Nonprofits Struggle in Era of Lower Returns, Ongoing Volatility
By Hal M. Bundrick
NEW YORK (
)--Clinging to investment strategies of the past may make it more difficult for nonprofits to generate sufficient income for their needs. In a just-released report entitled
U.S. Trust says that in an era of lower returns, ongoing market volatility and greater scrutiny from regulators, government agencies and donors, nonprofits relying on investments to span a shortfall of donor contributions will struggle if they rely on the traditional 60/40 stocks/bonds allocation.
"For the first time in years, perhaps decades, foundations, endowments and other nonprofit organizations question whether they will have the financial resources to continue to fulfill their missions," says Keith Banks, president of U.S. Trust. "To meet current and future needs, nonprofit organizations are urged to reach beyond traditional strategies and realign their approach to investing, spending and governance around the distinct mission and goals of their organization."
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Since peaking in 2007, donor giving experienced a sharp decline in 2008 followed by subsequent modest annual gains. Nonprofit contributions rose 3.5% in 2012, according to the Center for Philanthropy at Indiana University.
"Hospitals, colleges and universities, charitable foundations and other nonprofits have a distinct need for cash to fund current spending needs and, at the same time, a need to grow the purchasing power of their principal," says Christopher Hyzy, chief investment officer of U.S. Trust. "These needs are typically reflected in a traditionally conservative 60/40 percent mix of stocks and bonds. The typical nonprofit portfolio lost one-quarter of its value in 2008, the height of the financial crisis. While other individual and institutional investors have recouped much of their losses, many nonprofits continue to struggle."
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The research offers key advice for nonprofits:
- Rethink strategic asset allocation. Strategic asset allocation should marry two critical components of goals-based investing: forward-looking market expectations and selection of asset classes in appropriate proportions to generate incremental returns through good and bad markets.
- Diversify the portfolio to manage both risk and return. Optimal asset allocation strategies should include diversification with global and nontraditional investments such as real estate, private equity, commodities and hedge funds, not only to manage risk, but to drive incremental return. Of course, diversification cannot ensure a profit or guarantee against loss.
- Employ tactical asset allocation. By actively managing asset allocation and manager selection, nonprofits may generate additional return through tactical adjustments that increase or decrease exposure to near-term market changes.
- Analyze cash flow needs and set appropriate liquidity levels. Because cash on hand is forecast to earn a negative return when inflation and fees are taken into account, excess liquidity in a low-return environment can be detrimental.
- Adjust spending rates and investment strategy to meet both present and future goals. A proper spending rate is a critical factor in a nonprofits long-term sustainability. Boards have a fiduciary responsibility to balance the immediate needs of the organization and current beneficiaries with the expected needs of future generations.
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"The implications of negative return years and market volatility on spending are particularly problematic for mission-driven organizations," said Joe Curtin, head of U.S. Trust's Institutional Investments Group. "Nonprofits are finding ways to do more with less, but if they want to expand their mission and sustain it for future generations, they need to embrace more creative responses to new market realities."
--Written by Hal M. Bundrick