Step By Step
Deciding if you need help with investments
By John Zietlow, D.B.A., CTP

No doubt you have read or heard stories of nonprofits either taken in by various investment scams or investing in inappropriate investment vehicles. And, the recent Donors Forum survey finding that fewer than half of Chicago-area nonprofits had an investment policy suggests that many could benefit from an investment consultant's services.

Deciding if you need one and then selecting wisely can be a full-time job. Broadening roles of financial managers requires time spent in other duties, and many of these managers are trained in accounting, but not in finance, particularly investments.

• Proper investment management requires:
  Hands-on experience in the securities marketplace;
• The time, expertise, and software to properly evaluate investment risk/reward tradeoffs, construct, evaluate, and re-balance portfolios, and to maintain investment records that account for portfolio transactions and provide necessary alerts and reports;
• The ability to stay on top of developments and trends in the securities markets; and,
• The diligence to continually adhere to the boundaries prescribed by the organization's investing policy statement (IPS) and the overall context of an investing strategy.

With the increasing competition in financial markets, lowered expense ratios for various investment vehicles are also drawing organizations into the use of external investment managers. Two prominent examples are the use of money market mutual funds for short-term portfolios (perhaps up to a one-year investment horizon) and stock index funds for long-term portfolios.

Many nonprofit financial managers turn to outside professional investment advisors for assistance in managing their organizations' investment portfolios. However, simply allowing a bank trust department or local brokerage firm to recommend securities for purchase are quick fixes that fall far short of satisfying your board's fiduciary requirement.

TYPES OF OUTSIDE INVESTMENT ADVISORS

Two types of outside professional investment advisors work with financial managers in handling investment portfolios: investment managers and investment consultants.
An investment manager's services range from simple advisory consultation (with no authority to manage investments) to full management control over investment activities. Managers providing the full range of services use their own discretion in the selection of particular instruments within your IPS.

Investment managers often specialize in one investment area, such as stocks or fixed-income instruments, and possibly specific areas, such as in emerging markets, global markets (U.S. and international markets), and low-, mid-, or large-capitalization stocks. Within the fixed-income arena, they could specialize in short-, intermediate, or long-term maturities. Nonprofits generally seek investment managers who specialize in short- to intermediate-term maturities of fixed-income securities for their working cash investments and stock and long-term bond managers for their endowment, pension fund, or growth-type portfolios.

Investment consultants, however, do not manage funds. They assist your financial manager by reviewing the institution's investment objectives and other investment needs and searching for a suitable investment advisor/manager that appears qualified to fill those needs.

Investment consultants are not only instrumental in selecting an outside investment manager, but they also might help you to develop the investing IPS, monitor your investment advisor's performance, periodically review your current strategies, and make recommendations for adjustments in any of these areas.

SELECTING AN OUTSIDE INVESTMENT MANAGER

The selection process for an investment manager should include careful attention to all appropriate details. Frequently, an investment consultant is enlisted to assist in the selection. The process begins with the consultant's review of the existing IPS to ensure that it adequately addresses the organization's investing objectives and provide the necessary amount of flexibility. For example, it is not worthwhile to retain an investment manager if the IPS restricted the portfolio to U.S. Treasury bills maturing in 90 days or less.

When a well-crafted IPS is in hand, the consultant searches a proprietary database of investment managers to identify those who best meet the criteria for the type of investments, credit quality, and maturity required by the investor.

If a consultant is not used, your financial manager prepares a request for proposal (RFP) de-scribing the nature and size of the portfolio, the investment objectives and existing IPS, and the requirements for the investment manager.

The RFP should also describe any unusual features or requirements related to the operation of your portfolio. Invest-ment managers have widely varying approaches to the management of funds. You will want assurance that the investment manager will use appropriate methods of operation and pursue goals and objectives fitting your portfolio needs.

The potential investment management firms are then brought to your designated representatives to make the final selection. These representatives are usually a committee of the board of trustees, such as the investment subcommittee or the finance committee.

After receiving written proposals from the top candidates, the consultant and the financial manager, assuming that your board authorizes them through the IPS to act in the board's behalf, conduct in-person interviews. Each candidate is asked to discuss past performance and method of operation and to respond to questions. The interview process should include discussion of investing goals and the differing assumptions and criteria on which they are based. The investment manager must fully understand and accept the investor's goals before assuming investing responsibilities.

You should also investigate several other important issues through your review of the candidates' formal proposals and during the interviews:
· Philosophy and culture fit. Determine the willingness to engage in discussion, to demonstrate flexibility regarding the organization's investing program, and to use the organization's guidelines as expressed in its IPS;
· Ask for other nonprofit clients of the investment manager with a similar IPS and investing goals; and,
· Willingness to adhere to any socially responsible investing (SRI) and ethical practice requirements your organization might expect.

LEGAL/REGULATORY ADEQUACY
Check the registration of the investment manager with the U.S. Securities and Exchange Commission (SEC), under the Investment Advisors Act of 1940, and/or with the state of the investment manager's domicile.

Investigate if there are any past censures by the Securities And Exchange Commission, state authority, Depar-tment of Labor, or other regulatory authority of the investment management firm or its principals for misconduct.

You should use a written investment management contract including at least these four elements:
1. Clear description of how fees are calculated;
2. Additional charges above the basic fee;
3. Reasons for termination of the contract by either your organization or the investment manager; and
4. Capabilities of the investment manager to handle the type of portfolio involved.

Investment managers usually receive compensation based on the size of the portfolio that they manage. Investment consultants typically are compensated with a flat fee, which may be made in either soft dollars or hard dollars.

Soft-dollar compensation is when the investment advisor directs the commissions generated by the execution of investment transactions to the consultant. The use of soft-dollar compensation can discourage the investment manager from seeking the most competitive prices on the execution of transactions. Fewer firms receive soft-dollar compensation in today's environment.
· Your nonprofit's portfolio size in comparison with the portfolios of the investment manager's other clients
· The turnover rate among the investment management firm's portfolio managers and key support staff
· The experience, background, and specialized expertise of the investment management firm's principals and portfolio managers;
· Information technology and analytical resources, and the specific credit review services that are used.

Once the investment manager is selected, you could retain the consultant to provide assistance in reviewing the manager's performance. E

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This column is adapted from "Cash & Investment Management for Nonprofit Organizations" by John Zietlow and Alan Seidner (John Wiley & Sons, 2007). John Zietlow, D.B.A., CTP, is professor of finance at Malone College, Canton, Ohio, and a Certified Treasury Professional (CTP). He also serves as an associate faculty member at Indiana University/Purdue University Indianapolis, where he teaches nonprofit financial management. His email is jzietlow@hotmail.com