SONI Results – Segmentation & Asset Allocation

Alternative investments span a wide variety of investment vehicles. It’s important to understand the risk involved when choosing to invest in alternatives.

Nonprofits face a very difficult choice when deciding whether to invest in alternative investments— particularly hedge funds. Nonprofits that rely on investments for current spending require a high level of return to maintain their impact. They may also be risk averse. It’s no wonder that investments that seek to earn “equity-like” returns while experiencing “fixed income-like” risk are appealing.

In our professional judgment, since the 2008–2009 financial market collapse, such alternative strategies have largely disappointed. As a result, nonprofits may reasonably question the wisdom of investing in speculative markets with little transparency, liquidity constraints, and high fees. At RWM, we believe that risk and return are directly related. As such, greater-than-market returns are only available by assuming greater-than-market risk. Larger organizations with the willingness and ability to take on greater risk and whose leadership maintains the sophistication necessary to understand non-traditional market risks may reasonably decide to allocate to alternatives.

In our opinion, however, any nonprofit—regardless of size or sophistication level—that reasonably decides to forgo allocating to alternatives is not doomed to suffer lower return expectation.

The rise of Socially Responsible Investing (SRI) enables nonprofit organizations to better align their mission and vision with the investments they choose to make. When thinking about implementing an SRI policy, a variety of issues need to be reviewed and documented before being added to an Investment Policy Statement (IPS).

The first step in developing an SRI component to your IPS is identifying which specific criteria your organization would like to avoid or emphasize in order to have its values reflected in its investments. We recommend implementing a thorough process to make sure that all board members are in agreement about what values are to be reflected and to make sure they are not personal values, but organizational values.

Next, determine whether direct or indirect exposure to the companies your organization wishes to exclude or promote in the portfolio is acceptable. Direct exposure comes from buying individual companies’ securities on the open market, while indirect exposure reflects owning shares of a mutual fund or Exchange Traded Fund (ETF) where a fund manager purchases securities as holdings of the fund.

If the organization is comfortable with indirect exposure to the companies it wishes to exclude then all mutual funds and ETFs could be used as investment options since your organization wouldn’t directly hold shares of those companies. If your organization is already invested in mutual fund or ETFs then no changes would be required from the addition of an SRI policy. If your organization is not comfortable with indirect exposure, your investment options become limited to SRI funds or separately managed accounts. When choosing SRI-focused mutual funds or ETFs, make sure to review the fund’s prospectus to analyze the fund manager’s screening criteria and confirm that they align with the goals and objectives of your organization’s SRI policy.

Determining which companies your organization wishes to avoid or emphasize, along with the type of exposure to those companies that is acceptable, will lay the foundation for implementing a socially responsible investment plan for your organization.