Institutional and nonprofit investors have seen a lot of changes in the past few years that make navigating their investment issues a challenge. The bear market of a few years ago may have disrupted plans, and services and new legislation have set forth a host of different investing rules. These factors have combined to make many institutional investors more needful of quality investing assistance than ever before.
Advisors have numerous opportunities to serve these clients. The key to serving institutions is to understand their specific needs. Before diving into the specifics of serving institutional investors, it's helpful to understand how institutions differ from individuals when it comes to investing. Here are just a few of the main differences:
The time horizons of institutions and nonprofit organizations are very long, with many investing in perpetuity. The long time horizon to invest and generate income is a benefit when it comes to riding out volatile markets, but it also means that growth must keep pace with or exceed inflation to preserve buying power.
With individual investors, the main goal is typically to provide for the individual and spouse, with thoughts of leaving something to heirs being secondary. Intergenerational equity is a concept that refers to the equal treatment of present and future recipients. In other words, for institutions, an asset allocation and spending policy should be designed with equal emphasis on or benefit to current and future beneficiaries.
Tax-exempt status means ordinary income and capital gains no longer cause friction for an organization's investment portfolio, opening up institutions to asset classes that may not be as prudent for individual investors. The barrier to investing in tax-inefficient asset classes such as REITs, commodities or taxable bonds is not an issue, and the additional cost of tax management is eliminated.
The most widely adopted guideline for institutions and nonprofit organizations is the Uniform Prudent Management of Institutional Funds Act (UPMIFA), which has been enacted in every state except Pennsylvania. By incorporating modern investment theory and practice, UPMIFA replaces the 1972 Uniform Management of Institutional Funds Act (UMIFA).
One of the biggest items set forth by UPMIFA is that institutions and nonprofit organizations have a fiduciary responsibility when it comes to investing and handling endowments, meaning the staff, board and committee members have a legal obligation to do only what is in the organization's best interest. UPMIFA permits board members to delegate their investment management responsibilities to one or more investment advisors if they do so with prudence. This also means that any advisors acting on behalf of such an organization must uphold the same fiduciary requirements as board members.
For advisors, recognizing the differences between serving institutional and individual investors is only a starting point for effective investment management. Guiding an investment or finance committee through the investment management process can be complicated, depending upon the range of experience and personalities of committee members. Careful planning and active communication between the organization and the investment advisor not only simplifies the process but also reduces the number of conflicts that may arise.
First, the board must agree to the overall mission and goals of the organization. Next, they should create a written investment policy statement (IPS) that governs the funds that will fuel the mission. This goes beyond simply serving as a blueprint for investing. The IPS ensures that future board members, staff and advisors understand why endowment funds are invested in the manner they are, helping mitigate confusion and potential conflicts down the road. An experienced investment advisor can help with that process, providing an outline of an appropriate IPS and helping with recommendations.
The IPS not only outlines the mission, but also prioritizes objectives, defines responsibilities of the investment committee and investment advisor, and sets the investment parameters. For example, a comprehensive IPS will state acceptable and prohibited asset classes, target asset allocations, rebalancing guidelines and methodologies for measuring performance. An IPS should cover all the funds of an organization, especially those with differing objectives. A general operating fund and an endowment fund may have different priorities, asset allocations and spending policies, which should be clearly outlined in the organization's IPS. Alternatively, a board could create a separate IPS for each specific fund.