Foundations and Endowments Your charitable organization works diligently to make your community a better place. At Garde Capital, our job is to make sure that your endowment is properly managed so that you can focus on that critical effort. We specialize in providing investment management solutions that are cost effective, globally diversified, and customized to your needs. As fiduciary board members, you have a lot of responsibilities. When it comes to management of your endowment or foundation assets, you will focus on a number of areas: Long Term Vision for the Assets Asset Allocation Manager/Fund Selection Spending Policy Reporting Requirements and Performance Measurement Long Term Vision The first issue at hand for a non-profit organization is to define the goals for your asset base. Many organizations have a combination of short term cash needs and long term sustainability objectives that must be satisfied. This may necessitate multiple accounts with different portfolio allocations. If you need to draw upon the assets to sustain the organization in the near term, then a spending policy must be established that will accomplish the goal but not jeopardize the long term health of the portfolio. The investment policy statement (IPS) is a document that is used to memorialize your vision and clearly specify these details. It is an excellent communication tool for the investment advisor, and it also becomes a framework for your future investment decisions as a board. Asset Allocation Once you have clearly established the timeframe for investment and the long term goals for the portfolio, you then need to understand how much volatility is appropriate and the return assumptions that are required to accomplish those objectives. At Garde Capital, we believe that the right asset allocation is the one that is sufficient to meet return objectives over the long term but does not take on excess risk. Creating this portfolio requires a global approach. Our solution is to spread the investment assets over many different asset classes, each of which may behave differently in response to varying economic and market conditions. The portfolio is then rebalanced on a regular basis to further enhance the risk/return characteristics over time. We know from countless studies that asset allocation is responsible for more than 90% of the variability of returns over a market cycle, and we encourage boards to devote the proper amount of time to this issue. Manager/ Fund Selection When selecting investment vehicles, the board must be aware of the total cost of ownership of an investment solution. Boards expect that they will pay a management fee to the investment advisor, but very often, investors are unaware of the potentially hazardous level of fund fees which can easily exceed 1.00% per year. As fees are highly correlated (inversely) with future performance we strongly encourage investors to consider index funds as the building blocks for their portfolios. A globally diversified portfolio of exchange traded index funds has an approximate cost of 0.20% or less, a very meaningful savings to the investor. The following data helps illustrate the dangers of trying to select an actively managed product with higher fees. In looking at the Large Blend Category of U.S. stock funds, we found the following: There were 443 funds (excluding multiple share classes) in this category as of 5/31/2012 If we eliminate the funds without 10-year track records, we are left with 258 funds If we then remove the funds that have deviated into other styles (growth or value) over the 10-year period we are left with 86 funds Of the remaining funds (best of breed) only 38 funds, or 44%, beat the S&P 500 Index over that time frame! In addition, there are two factors that are not accounted for in this exercise. First, we are using an index mutual fund to approximate the returns of the S&P 500 index. Because that fund has fees associated with it, it is slightly understating the performance of the index itself. Second, and more importantly, this analysis is not addressing the significant problem of survivorship bias. When an investor selects an actively managed vehicle today for a 10-year holding period, there is a very real chance that the fund will not survive for the entire 10 years. The returns of the 443 funds that we started with only take into account the survivors, and as such, the percentage of funds that were in existence 10 years ago that outperformed the S&P 500 Is far smaller than the number shown here. Endowment and foundation boards have a fiduciary obligation to understand the costs associated with an investment strategy. It is one of the most important actions that a board can take to ensure the long term success of the portfolio. Spending Policy As a board, you are tasked with determining a spending policy that will strike a balance between providing for the current sustainability of the organization and the long term sustainability of the portfolio. There are a number of annual spending calculation methods to choose from that can be suitable depending on your needs: Percent of original portfolio value Percent of prior year end portfolio value Percent of portfolio value with multiple year smoothing Inflation indexed amount There are certainly other methods or combinations of these as well. Of the options presented here, using a percent of portfolio value with a smoothing component that averages the balances of several recent years tends to provide the most conservative approach for both long term protection of principle and ease of budgeting. To select the proper method, it is important to take into account the volatility of your assets and the expected time horizon of the funds. Reporting Requirements and Performance Measurement You have the ability to provide very clear direction to your investment advisor via the IPS for the performance measurement and the frequency of reporting that you expect. We advise boards to have the advisor develop a customized benchmark for the purposes of measuring performance. That benchmark should be a portfolio of market indexes that are allocated in such a way as to properly capture both the domestic/international relationship as well as the asset classes that are represented in the actual portfolio. The board should be able to understand what deviations the advisor is making relative to that benchmark and be comfortable with those. Reporting requirements will vary by organization, but we recommend at least one in-person meeting with the investment advisor per year and quarterly reporting at a minimum. Quarterly reports should contain a time weighted return analysis that clearly spells out the starting and ending values, gains and losses, income and dividends, and most importantly, fees paid by the organization. It should also include a snapshot of the holdings in the account and portfolio analytics that allow the board to understand the investment exposures and potential risks.