Risk and Asset Allocation in Investment Policies

BY Gary C. Rooth, MBA, CFP

The development and maintenance of a well-constructed investment policy statement is among the most important fiduciary responsibilities of an association’s board and staff.  When developed thoughtfully, and communicated to all relevant parties, the investment policy statement goes a long way toward managing investment risk and avoiding investment disasters long before they creep up. While a qualified financial adviser can assist you in developing your own guidelines through the use of surveys and assessments, following are some suggestions to keep in mind in determining two of the most important parts of the investment policy: your risk tolerance and, based on that, your asset allocation strategy.

IDENTIFYING TOLERANCE LEVELS

As with personal investors, associations must make investment choices based on the knowledge that the higher rates of return generally mean higher risk. Thus, it is important to establish your risk tolerance before selecting specific investment instruments.  In fact, the decision regarding risk tolerance is one of the most important investment decisions an association can make. An organization needs to consider various factors in order to make sound risk tolerance decisions.

Consider revenues.  It is important to view the risk decision within the context of the overall fiscal health of the organization. For those associations that enjoy varied and stable sources of revenue and have regular budget surpluses, the tolerance for volatility is higher than for associations in different circumstances.

Know your reserve fund’s purpose.  Some organizations might use their investment income as an operating budget revenue line item. Therefore, they would be unable to tolerate high-risk investments, as the budget could not handle such volatility and would have a lower risk tolerance. Others might not touch their funds unless a true emergency arose; they would have a higher tolerance for volatility.

Envision worst-case scenarios.  In setting appropriate risk levels, I recommend that association decision makers consider hypothetical scenarios using the organization’s asset levels, thinking in terms of actual dollar losses in addition to percentage losses.  When evaluating the risk tolerance for, say a $1 million reserve fund, a 15-percent loss in value may not sound terribly harmful to some ears, but a $150,000 loss may conjure up images of dues increases, discontinued programs, or staff layoffs.

The process of documenting an investment policy forces all those involved to carefully consider the validity of current practices. The ongoing process of policy reviews helps to ensure that the correct investment approach is being used to meet the objectives of your organization.