Issue 28: 2014

Insights

Philanthropies and the
Risk of Misjudging Risks

For nonprofit fiduciaries, an insufficient grasp of issues can have
serious consequences, both organizational and personal.

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If you served as a financial steward of a nonprofit organization (NPO) during the Great Recession, you’ll know that financial weakness was a huge concern. If this was not the case for your group, it almost certainly was for many other NPOs, as a result of lower donations and declining investment values. (U.S. donors reduced their giving by 7% in 2008 and by another 6% in 2009, according to Giving USA Foundation. Meanwhile, the Standard & Poor’s 500-stock index fell 56%, from a peak of 1565 on October 10, 2007, to a valley of 676 on March 9, 2009.)

Today, roughly six years after the recession began, with many economic indicators close to or at pre-recession highs, and with giving on the rise, an important step your board should take is to determine ways to reduce risks in a future downturn.

Financial risks

Often the most obvious risks are financial in nature. Your investment manager should discuss these risks with you, using concepts such as capital loss and standard deviation. The second concept is a way to measure an investment’s price volatility, where a low number means lower risk and a higher number means higher risk.

In addition to standard deviation and other gauges of risk, your board should consider other aspects of the financial health of your NPO. As Stephen Campisi, senior institutional investment strategist at U.S. Trust, says, “After the Great Recession, many philanthropic organizations had to take a long, hard look not just at their portfolio’s performance, but also at whether their withdrawal rates were sustainable, and whether their investment policies were as prudent as they ought to have been.”

Some went further, he notes, questioning a range of their basic operational criteria: “Their foundational principles, their governance practices, their goals regarding the preservation of their mission and what they might need to do to keep it going.”

In Campisi’s comment there’s a concept that’s key for almost every philanthropic organization: mission. It is around a philanthropic organization’s mission that virtually every investment decision should turn. But what does mission mean?

Financial risk is just one of many types of issues a board of directors must deal with.

Mission in action

In general terms, a philanthropic mission must center on “maintaining the ability to pay out funds to current beneficiaries according to the founder’s wishes, while preserving enough funds to support payouts to future generations,” says Joseph Curtin, head of Global Portfolio Solutions and Institutional Investments at U.S. Trust. “So, nonprofit fiduciaries should view risk in terms of accomplishing that mission or, the other side of the coin, risking mission failure.”

Types of Risk Facing NPOs
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Types of Risks Facing NPOs

Financial risk is certainly an important concern for nonprofit organizations (NPOs), but it is far from the only one. As an NPO fiduciary, you (and your fellow board members) should be aware of the range of risks you need to consider. This list, divided into five main categories, is extensive but may not be exhaustive. For a more inclusive list, be sure to consult with an expert in NPOs.

Facing so many risks, and with personal stakes high, you and your fellow fiduciaries should decide, as Elizabeth P. Henderson of U.S. Trust puts it, “which kinds of risks to keep within the organization and which risks to consider outsourcing,” because you don’t have the expertise, or because you may simply be unwilling to manage them by yourself without professional help.

Regulatory Risk
  • Inadequate governance
  • Ineffective compliance
Reputation Risk
  • Ineffective public relations
  • Ineffective communications
  • Failure to anticipate problems
  • Failure to publicize success
Funding Risk
  • Ineffective donor development
  • Overdependence on single funding source
  • Failure to integrate chief financial officer into investment planning process
Board Effectiveness Risk
  • Inadequate evaluation metrics
  • Lack of commitment and continuity
  • Trouble in attracting talent
  • Lack of diversity
Mission Failure
  • Insufficient assistance to beneficiaries
  • Failure to preserve value of assets
  • Lack of program effectiveness
  • Lack of “intergenerational equity”

To put that another way, although the investment portfolio is extremely important for a nonprofit, it is not an end in itself, but rather a means to supporting the mission.

Who is responsible?

This clearly goes beyond what might be considered the traditional view of financial success; that is, an investment manager’s view: “We beat our asset benchmark.” But financial outperformance in itself may not address a nonprofit’s true capacity to meet the mission: to earn the return necessary to grow the assets and fulfill the mission over generations.

So it’s entirely possible for an NPO to succeed by traditional measures — say, beating a benchmark — “but fail in accomplishing the mission: generating the money to pay the current beneficiaries and growing the portfolio to fulfill that same responsibility to the next generation of beneficiaries,” Curtin says.

Financial stewardship “should be a concern for anyone involved in a nonprofit organization,” Curtin says. But this is especially true for fiduciaries, he notes, as they can be held personally responsible for any miscalculations they make.

Other types of risk

For starters, the board must ensure that the organization has a vision for the future. Generally, nonprofits are supposed to last in perpetuity. Therefore, the board of directors must strive to maintain the organization’s charitable purpose — its mission — over successive generations.

Then there’s increased governmental regulation, which puts philanthropic groups under greater regulatory scrutiny. “So they must consider the risk to their reputation if they fail to comply with the many laws, rules and guidelines that pertain to them,” says Elizabeth P. Henderson, head of investment consulting, Global Portfolio Solutions and Institutional Investments at U.S. Trust. But that’s not all.

Set expectations; empower the investment committee’s members.

Says Henderson: “NPOs may fail to make the public aware of their successes, which may affect the number of donors and size of donations they attract. They may also fail to attract the kind of board members they need, or fail to hold on to them, which can have an impact on board continuity, another potential issue.” (To learn more, see the sidebar, “Types of Risk Facing NPOs.”)

Decide what to outsource

Before you decide what responsibilities to keep under your auspices and what to pass on — albeit with you providing oversight — an important step is to look at all the information you’ve been given by your NPO’s investment provider, says Curtin. “Determine if there are gaps, or if there are items you need help understanding or should be more aware of.” As part of this step, he says, you should talk to the investment manager, accountants and tax professionals. Even if you (or another fiduciary on the board) are a financial expert, a smart move may be to source investment management to other financial professionals. “That way you should end up being an overseer of investments rather than a manager of investments,” he adds.

That should give you, as a fiduciary, more freedom to do what only someone in your position can do — from leading the organization and making a range of risk decisions, to engaging in public relations, enhancing the reputation of the organization and developing the donor base.

Building a strong committee

Being a part of a strong investment committee should make your fiduciary work easier and more enjoyable. Here are the focal points:

  • Make sure members under­stand the organization’s mission
  • Seek diversity of experience and perspective
  • Set expectations; empower the investment committee’s members
  • Pick a strong and capable chairperson
  • Watch out for the micromanaging investment committee
  • Structure the committee to preserve institutional memory
  • Conduct periodic self-evaluations

NPO over generations

If you decide to give your NPO’s investment management to professionals, consider this: Most investment managers will provide investment results and analytics for the quarter, 12 months, five years and sometimes 10 years. “They let you know what’s going on and alert you if anything is boiling over,” Henderson says. “But nonprofit organizations are typically multigenerational enterprises. So it’s important for a few investment organizations, including ours, to let clients know how things have gone not just over the past quarter or the past year, but over the past generation.”

You should be able to see how you (or your predecessors) have guided your organization over the long term. You’ll also get a sense of how to guide investments to help ensure that there will be ample capital in the future. “In this respect,” Henderson says, “we believe we are viewing the NPO not from our perspective as asset managers, but from the perspective of the beneficiaries and the asset owners.”

Enhancing the fiduciary role

Being a fiduciary for an NPO group is a serious responsibility and a wonderful opportunity. If you’ve ever wondered how you might rise to the challenge, then consider these words, offered by Campisi: “Focus on what only you can do. Determine what your best use is to the organization. Then establish relationships with appropriate investment professionals who can focus on the financial needs of the mission.”

As for U.S. Trust, he adds, “We are investors, of course, but we are investors with the heart — and experience — of philanthropists, and we can help investment committee members to better pursue the mission of their organizations.”

How successful you are will likely be most evident in some of the real stress periods in the economy and the markets. “That’s when some organizations, particularly educational organizations, often make news for having to reduce their support for the mission, reduce their programs, even change their organizations,” Curtin says. With your fiduciary guidance, and with investment professionals that think in terms of generations rather than just the latest quarter, your organization’s mission could last indefinitely.

IMPORTANT INFORMATION

Projections made may not come to pass due to market conditions and fluctuations.

Past performance is no guarantee of future results.

Always consult with your independent attorney, tax advisor, investment manager and insurance agent for final recommendations and before changing or implementing any financial, tax or estate planning strategy.

OTHER IMPORTANT INFORMATION

The Standard & Poor’s (S&P) 500 Index tracks the performance of 500 widely held, large capitalization U.S. stocks.

Bank of America, N.A., and U.S. Trust Company of Delaware (collectively the “Bank”) do not serve in a fiduciary capacity with respect to all products or services. Fiduciary standards or fiduciary duties do not apply, for example, when the Bank is offering or providing credit solutions, banking, custody or brokerage products/services or referrals to other affiliates of the Bank.