Long-Term Stewardship Funds
Long-term stewardship funds or “mitigation endowments” are a specialized class of mitigation funds. These funds typically arise when a permit or other governmental approval requires as a component of mitigation that: (1) a parcel of real property be purchased or otherwise set aside in perpetuity for conservation purposes; and (2) a funding mechanism be established to provide ongoing payment for a defined set of land management or “stewardship” activities on the site, also in perpetuity. The funds described in item (2) are often referred to as long-term stewardship or mitigation “endowment” funds.
It is important to note that the long-term stewardship funds (LTSFs) managed by the IDEA department come into existence only because of the mitigation requirements set forth in a permit or other governmental approval. Thus, like other components of permit-required mitigation, LTSFs are legally exacted funds and are therefore significantly different that philanthropic or other charitable funds managed by NFWF. In recognition of this difference, when IDEA receives and manages permit-required LTSFs, IDEA acts solely as an agent, trustee, or escrow provider for the permitting agency or the permit regime itself, in each case solely to ensure the funds are applied to satisfy the mitigation requirements specified in the applicable laws, regulations, permits, and mitigation plans (including long-term land management plans).
Another critical point is that the calculation of the appropriate initial value of a particular LTSF is entirely dependent for its accuracy on the quality of the underlying inputs derived from the underlying permit and mitigation plan. Those essential inputs are: (1) the year-by-year work items required for long-term management of the parcel in perpetuity; and (2) the fully-loaded costs to perform each of those items, including appropriate contingencies to reflect the variability in tasks and costs that may occur over long periods of time.
Once the tasks, costs, and contingencies for a particular LTSF have been confirmed, the next step is typically to convert that stream of annual cash needs into a lump-sum, present value amount. This conversion is often accomplished through the application of a “capitalization rate” (sometimes called the “Cap Rate”). The Cap Rate is essentially the percentage of the LTSF assumed to be drawn each year to meet the annual cash need to pay for work on the property. As a formula, the initial principal of the LTSF equals the annual cash need divided by the Cap Rate.
In calculating the Cap Rate itself, a key concept is that the Cap Rate reflects the net amount of gain that the LTSF investment portfolio must achieve each year on average over long periods of time. “Net” in this sense is not only net of costs such as investment manager and other administrative fees, but also net of inflation. Thus, for example, assuming administrative costs at 1% annually and inflation at 3% annually, a Cap Rate of 3% would require average gross annual returns of at least 7% over time.
Finally, because any Cap Rate necessarily involves assumptions about future expected investment returns, it is critical that the Cap Rate be aligned with the investment strategy to be employed for the associated LTSF portfolio.
The IDEA department has worked closely with federal and state permitting agencies for several years on the development of programs for the receipt, management, investment, and disbursement of LTSFs. Some of the focal areas of IDEA’s work in this area include:
Understanding differing agencies’ respective risk tolerances for the investment of LTSFs exacted under their permitting regimes
Consulting with permitting agencies on the development of investment policy statements (IPSs) to reflect the investment parameters determined by the agencies to be appropriate
Working with NFWF’s outside investment advisors on the construction of investment portfolios that align with the IPSs adopted or approved by permitting agencies
Working with both permitting agencies and land stewards on the development of mechanisms to provide for the ongoing disbursement of funds from LTSFs, including contractual arrangements, automated disbursements, and reporting systems.