2022 has been a challenging year in many respects. While COVID slowly starts to fade into the background, the war in Ukraine, inflation not seen in decades, and the fear of a recession put pressure on financial markets.

As a result, many purpose-driven investors are looking at negative financial returns. At the same time, amid a weakening economy and higher inflation, they likely need additional resources to achieve their purpose.

How should one manage this difficult situation? For a number of organisations, including many community trusts and foundations in New Zealand, their Statement of Investment Policy and Objectives (SIPO) may have an unappealing answer: grant less.

The built-in rules of some SIPOs raise a “slow down” or “stop” sign for granting whenever markets take a turn for the worse. Some of the common rules used are “reserving” and “smoothing” policies.

Whether it is reserving or smoothing, these investment policies are designed to protect organisations from overspending and ensure their long-term viability.

That is a laudable objective, but we believe it is crucial not to overstep the mark. The goal of a purpose-driven organisation is typically not to grow the investment portfolio, first and foremost. The primary objective should be to achieve the mission – the purpose for which the organisation was originally set up.

Therefore, we prefer a more balanced approach that we believe could help ensure that the purpose remains in focus. We have coined this approach “mission-first”.

Mission-first explained

The component that our approach shares with other policies is the determination of a long-term sustainable level of granting. We agree that if grants (and expenses) exceed inflation-adjusted returns over longer periods of time, an organisation will be left with fewer financial resources to further its mission.¹ However, compared to other policies, our mission-first approach would only prompt a change in investment risk or granting when the value of the assets is well outside the range of normal fluctuations.

Naturally, expert advice or guidance may be required to determine a sustainable level of granting across different investment environments. This assessment should have regard for the length of the investment horizon and, if appropriate, account for the unique opportunities perpetual investors have.

We believe that this approach creates a sustainable and stable granting forecast for the organisation and its beneficiaries. This ensures consistency in implementing long-term initiatives and that funds are available when they are likely needed most. The mission of the organisation should always come first – slowing or stopping granting should be seen as a last resort.

Comparison of approaches

In order to illustrate the differences between reserving, smoothing and our preferred approach, “mission-first”, we use an example of a hypothetical trust with ongoing spending requirements.

We use an example of a downturn and recovery in financial markets to calculate the following:

• Initial capital: the amount that was originally pledged to the trust.
• Inflation adjustment: the additional value required to maintain the inflation-adjusted value of the initial capital.
• Surplus/Deficit (“reserves”): the difference between the current asset value of the investment portfolio and the sum of initial capital and inflation adjustments.
• Granting: the level of distributions suggested by the methodology used.

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The graphs above illustrate that under “Mission-first”, the trust continues to spend money through a difficult period in financial markets, thereby ensuring that beneficiaries are not suffering from the volatility of investment returns. And while the trust ultimately ends up with a smaller asset value than under the “Reserving” and “Smoothing” models, the trust has been more effective through its granting – without threatening the long-term viability.

Focus on the big picture

We do not argue that the mechanics of reserving and smoothing are completely flawed. However, we believe that the long-term mission of an organisation should be the focus. Therefore, our mission-first approach may be an attractive alternative for some purpose-driven investors. We believe it could help create a better balance between prudent investment management and making a positive and sustainable impact over time.

¹ We note that there are organisations that have a limited timeframe, or a clear goal which may mean that this calculation is not necessary. Or, impact measurement may suggest that now is the best time to spend more of the financial resources than would otherwise be considered acceptable.