Advising >Investment Strategies

Investment & Spending Policy of the Foundation

Donors thinking about making gifts to the Foundation may have questions about how their gifts will be managed to ensure their community legacy. Questions about the Foundation may include:

• How are investment decisions made?
• What is the rate of return on the Foundation's investments?
• How does the Foundation determine how much it will spend on grants and administration each year?

While the answers can get technical, these are important questions to ask. The Foundation's Investment & Spending Policy is carefully designed with both the present and the future in mind. Watchful growth and responsible spending ensure that the donations provided by our donors will continue to make a difference in perpetuity.

Unlike organizations that raise funds each year to carry on daily operations, the objective of a community foundation is to build funds that will grow with community needs, and continue to provide funding for opportunities for generations to come.

2007 Investment Performance

Investment Return

• Overall return on investment for 2007: 7.71%
• Five-year annualized return on investment:  10.90%

Investment Consultant

• Mason Investment Advisory Services, Inc.

Local Advisors

• FNB Bank
• Merrill Lynch
• Mifflinburg Bank & Trust
• MTB Investment Advisors
• Sovereign Bank
• Susquehanna Trust and Investment Company
• The Muncy Bank and Trust Company
• Wachovia Bank, N.A.
• Woodlands Bank
  

Investment and Spending Policy

Purpose and Background

The purpose of the First Community Foundation of Pennsylvania's Investment and Spending Policies (IS Policies) is to support current as well as future grantmaking and administrative needs while ensuring the inflation-adjusted spending power of the Foundation's charitable assets over time.

Fiduciary Responsibility

The Board of Directors has fiduciary responsibility for all funds of the Foundation, which are held subject to and in accordance with the Foundation's governing documents (namely its articles of incorporation and bylaws, as may be further amended from time to time).

The Foundation holds all of its assets in corporate form, whether managed as part of the Foundation's pooled investments or separately managed by a financial institution preferred by a donor.

All investment firms and banking institutions must be willing to manage assets subject to the Foundation's governing documents, IS Polices, and the fiduciary oversight of the Board of Directors to assure that our donor's funds, whether part of the Foundation's investment pool or separately managed, will qualify as a "component fund" of our community foundation as defined by the Department of Treasury and Internal Revenue Service (IRS).

Finance Committee

The Board of Directors has delegated supervisory authority over its financial affairs to the Finance Committee of the Board. In carrying out its responsibilities, the Finance Committee and its agents will act in accordance with IS Policies and all applicable laws and regulations. The Board reserves to itself the exclusive right to revise IS Policies, though it will look to the Finance Committee for counsel and guidance.

The Finance Committee will include at least three Board directors, at least two representatives from the community at large, the Board Chairman as an ex-officio member, and the President as an ex-officio member. Members will be appointed by the Board with the goal of creating a diverse committee with expertise in both the financial and charitable fields.

The Finance Committee has the following responsibilities:

• Submit to the Board, for approval, IS Policies outlining the objectives and guidelines for the Charitable Pool.
• Periodically review the Investment and Spending Policies and recommend appropriate changes to the Board.
• Include in its IS Policies a list of investment restrictions that the Committee believes are not appropriate for the Foundation.
• Recommend to the Board a spending policy for the Charitable Pool, taking into account sustainable payout rates.
• Monitor the Foundation's Charitable Pool on a quarterly basis and report to the Board at least annually on the status of investments.
• The Committee has chosen to hire an Investment Consultant and shall review them periodically.

In general, the purpose of the IS Policy is to outline a philosophy and attitude that will guide the investment management of the Foundation's funds toward the desired results.  It is intended to be sufficiently specific to be meaningful, yet flexible enough to be practical. The Committee has considered the financial implications of a range of policies, and this statement describes the prudent investment process that the Committee deems appropriate.

Certain italicized terms in this document are more specifically defined in the Definitions section.

Total Return Approach

The Foundation utilizes a "Total Return" approach to guide its investing and spending, as allowed by Pennsylvania Codes 5547, 5548, and 5549 pertaining to the use and management of trust assets by nonprofit corporations, and as permitted by its governing documents. This approach allows the Board to establish an annual payout rate based on a percentage of the asset base over a five-year period. The payout amount may be more or less than the actual income earned by interest and dividends, with capital appreciation (and in rare cases principal) used to help meet the established payout when necessary. By using the total return approach, the Foundation is able to maintain and increase the value of donated assets while funding current needs at an appropriate level.

The benefits of total return include:

• The Foundation and its financial partners are not forced to focus investment strategies on required distributions from income alone.
• Because investments can be managed for both growth and income, the Foundation can better focus on current needs while assuring adequate funding for future needs.
• A larger and more predictable flow of funds will be available since distribution will not be determined solely by changes in current investment income, interest rates, etc.

Spending Policy

The annual cash payout of all funds, except those funds containing illiquid assets (such as certain real estate or other property) will be 5.0% of the average market value, using a 20-quarter or 5-year trailing average and net of financial management fees. For funds less than five years old, the market value will be the average of all quarterly market values to date. This payout will be used to meet both grantmaking and administrative needs per schedule.

Investment Objectives

The investment objective of the Foundation's Charitable Pool is to meet the payout percentage, plus inflation, plus 0.5% of underlying growth in the pool.  This is an investment objective that attempts to grow the portfolio, after distributions and after inflation.  The Committee has agreed to tolerate the volatility of a growth oriented asset allocation strategy that may offer the potential for greater Charitable Pool values and greater payouts in the future, understanding that this may result in a less stable payout from year to year.

As is consistent with a growth-oriented portfolio, the investment time horizon is over ten years. For evaluation purposes, discussed more fully in the Asset Allocation Section, the Committee will monitor performance and peer group rankings over the trailing three, five, and ten year periods.

The Foundation's current Spending Policy of 5%, which includes the payout for grantmaking and the annual administrative fee, implies a target rate of return, before inflation, of 5.5% per year for the Charitable Pool.

To assist the Foundation in gauging the success of the return on investments, the Foundation shall employ as its investment return goal the following formula:

5 yr Annualized CPI + Spending Policy (5.0%) + 0.5%

 

This target return is an average annualized return to be measured on a five year trailing basis.  This is the time period used to judge whether or not the portfolio is meeting its objective.  Each individual year may be more or less than target.

Asset Allocation

The Charitable Pool's risk and liquidity posture are, in large part, a function of asset class mix. The Asset classes are listed in the Asset Allocation Targets chart in this section.

Considering the Charitable Pool's investment objective, time horizon, risk tolerances, performance expectations, and asset class preferences, an appropriate portfolio allocation was identified.  After the allocation strategy is implemented, the percentage allocation to each asset class sub-category may vary by as much as plus or minus 20% of the target. These ranges are illustrated in the following Asset Allocation Targets chart in this section.

Significant capital market movements, as well as relative manager performance, can lead to the asset allocation moving beyond the allowable ranges of 20%.  The Investment Consultant shall monitor the effectiveness of the asset allocation targets and assure that the allocation is staying within the established ranges by rebalancing the portfolio as needed. Asset allocation targets will not be changed without Committee approval.

The Foundation desires to maintain positions with certain Local Advisors. This may result in a portfolio that, in the early years, does not follow, exactly, the asset allocation targets and due diligence criteria as outlined in this policy. This policy sets targets and due diligence criteria to work toward over time. New gifts and agency funds will be used to continue to work toward the investment policy asset allocation over time while coordinating the Local Advisors for their best fit into the desired asset allocation strategy.

Asset allocation Targets - "D" Portfolio

Investment Restrictions

When selecting mutual funds and separate account managers, the Investment Consultant will use due diligence criteria prescribed in the IS policies (mutual funds and separate account managers will be referred to as "managers" unless specifically referenced).

With the exception of mutual funds chosen pursuant to the due diligence criteria prescribed in the IS Policies, separate account managers must seek permission to use derivative instruments as described in the definitions section of the IS Policies.

With the exception of strategies employed by mutual funds that are chosen pursuant to the due diligence criteria prescribed in the IS Policies, no securities may be purchased on margin.

No "illiquid" investments may be purchased by a separate account manager or the Investment Consultant, such as private placements, limited partnerships, and hedge fund vehicles, among others.  The Committee will consider illiquid investments on a case by case basis.

Cash Management Policy

From time to time the Foundation may maintain large cash balances in reserve for future needs and contingencies or for Non-Endowed Funds. The Consultant is authorized to manage these reserves for enhanced yields consistent with a conservative cash management policy. To manage credit risk, instruments used for cash management will be limited to the following:

• Government issues (known as "Treasuries")
• Government-Sponsored Enterprise Securities (known as "Agencies"), such as Farm Credit System, Federal Home Loan Bank System, Federal National Mortgage Association, and Student Loan Marketing Association, some of which are not explicitly backed by the full faith and credit of the U.S. Government.
• FDIC insured Certificates of Deposit, to be bought only in $100,000 increments per bank to assure insurance coverage and only at banks rated 165 ("Excellent") or higher, as rated by the Bank Financial Quarterly, issued by IDC Financial Publishing, Inc.

Usually, no instrument will have a maturity at issue, or remaining maturity at purchase, of greater than twelve months.  Generally, and depending upon the specific liquidity needs of the Foundation, a ladder strategy will be employed to further minimize interest rate risk.

Due Diligence Policy

Introduction

For an asset allocation strategy to be effective, each asset class must be represented by using a manager that will best represent the class objective.  Otherwise, the results will be much different than anticipated. This is particularly true during times of adversity or crisis.

A qualifying manager must be a registered investment advisor under the Investment Advisors act of 1940.  In most instances the Committee will use managers that have established track records of at least five years.  A ten year track record is preferred, if possible.  Professional management must be in place, with few major changes, for the period being evaluated. The Committee, with the assistance and support of the Investment Consultant, will decide which managers to use based upon their particular contribution to the portfolio. This often results in having more than one manager for the same asset class, each with a different bias and approach.

To identify managers who fit the implementation objectives, a rigorous research process is followed. The research process involves both a quantitative and qualitative review.

Quantitative Analysis

The quantitative analysis attempts to distill a large universe of managers into a small group of strong performers. Managers who pass this phase of the research process have a history of delivering above-average risk adjusted returns, as measured against their peers who fit the same asset class. Performance during multiple market cycles is observed.  The goal is to not chase returns, but to look for consistent, long-term track records of at least five and preferably ten years.  Also, a returns based style analysis is performed to assure accurate asset class fit.

Qualitative Analysis

The qualitative analysis involves an in-depth review of the manager and its history. Several years of all published reports are reviewed for consistency of management style and stability of professional staff.  A review of historical portfolios is performed for clues about the true style and risk posture of the manager over time. Personal interviews and on-site office visits may be made, as necessary.

Managers are continuously monitored and new managers are reviewed in an attempt to find the most effective managers, in the judgment of the Investment Consultant.

Benchmarks (Reference Points)

Several evaluation benchmarks are required. One to measure the success of the allocation strategy and others to measure the success of the managers used to implement the allocation. 

Growth Allocation Reference Point: This reference point, produced by Morningstar as “Moderate Allocation”, invests in both stocks and bonds and maintains a relatively higher position in stocks. These managers typically have 50%-70% of assets in equities and the remainder in fixed income and cash. 

The performance of the Foundation’s Charitable Pool may be greater or less, depending upon how aggressive the asset allocation strategy is relative to the reference points.

Each manager will be measured against its specific peer group, using a category average of mutual funds with the same asset class focus.

Accounts Managed by Local Advisors

A list of allowable and prohibited securities and transactions for equity and fixed income accounts, managed by local financial partners, is available on request.

The Foundation and Investment Consultant are to be informed immediately by telephone of any significant changes affecting the investment management company or bank, its parent(s), management personnel, ownership, structure, or key personnel, including partners, principals, officers, strategists, and individual portfolio managers.  This communication should be followed up in writing within seven (7) business days.

Other Considerations

In all cases, performance evaluations will focus more on trailing three, five, and ten year performance measures (including risk and risk adjusted measures), rather than short term variances from the benchmarks.  Managers are normally expected to perform at or above their peer group averages.

Program-Related Investments

Definition & Background: A Program-Related Investment (PRI) is an investment by a foundation to support a project or activity, which is of a charitable or community benefit nature, is typically beyond the scope of traditional grantmaking, and is viewed as an asset because the principal value of the investment (at a minimum) is expected to be returned. A PRI is similar to a recyclable grant: the repayment of a loan or the return of equity can eventually be recycled for another charitable purpose. PRI's may be made to a non-profit or a for-profit entity engaged in activities that demonstrate a clear community benefit within the parameters identified by the IRS.

PRI's may include, but are not limited to, loans & financing arrangements, loan guarantees to share risk with a traditional lender, pooled or venture capital funding, stock purchases in certain local enterprises, and certificates of deposit with community reinvestment banks. The Foundation may make PRI's directly or may disburse funds to an intermediary organization that then lends or invests the funds for the benefit of qualifying projects. PRI's are not intended to compete with or substitute for traditional for-profit financial resources available within the area, but instead to bridge the gap between traditional funding sources and clearly identified financial needs within the community.

The IRS provides that all investments that qualify as PRI's are exempt from classification as "jeopardizing investments." The IRS defines a PRI as satisfying the following three tests:

• Its primary purpose is to further some aspect of the foundation's charitable mission;
• The production of income or the appreciation of property is not a significant purpose of the PRI (i.e. it is structured to produce lower-than-market returns on a risk-adjusted basis); and
• It may not be used to support any lobbying or political campaign activities.

PRI's are most frequently used to support economic and community development projects, but can be used to assist a wide range of public benefit and charitable opportunities. Examples include: neighborhood redevelopment projects, land conservation or historical preservation efforts, job training & development, small-business start-ups, sustainable farming operations, nonprofit capital needs, etc.

The benefits to the Foundation of using PRI's include:

• Recycled Resources – PRIs can be used to advance program goals and, once they are repaid, can be re-used for new projects
• Large Projects – When a desirable project requires funding that exceeds the Foundation's typical grant size, PRIs can sometimes provide the needed capital
• Varied Partners & Leverage – PRIs may attract other lenders to the project and leverage additional funds from banks, corporations, or government.
• Visibility – PRIs may help support a particularly important local project that requires capital investment.

The benefits of PRIs for potential recipients include:

• Applicant Pool – Applicants that may not qualify to apply for a grant from the Foundation, may qualify for a loan or equity investment.
• Administrative Strength – PRIs can help foster management capacity and produce a more "bankable" organization over time by helping to establish a credit history.
• Large Projects – PRIs can help raise capital in addition to grant resources for larger projects.
• Long-Term Relationships – PRIs help establish productive relationships with the Foundation and/or an intermediary funder by creating a partnership with mutual financial and programmatic objectives.

Spending Limits: The Foundation may use up to 1.5% (cumulative) of its assets to make Program-Related Investments. In determining that percentage, the Foundation will use a 20-quarter or 5-year trailing average market value, exclusive of illiquid assets (such as real estate and other property) and exclusive of any designated funds where PRIs may, in the judgment of the Board, be considered imprudent or impractical. Such investments may be made from the annual payout used for unrestricted grantmaking or may be made from the invested corpus of its assets. Because PRIs funded from corpus and in excess of the 5.0% annual payout may affect the overall total rate of return, such PRIs will not be included when calculating total return. However, performance measures will be established and monitored for all PRIs, and reported to the Board at least annually.

Nature & Type of PRI: The decision to make a PRI will be made on a case by case basis by the Board of Directors and shall be consistent with IRS parameters for PRIs and community priorities identified by the Foundation. When necessary, the Foundation shall seek legal counsel from an attorney or attorneys knowledgeable about federal and state regulations as they pertain to PRIs.

Interest Rates, Terms, & Structures: Interest rates on PRIs may vary from zero percent to just below the prevailing market rate. The IRS requires rates to be below-market on a risk-adjusted basis. Typically, rates are calibrated to each borrower's capacity and to the project's ability to make principal and interest payments, return equity, etc. The Foundation's desire to generate interest income from its PRIs may also determine or affect rates, provided earnings are not a significant reason for making the PRI. Generally PRIs will only be made where there is a likelihood of 15% or less that the PRI will default, although the Board may approve a higher level of risk where warranted.

Re-Payment: PRIs are to be taken seriously and are intended to be repaid. All applicants and projects will be carefully screened, including review of financial status, management capabilities, potential for long-term self-sustainability, credit and community involvement histories, other funding sources, proposed use of funding and relation to identified community needs, risk of default, etc. Written agreements shall be developed for each PRI. When appropriate and possible, the Foundation will work with an intermediary organization – such as financial institution, governmental entity, major nonprofit service provider, etc. – which can reduce the level of risk by drawing on the intermediary's expertise.

Accounting: Foundation staff will work with the Foundation's auditor to track and report on PRIs. In the year that a PRI is made, its entire value will be reflected as a qualifying distribution from the Foundation, as is the case with traditional grants. Outstanding PRIs will remain on the Foundation's balance sheet as a separate asset category until they are repaid or forgiven. Periodically, adjustments may be made to the carrying value of PRIs, based on the likelihood of collection. Interest income from PRIs is treated like interest on any other foundation investment.

Fee Schedule

Based on Average Market Value Determined at the Start of Each Year

Administrative Fees

Permanent Endowments

Provisional (Non-Endowed) Funds

5% of market value of the fund or total gifts into the fund annually, which ever is greatest depending upon fund activity and anticipated duration of the fund.

Pass-Through Gifts/Stock Gifts for Designated Charities

5% of the market value of the gift

Trusteeship of Charitable Remainder Trusts

Use above endowment fee schedule as the basis, with the understanding that fees will be negotiated based on the anticipated value of the remainder interest to FCFPA as well as the complexity and likely duration of the trust.

Foundation Management Services

The Foundation will encourage, and as appropriate, accept new or existing private foundations with assets of at least $1 million as supporting organizations; foundations with a lesser asset base may be accepted as advised component funds. The above fee schedule will serve as a basis for negotiating a fee structure in each situation consistent with the philanthropic focus and complexity of the foundation. At present, the Foundation will not provide management services to private foundations that do not affiliate with the Foundation.

Updated September 4, 2007