Traditional Investing Strategies Serve Nonprofits Poorly, Report Finds

Nonprofit organisations can use goals-based strategies to adapt to new market realities: an era of lower returns, ongoing market volatility, higher inter-asset class correlations and increasing fiduciary responsibilities with greater scrutiny from regulators, government agencies and donors, claims a report.

Entitled ‘The Endowment Challenge’, the report is issued by US Trust’s institutional investments and philanthropic solutions group, which is ultimately part of Bank of America (BoA). It outlines how, with donor funding in stress, increasing needs of beneficiaries, and rising costs, nonprofits are increasingly relying on investment returns to fund their operations and spending mandates.

The analysis finds that it will be challenging to generate sufficient returns to support historical spending levels if organizations continue to invest as they have in the past.

“For the first time in years, perhaps decades, foundations, endowments and other nonprofit organizations question whether they will have the financial resources to continue to fulfill their missions,” said Keith Banks, president of US Trust.

“To meet current and future needs, nonprofit organizations are urged to reach beyond traditional strategies and realign their approach to investing, spending and governance around the distinct mission and goals of their organisation.

According to Christopher Hyzy, chief investment officer (CIO) of US Trust: “Hospitals, colleges and universities, charitable foundations and other nonprofits have a distinct need for cash to fund current spending needs and, at the same time, a need to grow the purchasing power of their principal. These needs are typically reflected in a traditionally conservative 60/40 percent mix of stocks and bonds.

“The typical nonprofit portfolio lost one-quarter of its value in 2008, the height of the financial crisis. While other individual and institutional investors have recouped much of their losses, many nonprofits continue to struggle. By adhering to traditional strategies that have not kept pace with changing market dynamics, many have been unable to benefit from emerging and rebounding growth opportunities.”

Joe Curtin, head of US Trust’s institutional investments group, added: “The implications of negative return years and market volatility on spending are particularly problematic for mission-driven organisations.

“Nonprofits are finding ways to do more with less, but if they want to expand their mission and sustain it for future generations, they need to embrace more creative responses to new market realities.”

Goals-based strategies

The US Trust report outlines a new roadmap, with goals-based strategies nonprofit for organisations to consider in order to add long-term value and build resources that will support its mission. Among its key advice for nonprofits:

  • Rethink strategic asset allocation. Strategic asset allocation should marry two critical components of goals-based investing: forward-looking market expectations and selection of asset classes in appropriate proportions to generate incremental returns through good and bad markets.
  • Diversify portfolio to manage both risk and return. Optimal asset allocation strategies should include diversification with global and nontraditional investments such as real estate, private equity, commodities and hedge funds, not only to manage risk, but to drive incremental return. Diversification cannot ensure a profit or guarantee against loss.
  • Employ tactical asset allocation. By actively managing asset allocation and manager selection, nonprofits can generate additional return through tactical adjustments that increase or decrease exposure to near-term market changes.
  • Analyse cash flow needs and set appropriate liquidity levels. Because cash on hand is forecast to earn a negative return when inflation and fees are taken into account, excess liquidity in a low-return environment can be detrimental. Nonprofits that have not yet analysed liquidity needs relative to the distinct mission of the organisation may be sacrificing additional return opportunities.
  • Adjust spending rate and investment strategy to meet both present and future goals. Proper spending rate is a critical factor in a nonprofits long-term sustainability. Boards have a fiduciary responsibility to balance the immediate needs of the organisation and current beneficiaries with the expected needs of future generations.
  • Measure goals versus benchmark performance. The most relevant measure of success for nonprofit organisations is not rate of return, but rather, how much money the organisation has to support its mission.
  • Strengthen board governance. Well-crafted board governance increases the likelihood that investment decision making is nimble, proactive and aligned with the goals and mission of the organisation. Members of the investment committee are now expected to be active participants in formulating overall strategy as well as the selection and assessment of advisors.
  • Outsource to mitigate risk and maximise resources. With fiduciary risk falling squarely on members of the board and investment committee, many investment committees are reassessing their ability and willingness to manage the organisation’s investment portfolio. By outsourcing the investment function, boards mitigate risk, use resources more efficiently, gain expertise and have access to the best professional investment managers.


Related reading