NFPs have all the main sources of cash inflows into their portfolios that other Australian investors have, including coupons, dividends, franking credits and, of course, the ready ability to sell their more liquid investments
Broadly, NFPs have all the main sources of cash inflows into their portfolios that other Australian investors have, including coupons, dividends, franking credits and, of course, the ready ability to sell their more liquid investments. There are a few wrinkles though. Unlike “taxable” investors, NFPs don’t get foreign tax credits to offset the effects of taxation on overseas assets and some receive substantial, if often irregular, donations.
However, the cash outflows for NFPs, like other investors, tend to be fairly stable. Clearly, no NFP board relishes the prospect of cutting a third of its frontline workers as a response to a GFC-style event hitting its investments.
Any NFP must balance its rather irregular cash inflows with a need for fairly stable income. For some NFPs this problem will be particularly acute: organisations which tackle poverty are likely to see demand for their services increase strongly when markets have collapsed and a major recession is underway.
What can be done from an investment perspective to minimise this cash flow mismatch?
Firstly, NFPs can decide they want to have 100% of their required income requirements for, say, the next one to three years, coming from very dependable sources, including bond coupons, dividends, franking credits and cash. Typically it is the finance team that will be called upon to periodically forecast this. With such a measure in place, the need to be a forced seller of shares in down markets is reduced.
Next, boards should remember that their tax preferred status can actually help them manage their liquidity. For example, there are no capital gains consequences from realising a profit on a bond before maturity to meet operational liquidity needs.
Third, investment policy statements can be reviewed to see whether there are some simple things that can be done to improve income. For example, when it comes to investing in term deposits, is investment allowed with any Authorised Deposit-taking Institution (“ADI”) with a minimum credit rating, or just those rated by one agency? In fact does it make sense to invest in any ADI, assuming it is covered by the government guarantee?
Finally, many NFPs use some sort of smoothing mechanism that partly adjusts organisational spending in response to changes in the market value of their investment portfolio. It’s a good way to have your cake and eat it too: organisations have a fair amount of certainty about their future income stream while also being able to invest with a longer term perspective. There are various formulas detailed on the web, the most famous being the “Yale Formula”, named after the University where it was invented.
Please visit www.fiig.com.au/nfp or contact Kate Hurse on (03) 8668 8834 for more information.