Nonprofit Asset Management Effective Investment Strategies and Oversight

Robert A. Dimeo, CIMA, CFP, is the Managing Director and cofounder of DiMeo Schneider & Associates, LLC. He has been featured in prominent publications such as the Los Angeles Times, Crain's Chicago Business, and Pensions & Investments and is coauthor of numerous books, including The Practical Guide to Managing Nonprofit Assets (Wiley).

Matthew P. Porter, CIMA, is Director of Research Analytics and a Principal at DiMeo Schneider & Associates, LLC. He has served as consultant to a number of nonprofit and corporate clients and is coauthor of The Practical Guide to Managing Nonprofit Assets (Wiley).

Acknowledgments xv

CHAPTER 1 The Three Levers and the Investment Policy 1

The Three Levers 1

Investment Policy Statement 5

Statement of Purpose 6

Statement of Objectives 6

Liquidity Constraints 8

Unique Constraints or Priorities 10

Investment Strategy 11

Duties and Responsibilities 14

Investment Manager Evaluation 15

Conclusion 16

CHAPTER 2 Asset Allocation 17

Modern Portfolio Theory 17

Capital Market Assumptions: The Building Blocks of Portfolio Construction 20

Shortcomings of Modern Portfolio Theory 20

Probabilistic Optimization Models—The Frontier EngineerTM 24

In the Long Run . . . 26

Strategic, Tactical, and Integrated Asset Allocation Steering Mechanisms 27

The Low Volatility Tailwind 29

Tail Risk Hedging 31

Counterparty Risk 33

Portfolio Rebalancing 34

Conclusion 38

Notes 38

CHAPTER 3 Traditional Global Financial Asset Classes 39

Global Fixed-Income Asset Classes 39

Global Equity Asset Classes 55

Conclusion 59

Notes 59

CHAPTER 4 Traditional Asset Class Manager Selection 61

Manager Search and Selection 61

Investment Vehicles 67

Active versus Passive Management 68

When to Terminate a Manager 70

Conclusion 72

CHAPTER 5 Hedge Funds 73

The Evolution of Hedge Funds 73

Modern Hedge Fund Strategies 74

Why Invest in Hedge Funds? 78

Alpha-Beta Framework, Hedge Funds, and Fees 85

Hedge Fund Indices and Benchmarks 87

Hedge Fund Terms and Structures 88

Fund of Hedge Funds versus Direct Investment 89

Hedge Fund Investment Due Diligence 90

Hedge Fund Operational Due Diligence 92

Hedge Funds in the Post-2008 World 93

Conclusion 94

Notes 94

CHAPTER 6 Private Equity 95

Private Equity Investment Strategies 95

Why Invest in Private Equity? 98

Structure and Terms 99

Private Equity Risks 100

Direct Private Equity versus Private Equity Fund of Funds 101

Selecting Private Equity Managers 102

Benchmarks 102

Conclusion 103

Notes 103

CHAPTER 7 Real Assets 105

Commodities 106

Equity Real Estate Investment Trusts and Private Real Estate 108

Farmland 109

Energy Infrastructure Master Limited Partnerships 111

Broad Infrastructure Investing 112

Timberland 113

Gold 115

Other Investible Real Asset Categories 116

Conclusion 117

Note 117

CHAPTER 8 Performance Measurement and Evaluation 119

Why Monitor Performance? 119

Performance Calculations 119

Benchmarks 120

Market Index Basics 120

Investment Style 121

Major Market Indices 123

Determining the Right Index 124

Peer Group Universes 124

Modern Portfolio Theory Performance Metrics 126

Style Analysis 127

Portfolio Analysis 128

Performance Reporting 128

Conclusion 129

CHAPTER 9 Structuring an Effective Investment Committee 131

Procedures 131

Committee Structure 132

Committee Makeup 133

When an Investment Committee Needs Outside Help 134

Effective Use of the Consultant 135

Conclusion 136

CHAPTER 10 Outsourced Chief Investment Officer Services 137

Overview 137

Why Outsource? 138

Outsourced Services 139

What Is Done in Conjunction with the Committee? 139

Potential Benefits 139

Finding a Firm 140

Characteristics 140

The RFP 141

Interviewing Finalists 141

Fees 142

The Contract 142

Reporting 143

Conclusion 143

CHAPTER 11 Environmental, Social, and Corporate Governance-Focused Investing 145

History and Evolution 145

Negative Screening 146

Positive Screening 146

Shareholder Advocacy 146

Community Investing 147

Strategy Considerations 148

Investment Selection 149

Separate Accounts 149

Mutual Funds 149

Commingled Funds 149

Exchange-Traded Funds 150

Alternative Investments 150

Performance Impact of ESG 151

Incorporating ESG into Investment Policy 151

Conclusion 152

Notes 152

CHAPTER 12 Selecting Vendors 153

Custodians 153

Record Keepers and Administrators 156

Broker/Dealers 157

Transition Managers 158

Conclusion 160

CHAPTER 13 Hiring an Investment Consultant 161

The Investment Consultant 162

Identifying a Qualified Investment Consultant 162

Effective Use of a Consultant 168

Conclusion 168

CHAPTER 14 Behavioral Finance 169

Trying to Break Even 170

Snake Bitten 170

Biased Expectations and Overconfidence 170

Herd Mentality 171

Asset Segregation or Mental Accounting 171

Cognitive Dissonance 171

Anchors 172

Fear of Regret and Seeking Pride 172

Representativeness 172

Familiarity 173

Investor Personality Types 173

Risk-Seeking Behavior 173

Naturally Occurring Ponzi Schemes and Market Bubbles 174

Conclusion 175

Note 175

CHAPTER 15 Legal Aspects of Investing Charitable Endowment, Restricted, and Other Donor Funds 177

Nature of Endowment or Restricted Funds 177

Endowments Created by the Board 178

Donor-Created Endowment Funds 178

Donor-Created Restricted Gifts or Funds 179

GAAP Accounting Treatment 179

General Statement about Investing Endowment 179

Context: The Historical Prudent Man Rule 180

Trusts: The Prudent Investor Act 180

Uniform Prudent Management of Institutional Funds Act 181

Private Foundation Rules 184

Conclusion 185

Final Thoughts 187

Takeaways 188

Conclusions 188

Appendix: Case Study: Developing Capital Market Assumptions 189

About the Authors 209

About the Contributing Authors 211

Index 215

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