When it comes to building an effective portfolio to fuel your organization’s goals and mission, there are points to consider and questions to ask your board, investment committee, and investment manager.

Having these conversations and achieving your goals isn’t always as simple as taking the straightest path forward. Goals change, markets are nuanced, and boards evolve. It is helpful, however, to hear what other organizations are doing as they work to grow their assets and endowments just like you.

So, based on conversations we’ve had with our non-profit partners, questions they’ve asked, and common areas of confusion, our non-profit specialists are sharing key takeaways you can utilize to help grow your endowment today and into the future.

Consideration 1: Given today’s market environment, non-profits should pivot to more attractive asset classes to maximize returns.

A community foundation approached us last year and asked, “Why shouldn’t we take all of our assets and earn a guaranteed 5% on short-term bonds?”

Our response was confident but admittedly made us hesitate for a moment. After all, earning about 5% a year on effectively risk-free investments did sound pretty good. Ultimately, though, a decision like this – like most other strategic asset allocation decisions – comes down to the goals that the organization has for its assets. If a pool of money is intended to provide short-term liquidity, with return generation being the icing on the cake so to speak, then earning mid-single digit interest on short-term bonds absolutely makes sense.

Like most non-profit investment assets, however, that was not the case here as the organization’s goals are much longer term and growth-oriented in nature.

With our acknowledgement of the real opportunity that exists in short-term bonds aside, there are two main challenges to de-risking a portfolio to such an extent for a long-term-focused organization: reinvestment rate risk and the risk of not meeting long-term needs.

1. Reinvestment rate risk, in other words, is simply the risk that while interest rates are quite attractive right now, that is not always going to be the case, and it’s difficult to predict what that path forward will look like. Earning 5% on one-year notes is great for that year. However, those assets then need to be reinvested at maturity, with the risk of such interest rates no longer being offered at that point a year in the future.
2. Perhaps the even greater risk for such an organization is one that impacts the long-term ability of its financial assets to provide needed support into perpetuity. Seeking out a 5% return – even at essentially no risk and even if it were to compound over an extended period – would be unlikely to support the organization’s need and grow that level of support into the future.

So, while taking on the risk of volatility through exposure to stocks or other “risk” assets in the pursuit of greater long-term returns may feel undesired at a time when bonds are offering interest at a level that hadn’t been available in quite some time, it remains necessary for non-profits that are seeking to generate investment returns that will provide the perpetual support they need.

While you’ll work with your investment manager on day-to-day investment decisions, having reliable policies are a necessity to inform those decisions and stay on strategy when managing your endowment fund. Learn the four must-have policies.

Consideration 2: Are you being complacent or consistent with your investment approach?

Being a successful investment manager for non-profits is about much more than year-to-year performance. It’s about having breadth and depth of experience navigating markets. It’s about understanding deeply what makes non-profit organizations tick and what they need. It’s about focusing on long-term outcomes above all else. And it’s about remaining consistent in the face of inevitable change within both markets and the organization itself.

A key distinction we discuss with many of our non-profit clients is between consistency and complacency. There are many parallels between the two but very different connotations and very different outcomes that result from each. While complacency can be disguised as consistency, and vice versa, the difference can be distilled down to one main idea: complacency is inaction in the face of risk or opportunity, while consistency is implementing a steady, disciplined, and repeatable approach in managing those risks and opportunities. This distinction can be applied to, say, the investment committee or board of a non-profit itself, and perhaps even more so to the investment manager tasked with the responsibility of stewarding the assets of that organization.

Consistency can come in many forms: sound formal policies governing the management and stewardship of an organization’s assets, a time-tested investment approach to that asset management, and a steady hand in setting and monitoring the investment objectives of the non-profit through and regardless of changing market conditions, to name a few. Complacency, on the other hand, can take the form of allowing regular due diligence of an investment manager to sit on the back burner or implementing an investment approach that doesn’t account for current risks or opportunities.

Let’s use an example to illustrate some of the nuances in these distinctions. An organization has employed an investment manager for many years and enjoys a strong relationship. As a result of changes to the non-profit’s income from fundraising and spending needs, they now need to rely on withdrawals from their assets to a much greater extent than they previously did. Complacency could rear its head in this situation if the manager and organization didn’t work together to amend their investment policy and ensure that an appropriate investment approach for those changing objectives was being implemented. Consistency, on the other hand, could take the form of being measured and diligent in revising the organization’s objectives and shifting the investment approach to reflect those objectives, and then crucially maintaining that approach through market environments while not overreacting to short-term market events at the expense of long-term goals.

Manning & Napier has decades of experience providing consistency in investment management through a variety of market environments and stewarding our clients’ assets with a focus on long-term outcomes. We can also use portfolio modeling to help you answer the “what ifs” for your organization – like ‘What if inflation is higher than expected?’, or ‘What if we take a more conservative or more aggressive approach?’ – and feel confident that your portfolio is set up for success. Learn more about portfolio modeling in this article.

Consideration 3: What’s the best way to set expectations and understand the results of our portfolio?

“Never try to cross a river just because it has an average depth of four feet.”

The best adages are both amusing and true – and this is one we reference often when discussing expectations. Someone crossing a river needs more information than just the average river depth in the same way that an investor needs more than just average returns when setting expectations and understanding results. What’s needed in both instances is context to help round out our understanding of outcomes and decisions. In the investing world, there are three types of important context.

1. Types of investments – Different investments have different characteristics and there are different ways to segment investments based on these characteristics. Broad asset classes like stocks, bonds, and cash have fundamentally different legal structures and protections, but there are additional categories within each of these classes as well. Stocks can be defined by style, market capitalization, business sector, and domicile. Bonds can be defined by credit quality, maturity, sector, and payment structure. Each of these classifications then have their own characteristics. For example, growth stocks are those that generally have higher rates of growth in their business and trade at higher multiples. Growth stock expectations and results might be different from value stocks, which are generally more mature businesses, trading at lower multiples. Board and committee members can look at how their portfolio is allocated across all these segments to gain a better insight into their portfolio.
2. Volatility – Volatility measures the range of different outcomes, either historically or expected, around the average. Board and committee members don’t need to be experts in market history, but they do need to familiarize themselves with the range of expectations for different assets. Stocks are a prime example. Large-cap stocks have returned about 10% per year on average over its long history, but there have been periods of time when returns have been much better and much worse. In about 1 out of every 4 rolling 1-year periods, stocks have a negative return. Stocks have a return of 25% or greater, also in about 1 out of every 4 rolling 1-year periods.
3. Current Conditions – Current conditions matter because there is a relationship between starting market fundamentals and future results. Speaking broadly, when assets are more expensive and/or economic drivers of growth more uncertain, future outcomes are more likely to be challenged, and vice versa. The strength of this relationship varies depending on the type of asset. For example, bonds are a little easier to predict than stocks because their underlying cash flows are more predictable. But for any asset class, it pays for board and committee members to work with their advisor to understand current market conditions so they can build expectations for future outcomes.

Non-profit leaders can use these different levels of context to set investment objectives, establish portfolio guidelines, and evaluate outcomes. They are the building blocks of being a prudent non-profit fiduciary.

At the end of the day, your organization’s needs and goals are the top priority when creating an investment plan to successfully grow your endowment that will support your short- and long-term objectives.

Your fundraising strategy is just as important as a strong investment strategy. When paired together, you can set your organization up to be able to serve your community for decades. With a variety of resources, templates, and actionable tips, this free toolkit can help you take your fundraising to the next level. Download yours today.

The information in this paper is not intended as legal or tax advice. Consult with an attorney or a tax or financial advisor regarding your specific legal, tax, estate planning, or financial situation.