The investing style unlocking the solution to long-term NFP capital
29 April 2021 at 8:05 am
Experts say that endowment style investing leads to greater diversification, lower levels of volatility and higher chances of achieving objectives over the long term. But what is it? And is it something that all charities can bring on board? We take a look.
Since COVID-19 started, there has been a significant increase in larger charities and sophisticated not-for-profit organisations rethinking the way they manage their cash and reserves.
One of these ways is endowment-style investing. It’s an approach that has been successful for institutions such as Yale University and Australia’s Future Fund, helping to generate consistent long-term returns while preserving the capital invested, even during crises such as COVID-19 or the global financial crisis.
A paper recently published by Koda Capital found that this approach leads to greater diversification of assets, lower levels of volatility, and the increased likelihood of achieving objectives over the long-term.
So what is endowment style investing, and how is it different from other methods of investing?
Endowment funds are pools of assets created by NFP organisations such as universities and religious institutions, intended to be invested over a long time period and generate regular returns to fund financial withdrawals.
An endowment-style approach to investing focuses on achieving superior results through exposure to alternative, private and illiquid investments. And while many investors invest over shorter periods of time so they can get a quicker return, the endowment approach stretches over decades, rather than months and days.
In Australia, the NFP sector has traditionally invested in cash and property assets – which make it challenging to generate strong returns, especially in such a low interest rate environment and with very low property rental yields.
In comparison, endowment-style investing aims to generate consistent long-term returns through diversification into non-traditional asset classes.
David Knowles, Koda’s head of philanthropy and social capital, said that organisations enter into these investments believing they can keep most, if not all, of the money that they’ve invested for many years without having to draw down on it.
“So you might invest in, for example, a business that runs toll roads and offers a very predictable investment return over an extended number of years,” Knowles told Pro Bono News.
“An investment like this is something that’s attractive to a long-term investor because it provides long-term predictable income.”
Why should NFPs consider this approach?
Knowles said that by embracing this long-term and sophisticated thinking, it protected charities and NFPs from making rash, emotional decisions in times of stress and crisis, like during COVID-19.
“Because you remain invested and you’re thinking very long term, you see out the crisis that we had last year. And while your assets may fall in the short term, if you don’t sell them then you’re able to participate in the recovery and continue to make money,” Knowles said.
Koda’s report also noted that because not-for-profit organisations serve a purpose or mission that is often multi-generational, it’s important that their portfolios are invested in a way that is designed to last for several generations – the endowment approach is one way to achieve that.
Should all organisations adopt this approach?
Not necessarily. Charities or not for profits that have at least $5 million to invest and keep invested over a long period are key candidates for this kind of investment style, but this style isn’t appropriate for all organisations.
“If you can’t say with a high degree of conviction that you have surplus monies that you can invest and you won’t really need to pull back out of the market for a minimum of five years, then it’s probably not for you,” Knowles said.
While no organisation is excluded from trying out this strategy, in reality, Knowles said most smaller or medium-sized charities never have this much money sitting around, and even if they do have the money, it shouldn’t be spent in this way.
“There are some organisations who would have the money but shouldn’t invest it, because their mission requires them to spend that money on the people or things that they’re trying to help,” he said.
“You would be far more likely to find this investment style in long-term philanthropic foundations, medical research, universities, and some of the very successful fundraising organisations.”
How do you go about trying this style out?
If you are an organisation with the kind of money needed to invest, Knowles suggested either forming an investment committee, or outsourcing help to professionals.
“It’s not particularly difficult. You need to just get organised internally and then you need to seek professional advice,” he said.
If you are interested in finding out more about endowment investing, you can see Koda’s report here.