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What to consider when forming an investment policy

An investment policy is important as it documents your organization’s investment plan and provides guidance for consistent, informed decision-making.  Does your nonprofit have a formal investment policy? If not, your organization’s investment committee might want to take a look at the following suggested outline as you consider formalizing a policy.

State investment objectives and constraints

First, ask: What do we hope to accomplish with our investment policy? General objectives stated in your policy should address return, spending rate and risk. Consider including details such as assumed rate of inflation, investment management fees, and any desired real portfolio growth to reach long-term goals. Most important, how much risk is your nonprofit willing to experience?

Your policy also should address investment constraints, such as liquidity and time horizon. Does your organization, for instance, rely on investments to “throw off” a certain percentage of income each year to meet spending needs for operations? What’s the time horizon of your investments? Is their purpose largely to support current programming or endowments?

Describe performance measures

Additionally, your policy should state how you’ll measure performance. Outline how benchmarks will be developed and compared to actual performance, both in the areas of risk and return. An annualized nominal rate of return should be stated as a goal as well as how market, inflation and interest-rate risk play into investment decision-making.

Specify spending rate and asset allocation

Your spending rate will likely be a percentage of total return. But how do you define “total return”? Does this include unrealized or market gains as well as current dividends? And how is the amount calculated? Many organizations adopt an average of the trailing 36 months’ results.

Give asset allocation special attention, because it’s one of the most important decisions your investment committee can make. Base the allocation on the factors discussed above — it should be commensurate with your acceptable amount of risk and most likely to generate your expected return. Your investment policy might detail asset allocation, in general, as follows:

 Total equities 50%
 Total fixed income 36%
 Total alternatives 14%
 Total 100%

Be sure to review and revise your allocation strategies regularly. Given U.S. market volatility, diversifying across industries, geographic areas and types of assets reduces risk. Certain types of assets, such as fixed-income securities (for example, Treasury bills) are less volatile, while others such as equities are considered a source of long-term growth.

Define prohibited investments and portfolio rebalancing

Your policy should detail permissible and prohibited investments. Permitted ones might include real estate investment trusts, domestic large-capitalization equity securities, and cash equivalents. Investments inconsistent with your mission or considered outside an acceptable range of risk may be prohibited.

Include in your policy how frequently your investment team should rebalance the portfolio to realign with your investment allocation. Some policies state that rebalancing must occur every quarter. Others state that rebalancing will take place when there’s a certain percentage deviation from the desired asset allocation.

Other considerations

You may want to incorporate the following components into your investment policy for a more complete depiction of your objectives:

A delegation of responsibilities and authority. Detail the expectations for, and functions of, the general board, investment committee, investment advisors, managers and custodians, and specify how brokers and advisors will be selected.

A conflict of interest statement. Written disclosure of any conflicts should be required. The investment committee can ask those with a conflict to excuse themselves from voting on investment decisions.

The investment process. Outline how investment information will be monitored and communicated.

A formal procedure for revising the policy. State how often the policy will be reviewed and amended. What changes will require board approval?

A matter of support

Your formal investment policy should be designed to support your organization as it moves forward. Be sure to review it with your CPA and your attorney to ensure your policy meets all legal and reporting requirements.

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