants. This introduces yet a new dimension of distortion and speciousness into the donor-advised fund industry’s claims of high distribution rates.
Exaggerated Numbers
To understand the context, it’s important to know that, over the past few years, as critics have expressed concern about the growth of donor-advised funds, the industry has done everything it can to publicize and exaggerate its reported spending rates.
Donor-advised funds methodically began to supplement their feel-good but hollow claims (“We’re expanding the philanthropic pie!” “Donor-advised funds are democratizing philanthropy!”) with puffed-up grant-distribution numbers, hoping that the public might not notice many core problems with the industry. “Stop carping!” the donor-advised fund industry seemed to be saying. “Look at the high payout numbers!”
Well, fine. Let’s look at those payout numbers.
One would think that the way in which DAF payout rates are measured would be standardized and obvious. After all, calculating the payout rate would seem as simple as this equation:
Grants/Assets = Payout Rate
But there’s no consensus, first of all, on whether the assets number should be drawn from the start of the fiscal year or the end.
Several years ago, the National Philanthropic Trust, a donor-advised fund sponsor and the source of a much-cited annual report on such funds nationwide, made a simple but significant shift in the way it calculates payout. Earlier, the trust relied on the end-of-year numbers for determining the assets. Then it started using asset numbers from the start of the year.
National Philanthropic Trust asserted that this formula made for a more consistent comparison with private foundation spending rates. But because assets at DAFs grow during the year, the result, presto change-o, was an increase in reported industrywide annual distributions from about 15 percent to 20 percent.
One would think that the way in which payout rates are measured would be standardized and obvious, but there’s no consensus.
Meanwhile, the NPT calculation — whether using the start-of-year or end-of-year asset number — doesn’t account for money that’s contributed and distributed within the same calendar year. Let’s say that a donor contributes $100,000 to her DAF in February and distributes it all by December. The DAF industry counts the $100,000 in the grants number, but it doesn’t count a penny among the assets, because the $100,000 was not present in the donor-advised fund either at the start or the end of the year. This clearly inflates the supposed distribution percentage.
Sleight of Hand
Meanwhile, Fidelity Charitable (which declined to comment for this article) as recently as 2015 has used its own unique and utterly inappropriate way of calculating its DAF payout rate, borrowed from the world of nonprofit endowment management.
To figure out its asset number, Fidelity has used the average size of its assets over the past five years. Because of the sharp growth in their assets in recent years, this sleight of hand by Fidelity drastically inflates the percentage supposedly distributed. This led Fidelity in 2015 to announce a lordly distribution rate of 28 percent. (For those of you struggling with the math, believe me that this calculation has no intellectual validity and serves to wildly exaggerate the spending rate.)
On the other hand, The Chronicle, using a formula developed by the Internal Revenue Service, put overall distributions from donor-advised funds in the most recent year studied at 14 percent. The approach takes into account the funds deposited and distributed within the year by adding grants made during the year into both the numerator and denominator of the formula, which serves to capture funds contributed during the year, and by using year-end asset values. There’s no perfect way of measuring payout, but to my mind the approach taken by The Chronicle and the IRS makes a great deal of sense.
But now, thanks to The Economist article, we know that a fairly large portion of DAF grant dollars are not actually grants to charities but transfers from one donor-advised fund to another. How much? We don’t know, because of the lack of transparency of donor-advised funds: The DAF sponsors won’t tell us, and they’re even less likely to open the books so that researchers can test the numbers. But I would assert that the real payout rate to charity is significantly less than 14 percent. No matter: In the house of mirrors that is donor-advised fund accounting, a grant is a grant, even if the grant is to another donor-advised fund, and the industry will claim a payout rate of 20 percent or even 28 percent and for the most part get away with it.
Which is to say that if the folks at Fidelity Charitable owned our neighborhood movie theater, they would have reported that they’d sold six tickets, not four, in the same way they count money shifting around from one donor-advised fund to another as grants to charity. This kind of slick and casual accounting is common in the world of commercial donor-advised funds.
The people being hoodwinked are the taxpayers who subsidize DAF shenanigans through the charitable deduction and the charities that are seeing dollars diverted into an unaccountable netherworld that claims to have charitable motivations but doesn’t. The commercial donor-advised fund industry loves to preen in self-congratulation, while describing itself as an engine for philanthropy. But the bottom line — when calculated accurately — is this: DAFs are very good for donors and a cash cow for Wall Street. But they’re not so good at actually getting money to charity.
Alan Cantor is a consultant to nonprofits.