Investment management for nonprofits: Outlook 2022

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Investment management for nonprofits: Outlook 2022

Please see important information at the end of this program.

PROGRAM TRANSCRIPT:

JENNIFER CHANDLER: Thank you for joining today. I'm Jennifer Chandler, Head of Philanthropic Solutions for Bank of America Private Bank. And we're so pleased you could join us for today's important conversation. You all play a key role in driving impact and change to better our communities. You include nonprofit CEOs, CFOs and CIOs, as well as board members and board chairs, and those serving in other capacities representing organizations across the country. You all make a positive difference in our society, and we thank you. In the same way you live your lives with impact and purpose, we at Bank of America are also engaged in a social mission, adding to our long standing commitment to supporting jobs, housing, health and small business, Bank of America Corporation committed an additional 1.25 billion during the pandemic, which was incremental to our prior foundation giving.

As one of the longest established investment management firms in the country, we oversaw 65 billion in discretionary Outsourced Chief Investment Office, OCIO assets, for nonprofits just like yours and more than 63 billion in additional philanthropic assets as of September 30th, 2021. In addition, through the trust we administer, Bank of America is one of the largest grant makers in the nonprofit sector, and we distributed 498 million in 2020. Through this combined set of practices, we bring extensive experience delivering a wide range of services to nonprofit institutions. This experience also helps give us the ability to anticipate and address the distinctive needs of organizations just like yours. Now we frame today's conversation around six key topics. Market outlook for 2022. Liquidity solvency and the role of credit. Asset allocation and an environment of higher inflation and rising interest rates. Values as drivers of portfolio construction, fiduciary governance and high impact philanthropy to further advance endowment growth for your organizations. And today you'll hear from a number of our thought leaders, including Chris Hyzy, our Chief Investment Officer for Merrill and Bank of America Private Bank, whom you see regularly on CNBC and other media outlets. Chris is responsible for determining the Investment view for our wealth management business. We also have Ken Burton with our specialty health care and education nonprofit division with Bank of America's Commercial Bank. Ken will share how we have a broad range of services to help support the nonprofit organizations we work with, including banking, credit, treasury management and investment banking services. We in the philanthropic group work hand-in-hand with Ken's team to provide nonprofits with a comprehensive approach to help address their financial needs across both sides of the balance sheet. We also have Dianne Bailey, who heads our private bank, national consulting and advisory practice. Dianne manages a team of professionals who bring our nonprofit clients expertise across foundation grant, making board governance evaluation and strategic fundraising. You've likely seen her speaking publicly as a thought leader or you've seen or captured her TED talk on Fierce Optimism. Last but not least, we have Bill Jarvis, who leads our thought leadership for the Bank of America Private Bank Philanthropic Practice. Bill will moderate our discussion today to ensure we hit on the topics that are most timely to you and relevant for 2022. Today's event is the first of a series, so after the panel, I'll tell you more about what to expect in 2022 in the New Year. So without further ado, I'll turn it over to Bill Jarvis.

BILL JARVIS: Thanks very much, Jennifer. And thanks to all of you who are joining us today. A year ago, we gathered to salute 2021 and to anticipate the trends for that year. Today, Jennifer has laid out the six broad topics that our colleagues will be reviewing in today's talk. They can be grouped under three major themes. First of all, what is new for 2022 and for better or worse, what has remained? Second, for those of you in charge of fiduciary governance for your organizations, what challenges confront you in balancing the urgent interests of the present against those of the future? And third, but not least important, what will it take to succeed not just as investors, but as mission-driven organizations in 2022. For our initial theme, I'm going to turn first to Chris Hyzy, who will set the stage from the economic and investment point of view, our colleague Ken Burton from our nonprofit banking team will then review the key factors of liquidity, credit and optimization of incoming cash flows. We’ll then come back to Chris and ask him to address what these factors mean for strategic and tactical asset allocation decisions for organizations like yours. And finally, but equally important, our National Philanthropic Strategy Executive Dianne Bailey will set these factors in the context of the integration of organizational and mission values into the investment process. So let's start with Chris

CHRIS HYZY: Okay thanks, Bill, you mentioned what is new for 2022, and our whole theme for 2022 is called the Great New Dawn. And the Great New Dawn is really in the morning hours of what we originally produced more than a year ago, or just about in about a year and a half ago in May of 2020, where we outlined the five phases of a workout process. And the fifth phase was in 2022, which we called the New Frontier. So the New Dawn is the first half of the New Frontier, and it includes many shifts, many adjustments. And when markets go through quite a few shifts and adjustments, typically volatility increases. So the prevailing wisdom out there is markets are going to get more complex, policy is going to get more complex. And when we hear that and we think about that, what we have to do is get a little bit more simple as it relates to the outlook and what to do in portfolios. It's a little counterintuitive than what most people believe, but we see a number of different shifts in regimes that I'll go through briefly. The first one is obviously the Federal Reserve's monetary policy. It's not only going to going to get tighter, but dramatically less accommodative and at the same time entering in a few wild cards like balance sheet contraction. In the market, overall, both the fixed income and equity capital markets have yet to fully discount the aggressive nature of what the Fed could do by the end of next year. We'll see more about that in the next few months. That's point number one.

Point number two is nominal growth led by stickier and higher level of inflation is not only still with us, but it's likely to be higher than what the conventional wisdom believes. Point number three, driven by revenue growth and operating leverage, profit growth, in our opinion, should also be significantly higher than what the consensus believes and roll that all together, the market environment. We still believe we're in a bull cycle. However, we're going to work harder for those returns. It's a grind it out, higher volatility environment, one of which we have characterized this market as a buffalo market. A buffalo market is still in the bull family, but it's heavier. It tends to roam once in a while. There's a lot more action on the prairie. In other words, below the indices, and we have to look for trends that are gathering momentum. The trend that we see gathering momentum continues to be the more value end of the market, taking the leadership end, on a sector basis, a split within the technology sector. And then last but not least, we see the core elements of driving competent and yet growing dividend yield being a major important factor for this type of marketplace. Last but not least, Bill, when we end 2022, we will still have a tightening cycle, in our opinion, from the Federal Reserve. We will have a higher level of geopolitical risk. But the single most important bedrock for our foundational buffalo or bull market cycle continues to be profits, and that's the area that we still see moving forward and not backward. Last but not least, there's a lot of talk about higher rates increase in yields, not just the short end of the curve, but the long end of the curve impacting discount rates and valuations. We agree. But we believe that the level of profit growth supersedes the level of potential valuation decline, thereby creating still an uptrend in this potential bull market continuing.

BILL JARVIS: Well, thanks very much, Chris. That's a lot of territory covered in a brief period, and I know we'll return to you, but thank you for setting the stage there. I'd like to turn now to Ken to address questions of liquidity, solvency and the role of credit, Ken.

KEN BURTON: Thank you, Bill. Liquidity and access to credit are main concerns of CFOs because the pandemic has affected all nonprofits differently, with some organizations fighting to keep their doors open and others experiencing record levels of funding. We're seeing CFOs and finance teams go back to basics, meticulously managing sources and uses of liquidity, keeping a tight rein on operating liquidity and putting any excess liquidity to work. In today's low rate environment, CFOs are keeping their liquidity at the short end of the curve and choosing financial providers based on risk profile and not just rate paid as they anticipate potential rate hikes in 2022. On the credit side, demand has moderated from early pandemic levels, COVID-revolving credit facilities have been replaced with resized general corporate purpose revolvers and pricing has moderated. Cash and liquidity continuum management, however, have also become part of the strategic picture because it takes resources and infrastructure investments to meet the mission of most non-profits. Investment in infrastructure could include increasing digital capabilities, enhancing cybersecurity or attracting, retaining and developing staff. From a resource perspective, I'd like to highlight the impact of transformational gifts. CFOs and finance teams must ensure that transformational gifts have transformational impact over the short, medium and long term. And while this can be a daunting task for staff teams, Bank of America's banking and philanthropic solutions teams seamlessly deliver solutions to help CFOs maximize their organization's liquidity position every day. Finally, the significant ebbs and flows in the contributions, disbursements and operational needs make coordination between financial management, investment and development functions more important than ever. This coordinated approach helps to ensure that nonprofits not only survive in this environment, but that they thrive and achieve their greatest good. Back to you, Bill.

BILL JARVIS: Well, Ken, thanks very much for that overview, and I want to take a pivot back to Chris here because you both referred to the potential for increases in interest rates. And I know this also is an environment in which we've seen reports of higher inflation. Chris, can you give us an investment context in terms of asset allocation in this environment of higher inflation and potentially rising rates?

CHRIS HYZY: Yeah, Bill, it's an important concept, and, you know, Ken touched on a lot about the direct impact that inflation can have on the rate structure, and I’m just going to briefly go back a little bit that we've all, since the global financial crisis, been in this environment of secular stagnation. And there was a major shift by the Federal Reserve's policy back in 2019, which began to target inflation, to get inflation up to a particular level. Well, with the amount of money that's been added to the balance sheet, as well as other fiscal outlays, we're now working off of inflation that is four decades at a peak. In other words, the last time we reached this level was four decades ago in the number of inflation indicators. It's going to be hard to get that inflation reading down to a level that they're comfortable with without doing the dual tightening of quantitative tightening. In other words, balance sheet contraction and rate increases. That's going to take time, and they're looking to phase that in and be a more balanced approach to removal of excessive accommodation. So what do you do? Well, on the fixed income side, more exposure to floating rate instruments is one area that we're seeing people add allocations to. In the equity side, one of the ways particularly is equity is net worth. Equity is the residual value of between assets and liabilities. So that's an area where dividend, core dividend areas of a portfolio are enjoying more flows as well heading into this year, which is very different than last year, which was all about conceptual, lower quality, higher tech innovation companies that were known as long duration parts of the market. So we see a big split going on in the market. We call it a parting of the seas, and a lot of it's driven by this new regime we're in not just by the Federal Reserve, but honestly an elevated level of inflation that's going to be hard to bring back down to the level that they're more comfortable with.

BILL JARVIS: Thanks very much, Chris and Dianne, I want to turn to you now because we've talked about the environment, we've talked about the economic situation, but of course, nonprofit portfolios are not constructed in a values vacuum. They're constructed with a strong view, often toward institutional and stakeholder values. Can you address how this affects this process then?

DIANNE BAILEY: Bill, before I talk about how boards are building values into their portfolio construction, I'd like to take a step back and reflect on the generosity of donors that enable boards to steward these assets. Last year, as Ken has already indicated, we saw transformational giving increase in many instances. Of course, we all read the headlines detailing Mackenzie Scott's generosity. But we also know about this phenomenon through our research. In the 2021 Bank of America Study of Philanthropy, which was released in September of that year, we saw giving increased by affluent Americans up to 48% to meet these urgent needs. And organizations that received these transformational gifts, and other organizations as well, are making informed decisions about how to use these assets or invest them. And increasingly, we're seeing mission-aligned investment strategies gaining popularity. And that is in large part due to the demographic shifts in philanthropy and in board membership. Let me tell you a little bit more about what we've learned from the Bank of America study of philanthropy. What we've learned in this research is that the rising generation and also black African Americans, as well as LGBTQ+ individuals, are building sustainable investment strategies into their own portfolios. So naturally, they would bring these mission-aligned investment practices to the boardroom and investment committee meetings as well. So as board, demographics are changing, so are the conversations about how organizations can align their endowments with their mission values.

BILL JARVIS: Well, thanks to all of you, Chris, Dianne and Ken. I'd like now to turn to the topic of fiduciary governance, in other words, the governance structures that are used for endowment investing. We know that the traditional investment committee structure that many of you use in your own organizations has been challenged in the volatile investment environment that's existed since what Chris referred to the global financial crisis of 2008/’09. Most investment committees meet only a few times a year, four or maybe five times, and as a result, they're unable to respond to fast moving market changes. Increasingly, we see investment committees recognizing that they do need greater agility to benefit from market movements, and this has led to the growth of what Jennifer referred to earlier. The growth of implemented consulting, as it's called, sometimes Outsourced Chief Investment Officer, OCIO structures. But outside the investment arena, we also know that nonprofits are seeking to grow for the future and frequently need funds in order to do that. And in this regard, credit and debt facilities can be very important. I'd like to turn to Ken now, Ken, could you comment on developments relating to operating funds and liquidity?

KEN BURTON: Absolutely, Bill. With interest rates at or near historical lows, we're seeing many non-profits set up credit lines to lock in low rate funding. Eligible nonprofits are issuing tax exempt bonds to fund their long lived assets for long tenors at low interest rates. Yet in certain circumstances, bank credit facilities can be an attractive alternative to public bonds for three or four reasons. First, because of lower issuance costs. Also simpler documentation, limited disclosures and the speed of execution. And longer tenors of 10 to 15 years for well-qualified borrowers is also making bank financing an even more compelling alternative to bonds. In addition, when an entity borrows from a bank, they get a dedicated relationship manager that is committed to bringing the full resources of Bank of America to help them achieve their mission, continue to improve their operations and navigate the changing financial landscape. And this dedicated coverage will be particularly valuable now as borrowers begin the shift from the historic LIBOR-based loan convention, to new base rates like SOFR and BSBY. On another note, we often see nonprofits issue long term bonds to avoid drawing down endowment assets. But many of our clients have borrowed in the bank market to fund cash outflows for two reasons. First, bank tenors have increased, as I said earlier, to 10 to 15 years for well-qualified borrowers. Second, banks offer medium term capital for those clients who are looking to invest in infrastructure and technology projects. And since medium term capital is a leasing solution, it can be done outside of the Master Trust Indenture or MTI, since it would be secured by specific assets. So to recap Bill, rates are attractive, the bank market is available to nonprofits with strong credit profiles, and our teams across the country are ready and willing to review specifics on a case-by-case basis.

BILL JARVIS: Thanks very much, Ken. A very valuable perspective, particularly since rates may be rising over the medium term. But from the governance side, Dianne, it may be more difficult to make the case for endowment with donors. If, as we seem to anticipate, investment returns may be lower in the future than in the past. Can you show us some of the factors at work here?

DIANNE BAILEY: Absolutely, Bill. In a low interest rate environment and particularly an environment, we're balancing the urgency of the day with the desire for many organizations for the ability to operate in perpetuity. You know, you're looking at a time when the needs are vast and increasingly urgent. And so conversations are happening both with donors and with operating charities about this balance. And for many, it's actually attention and they're falling on the side of deploying capital today. We're increasingly seeing donors give funds that are unrestricted and also organizations that are donors being created with a limited lifespan; a finite time horizon in which to propel their good work. And I will say, though, as a counterpoint, if the pandemic has taught us anything at all, it's that we can't predict the future with complete certainty. Right? So we're at a point where we need donor education, right, to really enable nonprofits to obtain significant but unrestricted funds to support their ongoing operations, really trusting future leaders with the flexibility to either invest or deploy these resources in an environment that is constantly changing.

BILL JARVIS: Thanks, Dianne. And I'd like to supplement your comments with a few of my own on endowment spending trends and preserving assets for the future. Many nonprofits, including private foundations, have traditionally considered a 5% annual spending rate as prudent, but in a lower return environment, if a key goal is to maintain purchasing power how do you determine what’s a prudent spending rate in light of this tension that Dianne described between the needs of today and the needs of the future? That inflation adjusted maintenance of purchasing power. In this context it’s helpful to think of endowment as a kind of potential capital for the organization and be thinking about that balance sheet maintenance in the context of prudence with respect to the long term future, and the relationship that exists as a whole between spending, asset allocation and risk. We're now going to turn to the third of our major themes. What will it take to succeed in 2022? Chris, could you kindly give us your view from the investment side?

CHRIS HYZY: Yeah, I think success in 2022, Bill, is about it first becoming a foundational year for the next ten years. A foundational year in which demographics across the United States and the globe are taking a little bit more of a leadership position on the driving of trends, particularly as it relates to the millennials and Gen Z crowd and how that affects economic growth. So if you start there and you look at your portfolio, I think we got to go back to basics again. Very much, what is the role of each instrument of each segment of the portfolio? What does it play for that portfolio? And then when you roll that all up, how does that total return environment look versus the most recent past? I think what we'll see is that 2022 becomes, yes, potentially a lower return environment, but actually a foundational year that still creates, in our opinion, a total return that's still attractive on an overweight to equity basis. One of the things that we are looking forward to in the next few years is New Vintage Years, particularly in alternative investments in private equity and real estate, coming off of areas that have enjoyed some sizable returns recently, but also a whole new world of infrastructure, a whole new world of how real estate is changing and a whole new world of new private equity area. And that's an area of potential growth still as it relates to a full portfolio. But when you're talking about equity and fixed income, the equity asset class, in our opinion, is still more attractive than fixed income as yields rise. That's number one. Number two, if we're going back to basics, we also have to consider more frequent rebalancing. Being a little bit more active with asset allocation around a dedicated risk budget. That sounds very fancy and complex. But it's very simple as it relates to what is the tactical asset allocation that one particular entity needs to create a potential total return that is consistent with spending patterns. And when you over-risk that budget, in other words, appreciation happens, and it's good, it's time to take some of that surplus down. And then the opposite when an asset class obviously enters into more volatility, negative volatility, it's time to reweight that back up to tactical asset allocation. We haven't seen that type of environment in quite a few years, and with these regime shifts changing, we think more active rebalancing also should be considered.

BILL JARVIS: Thanks, Chris. And in that context, it's important to remember that risk can be considered and defined in a number of ways. Risk is not just volatility. There's liquidity risk, drawdown risk, reputation risk, other types of risk than are taught typically in investment textbooks. And part of your challenge as fiduciaries and with the advisers who counsel you is learning how to measure and assess types of risk holistically in the context of not only your balance sheet and income statement and investment programs, but also in the context of your mission. And overarching all these issues we've touched on today is this question of roles and responsibilities. The things that you who are attending the session today as fiduciaries of the organizations will need to address and develop. Dianne, would you let us know your thoughts on these important issues?

DIANNE BAILEY: Certainly. We know that boards are going to be called upon to make strategic decisions not only about their investments, but also about how to attract the high impact donors we've already discussed today. And to do this, nonprofits must have boards that are diverse and inclusive of many, many voices. And to that end, we are working with our clients to overcome both the structural and the cultural barriers to board diversity. Through these practices we’ll ensure that the right group of leaders are in the seat and empowered to ensure that mission advancement and the success this year and well beyond.

BILL JARVIS: Thank you very much, Dianne, and thanks as well to our other colleagues, Chris and Ken. We hope that this has been a helpful discussion for you as we all enter this new and hopefully better year. And with that, I'd like to return to Jennifer for some concluding remarks.

JENNIFER CHANDLER: Thank you so much, Bill, and thank you to all of our panelists, Chris, Ken and Dianne, it was a great discussion. We hope you all found this information today very helpful as you navigate the complex and changing tomorrow. I also want to emphasize that we are here to help you and your organization and help you seek counsel on making informed investment decisions. Making both strategic and tactical decisions in a complex world. Advice and guidance with philanthropy. And all those things that impact your sustainability and the achievement of your mission. We're also here to help you with your implementation, whether it's grant making or creating greater impact or that benefit of fiduciary administration. As Ken mentioned, Bank of America is also here to help you with banking, liquidity and lending needs. We're an enterprise that can help you across both sides of the balance sheet with a cohesive team and a consistent view. Now I know we've just scratched the surface today on these topics, but the great news is that we're all here to help you with these topics and any others in much detail, so simply reach out to the colleague that invited you today. And we're happy to help. As I also mentioned, this is just the first of a series of conversations, so keep an eye out for invitations for more calls and discussions like these as we head into 2022. Again, thank you all. Wishing you all well and safe years ahead. And again, thank you to my colleagues joining today and all those attending.

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