The primary document governing investment decision making by fiduciaries is the investment policy statement (IPS). The fiduciaries are the board and finance committee members, as well as senior management.
However, sometimes fiduciaries do not treat the IPS as an important tool and consider portfolio strategies to justify the Board’s current view of the market. A well thought-out IPS should serve as the portfolio business plan.
There are three obligations that fiduciaries must fulfill which can be addressed in the IPS. The first is reasonable basis suitability, which requires the fiduciaries to have sufficient understanding of the risks and rewards of the securities and investment strategies. The second is for organization-specific suitability. This obligation must address issues like time horizon, liquidity needs, risk tolerance, investment objectives, and other investments owned. The fiduciaries must reasonably determine, based upon the information gathered, that specific recommendations are suitable for the investment portfolio. Finally, the fiduciaries must determine that investment recommendations are consistent with the organization’s best interests.
As a general rule, the IPS should be broadly written and never prevent the investment advisor from doing what is in the organization’s best interests. The IPS should have enough detail to execute the Board’s intentions. Investment objectives are broader than simply a target rate of return and should include minimizing variability in returns, maintaining sufficient liquidity and reducing the probability of major losses.
Nonprofits should be prepared to address how they will respond to volatile markets and the possibility they may not be able to achieve their target investment return objectives. Options nonprofits can consider include lower payouts, increasing the risk profiles of their portfolios, accepting lower returns, adding to their portfolios and improving the portfolio structure and process to seek better risk adjusted returns. IPS adjustments should never be made during times of stress.