Investment Spotlight – Best Practices for Foundation & Endowment Management
OPERATOR: Thank you for joining today’s Investment Spotlight: Best Practices for Foundation and Endowment Management. The views and opinions expressed are those of the presenters as of September 17th, 2021, subject to change without notice and may differ from the views expressed by Bank of America Corporation or its affiliates. This is presented for informational purposes only and should not be used or construed as a recommendation of any service, security or sector. Please see important information at the end of this event. I will now turn it over to Ann Limberg.
ANN LIMBERG: Thank you for joining us today, I’m Ann Limberg, the head of Philanthropic and Family Office Solutions and I’m delighted to welcome you to today’s event.
All of you make an essential and positive difference in our global society through your service to the nonprofit sector and to the missions of the organizations that you care so deeply about. You represent a very diverse cohort of leaders including board and investment committee members and chairs, chief financial officers, chief investment officers, trustees, directors and donors –all of you are philanthropic individuals who create, support and sustain nonprofit organizations across sector and to all of you, I wish you a very warm welcome.
Thank you for contributing your time, your talent and your overarching support to drive and sustain such an important segment of our society today. And building on our sessions earlier this year, we have shaped today’s conversation with you in mind, responding to your interests and asks, and in keeping with our own role as a global enterprise financial institution and an active local community partner. We’re here to help you better serve your organizations across your entire continuum of needs in a careful and a very customized way.
And in the same way that you drive impact and purpose and lead your lives with purpose, we at Bank of America are also engaged in a social mission. We share your values to improve the world by supporting education, healthcare, racial justice, social wellbeing, the arts and culture and many other causes. And in the last year alone, we’ve expressed those values in many, many ways, through the leadership commitments that we’ve made to support COVID relief in communities throughout the country and to accelerate our work in advancing racial and social justice and economic mobility.
We’ve continued to increase and accelerate our ongoing support through programs across the country, delivered through the Bank of America Foundation, and also through our local market president network. And as a values driven enterprise, we believe that we’re uniquely positioned to understand and advise you in the work that you do for your nonprofit organization.
And so today, we’re presenting on three highly relevant topics. Issues that we know are important to you. The first is how nonprofits are negotiating the current, very challenging investment environment. Second, and which is connected to that, are trends in endowment spending. And finally, and perhaps most importantly, our third topic will be governance and how you express your values through the way that you run your organization. And with that now, I’ll turn things over to our moderator Bill Jarvis to introduce today’s three panelists.
BILL JARVIS: Thank you Ann and welcome to all of you who are joining us today, whether you serve a grant making foundation or an operating nonprofit. The last 18 months have been a momentous time for our society, not only because of the effects that the global COVID-19 pandemic has had on individuals, families, communities and businesses but also because of the calls for racial and social justice that characterize this period and are not unconnected with the effects of the pandemic itself. In this environment, nonprofit organizations – healthcare and social service providers, educational, religious, arts and cultural organizations – have been important actors serving communities directly affected by COVID-19 while also striving to mend the tears in the social fabric that were caused or exacerbated by the pandemic.
In today’s conversation, we’re going to shine a light, from our own work with endowed nonprofit organizations like yours, on the best practices that these organizations are pursuing, and we’re going to share our view of what the investing framework for nonprofits may look like going forward. I’m very fortunate to be joined by three terrific colleagues. John Wong, Senior Vice President and Institutional Portfolio Manager, Sarah Clark, Managing Director and Institutional Portfolio Manager, and Elizabeth Barnett, Senior Vice President and Philanthropic Strategist.
John and Sarah have long experience in counseling nonprofit boards and investment committees on how to achieve their long term investment goals. Their work ranges from helping a board or committee to determine what’s an appropriate level of investment risk to take in light of the organization’s goals, to constructing and guiding asset allocation decisions in terms of how the portfolio will be invested across stocks, bonds, cash and, where appropriate, alternative investments, to providing guidance on sustainable levels and methods of spending from these endowments. Elizabeth, as a senior member of our National Consulting and Advisory Practice, is an expert on nonprofit governance. Her work extends from strategic and implementation through board self-assessment to formulation of key policies and endowment fund-raising.
In today’s conversation, we’re going to start with the investment environment, how it has changed as a result of the pandemic and the economic crisis, what changes are likely, in our view, to be permanent, and how boards and investment committees are dealing with these issues.
I’d like to begin with a topic that we know is at the top of many board and investment committee agendas. Interest rates have remained very low during the last decade, and that has led to lower returns, not only for bond investors, but also for equity investors, since the equity risk premium, the amount that an investor may receive for allocating to stocks instead of bonds is also defined as a potential return above that of a risk free asset, such as a treasury bond. The current economic recovery, bolstered by support from markets from the federal reserve and other global central banks has led to very strong equity returns over the last 12 months, but when the stimulus ends, portfolios may be faced with a continuing low return environment.
John, turning to you as a professional who advises nonprofit boards and investment committees on their long term portfolios, how are you addressing this situation? With an interest of historic lows, many endowments may experience lower investment returns in the future than in the past. What investment and portfolio strategies are in your view, open to those charged with oversight of endowments and foundations as they seek to sustain the missions of their organizations, now and into the future?
JOHN WONG: Yeah, thanks Bill, let me just start at a high level, for those of you on the call and illustrate how we think about managing nonprofit portfolios and determining an appropriate mix of investments. A key objective of the endowment and foundation portfolios we manage is to seek returns that are in excess of the sum of inflation, the organization’s distribution or spending needs, and costs. We use our market forecasts, which are updated each year, to work with you on building out a long term asset allocation that provides the highest risk adjusted probability of meeting this goal. To that end, and to help guide you through the various market environments such as low interest rates, we use our proprietary portfolio modeling tool to run probabilistic simulations which are designed to estimate a range of possible outcomes based on specific portfolio details such as your expected cash flows, the asset allocation mixture of your investments and market value.
The output from this modeling exercise provides risk metrics, stress tests, wealth projections and cash flow probability among other data. We then use this detail to work with your board, or investment committee on different risk and return scenarios based on statistical calculations. This process has proven to be valuable as it has helped many of our clients determine if their existing portfolio is appropriate or not.
BILL JARVIS: John, that’s really interesting, but how does it work in practice?
JOHN WONG: To give an example, we regularly meet with our nonprofit client boards for our annual review of the organization’s investment portfolio, Investment Policy Statement and future distribution needs. As I noted previously, once our economist’s forward-looking capital market assumptions are released, I’ll review our client’s strategic asset allocation to determine if it is appropriate. If our economist’s forward-looking return assumptions are reduced, a consideration may need to be made for either more risk, such as equities, lower future distribution, or increased contribution. I would then provide an asset allocation analysis to show how the current portfolio is expected to perform, versus a portfolio with more equities and less fixed income. During several meetings over almost the past decade I have been with the bank, the board agreed that a change to the target portfolio was warranted in order to increase the probability of preserving the real value of endowment while providing growth. We therefore increased the strategic asset allocation to equities and provided the client with a new IPS. We have executed this strategy many times over the past decade, and this new asset allocation has proven to be a sound one for the various nonprofits in the environment we have been in.
BILL JARVIS: John, a decade is a long time and markets are constantly fluctuating. I get it that the strategic targets are very important, but how do you deal with the shorter term market environment?
JOHN WONG: Remember that an Investment Policy Statement contains not only a target portfolio but also ranges around which the individual allocations may be allowed to fluctuate. While the strategic asset allocation process that I’ve just described is very important, we also pay close attention to tactical management, or the shorter term 12 to 36 month outlook, combined with a disciplined rebalancing process.
So as rates rise, fixed income may become more attractive. But the relative valuations of equities over fixed income at this time, remains our most significant tactical portfolio decision. In the present environment, we prefer being underweight fixed income, relative to the strategic allocation in a typical IPS, considering current low rates and the likely rise of interest rates in the future. We have a preference for shorter maturity bonds along with corporate bonds over Treasuries. We like shorter-term bonds because they mature relatively sooner and can be reinvested in bonds with higher rates in the future. As for corporate bonds, they can perform well in a rising rate environment as they tend to offer a yield above Treasuries. Within the corporate bond sector, we prefer higher-quality corporate bonds such as those rated triple B or above by the major agencies, Standard & Poor’s, Moody’s or Fitch.
And while forward-looking rate expectations are concerning for Treasuries, they do still have a place in your portfolio as they can reduce the overall volatility and provide protection during market downturn. Think of the past market downturns such as 1998 when Russia defaulted on its debt and long-term capital management collapsed, or 2000 when we saw the dot-com firms go bust, 2002 when investor confidence was shattered by accounting scandals, 2008 when the housing market crashed, and 2011 when Standard & Poor’s downgraded US debt and the European Central Bank raised interest rates prematurely. These periods saw very strong returns from Treasury bonds. And for rebalancing, as you know, Bill, this term means selling assets that have gone up and using the cash to buy assets that have gone down in order to return the portfolio within the ranges set forth in the Investment Policy Statement.
BILL JARVIS: So John, in addition to the strategic and tactical portfolio guidance that you provide to our clients, what other support do you provide?
JOHN WONG: We spoke to strategic long term and tactical short-term portfolio allocations, but I’d like to mention one more key impact on returns, investment manager selection, which is also where you can focus more on keeping your investment costs low. A low interest rate and potentially low return environment puts greater emphasis on lowering your fees. Where possible, we recommend instead of mutual funds, separately managed accounts, which some larger nonprofits may have access to. We also offer a few in-house strategies that do not charge an asset management fee. Examples of these strategies include Socially Responsible Investing investments where they focus on Environmental, Social and Governance sectors, along with various stock and bond solutions.
I’ll just end with a summary. It is prudent to review the Investment Policy Statement on an annual basis to consider any changes to the long term strategic asset allocation. The strategic asset allocation is a driver for meeting your goals. Over the shorter term, it is important to pay attention to tactical asset allocation decisions, continuing to assess portfolio holdings and having a disciplined rebalancing process.
BILL JARVIS: Thanks so much John, that’s very helpful. I’d like now to turn to another very important policy issue facing endowments and foundations, which is spending. We know that private foundations are required to make qualifying distributions averaging at least 5% of their assets, while other types of nonprofits have more flexibility. Sarah, you work with many types of organizations. During the crisis, some endowments and foundations spent at a higher rate in support of their missions. In the current environment, what spending practices are emerging? How are nonprofits managing to balance spending with their desire to maintain the purchasing power of their endowments, and what have we learned from foundations committed to bold grant making strategies, including those potentially spending down their entire portfolios?
SARAH CLARK: Bill, you are correct. The general response for nonprofit community was to increase their spending for many different reasons. Across the board in the nonprofit sector, we saw operating institutions costs increase due to the need to respond to the pandemic, whether to purchase personal protective equipment for staff and clients, to equip classrooms with remote learning, or to conduct more frequent and thorough cleaning and sanitization. The hope of these nonprofits is that this is a 12 to 18 month need. For some nonprofits, these practices may be required for a longer period of time.
Turning from operating nonprofits to grantmaking, private foundations responded to this need among their grantee organizations by increasing their payouts as well, recognizing that these operating organizations needed extra support for their budget. This is not the first time we’ve seen this type of spending shift. We saw a similar situation in the 2008/2009 financial crisis when private foundations spent levels in excess of 6 to 7% of assets during that period. So while private foundations are required to distribute the 5% of their average assets, we’re seeing a growing practice of increasing these distributions in times of stress, and also they’re making an effort to assess and increase the social impact of their grantmaking. To cite a few examples, healthcare related institutions were increasing their spending to support COVID relief in their communities. We saw community foundations increasing their support to their communities as well.
BILL JARVIS: Sarah, that’s very interesting but how are these nonprofits reconciling this higher spending with their need to maintain the inflation adjusted purchasing power of their endowments over multiple market cycles?
SARAH CLARK: Bill, you’re right. The flip of this additional spending by both operating nonprofits and foundations is that it’s definitely affecting their ability to maintain the inflation adjusted purchasing power of their endowments into perpetuity. We’re having many conversations regarding how to accommodate higher spend rates, either on an episodic basis or over the long term. There are several avenues that we’re discussing.
The first is how much more risk an institution is willing to accept for the potential of higher, longer return. As John just mentioned, that trade-off of added risk for returns needs to be based on objective factors and considered across multiple market cycles, not just a year or two.
Another discussion is regarding the spending formula that the nonprofits use to smooth out the distribution from year to year. If the committee feels comfortable with significantly higher equity exposure or market risk, which can lead to higher volatility of returns and market values, what changes do they need to make in their spending formula? Over the years, I have analyzed portfolios that have much more volatile portfolios than most nonprofits would consider, consisting of 90 to 95% equity. But the boards of these organizations utilize a spending formula that smoothes the valuation over a 10-year period to dampen the volatility of the distribution. They use that long term smoothing period to reduce the increased volatility of the market values from the nearly all equity portfolio. We’re not recommending that, but it highlights the point of revisiting the spending formula if you need more dependable payout amounts.
BILL JARVIS: Sarah, aside from spending practices, are there other tools that are available to nonprofits that want to make larger distributions on say, a temporary basis?
SARAH CLARK: Yes. Another alternative for some organizations that have wanted to spend more but are reluctant to raise their endowment spending rates has been to set up a line of credit secured by unrestricted or board-designated assets in the endowment. With interest rates at historic lows, this has been a practical, if temporary, alternative for some organizations.
BILL JARVIS: Thanks Sarah. And finally, one more question. Are organizations reconsidering their commitment to a perpetual existence in light of the extraordinary challenges that society has been facing?
SARAH CLARK: Bill, although this is not common, we have read in media and heard about some foundations that have decided not to structure themselves as perpetual existence but are instead planning to spend their assets out over a certain amount of time, frequently to alleviate a particular set of social or health issues. In other cases, private family foundations, as generational shifts occur, we find that their family members are revisiting the purpose of the foundation and whether it makes sense to be perpetual or spend down over a specific period of time, maybe 10 to 20 years.
BILL JARVIS: Thanks Sarah, very helpful, very insightful. Now investment policy and spending practices are two very important topics, but nonprofits don’t exist in a vacuum, they’re intimately embedded in our society and the communities they serve. The COVID-19 pandemic upended the economy and markets, but it also placed tremendous stress on families and individuals and the calls for social and racial justice that we saw were not unconnected to those stresses.
Elizabeth, in your practice, you work with a wide range of nonprofits, the movement for racial and social justice had led to renewed calls for changes in the ways endowments and foundations are governed. What are the governance implications for endowed organizations and for the foundations that support them with regard to diversity and board composition, staffing and other roles? How are these changes accelerating mission advancement?
ELIZABETH BARNETTE: While many of the conversations that we’ve been having Bill, with both our public charity and foundation clients over the last year or so, have focused on one of the most pivotal questions facing nonprofits today, what should a 21st century board look like? And how can nonprofits take the correct actions needed to build a board and an overall organization, a structure that both embraces and empowers diverse voices.
We know that governance begins with the board and through working with our operating charity clients, we know that most boards understand their responsibilities regarding fiduciary, strategic and financial matters, as well as their legal obligation. However, having a clear understanding of responsibilities and legal obligations is just one part of creating a high-functioning board. A 21st century board is one that both listens and responds to diverse voices in order to best fulfill their mission. And here of course, I think it’s really important to note that the US is experiencing what I recently heard called a diversity explosion. In August, the 2020 US Census data was released reporting that the US population has become much more multi-racial and much more racially and ethnically diverse since the last census was taken in 2010. However, many nonprofit boards are still really struggling to make headway towards achieving racial and ethnic diversity, as well as diversity in age, gender, identification, sexual orientation and socioeconomic status. And for many organizations, it may be difficult to know where to begin the process and the solutions that are needed are sometimes complex. This process certainly requires a long-term commitment which can be overwhelming but there are many ways to approach this task.
BILL JARVIS: Elizabeth, can you provide a few specific reasons why diversity is so important for board success?
ELIZABETH BARNETTE: Of course Bill. There are so many reasons why diversity matters with regard to board composition, but I’ll just touch on a few.
From an overall perspective, creating a truly inclusive organization starts with establishing a diverse and inclusive board. Setting that example at the board level can really help move the entire organization towards a more diverse and inclusive model.
Boards that are homogenous can sometimes be limited in their viewpoint and ideas and they can create sort of an insular atmosphere. By comparison, a board where members have a variety of backgrounds, skills, experience, resources and perspectives will just naturally promote new ideas and have a much more innovative and creative mindset, while also really helping the board better understand their constituents and the needs of the community that they’re serving.
Organizations without diverse boards are likely to miss opportunities to develop diverse leaders who can provide that fresh perspective on the mission of the organization, and also Bill, studies have shown that for profit corporations that have more gender, cultural and ethnic diversity in the ranks of their executive teams, they are significantly more profitable than those who are less diverse. So, having a diverse board can actually just help improve performance.
For public charities, diverse boards are more likely to attract diverse donors including, increasingly, the support of the most sophisticated foundations. Some foundations actually will limit or even withhold funding from organizations that they don’t see as prioritizing diversity, including on their board.
BILL JARVIS: Hmm. Elizabeth, you mentioned earlier though that many organizations may feel overwhelmed as they approach this task, can you get a few pointers as to where they might start?
ELIZABETH BARNETTE: Of course, we know that a lot of organizations may feel blocked by obstacles in their attempt to create change in this area. There are some very simple suggestions to consider as organizations develop a board recruitment plan focused on creating increased member diversity.
Regarding the search to find the right board members, looking at expanded networks and groups can be really useful, so sort of thinking outside just the people who are close to the organization. It can be helpful to connect with affinity and young professional groups, as well as groups that assist in the community that your organization serves. Engaging recruits in programs or mission work related to an organization can get them involved and can get them more open to potentially thinking about joining the board.
It’s also important to address the needs and concerns of prospective board members. Take time up front to educate and answer their questions. Providing a detailed board member role description can also be helpful and be clear about the expected time commitment. Prospective board members may also have some concerns about the current existing lack of diversity on the board. So that needs to be addressed; those concerns should be addressed with candor and sensitivity. Our clients have told us that assigning ongoing mentors and providing up front training can really help new board members thrive and get them up and running quickly.
We’re also seeing that foundations are making similar prioritizations around diversity, Bill. If diverse voices are not at the table taking part in the decision-making process, there is an increased possibility that uninformed funding decisions may be made. A key ingredient for effective philanthropy is a robust, ongoing dialog between donors, nonprofits, grantees and community stakeholders. Philanthropists should seek and prioritize the input of community members, leaders and organizers, practitioners and front-line organizations.
So Bill in the end, I think what we are saying, and what we are seeing in practice, is that 21st century boards and the organizations that they serve will be the most nimble, creative, energized and in the end, high performing when they are mirroring the modern world that we actually live in.
BILL JARVIS: Thank you Elizabeth, thank you very much for those insights. Now as we approach the end of our time together, we hope that you have found this discussion useful for your own organizations. We will be sharing some of our thought leadership on these and other topics with you as a follow-up to this call and, as always, please feel free to reach out to your advisor with any questions you may have. I’m now going to hand the microphone back to Ann to conclude.
ANN LIMBERG: Thank you so much to all of our panelists, Bill, John, Sarah and Elizabeth who are just a few of our 200-person philanthropic team here at Bank of America, all of whom are focused on helping you and your organizations to succeed in your missions.
I promised at the start of our call today that we’d provide you with information that you need and hopefully, there are a few takeaways here.
The first is that the work you do serving the mission of a nonprofit organization requires intent and knowledge of a very special type. Some of you have acquired this knowledge over years of practice, but for others, the process may just be beginning and we hope that you’ll feel confident in turning to us as you seek to strengthen your own skills and knowledge in this area.
The second point is that the investment environment we’re in is dynamic and so as with the highly diverse nature of your organization, one size will not fit all and a careful and individualized approach to investment spending and governance will be fundamental to your organization’s success.
Third, and finally, I hope that you know that we, across the entire Bank of America Enterprise are here to serve you across the continuum of strategic investment advisory and governance needs, whether for a very large sophisticated organization or for one that’s just emerging in terms of impact and mission.
Thank you so much for joining us here today. We greatly appreciate that and thank you for all you do, such a critical and important part of our society. We strongly believe as you do, that we have a role to play in this continuum and through our collaboration, we’ll play that role together. We’d love to talk with you more in detail on specifically what you need, so please let us know how we can help and we look forward to further conversation.
Thank you, and have a great afternoon.
MAP3740475 | 9/10/2022
