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.
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.
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:
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.
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.
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.
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.
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.
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.