In the world of investing, crises are inevitable. Yet, many investment committees find themselves unprepared when these crises strike because they haven’t taken the necessary time to scenario plan. Granted – crisis planning isn’t the most exciting part of a fiduciary’s role – but it’s critical to the long-term health and sustainability of our organizations. That’s why we work with many of our clients to create a “Crisis Playbook” during periods of relative calm, allowing us to thoroughly challenge our assumptions about what could go wrong and how bad it could get, and then codify our response plans so that we’re ready to respond when the crisis is upon us.
The Unseen Crisis
Investment committees often fail to anticipate crises and lack the necessary plans to manage them. Unlike industries such as manufacturing, energy, or healthcare, which regularly engage in contingency planning, investment committees rarely discuss potential disruptions. This lack of preparedness is not due to the infrequency or insignificance of these disruptions.
Historical Crises and Their Impact
The 1970s oil crisis, the 1987 market crash, the dot-com bubble burst, the Great Financial Crisis, and the COVID-19 pandemic are all examples of significant crises that had profound impacts on markets and nonprofit investors. Each of these events led to substantial market downturns and financial disruptions, highlighting the need for effective crisis management strategies.
Bear markets, defined as market declines of 20 percent or more, have occurred on average every ten years, with an average cumulative loss of 41 percent. This frequency and severity underscore the importance of being prepared for a significant market downturn – probably sooner rather than later.
Developing an Effective Crisis Playbook
An effective crisis playbook includes three critical components. First is considering the duration and severity of potential crises. For example, the 2000-02 recession was both long and severe, while the Great Financial Crisis, though severe, was shorter in duration. COVID-19, on the other hand, had varying impacts depending on an institution's reliance on tuition versus endowment revenue.
The COVID crisis was a good example of why duration and severity are both important considerations for preparing your crisis playbook. Following is an example of a framework we developed for our educational institutions and published in April 2020. Keep in mind, that the components of the framework can be applied to any endowed, perpetual organization with small adjustments to reflect differences in business structure, etc.
The vertical axis of the chart represents time, or in other words duration. Envision April of 2020, a scary time for all of us. In developing a crisis playbook for this unique event, we framed three time periods:
- Short term, meaning that students returned for the immediate fall semester and thus so did tuition revenue.
- A medium term which we defined as lasting into the next academic year.
- And a longer-term disruption in revenue generation.
Across the top or horizontal axis measures if you had the resources to, first, survive the crisis, second to rebound once the crisis ends, and third, pivot to whatever the new reality was going to look like.
- The scores indicated relative confidence in having the resources to survive, pivot or rebound, depending on different time periods.
- The colors looked different for each institution we did this for. The dashed line is representative of the trade-off between relying on the income statement vs. the balance sheet to fund the survival, rebound and pivot. This helped to inform decisions such as whether to increase spending from endowment, which is a short-term decision with long-term consequences.
Unique and Exogenous Risks
Institutions face both unique crises, such as enrollment declines, and exogenous risks, such as economic downturns. The biggest risk arises when these crises occur simultaneously. So, the second component of our crisis playbook must account for both types of risks.
Revenue vs. Expense Crises
Third, crises can impact revenue, expenses, or both. COVID-19, for example, led to both declines in net tuition revenue AND increased costs for things like testing and social distancing. Understanding the nature of the crisis is crucial for effective planning.
Decision-Making in Crises
If we put together these three components, we have a framework for understanding the nature of potential crises we may face. This allows us to make more informed and better considered decisions. During a crisis, investment committees may need to deviate from established policies to respond effectively. This could involve rebalancing to policy targets, revisiting strategic policies, or addressing liquidity considerations.
The Importance of Imagination in Crisis Planning
One word of caution – Investment committees shouldn’t underestimate the potential severity of a crisis. Many past crises were unexpected and had significant consequences. It is essential to think big and consider the worst-case scenarios when developing a crisis playbook. Another consideration, Investment committees often experience turnover, and the group around the table may not have faced a crisis together. Testing the committee's response to potential crises in advance can be beneficial.
Conclusion
Investment committees should be proactive in preparing for the next crisis. By developing a comprehensive crisis playbook, considering both unique and exogenous risks, and understanding the nature of potential crises, committees can better navigate the challenges that lie ahead.
