Operating Charity Implements a Risk-Based Investment Policy

May 31, 2016 |
2 minute read
|

An operating charity in the Northeast is in the process of implementing a risk-based investment policy for its $30 million endowment. The organization’s seven-member Investment Committee includes individuals with experience at leading securities and investment firms; a majority of the Committee members are graduates of the university that was the organization’s original sponsor and with which it was long affiliated.

In drafting its investment policy statement (IPS), the Committee created a separate section entitled “Risk Tolerance”. In that section, it set forth the following specific risk parameters:

Intergenerational equity was set as a minimum goal, but expansion of the endowment was also viewed as desirable. This meant that the endowment would need at least to keep pace with inflation, while also meeting its annual average spending target of 4.25 percent, net of fees and expenses, into the indefinite future. For this reason, the portfolio would have to have a bias toward equities in order to obtain the potential for future growth.

The Committee set a liquidity budget requiring that one year’s targeted spending, or 4.25 percent of the endowment, be retained in “highly liquid, low volatility instruments” on an ongoing basis. While highly illiquid instruments such as private capital limited partnerships could be part of the port- folio, this liquidity budget requirement would take priority.

Turning to market risk, the IPS required that the portfolio be constructed in such a way that there would be less than a 5 percent probability of an annual drawdown of greater than 10 percent.

With these guidelines as background, the Committee then turned to the question of constructing a portfolio that would meet these criteria. Using a Monte Carlo simulation model, four portfolios were analyzed, with equity allocations ranging from 43 percent of the portfolio to 61 percent, of which private capital allocations ranged from nearly 5 percent to over 14 percent. Fixed income and hedge allocations were also part of these proposed portfolios, as were non-U.S. dollar investments.

When it examined the results of the simulation, the Committee found that none of the portfolios met all of its requirements. The maximum drawdown constraint, in particular, led to a portfolio with an unacceptably low annual return of 6.9 percent, compared with a somewhat looser but still well-diversified portfolio that had a projected annual return of 7.6 percent. Equally relevant, the limited-drawdown portfolio had just a 38.5 percent chance of maintaining intergenerational equity over a 20-year period, while the somewhat looser portfolio’s intergenerational equity likelihood was 54.9 percent.

The Committee decided to concentrate on the looser portfolio, which had a target allocation of 55 percent to public equity, 30 percent to fixed income,  and 15 percent to private capital strategies. While the final portfolio construction has not yet been determined, the Committee agrees that the ability to perform this kind of analysis has been crucial in enabling it to construct a portfolio with a greater likelihood of behaving according to the risk prescriptions in the IPS. Further iterations will be necessary for the Committee to reach a final decision, and the parameters of the resulting portfolio will be recorded in the IPS when it is adopted by the Board.

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Commonfund Institute

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Commonfund Institute

Disclaimer

Certain information contained herein has been obtained from or is based on third-party sources and, although believed to be reliable, has not been independently verified. Such information is as of the date indicated, if indicated, may not be complete, is subject to change and has not necessarily been updated. No representation or warranty, express or implied, is or will be given by The Common Fund for Nonprofit Organizations, any of its affiliates or any of its or their affiliates, trustees, directors, officers, employees or advisers (collectively referred to herein as “Commonfund”) or any other person as to the accuracy or completeness of the information in any third-party materials. Accordingly, Commonfund shall not be liable for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on any statement in, or omission from, such third-party materials, and any such liability is expressly disclaimed.

All rights to the trademarks, copyrights, logos and other intellectual property listed herein belong to their respective owners and the use of such logos hereof does not imply an affiliation with, or endorsement by, the owners of such trademarks, copyrights, logos and other intellectual property.

To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated herein. Forecasts of experts inevitably differ. Views attributed to third-parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Market and investment views of third-parties presented herein do not necessarily reflect the views of Commonfund, any manager retained by Commonfund to manage any investments for Commonfund (each, a “Manager”) or any fund managed by any Commonfund entity (each, a “Fund”). Accordingly, the views presented herein may not be relied upon as an indication of trading intent on behalf of Commonfund, any Manager or any Fund.

Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Fund. Such statements are also not intended as recommendations by any Commonfund entity or any Commonfund employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information or statements. Past performance is not indicative of future results. For more information please refer to Important Disclosures.

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Disclaimer

Certain information contained herein has been obtained from or is based on third-party sources and, although believed to be reliable, has not been independently verified. Such information is as of the date indicated, if indicated, may not be complete, is subject to change and has not necessarily been updated. No representation or warranty, express or implied, is or will be given by The Common Fund for Nonprofit Organizations, any of its affiliates or any of its or their affiliates, trustees, directors, officers, employees or advisers (collectively referred to herein as “Commonfund”) or any other person as to the accuracy or completeness of the information in any third-party materials. Accordingly, Commonfund shall not be liable for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on any statement in, or omission from, such third-party materials, and any such liability is expressly disclaimed.

All rights to the trademarks, copyrights, logos and other intellectual property listed herein belong to their respective owners and the use of such logos hereof does not imply an affiliation with, or endorsement by, the owners of such trademarks, copyrights, logos and other intellectual property.

To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated herein. Forecasts of experts inevitably differ. Views attributed to third-parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Market and investment views of third-parties presented herein do not necessarily reflect the views of Commonfund, any manager retained by Commonfund to manage any investments for Commonfund (each, a “Manager”) or any fund managed by any Commonfund entity (each, a “Fund”). Accordingly, the views presented herein may not be relied upon as an indication of trading intent on behalf of Commonfund, any Manager or any Fund.

Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Fund. Such statements are also not intended as recommendations by any Commonfund entity or any Commonfund employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information or statements. Past performance is not indicative of future results. For more information please refer to Important Disclosures.