Principles of Nonprofit Investment Management - Commonfund

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.