Charitable Foundation Investing, with Endowments

It is vitally important that Foundations, Endowments, and Charities have customised investment programs to better support their very long-term goals.

Not only is a customised investment program important in meeting their investment objectives, such a robust process will also help them in attracting new donors.

This Post reviews a paper written by Cambridge Associates on how community foundations can develop customized investment programs to better support their long-term goals.

The key to success is to have exposure to a truly diversified range of investment risks and returns.  A more diversified portfolio is recommended which has better risk and return outcome than a portfolio solely reliant on Equities and Fixed Income.

A high listed equity allocation is detrimental to a portfolio that has regular cashflows i.e. Endowments, Charities, and Foundations.

The point is that Foundations, Charities, and Endowments can increase their overall diversification and this will provide stronger return expectations. They need to play to their strengths, which includes their longevity.

 

As Cambridge note in their paper “One of the most important roles of a community foundation is to steward philanthropic assets well. A thoughtful and disciplined investment approach increases the probability of generating higher portfolio returns and amplifies the foundation’s philanthropic impact.”

“Each Foundation has a unique focus on the needs and priorities of its particular community, which translates into a particular mix of assets under management.”

Implementing a successful investment program requires a customized approach that considers all the philanthropic funds under management, their role in supporting philanthropy and programs, and how they come together in the aggregate.

 

Cambridge argue that an investment strategy that employs the endowment model can differentiate a foundation in a vast landscape of options available to donors. i.e. they are likely to attract more donors.

The Endowment Model of investing can deliver on investment and stewardship goals, but the approach requires a deep understanding of risk, liquidity, and investable assets, and may not be the appropriate strategy for all assets under management.

The endowment model is anchored to four core principles: equity bias, diversification, use of less-liquid or complex assets, and value-based investing.

 

Therefore, given “that each organization brings a unique combination of circumstances, the development of the optimal investment program starts with an enterprise review. This provides a deeper understanding of a foundation’s assets, fundraising flows, and the role the investment assets play in supporting the mission. These factors frame the portfolio’s risk and liquidity, which are then reflected in investment policy and implemented in portfolio construction.”

To illustrate a more robust investment approach, Cambridge provide an illustrated example by creating a representative community foundation with $500 million in assets under management.

 

As you know, Foundations, University Endowments, and Charities deliver a range of philanthropic, programmatic, and investment services.

Community foundations lead and serve their local community, fundraise, and deliver programs. Like private foundations, they identify grant-making opportunities and support charitable causes with grants and program-related investments.

 

Tailored investment solution

“Once truly short-term philanthropy has been set aside, community foundations often find that the aggregate portfolio of funds is aligned with a long-term investment strategy, because spending is matched by fundraising. This provides a level of stability for investment assets and indicates that liquidity requirements do not constrain investment policy. The foundation’s portfolio is in an advantageous position where spending needs are matched or exceeded by inflows of new funds, so the investment portfolio can take on more illiquidity to achieve return objectives.”

 

An individual can be characterised in a simply fashion, future liabilities of desired spending in retirement need to be “matched” by investment assets. This is the basis of Liability Driven Investing for Banks and Insurance companies and Goals-Based Investing for the individual.  Such an approach is appropriate for a Charity, Foundation, and Endowment.

 

Foundation Example

After undertaking a review of their representative Foundation, Cambridge note the foundation has a substantial level of non-endowed funds, those funds behave like long-term capital because of strong fundraising that replenishes fund levels each year. The foundation can thus grow assets and offer donors a risk-appropriate, competitive return on their philanthropic funds. “Optimizing the endowment investment offering further distinguishes the foundation from competitors.”

Given these endowment characteristics Cambridge argue the foundation can have a greater emphasis on less liquid investments such as private investments.

The point is that the Foundation can increase its overall diversification and this will provide stronger return expectations. Foundations, Charities, and Endowments need to play to their strengths.

 

With such an approach the Foundation is more likely to preserve its purchasing power and grow market value over time.

A more diversified portfolio is recommended which has better risk and return outcome than a portfolio solely reliant on Equities and Fixed Income.

As would be expected by any asset consultant extensive portfolio modelling has been undertaken to understand the resilience and robustness of the portfolio under different market conditions.

As would also be expected a more robust portfolio translates into greater performance over the long term, often with similar if not better protection in poor market conditions i.e. down markets.

 

Likewise, with an increased allocation to illiquid assets, stress testing of different liquidity scenarios is undertaken to gain an understanding of the recommended portfolio’s ability to support annual foundation operations, programs, and grant-making.

Scenario analysis includes the foundation deciding to maintain its level of grant-making to help grantees weather financial challenges, despite the fact that the effective spending rate will exceed its policy target, and the scenario were the Foundation cuts the fundraising achievement level in half, reducing the rate in which new capital is added to the portfolio.

Cambridge conclude ”To evaluate whether the recommended investment portfolio is a good fit, the foundation’s staff, investment committee, and board need to assess whether they are comfortable with the potential portfolio losses and levels of spending presented by a stress scenario. They will also need to consider whether the foundation will maintain grant funding (as modelled) or even grow grant funding in an economic downturn. While an investment policy’s focus is long term, it needs to be able to withstand difficult short-term periods.”

 

 

I have written a number of blogs on the risk of having high equity weightings and the benefits of true portfolio diversification.

A high equity allocation is detrimental to a portfolios that have regular cashflows i.e. Endowments, Charities, and Foundations. This was covered in a previous Post, Could Buffet be wrong? This Post highlights the devastating impacts listed equity market volatility has on a portfolio such as an Endowment/Charity/Foundation which need to provide regular income and to periodically draw on capital.

For those wanting a short history on the evolution of Portfolio Diversifications and the key learnings over time, this Post may be of interest. Current investment portfolios should reflect key learnings from previous market meltdowns.

My last Post, What Does a Diversified Portfolio Look Like? May also be of interest. This Post highlights that a diversified portfolio has a number of risk and return exposures and is not overly reliant on listed equities to generate investment outcomes.

 

 

Happy investing.

Please see my Disclosure Statement

 

Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.

 

One thought on “Charitable Foundation Investing, with Endowments

  1. Pingback: Reported death of the 60/40 Portfolio | Kiwi Investor Blog

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