Nonprofits are required to use their funds to support their charities. That doesn’t mean that they’re not allowed to invest funds to help their money grow. While most of the financial regulations apply to for-profit organizations, board directors of nonprofit organizations need to be aware of the laws and regulations that apply to nonprofit investing. In addition, donors may place restrictions on how donors can use the funds they offer nonprofits.
Nonprofit investment committee best practices should first consider how nonprofits can use their investments to support long-term sustainability. Committee members must also be aware of the nonprofit’s short-term capital needs. Meeting a nonprofit organization’s short- and long-term demands requires a degree of financial flexibility that only a qualified financial expert can navigate responsibly.
Nonprofit investment committee best practices require boards to understand whether their endowments are considered large or small, and how the strategy differs either way. Nonprofit board directors also need to understand the risks in trying to manage investment portfolios on their own and how to choose the members of an investment committee.
Five Best Practices for Nonprofit Investing
- Understand Financial Regulations for Nonprofits
Nonprofit board directors need to know the state, federal and local laws that apply to nonprofit organizations. They also need to be aware of the sections on financial regulations that apply to them. In particular, nonprofit boards should get acquainted with the Uniform Prudent Management of Institutional Funds Act (UPMIFA), which requires nonprofit organizations to classify their endowment funds as restricted or non-restricted.
Nonprofit investment committee best practices require nonprofits to consider specific factors when investing funds by establishing a prudent spending policy.
The Sarbanes-Oxley Act (SOX) focuses primarily on for-profit corporations, but nonprofit boards should be careful not to overlook the provisions of the Act that apply to them. SOX requires nonprofit organizations to have whistleblower policies, document retention policies and policies regarding government investigations. Nonprofits are at risk of losing their tax-exempt status if they fail to comply with these regulations.
- Best Practices for Small and Large Endowments
Larger endowments fall into the $1-$2 million range. Nonprofit investment committee best practices expect that funds of this amount require a high-level financial expert with experience in multiple asset classes. Investment committees may explore a wider array of asset classes, including hedge funds, private equity, venture capital or real estate, as they have the ability to take on more risk. The National Association of College and University Business Officers (NACUBO) cites their study, which shows that larger endowment funds are three times more likely to invest in a wider array of asset classes.
Smaller endowments may find it more practical to consider a broker or independent investment advisor, as wider asset classes may not be available to them.
- Do Due Diligence in Finding a Qualified Investment Advisor
Nonprofit investment committee best practices indicate that even the smallest nonprofits shouldn’t risk managing their assets internally. Investing donor funds is of such importance that it requires objective oversight. Moreover, it creates a conflict of interest when board directors oversee investments. It’s considered best practice for nonprofit organizations to have at least three reputable, qualified financial experts with nonprofit experience on their investment committee.
The fiduciary duties of nonprofit board directors require them to perform due diligence when selecting investment experts because of the prevalence of Ponzi schemes and fraudulent practices among investment managers. Nonprofit investment committee best practices advise nonprofit board directors to vet their investment managers carefully by reviewing and verifying their public filings for their experience and credentials. Nonprofit boards should only consider candidates that have well-defined procedures and processes for investing and can explain how and why they make investment decisions. Investment firms should also have strong compliance and operational support.
- Create an Investment Policy and Review It Regularly
Best practices require nonprofit boards to consider how investments will serve their organization and support sustainability now and for the future. Meetings between the investment committee and the investment manager should strive to communicate the well-defined needs of the organizations with the role of the endowment portfolio.
An important first step for the investment managers is to assist the investment committee in developing a well-crafted investment policy that has a clear statement of the following:
- Investment objectives
- Asset allocation ranges
- Risk tolerance
- Portfolio measurement
D. Ellen Shuman, managing partner of Edgehill Endowment Partners, recommends a straightforward policy of low-cost stock and bond funds, allocating the money appropriately and rebalancing it periodically to ensure that it continues to meet the organization’s needs.
Regardless of a nonprofit’s size, the average distribution across the board is 4.7%. UPMIFA rules indicate that a distribution over 7% is imprudent.
- Determine Best Course of Action for Reviewing Portfolio and Investment Manager Contract
Continual review of the investment portfolio and the board’s relationship with the investment manager is a crucial component to successful nonprofit investing. Nonprofit boards should expect to receive a portfolio review at least annually.
As people and situations tend to change over time, nonprofit investment committee best practices should extend to reviewing the investment manager at least every three to five years to ensure that they still have the best person assisting with their investments.
Three Elements Combine to Support Nonprofit Investment Committee Best Practices
Nonprofit organizations that aren’t ready to begin investing have a few options for funding their organizations. Nonprofits that are ready to take the plunge in investing can do so with the understanding that they have some limitations. Preserving and growing investments help nonprofit organizations with long-term sustainability. Nonprofits often find that wise and responsible investing to support the goal of long-term planning is a necessary endeavor to attract the types of large donors that every nonprofit wish to connect with.
By securing the right investment manager, who can steer nonprofit investment committees toward the right investment plan, and with a board portal system by BoardEffect, nonprofit boards position themselves for an investment plan that meets regulatory requirements and sets the stage for long-term growth and sustainability.