At ANZ Trustees we believe there are two key long term risks that an NFP should consider – reputation risk and the impact of inflation over time.
This may appear counter-intuitive to the commonly held preoccupation with short term total return. Despite the volatility evident in today’s markets, it is still important that a NFP preserves its income stream to enable it to steadily grow its activities year after year.
Adopting a total return approach raises the risk of not recognising the principal objective of most NFPs – to deliver a consistent income stream each year to fund their grant-making. Focusing on total return will lead to volatile budgets as total returns can vary significantly from one year to the next.
Increasingly, donors, the community and beneficiaries are demanding that NFPs and charities adopt responsible investment strategies that mitigate the risk of market volatility impacting on income, and ensure they have sufficient funds to continue their activities irrespective of economic conditions.
A viable strategy is to recognise the distinction between capital and income and secure a predictable and growing income stream through an appropriate investment strategy. By distributing income only and maintaining an investment strategy which targets capital growth in excess of inflation, the real value of the capital base should be increased over time. This is in turn an important process in ensuring a sustainable income stream over time.
The bulk of price volatility in growth assets can generally be isolated to changes in capital values. If the investment is in perpetuity, shorter term shifts in the value of the capital should not be as important – so long as capital is not totally destroyed. As the capital is never to be spent and as long as the income is recurring, the market value of the capital will not impact on the performance or principal activities of the NFP.
In addition, it is very important that NFPs incorporate prudent overlays on their investment portfolio to limit exposure to unnecessary risks, in particular reputation risk. Aiming for an income target rather than maximum capital gain allows an organisation to focus their investment energies more prudently and with a longer term view.