An investment policy is a road map for your non-profit portfolio. It guides your investment program, specifying the risks you’re willing to take and the goals you’re trying to achieve.

It should be the first step when an organization funds a portfolio, but it is not a ‘set it and forget it’ type of document. It requires regular updates to stay in good working order, especially if the characteristics and needs of your organization have changed.

Here are four important considerations to help make sure your investment policy is well positioned for the future:

Framing Your Goals

Some portfolios use a specific return target. That can be helpful, but only up to a point.

We find it more useful to frame your goals in terms of what they mean for your organization. What kind of support is the portfolio intended to provide? Over what length of time does it need to provide it? What kind of variability in support is acceptable?

Define your objectives in a way that’s specific to your organization (e.g., your withdrawal needs, time horizon, risk tolerance, etc.). Doing this helps acknowledge that your investment results have real world consequences. It provides more insight to board members and advisors, and it recognizes that it’s okay to have year-to-year variation around return targets, assuming you and your manager keep an eye on the portfolio’s overarching goals.

Aligning Guidelines and Constraints

Once you’ve framed your goals, it’s important to set guidelines and constraints for how a portfolio should be managed. This includes growth and preservation priorities, allocation and diversification limits, restricted securities, and environmental/social/governance considerations.

Alignment is the key word here. These are not one-size fits all decisions and failure to align your goals with your guidelines is a recipe for disappointment.

One common mistake is a portfolio with a high withdrawal need and a high allocation to volatile securities like stocks. When volatility hits, the portfolio can be forced to fund withdrawals by selling securities at depressed prices, making a recovery more difficult. It’s also common to see a portfolio with an infinite time horizon (i.e., in the case of an endowment) positioned too conservatively. For these types of portfolios there is a risk of failing to grow in excess of inflation and gradually losing the purchasing power of its assets.

Clearly there’s balancing act to aligning goals and guidelines and there’s certainly room to interpret differently the best approach for a portfolio. But at the very least, it’s important for a board to have regular conversations about how a portfolio will achieve its goals by actively reaffirming its guidelines.

Considering Flexibility

It’s no great secret that investment returns can vary, even over long-term periods. Large cap US stocks have averaged returns of over 10% per year since 1926, but they’ve also experienced periods as long as 20-years where average annual returns were as high as 18% or as low as 2%.

It takes skill to manage shifting environments like this, but too many policies don’t provide the flexibility to try. Many utilize specific asset allocations targets that remain fixed over time. A given target might make sense when your organization adopts its policy, but inevitably, market environments change, potentially leaving your portfolio poorly positioned going forward.

We believe it’s better to use a range of permissible allocations, rather than hard targets. This lets investment advisors adjust the allocation over time to take advantage of opportunities and avoid areas of risk. For example, holding more stocks when valuations are attractive or owning an alternative, like bonds, when stocks become less attractive. Building flexibility directly into your policy can be your most effective tool for helping a portfolio reach its goals regardless of the market environment.

Integrating UPMIFA

The Uniform Prudent Management of Institutional Funds Act (UPMIFA) is the law of the most of the land when it comes to endowed assets. It’s a template law – each state, except for Pennsylvania, has drafted and passed its own version.

Its purpose is to govern the management and expenditure of funds that have been donated to charitable institutions. UPMIFA says that endowed portfolios must have an investment policy, although it leaves the exact content up to the board. UPMIFA does, however, provide a list of very specific factors that it says must be considered in the management of the portfolio and when withdrawing funds. A full list of these factors can be found in the text of the law for your respective state. Best practice is to integrate UPMIFA factors and guidelines right into your investment policy, making it explicit for all parties and stating your intent to comply with UPMIFA.

It seems like uncertainty is the number one concern for non-profit investors today. Our recommendation for boards and other non-profit leaders is to focus on what you can control. First and foremost is your investment policy. Keeping your policy in good working order can help position your organization for long-term success, no matter what the short-term throws at us.

Large cap US stocks mentioned within the article are represented by Ibbotson Associates SBBI US Large Stock Index.

Ibbotson Associates SBBI U.S. Large Stock Index (Ibbotson U.S. Large Stock) is an unmanaged index representing the broad U.S. large cap stock market. The index returns do not reflect any fees or expenses. Index returns provided by Morningstar.

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