Fall 10 - Balancing Risk and Return; It Starts with an Investment Policy
The days of “set-it-and-forget-it” investing are gone. In these uncertain times, it’s essential for charitable organizations to carefully review their investments — and establish a written investment policy.
Like anything else, an organization’s assets — whether it’s a substantial endowment or simply certificates of deposit salted away for a rainy day — require sound governance. Typically, this entails a board-appointed investment committee and, often, experienced outside counsel, such as investment consultants, professional money managers and accounting professionals.
The challenge is that any investment strategy requires maintaining a balance between often-competing goals:
- Minimizing investment risk
- Ensuring access to the funds
- Earning a reasonable rate of return
This is where a well-planned investment policy can provide crucial guidance. In general, an investment policy outlines the philosophy and attitude that will guide the management of organizational assets. At its most basic, it accomplishes the following:
- Establishes a clear understanding of the investment goals and objectives.
- Defines and assigns the responsibilities of all involved parties.
- Offers guidance and limitations regarding the investment of organizational assets.
WHAT GOES INTO A PLAN?
A solid investment policy is specific enough to provide clear-cut guidance, yet flexible enough to be practical in the face of changing situations. Guidance is typically provided in these general areas:
Investment goals – Taking your organization’s mission, operations and financial needs into context, the investment policy should outline your broad investment goals (e.g., preservation of capital, long-term growth, capital growth with some focus on income). Drilling down further, the policy might stipulate that over the established investment horizon, an absolute rate of return of 6 percent to 9 percent is desired.
Investment horizon – Looking at your organization’s short-term and long-term goals, the policy should establish a time period over which the investment objectives are expected to be met (e.g., three to five years).
Risk tolerance – This section should reflect your organization’s willingness (or lack thereof) to accept risk. Here, a thorough understanding of the relative risk of various instruments and an acknowledgment of your time horizon come into play.
For example, your board may be comfortable with investing funds from a permanent endowment in a portfolio that entails some degree of risk in return for higher long-term return. On the other hand, they may be averse to taking those same risks with grant funds that will be needed during the next quarter.
Asset allocation – Based on your organization’s time horizon and risk tolerance, your investment committee may choose to establish target percentages for different asset classes, such as 60 percent in U.S. and global equities and 40 percent in fixed income investments.
Be sure to include requirements to periodically rebalance portfolios back to original policy targets. This section might also include authorized investments — for example, saying “yes” to United States Treasury securities, commercial paper and mutual funds, but “no” to junk bonds.
Investment restrictions – At the other extreme, your investment policy might specifically prohibit or limit high-risk investments like commodities, real estate, futures and options.
Liquidity requirements – Of course, your investment policy should direct that cash be employed productively by investing in short-term cash equivalents. However, if your organization faces large demands for cash, your policy may need to specifically direct that a portion of the portfolio be maintained in investments that provide same-day liquidity. At the very least, there should be active secondary or resale markets for any securities held in the portfolio.
Standards of care and ethics – An investment statement should establish the standard of care to be used by investment officials (e.g., the “prudent person” standard). It should also spell out ethical expectations, such as specifying what to do in the event of any potential conflicts of interest.
Performance review – Establish mechanisms for regular portfolio reviews as well as benchmarks for measuring portfolio performance. Likewise, establish a periodic review of the services offered by any of the organization’s outside investment managers and/or brokerage firms.
RIDE THE STREAM
Healthy nonprofits with sound investment strategies can enjoy a steady income stream from their investments. Even smaller nonprofits can put their cash to work in interest-bearing checking and money market accounts and/or federally insured certificates of deposit.
A variety of sample investment policies specific to the nonprofit sector are available online and can easily be modified to your organization’s particular needs. In addition, several useful publications outline the steps for establishing sound investment policies, including:
Nonprofit Investment Policies: Practical Steps for Growing Charitable Funds by Robert P. Fry on Amazon.com
Minding the Money: An Investment Guide for Nonprofit Board Members, a booklet from http://boardsource.org.
Sidebar
Play It Safe
While a solid investment policy statement is a good start, the ultimate responsibility for safeguarding organizational assets lies with the board of directors. Here, some basic management and accounting controls can help protect your investments:Control access. Investment instruments such as bearer bonds are cash equivalents, so store them securely, preferably in a safety deposit box. Securities (stocks, bonds, mutual funds) can be left in the custody of the securities firm or financial institution in what is known as “street name.”
Segregate duties. Never concentrate authority with one person. Whoever is authorized to purchase or trade investments on behalf of the organization should not be the same person responsible for documenting investment transactions and reconciling statements with the internal accounts. Likewise, the person responsible for soliciting investments from donors should not have any of the above duties.
Perform a reality check. Create an inventory of all the investments that you hold and where they are located. Have a second set of eyes periodically compare the list with statements from your broker or trustee. Likewise, check published sources to compare market prices and dividend income with what is displayed on statements.
Oversee the investment manager. If you are working with an outside investment firm, assign an officer (such as your treasurer) to oversee the investment manager. This trusted person can be empowered to review account statements, approve transactions above a certain monetary level, and ensure that any donor restrictions are observed. He or she should also provide regular reports to the board outlining the investment manager’s performance.
###
The Nonprofit Advisor is produced quarterly by Bober Markey Fedorovich. For more information about our services, please contact Lori Sheets, at (330) 762-9785 or by email.