How should nonprofits’ trustees invest now?

The deep financial market sell-off of February and March 2020 was highly unsettling for investors of most types. Many nonprofits – public charities, private foundations, and certain other organizations – suffered sharp mark-to-market losses on their investment portfolios. As such, they found themselves facing the unhappy possibility of having to reduce both their future operational spending and grant making to their chosen causes. The powerful subsequent market rally has thus come as a welcome reprieve. So, what should nonprofits’ trustees do now in relation to portfolios?

Citi Private Bank believes that it would be wise to treat the markets’ recent rally as a window of opportunity. In our view, further significant volatility in risk assets seems likely. Our Strategy team cautions that economic recovery after the COVID-19 shutdown is likely to take longer than many seemingly expect. We therefore recommend that nonprofits and other investors seek to ensure they are positioned for potential further turbulence.

This follows our advice last summer that nonprofits elevate risk management above enhancing returns at the moment based on our long-term outlook for asset classes. Disciplined risk management remains equally relevant today.

As a first step, trustees should assess how the portfolios they oversee held up during the market turmoil. This involves asking several important questions. How did the asset allocation perform on an absolute and risk-adjusted basis? Did it meet expectations, given the market environment? Did the fixed income allocation help to offset equity volatility? Did actively managed strategies contribute to improved risk-adjusted returns? Did alternative investment holdings fulfil their intended purpose?

In light of the answers to these questions, the next step for trustees is to consider whether the portfolio conforms to our recommended criteria as follows:

• Cash and cash equivalents: We advise nonprofits hold sufficient liquidity to meet their annual spending and grant-making needs, irrespective of market turmoil or crises. To illustrate the value of this approach, trustees should ask themselves what would have happened had this year’s grant funding been held in equities instead of cash in March.
• Fixed income: Higher quality fixed income holdings provide a reserve for making distributions, as well as potential capital preservation during bouts of equity volatility. We suggest sizing fixed income holdings such that there are another three to four years’ worth of grants in this part of the portfolio. Also, by investing some of these holdings in long-duration US Treasuries, overall portfolio volatility may be dampened, especially during episodes such as March’s sell-off.
• Equities: While a vital driver of a portfolio’s long-term growth, this asset class is a significant source of volatility. However, it is vital to resist the temptation of trying to switch into cash ahead of potential sell-offs or indeed during them. The equity markets’ best and worst days tend to be tightly clustered together.¹ Missing the best days can seriously hinder long-term returns. Trustees should thus keep portfolios fully invested, but consider hedges to help mitigate volatility, if needed.
• Hedge fund: Strategies from this asset class can not only potentially enhance a multi-asset class portfolio returns, but may also dampen portfolio volatility. Suitability in light of a specific nonprofit’s portfolio’s goals is critical, however.
• Private equity and real estate:Where appropriate, we utilize these to take advantage of the very long investment time horizon and tolerance for illiquidity that most non-profit entity portfolios possess.

By understanding and implementing these criteria, nonprofit trustees can build portfolios that can keep funding operations and grant making, even during times of market turbulence. With volatility having subsided for the moment, we believe it is a good time to put these criteria into practice.