Boot Camp for investment Committees: Fundamentals for Success

 

OPERATOR: Thank you for joining today's Boot Camp for Investment Committees: Fundamentals for Success. The views and opinions expressed are those of the presenters as of May 11th, 2021, subject to change without notice, and may differ from the views expressed by Bank of America Corporation or its affiliates. This is presented for informational purposes only and should not be used or construed as a recommendation of any services, security or sector. Please see important information at the end of this event. I will now turn it over to Ann Limberg.

 

ANN LIMBERG: Thank you for joining us today. I'm Ann Limburg, the Head of Philanthropic and Family Office Solutions at Bank of America Private Bank. And I'm delighted to welcome you to today's event.

All of you make an essential and a very positive difference in our global society through your service to the nonprofit sector, and to the missions of the organizations that you care so deeply about. You represent a very diverse cohort of leaders as well, including board and investment committee members and chairs, chief financial officers, investment officers, trustees, directors and donors, all philanthropic individuals who create, support and sustain nonprofit organizations across sectors. To all of you and to our clients and partners, and to our prospective partners and clients, I wish you a very warm welcome.

Thank you for contributing your time, your talent and your overarching support to drive and sustain such an important conversation in our society today. And we've shaped today's sessions with you in mind, responding to your interest and asks and in keeping with our own role as a global enterprise financial institution, and an active local community partner. We're here to help you better serve your organizations across your entire continuum of needs in a careful and a customized way.

 

And in the same way that you drive impact and purpose, and you lead your lives with purpose, we at Bank of America are also engaged in a social mission. We share your values to improve the world by supporting education, health care, social wellbeing, racial justice, the arts and culture, and many other causes. And in the last year alone, we've expressed these values in many, many ways through the leadership commitments that we've made to support COVID relief in communities throughout the country and to accelerate our work and advancing racial and social justice and economic mobility.

We've continued to increase and accelerated our ongoing support to programs across the country, delivered through the Bank of America Foundation, and through our Local Market President network. And as a value-driven enterprise, we believe that we're uniquely positioned to understand and advise you in the work that you do for your nonprofit organization.

 

Today we'll be presenting two sessions on highly relevant topics. The first is a discussion of strategic investment goals for long-term funds, featuring some of our senior investment professionals, moderated by Bill Jarvis, the Head of Strategic Thought Leadership and our Philanthropic Practice at Bank of America’s Private Bank. We will then drill down more deeply with an in-depth case study on another very important topic, and that's the implementation of environmental, social and governance investing. And in this case study will feature a major university endowment, moderated by Diane Bailey, the head of our National Consulting and Advisory Practice at Bank of America Private Bank.

And now, I'll turn things over to Bill Jarvis, to introduce our first panel.

 

BILL JARVIS: Thanks very much, Ann. And welcome to all of you who have joined us for today's session. We've titled this a Boot Camp, and that term implies an experience that's both concentrated and brief, and we hope also useful for you in your work.

In our 45 minutes today, we're setting out our topics in a logical order, and we have a terrific panel of Bank of America investment professionals to help see us through this agenda. We're joined today by Mary Stokes, Market Investment Executive; by Michael Strauss, Private Bank Senior Investment Strategist; and by Danielle Ward, a portfolio manager and as we'll see an expert in environmental, social and governance investing. But we're going to begin by grounding us first in our topic, what is an endowment? Then we'll move on to how endowments are governed and invested. Mary, Michael and Danielle will take care of that. We'll then turn to the most common models in use, for example, oversight; Mary will help us in that topic. Danielle, Michael and I will cover the spending and distribution practices in endowments. Mary and Danielle will talk about the very important topic of fund flows into endowments and the increasing need for transparency in endowment governance. Finally, we'll give you some sources for further information and talk a bit about our companion session today, which Ann just refer to, on the integration of environmental, social and governance at a major university endowment.

 

So let's begin. I'm going to set out the topic by talking a little bit about what endowments are. Nonprofit organizations such as yours are a significant portion of the US economy, you provide jobs, you foster economic activity and you provide services that aren't provided by the government or private sector. You can take the form of a corporation, a trust, an educational institution, a club or an association. But generally, you’re formed with a view to perpetual existence. No one really owns your assets, they exist to serve the public. And often you are free from taxation, with the exception of private foundations that do have to pay an excise tax and as we'll see, have to make annual qualified distributions that average at least 5% of your assets.

Now, for a number of your nonprofits out there, your operating budgets are supported to some degree, not by just memberships or federal government, local contracts, or other sources of funds but by these permanent long-term investment pools that we call endowments. At private foundations, the endowments are typically created by a donor or a family from a pool of assets is given at one time, or over a period of years, and after that, they typically don't receive further funds. But at most other types of nonprofits, endowments are often made up of individual gifts from donors who frequently impose restrictions on how their gift is to be used. So this is what we're talking about here in terms of donor-restricted endowments. That's often donors making unrestricted endowment gifts that have to be invested for perpetuity that may be used to support any of the nonprofit's purposes or programs. And then finally, some nonprofits, some of you out there are able to generate operating surpluses, as it were a kind of extra money from your activities, and in these cases, your board may vote to treat these amounts as if they were long-term endowments and these are called board-designated or quasi-endowment funds.

So with that as a background of what we're talking about here, we're not going to turn to Mary Stokes. Mary, can you give us advice as to how endowments are governed?

MARY STOKES: Thank you, Bill. As a board member, you are not responsible for the day-to-day decision-making at the nonprofit organization, however, you do bear responsibility for setting investment policy and assessing performance. The role of the board member is to provide direction and oversight of their investment programs. Extensive investment expertise is not required, you just serve effectively in a board role. However, for you to exercise good judgment in making decisions, you should possess a working understanding of basic investment principles and concepts in order to

 

exercise good judgment in decision-making. A lack of investment understanding can seriously harm an investment program and limit the likelihood of achieving the funds mission. Board members are usually very successful in their careers if they take on the responsibility of oversight of financial assets that have a material impact on the welfare of their funds beneficiary.

 

In our experience, high-performing board and investment committee members, acknowledge and respect diversity of money experience among fellow members. They also welcome occasions to increase their knowledge of financial and fiduciary issues through continuing education and contribute constructively to meetings that consider of long-term purposes of the endowment and the organization. High-performing board and investment committees are made not born. As fiduciaries, you play a role in helping strengthen the governance process and the structure of the organization you serve.

It's not possible for one person on the Board, committee or staff of an organization to do everything. Therefore delegation is key and necessary for all the work to be completed. It is important to remember that authority can be delegated but not responsibility. For effective delegation, the key points are really, make it legal, so any delegation should be in line with your organization's governing document and relevant legislation, and it should be systematic. Secondly, it should provide oversight. So delegation should provide the proper oversight by ensuring a reporting mechanism is in place.

BILL JARVIS: Mary, these duties that you've just described sounds like a lot but actually there's a long tradition of the three fiduciary duties that can serve as guides for individuals who are serving on boards, can you tell us about those?

 

MARY STOKES: Bill there's one major fiduciary duty and that is the Uniform Prudent Investment Act of 1994. That Act sets out guidelines for boards to follow when investing trust assets. The board should invest in managed trust assets as a prudent investor, by considering the purpose, the terms, the distribution requirement and other circumstances of the foundation or endowment. And satisfying the standard, the board should exercise reasonable care, loyalty, and obedience. And so the duty of care is generally satisfied when the fiduciary carries out his or her duties on behalf of the nonprofit organization using reasonable prudence. Examples of fiduciary care would include things like attending meetings regularly, reviewing the materials in advance and being prepared to contribute to the discussion. Also taking action to stay informed about developments relevant to the organization and seeking out sources of information that are reliable and not speculative. The duty of care requires that the fiduciary take his or her responsibility seriously, and devote sufficient attention and skills to the tasks involved in serving the organization.

The second duty is really loyalty. The duty of loyalty requires that the fiduciary put aside their own interests and act only in the interest of the organization. This involves not only avoiding conflicts of interest such as taking financial advantage of a fiduciary insider position but also can demand more subtle judgment when, for example, the fiduciary serves on more than one board, and must consider how a given opportunity whether it's financial or otherwise, should be directed. The considerations of confidentiality are also very important. And so, in this regard, it is important that the organization have a conflict of interest policy and that fiduciaries understand and adhere to it.

And then lastly is the duty of obedience. And that requires a fiduciary ensure that the organization remain true to its purpose, set to work in the charter in the founding document, and know and follow state and federal law. Although nonprofit organizations frequently have perpetual existence and a mission, it's not unheard of for boards to drift away from that mission that are perceived as

 

less interesting and towards those that may seem more current or more glamorous. This is different from embracing new strategies and tactics to address the society's most urgent needs. There are legitimate cases in which nonprofit organizations have been repurposed. For example, those devoted to raising funds for polio research in the 1950s, redirected themselves to other childhood diseases when a vaccine for polio was developed. But in general, organizations must use caution when deviating from the purpose as stated in their charter and by law. This is even more so for endowment organizations where the donor’s intent is really paramount.

BILL JARVIS: Mary, you mentioned already the Uniform Prudent Investor Act, which is the law in one state Pennsylvania, but also going through all the other states as you said covering trusts including private foundations that are set up as trust. But there's another also very important law for nonprofits that are not set up as trust, that's the Uniform Prudent Management of Institutional Funds Act. We don't have time to go through that in detail, but it's probably important for us to touch on it and acknowledge its importance. Can you say a few words about UPMIFA, as it's called?

MARY STOKES: Certainly, Bill. So many of our audience may be familiar with UPMIFA. And the acronym really stands for Uniform Prudent Management of Institutional Funds Act, and it's a state law that governs behavior by fiduciary of donor-restricted endowment funds when investing spending and delegating responsibility to a third party. It has been adopted in all states except Pennsylvania, which has its own laws and similar provisions, and as its name implies set towards a fiduciary or statutory standard of prudence for the behavior of fiduciary who have authority over donor-restricted funds.

BILL JARVIS: And this prudence standard is very important, we'll be coming back to that. Thanks very much, Mary. I'd like now to turn to Michael Strauss. We talked about perpetuity, Michael, what is the investment horizon of an endowment?

 

MICHAEL STRAUSS: The investment horizon for endowments, in many cases, is generally forever or for a perpetual period of time, or at least a really long period of time 40 or 50 years. But interestingly, the modern-day focus of this long-term investment horizon, it's actually reasonably new. It began a bit more than 50 years ago and followed the work of noted Yale economist James Tobin, who touted that trustees of an endowment, endowed institution, are the guardians of the future against the claims of the present. Or in plain English, the role of the trustee is to protect the endowment of the future from the endowment today. So one of the questions to ask is what was Tobin describing?

In many ways he was describing the concept of intergenerational equity, which is the need for trustees to provide the endowment of the future with the same spending power of today’s endowment. To attain this objective, endowments need to focus on long-term total returns rather than either coupon clipping or dividend payments that they received, which were often the major determinant of spending 50 years ago. As Chris Hyzy, our Chief Investment Officer, has often stated, the key for long-term investors is time in the market, not timing the market. And that's especially true for endowments and foundations. This is of the utmost importance. And the focus on long-term total returns needs to be with an objective that supports a combination of spending needs, inflation, and the cost of operations, as well as making sure you can maintain the liquidity needs of your institution. This often points to a long-term return objective of about seven and a half to 8% or so.

Moreover, in recent years, the critical inflation rate for many institutions has shifted from focusing on the consumer price index to focusing on an inflation rate or cost structure that is relevant to the institution itself and the mission that it supports. On a forward-looking basis this is an extremely challenging bar, especially given the low starting point for fixed income yields in the current

 

environment. In some cases shortfalls can be filled by fundraising campaigns and or a combination of that and future donations. However, in recent years the low-interest-rate environment and the desire for some institutions for even higher spending rates to meet the entities mission has touched a few foundations to potentially shift to a time-restricted term, with a sunset provision that targets a faster spending rate, recognizing that the foundation might end or sunset in about 20 or 30 years.

 

BILL JARVIS: And if I can just say here, Michael, you referred to low-interest rates. We're here in a position where interest rates are at historic lows in a cycle, but even if they come up after this a little bit, it will still be in terms of decades and centuries what are close to all-time lows. So please go ahead Danielle talk to us about how this actually gets carried out in investment terms.

DANIELLE WARD: Sure, I’m just going to talk about the purpose of how you need to really link how an endowment investment, it really begins with the purpose of the endowment itself. So as Mary had alluded to earlier, you know, as fiduciaries, boards of directors and investment committees are responsible for investing organization's assets to support its mission and purpose. While private foundations are generally formed from one or a series of gifts, from a single donor or single family, most other types of nonprofit endowments are typically funded by donations from different donors at different times and can support a wide variety of mission-related goals. For example, you know, many endowments support research, teaching, scholarships and specific programs, in addition to general operating support. You know donors frequently impose restrictions on how their gift is to be used and occasionally even how it should be invested.

UPMIFA, which we've already discussed, you know, requires an organization and those who manage its funds to give primary consideration to donor intent as expressed in a gift instrument. So understanding donor intent is a key consideration for how endowments are invested and managed. And unless the donor has specifically stated in writing that the gift may be spent in its entirety, the expectation is that the fiduciaries that are overseeing the endowment are going to use the reasonable, but best effort, to preserve the purchasing power of the fund after spending inflation and costs over multiple market cycles as Michael just touched on, you know, in addition to making those distributions that match with the donor’s intent.

BILL JARVIS: So when we talk now about prudent investment we're necessarily talking about diversification, that big word. Lead us through here Danielle, how does diversification work in practice?

 

DANIELLE WARD: Sure Bill. I think we've all heard the expression, don't put all your eggs in one basket. You can think of diversification as having many eggs in many baskets or building a portfolio out of investments whose returns do not move in the same direction at the same time. That is it means that their returns are not highly positively correlated.

Since future returns are unknown, investing in many different types of investments from different asset classes, geographies and styles can help lessen the volatility of returns of the portfolio. And it can offer a simple and generally low-cost means of managing investment risk. With that said, you know, many asset classes seem to display low correlation with one another in normal economic environment. But when the market climate turns sour, some of these asset classes actually experience high correlation and that can reduce the diversification benefits. So that's really something important to keep in mind.

And from a regulatory perspective, the Uniform Prudent Investor Act sets an expectation for private foundations that their trustees will consider diversifying portfolios unless there are special

 

overriding circumstances. There are similar diversification considerations that apply to public charity or institutional nonprofit fiduciary under UPMIFA. And in either case, fiduciary subject to one or the other are expected to consider diversification of portfolio holdings.

Another related concept from UPMIFA is that fiduciary is required to make decisions about each asset class in the context of the entire portfolio of investments as a part of an overall investment strategy. You know, this means that an asset which is in isolation might seem imprudent for a nonprofit organization, may actually be held because it’s part of a diversified portfolio of many assets. And diversification is most often documented in the investment policy statement, and is reflected in the asset allocation which defines the asset classes that will be represented in the nonprofit portfolio. So, Michael, can you tell us more about the structure of an endowment’s investment portfolio?

 

MICHAEL STRAUSS: Thank you, Danielle. A fundamental part of an endowment framework or structure is to try to grow assets for long-term returns. This often includes a structural bias towards equities or being the owner of assets. This is especially true when we have extremely low nominal and potentially low or negative real yields and when something called the equity risk premium is solidly positive. The question is often asked, what is the equity risk premium? In simple terms, it's the earnings yield on equities, for example, the S&P 500 earnings divided by the price of the S&P versus the yield on treasuries. If for example the forward earnings yield on equities is five and a quarter percent and the tenure note was 175, the equity risk premium would be about three and a half percent.

Endowments often focus on the long-term returns and the opportunity set to take advantage of this equity risk premium when it's available, and at times it might not be available, and actually, the risk from fixed income might be less and offer higher returns than equities. We saw that after Volker and company got inflation under control in the early '80s when we have the opposite of today, very high, very positive real yields that were offering a very good return relative to the volatility and risks of equities.

But the second part of the equation for endowments, or what we call perpetual pool of assets, is to analyze and potentially take advantage of the illiquidity premium of private investments, which is effectively the increased return that is expected to be earned by investments in less liquid private programs. So in other words the added return that you might get by not necessarily having day to day, week to week, month to month or longer liquidity for those assets. The challenge isn't just finding it, the challenge is also earning it. But endowments typically have a high tolerance for less liquid or illiquid investment strategies, have a higher tolerance relative to individual investors. Why? It's consistent with their long-term investment horizon and the fact that they genuinely know their liquidity needs well ahead of time for several years. These institutions often invest with a lens that is focused on long-term total returns, recognizing that they often don't need to hold 100% of their endowment assets in liquid terms.

Danielle, can you maybe provide some insights on how the growth of ESG and ESG implementation has worked its way into the Endowment Foundation community?

 

DANIELLE WARD: Michael, I would love to. You know, we're seeing nonprofit organizations increasingly interested in how integrating environmental, social and governance, known as ESG, considerations into their portfolio to help better position them for the long term and pursue their missions more holistically.

 

When people think of ESG investing, they may mistakenly think it's about limiting the investment universe or limiting their field of view when it's quite the opposite. It's really thinking about enlarging your focus and seeing what's really around your investments that might impact it. So how could have an environmental or social lens help you get to a better decision? You know, what could you see from a different perspective? And that's what modern ESG investing is all about.

 

ESG analysis helps discover issues that traditional financial analysis may overlook and it may have a material effect on a company's future performance. ESG investing retains all the rigor of traditional financial analysis and it enriches it with that additional data you get if you think about the environment, community and society.

Michael, you know, what's the importance of asset allocation?

MICHAEL STRAUSS: Thank you Danielle. Often lost in the world of 24-hour news on the economy and financial markets, is the importance of asset allocation. In the late 1980s, a team led by Gary Brinson began to publish research that revealed that more than 90% of the variability of a portfolio's performance over time was due to asset allocation. The team's initial findings have been validated by other researchers over the years, but not necessarily at the same 90% rate. Nonetheless, it has become clear that asset allocation and to a lesser extent strategic and tactical asset allocation are often the key drivers of returns.

The goal for most long-term investors is also to target returns relative to risk with an attempt to minimize downside deviation, both in magnitude and in time. For operating reserves, investment allocations are often targeted to the appropriate investment horizon for the projects that those operating reserves need to support and specific liquidity needs that they may need to meet over the near and intermediate term. This often takes into account a great deal of focus on looking at the operations of the institution. And again here the importance of limiting the downside deviation but still producing some positive return is extremely important.

We'll now turn it back to Danielle to discuss the role of benchmarks.

DANIELLE WARD: Thanks, Michael. The use of benchmarks are an important reference point to help fiduciaries answer the question of how are we doing, you know, versus the market, versus goals and versus here. Benchmarks help fiduciaries in their obligation to monitor and evaluate performance.

 

We typically see three different types of benchmarks being used to assess how the investment strategy is doing. First is a policy benchmark: really, have we outperformed a mix of indexes that represents our long-term strategic asset allocation? You can also hear this referred to as a policy portfolio. It's essentially a total portfolio benchmark that blends the strategic asset allocation targets from the investment policy statement and includes the asset classes that are in the portfolio. It's an important basis for performance and risk assessment. By comparing the portfolio to the policy benchmark, the organization is better able to evaluate performance by separating the impact of the investment policy decisions from the execution of the investment strategy. It supports the reporting of performance attribution, which separates and quantifies the impact of tactical asset allocation and manager selection decisions on performance.

The second type of benchmark is an absolute return benchmark: have we earned enough to meet our financial objectives? We often see this as a spending policy benchmark, usually the spending rate plus inflation.

 

Then the third is a peer group, if it’s relevant for your type of organization, have we outperformed other similar organizations? Popular peer groups include the Council on Foundations, private and community foundations and NACUBO. And in cases where impact investing objectives are part of the mission, performance towards these goals should also be part of the portfolio evaluation process.

 

BILL JARVIS: So, we've given you a lot of content. We started with what the endowment is. We've gone through how they're governed. We've gone through the basics of the investment horizon, how they're invested.

And now I'd like Mary to turn to a very important aspect that many of you listening today or viewing today have probably wrestled with. What is the model that you should use for overseeing your endowment? Mary, can you give us a sense of what these models are?

MARY STOKES: Thanks, Bill. It is common for larger endowments and foundations to retain professional service providers to carry out duties with regard to investment management under the oversight of a board or the investment committee. There are three primary models.

 

The first is the advice-based or the consultant model. So in this model an investment consultant typically serves in a non-fiduciary capacity and recommends investment managers to the board or investment committee. Once the managers have been approved and hired, the investment consultant reviews and monitors them with the aid of the organization’s staff, making regular reports to the board or the investment committee usually on a quarterly basis. While in wide use, this model has been challenged in recent years by the difficulty of assessing accountability and of managing more complex portfolios using volunteer board or investment committee members who meet infrequently. This is particularly true in times of extreme market volatility, and it's been complicated by the fact that most nonprofit organizations do not have a large staff devoted to the investment function. The so-called, what I will term, governance budget available under this model, which is the time, skill and resources available to oversee the portfolio and respond quickly to unforeseen market events, can seem really inadequate. This is particularly true for organizations that have invested in less liquid strategies such as hedge funds, private equity, venture capital or real estate, which require special attention or oversight.

A second model is the in-house model. And so with the in-house models there is a team of in-house professionals that are hired to do the work that I just described. And so they will invest the portfolio's assets and report on those assets independently to the board on a quarterly basis. At times, in the in-house model, the in-house staff will use an investment consultant to report on the foundation's assets.

 

And then lastly, the last model is what I would term the discretionary model or the outsourced chief investment, or OCIO, model. So in recent decades, as investment portfolios have become more complex and highly diversified, the two models described previously have been deemed by some organizations to kind of lack the flexibility to respond to volatile events in the market. And so in an OCIO or outsourced chief investment model, they use that outsourced provider to hire, fire and choose managers for each of the approved asset classes. This model has gained traction over the years as it allows investment committees and boards some more flexibility to respond quickly in times of extreme market volatility.

BILL JARVIS: Mary, this is a great overview, but probably the grounding of endowments, as a wise person I knew once said, is their distributions or their spending. So we're going to turn now to spending practices.

 

I'll start off and then I'm going to get some help from Michael and Danielle. As I mentioned earlier, private foundations are in a special class. They're required under Internal Revenue Service rules to distribute at least 5% of their average assets every year. And this, obviously, as Michael implied, places the burden or a certain requirement on the investment practice to maintain that inflation- adjusted purchasing power. Other types of endowments or nonprofits that are not private foundations have much more flexibility. And there you see spending rates that are typically between four and 5% at a year. Again, if they want to maintain that purchasing power over time. And this is often subject to the use of smoothing formulas because most institutions want to have a consistent, and ideally consistently growing, source of distribution from the endowment.

So, Danielle and Michael, please tell us about smoothing formulas.

DANIELLE WARD: Sure. You know, as we already described, many organizations base their spending rate on the current market value of the portfolio. But given market volatility and the long-term nature of the charitable mission, it may make more sense to average that market value, usually, over a period of three to five years. That's what we see most used, and that's what's moving it. So it really helps to dampen in the year-to-year volatility and the amount that's distributed out of the endowment. And how it works, is you take an average of the market value of the endowment at the ending of the last three years or 12 quarters, or if you're going to use five years it'd be 20 quarters, and then you apply the policy setting rates to this average portfolio value.

BILL JARVIS: Thanks, Danielle. I can say from the studies that I've edited over the years, the NACUBO study, the Council on Foundations that you referred to, the public charities and universities, about three-quarters of them do use this moving average smoothing method. And so it's important to understand what it is.

 

There are though a couple of other methods. One is an inflation-based method, the other is a hybrid formula. In inflation-based method you don't look so much to the value of the actual asset pool, you look to what you spent last year. And using what Michael referred to either the consumer price index or particular inflation index which a nonprofit realizes is more appropriate, you simply increase the spending from year to year by inflation.

We have papers on this that are available that we can provide to you about the various spending methods. It's a little bit complicated but not impossible to know, but that's something that's also important for you as fiduciaries to understand what the alternatives are and how you can choose among spending methods.

 

On the other side of spending, we have flows into the fund, endowed gifts, annual giving, planned giving, and for an explanation of how these are important, I'm going to come back and ask Danielle.

DANIELLE WARD: Thanks, Bill. As you know, income and flows into the fund is an important factor in determining the overall investment strategy. For some institutions, endowment giving can be a major source of growth. It can supplement or even in the case of major capital campaigns, sometimes even surpass the growth from investment returns. And generating new fund flows from development efforts can go a long way of relieving the pressure on the endowment’s investment program. And as you mentioned earlier, some nonprofits are able to generate operating surpluses from their activities and annual giving. And in these cases, the board of the organization may vote to treat these amounts as if they were a long-term endowment.

 

For others, like private foundations who typically do not raise additional funds and have no inflows from outside sources, the investment program bears the burden of maintaining purchasing power and meeting the required 5% spend rate.

When considering the impact of flows into the fund, it's important to consider not just how much money comes in each year, relative to the overall portfolio assets, but also how predictable that income is, where the money has traditionally come from, and what changes may lie ahead? You know, we're seeing demographic shifts and a wealth transfer to the next generation. And this is particularly relevant for planned giving given the long-term and strategic nature of these gifts. And speaking of donors, we are also seeing in light of today's challenging social issues that organizations may experience pressure from donors or other funders to achieve near-term goals, which can potentially be at the expense of future better beneficiaries.

 

As we've already discussed, nonprofit investment practices require that unique balancing of interests, because of their perpetual nature and the need to maintain intergenerational equity. And another area where pressure from stakeholders and donors that we're noticing is around sustainable impact investing or ESG investing. You know, we know from our biannual High Net Worth Study of Philanthropy that the first thing donors tell us is important to them when choosing where to make a gift is alignment of their own values with the values of the organization. So sustainable or ESG investing can be an important consideration when attracting donors, as they look at what the organization is doing with all of their resources and financial capital.

MICHAEL STRAUSS: Yeah, I can add something here. One of the things that we saw during the pandemic is some institutions did need to increase their spending short term. I mentioned the Tobin quote earlier, in 2020, '21, some institutions did need to put a little bit more effort in fundraising, did need to spend a little bit more because they needed to use the endowment so that the institution itself can better manage to the future, a slight twist on Tobin's work of 50 years ago.

 

BILL JARVIS: Absolutely, Michael, and thanks for bringing that in.

Mary with all of this, there must be an increased need for transparency. Can you talk a little bit about that before we wrap up?

MARY STOKES: Certainly, Bill. So tax-exempt organizations are required to file Form 990 with the IRS. Form 990 gives the IRS insight into a nonprofit organization’s governance, activity and detailed financial information. The 990 must be made public and provides an easy, convenient way for donors and other people interested in supporting a particular cause to identify and evaluate the best nonprofits to support. This is one of the key objectives of the 990 and it is made possible because of the critical information that is not available to the public. Because an organization can clarify its mission on the 990 and detail its accomplishments of the previous year, donors can find out where the group generates and spends revenue.

A donor can also see just how sustainable the nonprofit might be by having access to its cash reserves, which demonstrate for potential donors and employees, how well the nonprofit pays its top employees and how financially stable it is. Since the form supplies such critical information and data about the organization, it is easy to see that it can be an excellent public relations tool for the group when care is taken to fill it out correctly and carefully and on time. As such many nonprofits now make 990 available on their website as well as reminding their supporters that they can be viewed on GuideStar, which is an organization that provides information about nonprofits. Likewise

 

audited financial statements as well, Bill, provide and can reduce the uncertainty into the financial affairs of a nonprofit organization.

BILL JARVIS: Well thanks very much, Mary. We've been through a lot of territory here in our Boot Camp and we've marched over it pretty quickly.

 

For those of you who are on the call, who may want to know more, there is other information that's available about best practices. If you're a higher education institution, NACUBO, the National Association of College and University Business Officers, AGB, the Association of Governing Boards or the Treasury Institute for Higher Education can be sources of help. These are nonprofit organizations that are pretty well recognized. If you're a foundation, obviously the Council on Foundations is a long-standing source of support and information. And for information on investing, generally, the CFA Institute has a whole library of information that's available. We here at Bank of America also provide papers, reports, analytical support for you in your practice and in your work.

So thank you for joining us today.

We're now going to transition after a brief five-minute pause to this very important session that we've alluded to on integration of environmental, social and governance factors, ESG.

[PART 2]

DIANNE CHIPPS BAILEY: Welcome, my name is Dianne Bailey. I’m the National Philanthropic Strategy Executive for Bank of America Private Bank and I’m delighted to share with you today’s Bank of America, Foundation Endowment Investment Management, Part 2 of our bootcamp, focused on equipping investment committees.

 

Our topic today is to dig deeply into the integration of ESG, environmental, social and governance factors into nonprofit investment portfolios. We’ve got an all-star panel that I’m excited to introduce you to. But first, I want to point you to some of the highlights of the 2020 NACUBO, that is the National Association of College and University Business Owners, their endowment study because it indicates that most higher education endowments remain in the very early stages of implementing responsible investing. 56% of their respondents have ESG factors reflected in their investment policy statement, but, by way of example only 19% of the study’s respondents reported that they have actually incorporated responsible investing goals into their strategies, in their US equities portfolios.

So today, we’re joined by three guests who are among the leaders in their representative fields to talk about ESG investing strategies. They will share strategic insights and also provide practical advice about how to make these aspirations to sustainable investing a reality. First is Jackie VanderBrug, she’s the Head of Sustainable and Impact Investment Strategy for the Chief Investment Office for Merrill and Bank of America Private Bank. Brian O’Donnell is also here, he’s an institutional portfolio manager with Bank of America Private Bank. And most importantly, I know you’re eager to hear from Dr. James Herbert, the President of the University of New England. With James’s leadership, the UNE Board of Trustees recently voted unanimously to adopt a carbon-reduced

portfolio for the university’s endowment.

 

Jackie, let’s begin the conversation with you. There are no shortage of industry reports and headlines about sustainable investment strategies. How did we get here and what is continuing to fuel this movement?

 

JACKIE VANDERBRUG: Yeah, thanks Dianne and it’s a pleasure to be here today. There is no question, last year we came out and said sustainable investing is not having a moment, this is a movement and it is a movement that’s been building over the last 30 or so years. But it’s important to say we’re not talking about a fad, we’re really talking about the future.

 

And then what happened is COVID fundamentally was an accelerant and, obviously, an unexpected accelerant. But what COVID did was it put front and center for all of us, our interconnection, at some level our collective vulnerability and the materiality of things like the health and wellness of workers. The challenges that we have in terms of the ability to agilely shift to different business models like work from home. The importance of redundancy of supply chains and obviously the reality that pandemics and extreme weather don’t respect borders. So what happened was COVID moved forward a movement that has been called stakeholder capitalism and Dianne, that’s the idea that businesses can deliver for shareholders when they deliver for all of their stakeholders. So their focus on their employee, on their customers and on the communities in which they operate, that collective focus allows them to, over the long term, deliver for shareholders.

Now, all of this put together accelerated the movement to sustainable investing. What we saw, in terms of confirming that, was significant flows. Last year in the US, ETFs and mutual funds alone, over 50 billion dollars of flows into sustainable funds. That has continued. Our BofA global research partners have estimated that there will be over 20 trillion dollars of flows over the next two decades to sustainable funds, and we’re seeing our asset managers over 80% of them saying that the integration of ESG factors is something that they’re doing on the merits of those factors, on these definite merits, so we are going to continue to see product availability grow.

All of that put together, I’ll just say in the end sustainable investing is growing because people see it as strong from an investment process. So everything that happened in COVID, if this was concessionary investing, would not have led us to the movement we’re in right now. What we’ve seen historically is that funds classified as sustainable by Morningstar have been disproportionately in the top quartile of their asset class peers in terms of performance and underrepresented in the bottom quartile. So we are seeing the ability of sustainable funds to perform in a way that is at par with traditional investment peers and so that obviously is propelling investment forward.

 

DIANNE CHIPPS BAILEY: Thank you for that framing Jackie, so helpful. James, I want to go right to you. As I mentioned in the introduction, our guests are particularly interested to hear from you, because so many of them are talking about integrating ESG factors into their portfolios, but UNE is among the few who have actually done so.

 

So let’s take a step back. How does the move towards a carbon reduced portfolio fit into your broader vision for UNE?

DR. JAMES HERBERT: Well thanks so much Dianne, I appreciate the question and it’s a real pleasure to be here and be speaking with everything. So every institution is different, but at UNE,

sustainability and environmental consciousness and activism is a core part of the university’s DNA and reflected in our mission and in fact, our tagline for the university is innovation for a healthier planet and so you can kind of get the sense of the centrality of sustainability, right there just in our tag line.

 

When I first got here four years ago, we embarked on a strategic planning process and we broadened the conception of health, which was really the central theme in our strategic plan, to include health of individuals certainly, but also of communities and of the entire planet. And so that

 

reflects a commitment campus wide amongst our students and our faculty, our professional staff focused on environmental activism and just a consciousness around sustainability. And so for us,

that’s always looming large in our decision making, but of course like most places, we live with finite resources and it’s always a challenge to decide how are we going to meet our sustainability goals, while at the same time paying for other kinds of investments that we need to make at the university. So the move towards an endowment portfolio that is sensitive to ESG came naturally to us, the environmental sustainability piece of it in particular.

 

DIANNE CHIPPS BAILEY: So what would you say to other university presidents as they seek to advance these goals?

DR. JAMES HERBERT: Sure. Well, I should begin by saying that every board is unique, every university is unique and so I wouldn’t presume to speak for everyone, but I can share our experience in case that might be helpful to others.

 

The first thing that was very helpful and, this was in partnership with our colleagues at Bank of America Private bank, was to discard and all or nothing approach. People tend to think that you’re

either all in on fossil fuels and there’s just no limitations whatsoever, or that you go to a carbon zero portfolio and there’s sort of a middle ground in there. You can move away from carbon investments, down to a very, very minimal amount without guaranteeing that you’re 100% carbon-free. And so for us, that was important because the difference between being able to say that we have a greatly reduced portfolio, versus going carbon-zero, there’s a big bridge there between those two and that was the first thing, is discard the all or nothing approach.

Second is there’s a myth, a very commonly held myth and certainly amongst our trustees, that the returns, that if we were to make this move, we would be sacrificing returns. And indeed, we had one trustee on our investment subcommittee who believed that philosophically, any limitations that were put on our investments would, one way or another, be concessionary with respect to returns and that it’s his job as a trustee, the fiscal governance part of his job, is to make sure that we don’t do that, that we return the maximum returns. And so he had some concerns about that. So, as I can describe more, our partners were able to help us see that we don't have to make that sacrifice that, in fact, it's a myth. And that this was getting to where Jackie was just talking about, the actual returns can be on par with what they would have been otherwise or actually even a bit better.

And finally, the third point, and this was the one that was really critical for us, because we had a number of trustees who were sort of in the muddy middle who weren't sure if this was a good idea or not. They understood the point of sustainability, to our core mission, but on the other hand, it just didn't feel right to them to be making this change because they worried about the precedent it would set and that we were going to embark on a slippery slope. In which case if we made this change, then tomorrow, it's going to be something else and the next day, something else and they're going to be constantly asked to further restrict the portfolio in some way. And so what we did is I made it very clear that the proposal was not to set a precedent and that this would be a change only focused in this way. And that we would be very explicit about not setting a precedent and we would include that in the meeting minutes, going forward that this was the change we're making, but it's in no way intended to open up the door for future change. And that was really what was that last piece that was instrumental in convincing the rest of the Board that this was a good thing to go ahead and do.

 

DIANNE CHIPPS BAILEY: Fascinating. James, let's talk a little bit more about the role of UNE’s volunteer leaders. And I'm thinking both in terms of the members of the Investment Advisory Sub-

 

committee, but also the full Board of Trustees. This outcome, it was not achieved in a meeting or two, it was a layered strategy to achieve this really powerful mission-aligned goal. Can you reflect more about the board governance process?

DR. JAMES HERBERT: Sure, sure. Absolutely. Thank you for that. So we, first of all, I would say this, as you said, this didn't happen overnight. It wasn't something that just happened. This is something that's been on my mind for quite a while. And it began with discussions with myself and the Board Chair, as well as the Chair of our Finance Committee; those two people were really key partners. And I think without their buying into the idea of moving forward with this, I would not have pursued it.

But that was a partnership, and they understood the importance of trying to see if we could do this. And with their partnership, we then had something that really helped us, which was we had a new trustee join our board who was very committed to environmental activism and to sustainability goals. And so the Board Chair with my consultation, we appointed her to the Finance Committee and to the Investment Subcommittee of the Finance Committee. So now we had an advocate amongst the Board, a very vocal advocate, who could bring this forward. Now on this Subcommittee, as I mentioned, we also had some early one trustee in particular, who was not so keen on this idea, but at least allowed the conversation to be heard at the meeting. And then what my goal was, at that point, was to get them to be willing to consider it, consider the data.

 

And it's at that point that we reached out to our friends at Bank of America Private Bank and they put together... and we asked them to come back and put together a proposed portfolio. And then to come back and with data indicating how it would look compared to our existing portfolio and our custom benchmark as well. And so they did just that. They put together a really nice portfolio that was uniquely tailored to us, given the size of our institution and the size of our endowment, and then we did the analysis. And in the end, we asked them to go back. And they went back and looked at various metrics over the trailing eight years. And sure enough, the data spoke for themselves and showed that the returns we would expect to the extent that, you know, past is prologue, the returns that we could expect would be comparable, actually slightly better than our existing portfolio. And that was really key.

And so it was a series of conversations, if you will, with the Board informed by data. So once I made the first step of getting them to commit to at least looking at the data, then when the data came back, it was very empowering. So eventually we got the Subcommittee on board and then they took it to the rest of the Board and with the Subcommittee's... well they took it to the Finance Committee, which then of course went to the rest of the Board. So with each step of the way, given that we had done our homework and we were able to ensure that we should expect that the returns would not be impacted negatively, and this would be an otherwise good thing to do, folks got on board.

DIANNE CHIPPS BAILEY: And a unanimous vote no less, that's terrific. Brian, as the outsourced Chief Investment Officer for the UNE Investment Advisory Subcommittee, I'd be so curious to hear you reflect on your role. James has already described it, from his point of view, but in really working closely as a collaborator to achieve this result. Now, what are some of the specific steps that you took in supporting the process?

 

BRIAN O’DONNELL: Thank you, Dianne and certainly great to be here as well. Let me just start with kind of echoing Dr. Herbert's comments, in terms of how we want to engage.

First and foremost, every institution is definitely unique, and how they want to pursue their unique mission, and how their board of trustees and investment committee members approach things and

 

collaborate on things. And so our role really is to start off with this idea of doing great discovery work, listening to all the constituents and what they're trying to achieve, and then help guide them with real dispassionate data analytics, so that they can make really informed decisions when we're done. And this topic of conversation around ESG is one that is definitely not clear cut in all cases and can lead to some very robust debate.

One example that I would give is how the industry has really transitioned over time from this idea of just negatively screening securities out of portfolios, to one that is today much more proactive in identifying the best actors that are really making a difference and fulfilling on all aspects of ESG. And so helping people understand that framework and what the data actually means.

The other piece of the puzzle that every committee will bring up is understanding, am I giving up anything performance wise? So we went through a very disciplined exercise to take the current portfolio, and then compare that to other iterations that would potentially accomplish the goal of reducing carbon exposure, and then doing the analytics around historical performance and was one favored versus another. And we were able to really clearly demonstrate for the committee that there was no performance give up by making a series of decisions to move them towards more sustainable practices. And so we always want to lean in on this idea to establish the strategy, and then we set about executing it, and then lastly, we're going to help them evaluate it on an ongoing basis. And the example that I would give is, over time, many companies have morphed their business practices. And maybe at one point in the past, they would not have scored well on certain ESG factors and they're making decisions actively today to make improvements. And in the future, that same company may score actually very positively and be more in that proactive camp. And so this will be an ever evolving puzzle for people to track the data and try to understand what really fits and aligns with their mission.

 

And so our role continues to be to bring them the right data set, be dispassionate and really give them a 360 degree view before they engage in making those decisions.

DIANNE CHIPPS BAILEY: Thanks for that, Brian. You know Jackie, if you listen to James and Brian's case study here, right, with UNE, how do you connect it back to the broader trends and what you're seeing in the industry?

JACKIE VANDERBRUG: Yeah Dianne, there’s so many echoes here between what UNE’s process was and the overall industry. I’ll just point out three.

 

The first, exactly as Dr. Herbert said, the shift of that myth of underperformance and specifically the concern about ESG data being a constraint. The overall industry starting to understand that because the ESG data that we have now is so completely different than it was even five and ten years ago.

You know, historically, as Brian said, sustainable investors had more crude data and they used it to just exclude. We now have data, over 90% of companies are disclosing ESG data in different ways. We’re scraping the web, using all sorts of AI to get better data. And so investors are using this data, in addition to traditional fundamental analysis. It’s an expansion, not a limitation in terms of that

investment process. So that’s number 1 in terms of why we think that this is not that limitational, getting you to a lower risk return profile.

 

And then the second thing is really this process piece, which is it’s not an all or nothing and it’s not something that happens overnight. So investment committees and boards understanding this is a journey. It’s a journey that they want to start and there’s lots of different ways that we see boards starting, but that aspect of okay, let’s take a look at our portfolio and how does it align or not align with our values. What does this mean, also from a risk exposure perspective?

 

And then finally the commentary in terms of climate, we are seeing clearly across the financial industry an understanding of the materiality of climate to the investment process, both from that perspective of the physical risks that we’re seeing from extreme weather, but also from the transition risks, whether it be from technology, whether it be from policy or regulatory changes, the incorporation of that being really important.

 

And I think you saw all three of these in this dynamic between how the Board went through and played through their fiduciary responsibility of asking questions and looking at what does this mean both for our investment process now and for that precedent in the future.

DIANNE CHIPPS BAILEY: Thank you Jackie. And Brian, likewise, from your perspective – how is the UNE case study representative, or not, of your experience working with other clients?

BRIAN O’DONNELL: Certainly, it’s representative in that there’s always a variety of opinions and positions that committee members or people who are on the board of trustees are coming from and it takes somebody with the right temperament I think, like Dr. Herbert, to get them to coalesce and engage in what I would just describe as a very productive conversation. Whether UNE pursued this path when we were done with the analysis or not, they took the right steps in getting the issues on the table and having a robust dialog around it. And, I think ultimately for any institution, that would get them long term where they need to be.

 

And so while every institution is unique, and I would say the investment landscape is also unique in that it’s ever evolving, this is will continue to be, I’ll say, an issue that’ll be front and center for the rest of my investment career in helping committees understand what the tradeoffs are, if there any and make sure they have the right dataset to make informed decisions and I think of it as this 360 degree view before you make a decision.

 

DIANNE CHIPPS BAILEY: James, our focus so far today has been on investments, appropriately so, this is an investment committee bootcamp after all, but say more about the other positives aspects that came from this decision to embrace a carbon reduced portfolio at UNE.

DR. JAMES HERBERT: Sure, sure. Be happy to, but first I have to say, it’s very nice of Brian to essentially complement me, but it really is – it was a team effort. I mean nothing happens, it takes a village and I have a wonderful relationship with my Board Chair and the Finance Committee Chair and I think that having that strong foundation was very helpful and also frankly, the partnership with you all was very, very helpful. Because, to Brian’s credit, when he presented the data to us, he did not, there was no hard pitch, not hard sell to it. It was just, he was giving, we asked for the data, he presented the data, he answered the questions fairly and objectively, and I have to say that was very helpful, because I think, knowing our trustees, if they had suspected that they were being sold something, even if it was a good thing, that would not have gone well. So allowing me to orchestrate the conversation, but to help provide us the data and to answer the questions clearly was really helpful. So just wanted to focus on that process.

But Diane, back to your question, this was a huge gain for me personally and for our community, because as I mentioned before, we have a lot of our faculty and students are very invested in this space, in these concerns and I am under constant pressure to spend more and more resources on developing new alternative energy sources and that sort of thing, which we’re addressing, but at the end of the day, you only have so many resources.

 

This is something that didn’t cost me personally, anything out of our budget and yet it was something we were able to do, which is a big win. And materially, it really is a big win, but psychologically, and from an optics perspective, it was also very important. So, I was able to go back to our faculty and our students and say, our trustees have made this decisions and they were very, very pleased and so it built a lot of good will at the community around this issue. And also frankly, for the Board of Trustees. It helped our community see the Board as partners, as opposed to as this entity that is only concerned about the bottom line. And you know, a lot people, a lot of folks, within the academy tend to see trustees as being business people who are disconnected from their core

concerns. And I’m not suggesting in any way that that’s the case, I’m just saying that that’s the reality of the perception oftentimes. And this actually built a lot of goodwill towards our trustees as well.

And I’ll say one very positive thing about this is that the individual, the trustee who I mentioned – this was her passion and she was a real partner in helping move this forward, about 10 days after this decision was made, she made a million dollar gift to the university. Quite unexpected, and very welcome I might add. But that was another sort of indirect, positive thing that came out of it.

 

And at the end of the day, fundamentally, it’s about our mission, right? So circling back to the beginning of the conversation, at the University of New England sustainability is really a key part of our mission and this is something that advances our mission and it’s very consistent with our mission. So I think, had that not been the case, it might have been a different conversation. And again, I want to be clear once again that I’m not suggesting that the path, the exact path we followed will work for everyone else, every situation is unique. But you know, it was a good thing. It was a great thing and it was very helpful, really across the board with all the various stakeholder groups.

 

DIANNE CHIPPS BAILEY: Wow, just wow. James, thank you so much and thank you of course Jackie and Brian too. What a great conversation and the lessons learned from the University of New

England, they’re just a guiding light for leaders that volunteer and professionals at nonprofits who are ready, really ready to reflect those mission-aligned values in their investment portfolios. Thank you again for your expertise and your insights. And with that, I’d like to hand it back to Ann Lindberg for closing remarks.

ANN LIMBERG: Thank you so much to all of our panelists. I promised at the start of our call today that we’d provide you with information that you need and hopefully there are a few takeaways here.

 

The first is that the work you do, serving the mission of a nonprofit organization requires intense and knowledge of a very special type. Some of you have acquired this knowledge over years of practice, but for others, the process may just be beginning and we hope that you’ll feel confident in turning to us as you seek to strengthen your own skills and knowledge in this area.

The second point is that ESG investing is here to stay. Whether or not your organization chooses to integrate ESG considerations into your portfolio, like the University of New England, the ongoing evolution of ESG measurements will be a strong influence on your work, and we at bank of America will continue to help lead in this area.

 

Third, and finally, I hope that you know that as an organization, we’re your partner. And we’re here to serve you across the continuum of strategic investment, advisory and governance needs, whether

 

for a very large, sophisticated organization, or one that’s just emerging in terms of impact and mission.

Thank you so much for joining us here today. We greatly appreciate that and we’d love to talk with you more in detail on anything specifically that you need. Please let us know how we can help. I want to thank you so much for your time and for your attention today and we certainly don’t take that lightly.

 

And most of all, thank you for all you do as such a critical and important part of our society. We strongly believe, as you do, that we have a role to play in this continuum. And through our partnership and collaboration, we’ll play that role together. We look forward to our further conversations.

Thank you, and have a great afternoon.

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