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Investing for your organization
By David Michaels
March 3, 2008
Last month, we looked at a shorter-term strategy for charitable organizations to make better use of their funds with a strategic approach to investments and cash management. This article looks at investing funds that appear on the balance sheet as long-term assets (over one year until maturity).
Investment time horizons
Many times, and especially for smaller not-for-profit organizations, a one-year time horizon is often the norm. These days, with core funding at such a premium, and organizations struggling to keep up with expenses, it is common to look at annual budgets and the rest of finances on that one-year basis.
However, if we take a longer term view (3-5 years for example), and look at certain items like cash flow and deferred revenue, the evidence in favour of longer-term investing is right there on the balance sheet.
Here is a hypothetical example. ABC Charity receives annual grants for its ongoing operations. Due to the difference in the timing of when these grants are received and when the expenses related to the grants are realized, the charity routinely has an amount of $200,000 recorded as Deferred Revenue. Upon examining its balance sheets over the last number of years, ABC Charity finds that this $200,000 has been relatively constant. The finance officer notices that, instead of investing in only GICs (which typically offer the lowest rates of return), there is an opportunity to invest this $200,000 in a bond or series of bonds with maturities ranging between one and five years, and at rates higher than the going rate for a GIC.
Asset Classes
Investment assets typically fall into one of three categories:

Cash or cash equivalents: treasury bills
Fixed income: bonds
Equities: stocks
Within each of these classes, there are a number of different types of investments and some are hybrids. For example, certain bonds have equity features attached to them. Investments may be domestic or foreign, and each class has various risk characteristics that we will briefly examine below.
It is widely accepted that the best way to manage investments is to diversify. For our personal plans, we are often advised not to put all our eggs in one basket, and the same holds true for organizations, especially over the long term (more than one year using the balance sheet as a guide).
Risk and return
Each individual defines “risk” in his or her own way. To some people, risk is represented by volatility, for example, they are averse to the ups and downs of the market. Others look at risk in terms of a loss of purchasing power, i.e., inflation may be more than investment returns, so that even though some interest is being earned, it’s not keeping up with inflation.
With any investment, there is a trade-off between risk and return. In general, the greater the risk associated with an investment, the greater the potential return. Importantly, while risk cannot be eliminated, it can be controlled.
Risk, return and asset classes: Considerations for charities
Cash and cash equivalents carry the lowest level of risk, but offer the lowest returns. If an organization is concerned about keeping up with inflation (purchasing power risk), having all investment funds in GICs or treasury bills will very likely not be the most prudent approach.
The risks associated with bonds are more complex. In a rising interest rate environment, the value of a bond will diminish - there is an inverse relationship between interest rates and bond prices. However, the organization needs to consider the term to maturity of the bond, the creditworthiness of the issuer and, perhaps most importantly, whether or not the bond is purchased with a view to holding it until maturity. Active buyers and sellers of bonds are often more concerned with short-term interest rate fluctuations; this is why bond mutual funds can have negative returns.
Equities are considered to be the most risky asset class, but also the investment class that offers the greatest potential for returns, especially over a long-term horizon. In the next article, I will be devoting more time to equity investing when discussing endowment funds and other strategies related to a longer investing horizon (five years or more).
Diversification helps to control risk and diversification can be achieved through asset class, investment style, and type of security. In general, the longer the investment time horizon, the greater the need for growth and the higher the tolerance for risk.
A major issue for charities to consider is that risk is not limited to a loss of the capital invested; risk also needs to be looked at in terms of inflation and purchasing power. If your organization is not doing all it can to at least keep pace with inflation, you may be taking undue risk!
David Michaels is an Investment Advisor with BMO-Nesbitt Burns, Exchange Tower branch, in Toronto. Before joining Nesbitt-Burns, David was in charge of the finances of three legally separate but related medium-sized charitable organizations in Toronto where he used a cash management and fixed income strategy to significantly improve interest earnings.
David can be reached at (416) 365-6038, or via his website at www.davidmichaels.ca.
Opinions are those of the author and may not reflect those of BMO Nesbitt Burns. The information and opinions contained herein have been compiled from sources believed reliable but no representation or warranty, express or implied, is made as to their accuracy or completeness. BMO Nesbitt Burns Inc. is an indirect wholly-owned subsidiary of Bank of Montreal. Member CIPF.