Asset Allocation for Foundation and Endowment Investment Portfolios

Foundations, endowments and other not-for-profit organizations come in all shapes and sizes. The assets that they control and manage for the benefit of countless projects, charities, and causes is staggering in total and it has become a primary market for the vast array of investment products developed by Wall Street financial institutions. One can only speculate about how much "bubble paper" finds its way into the these portfolios, but nearly all of them are managed by the major brokerage firms, and all such firms bonus their brokers on the basis of product sales. It is not uncommon for Wall Street to re-write the syllabus for Investments 101, redefining quality, diversification, and income to suit its own dark purposes...

If you were to look back at your foundation/endowment/not-for-profit portfolio of the late 90's, how much was invested in NASDAQ issues, either directly or in the form of mutual funds? Dot-coms? Don't be at all surprised if your more recent reports (2006 thru 2008) are replete with CMOs, CDOs, index funds, foreign investments, asterisks, footnotes, etc. This is the type of investing that is standard fare on Wall Street and it is certainly something that you need to be concerned about. Wall Street pros always move the money toward whatever is most popular at the moment. Always, no matter how late in the cycle it happens to be.

Regardless of the proprietary label given to this new age, scientific asset management, the speculation level is barely above that of options, commodities, and futures. You don't need to go there to achieve the goals of your organization... plain vanilla stocks and bonds are not broken, they have just been replaced with better income generators for the wizards of Wall Street. I understand that they've even been able to change the "prudent man rule" to allow unusually high risk, get this, so long as the potential reward is equally significant! Have I gotten your attention?

From what I've been reading, it seems that the disbursement-budget determination process in some organizations is based on information that has absolutely nothing to do with a portfolio's ability to generate the money being disbursed. Similarly, it appears as though all investments are expected to grow in market value all of the time, irrespective of where mother nature's investment twin is in developing her various cycles. Somehow, a higher market value translates into higher availability of disbursable funds, when, in fact, no such relationship exists.

Some organizations determine their annual disbursement budget based on the average market value of the investment portfolio over the past several years. If the investment markets cooperate, and the market value remains above the average, the disbursements take place as scheduled. If not, some beneficiaries may have to go without. This is unnecessary, as well as absurd. The average market value of the portfolio is not what determines the amount of spendable income the portfolio produces. The market value approach also assures that payouts will decrease just when they are needed the most... when the market is in a prolonged correction, donor contributions are down, and interest rates or inflation (or both) are trending higher.

Let's say, for example, that we have a portfolio invested solely in government bonds yielding 6%. This 6% will be available for disbursement regardless of the direction of the portfolio market value. Lower valuations are always opportunities to add to holdings; higher ones should provide profit-taking opportunities. Similarly, a portfolio invested in equities with an average dividend yield of 1.5% just will not cover a 4% disbursement nut unless something is sold... a sale that could well be a losing transaction. (Wall Street pros take losses quickly, but rarely take profits in the same manner.)

The amount of base income produced by a portfolio is very predictable. In the case of most foundation and endowment portfolios, the rate of annual additions from contributors can also be safely, and conservatively, estimated. Creating a portfolio that produces enough income to cover programmed disbursements, even with a three-month money-market reserve, is simply simple... and has absolutely nothing to do with the portfolio market value. Another thing to look for, as a trustee or director of your organization is the profitability of sales transactions. The results may surprise you.

Inflation is a purchasing power issue, and purchasing power depends on income. Hoping, as many people do, for an upward only portfolio-market-value scenario is, at best, comical. A properly designed portfolio will constantly generate increasing levels of base income at varying market value levels, and that is the stuff from which disbursements are made. If the payout rate to beneficiaries is 4% (of working capital, perhaps) and we want to increase the dollar amount of the 4%, we need simply to increase the assets that are producing the cash flow... by reinvesting some of the income and contributions appropriately.

Increasing the market value of the securities looks good but generates no additional regular spending money. In fact, higher yields are always more readily available when prices are down than when they are up... go figure. Really, go figure.

If we can (through proper asset allocation, and a portfolio management methodology that focuses on working capital) increase our investment in our income producing securities base, we can stay ahead of inflation and satisfy our commitment to whatever cause it is that concerns us. This can be done with much less risk than most not-for-profit board members have become used to in recent years while they blindly chase the gold ring of ever higher market values. Market value, though, will cycle to new highs periodically, as the stock market, interest rate, and business cycles move on down, and up, the road. Isn't the primary purpose, after all, to grow the distributed benefits?

As important as income is to the achievement of your disbursement goals, there is certainly a place for a diversified portfolio of investment grade value stocks within the asset allocation. You will have difficulty convincing your broker to stick with IGV stocks, and to trade them for short-term profits. Frankly, most are inexperienced at doing so. But your tax status, size, and mission are perfect for this kind of strategy. Your investment manager should take care of the income part of the asset allocation first, before venturing into the riskier realm of equities. Stop! No matter what you've been told lately, quality income investments are always less risky than even the best equity investments. What about the 2007 CDO mess? Junk is junk, no matter how pretty the package.

You have a fiduciary responsibility to understand what's inside your not-for-profit investment portfolio... even if you think that you are pleased with its recent performance. It just makes good sense to get another opinion. Similarly, if you donate money to a cause that interests you, the general structure and content of the investment portfolio should be of some interest. Complicated products with trunches, and multi-level ifs-ands-and-buts are for arbitrageurs and speculators. Any investment product that requires a masters degree in quantum mathematics to decipher is hiding something... and that something is excessive risk.

What's in your not-for-profit portfolio?