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Even small organizations can achieve a competitive rate of return
by Winsor Pepall
January 15, 1996; Canadian FundRaiser

What can we expect when it comes to rates of return? Since the North American economies are built on the principals of ownership and free enterprise, it should not come as a surprise that equities have outperformed bonds or fixed income type investments consistently over the last 70 years. In addition, the superior equity results become more significant with the increase in the length of time over which the investments are measured, reinforcing the point that "time is Archimedes' lever in investing."
Risk, or the variability of values, will be one of the most immediate concerns of board members once the discussion turns to equities in foundation portfolios. Clearly there will have to be a break with the common behavioral norm of looking at risk as something to be avoided; instead, let's look at risk as something to be exploited.
We can moderate the risk by setting guidelines to limit the exposure to any one type of investment, standard procedure in the design of policy statements for most managed funds.
Capital market data for the last 70 years provides a clear picture of the returns and the risk features of the two broad vehicles that make up managed portfolios. While the equity returns are appealing, the risk factor may be daunting. However, a large part of the return can be captured by having a diversified portfolio of stocks and bonds. In the illustration given, the bond return improved by almost 40% and the volatility increased only about 10%. Put another way, the managers in this case captured over 80% of the equity return and cut the volatility in half.
What is the measure of lost opportunity?
Total investable assets in the Canadian not-for-profit field are hard to judge, but could be as much as $75 billion. If $25 billion of this is invested in typical short-term investment vehicles we can get some idea of the opportunity loss that the industry is experiencing. For example, if the rate of return on the portfolio can be increased by 2.5% from 8.5% to 11%, over a five-year period, the return will increase by almost $4.8 billion. In other words, the opportunity foregone by a avoiding even a prudent or bearable level of risk cost the industry 19% of the starting amount, or $4.8 billion, in just five years!
These numbers may be easier to assimilate if we relate the example to a $10 million fund. By assuming a modest increase in volatility, the extra rate of return would produce an additional $1.9 million over the five year period. The extra return would generate some management fees, but the costs per extra dollar realized would be under $0.20. At this level the cost of raising the extra dollars would be approaching the most efficient level seen in the industry.
What can we do?
There are a host of benefits that the not-for-profit industry could realize. To achieve these, we need a thoughtful review of board composition, investment policy and strategy, and the parameters of risk and return. Then we must integrate these concepts with the long-term goals of our organization. Modest size and limited access to financial markets does not exclude a small organization from competitive rates of return. The pension markets of Canada and the U.S. have dealt with similar problems effectively in by pooling. In the last 25 years smaller not-for-profit groups in the U.S. have used the same approach to achieve excellent results. It can be done in Canada.
Winsor Pepall is Vice-President of Integra Capital Management Corporation. He has an extensive background in investment research, portfolio management and business development. Mr. Pepall is particularly interested in the investment management needs of foundations and endowments in the broad not-for-profit sector.