NFP Growing Pains and the Strain of Low Interest Yields

The persistent low interest rate environment is a pain point for many Australian Not for Profit organisations, but it has also been the catalyst for Boards to review investment policy statements to help future-proof their organisations, writes Daniel Tomé, Senior Adviser at Perpetual Private.

In times past, earning six per cent on a “no risk” term deposit with inflation at three per cent was an easy decision – or non-decision – for many Not for Profit Boards. In such an investment context, there was little need to think innovatively or test the boundaries of risk in striving for long-term organisational goals. Good enough was good enough.

At best, such a mindset has led to suboptimal outcomes across the NFP sector. At worst, it has bred complacency around the boardroom table, with organisations operating with a false sense of “revenue generation” security. However, with interest rates falling and remaining low, decision-makers have been shaken to attention in recent times.

With term deposits now providing less than three per cent return on capital, the conversations around alternative investment mandates, alternative sources of funding and the overall business approach to improving operational outcomes have gained significant momentum at the Board level. Boards are realising they need to take action if they want their investments to continue to genuinely support their mission.

Internationally, NFPs have been operating in this low income environment for much longer than we have in Australia. There’s much to be learned about what has worked in endowment building overseas – one key learning is the need for greater diversification in investments and use of alternative assets. The traditional model of weighting heavily to Australian equities needs closer examination given the lack of sector diversification within the ASX and the subsequent volatility and risk that it exposes.

While markets are forever changing and volatility continues, one thing we know for sure is that revenue that was once easy to find with virtually no risk is now gone and a new normal has arrived.

Strong governance more important than ever

During the past couple of years, NFP advisers have been inundated with questions from leaders across the NFP sector on how to generate the income their organisations need in a low interest rate environment, where the traditional mainstays of cash and fixed income aren’t delivering.

Of course, the answers to these questions depend on the individual organisation and the specific constraints it may have in accessing capital for operational use, as well as its tolerance for taking on more risk and alternative revenue generation sources. But one fact is true, no matter the organisation in question – stronger financial and investment governance leads to greater confidence and enhanced impact in delivering to mission, even in down times.

Earlier this year, Perpetual held a number of roundtable discussions across Australia in conjunction with the Australian Institute of Company Directors. The initiative brought together NFP directors who represented the diversity of size and scope of the sector. These directors candidly discussed key challenges and their investment governance strategies, forming the basis of an informative discussion paper. Through this process we discovered confidence about the future was highest among directors with a formal investment policy in place.

An “investment policy statement” (IPS) is a practical solution which allows NFPs to align their investment policy with their mission, while allowing for changing circumstances and challenges. It provides a valuable way for an organisation to consolidate key information into one document, including:

• The investment policy objective
• Governance responsibilities
• The process of appointing investment manager(s)
• Asset allocation guidelines
• Benchmarks and performance measures
• Administrative duties and decisions.

Simply having an IPS in place does not mean an NFP has strong financial governance. The IPS should be seen as a living and breathing policy, one that is linked to a mission, as well as the revenue and expenditure cycle. It also needs to be written with consideration for the Board’s obligation to ensure these financial resources are secure and are working as effectively as possible for the organisation. Importantly, an IPS provides a record of the Board’s robust consideration of the responsible and sustainable management of donations and endowments.

The great positive that has come out of the economic conundrum of low income returns is that many Boards are revisiting their governance structures, most prominently their IPS. The sustained low interest rate environment has compelled them to go through the process of better understanding the function of invested funds in the health of their organisations, now and into the future. It has also been a catalyst for the internal review of efficiencies within organisations and testing the real boundaries that stakeholders can tolerate now for significant long term gains.

Being able to demonstrate good investment governance through an IPS can actually assist NFPs to attract funds from donors who want to ensure their resources will be well managed. It also provides clarity for NFP staff around the roles of document preparation and compliance reporting. Most importantly, as circumstances change, an IPS should be considered a dynamic document that evolves in much the same way as a financial plan does when objectives change.

The benefit of revisiting or building an IPS is this process of discovery greatly improves decision-making and resource allocation. The guidance of independent advisers can also enhance the myriad rewards an organisation can reap through this structured self-reflection. Strengthening investment governance in this way inevitably generates better outcomes and helps deliver a sustainable long term impact on the causes or communities an organisation serves.

About the author: Daniel Tomé is a Senior Adviser at Perpetual Private specialising in advice on structures and investment for philanthropists and Not for Profit organisations.