What’s Unique About Nonprofit Investing?

Managing investments for a nonprofit is significantly different than investing assets for yourself. In fact, there are legal and ethical requirements that need to be considered. The Uniform Prudent Management of Institutional Funds Act (UMPIFA) provides standards and responsibilities that those overseeing nonprofits must adhere to¹[1].  We have outlined eight key areas that make nonprofit investing unique and which need to be considered by fiduciaries when investing their cash assets.

Understanding Your Organization’s Risk Profile

Knowing your organization’s risk profile is the first step in investing your organization’s cash assets.  It’s vital for establishing the portfolio’s performance expectations and brings structure to the investment program that ideally enables you to remain disciplined to your investment strategy.

We recommend going through a process to understand the organization’s ability and willingness to take risk with its cash assets that includes reviewing your financials, having discussions about current and future operating expectations with executive staff and Board members, and conducting a risk tolerance survey with members of the Finance Committee/Board.  A survey can be helpful to give everyone an equal say and help reduce any one Board member’s strong opinion from dominating the decision making process.

Factors including greater diversity of revenue, more reliable income streams, and a long time horizon give an organization the ability to take on more risk within a portfolio, while concerns about future operations and concentrated revenue streams could drive a more conservative investment portfolio.  Making sure the ability to take risk aligns with the willingness to take risk is a key factor as well.  If an organization has a limited ability to take risk, but the Board has a willingness to take risk with a more growth-oriented portfolio and the market sees a significant pullback, the portfolio could see large declines when it’s needed most.

Changing Financial Conditions Require Ongoing Policy Support

Nonprofits frequently have multiple goals for their cash assets.  Some dollars are there to support the long-term mission of the organization and have no immediate need.  Other funds could be needed in the next few months to meet operating expenses.  As a result, it’s important for organizations to segment their cash assets based on goals and expected timing of cash flows.  This can help maximize the overall cash assets of the organization, maintain the purchasing power of the organization’s funds, and help avoid realizing losses.

There are many ways reserves can be segmented.  Some common reserve types include:

Board Restricted, Emergency, Strategic and Long-Term Reserves.  These frequently have five plus year time horizons, typically have a mix of stocks and bonds, and have growth of the portfolio as a primary goal. 

Other reserve types include Legal Defense Funds, Conference Insurance Funds, Short and Intermediate Term Reserves.  These typically have shorter time horizons, are invested more conservatively, and have capital preservation as a main goal. 

Finally, Cash or Operating Reserves help manage excess cash on hand that is likely needed in the current budget year.  Very high-quality fixed income and cash equivalents are frequently used in these reserves.  These portfolios have become much more common given the increase in short-term interest rates we have seen over recent years.

With the proper investment structure in place, it’s then important to frequently revisit the dollars held in each reserve type and if those amounts still make sense.  Financial conditions of an organization can change fast if donations come in lower than expected, or if the annual conference performed better than expected.  Making sure that reserve balances are adjusted to factor in the organization’s changing operating position can help ensure the long-term sustainability of the organization. 

Board Turnover Necessitates Ongoing Education

Given the frequency that Boards turnover, making sure that new Board members are educated on investment policies and how those policies were determined is crucial.  We recommend documenting how policy decisions were made by recording and outlining the process in a memo.  This can then be shared with current and future volunteers so they can understand the process the organization went through.  In addition, we recommend all Finance Committee meetings begin with a review of the current polices so that all members can consider if they still make sense for the organization, or if changes based on the current operating position of the organization should be considered.

Relative Performance

It’s essential to have a static benchmark that is defined in your investment policy to serve as the performance expectation for your organization’s investment portfolio.  The static benchmark should mirror the target asset allocation of your investment portfolio.  For instance, if your policy indicates a target of 50% to stocks and 50% to bonds, your static benchmark should also be 50% stocks and 50% bonds.  The benchmark brings context to performance results.  It can remove emotions from decision making allowing for objective evaluation.  Finally, it makes oversight of the investment reserve straight forward enabling the board to focus on strategic planning.

Downside Protection

If the portfolio experiences a decline beyond what an organization is comfortable with, it likely will spur changes to investment strategy at the worst possible time.  Downside risk can be limited by including restrictions in your policy.  On the stock side of the portfolio, diversification requirements limiting security, sector, and country concentration can reduce risk.  On the bond side, including a minimum weighted average credit quality and maximum weighted average maturity for the portfolio can limit the degree of volatility experienced.

UPMIFA and Investment Fees

When a nonprofit organization is investing its reserves, it’s investing “other people’s money.”   The organization and the Board are stewards of these funds.  UPMIFA outlines standards for managing investment assets held by nonprofits and importantly states that nonprofits may incur only appropriate and reasonable fees.  What are the fees a fiduciary should be responsible for knowing in the management of a nonprofit’s investment portfolio?

There are three main areas: 

1. A fee paid to an investment adviser that provides policy support, investment management, reporting, Board education, and administrative services.
2. Fund manager fees which are fees charged by the funds that the investment adviser recommends, commonly known as expense ratios.
3. Other expenses including account custody fees, transaction costs, cashiering fees, and administrative fees.

Fees impact performance.  All else equal, the lower the fees the more likely you are to outperform your portfolio benchmark.  However, are higher fees always bad?  The best way to evaluate if your fees are reasonable is to compare your portfolio performance to a static, neutral benchmark.  If your portfolio’s net of fees performance is better than your benchmark, then you are receiving value add for the fees you pay.

Concise, Custom Reporting

Volunteers have limited time to spend reviewing investments.  It’s important that their time is used in an oversight capacity and focused on best positioning the organization for the future.  Thus, it’s important that the reports shared with the Finance Committee or Board are concise and clearly convey:

-How Reserves are segmented to ensure that aligns with the organization’s operating expectations moving forward
-Investments are in compliance with the guidelines and restrictions outlined in the policy
-Benchmarking that shows the portfolio is performing in line with expectations

Financial Statement Sensitivity

It’s important for your investment adviser to know your organization’s fiscal year and operating position to ensure when they are making trades that they don’t make trades that negatively impact the financial statements.  An organization could have a positive net income, but if a loss is realized in the portfolio, it could turn that positive net income to a loss.  This could then negatively impact an organization’s perception amongst its stakeholders.  Communication between staff and the investment adviser is key.

Conclusion

There are many reasons that nonprofit investing is unique.  It’s incumbent upon staff, the Board, and the investment adviser to ensure that the organization’s cash assets are managed considering these key points to maximize the organization’s impact.

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Better understand the intricacies of nonprofit investing with our comprehensive guide detailing What’s Unique About Nonprofit Investing.  Partnering with an investment adviser that knows you is key to the effectiveness of your investment program.  Learn why understanding the nuances of nonprofit investing matters from someone who knows – Raffa Investment Advisers. 

Download the PDF by clicking below to explore tips (and more) to empower your organization and make better informed investment decisions.

 

1. As of 2012, UPMIFA is the law in 49 states, the District of Columbia and the U.S. Virgin Islands.  Neither Pennsylvania nor Puerto Rico has adopted UPMIFA. ↩︎