Nonprofts: Are You Ready for Alternative Investments?

Is your nonprofit considering making alternative investments? First, take a close look at your investment office staff.

Alternative investments have become increasingly attractive investment vehicles for institutions due to their often above average rates of return. They are trickier to manage, however, and place more of a burden on staff resources. Answering a couple of questions about the staffing of your investment office will make the change from traditional to alternative investing more painless, and more successful.
 
Is there enough staff? A simple question, but very important to answer as the increased selection, monitoring, valuation, and reporting requirements of alternative investing come into play. Investment staff should grow at a rate that is proportional to the growth in the number of investments. Has this been the case in your investment office? If not, correcting a lag in hiring should be seriously considered before making any alternative investments.
 
Does the staff have sufficient sophistication? Alternative investments are much more complicated to choose, manage, and report on than traditional securities investments and a higher level of staff sophistication will be required. The following list illustrates some of the ways in which alternative investing imposes greater requirements on investment staff:
 
  1. Selection. Investment staff will need to perform due diligence, risk and tax exposure assessments, and anticipate the costs of monitoring, valuing, and reporting on a specific investment going forward. The selection process must be well documented, both to provide information to your institution, and to document the decision-making process for the independent auditor.
  2. Monitoring. Alternative investments place additional monitoring burdens on investment office staff. For example, there is more difficulty in valuation (often only quarterly, or only when a “valuation event" occurs),assessment of the legitimacy of “capital calls” is necessary, there is a need to periodically meet with the alternative investment’s managers, and the ongoing exposure to risks such as unfair trading practices charges must be monitored.
  3. Valuation.  Unlike traditional investment vehicles, which can be valued minute-by-minute using market quotes, it is often difficult to assign a value to an alternative investment. Often the value is carried forward as at cost basis until a “valuation event” occurs. Establishing valuation policies is therefore a key task of the investment committee. In addition, documentation of the valuation process must be maintained, valuations for different funds that invest in the same private investments should be monitored for inconsistencies, and procedures must be put in place for management and independent auditors to test the reasonableness of valuations.
  4. Reporting. Alternative investments, with all of their complications, need to be integrated into your institution’s financial reporting system. Reporting must be clear on valuation policies, allow the investment committee and board to properly assess the investment’s performance, and fully disclose capital commitments.
 
Alternative investments remain an attractive option for non-profit institutional investing, but they do require more of investment managers and staff than traditional investment vehicles. Investment staff will need to have greater skills in due diligence, risk assessment, and policy and procedure development. Taking the time beforehand to assess staffing levels and sophistication will reduce the cost and risk of alternative investing.
 
For further guidance on preparing to make alternative investments, contact an MGO professional in your area.