-
Oct 17 2019 
The Importance of the Sustainable Endowment
Nonprofit organizations and foundations have played a pivotal role in American culture for nearly a century. As a third sector next to corporations and government, they provide many types of programs and services to support the public that the other two sectors do not or cannot provide.
The National Center for Charitable Statistics (NCCS) estimates that there are more than 1.5 million nonprofit organizations registered in the United States. These include public charities, private foundations, and other types of organizations. Nonprofits and foundations are also found throughout the world, but our concern in this book is solely those operating in the US under specific American tax laws and financial regulations.
Nonprofits participate in a wide range of fields, including health, educa- tion, literacy, poverty reduction, social justice, religion, disaster relief, support for the arts, and more. They have been responsible for significant advances in the health field, such as eliminating hookworm and yellow fever in many countries, disseminating polio vaccines to the far reaches of the world, and virtually ridding humanity of smallpox. They have played a strong role in educating people about and treating HIV/AIDS.
Nonprofits help fund theatrical and artistic productions, museums, cultural attractions for the public, and student scholarships for higher education. There is no doubt that nonprofits and foundations are a vital element in society that must continue contributing wherever they are needed.
The Sustainable Endowment is my contribution to helping nonprofits and foundations learn how to be effective, well-managed, and sustainable. It is intended for executives and board members involved in the management of nonprofits, public charities, or private foundations operating in the United States. For our purposes, I do not make a distinction between these terms; all are organizations following the same basic ground rules when it comes to adhering to regulations to maintain Section 501(c)(3) tax-exempt status.
For clarity, let’s note that “nonprofit” is an overarching term for many types of non-governmental corporations or organizations that do not seek to make a profit from their activities and are exempt from federal income taxes under IRS Section 501(c)(3). Instead, they use their financial resources to benefit a mission of some kind.
There are roughly 29 sub-classes of nonprofits. One of these is a public charity, which collects donations from the general public to support a public cause, such as safety, disaster relief, assistance to the poor anywhere in the world, animal rights, and so on. A private foundation, often funded by a single individual or business, is equally dedi- cated to a cause or mission. Private foundations may donate to charities or may hand out monetary grants to individuals who seek to accomplish a goal on behalf of the foundation. Churches, religious organizations, educational institutions, and several other types of organizations may also be tax-exempt nonprofits.
In my book, I will use the terms nonprofit and foundation interchangeably without distinction, as my goal is to help all types of nonprofit organizations that desire to improve their executive management, especially regard- ing their financial health. I will discuss the principles central to becoming a well-run nonprofit that understands how to manage its finances. Whether the nonprofit raises funds from public donors or is a foundation funded by a single source, the management of its investments plays an important role in its year-to-year success as well as its long-term sustainability.
ORGANIZATION OF THE PRINCIPLES
Discussing the financial management of a nonprofit encompasses many issues beyond the basics of investing. That is why this book is organized around 10 principles, beginning with three chapters covering the critical basics of foundation management.
Following those three principles, the remaining seven will explain the specifics of how to go about the financial management of your endowment, especially in regard to investing the principal to maximize returns while minimizing risks. I do not delve into issues regarding a nonprofit’s fundraising efforts or operating budgets — those are your decisions.
My goal is strictly to educate foundation leaders and investment committee members on the best practices for investing an endowment to maintain stability or to grow it over time with the least amount of risk. Executives at nonprofits and foundations, especially those on investment committees, come from a wide range of backgrounds. You may or may not be familiar with the investment concepts and principles that I present in my book, so please excuse the caution I have taken to ensure that I thoroughly explain basic terminology and the fundamentals of investing. I want to be sure all readers are comfortable with its contents.
The Sustainable Endowment was written for executives and board members of small- to mid-size U.S.-based nonprofits, charities, or foundations. Running a nonprofit requires specialized knowledge and skills, especially regarding foundation management and investing your endowment so it remains sustainable for years to come.
This book walks you through the basics and best practices of what you need to know to be successful.
-
Oct 17 2019 
Environmental, Social & Governance (ESG) Awareness
ESG Investing Adds Value on Many Levels
In recent years there has been an increased awareness regarding public companies and their ESG track record. In my own work, I have also been witness to this trend. I often hear CEOs and research partners weighing in on enhancing their corporate culture as it relates to issues of governance, society and sustainability. Moreover, there is a growing movement of “smart money” investing in companies that have a strong history of these pertinent issues and I see this as something that adds value for shareholders. Over the years, I have included ESG components in my company’s research process to avoid investing in companies that have flagrantly poor environmental, social and governance track records.
Investing in companies that cultivate ESG best practices just makes good investing sense. In the “old days” one might argue that to invest with a social conscious might mitigate performance – but today that is just not so. There are an increasing number of large institutional investors who appreciate companies with high ESG marks and their hefty investment dollars can go a long way in supporting both higher stock prices and industry standards.
For many, investing with a social conscious is a challenge since most mutual funds – especially the index funds – invest in a wide array of companies without regard or ability to be ESG sensitive. This invariably exposes investors to companies that may have egregious violations, which hurts these index shareholders in the long run.
ESG investing means different things to different people. Searching for companies with certain characteristics that show the promise of accelerated growth – with a bias towards those with positive governance, environmental and social awareness, is how I look at it. However, you may feel that you would like your portfolio to be more sensitive to specific ESG constraints. Do what works for you.
The Sustainable Endowment was written for executives and board members of small- to mid-size U.S.-based nonprofits, charities, or foundations. Running a nonprofit requires specialized knowledge and skills, especially regarding foundation management and investing your endowment so it remains sustainable for years to come.
This book walks you through the basics and best practices of what you need to know to be successful.
Order your copy today on Amazon
-
Sep 11 2019 
Are Investment Fees Draining Your Foundation’s Endowment?
The success or failure of an endowment relies on many interrelated and important factors. Some of these factors are impossible to control or predict such as the level of next year’s donations? Or the return of the endowments investment portfolio in the years ahead?
However, foundations should strive to do their best in areas where they can take control and make a difference. An area we often see ignored or misunderstood by nonprofits and foundations is the cost of investment management. A keen eye on these costs can enhance significantly enhance long-term performance.
In our opinion, most investors both institutional and individual pay too much for investment management. When one considers that most endowments strive to distribute 5% of the value of their asset base annually but also incur 1% in administrative expenses, any additional “above normal” expenses for investment management puts pressure on the endowment to take risks that may not be otherwise necessary.
For example, we often see foundations that have hired an outside manager or “consultant” who charges an annual fee, which is normal but then puts the foundation assets in investments that charge additional annual fees. These include mutual funds, exchange-traded funds, or even investments that have to compensate other outside managers.
This layering of fees may not look like much by decimal points or in any given year, but they add up over time and can significantly reduce the endowment’s long-term returns.
For example, consider a foundation that distributes 5% annually in grants, incurs 1% in administrative fees and pays 1.8% annually for investment management (we’ve seen higher fees!). Combined, this adds up to close to 8% flowing out of the endowment annually. The investment manager is almost 25% of the total annual outlay!
Of course, there may be investment managers somewhere in the world who may deserve such a high fee due to their spectacular results. But the fact is, on average, this is not the case. Indeed, given that the average endowment usually has a maximum of 60 to 70% stock exposure at any given time and the historical returns on a 60/40% stock/bond mix over the last 50 years has been a mere 6%, paying a high investment management fee might reduce your effective return to 4% or less.
For foundations and endowments, doing and understanding this math is essential to your long-term survival!
To avoid these fee pitfalls, foundations and nonprofits need to ensure that their investment management costs are competitive based on their endowment’s size. Most importantly, they need to avoid the layered fee arrangements that so often exist and go unnoticed – until it’s too late. Keeping an eye on the costs you can control will put your organization in better shape to remain sustainable for many lifetimes.
The Sustainable Endowment was written for executives and board members of small- to mid-size U.S.-based nonprofits, charities, or foundations. Running a nonprofit requires specialized knowledge and skills, especially regarding foundation management and investing your endowment so it remains sustainable for years to come.
This book walks you through the basics and best practices of what you need to know to be successful.
-
Jan 02 2019 
Global Stock Markets Face Fork in the Road: Is the Worst Over?
2018 can best be described by Charles Dickens who wrote, “It was the best of times, it was the worst of times.”
Within the backdrop of strong economic data and corporate profitability, global equity markets advanced well into September, only to give back all of the gain – and then some – ending the year with all major indexes in the red.
The media quantifies a bear market as a decline of 20% or more, and most major indexes have either surpassed that threshold or are within striking distance. For all intents and purposes, I would classify this as a bear market. The question investors should be most concerned with is: is it a gentle bear market or a more aggressive grizzly? Let’s take a look at some data points.
As I mentioned in my last Strategy Update, the market is approaching a fork in the road and the direction it takes will be dependent on economic data. The road to the left (gentle bear) goes in a direction where we find that most of the decline in stock prices is behind us.
This road will be full of signposts that argue the global economy will continue to grow, albeit rather slowly, and avoid a recession. These economic data points released in the coming weeks will allow me to get some verification. One of the mile markers will be stronger than expected earnings. Earnings season starts this week, so I will be paying close attention to these reports.
Finally, a more constructive stock market environment requires significant policy expertise. This relates to a more accommodative Federal Reserve, progress in tariff negotiations and lastly, but not least important, getting our government turned back “on.”
From my perspective, the data points on earnings and the economy are easy to judge. However, I think the market’s biggest problem is the unknown of potential policy missteps. I am hopeful economic and earnings data are supportive and that policy makers can successfully navigate these issues. If some or none of these data points yield positive results, we are more than likely going to be traveling down the other, much less forgiving, fork in the road (grizzly bear).
In the absence of supportive economic data and/or policy success, I believe that global stocks could easily decline further. If one considers that the average bear market decline is approximately 38%, it is easy to see how much worse this could get for investors. Down this road are signposts that earnings are worse than expected and the economy is teetering on recession.
That alone could be enough to send stocks down another leg, but combined with a policy error could really solidify the grizzly bear case. Though bear markets can be difficult, keep in mind that they are not long affairs – usually just 6-9 months – which means we may be a good way through this one. The best thing about a bear market is that when they end there are tremendous bargains to take advantage of if investors have the cash and capital to do so.
It is impossible to know which fork in the road the market will take. Anyone who says they know for sure would be mistaken. To quote Jack Bogle, the veteran Vanguard CEO, this week in Barron’s magazine, “This is no time to take significant risk and if anything investors should reduce risk at these levels.”
I strongly agree with Mr. Bogle.
If at the present time the bulk of your assets are in fixed income, they will be generating better than money market return. I do not see this as a long term investment strategy, but a very good safe harbor until we get better clarity on the issues ahead of us.
In your taxable account, you may have taken some significant capital gains from selling some of your big stock winners in recent years. These sales on balance were timely as many stocks are much lower today and now your portfolio is more defensive. However, with the gains come capital gains taxes. Keep in mind my thoughts that it is better to pay thousands in taxes, than to lose millions in market value. Your tax liability will be about one-third of the total realized capital gains, which for most amounts to about 2-3% of their total portfolio value – a small price to pay for portfolio protection.
I wish you and your families a very Happy New Year!
The Sustainable Endowment was written for executives and board members of small- to mid-size U.S.-based nonprofits, charities, or foundations. Running a nonprofit requires specialized knowledge and skills, especially regarding foundation management and investing your endowment so it remains sustainable for years to come.
This book walks you through the basics and best practices of what you need to know to be successful.
-
Dec 21 2018 
The Bear Ate Santa Claus’s Rally
Until recently stock indexes traded within normal correction territory – demonstrating more than normal volatility. However, as of late, global stock indexes have declined beyond correction levels and sectors of the market have fallen into what we consider bear market conditions.
Investors would be wise to pay attention to this greater than normal decline in stocks, as it may very well be the precursor to a continued downward spiral.
I have been a seller of stock for the past few months, which has reduced my stock exposure significantly. Most importantly my selling was focused on the banks, technology and industrial companies – which have fallen the most in this recent selloff. Thankfully this reduction in stock exposure – and of the most vulnerable stocks – has and will continue to protect my portfolio should the market decline become more significant. Keep in mind when the market falls 5%, your total portfolio declines less due to these changes and our active risk management. So where do we go from here? Have stocks fallen enough? Let’s discuss.
In many ways the stock market is the economy. Though the past four quarters of economic growth have been stellar, the stock market is telling a different tale about the year ahead. This different and less bright future is tied to many issues including the Federal Reserve and their unwillingness (at least so far) to slow or halt interest rate hikes, tariff concerns, and geopolitical and global economic debt levels.
From my view, the stock market is beginning to discount one of two scenarios. Here are those scenarios and how we expect to get you through each successfully:
The global economy slows from recent 4% growth to 1.5-2% growth and avoids recession.
This scenario would cause corporate profit growth to slow – particularly for companies that require a fast growing economic backdrop: think banks, tech, industrial, energy and consumer discretionary companies, most of which I have sold in the past few months.
However, a slower economic climate would allow a bull market of another kind to emerge – one I have discussed in recent Strategy Updates. It would be a bull market not led by the FAANG stocks, or the fast growing consumer discretionary companies etc., but rather companies in the sectors that have great profit growth regardless of the strength or weakness of the economy – think consumer staples, healthcare, utilities and select technology companies whose fortunes are not tied to strong economic growth.
This is where the bulk of your remaining stock exposure lies today and so far these stocks are holding up quite well. If this type of “new” bull market can emerge in the next few weeks or months, I would be adding more of these types of great companies such as Proctor & Gamble and NextEra. Basically, companies with great balance sheets and brands that investors can be very successful owning should this scenario play out.
The global economy falls into a recession.
At a glance, global stock markets appear to be discounting a recession. All of the sectors that typically fall the most in a recession are doing just that. It is possible that the Federal Reserve has already raised interest rates too much and instead of trying to slow the economy in 2019, it may be headed to a screeching halt.
The last interest rate hike earlier this week may have been the “straw that broke the camel’s back.” In this scenario, we want to shed all stock that would be negatively affected. The good thing about recessions and bear markets is that they are rather short affairs. In fact, bear markets usually last just 6-9 months in which case we are already two months into this one.
Should we enter this scenario, I suggest keeping your stock exposure much less than normal and in the kind of stocks that survive a tough economy. I would also buy short term fixed income and preferred money market funds to provide you with the best risk-adjusted return possible. The best thing about a bear market is that when they end there are tremendous bargains to take advantage of if investors have the cash and capital to do so.
As you know, I take risk management very seriously. Always remember the “ugly math” – when investors lose 50% they have to go up 100% to get even! Continue to use stop losses on the remaining positions in your portfolio.
In the current environment, continue to play it “safe” rather than end up “sorry.”
I wish you a safe and Happy Holiday Season.
The Sustainable Endowment was written for executives and board members of small- to mid-size U.S.-based nonprofits, charities, or foundations. Running a nonprofit requires specialized knowledge and skills, especially regarding foundation management and investing your endowment so it remains sustainable for years to come.
This book walks you through the basics and best practices of what you need to know to be successful.
James Demmert
James Demmert has created 5 entries
