1. Diversification is a powerful weapon against market uncertainty
Asset classes move in and out of favor based on market and economic fundamentals combined with shifting investor value perceptions. No one asset class consistently outperforms, and predicting dramatic shifts in asset class performance is a notoriously inexact and risky undertaking. Portfolio diversification, therefore, is often your best defense against asset class volatility.
Establishing a strategic allocation in your investment policy statement coupled with a projected level of volatility that’s within your organization’s tolerance may significantly enhance your portfolio’s resilience. Rather than pinpoint targets, successful nonprofits tend to think in terms of asset class ranges (which allow for some flexibility in the portfolio), combined with the disciplined practice of rebalancing when asset class weightings shift due to relative performance or cash flows.
Tactical tilts can then be applied within the strategic framework to capture intermediate-term market opportunities. But these tilts need to be applied judiciously—with an eye toward the intermediate rather than the very short term. Over long periods of time well-diversified portfolios are designed to deliver competitive returns while avoiding the excessive asset class swings that can hamper long-term results.
2. Total return strategies offer more consistent returns
In the past, nonprofits typically focused on yield or income as the primary determinant of how much they could spend or distribute. But given the current low-yield environment, chasing income can quickly lead to assuming unnecessary portfolio risk and sub-optimal diversification.
A total return strategy is designed to deliver balanced portfolio-like returns with moderate overall expected volatility and drawdowns using a diverse array of fixed income, equity, and alternative investments. Adopting a total return approach permits the use of a broader mix of asset types (including alternatives) which can generate an attractive balance of risk exposures and return opportunities that closely align with your investment policy expectations.
While it may lag in a strongly up-trending market and offer less daily liquidity than traditional approaches, the potential reduction of risk in down-trending markets and the likely improvement in overall portfolio stability make a fully diversified total return strategy very attractive to organizations looking to mitigate risk and improve overall portfolio stability.
3. Periodic rebalancing will keep you on track
A disciplined rebalancing strategy can minimize risk and outperform a buy-and-hold strategy. Over time, allocations inevitably drift from their targets—especially during extended bull markets. In recent years, allocation drift has been particularly notable due to the outperformance of U.S. stocks versus other asset classes. It’s actually caused some to question the merit of allocations to any asset class other than U.S. stocks.
But past experience repeatedly reminds us of the costs associated with failing to rebalance. During the run-ups to both 2001’s dot-com bubble and 2008’s financial crisis, it was not at all uncommon to find a 60/40 stock to bond portfolio’s allocation having drifted closer to 75/25. Investors who weren’t risk disciplined subsequently experienced pronounced portfolio drawdowns when asset price relationships reverted to more normal levels. Without periodic rebalancing, your portfolio’s risk and return profile may no longer be aligned to either your organizational mission or your long-term and short-term needs. And unlike individual and for-profit corporate investors, nonprofits are free to implement proper portfolio rebalancing without the associated tax drag.
4. Focus more on liquidity to meet needs and commitments
Recent market crises have yielded substantial liquidity challenges, with organizations that locked into a broad array of illiquid investments facing a significant disadvantage. It’s the reason why in addition to considering long-term goals, sound portfolio planning must also factor in near-term liquidity needs and potential crisis scenarios. Financial market returns have become increasingly non-normal in their distribution, with ‘fat tails’ signifying the occurrence of events outside of a one or two standard deviation expectation.
Through the thought-provoking work of Nassim Taleb, the term ‘black swan’ has entered the lexicon, cautioning investors to be more attuned to low probability, high impact events (look no further than the COVID pandemic) that can dramatically affect outcomes. Thoughtful and wide-ranging conversations between investment committees and advisors can help anticipate the needs of the organization across an array of possible scenarios, so that when the unexpected happens, your portfolio has contingency plans in place. When the sun is shining, umbrellas languish on the shelf. When the VIX is near historic low levels, the concept of portfolio risk seems academic and back of mind. But a prudent investor will always keep one eye on the horizon, looking for early signs of dark clouds ahead.
About Truist Foundations and Endowments Specialty Practice
Truist has more than a century of experience working with not-for-profit organizations. Fiduciary stewardship is the heart of our culture. We’re not just a provider, but an invested partner—sharing responsibility for prudent management of not-for-profit assets. Our client commitment, not-for-profit experience, and fiduciary culture are significant advantages for our clients and set us apart. The Foundations and Endowments Specialty Practice works exclusively with not-for- profit organizations. Our institutional teams include professionals with extensive not-for-profit expertise. These professionals are actively engaged in the not-for profit community and are able to share best practices that are meaningful to their clients. Team members offer guidance and advice tailored to the various subsets of the not-for-profit community, including trade associations and membership organizations. Our Practice delivers comprehensive investment advisory, administration, planned giving, custody, trust and fiduciary services to trade associations, educational institutions, foundations, endowments and other not-for profit clients across the country.