Principles of Nonprofit Investment Management - Commonfund

Principles of Nonprofit Investment ManagementThe key issues facing trustees and financial officers

The financial world has changeddramatically since the first edition ofthis brochure was published in 2001.Well-publicized stories of corporatescandals, dubious trading schemes,public dissensions and individual fraudhave spilled out of the media into ouroffices and homes. Rigorous newlegislative and administrative rules havebeen established. It would be a greatmistake to think that these changesaffect only the corporate sector.Increased public scrutiny has placedeven more intense pressure on allboards to rigorously discipline theirfinancial operations and fiscal integrity.The breadth of these changes as theyaffect the nonprofit world has beencovered in Commonfund Institute’sMonograph, “Governance. YourBoard: Dynamic or Dysfunctional?”(See References, page 30.)Those responsible for the managementof a nonprofit investment fund bear aspecial burden, which is both ethicaland legal, for they are charged withthe preservation of capital and theresponsibility to fund the institution’smission. And there is no universalmeasure of what these responsibilitiesare and how long they will endure;appropriate time horizons can rangefrom one year to perpetuity.The roles and responsibilities of theinvestment committee members andstaff of a nonprofit are varied andcomplex. For that reason, we atCommonfund Institute have createdthis publication. In the followingpages we endeavor to summarize acomprehensive approach to nonprofitinvestment management that allconcerned can share: both the financialprofessionals and those with less expertise;both the trustees, who establishpolicy, and the officers who execute it.This publication identifies anddefines the seven key issues governingnonprofit investment management.These are the issues that you mustfocus on as you assume your responsibilitiesin managing your institution’sinvestment assets. These time-testedprinciples outline a clear and rationalway for you to make sound investmentdecisions while providing your boardwith best practices on setting objectivesand policies for your investmentactivities.- 1 -

Contents3 BasicsBeginning at the beginning, thispage tells what a nonprofit investmentfund is, what importance ithas for the institution, and thequestions it raises for trustees andother policy makers.PrinciplesA relatively simple guide tononprofit investment management,summarized in seven keyprinciples:4 Principle One: ObjectivesBased on the mission of the fund,briefly state the objectives of theinvestment funds and create astatement of investment policies,which include the time frameover which the assets need to beemployed.8 Principle Two: Payout PolicyDecide how much of the investmentfunds must be available tosupport the institution’s mission.14 Principle Three: Asset AllocationDetermine the optimum balanceof the portfolio to achieve the targetedlevel of return at an acceptablelevel of risk.20 Principle Four: Manager SelectionSelect the right investment specialistsfor each part of your diversifiedportfolio.24 Principle Five: Risk ManagementSystematically search for risks inevery facet of the investmentprocess.26 Principle Six: CostsKeep asking, “Can we get thesame results at lower cost?”28 Principle Seven: ResponsibilitiesDefine the roles of the trustees,investment committee, staff, andconsultants – in writing.30 References and ResourcesIn a brief brochure, we cannotpresume to provide a thorougheducation. For further informationand guidance, a bibliographyis included in the back of thisbook. We also invite you to takeadvantage of the decades ofexperience accumulated byCommonfund in the course ofadvising nonprofit institutionsof many kinds and sizes. Ouraddress and phone numberare shown on the back cover foryour convenience.32 About Commonfund- 2 -

BasicsThe very existence of a nonprofit investmentfund poses a number of difficult questionsthat the institution’s policy makers mustcontinually reconsider.To start, we will define a few basicterms and describe basic connections.Different types of institutions usedifferent terminology. Educational institutionsand foundations generally referto their long-term investment funds astheir endowments, while health careorganizations typically use long-termoperating funds to describe their longterminvestments. We will use theseterms somewhat interchangeably. It isimportant to note that this brochuredoes not deal with pension funds,insurance reserves, or short-term cash,although many of the principles apply.A nonprofit investment fund can bedefined as a portfolio of assets donatedto a nonprofit institution to aid in itssupport. In their medieval origins,endowments consisted of farmlanddonated to churches, which wouldearn rental income from the land’stenant farmers.In modern times, endowment assetsare held in a variety of financial instruments,which may include real estateand limited partnerships. Investment“income” in a modern portfolio canbe comprised of capital appreciation aswell as traditional income, i.e., interest,dividends, rents and royalties. In theU.S., investment of endowment fundsis generally governed by the UniformManagement of Institutional FundsAct (UMIFA), introduced in 1972and now enacted in most states.What benefit does the endowmentbring to the institution? In the shortterm, a portion of its annual returnon investment can be transferred tothe institution’s operating budget.Many institutions can realize theirmissions and achieve a high qualitylevel in their programs only becauseof endowment income.Institutions may periodically runcapital campaigns to attract newcontributions to their endowments.Depending on the wishes of thedonors, gifts may include restricted aswell as unrestricted funds, the formerlimited to such purposes as facultycompensation, community programs- 3 -or causes, specified research activitiesor disease treatment centers, athletics,arts, or expansion of facilities.Inherent in this brief description youcan sense a number of difficult questionsthat the trustees and investmentcommittee members, as the policymakers for the institution, must face:What is the real objective of theendowment? How should the endowmentrelate to the institution’s mission?How much should it contribute to theoperating budget? How can an investmentfund’s value be preserved for thefuture? How should it be invested formaximum return? How to controlinvestment risks? Who should makethe decisions? Who should assumewhich responsibilities in managingthe investments?Generally, six of the seven investmentprinciples speak to all types of institutions.The exception is Principle Two,Payout Policy, which is dealt withspecifically for each type of institution.

PRINCIPLE ONEObjectivesThe governing board, through its investment committee, mustdefine the investment objectives that will best support thenonprofit’s philanthropic mission. The committee should writethe objectives into an investment policy statement and use it continuallyas a guide for its investment managers and its own decisions.- 4 -

ObjectivesAll involved in nonprofit governanceand management certainly know theirorganization’s mission and – at least ingeneral terms – the kinds of programsmost likely to realize its goals. Butwhen it comes to assuring the financialresources to support those programs,different perspectives and expertiseare required.Members of the governing board whocame of age in the private sector maytend to think of ultimate objectives interms of net profit, return on investment,and shareowner value, all ofwhich are measurable. In their nonprofitroles, however, they have tocope with more subjective goals.These goals must be understood firstin terms of the social and intellectualutility of the institution, howeverintangible that may seem. Ultimately,the board must view the pools of assetsthat support the mission within thecontext of the entire organization andthe optimization of its mission. Whatcan create confusion is that the termsemployed resemble those used inbusiness; profit and growth certainlyhave relevance to the management ofa nonprofit’s investment fund. But ina nonprofit environment, success hasvery different implications.The board, usually through its investmentcommittee, exercises that responsibilityby defining the objectives thatwill guide its assigned investmentexperts. While the statement of theobjectives should be clear and simple,the process of formulating – as wellas maintaining – those objectives isnever simple.The committee has to weigh severalpotentially vexing issues that can affecthow the mission will be translated intoinvestment policy. The issues mayinclude:◆ The role of the fund in supportingthe institution’s mission, as well as inmaintaining a healthy balance sheet◆ The total real return goal neededfrom investment activities◆ The additional bequests and/ordonations that can be expected◆ The legal requirements affectingthe fund◆ How much of the endowment’sreturn should be spent, and howmuch reinvested, and how thisshould be calculated◆ The liquidity required to coverdistributions and expenses over areasonable time frame◆ The level of risk the board membersbelieve they can tolerate, includingdefinition of acceptable (and unacceptable)types of investments◆ Formal documentation of thedecision-making process, andresponsibility, accountability andauthority, including which investmentdecisions, if any, should bedelegated to outside consultants,advisors, or investment managers◆ Special characteristics of the nonprofit’sprograms, distributions, andother financial decisions that canaffect spending or tax exposure◆ Special limitations on investmentimposed on portions of the fund bydonors or by particular constituencies,such as a community nonprofit’sgovernance requirements◆ The impact of policy decisions onfuture giving◆ The strengths and weaknesses ofthe institutions, the investmentcommittees, staff and any outsideconsultants.- 5 -

The committee’s deliberations willalmost inevitably provoke some argument.Members must be cautious ofimpasse, delays or compromises thatcan weaken their decisions. It will helpsmooth the process if the committee,at the outset, establishes a timetable,final deadline and a few ground rulesfor resolving disagreements, andachieving resolution.These deliberations are best carriedout in a formal manner, with theresulting policy expressed in a writtenstatement. An informal or hurriedapproach risks confusion, misunderstanding,second-guessing, and delay.The members of the committee, afterall, represent various backgrounds,points of view, and priorities. As in anysuch deliberative body, conclusionsinevitably depend on compromise.One very important consideration isthat a nonprofit’s mission, and the wayit is translated into investment policy,makes a fundamental difference in itsinvestment strategy. If needed, expertisecan be obtained through outsourcing.But the fundamental responsibilityremains with the nonprofit’s governingboard – the responsibility for preserving,growing and allocating the fundsthat will be needed.One nonprofit might be facing anurgent humanitarian challenge or animminent construction project thatdemands large near-term distributions.In such a situation, the nonprofit mayhave to invest all or a large portion ofits funds in short-term, fixed-incomeinstruments to minimize any valuefluctuations during the period ofheavy disbursements.Another nonprofit might be committedto supporting educational missionsthat are presumed to be perpetual.That nonprofit might allot a portionof its portfolio to a variety of higherrisk investments with the potential forhigher returns in the future. Yetanother might be managing its fundsto build a particular set of physicalfacilities and opt for a portfolio ofguaranteed returns providing liquidityat the key points in the constructionprocess.- 6 -

ObjectivesTime horizons create a key considerationfor many endowments and apowerful definition of their managementrequirements. The length of timebetween a defined term and perpetuitycreates important considerations inmanagement perspective. There is anenormous difference between the durationof a construction project to builda new hospital wing and a mission toprovide services in perpetuity. But foranyone sharing responsibility for anonprofit investment fund, the term“capital preservation” takes on incomparablegravity; it can mean safeguardingassets during a period of marketdecline so as to be able to finish a contracted-forconstruction project, or itcan mean preservation forever.All of these considerations need tobe examined and codified by thecommittee, as well as legal considerationsthat may apply to given fundsor to an endowment as a whole. Theoutput of the committee’s deliberationswill be a written document: the investmentpolicy statement.The written statement brings thetensions of the varied perspectivesto a resolution, opening the way foraction – at least until the next round.The writing style should be clear andplain enough – free of jargon or technicalities– to be understandable byeveryone concerned, inside and outsidethe nonprofit’s organization. The useof numbers and specifics helps achievethe needed clarity.The statement should be as short aspossible but as long as necessary tocover all relevant points. The finaldocument should reflect the uniquecharacter of the nonprofit. Theinvestment committee presents thestatement to the full governing boardfor approval. The statement shouldthen be used continually as a guidefor investment manager selection andinvestment strategy decisions.At least once a year, the board shouldreview the statement critically againstchanging realities and make necessaryrevisions.You’ll find further discussion of someof these in the following pages.- 7 -

PRINCIPLE TWOPayout PolicyThe board and the nonprofit’s management should budget thetotal amount the nonprofit will spend in the next few fiscal years.Their decision process should take into account the nonprofit’stime horizon and any other considerations such as special requests frommanagement, other constituents, or any legal payout requirements.- 8 -

Payout PolicyWe define “payout” as the totalamount of money distributed fromthe nonprofit’s investment fund tosupport current programs. We use theterm payout policy for all types ofinstitutions, but there are significantdifferences among the ways varioustypes of institutions create and executetheir policies.For those nonprofits covered by theUMIFA, there is no specificity as towhat the payout percentage should be;the nonprofit’s governing board stillbears the burden of that decision.Certain rules of thumb, however,have become apparent from surveysof general practice.The overriding objective of the pool ofassets is to create a stream of cash flowto fund programs consistent withthe nonprofit’s mission. The establishmentof the objective of the pool willdetermine the time frame for payout.If the pool is perpetual, the liabilitystream associated with the pool isdifficult to predict. In most cases,the objective will be to maintain astream of distribution that grows bythe rate of cost increases impactingthe mission.Ultimately, the payout rate will proveto have a great effect on investmentstrategy and the longevity of thenonprofit. Experience has shownthat a payout in excess of 5 percentchallenges the ability to achieve maintenanceof purchasing power.This is why budgeting the payout forthe next few fiscal years is essential.Obviously, the payout rate will have acrucial effect on the formulation ofinvestment strategy and vice versa.The process of developing the budgetrequires a number of definitions anddecisions; some of them are fine pointsthat can try the patience of the unwary.In fulfilling the nonprofit’s mission, theboard decides how much to distributein the coming years, taking into considerationthe claims on its resourcesand the level at which the institutioncan and will respond. Income definedas capital gains, dividends and interestalone is not a complete determinantof payout policy or rates, because forquite some time income-orientedinvestments have failed to keep pacewith economic growth.When the total payout rate has beentallied, the board or its financial teammust consider the level of liquidityit will need in its asset base andwhat strategies to use in its cashmanagement.This being said, it must be recognizedthat the types of institutions covered inthis brochure have very different influencesaffecting their payout policies, asdescribed on the following pages.- 9 -

Payout Policies for EducationalInstitutionsEducational institutions have a significantdegree of latitude in setting theirown payout policies, as there are nostatutory mandates dictating minimumpayout levels. However, there arecertain practical considerationsaffecting payout policies, as theseinstitutions are generally dedicated tofulfilling their educational missions inperpetuity. Therefore, a balance mustbe struck between building the valueof the endowment to provide for theneeds of future generations and contributingto the quality of educationin the present by supporting staffinglevels and programs.Traditionally, the popularly acceptedformula has been “5 percent of a threeyearmoving average of market value.”However, the recent bear markets haveexposed the weakness of this approachas many schools saw their returnsplummet, creating shortfalls in thefunds available to support theiroperating budgets. An example of thisphenomenon can be found in the 2004Commonfund Benchmarks Study TMin which 22 percent of respondentsincreased their spending rate with17 percent increasing the dollaramount; 25 percent decreasing theirspending; and 17 percent decreasingtheir dollar spending. Overall, only51 percent held their spending ratestable year-over-year.Recently, there has been muchdiscussion about spending levels andmethods. There has been an increasinguse of formulas that use cost increasesas part of the determination of thenew distribution amounts. Manyinstitutions that have converted tothis method use the Consumer PriceIndex plus a percentage of the HigherEducation Price Index compiled byCommonfund Institute.Another consideration concernsspending from restricted funds forwhich the market value has fallen belowtheir “historic dollar value.” These arereferred to as “underwater funds.”Once this has occurred, endowmentmanagers must refer to applicable lawsin their state (most states have adoptedthe UMIFA for guidance on whetherspending of any sort can be continuedfrom these funds).In certain states, spending from underwaterfunds is restricted to “income” –interest, dividends, rents and royalties– per the old trust law definition.In others, spending may be forbiddenaltogether. But, in many cases, theprograms endowed by these restrictedfunds continue, such as the supportneeded to underwrite an endowedprofessorship, and the shortfall mustbe met from other sources. The 2004Commonfund Benchmarks Studyfound that 54 percent of respondentsreported having underwater funds.Of these, 35 percent were no longerspending from these funds, while 25percent were spending “income” only.Ten percent had asked the originaldonor for additional funds so that theprograms supported by the fund couldbe continued.The volatility of markets in recentyears – euphoric gains followed bycrushing declines – means that investmentcommittees must take a moreactive role in managing their spendingto deal with the tension created bybalancing the needs of today’s studentsand those of future generations.- 10 -

Payout PolicyPayout Policies for FoundationsFoundations have very special legalrequirements concerning theirminimum payout level, currently aminimum of 5 percent of the endowmentvalue (subject to possible legislativechange as this is being written).Further, there are fairly technicalrequirements as to what types ofspending may be counted against the 5percent minimum. In the most recentCommonfund Benchmarks Study, 39percent of foundations responding –the largest proportion – indicated thatthey set their spending rate by targetingthe 5 percent distribution requirement.In other words, it appears thatthe most they plan to spend is the minimumrequired by law.However, in practice the 5 percenttarget is often exceeded. The sameBenchmarks Study found that the averagespending rates for all foundationswas about 6 percent, ranging from6.1 percent for the largest foundationsto 5.5 percent for foundations withbetween $50 million and $100 millionin assets.Several factors account for the differencebetween the traditional targets of5 percent and the actual level of spend-ing. The items allowed in computingthe statutory spending level includepayments to support the operatingbudget, distributions to grantees, thecost of services the nonprofit mayprovide grantees, and the overheadand administrative costs incurred inrunning the nonprofit.The relatively high spending rate of6 percent is also due to a number ofother factors, including the effect oflower market values of the underlyingfunds during a prolonged bear market.Multi-year commitments to granteesand an unwillingness to reduce thevolume of new grants to increasinglyhard-pressed charities has also played apart in keeping spending rates higherthan the legal minimum, in spite of thedeclared policy of many foundations tospend no more than 5 percent.In deliberating and managing its payoutrate, the board navigates throughrocks and shoals. Are there legal orregulatory changes ahead? Mightenvironmental or societal changescreate pressures to modify the foundation’smission? Are the number ofgrantees and their needs increasing?A community foundation is likely tohave a regular fundraising programthat, in good times, can make up thedifference. A private foundation mayreceive further donations, in time,from the founding family.Many foundations spend down theirassets in about fifteen years. A foundationthat aspires to a longer timehorizon or to perpetuity, unless it willreceive further infusions, is driven totake a more conservative payout policy– and a more aggressive investmentstrategy.It appears that a large proportion ofthe nation’s foundations are striving torestrain payout and project a long timehorizon. But the distribution goal doesnot encompass all payout. Investmentcosts must be counted outside the payout.Whether you count those costs asa deduction from total return or anaddition to payout, they are weighingagainst mission.Foundations often face the challengeof managing a large amount of thedonor’s stock and developing anacceptable diversification process.In addition, in the course of makingtheir decision concerning payoutpolicy, boards must keep in mind theprevailing definition of “distribution”and the current legal restrictions underwhich their foundations function.- 11 -

They could then calculate the payoutrate as a percentage of the investmentfund’s total net asset value. The overridingconsideration is the relevantsection of the Internal Revenue Codestipulating that foundations mustdistribute at least 5 percent of theirassets every year if they are to preservetheir status as tax-protected entities.The calculation of the 5 percent isbased on the average of the marketvalue of the foundation’s portfolio atthe end of each month of the previouscalendar year. Once that is known, thepressure is on to debit at least 5 percentof that average from the foundation’sbalance sheet and to make sure themoney has been spent – deposited intothe bank accounts of qualified grantees– by the end of the current year.Making this calculation even morecomplex are the regulations concerningattribution of administrative and overheadexpenses, as well as excise taxes.The calculation must be timely enoughto facilitate accounting and execution.Overhead and all other expenses mustbe precisely defined to determinewhich are attributable to distribution.Program expenses and staff time spentin grant making may be included.Meanwhile, another factor enters theboard’s deliberations about its distributionrate: the excise tax that the federalgovernment imposes. The tax amountsto 2 percent of annual net investmentincome and realized gains, unless totaldistribution reaches a certain tippingpoint which then brings the tax ratedown to 1 percent. Because the formulaused to determine qualificationsfor the reduced rate is so complicated,relatively few foundations apply forthe reduction. The new legislationproposes to reduce the rate to 1percent overall.As it has stood, the two-and-onepercent excise-tax formula has tendedto motivate foundation decisionmakers to raise their distribution ratehigher than they might have otherwise;better to pay more to grantees and lessin tax. The old tax formula could alsoinfluence decisions about when totake investment gains or losses.And so, the foundation’s financialteam determines its optimum course,weighing income, distribution andtax issues.To be sure, distributions are not theonly payout impacting a foundation’slife expectancy. Expenses related tomanagement of the foundation’sinvestments are counted outside ofthe distribution allotment.These include not only fees paid tooutside consultants and investmentmanagers but also related investmentoverhead expenses, e.g., administrativesalaries, space costs, and expenses ofthe board and investment committee.Inevitably, ambiguity arises. Someadministrative expenses are not clearlyclassifiable as part of either distribution,administration or investmentmanagement: certain costs of research,for instance, or conferencing. If a foundationsponsors a forum for grantees,is that counted as part of the 5 percentdistribution requirement?In recent years, new federal legislationhas been proposed (the timing ofpossible passage is unclear) that couldeliminate the attributable administrativeand overhead expenses that can now beincluded in the 5 percent total. Such alaw would tend to accelerate the rate oftotal payout of most foundations, possiblybringing some of them to depletionsomewhat sooner than they would haveplanned or wished.Aside from these pressures, a foundationmay be impelled by its mission todistribute more than 5 percent of itsassets. The needs of its grantees and theurgency of their work may demand it.A foundation so inclined must recognizeit may ultimately be limiting itstime horizon.- 12 -

Payout PolicyPayout Policies for Health CareHealth care organizations differ fromendowments both in how assets areobtained and how funds are spent.First, health care organizations generaterevenue from the services provided.These funds are obtained from insurancecompanies, government programsand patients. Additionally, some healthcare organizations receive donationsfrom individuals or organizations thatwish to support overall operations or toassist in funding a specific project (i.e.,a cancer wing). Both of these fundingsources serve to build the long-terminvestment assets of the organizationand are needed to support the missionof providing health care services.Health care organizations typicallyhave significant capital requirements.The capital is spent on items such asmedical equipment, construction orremodeling of the physical structure,information technology, etc. Mosthealth care organizations review theircapital needs on an annual basis andthen determine which projects willbe funded. Projects can be fundedthrough cash generated from operations,issuing tax-exempt bonds,fundraising initiatives and/or withdrawingfunds from the long-terminvestment assets. Typically, a mixtureof these funding sources is used topay for the capital expenditure.While there is no predetermined‘‘payout policy” for health care organizations,one important consideration ishow the funding method impacts theoverall strength of the organization’sbalance sheet. One way to measure thisstrength is by the number of ‘‘days cashon hand.” A day of cash on hand isequal to the amount of money it takesto operate the health care organizationfor one day and is indicative of theliquidity of the entity.Days cash on hand is one of manyindicators used by the rating agencies(e.g., Moody’s, Standard & Poor’s, etc.)to assign a rating (i.e., AA) on the taxexemptdebt issued by the health careorganization. For example, an AA-ratedhealth care organization typically has175 days cash on hand or greater. Manyconsider it advantageous to obtain thehighest rating possible as the best-ratedhealth care organizations typically paya lower interest rate on debt.Another important indicator is thedebt-to-capitalization ratio. This ratiois also closely monitored by the ratingagencies to ensure that the health careorganization does not utilize unreasonableamounts of leverage to pay for itscapital expenditures. A health careorganization with a AA rating, forexample, normally has a debt-tocapitalizationratio of 30-40 percent.The next section, Principle Three –Asset Allocation, discusses the keyissues in managing investment strategy.- 13 -

PRINCIPLE THREEAsset AllocationAllocation of the portfolio among the principal asset classesis the committee’s most crucial investment strategy decision.Considering the nonprofit’s mission, the investment committeemust weigh the investment risks the nonprofit can afford to take inseeking the return needed to support its obligations.- 14 -

Asset AllocationThe inevitable ebb and flow ofmarkets pose a special challenge tononprofits, whether they are striving topreserve their capital base over the longterm or concentrating their distributionswithin a limited time period.Anyone faintly aware of the behaviorof the stock and bond markets fromthe early 1990s into the early 2000shas seen how extreme and rapid theups and downs can be, and how unpredictable.Even within short time frames– single trading days, for instance –market volatility has become moreextreme than in almost any time in thepast century.Nonprofits obliged to make relativelyfrequent withdrawals from their portfoliosmay naturally wish for somesemblance of consistency in theirinvestment results. This suggests alow-risk, low-volatility strategy.Nonprofits with urgent distributioncommitments and shorter timehorizons, such as international relieforganizations, might well concentratea portion of their portfolios in fixedincomeinvestments of short durationand high liquidity, a strategy thatminimizes volatility.On the other hand, nonprofits with along time horizon may find that riskavoidance has a very significant cost.Over the long term, high returns generallycome as the reward for takinggreater risks. And, with rising payoutpressures, nonprofits certainly needhigher returns.Either way, nonprofits face difficultdecisions in investment management.Obviously this challenge calls notonly for financial expertise but alsofor great prudence in managing theinvestment process.Historically, prudence was a legalrequirement of fiduciary responsibilityand fostered a highly conservativeinvestment bias. In some early commonlaw rulings, common stock weredeemed “per se” imprudent. The experienceof the 1930s, however, provedthat bonds could be risky, too. Thecentury-old legal principle, popularlyknown as “the prudent man rule,”then became the pervasive guide fortrustees, giving them greater discretionin selecting investments, but stillrequiring them to invest for currentincome rather than total return.- 15 -

Since the introduction of the UMIFAin 1972 broadened the “prudent manrule” into a “prudent investor rule,”fiduciaries are permitted to take intoaccount many of the new developmentsthat have changed the landscapeof the investment world during thepast half century. The so-called“prudent investor rule” permits themto consider the expected total return(i.e., capital appreciation as well asincome) of the institution’s investments.They could then calculatethe payout rate as a percentage of theinvestment fund’s total net asset value.Most nonprofits now use this approach.But in the post-World War II decades,the concept of prudence changed fromone of avoiding risky investmentsaltogether to one of balancing therisks of various kinds of investmentsagainst one another.This change in attitude was encouragedby the theoretical work, often referredto as “modern portfolio theory,” thatwon Nobel Prizes for the economistswho originated it. Their aim was abetter understanding of the relationshipbetween investment risk and return.A highly simplified summary of theseideas might go as follows:The degree of risk entailed in aninvestment can be expressed as itsvolatility, which can be calibratedstatistically. This measurement, calledthe “standard deviation,” indicates inpercentage terms the degree to whichan investment’s value has varied – upand down a fixed 66⅔ percent of thetime – in the course of arriving at itsmean return over a given time period.Investments with higher standarddeviations will generally producegreater gains over the long term.Therefore, if you aim to get the mostout of your investments long term, youhave to own some that have a higherdegree of risk.But you can offset their volatility byalso holding investments that performdifferently – whose performance has alow degree of correlation with the restof your holdings. The volatility of oneinvestment tends to lower the volatilityof a portfolio without impairing thecombined return potential. Combiningrisky assets can lower the overallvolatility of the portfolio.- 16 -

Asset AllocationThis thinking widened investors’ focusfrom the selection of individual securitiesto include the design of theiroverall portfolios, as reflected in theproportions of stocks to bonds to cashthey held in their portfolios. In fact,the allocation of the portfolio amongprincipal asset classes has been shownto be the main determinant of investmentsuccess.Increasing diversification within eachof the principal asset classes can furtherdampen volatility. A well-diversifiedportfolio may include small-capitalizationstocks as well as large-cap stocks,international stocks as well as U.S.-based stocks, corporate bonds as wellas Treasury bonds, short-term fixedincome as well as long- and intermediate-term,and so forth.Commonfund conducts BenchmarksStudies covering educational institutions,foundations and health careorganizations that measure a varietyof different practices among them.The following table compares the assetallocations made by educationalinstitutions, foundations and healthcare organizations, which are derivedfrom three Commonfund BenchmarksStudies conducted recently. It shouldbe noted that there is a significantamount of distribution aroundthe allocations averaged out in thesurvey data.Generally, these Commonfund surveyshave found that institutional assetallocations have moved strongly awayfrom fixed income in favor of equities(both U.S. and international) andtoward alternative investments, a broadcategory that encompasses hedgefunds, private equity, venture capital,equity real estate, distressed debtstrategies, commodities, and energyand natural resources. In general, theperformance of alternatives tendsto have a reduced correlation to thatof publicly traded investments (stocksand bonds); many nonprofits havebeen increasing the proportion ofalternatives they hold.A huge accumulation of historic dataon portfolio performance has providedthe basis for suggesting a point ofoptimum portfolio balance for eachof various long-term return targets atgiven standard deviations. Laid outon a graph, these optimal allocationsappear as a rising convex curve, knownas “the efficient frontier.”Asset Allocation Dollar WeightedEquities are the largest asset class for all types of institutions, but the largest variations are found inFixed Income and Alternative.Type of U.S. International Fixed Alternative CashInstitution Equity Equity IncomeEducation * 32% 14% 19% 33% 2%Foundation ** 48% 10% 24% 14% 4%Health Care 1*** 37% 10% 43% 9% 1%Note: 1 All long-term operating fundsSources: * Commonfund Benchmarks Study – Education 2004**Commonfund Benchmarks Study – Foundation 2003***Commonfund Benchmarks Study – Health Care 2003- 17 -

Many such analytical tools are availableto institutional investors to aid themin making asset allocation decisions.Their utility, of course, varies. Thosemodels that use the concept of theefficient frontier must, by definition,assume the predictive validity of historicdata. But it’s axiomatic that pastperformance does not necessarily predictfuture results. Economic andfinancial events often swing far outsideof past ranges, and the ranges are notalways reflected clearly in the averages(e.g., the average temperature of a mansitting on a cake of ice with his feet ina stove).The allocation planning model usedat Commonfund factors in manydifferent economic scenarios to projecta very wide range of possible outcomesfor any given asset allocation. In acomplex statistical process, the modeluses “Monte Carlo simulation” torandomly generate a thousand differentyield curves for next year and thenprojects how each of these is likely toaffect the results of each of nineteenasset classes.For each of the thousand scenarios,the model then generates anotherthousand yield curves for the secondyear and again projects the probableresults for those nineteen asset classes.The model runs these simulations foreach of twenty years into the future.Having processed so many differentpossible values for each variable, themodel’s output will show not just amean outcome but also a distributionof possible outcomes for each projectedinvestment period and the probabilityof each of those outcomes. Thisapproach, as you can see, goes beyondhistorically based averages and looksat what economic and financialconditions might really turn out tobe down the road. It also allows forthe examination of risk in the tailsof potential outcomes beyond onestandard deviation.As a further guide for their decisionmaking, investors are also advised totake a hard look at the present environment,consider what the economic andmarket outlook might be for the nextfew years and what that suggests forinvestment strategy.No matter how sophisticated theplanning tools employed, the futureis unknowable. Ultimately, it comesdown to human judgments aboutwhat could happen, based on the bestinformation available at the time.Sometimes basic questions can tip thebalance. For example, in an environmentof rising interest rates, shouldn’tyou be underweighting your bondallocation? When the returns of thebroad indexes are expected to becomparatively modest, shouldn’t yoube giving greater emphasis to skillfulstock picking and opportunistic tacticsto help achieve the returns needed tocover payout and inflation rates?- 18 -

Asset AllocationIn the fast-moving world of nonprofits,where investment returns can be socrucial, a detailed point of view aboutthe trends in the economy and marketsis essential.For all the information and analytictools used to guide decision makers,the asset allocation decision stillremains difficult; it involves more thannumbers. For nonprofits, this decisionmust embody the philanthropic missionand perhaps deeply held feelingsof founders and members of governingboards, their risk tolerance, their senseof the nonprofit’s time horizon, andany number of policy issues that cannotbe expressed in numbers alone.Private nonprofits, established on thestock of the founder’s company, remainin a highly risky predicament untilthe portfolio can be diversified. Thatin itself needs careful planning –assuming that liquidation is allowed.In any scenario, the determinationof the asset allocation target must becarried out in a disciplined manner. Atthe outset, the investment committee,or the full board, ought to agree ona moderator and an agenda for thediscussion. Every member should havethe opportunity to express his or herconcerns and expectations. Allow eachone to propose the level of risk he orshe considers tolerable.In writing its investment policy statement,the committee should includea rationale for the asset allocation onwhich it has decided. A brief, wellstatedexplanation could help achievethe concurrence of the full board andfounder or founding family and helpguide portfolio managers in implementinginvestment strategy.In time, as markets change, theportfolio’s actual asset allocation willdeviate from the targets set down inthe policy statement. This is a naturalconsequence of the markets grantinghigher returns to certain asset classesthan to others. Therefore, adjustmentsmust be made on a regular basis.The theory underlying asset allocationstrategy prescribes periodic rebalancingto bring the portfolio back into targetedranges. This means sellingsome of the appreciated assets andreinvesting the proceeds in assetcategories that have declined.For the inexperienced, selling successfulinvestments may seem counterto long-held beliefs. But, looked atanother way, it forces action that getsto the very essence of successful investing– buying cheap and selling dear.The investment committee mustmaintain oversight of the portfoliothrough all the cycles of the investmentmarkets. But for implementation ofits asset allocation policy it employsprofessional investment managers.And that is the subject of the nextsection, under Principle Four.- 19 -

PRINCIPLE FOURManager SelectionThe investment committee or investment staff hires an arrayof investment managers to implement the plan presented in theinvestment policy statement. The selection of managers requiresa diligent investigation of each candidate’s entire set of qualifications,not just past performance and philosophy.- 20 -

Manager SelectionAn asset allocation plan calling fora diverse selection of investmentsrequires a diverse selection of investmentmanagers. Expertise is neededfor each type of investment.Recent Commonfund BenchmarksStudies found a wide range in thenumber of managers used by nonprofitinstitutions, with the greatest diversificationto be found among educationalinstitutions.A nonprofit’s investment policystatement might indicate the kindsof specialized managers needed, and itmight state their required qualifications.But the actual selection processusually turns out to be more than theinvestment committee or staff cancomfortably handle. Furthermore,the character of the institution mayalso dictate policies for managerselection, such as avoiding tobaccoand alcohol-related securities, focusingon socially responsible companies, orother qualitative criteria.Selecting investment managers is itselfa specialized capability. The processincludes not only selection of candidatesbut negotiating the engagement andmonitoring the managers on a continuingbasis. That is why nonprofits oftenoutsource the entire selection process.In the interest of full disclosure, wemust point out that selecting andmanaging investment managers constitutesone of the chief occupations ofCommonfund. We manage managersfor many hundreds of nonprofitinstitutions. The following discussion,while admittedly based on ourapproach to managing managers, isnot consciously intended to promoteour own services.What makes manager selection socomplicated? Start with the fact thatthere are thousands of managers tochoose from and new firms crop upregularly. Local sources, thoughconvenient for face-to-face meetings,do not necessarily provide the bestmatch. And the well-known stars arenot necessarily the best choice.Numbers of Managers UsedThe number of managers increases with fund size.Endowment SizeType of All Over $1 $500-999 $200-499 $100-199Institution Institutions Billion Million Million MillionEducation * 13 81 30 14 14Foundation ** 13 35 16 10 10Health Care *** 8 15 11 6 5Sources: * Commonfund Benchmarks Study – Education 2004**Commonfund Benchmarks Study – Foundation 2003***Commonfund Benchmarks Study – Health Care 2003- 21 -

Selecting investment specialists hasitself become a specialized skill.Candidates must be investigated indepth. Performance data alone canprove misleading, especially if theycover only a short term – less than fiveyears. Performance in less than onemarket cycle could tell more about thefirm’s luck than skill. And past performancealone has never provided areliable prediction of future success.For each specialization, the selectiongoes forward step by step:◆ Compiling an initial list of candidates◆ Gathering basic information abouteach one◆ Narrowing the list◆ Conducting preliminary due diligence◆ Selecting the finalists◆ Completing due diligence andcomprehensive portfolio attributionanalysis◆ Hearing presentations of the finalists◆ Making final selections◆ Conducting negotiationsA key resource of the manager ofmanagers is the database of theexpanding world of investmentmanagers. The information collectedon any one manager covers everyaspect of that firm’s business. In ourmanager information template atCommonfund, the questions alonetake up twenty-three pages.You must also be aware of possibleconflicts of interest. Does the firm haveany connection with any member ofyour board or management?And, after all of that, you have toconsider the “alpha” factor – the talentthe manager demonstrates within a riskparameter for achieving results beyondthe average of the market in which he- 22 -

Manager Selectionor she functions. Effective activemanagement – as opposed to passive,index-centered management – nowmakes the difference to the financial lifeof a nonprofit. And your effective managersshould now be given the freedomto maximize investment opportunity asthey know best.After selection and engagement, themanager of managers regularly monitorsthe “combination effect” of variousmanagers within a single portfolio.They review performance againstbenchmarks and remain vigilant forsignificant changes in any of themanagement firms.To facilitate portfolio building, amanager of managers may packagegroups of investment managers intospecific kinds of investment pools orfunds. For instance, it may create asmall-cap fund, grouping managerswith different investment styles orstrengths.It may offer funds that represent particularstrategies. It may also create afund around a particular manager,using its group-buying position tolower fees and make that manageravailable to smaller investors than itnormally accepts.The manager of managers may, inaddition, provide related services toenhance the institution’s investmentcapabilities; services such as risk management,legal oversight, investmenteducation, integrated reporting andanalysis.Ideally, the manager of managersdevelops a working partnership withthe nonprofit’s investment committeeand consultants, working togetherto realize the objectives set forth inthe nonprofit’s investment policystatement.In evaluating managers, hereare some of the things you needto know:◆ The firm’s investment style andphilosophy◆ Actual evidence of its commitmentto that philosophy◆ How the firm’s decision-makingprocess works◆ The kinds of internal controlsthe firm uses◆ The quality and timeliness of itsreporting system◆ How the firm complements the otherinvestment firms working for you◆ The firm’s ownership structure◆ The quality of its senior management◆ The qualifications of its professionals◆ The stability of its professional staffand management◆ The size of the firm in terms of staffand assets under management◆ How the firm has changed over time◆ Its fees◆ Risk management capabilities- 23 -

PRINCIPLE FIVERisk ManagementYou should think of risk as the possibility of failing to fulfill thenonprofit’s mission in any way. More immediately, you may be atrisk of failing to meet current financial commitments. You mustestablish a discipline to first recognize the risks inherent in every facet ofyour investment system and then to control them.- 24 -

Risk ManagementBecause so much is at stake, a governingboard must give the subject of riska permanent place on its agenda. Ifand when losses occur, those involvedmight well wonder if they could havebeen avoided. The answer is often yes,if the question had been asked beforethe losses happened.To make sure the right questions areasked at the right time, a systematicapproach to risk must be built into anonprofit’s investing process.In the dictionary sense, “risk” is simply“the possibility of harm or loss.” In theinvesting arena, risk commonly refersto the effect of market volatility andthe possibility that the investor mayhave to sell when valuations are down.But for a nonprofit, risk has broadersignificance.A nonprofit’s investment risk meansthe possible failure to meet its commitmentsto beneficiaries. Think of it asthe failure to earn a sufficient return tocover this year’s distribution requirementor the intended transfer to theoperating budget. But the risks do notstop there. Failures can occur in anypart of the investment process, internalor external – in operations, in the safekeepingand accounting of assets, inlegal or regulatory issues, in outrightfraud. Any such failure could reverberatefor generations.In the investment industry, theresponse to this challenge is a specificrisk management discipline. Whilethe board must lead in this effort, theresponsibility must become pervasivethrough the investment system.Ideally, it becomes ingrained in theorganization’s culture.The practice of risk management startsby identifying every possible reasonwhy the nonprofit might fail to achieveits objectives. The board, the staff, andall relevant outside sources must besensitive to the “galaxy of risks” thattheir decisions and actions mightentail. All possibilities for failure mustbe evaluated and controls put in place.It’s difficult because it’s contrary to ournatural inclination toward optimism,our reluctance to think the unthinkableor ever appear negative.A matrix approach has proved effectivefor us at Commonfund; it helps promotethe needed discipline. The investmentprocess is divided into specificsteps. For each step you enter everyrisk you and your team can think of.The listed risks must be evaluated fordegree of possibility and seriousness ofconsequences. For each prioritized risk,you consider possible alternatives, controls,or defenses. And then make surethe controls are put in place andregularly monitored.With the matrix as your base, youcontinually recycle this process, seekingto sharpen and enlarge the matrix. Itrequires taking a skeptical attitude andasking tough questions, such as:◆ In whose name are the assets in ourportfolio being held?◆ Where are the securities being held?◆ Is the valuation accurate?◆ Are we applying all the resourcesactually needed to manageeffectively?◆ What are the laws and regulationsfor compliance?◆ Who is responsible for compliance?◆ What makes us sure we can trust ourinvestment managers and our otherproviders?One overriding question runs throughoutthe process: “What can go wrong?”And everyone involved should keepasking it.An emotionally difficult and potentiallycontroversial process like thiscan quickly peter out if it does nothave visible support from the top.An experienced risk manager withappropriate authority is essential.So is the outspoken agreement of theboard. If the board or staff does notseem to have the wherewithal for anintegrated risk management program,you may need consultative supportto get you started.- 25 -

PRINCIPLE SIXCostsContinually ask: “Can we get the same results for less?” The costsof your investment program can quietly undermine returns andcut into the corpus of the nonprofit’s assets. Make sure you keepinvestment costs under control.- 26 -

CostsVarious changes in the investmentindustry during the postwar decadeshave helped raise the awareness ofinvestment costs. Some argue that costcontrol is the key to investment success,since in the long run no investmentcan beat the averages.Cost control lacks glamour; no oneaspires to the job. It requires detailedanalysis, review and monitoring, bothbefore selecting a manager and then onan ongoing basis. In addition to investmentmanager fees, a host of otherinvestment costs must be watched:custodial, legal, accounting, consulting,overhead. Cost increases can besurprising and difficult to restrain.Controlling the cost of investmentmanagement involves three typesof activities:◆ Diligent investigation of alternativeinvestment management candidates◆ Tough negotiation of fees◆ Efficient management of themanagement firmsYou need to look at the prospectivemanager’s portfolio turnover rate. Inother words, how much buying andselling does the manager do to achieveits results? Every transaction incurscost; good management means avoidingneedless transactions. Are the managersnegotiating the best prices fortheir investors? Are the managers’ feesand compensation structure alignedwith their investors’ interests?You need to continually ask: “Can weget the same results for less?”But keep in mind that cost reductionitself can have a cost. For instance, youdon’t want to compromise the effectivenessof your risk management forthe sake of cutting costs, or settle forless than optimal diversification. Keepthe balance.It is also important to recognize thatdifferent investment products can havesubstantially different costs and coststructures. Understanding thesedifferences is important in evaluatingthe costs. Many managers, particularlyin alternative asset classes, have a basefee, plus incentive fees which can besubstantial. Ultimately, the importantissue is total return on the asset net ofthe costs.- 27 -

PRINCIPLE SEVENResponsibilitiesTo promote harmonious effectiveness of your investmentprogram, define the roles of the trustees, the investmentcommittee, the business or investment officer and staff, keydonors, and your consultants, in writing, and make certain that eachunderstands and agrees.- 28 -

ResponsibilitiesOur first six principles have beenconcerned with the kinds of planning,processes, and controls essential to aneffective investment program. Theultimate issue is execution. And thatdepends on allocation of responsibilities– our seventh principle.While you have an array of investmentmanagement firms implementing yourplan, you must make sure that youhave a clear organizational structure fordecision making and oversight withinyour organization itself.To avoid slippage or confusion, responsibilitiesshould be spelled out in an“investment program responsibilities”document that should be part of theinvestment policy.Completeness and clarity are important.Let all players make suggestions.Who’s in charge? Who is responsiblefor risk management? Who for liaisonwith the investment managers? Who iskeeping an eye on investment costs?What do those individuals have to doto prove the success of their efforts?To whom do they report? How often?The answers, of course, depend on theparticular nonprofit and the talents ofits people. The difficulties you mightencounter are also quite individual.In allocating responsibilities, it isimportant to fully evaluate thestrengths and weaknesses of the entireorganization and develop a clearunderstanding of the resources neededfor each decision. This is particularlyimportant in setting priorities fordecision making to assure that themost important decision has thehighest level of resources.For a foundation, the founder orfounding family could pose an organizationaldifficulty. How much responsibilitydo they want to take? It should bespelled out in the document. The family’snatural authority could overhangthe structure of responsibilities you setup. Having family members participateactively in development of the responsibilitiesdocument could help achieveclarification of their own roles.The investment committee typicallyplays the key role. The latestCommonfund Benchmarks Studyindicates six members make up theaverage investment committee, somewhatmore among community foundations.In nearly half the nonprofitssurveyed, the investment committeehad members who were not trustees;among community foundations, 80percent included non-trustees.A diverse membership is desirable, butyou do want to have some memberswith investment knowledge andexperience. Among the committees ofa typical board, the investment committeedeals with the most complexand specialized subjects. Special expertiseis required, but so is commonsense and a variety of viewpoints.Experience suggests a few pointers foran effective investment committee:◆ Keep it small enough to allowdiscussion by all members.◆ Four or five meetings a year shouldbe enough.◆ When a decision seems too difficultto reach, try referring it to a subcommitteeor consult an outside expert.◆ Seek knowledge from your investmentmanagers and other outsideexperts.◆ Strive to maintain continuityof membership, attitudes, andphilosophies.◆ Keep your board informed.As in any group effort, the strengthand character of the people involvedmake the ultimate difference. We canassume that all responsible participantsunderstand the nonprofit’s mission andare committed to its fulfillment. Still,they have to make sure they know howto work together.- 29 -

References andResourcesDow 36,000: The New Strategy for Profiting from theComing Rise in the Stock Market. James K. Glassman andKevin A. Hassett, Times Books, 1999.Endowment Management. William T. Spitz, Association ofGoverning Boards of Universities and Colleges, Board BasicsSeries, 1997.Endowment Management, A Practical Guide. Jay A.Yoder, Association of Governing Boards of Universities andColleges, 2004.Endowment: Perspectives, Policies, & Management.William F. Massy, Association of Governing Boards ofUniversities and Colleges, 1990.Suggested Reading:2004 NACUBO Endowment Survey. NACUBO, 2004.An Unconventional Approach to Institutional Investing.David F. Swensen. The Free Press, 2000.Asset Allocation: A Handbook of Portfolio Policies,Strategies, and Tactics. Robert Arnott and Frank J. Fabozzi,eds., Probus Publishing Co., 1988.The Asset Allocation Debate: All About Alpha.Commonfund Institute, Monograph Series, 2005.The Challenges of Investing for Endowment Funds.Cathryn E. Kittell, ed., Institute of Chartered FinancialAnalysts, 1987.Classics: An Investor’s Anthology. Charles D. Ellis andJames R. Vertin, eds., Dow-Jones Irwin, 1989.Commonfund Benchmarks Study ṬM CommonfundInstitute, Education Report, Foundations Report,Healthcare Report, Revised Annually.The Complete Guide to Securities Transactions. Wayne H.Wagner, ed., John Wiley & Sons, 1989.Creating and Using Investment Policies: A Guide forNonprofit Boards. Robert P. Fry, Jr., Association ofGoverning Boards of Universities and Colleges, 1997.Debt Is Not the Issue. Commonfund Institute Whitepaper,2005.Endowment-Spending Policies. Stephen T. Golding andLucy S. G. Momjian, Morgan Stanley InvestmentManagement, 1998.The Financial Analyst’s Handbook. Sumner N. Levine,ed., 2nd ed., Dow-Jones Irwin, 1988.Financial Responsibilities of Governing Boards. William S.Reed, Association of Governing Boards of Universities andColleges, 2001.Fixed Income Portfolio Strategies. Frank J. Fabozzi, ProbusPublishing Co., 1988.Foundation Trusteeship, Service in the Public Interest.John Nasson, Council on Foundations, 1989.Funds for the Future: College Endowment Managementfor the 1990s. J. Peter Williamson, The Common Fund incooperation with Association of Governing Boards ofUniversities and Colleges, and National Association ofCollege and University Business Officers, 1993.Governance. Your Board: Dynamic or Dysfunctional?Commonfund Institute, Monograph Series, 2005.Guidebook for Directors of Nonprofit Corporations.George W. Overton and Jeannie Carmedelle Frey, eds.,American Bar Association, 2002.The Handbook on Private Foundations. David F.Freeman, Council on Foundations, 1991.- 30 -

Hedge Fund and Absolute Return Strategies.Commonfund Institute, Monograph Series, 2005.How Efficient is Your Frontier? Commonfund InstituteWhitepaper, 2003.How to Write an Investment Policy Statement.Jack Gardner, Marketplace Books, 2003.Improving the Investment Decision Process: QuantitativeAssistance for the Practitioner and for the Firm.H. Russell Fogler and Darwin M. Bayston, Institute ofChartered Financial Analysts, 1984.Inflation: Avoid that Sinking Feeling. CommonfundInstitute, Monograph Series, 2005.Investing with the Best. Claude N. Rosenberg, John Wiley& Sons, 1986.The Investment Committee. John H. Biggs, Association ofGoverning Boards of Universities and Colleges, Board BasicsSeries, 1997.Investments. William F. Sharpe and Gordon J. Alexander,4th ed., Prentice-Hall, 1989.Investments. Zvi Bodie, Alex Kane and Alan J. Marcus,4th ed., Richard D. Irwin, Inc., 1999.Irrational Exuberance. Robert J. Shiller, PrincetonUniversity Press, 2000.The Law and the Lore of Endowment Funds. William L.Cary and Craig B. Bright, The Ford Foundation, 1969.The Management of Investment Decisions. Donald B.Trone, William Allright, Philip Taylor, Irwin Books, 1996.Managing Your Investment Manager. 2nd ed., ArthurWilliams, III, Dow-Jones Irwin, 1986.Nonprofit Investment Policies. Robert P. Fry, John Wiley &Sons, 1998.Performance Expectations and Reality: Smaller vs. LargerEndowments. Commonfund Institute, Monograph Series,2005.Performance Presentation Standards. Financial AnalystsFederation, adopted as amended by the Committee forPerformance Presentation Standards, April 1990.Pioneering Portfolio Management: An UnconventionalApproach to Institutional Investment. David F. Swensen,Free Press, 2000.Principles of Real Estate Investment. Commonfund, 2000.Risk Bucketing – Keeping an Eye on What Is Important.Commonfund Institute Whitepaper, 2005.The Role of Hedge Funds in Nonprofit InvestmentManagement. Commonfund, Revised 2005.Spending Policy for Educational Endowments. Richard M.Ennis and J. Peter Williamson, The Common Fund, 1976.The Standards of Measurement and Use for InvestmentPerformance Data. Investment Counsel Association ofAmerica, 1988.Succeed in Private Capital Investing. Commonfund,Revised 2003.Understanding the Four Levers of FiduciaryResponsibility. Commonfund Institute Whitepaper, 2005.Why Do We Feel So Poor? Commonfund InstituteWhitepaper, Reprinted 2004.Winning the Loser’s Game: Timeless Strategies forSuccessful Investing. Charles D. Ellis, McGraw-Hill,4th Edition 2002.The Yale Endowment. Yale University Press, 1995.The Yale Endowment, Updates 1996-2004. YaleUniversity Press, 1996-1999.Web sites:www.agb.orgwww.commonfund.orgwww.nacubo.org- 31 -

About CommonfundCommonfund provides vital financial services for institutionsdedicated to bettering society.Our mission is to enhance the financial resources of nonprofitinstitutions and to help them improve investmentmanagement practices. As the largest nonprofit investmentmanager, we place the fulfillment of this mission ahead ofprofit, unfettered growth, and asset gathering. This allowsCommonfund to offer thoughtfully constructed, highqualityprograms and services at competitive costs.Through well-managed, long-term investment programs, weendeavor to help these institutions strive to build the financialresources they need to maintain and improve their programs,staff, physical plant and infrastructure. And our state-of-thearttreasury management tools help them increase financialproductivity and reduce administrative costs.Commonfund was founded in 1971 as a nonprofit corporation.Together with our subsidiaries, we have approximately$30 billion in assets under management for more than 1,500nonprofit clients.- 32 -DESIGN: WEIR DESIGN ILLUSTRATION: NICHOLAS WILTON

Returns on investment funds will fluctuate, and investorscould lose money on their investments in any CommonfundGroup funds, just as they could with other investments.Past performance may not be indicative of future results.The information provided in this brochure is for generalinformational purposes only and is not an offer to sell ora solicitation of an offer to buy any securities, options,futures, or other derivatives related to securities in anyjurisdiction. This brochure is also not an offer or solicitationto participate in any particular trading strategy. AllCommonfund Group investment funds are offered onlyby means of detailed offering memoranda and relateddisclosure materials. Potential investors should read all suchmaterials with care prior to investing.Certain Commonfund Group funds impose variouseligibility requirements. For more information generally,see www.commonfund.org. Securities are distributed byCommonfund Securities, Inc.

Commonfund15 Old Danbury RoadP.O. Box 812Wilton, CT 06897-0812Tel 888-823-6246Tel 203-563-5000www.commonfund.org©2005 Commonfund 1/05