Commentary: Nonprofits and Investing: Goals, Governance and Giving

Source: Giving Forum Winter 2012 01/27/2012

In order for nonprofits to successfully address severe problems like poverty and increase equity in our communities, they must also manage their money well. Douglas Neimann, Okabena Advisors chief investment officer, has spent years directing investments for the Dayton family and many philanthropic and nonprofit organizations, giving him a unique perspective on how investment and nonprofit cultures can work together effectively. He shares his views here.

Q: What makes nonprofits unique?

A: I like to talk about three main areas: goals, governance, and giving.

Nonprofits have unique combinations of goals that require a different approach to investing. They may have a variety of investment time horizons, operational spending needs, and liquidity requirements – all of which must be factored into an overall investment strategy.

Some nonprofits rely heavily on investment income to support annual budgets. These dollars are not easily replaced by other revenue sources, which affects risk tolerance.

Others use investments to fund initiatives whose timing can greatly impact asset allocation strategies. Liquidity is a major issue for those that want to tap investment principal for short-term needs; however, a desire to maintain liquidity to meet short-term commitments usually entails a
tradeoff on potential return.

Q: That’s a complex set of issues. Is it the job of governance groups to address them?

A: It is, but nonprofit governance structures are diverse in their own right. In a family foundation, governance often falls in the lap of one or two people who see the funds as their money and view key decisions as theirs alone. In larger organizations, governance is typically done by a complex collection of trustees, investment committees, staff, and others, all of whom have different levels of investment experience and expertise.

Confidence and actual investment knowledge are not necessarily correlated. However, those involved in nonprofit governance typically share a sincere desire to provide good stewardship. Their concerns – when accompanied by strong opinions and style traits like flexibility and personality – make for a complex dynamic.

The most effective tool I’ve seen for ensuring productive interaction between governance and investments is to be very intentional about setting and confirming clear expectations.

Q: How about the last “G” you mentioned, giving?

A: For most nonprofit organizations giving is the biggest determinant of cash flow, but giving behavior can be as irrational as investment markets. It’s critical for anyone helping a nonprofit with investment decisions to understand that the organization’s cash flow might be subject to multiple emotional and relationship-based factors.

People’s ability and willingness to give is often correlated with their own security. When societal confidence and security are threatened, particularly by dour financial times, giving and investment returns decrease. This creates a feast or famine cycle for nonprofits, and the more short-term and aggressive an organization’s strategies, the more susceptible it is. This has driven some organizations to take an increasingly long-term investment approach, providing it is compatible with liquidity and operational budget requirements.

Q: How can investment committees work more effectively?

A: The most important success factor for any investment committee is to ensure its investment strategy is driven by the organizational mission and vision. Positions on risk tolerance and investment horizon should reflect the organization’s goals, not the biases of committee members.

It’s also important for an investment committee to know its strengths and weaknesses. Committee members typically have a range of expertise and different levels of time and energy.

Productive committees consider this and explore options to facilitate informed participation by all. For example, more experienced committee members could be asked to write and share white papers on key issues, and less experienced members could be offered training.

Investment committees must also realize that the markets will not respect their schedule. When market conditions require strategic decisions, committees need scheduling flexibility or an agreed-upon decision-making authority to enable timely action.

Q: What are the common investing mistakes nonprofit organizations make?

A: They’re often the same other investors face. The biggest one is focusing too much on the short-term. While long- and short-term are relative based on an organization’s vision, all organizations can fall into the trap of focusing too heavily on month-to-month and quarter-to-quarter performance despite longer investment horizons.

Similarly, many fall prey to the “one-cycle-behind” phenomena. It’s intuitive to think the best predictor of future performance is past behavior, but solid decisions are based on a blend of what was, what is, and what’s ahead.

Another pitfall is the temptation to define risk and performance as one-dimensional factors. Risk is thought of as willingness to stomach volatility, and performance is equated with returns. Narrowly defining these concepts is dangerous.

During the last ten years, many became victims of Ponzi schemes and suffered losses in funds overly leveraged in sub-prime assets. In both cases, returns were unusually constant over time, but this lack of volatility combined with healthy percentage gains generated confidence instead of raising warning flags about integrity and sustainability. This overconfidence ultimately had disastrous consequences for many.

Performance and risk are contextual and are better thought of within parameters such as investment timeframe, volatility, cost and liquidity. Ideally, returns are then measured against one or more benchmarks where the same parameters can be defined.

Q: Do you have one last piece of advice on maximizing investment efforts?

A: Make sure you have an investment philosophy capable of carrying you through good times and bad.

Market anxiety – accompanied by volatility – may or may not indicate a market paradigm shift. However, the combination of anxiety and volatility greatly increase the perceived need to do something, and they also amplify the chance of doing the wrong thing.

Committees can counteract these urges by obtaining outside perspective, evaluating current and anticipated market conditions in the context of their investment horizon, and determining if the market is truly in a paradigm shift. By applying these tactics, organizations can greatly increase their chances of making sound investment decisions. They’ll also be better positioned to keep their investment approach in alignment with their strategic goals.

Okabena Advisors specializes in managing investments for foundations, endowments and other nonprofit
organizations. www.okabena.com