Why nonprofit investors should stick to their strategic asset allocation right now
If you’re like many nonprofit investors right now, your board may ask you a lot of tough questions about the status of your investments. It’s understandable. The long bull market has done us all a little comfortable.
Today’s market is more than uncomfortable. It’s downright destabilizing. But before you panic too much, let’s put some context. First, take a look at volatility. It probably looks remarkably high right now, but a historical look back puts our current volatility into perspective. As of June 27, 2022, the CBOE Volatility Index (VIX) is at 26.95, which is above average. But compare that to the volatility peak of 79.13 on October 24, 2008 or, more recently, the peak of 66.04 on March 20, 2020. In other words, our current wild swings are fairly subdued by historical standards.
It is also important to consider the cyclicality of corrections and recoveries. Although past performance is not a guarantee of future results, it is important to note that dips and upswings tend to go hand in hand.
Finally, let’s look at the most likely scenarios for the near future. In our most recent Global Market Outlook, our colleague Andrew Pease, our Global Head of Investment Strategy, said: “We believe a slowdown or mild recession are the two most likely outcomes. US household and corporate balance sheets are in good shape, and they should protect against a more severe downturn.
With all of this background in mind, it was another difficult year for not-for-profit investors. So what should you do about it?
First do no harm
Now is not the time to start making wild changes. In this context of growing pessimism, non-profit investors might be tempted to react by making Something in their portfolios – whether that means reducing equities or increasing the proportion of fixed income securities. But we believe that making changes like these today would not be in their best interest. Instead, we argue that investors are best served by remaining patient and sticking to their strategic asset allocation and portfolio weighting for the time being.
Simply put, at this stage of the game, there is not enough information about what might happen to downstream economies and markets to place surefire bets. Yes, there could be a recession in 2023, but the Fed could also stage a so-called soft landing, where it slows growth enough to bring inflation under control without triggering an economic downturn. Or, the US economy could slip into a recession again – but not before 2024. Needless to say, each of these scenarios would likely have very different implications for equities and fixed income – and bet heavily on the one of them could turn out to be perilous when so much is still unknown.
Second, check your governance
I hope you’re the kind of nonprofit investor who’s taken the time to put together a rock-solid governance plan, with a solid investment policy statement that will guide you through our tough times. current. If you didn’t have the right governance in place before, making drastic changes to investments now won’t help. If you had the wrong strategic asset allocation, or if you didn’t know what your liquidity was or if your rebalancing ranges are too wide or too small, now is not the time to change them. As the saying goes, you go to war with the army you have, not the army you want.
If your governance – including your investment policy statement – is lacking, you’ve probably already found it out the hard way this year. Doing the work to create good governance can seem like a mind-numbing task during bull markets, but bad governance will be have a negative impact on you during difficult times. It is times like 2022 that test the quality of your governance. So, as difficult as it is, a governance audit is a good thing. If you find your plan and resources lacking, it may be time to consider increasing your resources through outsourcing.
Third, Use Your Rebalancing Bands Wisely
As we indicated above, we think now is the time to leave your strategic asset allocation aside. There are definitely some tactical moves you could make now, but we recommend you do. within the range of your rebalancing bands. Do you want to be at the bottom of your group or at the top of your group, depending on your short-term views of the market? Good. But stay in the bands to stay aligned with your long-term strategy, even as you adjust to them to take advantage of short-term tactical opportunities.
For example, suppose you are a university and due to declining markets you need to increase your spending percentage. You may need to increase your bond allocation to keep your liquidity high enough to meet these payment requirements. But it is important to stay within the agreed rebalancing ranges so that your long-term plan remains intact. If you find that your rebalancing ranges are too prohibitive to meet your needs, we recommend seeking professional help to resolve the issue. Making major changes in a volatile and unpredictable market comes with additional layers of complexity.
Bonus section: board questions you should be prepared to answer
You may have heard of your board before, with a question that somehow asks how well your plan is suited to handle the current market volatility. I hope you can respond and say, “We’re covered. That’s why we worked so hard on our governance and our investment policy statement. It positioned us well just for times like this.
Here are six more questions your board is likely to ask you — and which you should be prepared to answer:
- Which managers are down? Why are they broken?
- What exhibits do we have that help us? Is there anything positive?
- How much equity do we have and how much is it declining?
- Among the funds that are down, which is the lowest and why?
- Do we have enough cash to make the payments we need?
- Is there any use of leverage or derivatives on our behalf that could blow up in our face?
The bottom line
As a non-profit investor, a lot depends on the success of your investment strategy. And a big part of investing comes down to risk assessment. Earlier in the economic cycle, we thought the balance of risk was skewed favorably for equities and other risky assets to outperform bonds. Today, we consider the risks to be more balanced. Yes, there is a risk to owning stocks, but it is offset by the potential upside in market gains over the next year. And yes, there is a risk in owning bonds, but that is offset by the diversification role they are likely to play in the next recession. Ultimately, this is why we believe maintaining your strategic asset allocation or portfolio weighting makes the most sense at this time.
We understand that amid all the current uncertainty, it’s hard to resist the temptation for investors to do something about their portfolios. It’s only human, after all. But ultimately, we don’t think it’s prudent to make any changes to an overall investment strategy at this time. In our view, the best thing for investors today is to stick to their strategic asset allocation.
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Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.