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Balancing spending and asset appreciation

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Question:

What are three tips for nonprofits on managing their endowments?

Answer:

* Establish appropriate investment and spending policies.

Investment policies should reflect both spending policy and capital-appreciation goals.

Many organizations, particularly smaller ones, fail to perform the necessary due diligence required to create an investment policy statement.

Rather, they often simply borrow the policies of another organization, sometimes an unrelated type of organization.

They can develop their own policies either with the investment committee of their board, or with outside help from a qualified financial institution.

A lot of time and energy goes into constructing these policies, and once they are in place, organizations need to consistently follow them.

For example, many nonprofits fail to rebalance their asset allocations when they drift from their stated allocations. Nonprofits should review their portfolios at least quarterly to make sure things are in line with the stated guidelines.

* Plan for the long-term.

Often there is tension between the investment goals of a nonprofit and the actions of its board.

Unchecked, that tension can hurt an organization’s potential spending policy, as well as its long-term asset appreciation.

Board members usually serve a stint of two years or so, so their mindset typically is shorter-term in nature.

Everyone would like to earn as much as possible to spend, but they have to be reasonable in setting a spending rate so that the contending goal of capital appreciation is not impaired.

At the same time, board members typically want to invest in conventional investments such as domestic equity and fixed income, where more controversial options, like alternative asset classes such as real estate, hedge funds, private equity or contrarian positions, might make more sense for not only the short run due to low correlations between asset classes, but also the long-term growth of the organization.

There’s a balancing act in meeting the dual objectives of spending and long-term appreciation.

Organizations need to develop a portfolio that has the ability to meet the needs of both objectives over a perpetual time horizon.

* Strike a balance between spending and assets.

Nonprofits should create rules for their endowment distributions that enhance the relationship between spending stability and asset preservation and appreciation.

You want to have rules that won’t bias current or future generations.  So you don’t want a huge allocation to fixed income because you won’t have any growth, but you don’t want all risky asset classes — or high-correlation asset classes – either, or you won’t be able to keep a stable spending policy.

By placing some automated decision-making into your investment and spending policies, you will achieve a greater balance between the two objectives over the long term.

Question:

What are three tips for nonprofits on managing their endowments?

Answer:

* Establish appropriate investment and spending policies.

Investment policies should reflect both spending policy and capital-appreciation goals.

Many organizations, particularly smaller ones, fail to perform the necessary due diligence required to create an investment policy statement.

Rather, they often simply borrow the policies of another organization, sometimes an unrelated type of organization.

They can develop their own policies either with the investment committee of their board, or with outside help from a qualified financial institution.

A lot of time and energy goes into constructing these policies, and once they are in place, organizations need to consistently follow them.


William M. Guthrie, CFA, CFP  is the Director of Charitable and Endowment Services for the Private Client Group at National City Corporation, a Cleveland-based bank. His group manages more than 1,500 not-for-profit accounts with assets of more than $3.5 billion.

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