Forbes offers a ‘told you so’ overview about arts endowments, suggesting the significant declines in endowment funds during the recent crash exposed inappropriate risk strategy among nonprofit boards and investment managers. Says the author:
The reductions in arts endowments reported over the past year have been
significant, raising the question of how they have been managed. If the
investment goal of arts endowments is the preservation of capital, how
can they now face decreases of 35%, aside from the criminal actions of
investors like Bernard Madoff?
He goes on to suggest that endowment investment strategies, which increasingly sought ”total returns” including capital appreciation rather than just capital preservation, were inappropriate to their mission-based purpose. But the long rise in financial markets over the past many decades made the risk of this strategy less apparent.
In investments, management, and yes, even programming, arts organizations are all about understanding, managing, and adjusting risk when the equation seems likely to balance. That doesn’t mean risk-aversion, but rather risk-awareness. Many of the groups now smarting for deep declines probably also were quite happy about the large increases in endowment they observed over the past decades. The question is, was the rise worth the fall?
It will be interesting to watch how investment (and program) strategies evolve after this splash of ice-cold water.
I don’t understand this double standard about risk as applied to arts endowments just because they’re nonprofit. Who says the goal is capital preservation? Why wouldn’t you just want to maximize returns over the long term just like anyone else? Is Forbes saying that the banks should have avoided equity markets too?
Now, I could see a plausible argument for nonprofits accepting a lower return in exchange for investing in socially responsible businesses (or at least avoiding socially irresponsible situations). But that’s not the argument he’s making.
Totally agree with you, Ian. To suggest that the sole purpose of an arts endowment is capital preservation is patronizing and short-sighted.
Unfortunately, I believe the IRS applies this principle as a matter of policy at times, and non-profits have actually gotten into trouble for “risky” investment strategies that would be acceptable at a for-profit (or even a mutual fund) under the business judgment rule.
What’s even more ironic is that with the passage of UPMIFA by 39 states last year, nonprofits are required to use a total return model in their investment portolio’s guidelines. Ignoring total return puts nonprofits at risk of falling outside what the IRS or state attorneys general would consider reasonable or prudent — it would be illegal for nonprofits to do as the author suggest. Guess somebody didn’t do their research…
The problem with excessive risk in non-profit endowments is because many of those organizations depend on consistent annual returns. Now, because the endowments have decreased and are yielding smaller returns, organizations are left with operating gaps they cannot fill. If an organization is dependent on endowment, it needs to take measures to ensure that endowment will be there in the good times and the bad.
Yes, the organization would forego profits in the good years with conservative investing, but they would also avoid devastating income gaps like we are seeing this year.