By Mitzi Carletti

You drive according to the rules of the road. You play sports according to the rules of the game. And your nonprofit’s investment manager should invest according to mutually-accepted rules, too – rules laid out in an investment policy statement (IPS).

An IPS is a document that records the purpose and goals of your nonprofit’s investments and directs how the organization’s money is to be managed. Most importantly, it establishes guidelines to measure and evaluate the investment decisions made in support of your non-profit’s mission. It also protects the fiduciaries and the underlying assets. What’s more, it eliminates emotion from asset management. Without an investment policy statement in place, every interaction is open to reinterpretation.

How to develop an IPS

Your IPS begins with the stated financial objectives of your foundation or endowment – then defines an investment strategy with clearly-outlined parameters for the construction of your organization’s investment portfolio. Developing an IPS requires careful thought from your committee or board. The following important elements should be considered thoroughly and stated clearly in the IPS:

• Risk management – Identify risk tolerance and outline how risk will be managed.
• Spending policy – Balance between current spending levels and growth of assets to support future obligations.
• Investment manager selection – Will you self-direct, hire a consultant to assist with investment manager selection or directly hire an investment manager?
• Monitoring and evaluation – Identify appropriate benchmarks, time horizon and frequency of investment manager reviews.

In the IPS, allocate assets in a way that:

1. meets cash flow needs;
2. focuses on preservation of capital and growth;
3. takes into account spending policy and risk tolerance; and
4. is transparent, clearly specifying the level of liquidity needed to support your non-profit’s goals.

The IPS should define benchmarks so you know how the portfolio is performing in order to make adjustments, as needed – but also specify when not to make adjustments, such as knee-jerk reactions to short-term market performance.

In terms of asset allocation, time horizon and risk tolerance work hand in hand. Whether your organization is saving for a short- or long-term goal will help determine the most appropriate investments. Think of it in individual terms: If someone is saving for retirement in 30 years, they might want to consider riskier investments; if a major expense is coming up in five years, safer investments make more sense. The same holds true for your nonprofit’s IPS.

“It is true that the greater the risk, the greater the potential rewards in investing, but taking on unnecessary risk is often avoidable.” SEC.gov

Questions to ask about your IPS

Here are some important discussion points for your investment manager regarding your IPS:

• Will the nonprofit have a separate portfolio or will investments be pooled?
• How will assets be monitored and evaluated?
• If the assets have a long time horizon, what is the manager’s performance over the course of a market cycle (7 – 10 years), not just quarter to quarter?
• If considering a new manager, and the manager in question has outperformed the market, what is the source of his/her success?

After my organization’s portfolio is constructed, what’s next?

Measuring performance is critical for staying on track toward your nonprofit’s goals. Specify the frequency of manager reviews and track performance against benchmarks set forth in the IPS. Evaluate both relative and absolute returns, adjusting for changes in circumstances and changes in the conditions of the market. And, revisit the IPS annually or when material changes occur to make sure the objectives, strategies and parameters are up to date.

Just remember: Every foundation or endowment is unique – its IPS should accurately reflect those unique goals, time horizon and risk tolerance.

Need help with your IPS? Get in touch today. 

This blog was originally published on September 14, 2017.