Excessive caution can cost you money

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A litany of factors is forcing Boards to look for ways to be more effective, and risk exploitation rather than risk avoidance can produce improved results.

Investment counselors deal with a variety of different types of capital pools, including pensions, foundations, religious groups, insurance, union strike funds, aboriginal settlement monies, corporate working capital and reserve funds, mutual funds, and individuals. The groups that stand out among these funds are not-for-profit entities such as universities, hospitals and religious groups, and particularly the smaller institutions where the assets are under $35 million. There are some distinct exceptions, but in broad terms many in these sectors do not take advantage of the capital markets; often they operate in the cash or near-cash market of treasury bills, banker's acceptances, term deposits and guaranteed investment certificates.

External developments affecting charities

Charitable organizations find themselves under considerable pressure as a result of several economic factors, including reduced government funding, increased demand for services and reluctant donors. The most visible reaction to these pressures is a more organized approach to fundraising and the emergence of professional fund raisers or gift planners. We see this in the establishment of the Canadian Association of Gift Planners and the reopening of the Toronto Chapter of the National Society of Fund Raising Executives.

Virtually every not-for-profit organization in the country that has a capital pool and a long-run goal has mapped out a position description for a planned giving officer. In addition, because tax considerations are a significant factor in charitable gifting, many planned giving specialists are coming from the financial planning field. A professional gift planner can show a donor the most tax effective way to make a substantial gift.

Internal developments challenge old approaches

The not-for-profit industry finds itself having to answer penetrating questions from its own executives and from potential donors. Increasingly these focus on the investment approach taken with the existing and the planned pool of capital. Rates of return for every conceivable type of investment vehicle abound in today's marketplace. This is probably the result of the difficult conditions experienced by the corporate sector in recent years (or the challenge to its rates of return), the public's substantial move into mutual funds, and some unfortunate investor experiences in "guaranteed" products.

These factors are forcing boards and management to look for ways to be more effective from an investment point of view. However, those accountable do not want to run the risk of being unable to meet the increasing funding commitment to the parent organization.

The Board or Management Factor

The Boards responsible for monitoring the assets for many smaller pools of capital usually share common characteristics such as:

  1. The Board and/or Investment Committee is made up of representatives from the parent organization, along with an accountant, banker, broker, lawyer and one or two successful business people from the community.
  2. Most members of the committee are volunteers who are active in business or the community, making it very difficult to get the group together or to achieve the necessary quorum. Often, as a result, no decisive steps are taken.
  3. Typically there is little documentation of the investment policy and strategy.
  4. Board members and staff of not-for-profit groups invariably stress a low tolerance for risk in explaining the approach to the portfolio.

Investment committees and/or boards for these smaller groups frequently include bankers and accountants, but seldom investment professionals who can put the goal of the organization and the potential of the capital markets in perspective. In these circumstances the portfolios often consist of securities with little or no market risk.

The responsibilities and potential liability of directors and officers are also important factors, well explored in a paper by William Innes, published in the September, 1993 issue of the Estates and Trusts Journal, entitled "Liability of Directors and Officers of Charitable and Non-Profit Corporations." This debate is one reason why there are such diverse schools of thought on the investment approach of foundations.

No-risk vs the "prudent" approach

One group believes that there should be little or no risk in the investment approach; a second believes that the investment stance should conform to the standard of the applicable Trustee Act, and yet a third group believes in applying a "prudent" corporate philosophy. Certainly the "prudent approach" has gained huge ground in pension and insurance investment circles in recent years, underlining the fact that the investment restrictions of the Trustee Acts are outdated. Unfortunately there is no political will to update the provisions of these Acts and it is unlikely to happen.

A foundation portfolio of short-term type securities cannot be effective in meeting the long-term needs of the parent organization. This feature of U.S. endowment funds prompted McGeorge Bundy to comment, in his first annual report (1966) as president of the Ford Foundation, that excessive caution had cost the funds of religious groups, universities and health care institutions far more than imprudence or excessive risk-taking.

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.

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