6 steps for NFP boards looking to invest their cash reserves
As a not-for-profit (NFP) board member, you are responsible for making sure the funds collected work as hard as possible towards your organisation’s goals. Part of that task revolves around making the most of your NFP’s money.
It’s tempting to believe that keeping NFP funds in cash is the most responsible way to manage it. But, in reality, keeping long-term funds in cash decreases the ‘real’ value of your NFP’s funds as inflation eats away at its purchasing power. Some NFP boards are comforted by the idea that inflation is at historically low levels. But so are the rates for term deposits. For several years now, deposit rates have continued to fall, currently landing at around 2-2.5%, for a 12-month term. In other words, keeping your funds ‘safe’ in term deposits means you’ll only just be keeping up with inflation.
This is a real problem for most NFPs, which used to generate the majority of investment income from term deposits, without needing to venture further up the investment risk spectrum. But the days of healthy returns from cash investments are long gone.
What are the alternatives?
Even the most conservative NFP boards can generate a higher level of income by using fixed interest securities or diversified investment portfolios aligned to their risk tolerance. Typically, these portfolios will include equities that generate a good level of income through dividends. Ideally, these are selected for their franking credits because NFPs that have Deductible Gift Recipient status receive franking credit refunds – increasing the income they receive from their investment in certain Australian equities.
How do we keep risk to the minimum?
Responsible NFP boards should consider the following steps when looking to invest their cash reserves:
- Use a financial adviser – This is an expert who will help you to articulate your financial goals and advise on the appropriate asset allocation to help you achieve them.
- Develop an Investment Policy Statement (IPS)– This is a roadmap for the way your funds will be invested. It sets the ground rules for investing, including your ethical overlays. It also outlines how investment decisions will be made and what steps need to be taken to ensure good governance. Your financial adviser will help you write your IPS and they should review it with you regularly to reflect changes in your organisation (a large bequest, a new objective, a different requirement for funds) and in the investment universe. New investment solutions are being developed all the time, with lower fees and different ideas for diversification that could reduce risk. Your adviser will keep you up to date, so you have access to the best investment products for your NFP.
- Discuss your risk tolerance – Everyone has a different view on risk and return. As a board, you need to agree what you are comfortable with. Be aware that longer-term horizons mean you can invest in more volatile asset classes and still stay within reasonable risk tolerances.
- Understand what you need the funds for and when –Your financial adviser will ask you about your ‘liquidity’ needs. This is the amount of cash your organisation needs to be able to access easily and quickly at any time – your ‘working capital’. Tell your adviser when you’re going to need the funds and what you’re hoping to achieve. Do you also plan to draw down from the portfolio each year to fund activities? Do you have long-term plans to grow funds into perpetuity? What is the expected level of cash inflows into the organisation?
- Think about what you do and don’t want to invest in – Your board may have strong views on industries or companies that do you or don’t want your money to support. You can instruct your investment manager to avoid certain areas or proactively target others. This is called having an ‘ethical overlay’ across your portfolio. It means your portfolio will be customised along ethical or social lines, as you see fit.
- Appoint a professional investment manager – Unless your board has someone with the time and expertise to manage your investments, you need a professional manager. To minimise fees, while still getting the benefits of an institutional-grade manager, you can consider using an Individually Managed Account (IMA) or a Separately Managed Account (SMA). These accounts can meet your investment policy requirements, in a tax-efficient structure, while still giving the board absolute transparency. You’ll be able to see exactly where your funds are invested at all times. When changes are made, your adviser will tell you what they are and why, giving you comfort that your investments are being managed responsibly.
In the current financial environment of low term deposit rates, NFPs must consider moving beyond keeping funds ‘safe’. You also need to consider how to responsibly use the funds collected to generate additional income to help your organisation deliver its mission for years to come.