Investment and Endowment Policies

Each month, Nonprofits Assistance Fund hosts the Financial Management Network.  These free, informal gatherings are opportunities for members of the nonprofit community to get together to discuss different financial topics and network with peers. Key takeaways from these discussions will be posted and form an archive to help promote healthy financial practices.

Notes from endowment and Investment Policies (August 27, 2008)

Investment Policy

  • An investment policy should include the following:
    • Delegation of authority
    • Conflict of interest
    • Objectives
    • Asset diversification
    • Investment criteria (based on mission or social responsibility)
      • Example: An Animal Humane Society would probably not want to invest with any companies that engage in animal testing
    • Investment tolerances (risk)
    • Reporting requirements - how often and in what format you would like updates & recommendations from your financial adviser to the finance committee and/or board
  • The policy can be created by staff and/or the finance/investment committee.  The finance/investment committee or board should be authorized to approve the written policy.  It should be reviewed annually.

Draft an RFP, submit to selected financial advisers

  • Recommendations from the board
  • Include current advisers

Remember, when drafting the RFP and selecting a financial adviser, it is important to set expectations for roles and responsibilities.  Be specific and upfront about what kind of information you are seeking and how you would like communication to flow.

Investment Strategy

  • How do you decide on how much to invest versus how much cash to keep on hand?
    • Depends on what you want to do
  • Working towards short-term goals or need cash regularly, want liquid assets
  • Working towards long-range goals
  • You should also have a reserve policy to determine a healthy amount of cash on hand for your organization
    • Works with an investment policy to establish organizational goals
    • Many people cite 3 months for cash reserves
    • Kate Barr debunks The Cash Reserves Myth
    • The Charities Review Council has a standard for a cash reserves ceiling to guard against hording - Unrestricted net assets available for current use are not more than twice the current or next year's budgeted operating expenses.

Endowment Basics

  • An endowment is a permanently restricted fund, and the law requires that the funds are managed in a way that the purchasing power of the corpus - the original investment - exists in perpetuity. The restrictions can only be placed on the gift by the donor. Depending on the donor's intent, the earnings can be used for operating expenses, programs, or to address other organizational needs.
  • A gift instrument is a document that lays out the donor's intent.  It could be a letter from the donor or a fundraising appeal.  It legally defines how the funds can be used and any restrictions placed on the gift.
  • A board-designated restricted fund is a quasi-endowment.  Because the board has restricted these funds for the purpose of creating an endowment, they can also release the restrictions.

UPMIFA

UPMIFA (Uniform Prudent Management of Institutional Funds Act) requires that endowment funds are prudently managed so that the purchasing power of the corpus is maintained.  UPMIFA elaborates to say that a charity and those who manage its funds must:

  1. Give primary consideration to donor intent as expressed in a gift instrument,
  2. Act in good faith, with the care an ordinarily prudent person would exercise,
  3. Incur only reasonable costs in investing and managing charitable funds,
  4. Make a reasonable effort to verify relevant facts,
  5. Make decisions about each asset in the context of the portfolio of investments, as part of an overall investment strategy,
  6. Diversify investments unless due to special circumstances, the purposes of the fund are better served without diversification,
  7. Dispose of unsuitable assets, and
  8. In general, develop an investment strategy appropriate for the fund and the charity.

Resources on UPMIFA:

Donor Intent

As a general rule, if a nonprofit has restricted funds without good documentation of the donor's intent, it is best to contact the donor directly.  This can be an opportunity to maintain or re-affirm a relationship with a donor.

UPMIFA recognizes donor intent more broadly and allows for the possibility that a restriction may become impractical (for example, the program is no longer in operation) or wasteful. Under UPMIFA, there are two ways to release the restrictions:

  • Donor consent
  • If the donor is unable to give consent, the nonprofit can seek court approval. When seeking to modify a restriction, you must notify the Minnesota Attorney General.

UPMIFA also adds a provision that allows a nonprofit to modify restrictions on certain funds without going to court.  If the gift is less than $25,000 and more than 20 years old, and the restriction is impractical, you can notify the Attorney General of the desired modification. Unless the AG objects within 60 days, the change is approved.

If you have a set of small, undocumented funds (that are either unrestricted or released from restrictions) it may make sense to pool them together and use as a block. The board can then decide what to do with them.

Gift Policy

  • Don't accept gifts that don't fit with the mission - it's important to work with donors to ensure the purpose of the gift is a match for the mission and direction of the organization (rather than donors driving these decisions)
  • At what level do nonprofits accept permanently restricted funds?
    • What makes sense for the organization?
      • Consider what will be required to successfully manage the funds
      • Be prepared to maintain relationships with donors - set expectations at the beginning
        • Outline how the money will be used
        • Communication schedule - how often the donor will receive updates and what kind of information they'll receive
    • Different levels of gift can be treated differently, for example:
      • $100 towards endowment - picture/name included in marketing materials
      • $10K - personally named fund, restricted for a set purpose, regular updates on how the funds are being used
      • Other gift levels would have different packages
  • Establish policy about what to do with the earnings from an endowment

Advice and Insights on Establishing an Endowment

  • Endowments are not a quick fix. They take a lot of quiet work to set up and establish before you can reap any rewards.
  • Endowments should be in sync with larger organizational plans
    • Part of your strategic and financial plans
    • Have goals in mind well before launching a campaign - why do you want an endowment?
      • General operating
      • Fund a new position or program
      • Provide a more competitive salary to retain/attract staff
  • Have all the pieces thought through and in place before launching a campaign.  There are some things that you cannot change, so weigh your options.  Also, you don't want to be playing catch up after the launch of a major effort.
    • Have an investment policy established
    • Have a spending policy established. Decide what portion of the corpus you will spend annually, while still maintaining the fund's purchasing power.
      • When possible, especially at the beginning, dedicate larger portions of the earnings to growing the fund
    • Have an investment strategy.  Know where you will house the fund, who will be the financial adviser, etc. Spell everything out well in advance.
    • Be prepared to explain the concept of an endowment to potential donors. Some savvier donors will be familiar with the idea, but others may need more background.
    • Know your donors so you are able to provide them with the right kind of pitch
  • Be careful when crafting your appeal to donors because you are bound to it. Make it as broad and flexible as possible.  Some have included a clause that allows them to tap into the corpus during difficult times
  • Track your endowment on a separate line or column of the balance sheet
    • This more accurately reflects what is available for operational needs
    • Track unrealized gains/losses "below the line" of the income statement to avoid showing operational surpluses and deficits influenced by the endowment's market performance
    • Showing the endowment as restricted funds better reflects your actual financial position

Spending Policy

  • Typically, you spend a portion of the interest/dividends (rather than reinvest it) - being able to use this income is the goal of an endowment
    • Historically, you had to maintain the dollar value of endowment. You could not spend money when the endowment fund took a loss.
    • Under UPMIFA, you maintain the purchasing power of the fund
      • Takes inflation into account
      • Example: If your policy is to spend 4% annually, and you expect inflation at 3%, then you need a 7% annual rate of return on your investment
    •  Best practices
      • Rolling averages (such as over 20 quarters or 3 years) can be used to assess the historic average values of the corpus
      • Under UPMIFA, you can have losses in assets during individual quarters and  still spend endowment earnings, so long as you prudently maintain the fund's purchasing power
      • Use a 5 year average of CPIs to calculate inflation and maintain the purchasing power of you endowment
        • To project an inflation, use whatever index is most applicable
          • Consumer Price Index (CPI) from the US Dept of Labor
          • Tie to programs and their expenses, index the endowment to program costs - be specific
  • It's important to have a spending policy for all long-term investments, not just an endowment fund.
    • Being able to project a return and knowing how much you can spend helps with cash flow.  You can use the earnings for general operating and anything you might use an endowment for, except that the board can establish the fund and make any changes needed to support the earnings/assets.
    • This way you can be strategic and weigh your long-term options, rather than just spending on a whim

Investment Reports

  • How much detail do you include in reports?
    • Gains & losses (both realized & unrealized)
    • Fee structures
  • How often do you see them? Varies depending on type of board/nonprofit, but one organization outlined their schedule: Board
    • Finance committee
      • Monthly update
      • Quarterly meeting with detailed update, discussion
      • Annual in-depth presentation from financial advisor
  • Financial updates included in quarterly reports
  • Finance committee reports back to the full board once a year

Other Resources

Interested in Learning More?

View our Resource Collection or check out the Discussion Archive for notes from other Financial Management Networks.

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