PURPOSE

Investing as a Not-for-Profit… starting with purpose

Firstly, you know your organisation’s purpose. Whether it exists to provide support or services for disadvantaged people or those with disabilities, healthcare services, land, medical research or education, its existence is for a purpose and you are a strong part of that as a Director.
PURPOSE

Investing as a Not-for-Profit… starting with purpose

Firstly, you know your organisation’s purpose. Whether it exists to provide support or services for disadvantaged people or those with disabilities, healthcare services, land, medical research or education, its existence is for a purpose and you are a strong part of that as a Director.
Investing as a Not-for-Profit… starting with purpose

Firstly, you know your organisation’s purpose. Whether it exists to provide support or services for disadvantaged people or those with disabilities, healthcare services, land, medical research or education, its existence is for a purpose and you are a strong part of that as a Director. Your role as a Director is to ensure that your organisation has all that it needs so that it can fulfil its purpose now and into the future. Part of securing its existence is in the growth of the organisation’s assets, including those that are held in reserves or investment portfolios.

Your organisation may already have investment goals and it is important to check that these goals are still relevant and fit with the purpose of the organisation. As with most things worth doing in life, the first step is knowing what you want to achieve. This will help you decide how and where you want to invest.

If you ask most people what their goal is for their investment portfolio, the answer is often – make as much money as possible with as little risk as possible. And while this is the general aim of nearly every investor, there are some important distinctions that need to be made as the two goals of growing your assets and having limited risk are typically at odds with each other. Consider this: if you are being offered higher returns on an asset class, these are to compensate you for the higher risks associated with that asset class.

If you break asset classes down to types, there are basically two:

  • Growth assets that are expected to provide higher returns but also are riskier
  • Defensive assets that generally have lower returns but are less risky

So, you can see that if you want your portfolio to grow as much as possible over a long period of time, you’d probably look to invest in more growth assets. But if you have set aside some of your portfolio to pay for something in the next couple of years and would like to grow your money but don’t want to risk the value going down by very much, you will probably invest in more defensive assets.

Growth and defensive asset classes

Growth assets include investments like stocks, property, infrastructure, hedge funds, private equity. These are asset classes that are expected to provide higher returns over the long term, but can often provide negative returns over shorter time frames.

Defensive assets include investments like government bonds and bonds issued by companies as well as cash. These are asset classes that tend to offer fixed income payments and have lower returns, but are less likely to provide negative returns over shorter timeframes.

Growth and defensive assets have different characteristics and are often not strongly correlated with each other or may even be negatively correlated with each other, so that when one asset class provides positive returns, another may provide less or more positive returns, or even negative returns.

This means that it can be useful to invest in both types of asset classes.

More information on the roles that growth and defensive assets play and the behaviours they exhibit can be found in Section 3 of the Not-for-Profit Investment Handbook.

Not for profit 
Investment handbook

A five part handbook that covers topics fundamental to a investment program. It will help you define your goals and objectives, focus on governance and managing risk and develop a long term investment strategy.

Get your copy

How do we decide what investments to choose?

Once you are clear on your investment objectives and the goals that you have in growing or preserving your money, it is then time to consider the combination of asset classes that are most likely to help you meet your goals (in other words, form your investment strategy). Often, it is a matter of testing combinations of asset classes to determine how you are most likely to meet your goals. Usually, this sort of testing is reliant on assumptions on how the asset classes will perform over time, both in isolation and in combination with each other. These assumptions can be based on many different inputs, including: current market conditions (such as the current cash rate, the state of the economy, valuations on assets), expectations for the variability in (volatility of) returns, expected risk premiums and the historical behaviour of the asset classes. More information on capital market assumptions can be found in Section 3 of the Not-for-Profit Investment Handbook.

Testing different combinations of assets and reviewing the expected returns and risks associated with these combinations can help you determine the right mix for your organisation. Further, this testing can sometimes include scenario analysis to help you understand how your investment strategy will behave under particular circumstances. For example, we often talk about ‘risk’ or ‘volatility’, but unless it is part of your job to understand risk and volatility as they are defined in the investment world, it can be difficult to fully conceptualise how they would impact on the growth of your portfolio. It is useful to see what could happen if share markets fell by a large percentage or if bond yields spiked in a short period of time so that bond prices fell by a large percentage. Scenario testing takes into account not only the scenario pertaining to the specific assets experiencing the shock but also the impact that the shock will have on other asset classes, such that you can see how different investment strategies behave in particular circumstances.

So, how do you decide? Once you have the various investment strategy options (combinations of asset classes) and have reviewed the analysis on expected risk and return of these options, it is then easier to determine the strategy that is expected to best help you meet your goals and purpose.

Ok, I’ve decided on an investment strategy, now what?

The next step is implementation. There will be hundreds to thousands of products that offer access to a particular asset class. The next step is to pick one (or a few) that you think best fulfils your needs. For example, you may be exempt from Australian income tax and have a preference for Australian shares that are known to pay consistent and quality dividends. Or perhaps you have specific responsible investment principles that need to be reflected within the product choices you make. This process is a significant undertaking as there are so many choices and the time that would be required for you to consider each one, the investment philosophy and process behind it and how it might fit into your investment strategy would be too much for one small group of people. This means that Not-for-Profit organisations often rely on consultants or research houses to help them form a view on a particular investment manager or product.

Different fund managers specialise in different investment styles and use different processes that work well in some but not all market environments. For example, 2017 was a great year for growth stocks as investors favoured technology names on expectations of strong future growth and, as the year progressed, market analysts’ expectations of growth were met. This means that some of the best performing fund managers were those that focused on more quickly expanding companies with a history (or expectation) of strong growth (‘growth’ stocks). In contrast, managers that focused on ‘value’ stocks or companies with low price to earnings or price to book ratios, having fallen out of favour in a period where economic growth expectations were low, did not perform as well. Of course, markets change and so there will be periods where analysts’ expectations are not met and growth stocks struggle or where economic growth is expected to pick up and value stocks are rewarded.

This leads many Not-for-Profit organisations to prefer multi-manager (strategy) funds that use intelligent combinations of the best investment processes to get more consistent outperformance and reduce the risk (both investment risk and reputational risk) that can come with single manager approaches. Multi-manager (strategy) approaches are more likely to be able to diversify across investment styles and size biases, making the most of particular investment styles or biases in particular market circumstances so that returns are better and more consistent, regardless of the market environment. These approaches are also better placed to manage risks through diversification.

Section 4 of the Not-for-Profit Investment Handbook provides a summary level of insight into some of the principles and considerations that go into manager research, selection and portfolio construction.

Make sure it’s documented!

Document your investment goals, strategy, decisions, delegations and risk management processes. Good governance is when each investment position is the result of deliberate, considered decisions, with a clear point of responsibility. It’s important that these positions and decisions be made within your governance and delegation framework and risk management processes.

Documentation in an Investment Policy Statement allows you and your stakeholders to understand how decisions are made, who makes them and how they are monitored.

Section 1 of the Not-for-Profit Investment Handbook outlines the key elements in an Investment Policy Statement.

Not for profit 
Investment handbook

A five part handbook that covers topics fundamental to a investment program. It will help you define your goals and objectives, focus on governance and managing risk and develop a long term investment strategy.

Get your copy


Great, now I’m invested, anything else?

Yes, check in every now and then...no, that doesn’t mean look at your balance every day and panic when it’s gone down and cheer when it’s gone up, but you’ll need to have a regular ‘check-up’ and review a few things:

  • How am I tracking towards my goals? If I’m not on track, can I explain why I’m not and am I comfortable with the explanation? If your portfolio is meant to be longer term in nature, it is ok to have short periods where you are not tracking towards your goals. This could be for any number of reasons, like market jitters as a reaction to geopolitical concerns or a company reporting season that disappoints analysts. However, it is still important to understand if the performance is not strong for reasons that need to be addressed by your Board or investment adviser or managers.
  • How are my investment managers doing? Are they doing what they said they would do? Again, if one of your fund managers uses processes that prefer companies with low valuations and the market environment is one where low valuations are seen to be a negative, then it is not necessarily a concern that the fund manager is underperforming the broader market. What is more important is for you to consider whether the fund manager is doing what they said they were going to in a way that they said they were going to do it (following the philosophy and process strictly) and whether you are still comfortable with that style and process for investing.
  • Have any of the markets in which I’m invested changed significantly enough so that I would expect them to behave differently? Markets are always changing, but often they are changing in ways that are temporary (as mentioned above) rather than long lasting. But some changes, such as the current environment with low cash rates and bond yields, may impact your ability to meet your long-term higher return investment goals and it is useful to review if the market changes mean you need to make changes to your investment strategy.
  • Have any of my circumstances or goals changed? If your reserves are meant to last longer than you originally thought or you need your reserves sooner, then you will need to realign your investment strategy with your goals and timeframes.

Checking in will help you understand whether you are on track to meeting your goals or need to make changes to your investment strategy. While these reviews may result in no changes, they can help you uncover any inconsistencies or misunderstandings early and realign your investment strategy with your investment goals. There is an annual investment health check in Section 5 of the Not-for-Profit Investment Handbook.

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