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.

Boards must engage in learning as a core competency

Marty Martin

Serving on a board of directors is a learned skill and an art. Successful boards get that way by learning to ask the right questions and then applying an appropriate answer to their nonprofit’s unique circumstances. To be effective requires a board to know and understand their nonprofit and the environment in which it operates. Thus, a board must engage in learning as a core competency.

There are three broad areas which a board must learn: leadership and management, stewardship of resources, and public responsibilities. These overlapping and intertwined areas are embedded in nearly every significant issue that comes before board.

Leadership and management

The board’s first responsibility is to lead. Effective boards do so explicitly through strategic and management direction and implicitly through modeling clear purpose. Board members lead first and foremost by their personal and collective example. Their actions set the tone and direction for the organization.

A board of directors has the legal duty to manage the affairs of the corporation. For an organization with staff, this occurs when a board delegates the authority to act on its behalf to its senior executive. Once authority is delegated, the board manages through its senior executive. This requires establishing perfor­mance expectations and holding the senior executive responsible to accomplish them. While the board may delegate its authority, the board can never delegate the responsibility for what occurs as a result of its delegation of authority. They are the body legally accountable for the organization.

Stewardship

Stewardship is a board’s moral commitment and responsibility to its stakeholders and community at large. The board is entrusted with assets derived from others. During their tenure board members have the respon­sibility to manage those assets with absolute integrity. At the same time, the board is expected to use these assets effectively for the benefit of others.

Finally, the board is accountable for how (and how well) it has deployed the assets entrusted to its care. Good stewardship may require that the board maintain a higher standard than what is legally required in a given situation—and a high performing and ethical board seeks to maintain the highest of standards.

As stewards, boards are responsible for many different types of nonprofit resources (also called organizational capital). A nonprofit’s organizational capital consists of that unique combination of resources which result in its competitive advantage and ability to survive and thrive. Key resources include the nonprofit’s culture; integrity and reputation; human capital; social and political capital; intellectual and knowledge capital; program relevance and efficacy; and financial capital.

Too often when a board focuses on fundraising (i.e. acquiring financial capital) it fails to recognize its financial statements are lagging indicators of how well the nonprofit uses all of its organizational capital. Good stewardship and proper financial management require financial literacy, but the board must steward all elements of organizational capital.

Public responsibilities 

Most board members have had a basic introduction to the board’s three legal duties: to act in good faith and with the dual duties of care and loyalty throughout their board tenure. What these duties mean in a given situation may challenge a member and the board. If violated, they become the source of significant problems for both. Laws at the local, state, federal, and international level (for those organizations that reach beyond U.S. borders) also affect many board decisions and nonprofit actions. Most board members lack the technical and professional expertise to know these two areas and are well advised to retain experienced and independent outside counsel to advise them whenever legal matters arise.

In addition to its legal duties, the board also has a public responsibility on behalf of its nonprofit to sustain and improve the value stakeholders and the general public place on the organization. Stakeholders have both explicit and implicit expectations. Fulfilling stakeholder and public expectations provide for the nonprofit’s continuing relevance and existence.

Finally, a board always operates in the court of public opinion. Increasing transparency and rising public awareness and expectations for a nonprofit and its board present continuous challenges. Boards often are one incident away from this court. This is another reason why a board should establish and maintain the highest professional and ethical standards (an aspect of stewardship described above).

Educational opportunities

An effective board first determines how best to use its members’ skills and knowledge by systematically engaging in deep learning about its nonprofit’s needs and capacity to fulfill its mission. It then establishes priorities and secures resources to meet them. This is the essence of a board’s responsibility to manage its nonprofit. No board knows everything needed to handle its three core areas (leadership, stewardship, and public responsibility). With skill and knowledge gaps identified, the board can avail itself of many learning opportunities.

There are nonprofit programs offered by nonprofit associations, universities and community colleges, IRS resources, and webinars. Consultants and trainers can provide individualized board training programs. Publications, articles, and websites offer useful reference materials. External professionals can provide a board with needed expertise. Board members can also teach one another about topics affecting their nonprofit. Many boards set aside a portion of each meeting for some educational activity—either learning about the organization itself or about skills that deepen its leadership, stewardship, and public responsibilities.

A board must remain relevant and effective if their nonprofit is to succeed and thrive. Ultimately, effective nonprofit boards realize learning must be their core competency. Their devotion of time and resources to education pays off in a better functioning board—and a better operating nonprofit.

This story was first posted by First Nonprofit Foundation.

Marty Martin, J.D., M.P.A., of Martin Law Firm in Raleigh provides legal services and training related to nonprofit and tax exempt organizations. He recently presented a webinar for Philanthropy Journal titled “How to Start a Nonprofit: A Step by Step Guide.” It is available for download at our webinar archive.