Over the course of my career, I have reviewed countless investment policy statements. Many times I've found them complicated, incomplete, or simply unclear in terms of roles and responsibilities. Given the fact that an investment policy statement (IPS) is one of the most important governance documents for any nonprofit organization, I began to wonder how can someone be an effective fiduciary for that organization if the main document driving oversight of investment assets is unclear or is outdated.
It is extremely important for a nonprofit to develop an IPS that is clear to board members, managers, and volunteers alike. The IPS is essentially a fiduciary road map to help guide a nonprofit in the oversight of investment assets that support its mission. Building an IPS is very similar to planning a road trip. So, who’s ready for a road trip?
First, let’s think about how you plan a trip: how you set a goal, the steps that you take along the way, the people that you need to help you, and how it all works together.
ESTABLISH A FIDUCIARY FRAMEWORK – Your Mission, Roles, and Goals
Establishing a fiduciary framework to guide your organization is the first step. This framework should set forth the mission and the purpose of its investment funds. It should define the roles and responsibilities of the investment committee, board, and investment manager, as well as include a clear statement of the organization’s financial objectives.
Mission First
Consider how an organization’s mission connects to and is supported by the investment funds. What is the history of the organization, its reason for existing, its vision? For a nonprofit organization, the mission should always be at the forefront. I’ve seen many IPSs that don't include a statement of the organization’s mission. This can make it difficult for prospective donors to understand the purpose of their contribution and, further, make it challenging for your committee and board members to understand their roles and responsibilities in forming strategy and establishing financial goals.
Roles and Responsibilities
Back to our road trip. If I’m going cross-country, do I want to drive that distance by myself? Or do I want to hire someone who drives professionally such as a “chauffeur,” a pilot, or a conductor? A professional can help me meet my trip objectives, including safety, scenery, fun, and relaxation. Am I going to rely on myself to do that or shall I hire someone who does it every day and “knows the roads” better than I do?
Similarly, an IPS should address the investment manager’s role clearly as either discretionary or non-discretionary. A discretionary manager assumes responsibility for making investment decisions consistent with the IPS. A non-discretionary manager makes recommendations which must then be approved by volunteers serving on an investment committee. If I'm a volunteer on an investment committee, do I want to be responsible for the day-to-day management of the organization’s portfolio? Or should the committee hire a professional manager, thereby simplifying and limiting my role to manager oversight? There are rules and regulations that help set standards for the management of institutional investment funds including the Uniform Prudent Management of Institutional Funds (UPMIFA). UPMIFA guides both boards and investment managers but also gives the board the authority to hire professionals to do that work.
Investment Objectives
Investment objectives are established as the targets or goals that must be fulfilled in order to accomplish the organization’s mission; such as meeting spending needs, growing and protecting the assets against inflation, and covering administrative costs.
MAP OUT A STRATEGY – Determine your Route and Resources
Developing an asset allocation and constructing a portfolio are critical pieces of an IPS that need to be clear and well thought out. This is where having a discretionary manager makes a difference. It doesn't mean that a committee or board has abdicated responsibility. It means that an organization has chosen to delegate certain responsibilities to professionals, as allowed by UPMIFA, as part of its fiduciary duties.
Asset allocation and the types of assets that can be included in the portfolio should be discussed actively by a committee with the investment manager. Once those elements are in place, the investment manager must execute its investment strategy within the established IPS parameters, and be held accountable for the results.
Assess Risk, Time Horizon, Liquidity Needs
We start with basic questions. Are the investments intended to address short-term needs, intermediate needs such as reserve funds, or are they long-term endowment funds? In simple terms, what is the money there for and when is it expected to be needed? How much risk is acceptable along the way? In our road trip analogy, it’s like asking: When do you want to get there? Do you want to take the highways or the backroads? How do you prepare for unexpected roadblocks or traffic delays?
Develop Asset Allocation
Once those needs are determined, risk tolerance understood, and objectives confirmed, it’s important to develop an asset allocation that has the best chance to meet those objectives. If there’s a mismatch, there will be potential trouble down the road. Consider that the environment for investing has become much more complex in recent years. Think about the dynamics and volatility of current markets, the challenges of the times we live in, and the potential for all of these elements to impact a nonprofit organization’s operations as well as its investments.
Construct Portfolio
The next step is to construct a portfolio that reflects the asset allocation. What types of investments need to be considered in order to meet your objectives? Many policies are structured with a heightened focus on risk. In doing so, the IPS may lessen the ability of the portfolio to capture returns by prohibiting certain types of investment vehicles that provide additional diversification but do not really add risk. For example, in the current historically low-interest-rate environment we see portfolios with significant allocations to fixed income, while at the same time the IPS limits the types of investments that can be used to help increase income and yield. We are spending a lot of time with investment committees addressing this dilemma.
If an IPS is simple and straightforward, with well-defined investment options and ranges that allow for appropriate flexibility, the policy can work for a portfolio of a half-million dollars or a half-billion dollars. It’s important to take the time to develop an asset allocation and construct a portfolio that everyone can understand. When we get into reporting and measuring success, this becomes even more important.
MEASURING PROGRESS – Reporting Standards and Stewardship Process
We’re on our way toward the destination. We’ve defined roles, established goals, mapped out a strategy, gathered the resources, and put them together in a way that we believe will make the trip successful. Now, how are we going to measure progress and success along the way? Will the GPS pleasantly say, “Your destination is ahead” or will it say, “Recalculating?”
Establish Benchmarks
The establishment of appropriate benchmarks is key to measuring investment strategy and manager success. I can’t tell you how many investment policy statements I've seen that don't include any benchmarks. Benchmarks give a committee a way to assess how the portfolio is performing against organizational objectives, as well as to measure the investment manager’s skill in accomplishing those objectives.
What are the benchmarks going to be? They can be simple, using well-known broad market indices for equity and fixed-income investments, such as the S&P 500, Russell 3000, and Bloomberg Barclays Aggregate Bond Index. Benchmarks may also contain multiple elements customized for the organization or be something such as CPI plus a certain percentage. Bottom line, the benchmarks provide an objective measure of the portfolio’s performance and the manager’s success in advancing the organization’s ability to meet its long-term financial objectives.
Create Standards for Reporting and Communication
Once benchmarks are agreed upon, it is important to discuss with an investment manager the standard for the reporting: What is to be included, and what is the preferred format? The reports don’t need to be two inches thick in order to provide a committee with the information it needs for effective oversight and sound decision-making. A good IPS will include benchmarks, reporting intervals, performance time periods, meeting frequency, and other content it deems necessary to support a committee’s ongoing fiduciary responsibilities.
Document Ongoing Review Process
An IPS should contain a section, usually at the end of the document, that addresses how frequently the IPS will be reviewed. At a minimum, an organization should review the IPS annually and conduct a more formal review to update the IPS every three to four years.
Whether an organization is a start-up or is well-established, it is well worth having the appropriate committee or board implement a process to review and update its IPS.
I hope we’ve helped to demystify and decipher what an investment policy statement is designed to accomplish and provide you with a “roadmap” that will help you develop and maintain an effective IPS that will help your organization thrive. Organizations with investment assets but without a formal IPS should consider taking steps to develop this important policy document using the process outlined in this presentation.
My recorded presentation provides a deeper dive into the details for each of the nine roadmap elements and can be viewed on the Brown Edwards YouTube channel.
