Sharon Liebowitz ʼ91GSAPP is the CEO and co-founder of Meritam Investment Advisors. Meritam designs high quality, low cost investment strategies specifically for nonprofit reserves and endowments. Learn more at www.meritam.org
With over $4 Trillion in assets held by almost 2 million nonprofits across the US, there is an enormous potential for making investment mistakes.
July 6, 2016
You cannot read the news these days without seeing a story about nonprofit that mismanaged its investments. This is problematic for nonprofits – as poor financial management can lead to collapse.
This is also problematic for board members. The board is responsible for investments and they can violate their fiduciary responsibility if they do not act with proper care. Responsible investing requires good governance, strategy, planning and execution.
This is the first of a two-part article describing top pitfalls facing nonprofit investments, and focuses on governance and strategy. High performing organizations steer clear of these pitfalls. Organizations making these mistakes aren’t doing the best they can to protect their hard won capital.
Part 1 – Governance and Strategy
- Allowing weak governance.
Governance is the process of decision-making in an organization. Weak governance means that the board is not providing sufficient oversight, resulting in poor decisions. Weak governance can have disastrous results for investments. For example, finance committees can end up approving a spending policy that’s too high, and that can drain an endowment. Or, on occasion, a board becomes jittery during volatile markets, ignores their investment policy, and pulls investments from the market. This happened quite frequently during the financial crisis of 2009. Some organizations’ investments have still not recovered.
Markets and people can be unpredictable, but having the right governance in place brings better decision making, clarity and accountability.
- Having no Investment Policy.
All nonprofits should have an Investment Policy; in fact, it is currently required by law in most states. An investment policy documents the investment strategy of your organization, including how your investments support your mission, the level of investment risk, and a target asset allocation. One of the most important things you can do is to make sure your investment plan works from end-to-end – from strategy to execution – and write it down. An investment policy helps boards stay on track. This is especially important as board members change over time.
Investment policies should reviewed annually.
- Not understanding risk.
Taking the appropriate level of investment risk is key to ensuring your organization’s financial sustainability. Some nonprofits – especially small and midsize ones – are inherently conservative when it comes to managing money. They choose to take no risk and keep their funds in cash in their local bank believing that this will protect them against a downturn in the financial markets. However, too little risk means funds cannot keep pace with inflation, and this in effect reduces the purchasing power. The reverse, taking too much risk, means an organization can find itself with severe losses during a market downturn. These losses may not be recoverable.
Often we have seen organizations that struggle to talk about risk in common, easy-to-understand terms. This is a problem easily addressed by using risk spectrums shown in many online tools. These risk spectrums describe risk in return in terms of basic numbers like average returns and worst losses experienced, among others.
Once you’ve agreed the appropriate level of risk, document it within your Investment policy.
Part 2 – Planning and Execution
This is the second of a two-part article describing top nonprofit investing mistakes. This part focuses on investment planning and execution. It follows from part 1 that discussed governance and strategy.
Your investment plan should work end-to-end. Despite good intentions, organizations often jump into investing without a clear understanding that the way they invest should be connected with the needs and goals of their organization. A key role of board members, as fiduciaries, is to understand how your investment strategy is being implemented and confirm that it remains in alignment with your policies.
But your responsibility does not end there. Boards should monitor investment performance on a quarterly basis. In addition, as new investment opportunities arise, boards must be sure to tie these decisions back to the stated investment policy. This knowledge allows you to ensure that your investments are consistent with your organizations needs and constraints.
- Not doing diligence on fees.
Many nonprofits are unaware that they wasting money on two types of investing fees – fees for advice and fees for products – that don’t serve the interests of their organization. Average fees can total 2% or more every year. It’s not enough to understand your current fees; an organization should investigate other options that deliver similar quality at lower cost.
The need for awareness on fees is especially relevant given the fast pace of change in investment management services and products. Nonprofits need to both educate themselves about many new investment services that are available in the market and also deliver quality advice but at a lower cost. In addition, new high quality, low cost products such as index funds and ETFs (exchange traded funds) are now commonly available. Check and see if index funds that track major indexes are a good fit for your organization.
This diligence potentially saves a lot of money – a nonprofit with $1M in investments can reduce fees by ~ $20,000 each year by using low cost advice and products. This savings will compound over time, boosting investments even more.
Fees may not always be transparent – and this is all the more reason for diligence.
- Not understanding the financial products held.
Financial products can vary widely in terms of risk and cost, and it’s important that you understand both. We’ve heard too many stories of nonprofits being sold risky and unsuitable products that can lose value entirely. In terms of cost, actively managed funds can have fees that can be 20 times greater than passively managed (index) funds. High fees eat up returns.
Studies have shown that asset allocation accounts for about 85 – 90% of a portfolio’s performance over time. This means performance is less about the specific products you hold, so don’t get swayed by stock-pickers or the latest hotshot fund that promises to deliver a silver bullet.
- Not getting the right type of financial advice.
Nonprofits must carefully evaluate the type of financial advisor they choose – based on their fees, their strategy, and, perhaps most importantly, whether they are a fiduciary. The advisor who is a fiduciary is required by law to put the client’s interest ahead of his own. Far too often we see boards choose a big bank – because the brand name gives them a sense of security – without understanding the fees involved for the service and whether it’s acting as a fiduciary.
If you’re not sure, ask your advisors how they get compensated and whether they are a fiduciary. Note that the new Department of Labor (DOL) law requires all advisors handling retirement accounts to act in the best interest of their clients starting in 2017, but the DOL does not have jurisdiction over nonprofits’ organizational assets.
- Assuming Impact Investing is a silver bullet.
Lots of organizations are excited about impact investing. We all understand the appeal of investments that allow nonprofits to pursue their mission through investments. However, nonprofits need to be aware of some problematic dynamics. The first is that investors and entrepreneurs may benefit at the expense of the communities they promised to serve. The second is that impact investments may underperform because they often cost more than other financial products and are typically less diversified than other portfolios. The result is that impact investments could be at odds with a board’s responsibility to safeguard and build organizational assets. Make sure your organization understands the downside and communicates it clearly.
- Not monitoring investments.
Monitor your statements regularly for consistency with your investment plan. Monitor quarterly for performance and at least annually to confirm asset allocation remains consistent with your investment policy. Confirm that your assets are performing similarly to similar assets. Ensure funds continue to meet financial demands such as an annual spend. If you do need to make changes, start by reviewing the strategy your organization documented in its investment policy.
While many of these mistakes seem obvious, we have seen even well-known organizations fall prey to them.
BIO: Sharon Liebowitz is the CEO and co-founder of Meritam Investment Advisors. Meritam designs high quality, low cost investment strategies specifically for nonprofit reserves and endowments. Learn more at www.meritam.org
Disclosure: Meritam Investment Advisors, Inc. is registered as an investment advisor with the SEC and only transacts business in states where it is properly registered, or excluded or exempted from registration requirements. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors on the date of publication and are subject to change.