We demystify the jargon so you can make informed decisions
Traditionally, not-for-profits (NFPs) have stuck to investing in cash because it seemed the most responsible way to preserve their assets while still getting reasonable returns.
The continued outlook for low interest rates means NFP boards need to consider other options such as stocks and bonds to help fund the organisation’s mission.
This is not to suggest that NFP boards should be putting all the organisation’s cash into risky investments. It’s true that putting cash into anything other than a term deposit can put the capital at some level of risk. But well-managed investments can reduce portfolio risk to a level that even NFP boards find acceptable.
Understanding NFP investment options
NFP boards need to construct investment portfolios that produce the best possible returns for an acceptable level of risk. The key is to use a diversified portfolio that combines defensive and growth investment options.
Defensive assets
- Cash –Most investors allocate at least some of their portfolios to cash or cash equivalents, such as short-term money market deposits or bank bills.
- Term deposits – Returns a fixed interest rate over a set period of time, with the cash repaid at the end of the term. Interest rates depend on the term, the amount of the deposit and the interest payment frequency. You can choose to have interest paid into a nominated account, providing an income stream, or reinvested back into the term deposit.
- Fixed interest – These investments include bonds and some capital notes, which are short-term bonds issued by companies. Bonds usually pay interest twice a year at a fixed rate (known as the ‘coupon’). At the end of the term, the bond is repaid in full, with no risk to capital.
Growth assets
These investments tend to carry higher levels of risk, yet have the potential to deliver higher returns over longer investment time frames. They include:
- Equities – Investing in equities (Australian and international) involves owning a small part of a company and being entitled to a share in its profits and future growth. These investments are at the mercy of market volatility, which means their value can move up and down rapidly. However, over the long term these investments have outperformed more defensive assets. In addition, income from Australian Equities can have a particular benefit for non-tax paying entities through the uplift of franking credits. Please follow this link for additional details.
- Hybrids – These securities combine characteristics of both bonds and equities. They pay a known (fixed or floating) coupon until a certain date, at which point, a number of things could occur such as the conversion of the bond into the underlying shares. Due to the variety of possible outcomes, Hybrids can be classed as either defensive or growth assets.
- Property – Other than directly investing in residential, industrial and commercial property, NFPs can also invest in listed property vehicles such as REITS (Real Estate Investment Trusts)
- Alternatives – These are investments in non-traditional assets and strategies that can bring additional diversification to a portfolio. There are a broad range of strategies and assets included in ‘Alternatives’. Some invest in less traditional markets and some use strategies that deliberately generate different return patterns to traditional asset classes, such as equities. Examples are commodities, private equity and hedge funds, which pursue investment strategies involving a wide variety of assets and can use debt and derivatives to enhance returns.
Once NFP boards understand what each investment option offers over different time periods, they can get a clear idea of the likely outcomes of different portfolio allocations.
Investment vehicles
NFPs also have many options for investing in assets. They include:
- Managed Funds – Your NFP’s money and that of other investors is pooled and used by a fund manager, to buy and manage assets on your behalf. A fee is paid to the fund manager for this service. Investment options are varied, with some managed funds investing in equities. Others invest in securities that pay interest, like government bonds. Within these groups, your NFP can access sub-categories of funds. For example, equity funds can specialise in specific sectors, such as mining and resources companies. Or you can choose ethical investments that take into account environmental and social factors.
- Direct investments – Instead of using a fund manager, your NFP buys the underlying share or bond directly and makes all of the day to day decisions on the holding.
- Active investment management – Where a fund manager seeks to enhance returns through effective stock selection, asset allocation and current selection decisions. The manager generally seeks to outperform a benchmark and fees are normally higher than with a passive investment manager.
- Passive investment management – Where fund managers seek to track the returns from a given market index. Managers don’t seek to generate outperformance through active stock or asset allocation decisions. As a result, investment management costs are lower than for actively managed funds.
- Exchange traded funds – A relatively new category of investment funds, which are traded on stock exchanges. Usually based on an index or basket of securities, they cover an expanding range of asset classes, including bonds, Australian equities and International equities. Key attractions can include low dealing and management charges. As they can be traded on a stock exchange they are generally more liquid (able to be quickly converted to cash) than traditional managed funds.
- Individually Managed Accounts – Your NFP has a Fund Manager (Portfolio Manager) who manages your investment assets according to an individual investment mandate on a discretionary basis within limited parameters. This allows a high degree of customisation.
- Separately Managed Accounts – this is a customised portfolio where the assets are owned indirectly by the underlying investors via a custody arrangement. An investment is allocated across one or more available investment models, which are then actively managed by a professional fund manager.
There are thousands of investment options available to NFPs. If in doubt, get expert advice to help you choose an investment portfolio that reflects your NFP’s risk tolerance and investment timeframe.
We can help your organisation reach full potential and make a difference. Learn about our smart business solutions for not-for-profits, or reach out to a specialist today by contacting notforprofits@macquarie.com. All of our financial recommendations are tailored to your organisation’s specific needs and aspirations.
