Amid tightening budgets, increased costs, and reduced government support for nonprofits, the need for increased philanthropic giving reached new levels in 2013. It shows no signs of slowing. In the face of this tremendous and growing disparity between needs and resources, nonprofit executives, trustees, and investment committees continue to struggle to bridge the gap.
And as if these current challenges weren’t enough, another significant threat is looming: Rising interest rates. Rising rates will have widespread implications for nonprofits and donors. That means nonprofit organizations urgently need to develop proactive solutions and strategies to counter their financial risks.
A little explanation: For the better part of the last three decades,nonprofits and others dependent on the steady income stream provided by bonds and other fixed-income assets have benefited from having the wind at their backs as interest rates fell, and fell, and fell. Bonds and interest rates have an inverse relationship, which means that as interest rates fall, the prices of existing bonds rise and become more valuable than the newer, lower-yielding issues. As a result, the income streams of the past were supplemented with asset appreciation—a win-win situation!
Those fortunate bondholders included endowments of nonprofits and foundations, as well as donor portfolios. Not only did investors benefit from their appreciating bond portfolios, but many of those who had outstanding loans themselves (both individuals and organizations) were able to refinance their mortgages and other debt at more attractive terms (lower current interest rates).
However, those days may be nearing an end. In fact, in early May 2013, interest rates bottomed out (the 10-Year U.S. Treasury Bond rate dropped to just 1.6%) and began what could turn out to be a long climb back up to more normalized levels. A rate correction could potentially impact nonprofits across a broad spectrum of their livelihood and operations. It represents a significant risk to future cash flows, donations, and investment portfolios.
If your nonprofit’s trustees have typically been comfortable with a heavy fixed-income allocation within your endowment portfolio, you may already be re-thinking your approach. As rates reached historically low levels in recent years, the income generated by endowments declined in tandem. As we look ahead, your trustees now face a difficult scenario: Low income generated by your portfolios, and the potential for declining principal values in your bonds as rates begin to climb. As such, your nonprofit organization might be better off shifting the focus of your investment discipline from income to “total return,” which accounts for both income and potential price changes in the decision-making process.
Now let’s turn the focus to the lifeblood of any nonprofit: The donors. This is where the current interest-rate risk has the potential to collide with demographic trends. A 2013 study conducted by nonprofit software and service provider Blackbaud found that Baby Boomers and their elders (a demographic of those over age 68 and dubbed the “Matures”) account for two-thirds of charitable giving support. As more and more of that group of Baby Boomers near retirement, they will call upon their investment portfolios to replace their incomes (and in many cases the source of their donations).
Conventional wisdom tells us that both the Baby Boomer and Mature demographic groups are more likely to own bonds and other income-producing assets in their retirement portfolios. We know that bond prices share an inverse relationship with interest rates, but so may many other income-producing assets that are widely held by retirees, such as real estate, preferred stocks, utility stocks, etc. These other types of assets may also be sensitive to rates, given that investors often purchase them as income alternatives. We saw a brief glimpse of that potential impact in 2013 (see chart below) as the market rose (the S&P up over 17%, while income-oriented investments struggled):
In addition to portfolio losses, corporate donor programs may also be affected. As rates begin to rise, the higher cost of borrowing will begin to squeeze the profit margins of corporate donors that carry and service debt. While in the immediate future they will continue to benefit from recent refinancing efforts, over the longer term, higher borrowing costs could begin to impact corporations’ discretionary budgets. That means they could reduce their support of philanthropic causes.
Why do we point out the historical context here of 30 years of falling interest rates? It means that there is a significant portion of nonprofit sector employees/trustees and their advisors who have never navigated their way through a rising-rate environment. They are new to this. However, sticking with the status quo will not work in today’s financial landscape. Your nonprofit should demand comprehensive and proactive financial solutions. In addition to educating your officers and trustees, your financial advisors should also review your cash-flow funding, consider shifting from an income-focused investment strategy to a total-return approach, and suggest ways to create more flexibility in fixed-income management.
For more information on these concepts, as well as details on how RegentAtlantic is already addressing these concerns with many nonprofits and their donors, contact Joe Gazdalski at 973.425.8420 x222 or email firstname.lastname@example.org.
Important Disclosure Information
Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable. Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request. This presentation is not a substitute for personalized advice from RegentAtlantic. This information is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.
The index returns shown in the chart show the total return for various investment indices and include the impact of the reinvestment of dividends. A comparison to indices may not be a meaningful comparison. Comparisons to benchmarks have limitations because benchmarks have volatility and other material characteristics that may differ from the performance of a client’s portfolio. The investments in a client’s portfolio may differ substantially from the securities that comprise each index and are not intended to track the returns of any index. One cannot invest directly in an index, nor is any index representative of any client’s portfolio. Actual client accounts will hold different securities than the ones included in each index. The index returns are gross of applicable account transaction, custodial, and investment management fees. The actual investment results would be reduced by such fees and any other expenses incurred as an investor. Please see below for definitions of the indexes used.Index Definitions
S&P 500 Index: The S&P 500 is an index consisting of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large-cap universe. Each constituent in an index is weighted by its market-capitalization, as determined by multiplying its price by the number of shares outstanding after float adjustment. The price return of an index is a measure of the cap-weighted price movement of each constituent within the index.
S Network Composite Closed End Fund Index: The S Network Composite Closed End Fund Index is designed to serve as a benchmark for closed end funds listed in the US that principally engage in asset management processes seeking to produce taxable annual yield. The CEFX employs a modified net assets weighting methodology designed to assure accurate investment exposure across the various style segments that together comprise the taxable yield sector of the closed end fund market.
BarCap US Corporate High Yield Index: The Barclays Capital High Yield Index includes publicly issued U.S. dollar denominated, non-investment grade, fixed-rate, taxable corporate bonds that have a remaining maturity of at least one year, regardless of optionality, are rated high-yield (Ba1/BB+/BB+ or below) using the middle rating of Moody’s, S&P, and Fitch, respectively (before July 1, 2005, the lower of Moody’s and S&P was used), and have $600 million or more of outstanding face value. Only the largest issue of each issuer with a maximum age of three years can be included in the Index. Original issue zero coupon bonds, step-up coupons, and coupons that change according to a predetermined schedule are also included. The High Yield Index includes only corporate sectors. The corporate sectors are Industrial, Utility, and Financial Institutions. Excluded from the High Yield Index are non-corporate bonds, structured notes with embedded swaps or other special features, private placements, bonds with equity-type features (e.g., warrants, convertibility), floating-rate issues, Eurobonds, defaulted bonds, payment in kind (PIK) securities and emerging market bonds. The High Yield Index is issuer capped and the securities in the Index are updated on the last business day of each month.
BofA Merrill Lynch Emerging Markets Credit Index: The index is a broad, capitalization-weighted composite index designed to track the performance of U.S. dollar- and euro-denominated debt of corporate issuers who primarily do business in emerging market countries.
The S&P North American Utilities Index : The S&P North American Utilities Index provides investors with a benchmark that represents U.S. traded securities that are classified under the GICS® utilities and telecommunication services sectors.
S&P Preferred Stock Index: The S&P U.S. Preferred Stock Index is designed to serve the investment community’s need for an investable benchmark representing the U.S. preferred stock market. Preferred stocks are a class of capital stock that pays dividends at a specified rate and has a preference over common stock in the payment of dividends and the liquidation of assets. The index comprises preferred stocks listed on U.S. exchanges that have a market cap of at least $100 Million and have traded at least 250,000 in each of the previous six months.
FTSE NAREIT All REITs Index: FTSE NAREIT All REITs Index represents the full universe of publically traded REITs, including those companies that do not meet minimum size rule, liquidity criteria or free float adjustments. Stocks are free-float weighted to ensure that only the investable opportunity set is included within the index.
For more information on these concepts, as well as details on how RegentAtlantic is already addressing these concerns with many nonprofits and their donors, contact Joe Gazdalski at 973.425.8420 x222.
Important disclosure information
Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable.
Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request.
This article is not a substitute for personalized advice from RegentAtlantic. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.
RegentAtlantic does not provide legal or tax advice. Please consult with a legal and or tax professional of your choosing prior to implementing any of the strategies discussed in this article.