When creating an investment policy statement (IPS), the endowment/foundation/nonprofit often has as the primary return objective the spending rate (including administrative expenses) plus the expected inflation rate.
This should allow the organization to spend as much on future residents or beneficiaries as is spent today. As a general rule, the IPS should be broadly written and never prevent the investment adviser from doing what the adviser thinks is in the client’s best interest. The IPS should have enough detail so that a competent third party could execute the statement, yet not so much detail that it will not. Too much detail in a market like we face today could cause changes in the portfolio that are not productive in the long-term.
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.
Historically, many nonprofits sought to achieve their investment objectives by having 60% in stocks and 40% in bonds. According to Ibbotson Associates, from 1926 to 2009, an investor allocating 60% to stocks and 40% to bonds achieved an annualized return of 8%, albeit with some turbulence. (Please note: As the time horizon stretches, the asset mix shifts further toward common stocks or other risky assets.) Many experts believe stocks will return less than 8% annualized returns over the next decade and bonds will return well under their 5% historical average.
Nonprofits should be prepared for the possibility that they may not be able to achieve their target investment return objectives. Options to consider include lowering payouts, increasing the risk profiles of their portfolios, accepting lower returns, adding new assets to their portfolios, and improving the portfolio structure and process in order to seek better risk-adjusted returns.
William C. Fisher is president of Investment Advisory Group LLC, a business development company partnering with some of America’s leading financial companies to provide independent financial services to nonprofit organizations.