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Nonprofit Boards: Understand Your Alternatives

If fiduciaries at a nonprofit don't understand how an alternative investment really works, how can they fulfill their duty to protect the interests and contributions of donors?

W. Scott Simon, 02/07/2013

W. Scott Simon is a principal at Prudent Investor Advisors, a registered investment advisory firm. He also provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. Simon is the recipient of the 2012 Tamar Frankel Fiduciary of the Year Award.

As I noted last month, this month's column will delve a bit deeper into alternative investments in nonprofit portfolios and hopefully provide some guidance to advisors seeking to enter the nonprofit marketplace.

Perhaps the first thing that such advisors (and those already toiling in the nonprofit marketplace) should know is that the 2006 Uniform Prudent Management of Institutional Funds Act (UPMIFA) governs the investment conduct of the fiduciaries (e.g., directors and trustees) serving as stewards of the portfolios (e.g., institutional funds) of charitable organizations. UPMIFA also applies to the agents (e.g., investment advisors) to whom these fiduciaries have properly delegated responsibility for investment and management of such portfolios.

The Prefatory Note to UPMIFA makes clear that the 1994 Uniform Prudent Investor Act (UPIA) served as a model for much of UPMIFA--as it did for virtually every other model act that was promulgated to implement standards of modern prudent fiduciary investing in the 1990s and the 2000s. My book, The Prudent Investor Act: A Guide to Understanding, covers this in detail.

Under UPMIFA, "…standards for managing and investing institutional funds are...the same regardless of whether a charitable organization is organized as a trust, as a nonprofit corporation, or as some other entity." Further, "Like UPIA, UPMIFA imposes additional duties on those who manage and invest charitable funds. These duties provide additional protections for charities and also protect the interests of donors who want to see their contributions used wisely." (My emphasis.)

Forty-nine states (Pennsylvania is the lone exception), plus the District of Columbia and the U.S. Virgin Islands, have adopted their respective versions of UPMIFA. UPMIFA applies to a jurisdiction's nonprofits that are in existence on the day its version of UPMIFA was enacted into law and to any decisions made, and actions taken, on that day and thereafter.

A Trio of Foundations
Recently, I ran across a trio of foundations grouped in a tight geographical area, each with portfolio assets in excess of $100 million. All three foundations have retained the same nationally known advisor/investment consultant. When glancing at the FAQs on the website of one of the foundations, I was immediately struck by the excessive investment costs of its portfolio, given its size. It appeared that a lot of work and extra expense has gone into achieving the portfolio's return even though it was rather pedestrian at best. Hmmm, high investment costs and mediocre investment performance: not exactly a good prescription for helping contribute to the goals--the mission statement--of that foundation or the other two foundations that had portfolio asset allocations remarkably similar to the first.

I then looked at the investments in the foundation's portfolio--or rather its asset allocation--since the identity of actual investments are rarely (or never) disclosed. Over 25% of the value of the portfolio was allocated to what are termed "alternative investments."

W. Scott Simon is an expert on the Uniform Prudent Investor Act and the Restatement 3rd of Trusts (Prudent Investor Rule). He is the author of two books, one of which, The Prudent Investor Act: A Guide to Understandingis the definitive work on modern prudent fiduciary investing.

Simon provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. He is a member of the State Bar of California, a Certified Financial Planner, and an Accredited Investment Fiduciary Analyst. Simon's certification as an AIFA qualifies him to conduct independent fiduciary reviews for those concerned about their responsibilities investing the assets of endowments and foundations, ERISA retirement plans, private family trusts, public employee retirement plans as well as high net worth individuals.

For more information about Simon, please visitPrudent Investor Advisors, or you can e-mail him at wssimon@prudentllc.com

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar.

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