Best Practices for Maintaining an Investment Policy Statement

Does it sometimes feel like your nonprofit or foundation is making investment decisions in the dark? Having an investment policy statement, or IPS, is widely recognized as a best practice for achieving long-term investment success. Not only does an investment policy statement provide crucial benefits to your organization, but it also helps individual decision-makers make informed choices.

With an IPS, you’ll have a record of past investment decisions and the reasoning behind them, ensuring consistency even as board or committee members change. Plus, it can serve as a valuable onboarding tool for new members. By aligning your IPS with your strategic plan, you’ll increase transparency and communication between investment and development committees. And during challenging markets, the IPS provides direction and reassurance for sound decision-making. Finally, an investment policy statement demonstrates that your directors are fulfilling their fiduciary duties and following a prudent process.

What Is an Investment Policy Statement?

It’s the framework that guides how assets will be invested and why. An investment policy statement for nonprofits and foundations identifies the portfolio’s purpose and time horizon, providing a clear understanding of the investment goals and objectives—and how they support the organization’s mission. It also defines and assigns responsibilities for all involved parties, ensuring everyone is on the same page. The IPS offers guidance on allowable investments, asset allocation, and restrictions, and it establishes a basis for monitoring and evaluating investment results. In short, the IPS is the key to making informed investment decisions that align with your organization’s overall mission and goals.

What to Adopt and Avoid

Crafting an IPS is an important first step in establishing an investment program. But if left untouched, it can quickly become stale and outdated. In our work drafting and reviewing investment policy statements for nonprofits, tax-exempt associations, and foundations, we’ve identified a handful of best practices—as well as pitfalls to avoid. These tips help ensure decision-makers meet their fiduciary duties while effectively supporting their organization’s mission through the market’s ebbs and flows.

Monitor and Maintain the IPS

Don’t make the mistake of “setting and forgetting” your IPS. To ensure it stays relevant and effective, it should be reviewed and ratified each year. To stay on top of this, create a fiduciary calendar for the year and add the IPS review to the agenda for an upcoming quarterly meeting.

Does that mean the investment policy statement should be modified annually? Probably not. Making changes too often is liable to do more harm than good. A thoughtful IPS with the right long-term asset allocation can help you anticipate market swings without the need for frequent changes. Instead, your IPS should be adjusted over time as your organization’s financial situation changes and the investment landscape evolves. With that said, it’s important to stay up to date. Fiduciaries should expect to refresh the IPS every market cycle, or approximately every 3–5 years, unless there’s a change in your organization’s needs and objectives.

Allow for Separate Portfolios, including Short-Term Reserves

Are you investing all your reserves in one moderately conservative portfolio (e.g., 40% stocks and 60% bonds) due to uncertain spending needs? This common trap can hinder your board from investing long-term funds for the long term. Instead, consider a flexible IPS that accommodates multiple “buckets” with different purposes, time horizons, return/risk parameters, and spending objectives. By separating your operating cash or intermediate reserves from your truly long-horizon funds, you can achieve the growth your organization needs.

Maintaining a cushion is prudent, but it comes at a cost. Historically, holding too much cash has dragged down long-term returns. In the current environment, nonprofits with excess cash may underperform bonds, making it important to invest before interest rates decline. Bernstein has a proprietary framework to help nonprofits rightsize their cash reserves and align the investment allocation with the appropriate time horizon according to need.

Set Data-Driven, Integrated Goals

Are your return goals realistic for your target asset allocation, risk tolerance, and current capital markets conditions? Many institutions aim to generate returns that can cover annual distributions plus inflation. But with return expectations somewhat muted, spending goals may be difficult to achieve. To bridge the gap, some nonprofits have increased their allocations to return-seeking investments. Both the board and the IPS must acknowledge the risk required to achieve that return. Consider utilizing current capital markets forecasts for risk, return, and inflation to inform goals for allocation and spending. Bernstein can prepare a customized Forecast Analysis enabling fiduciaries to pre-experience the impact of their investment policy under fluctuating—and sometimes extreme—capital market conditions.

Measure Success Against the Overall Mission

An investment policy statement for nonprofits and foundations should also provide a framework for measuring success. That means assessing performance at least annually versus a portfolio with similar risk and return attributes—known as a risk-weighted benchmark. This will also tell you whether your investment manager has added value with their advice on geographic or sector weightings and incorporation of alternative investments. Keep in mind, while it’s important to consider the relative performance of individual investment services, comparing your diversified portfolio (net of all costs) to the risk-weighted benchmark will give you a better understanding of whether your holistic strategy is truly delivering the results you need.

Remove Overly Restrictive Investment Guidelines

Are you still prohibiting certain types of investments in your IPS? While this approach may have been well intentioned in the past, it’s no longer considered a best practice. The laws that govern fiduciaries have moved away from this approach, and the standard now is to create a prudent allocation that meets the overall objectives of the organization, even if that includes small amounts of seemingly high-risk investments.

The investment landscape is constantly evolving. And prohibiting investments (for other than mission-related reasons) often leads to suboptimal outcomes. Potential red flags in the IPS include:

  • a narrow list of permissible investments,
  • limits on investments by type, credit quality, industry, or position size,
  • insufficient geographic diversification, and
  • omitting alternative investments.

Define Your Organization’s Approach to Responsible Investing

Consider whether your organization wishes to align its investment practices with its underlying mission, vision, and values. If so, first define what “mission alignment” means for your organization’s investments specifically. Once you have a clear understanding of your goals, communicate appropriate types of investment strategies to your advisory team and codify your intent and preferences in the IPS. One best practice is to provide the flexibility to favor the alignment of investments in this way, and to direct the investment manager to integrate and/or prioritize, wherever practicable and in line with the IPS.

Don’t Let an Outdated IPS Hold You Back

If it has been years since you dusted off your IPS, it’s likely due for a fresh look. In the last few years, nearly 250 foundations and nonprofits have asked Bernstein to review their investment policy statements. If you’d like a complimentary second opinion, contact your Bernstein Advisor.

Christopher Clarkson
National Director, Planning | Foundation & Institutional Advisory

The views expressed herein do not constitute, and should not be considered to be, legal or tax advice. The tax rules are complicated, and their impact on a particular individual may differ depending on the individual’s specific circumstances. Please consult with your legal or tax advisor regarding your specific situation.

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