‍Asset Allocation: The Foundation of a Healthy Nonprofit Investment Program

The most important factor impacting the outcome of an organization’s investment program is asset allocation—the mix of stocks, bonds, and cash. The asset allocation policy a committee selects drives the asset pool's risk and expected reward. Choosing the appropriate assets is fundamental in balancing potential risks (downside volatility) and potential rewards (positive returns). Beyond cash, the primary toolbox consists of stocks and bonds. Within these two asset classes are numerous sub-categories, funds, ETFs, and investment managers, each influencing the risk profile and returns.

Arriving at the correct balance of stocks, bonds, and cash to meet a specific institution’s needs and goals requires a blend of science and art. The science involves Modern Portfolio Theory (MPT), a result of robust academic research into the risk-adjusted performance of various asset allocations. MPT matches the acceptable risk to an investor with a specific blend of assets likely to produce the desired results over time. This allocation is based on historical returns, the variance of those returns, and correlations between asset classes. The fundamental takeaway from this Nobel Prize-winning research is that a carefully constructed investment portfolio can maximize your return for a given level of risk.

While science and calculations are critical in designing an asset allocation policy, careful consideration and judgment are equally important. Producing forward-looking expected returns requires experience and understanding. Additionally, matching an organization's needs and aspirations with the appropriate mix of assets is vital in designing the investment program.

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3 Key Components of Determining an Optimal Asset Allocation

1. Establish Time Horizon

• What are the financial needs of the organization?
• What is the timing of those needs?
  

2. Determine Acceptable Risk

• Are board and committee members knowledgeable about investment risks and their implications for the organization’s financial needs?
• What would a loss of five or ten percent or more of the organization’s assets mean for the  mission?
  

3. Understand Expected Outcomes

• Are historical returns properly assessed including multiple time horizons, rolling time periods and worst case scenarios?
• How are current market factors accounted for in considering likely future returns of various asset classes?
• Within broad categories of stocks and bonds, how are sub-categories evaluated and how do the various mixes of these affect overall expected outcomes?
• How is the correlation between various types of assets measured?

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Download the PDF below to see sample asset allocations. Each organization and its needs are unique. So the process to determine the proper asset allocation should result in an outcome tailored to each organization.

How to Get Started

eCIO recommends a thorough needs and risk assessment of your organization and its oversight group. This creates the basis for an asset allocation study which results in a specific recommendation of how to allocate your organization's assets along with the likely outcomes. If you would like to know more about our asset allocation process for nonprofits, please reach out.

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