[Note: This article was published as an opinion piece in the Chronicle of Philanthropy on September 11, 2019.]
Donor-advised funds are the fastest-growing segment of philanthropy, and that’s attracted a lot of attention — much of it critical.
Because so many charitable dollars are sitting in DAFs waiting to be granted to nonprofit organizations, a growing number of voices are arguing for a required distribution of assets and greater transparency. That seems only fair since donors get an immediate charitable deduction every time they put a dollar — or in some cases, millions of dollars — into an advised fund. And it seems even more important as the long bull market has meant assets accumulating in donor-advised funds are now worth more than $110 billion (or the equivalent of nine foundations the size of Ford.)
The usual response from community foundations, financial institutions, and other DAF sponsors has been to focus on the funds’ seemingly robust payout rate: that is, the percentage of their assets that is going each year to charity.
But recently the DAF sponsors have amped up that public-relations effort by introducing a new, peculiar, and ultimately meaningless measurement: the “DAF flow rate.”
Before examining the flow rate, we need to note that the payout rate is not without problems. The formulas to arrive at those percentages are often manipulated to exaggerate the apparent charitable impact, with Fidelity Charitable serving as a master of this dark art. What’s more, “grants to charity” counted by DAF sponsors include transfers from one DAF account to another — say, from Vanguard to Schwab — which should hardly be considered outright grants benefiting operating charities.
But as flawed and manipulated as the DAF payout rate may be, at least it’s a recognizable statistic, borrowed from the world of private foundations.
By contrast, the DAF flow rate has simply appeared out of nowhere in the past few months. The DAF flow rate is a term that seems to have been borrowed from the science of hydrology — or perhaps household plumbing — to illustrate how much money is going out from donor-advised funds relative to how much is coming in.
It’s essentially just a ratio: the amount in grants distributed from donor-advised funds to charities in a year divided by the amount donors contributed to their funds that year.
A recent study of community foundations by Candid and the Columbus Foundation makes a point of noting that last year 39 percent of community foundations had a DAF flow rate of more than 100 percent. Which, frankly, means absolutely nothing.
Meaningless and Misleading
To gain an appreciation of the absurdity of the measurement, let’s imagine a sponsoring organization that receives annual contributions of $1,000 and each year earns 10 percent and distributes 10 percent to charity.
In its first year, it makes a distribution of $100 and receives a contribution of $1,000, making a flow rate of 10 percent.
Does it make any sense to imply that this DAF sponsor is 10 times more effective in year 10 than it was in year 1?
Clearly, this is an oversimplified example, but it underscores the specious basis for flow rate. Like much of DAF World, a flow rate of 100 percent sounds good: “Hey! As much is going out as is going in! Who are charities to complain?!” But the concept is meaningless and misleading. Creating a ratio between donations to and distributions from DAFs implies a connection, as though DAFs are a pass-through sort of mechanism. But that’s a red herring.
In fact, contrary to what the DAF industry is implying, the reason flow rates are at or approaching 100 percent is mostly because DAF assets have been accumulating for years — the very “warehousing” of charitable assets that has been such a rich target for those of us asking DAF sponsors and Congress to change the rules to encourage more money to flow out the door to nonprofits desperately in need of support.
Here’s what has been happening to DAFs over all, in actual dollars:
Annual contributions to donor-advised funds rose sharply from 2009 to 2017, from $6.85 billion to $29.23 billion, according to the National Philanthropic Trust. Combined with a healthy investment return, the ever-rising level of contributions to DAFs means that donor-advised-fund assets have grown enormously, even accounting for annual distributions to charity. And, of course, distributions from a huge pool of funds is going to be larger as a result. That big reservoir of invested money can’t help but spill out ever-rising charitable contributions.
Keeping Useful Data Hidden
In talking up the flow rate, DAF sponsors are really trying to distract us from the big story, which is how many billions of dollars continue to pile up in DAFs.
Donor-advised funds held $110 billion in assets as of the end of 2017, a number that has no doubt grown since then.
The flow rate is not in the slightest bit an indicator of merit or charitable impact, and a 100 percent flow rate is not an indicator of a DAF sponsor’s commitment to distributing to charity.
In fact, if anything, it’s just the opposite: A high flow rate is a marker that the DAF sponsor and its donors have allowed the funds to build up through the years.
But if flow rate is not a helpful measure, there are some vastly more useful statistics that the DAF industry knows or could easily uncover but that it chooses to keep hidden. Some examples:
- How much money coming into DAFs are grants from private foundations? Grant makers sometimes use DAFs to meet their 5 percent foundation spending requirement, evade public scrutiny, or both.
- How much of DAF “grants” are not outright distributions to operating charitable organizations at all but actually transfers to other DAF accounts?
- What is the management fee paid by each DAF sponsor (or its commercial affiliate) to the donor’s financial advisers?
- What is the investment fee paid by each commercial DAF sponsor to the for-profit firm with which it is affiliated?
- What are the combined management and investment fees of each DAF sponsor as a percentage of grants made?
- What does each DAF sponsor pay its CEO? (Lack of disclosure has long been an issue for many commercial DAF sponsors.)
- And how many funds in a given year either make no charitable distributions whatsoever or make only a token contribution? Though many DAF sponsors have established minimum distribution requirements, these are often laughably insignificant. And the notion that individual donors have received a maximum charitable deduction to create funds that subsequently made zero or minimal contributions to operating charities undermines the integrity of the tax code.
$110 Billion Sitting in Funds
Like magicians drawing our attention with a distracting gesture and reassuring smile, DAF sponsors discuss the flow rate because they don’t want us to focus on more compelling and troubling issues.
- DAF sponsors don’t want us to think about the more than $110 billion sitting in donor-advised funds, money that brought their donors charitable deductions but is yet to go out to operating charities.
- They don’t want us to focus on the money paid to financial advisers for managing DAF assets — an arrangement that essentially gives advisers a financial incentive to keep the money from ever going to charity.
- They don’t want us to think about how much of these charitable dollars are going each year in fees to Wall Street firms.
- They don’t want us to think about how there is no required spending rate or time period for distributing all the assets. That means some funds can and do sit inactive indefinitely.
- They don’t want us to think about how foundations meet their spending requirements by dropping grants into the black holes of DAFs or use DAFs as intermediaries to hide the identities of their eventual grantees.
- They don’t want us to think about DAFs’ utter lack of transparency.
- And they don’t want us to think about the disconnect between the charitable deduction for the donors, which is given in the year of the transfer of assets to the DAFs, and the benefit to charity, which may come many years later, or never at all.
DAF sponsors are essentially saying, “Trust us, and trust our donors,” while doing precious little to earn that trust. I, for one, don’t buy their sleight of hand. There’s nothing about DAFs that couldn’t be fixed with a few fundamental changes to federal law, such as required distribution periods, regulating transfers from private foundations, and increased transparency.
But “DAF flow rates”? Please. That simply won’t wash.
You are an expert and masterful writer. When will we see a book on all of this?? [please…}
Oh, pish, Chris!
But, thanks. I’m very appreciative, though not worthy.
Very well stated Al. I wonder what excuse the DAF managers will use to explain the charitable losses if and when the next market crash occurs.
Best rant ever! You nailed it, Al. Thank you for paying attention and for articulating such a passionate, intelligent, thoughtful response.
Thanks, Andy. You’re very kind to say that — means a lot to me!