As with any other pool of assets, the key to success in managing the investment portfolios of endowments and foundations lies in establishing a strong governance system. Endowments and foundations depend on investment returns to fund their programs and charitable activities. A successful investment and spending policy must provide sufficient resources to enable them to maintain their operating budgets and meet their goals and objectives without reducing the real value of the endowment or foundation over time (for those institutions whose missions are defined in perpetuity).

A poorly defined and managed portfolio would impair an institution’s ability to carry out its mission.

Investment management structure and investment policy can significantly affect an institution’s long-term returns. According to Acharya and Dimson’s Endowment Asset Management Investment Strategies in Oxford and Cambridge, “differences in management structures have consequences…for the institutions as they benefit from superior long-term investment returns….Thus, governance structures matter, if they can improve asset allocation decisions that result in superior long-term performance. Institutions need to address such arrangements to ensure their investment management is organized effectively.”

This article discusses four essential practices for the good governance of investment and spending policies for endowments and foundations.

1. Establish a clear investment policy aligned with the institution’s mission – The board should work with the investment committee to clearly define investment objectives that will delineate the institution’s investment policy. As the universe of non-profit institutions is not homogeneous, there is no one-size-fits-all investment strategy. Even institutions that share a similar purpose may need to take different approaches to managing their assets.

A successful investment policy must include factors such as endowment or foundation size, investment return objectives, non-investment income, spending policy, liquidity needs, risk tolerance and investment time horizon. The selected policy would, in most cases, be different than the one adopted for the institution’s pension assets.

Given the large number of U.S. endowments and foundations and the size of their assets, it’s helpful to look at their approach to measuring the success of their policies. According to the 2007 Commonfund Benchmarks Study, most U.S. foundations define their investment strategies quantitatively. In fact, 76% of survey respondents said their investment objective is to outperform a benchmark, while 40% reported that their goal is to exceed a specific rate of return. About 49% want to outperform a 5% rate of return.

In Canada, many endowments and foundations also consider a real rate of return objective, recognizing that principal preservation is important and that real returns assist in meeting and maintaining spending objectives.

To ensure that investment strategies are implemented and monitored appropriately, the investment policy should define and document the roles and responsibilities of the board and investment committee members. It should also state which investment decisions, if any, will be delegated to staff, external consultants or investment managers. Finally, according to the Commonfund Institute, these groups would be well-advised to review and re-approve the investment policy annually so that it continues to reflect the changing reality and needs of the institution.

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