In a post-Global Financial Crisis world nonprofits are reviewing their approach to endowments and investment more broadly. David Knowles reports from the coal face.

In a post-Global Financial Crisis world nonprofits are reviewing their approach to endowments and investment more broadly. David Knowles reports from the coal face.

After meeting with executives and directors from 30 leading nonprofit organisations to discuss their perspectives on endowments and investment, a number of recurring themes emerged. The meetings were held as part of a recent ‘strategy round’, and revealed the key factors and thinking behind how nonprofits are changing their approach. The important themes that arose during discussions are highlighted below.

The number of recently appointed executives was striking

It appears the number of newly-minted chief executive officers and chief financial officers is principally a function of internal reviews carried out by organisations in response to the fundraising environment and the broader economic climate of the last two years. The overwhelming impression was one of nonprofits reorganising themselves after a testing period, during which the need for experience in key positions became apparent.

If one thing stood out above other observations, it was in relation to the chief financial officer role. Specifically, it appears numerous organisations have appointed candidates with greater experience and professional qualifications to this role, whilst increasing the scope and seniority of the position, in recognition of the benefits of employing a chief financial officer who can make both an operational and a strategic contribution.

Governance and transparency are high priorities

There is an element of self-regulation at play here. Organisations are clearly responding to the renewed focus on corporate governance and transparency in the post-Global Financial Crisis world. However, far from being simply a response, many organisations are seeing good governance and transparency as an effective way to communicate their ability to be trusted with the management, investment and application of funder dollars. This is a good investment.

This recognition that governance and transparency need to receive greater attention bodes well for an observation we have made in advising our philanthropic clients over the last couple of years. Major donors, and donors who think of their contribution as an investment, are increasingly looking at an organisation’s internal structure and capability before they consider who to support. With over 25,000 deductible gift recipients to choose from in Australia, organisations that present their ability to effectively achieve their mission are finding governance and transparency valuable sources of competitive advantage.

Organisations are realigning policies and activities with mission

This appears to be more than just a normal part of the operating cycle. When the tide goes out, some programs dry up. Policies that once seemed sound can flounder on the rocks. And a low tide can expose just how far a mission has drifted. This is an opportunity not to be missed, and nonprofits seem to have seized it, reviewing their plans and returning to their core activities and strengths, in pursuit of their core mission.

One area discussed at length was the development of a formal investment policy and the many benefits of putting in place a comprehensive framework for investing surplus and endowed funds. Those benefits include using an investment policy to demonstrate to potential supporters that their money will be well managed and the ability of a policy to enable directors and executives to confidently and consistently articulate a course of action to key stakeholders.

Short-term concerns continue to influence long-term investment

When considering investment, not surprisingly, tension still exists between doing what makes sense to build long-term organisational capacity and sustainability and doing what seems to work in the short term. The lack of surprise stems from the obvious nature of immediate considerations: reputational risk to the organisation (related to poor investment returns), reputational risk to individual decision-makers (‘not on my watch’) and pressure to spend available funds quickly, in the belief that current needs outweigh long-term considerations.

Endowments are seen as a way to generate sustainable income

Many organisations clearly see the value of creating or building upon an endowment. It seems the GFC has only increased awareness of the value of a ‘rainy day fund’ which generates a passive income stream. In particular, nonprofits are attracted to building a pool, or pools, of untied funds that can generate income they can use to offset core operational costs they would otherwise struggle to fund. Creating an endowment around a particular long-term activity also appeals. The key point that came over again and again is that an endowment is a step towards self-sufficiency and sustainability.

Nonprofits prefer to structure endowments internally

Faced with the choice of establishing a separate legal entity to hold endowed funds or creating a separate account within the existing nonprofit, there is a clear preference. Whilst an external fund is handy for quarantining funds in an accounting or operating sense, the benefits of an internal fund tend to outweigh them. They are cheap to establish and easy to manage. The parent nonprofit retains full legal ownership, and there is no risk of ceding control to an external foundation board that develops its own ideas about how the money should be spent. That said, the need to develop a separate strategy, investment policy and spending policy for an internal fund is widely accepted.

The value of franking credits is well known

Imputation credits on franked income can significantly increase income yields on funds invested by eligible nonprofits. Access to franking credit income therefore becomes an important consideration for nonprofits looking to maximise their income. This means many rightly make the pursuit of franked income part of their investment decision-making process. However, it’s clear in some cases it’s not just an important consideration when formulating investment strategy: it is the investment strategy. It’s equally clear that those organisations that have considered franking in the context of an appropriate asset allocation are sitting more comfortably than those whose asset allocation was driven by a desire to maximise franking credits.

There is a focus on cash yields

Many of the organisations that participated in the strategy round acknowledged that there is scope to improve their cash returns. Most organisations are looking for ways to increase the yield on cash without disproportionately increasing their risk. They are aware that this is an area where money can be ‘lazy’ and there seems to be a belief that you can’t always rely on your banker to maximise your return. With the right level of active attention and advice, these organisations are looking beyond term deposits to a range of fixed interest securities and hybrids – provided they first understand the characteristics of each investment and provided they trust both the product issuer and their adviser.

Social investment is the new black

Almost without exception, nonprofits expressed considerable interest in JBWere’s work in social investment. The idea of offering an investment product that delivers social and financial returns is bound to arouse curiosity. In theory, it gives nonprofits the ability to take an alternative funding proposition to existing supporters and a compelling investment opportunity to a completely new pool of potential investors, led by superannuation funds and ethical investors. In truth, social investment is an emerging market and potential investors are only beginning to dip their toes into unchartered waters.

To attract funding, nonprofits will need to convince investors they can deliver the investment return as well as the social return and that their risk is comparable to similar investment opportunities available to them. Most Australian nonprofits are presently unable to meet this test, but there are plenty that can, and if they do crack the code the potential market for this type of capital raising is huge.

Social investment has the ability to change the funding paradigm … but not for everyone.