In times past, earning six per cent on a ’no risk’ term deposit with inflation at three per cent was an easy decision – or non-decision – for many not-for-profit Boards. In such an investment context, there was little need to test the boundaries of risk in striving for long-term organisational goals.
At best, such a mindset has led to suboptimal outcomes across the not-for-profit sector. At worst, it has bred complacency around the boardroom table, with organisations operating with a false sense of ‘revenue generation’ security. Now, however, with interest rates remaining low and financial markets uncertain, decision-makers have been shaken to attention.
No-one can predict the future or anticipate how markets will respond to surprise events. The trick is to focus on what you can control to secure the financial future of your not-for-profit. While markets are forever changing, one thing we know for sure is that interest income that was once easy to find with virtually no risk is now gone and a new normal has arrived.
With this in mind, when not-for-profits review their investment strategies, there are three areas of control to consider:

1. Diversification
2. Responsible investing
3. Spending policy

Diversify against volatility
Internationally, not-for-profits have been operating in this low-income environment for longer than we have in Australia. There’s much to be learned about what has worked in endowment building overseas, but one key learning is the need for greater diversification in investments and use of alternative assets.
The traditional model of weighting heavily to Australian equities needs closer examination given the lack of sector diversification within the ASX and the subsequent volatility and risk that it exposes.
It’s important to review your portfolio with a fine-tooth comb for true diversification. This is something we advise our not-for-profit clients on every day – diversifying across traditional assets and going further to consider alternative asset classes. These alternative investments fall outside traditional share and bond markets and their performance is largely determined by different factors.
Recognising responsible returns
Protective strategies like diversification are crucial in volatile investment markets. But the expectations placed on not-for-profit organisations extend beyond the financial, as more stakeholders place emphasis on responsible investing.
Not-for-profit boards are conscious of aligning their investment strategy to their mission and the expectations of stakeholders and communities. This isn’t limited to the balance of risk and return, but a commitment to ethical and responsible investing is a strong consideration.
Socially responsible investing is a broad and evolving investment strategy. Its origins were in screening out companies in controversial industries like tobacco or gambling. From there it extended to positive screening for companies with a commitment to social and environmental issues. Now it encapsulates new areas like impact investing that can involve investment in community projects or financing businesses with a clear social purpose.
Not-for-profit boards can use their mission statements to frame the investment restrictions placed on their portfolio. While this may address ethical considerations, the level of restriction may limit the range of potential investments, which concentrates risk and may be reflected in lower returns. It’s a delicate balance. There are numerous, interrelated elements to consider when creating a portfolio tailored to the individual requirements of a not-for-profit.
Setting spending policies
As well as determining the diversification and social framework of investments, not-for-profits can develop policies to control how capital and returns are spent, particularly in cases where an endowment is established. Spending policies should balance the provision of funds to current operational requirements whilst ensuring sufficient funds are left to sustainably fund future needs.
There are a number of ways to structure spending – meet the mission, spend income only, spend a portion of the capital base or create a hybrid solution. Boards need to balance predictable income – government grants – with less predictable revenue in the form of donations and bequests. The expense of running the funds and the variation of returns during investment cycles are other key factors for consideration.
Bringing it all together
Despite the market noise and unpredictable reactions to big events, not-for-profits still have control of their investment strategy and spending policy. The trick is bringing all of the elements together cohesively, given their interdependencies, to secure a financial future.
The right investment solution is the one that ties complex factors together in a cohesive strategy that is aligned with the organisation’s purpose. Ultimately you want current and future stakeholders to be satisfied with the clarity of thought, foresight and independence of thinking that has been brought to the development of the investment policy. Professional financial advice is an important component in assisting you to achieve this.
Scott Hawker, National Manager, Not-for-Profit Endowments, Perpetual