Q&A #159 – Should a nonprofit hire an investment advisor?
Question: For the first time, our nonprofit organization has built up sufficient operating reserves that we are now in a comfortable position to put a portion of the organization’s funds into long-term investments. Should we seek the services of a professional investment advisor, or can we rely on Board members who have investment management experience?
Answer: While nonprofit organizations are not legally required to use a professional investment advisor to help guide the organization with their investment management, most nonprofits correctly choose to work with a professional investment advisor. Delegating management of the investment portfolio to Board members is not a wise choice because this unnecessarily exposes the organization and its Board members to fiduciary risks related to potential compliance failures and performance shortfalls.
Whether or not to seek the services of a professional investment advisor is one of the first questions that must be addressed by nonprofit organizations that are considering expanding their cash management policies for the first time to include long-term investments. Some people argue that an investment advisor is not needed for very small investment portfolios or when Board members have substantial investment experience because Board members could potentially achieve similar results with perhaps lower costs.
However, these arguments underestimate the difficult fiduciary issues that arise when Board members have direct responsibility for managing a nonprofit organization’s investment portfolio. Moreover, many professional investment advisors are willing to explore approaches at a range of different costs with, importantly, full disclosure of the total cost impact on the investment portfolio. There are often hidden or hard to determine portfolio investment costs to consider that would make it difficult to determine potential cost savings for a “self-managed” investment portfolio, if any.
To get a deeper perspective of how Board fiduciary responsibilities relate to management of investment portfolios, consider how the principle of “prudent” judgment is a recurring theme under applicable laws.
Most states have adopted a version of the Uniform Prudent Management of Institutional Funds Act (“UPMIFA”), which governs the management of donated funds to nonprofit organizations, charitable trusts, and other institutions. One of the main purposes of UPMIFA is to help ensure that charitable funds are managed in a prudent manner, which includes monitoring economic conditions, managing investment strategies (balancing portfolio risk and performance), and determining how each investment course of action is impacting the overall investment portfolio. The Uniform Prudent Investor Act (“UPIA”), a law that preceded UPMIFA and whose principles were largely incorporated into UPMIFA, was similarly focused on prudence.
Prudent investment management and Board stewardship of organizational assets is also a key component of fiduciary duties that apply to Board members under state nonprofit corporation laws, specifically the duty of care.
Using the services of a professional investment advisor helps Board members to demonstrate prudent judgment (informed decision making without elements of bias) by adding guidance and insights from a third party with demonstrated professional expertise.
In particular, an investment advisor will strengthen the prudent investment judgment of Board members by sharing and augmenting responsibility for investment stewardship duties through the following:
Investment decision-making.
Developing investment policy statements (IPS) that meet accepted best practices.
Providing professional assessments of risk tolerances, ethical standards for investing, benchmarking performance, asset class selection, and portfolio rebalancing.
Providing investment reporting and analysis.
Expanding access to differing types of investments.
Helping with cash flow planning and timing portfolio liquidity to meet organizational needs.
Without an investment advisor, these duties would all fall squarely on the shoulders of current Board members. In contrast, delegating select fiduciary duties to an expert third party will add expertise that is usually not present on the Board, finance and investment committees, and staff, while limiting exposure to legal liability from insufficiently supported decision-making and raising trust levels of donors and funders.
Delegating specialized fiduciary duties to Board members instead of appointing a third-party investment advisor is always uncertain because Board members have different levels of expertise, working skills, and time constraints. And even if your current Board members are fulfilling their investment stewardship roles well, there is no guarantee that their future replacements will be able to continue to provide the same consistent level of Board stewardship.
Planning Tip – Nonprofit organizations need to be careful with their process for finding investment advisors. Front-end due diligence is critical for success and should focus on criteria such as experience with nonprofit organizations, qualifications (credentials and licensing), and, just as important, a caring disposition and interest in your organization’s mission, operations, and governance structure. Most organizations plan to stay with an investment advisor for at least 5 years, if not longer, to allow performance assessments and observe working relationships over differing economic and market conditions. Consequently, getting it right the first time is very important.
There are limited circumstances when it might be appropriate to go without an investment advisor. Examples could include capital campaign funds held for purchase of a future workforce training center, Board-designated funds for capital improvements to a headquarters building, and funds held to support an expected future merger of two organizations. However, these situations are very narrow in scope and shorter-term in nature and do not apply in most circumstances involving funds that are expected to be invested for a longer time period. Further, there are plenty of investment advisors that are willing to work with small and/or temporary investment portfolios.
For these many reasons, it is best to plan to use professional investment advisors when an organization has an investment portfolio. Think of this not just as an accepted best practice but also as an expected practice by the donors, funders, and constituents who all entrusted their hard-earned funding to your stewardship.
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