“We don’t need any policies.”
That was an actual quote from a nonprofit board member in response to whether the organization should establish an Investment Policy Statement to govern the organization’s endowment. A policy and procedure nerd like me was horrified at the lax approach to nonprofit governance. Policies can be interpreted as unnecessary, bureaucratic rules that limit flexibility, yet a clear and concise Investment Policy Statement that spells out nonprofit leadership’s roles and responsibilities in managing the restricted endowment or unrestricted board-advised fund can limit losses when problems arise and ensure leadership is working and communicating effectively in fulfilling the fund’s mission.
Continuing our series on endowments (read Endowments 101), the Investment Policy Statement (IPS) sets out standards for the nonprofit endowment that are maintained throughout the life of the endowment, keeping fiduciaries accountable for its supervision. A sound IPS is specific enough to avoid leaders from doing whatever they want to chase returns, but dynamic enough to be relevant in many economic or governance scenarios. The IPS should also be simply worded so any nonprofit board member should be able to follow the essence of the policy without a great deal of investment expertise.
A robust nonprofit IPS has two main purposes:
- It defines the responsibilities and standards of conduct consistent with applicable law for the Nonprofit Board and, if relevant, any investment professionals the nonprofit hires to manage the fund.
- The policy creates the investment framework for a well-diversified portfolio that can be expected to generate acceptable long-term returns at an acceptable level of risk.
Let’s explore these areas of the investment policy statement in more detail.
Investment Management Standards of Conduct
The Nonprofit Board typically delegates authority to oversee the management of the endowment or board-designated fund to a specific committee, such as the Finance Committee. Any decisions the members of this committee take with respect to the fund, must consider the purposes of the nonprofit organization, the purposes of the fund and, if funded by a restricted gift, the intent of the donor. Additionally, those responsible must manage the fund in good faith and exercise due care and skill as if the funds were their own. This responsibility is the core of the Prudent Person Rule.
The Prudent Person Rule originated from an 1830 US trust case Harvard College v. Amory. Harvard College and Massachusetts General Hospital sued the trustee of a legacy gift, Francis Amory, for mismanaging the funds. An appeals court held that Amory was not liable for losses to the fund.
- Specifically, prudent investment management considers the following factors:
- General economic conditions,
- The possible effect of inflation or deflation,
- Expected tax consequences, if any, of investment decisions or strategies,
- The role each investment or course of action plays within the overall investment portfolio of the fund,
- The expected total return from income and the appreciation of investments, and
- The needs of nonprofit and the fund to make distributions and preserve capital.
Investment Goals and Objectives
In managing the endowment, the nonprofit’s governing body and its delegates must ensure the fund,
- preserves purchasing power (read more on purchasing power here),
- provides funds to continue the nonprofit’s services and
- minimizes year-to-year volatility to avoid forced liquidation or, in other words, selling of critical investments.
What does that mean?
In this instance the policy is establishing the risk profile of the fund, based on the time horizon, return expectations and liquidity needs. There is a close relationship between these three factors and, as a result, specific tradeoffs.
- The longer an endowment’s time horizon, the greater volatility, measured by the size of the
swings in the market, the fund can withstand. - The greater the risk, there is generally a greater expectation of return or gain a fund may experience based on historical performance.
- But with greater risk/volatility is also a greater expectation of loss vs. less volatile investments.
- The more liquid a fund must be or the shorter the time horizon before funds are needed, the less volatility a portfolio can withstand and therefore, has a lower return expectation.
This risk/return tradeoff determines the appropriate mix of investments. You can read more about risk appetite here.
An IPS should be reviewed and revised periodically to ensure it adequately reflects current circumstances. Ultimately, nonprofit leadership should be comfortable with a document that reflects the investment needs of the organization and respects the expectations of its donors.
Download an example Investment Policy Statement template here or contact Fairlight for any questions you might have about customizing an IPS for your nonprofit.
Talk to the financial experts at Fairlight Advisors to learn more about managing your nonprofit’s investments. Schedule a free consultation today!
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