Analysts and critical observers of foundation and endowment funds comment that the related assets should not be managed or thought of in the same way as pension funds. This can happen easily, because the financial executive in many not-for-profit entities is responsible for both types of investment pools. In fact, taking a traditional balanced pension fund approach is better than holding a portfolio of short-term securities.
Most not-for-profit pools can afford to take a long-term view and an approach that is as long or longer than pension funds. As a result, they should consider portfolio structures that emphasize freely traded marketable securities in the capital, as opposed to cash or near-cash markets - an approach guaranteed to strike terror in the hearts of many board members. They can take some comfort, however, from a review of long-term trends in rates-of-return for the major components of the capital markets, which show higher returns for a balanced portfolio of stocks and bonds than for fixed income instruments- either long or short.
Endowments and foundations are sources of cash flow that help to defray operating costs for the related institution. They can also be drawn on to make periodic equipment purchases. But, like a pension fund, it is unusual for them to consume more than small amounts of their capital base. Assured cash flows and capital preservation are among the reasons why so many not-for-profit pools focus on Guaranteed Investment Certificates, Bankers Acceptances and Treasury Bills. These vehicles give trustees a comfortable feeling and produce reliable cash flows for the immediate, foreseeable future. This approach has the added benefit that no one can criticize them for being reckless with the organization's assets. The resulting feeling of comfort persists until there is an extended period of declining short-term interest rates. Then many foundation groups find themselves in a cash squeeze and belatedly start to look at alternative investment approaches.
If the fund had consciously taken a longer term approach to the market, the cash flow available at the start would have been a bit less, but the volatility of the income stream would have been reduced substantially, making these assets a more significant and reliable source of project funding. In fact, very reliable income streams can result from payout programs related to a combination of income and the value of the portfolio (not just its cash income), using a four or five year moving average time period.
The foundation is the organization's pension fund
Endowments and foundation funds are intended to ensure or enhance the long run well being of the organization. This is usually why we make donations, and the same long-term perspective dominates the thinking of those close to the fund itself. Simply put, the foundation pool is the organization's pension fund.
The most noticeable difference between the employees' pension fund and that of the organization is time. Consider the history of the particular institution and its likely role in the community. Many, if not most, of our health care, educational, religious and social institutions have already experienced the 50th, 100th or 125th anniversary of their founding, and most can expect to be an integral part of their community as far into the future as we can imagine. The time horizons here relate to the expected life of the institution and not that of the employees or the individuals serviced.
Participation in the capital market will always carry risk, something that is almost non-existent in a portfolio of short-term holdings. As Charles D. Ellis wrote in Investment Policy (Dow Jones-Irwin):
"The length of time investments will be held and the period of time over which investment results will be measured and judged, is the single most powerful factor in any investment program.
"If time is short, the highest return investments - the ones an investor naturally most wants to own - will be undesirable, and the wise investor will avoid them. But if the time period for investing is abundantly long, the wise investor can commit without great anxiety to investments that appear in the short run to be very risky.
"Given enough time, investments that might otherwise seem unattractive may become highly desirable. Time transforms investments from least attractive to most attractive and vice versa, because, while the average expected rate of return is not at all affected by time, the range or distribution of actual returns around the expected average is very greatly affected by time. The longer the time period over which investments are held, the closer the actual returns in a portfolio will come to the expected average."
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.