Potential easy fix for boards: Bolster investment policies

Special to Philanthropy Journal

Dennis Gogarty

As an investment advisor to nonprofits, I have been frustrated that some questions I am repeatedly asked haven't had clear answers. Smaller and mid-sized charities and associations alike often ask how similar organizations manager their reserves. How much risk do they take? What kinds of returns do they get on their investments? As good fiduciaries, they want to understand what "normal" means so they can determine if their organizations is willing to take on more or less risk to meet their needs.

Such peer benchmarking data exists for much larger endowments but not for the vast majority of nonprofits who have budgets less than $100 million or even $50 million. After complaining to my wife about the lack of data, she siggested I take matters into my own hands. I development the Study on Nonprofit Investing (SONI) to create new benchmarking tools, not just for my clients, but for all nonprofits.

I set out to gauge what is "normal" in terms of asset allocations, decision authority, and returns on investment by answering the questions we are most frequently asked:
    • How much do organizations of various size and type maintain in reserve?
    • How do different organizations segment their cash/reserves?
    • How much risk do organizations take with their long term reserves?
    • What types of topics are addressed in most investment policies?

More than 150 finance executives at associations, public charities, and other nonprofit organizations participated in an online survey administered by a third-party research firm. 

In addition to the benchmarking data I was seeking, I found critical lapses in investment policies that could potentially expose nonprofit institutions to unnecessary risk and depress returns on their investment portfolios.

Reserve Segmentation and Asset Allocations

The following charts show how various sized organizations segment their reserves and allocate long term reserves across various asset classes.

How much do organizations hold in reserve?

Budget of:	Median Total Reserve Balance for 2012	Percentage of Budget Held in Reserve
$0-5 mm	$1,597,500	79.9%
$5-20 mm	$7,458,658	68.5%
$20+ mm	$21,050,000	63.8%

How do organizations segment reserves?

	Budget of $0-5 mm	Budget of $5-20 mm	Budget of $20+ mm
Cash	23%	21%	19%
Short Term/Operating	27%	15%	15%
Short Term/Interim	9%	9%	6%
Long Term	39%	53%	60%

How do organizations invest long term reserves across asset classes?

	Budget of $0-5 mm	Budget of $5-20 mm	Budget of $20+ mm
# of organizations with LT Reserves	63	31	19
Cash	8%	2%	3%
Bond	38%	44%	31%
US	40%	37%	46%
Intl	10%	11%	11%
Alt	2%	6%	10%

How Does Asset Allocation Impact ROI?

We found that charities held more reserves in cash and other fixed income assets.  As a result, their portfolios underperformed other types of nonprofits.  Overall, smaller organizations held more reserves in cash than larger organizations; this correlated with a lower overall return on investment.  Larger organizations were much more likely to invest in alternative investments; real estate being the most common alternative.  Portfolios with higher allocations to equity performed better in 2012.  Overall, shifts to alternative investments in 2012 were generally not advantageous.

Good Policies Could Boost ROI

As investment advisors, we were surprised to find that many organization lack clear investment guidelines on benchmarking, diversification and even guidelines to address who is ultimately responsible for investment decisions.  When there aren’t clear investment policies and decision-making procedures, it is very easy to react to short-term market fluctuations, and timing the markets can be very expensive. 

About 30 percent of organizations surveyed made changes to asset allocations in 2012, most had more conservative policies.  And not surprisingly, those organizations reported lower returns on investment than those that did not make changes. Additionally, 38 percent of the organizations surveyed are missing guidelines that require sufficient levels of diversification and 43 percent are missing guidelines that indicate the degree of discretion given to outside advisors.  Neglecting to include such critical guidelines can open-up fiduciaries to unnecessary risk. 

Bolstering investment policies is a pretty easy fix that I hope many nonprofits will employ. 

Ongoing Expectations

We’ve gotten great feedback from this year’s respondents – that SONI is already providing actionable data that can take back to their executive teams as they work to build stronger investment policies. And this is just the first year. Going forward, increased participation by nonprofit finance executives will proved even more rich benchmarking data.

Dennis Gogarty, AIF, CFP, is president of Raffa Wealth Management LLC.