The article below is reprinted with permission from The Capital Issue, a quarterly newsletter published by Lancaster Pollard.
A nonprofit's board has ultimate responsibility and accountability to its constituents for the organization's actions. Each board member has a fiduciary duty to ensure that the board acts in the organization's best interests and works to fulfill the nonprofit's tax-exempt mission.
Indeed, in its review of the tax-exempt status of organizations, the Internal Revenue Service describes the duties of board members and even provides a checklist to its agents for a review of 501(c)(3) public charities. Further, most states have similar laws addressing fiduciary standards for a nonprofit organization's board.
Duties of board members
As board members pursue their passion, it should begin with a basic rule of governance: Board members must clearly understand the mission and work in unison to achieve well defined goals. More importantly, for the betterment of the organization, the board must take advantage of its collective wisdom to prevent a single passionate individual from turning the mission into a bully pulpit. A personal crusade, while exciting, tends to narrow the focus of the mission, limiting the leverage of the resources available, including board members and available assets.
Staying true to the duties of board membership serves to maintain the focus of the board. Arguably, the most important is the duty of board members to be informed. Just as the board must work together to ensure that the mission remains the organizational priority, being informed is a collective duty as well. For example, there may be a few board members who lack the understanding of certain aspects of the organization, such as the effect of a recent decline in funding sources or the prospect of an unfortunate legal entanglement. To counter the collective lack of understanding, nonprofit boards should conscientiously and purposefully add board members whose professional expertise can be a resource for management.
Informed board members
These informed individual board members should not automatically be considered subject matter experts. Quite the contrary, they should know when to engage an outside advisor as a subject matter expert, whose qualifications are described by the knowledgeable board member, vetted by the appropriate committee and approved by the board.
However, it is sometimes difficult to separate the zeal from the knowledge of informed board members. This is especially true for board members who are also passionate about their profession or whose profession is closely aligned with the needs of the organization.
Because of the reliance of the nonprofit organization on its invested assets, it is not uncommon for at least one board member to have professional experience in the investment markets, such as a trust officer or broker. The existence of an investment professional on a nonprofit board fits well with the mandate of knowledge and experience in good governance.
Investment professionals as board members
Although there is an expectation that all board members are knowledgeable and can contribute to the strategy and oversight of the nonprofit organization, it is not without risk. One of the greatest risks is the introduction of a personal bias and opinion which may not reflect the policy defined risk profile of the organization. This is especially common as it relates to the investment portfolio.
Board members can share a common, albeit personal, experience with the professional trust officer or broker. This peripheral understanding provides the investment professional a platform and an audience to share the insight gained from experience. During investment discussions, however, the investment professional may interpret the interest in the topic to be one of building consensus, when in fact it is curiosity and deference to the professional. In this instance, the investment discussion becomes personal as board members look to enhance their knowledge of investment markets, possibly for their own personal use. The investment professional, then, must recognize the risk of "groupthink" in a board setting while providing expertise as well as introduce a subject matter expert when necessary.
Influences and risks
While the experienced investment board member is cautioned to temper his/her own personal opinions in order to avoid the advent of groupthink, they are not alone in this caution. Unlike many other outside experiences brought to the board by its members, nearly all board members have at least some direct experience in the investment markets, even if limited to a personal retirement account, such as an IRA or a 401(k), or a college fund, such as a 529 plan. Just as a board member’s personal portfolio should reflect the unique obligations and risk profile of the individual, the nonprofit portfolio should reflect the commitments and risk profile of the organization.
The direct personal involvement may inadvertently define the risk profile of the organization. There are generally two primary inputs to defining organizational risk profile: the ability and willingness to take risk. A more objective input, the ability to take risk is directly associated with the financial strength of the organization. The financial strength includes not only the current financial condition but financial prospects, such as a pending capital campaign.
On the other hand, the willingness to take risk arises from the personal attitudes of the board members. The personal attitudes are an important input, but must be held in context. Board members must be careful to separate their own personal bias and risk preferences from those of the nonprofit organization. In other words, the recommendations expressed by experienced investors should focus on what the organization should do, not what the board member would do (or has done) with his/her own IRA.
Comfort with board member experience in the investment markets may even lead a board to actions that seemingly eschew fiduciary duties, including the decision to internally manage the investment portfolio without the use of an outside advisor, sometimes referred to as "in-sourcing." While it is clear there is a cost to hiring an outside adviser, it is not clear that saving the advisory fee would result in a better outcome, even if the portfolio was invested only in index funds. A better decision is to ensure that the advisory fee is in line with services and expertise associated with the needs of the portfolio and organization.
Even though active boards and experienced board members periodically consider the risks and benefits of internally managing the invested assets, the vast majority of them choose to outsource rather than "in-source" that obligation. An honest assessment of available internal resources, including the cost of in-house management should be weighed against the risk of an undesirable result.
There are five key factors pushing institutional investors to move assets in-house:
- Access: There are instances where the third-party vehicles are not attractive, and access to a given asset or market can be more effectively achieved on a direct basis.
- Alignment: Principal-agent problems are pervasive in the asset management industry, and some institutional investors view in-sourcing as a useful mechanism to minimize agency costs.
- Capabilities: By developing an investor's internal resources, all aspects of the organization's capabilities are improved, as internal teams can identify 'unknown unknowns' about the business.
- Performance: Perhaps the most cited reason for in-sourcing by institutional investors was the desire to maximize net-of-fee investment returns.
- Sustainability: Managing assets in-house offers an investor the ability to think critically about how to tailor a portfolio to meet its needs (as opposed to trying to cobble together a series of external mandates).1
According to Principles and Policies for In-House Asset Management, "The independence of the organization, its resources and systems and the ability to identify areas of opportunity as well as challenges are all crucial elements of governance that can dramatically impact the success of any in-sourcing policy. So, before moving assets in house, institutional investors should first assess their governance capabilities to determine whether a given investment strategy is commensurate with its organizational capabilities."1
Board governance is an obligation that should not be taken lightly. Board members are passionate not only about the objective of the mission, but also of the manner in which the organization advances its mission. As such, board members should not be seen as subject matter experts, but as resources for the benefit of the organization, spending time and funds wisely. Fiduciaries should not seek to be high performing board members, but rather, encourage the development of a high performing board.
William M. CoursonWilliam M. Courson is the president of Lancaster Pollard Investment Advisory Group in Columbus. He may be reached at wcourson@lancasterpollard.com.
1 “Principles and Policies for In-House Asset Management.” Gordon L. Clark and Ashby H.B. Monk. Global Projects Center, Stanford University; December 2012.
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