HELPING LEADERS BECOME
B E T T E R S T E WA R D S .
CHURCH INVESTMENT SOLUTIONS
Presented by: Permanens Capital
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CHURCH EXECUTIVE • C H U R C H I N V E S T M E N T S O L U T I O N S
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Table of Contents GOOD GOVERNANCE = GOOD GIVING 4 A clear financial plan, including a sound investment policy, protects a church, its ministries and its people from a potentially devastating financial misstep. However, did you know this same plan can actually drive better giving, too? John Regan, Partner and Chief Investment Officer at New York-based Permanens Capital, which counts among its clients several large churches and the largest Christian university in America, explains. Featuring John Regan
MAKING THE CASE FOR CHURCH INVESTMENTS
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In many churches, cash reserves are either immediately applied to ministry expansion, or deposited into a traditional savings, CD or money market account. But, does this really represent the best possible stewardship? Featuring John Regan
HOW TO ESTIMATE NEEDED RESERVES Coming in July 2017
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C H U R C H I N V E S T M E N T S O L U T I O N S • CHURCH EXECUTIVE
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Good governance good giving A clear financial plan, including a sound investment policy, protects a church, its ministries and its people from a potentially devastating financial misstep. However, did you know this same plan can actually drive better giving, too? John Regan, Partner and Chief Investment Officer at New York-based Permanens Capital, which counts among its clients several large churches and the largest Christian university in America, explains. Q: A church’s revenue stream is largely outside its control. How can good governance and responsible investing make the revenue stream more predictable? Regan: Churches’ revenue streams are primarily derived from parishioner contributions. As there are many unknown variables (the economy, attendance drop-offs and so on) churches may not know when they’re going to be cash rich or cash poor. It’s difficult to gauge, especially for the future. A church leader might know that giving around Christmastime will often increase and that it may decrease during the summer; however, in between, he / she may have a more difficult time predicting church cashflows. How does a church protect itself against that unpredictability? One thing the church can do to smooth a “bumpy ride” is to have a cash spend policy in place, whereby the church never moves forward with a new project unless a certain dollar amount / percentage of that dollar amount is available in cash on hand. Additionally, if the church is fortunate enough to have saved money along the way, excess cash could be wisely invested to earn interest. The church could use some of that interest income, without touching the principal, to help smooth out those uncertain revenue flows. As an example, many independent schools do this; it’s called a ‘draw rate,’ or ‘draw policy.’ Based on tuition, the school knows how much it’s going to earn in the fall and spring, and what the overhead and operational expenses will be. Then, to the extent the school is going to spend more than it brings in in revenue, it draws off its endowment (without touching the principal) in order to fund the excess operating expenses. 4
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Q: In what ways does investing those funds represent good stewardship? Regan: I think it’s important to acknowledge a prevailing mind-set, here: that money donated to the church is ‘required to be spent.’ Regarding funds given to support a specific mission, this might very well be the case. However, the Church has an opportunity to employ good stewardship over general donations by retaining a portion of those donations to protects itself against future downturns and unforeseen financial circumstances. Good governance can drive the church’s spend policy, and how the church spends gifts and donations. Q: Understood. To that end, why is an Investment Policy Statement (or written spend policy) so critical? And, what elements or mandates might it include? Regan: An Investment Policy Statement, or written spend policy, provides guidelines for authorizing investments and, among other things, maps out the internal investments committee: how many members it should have, their term limits, who leads it, how many are parishioners versus staff, whether or not it includes the pastor, and more. It dictates whether investment authorities and responsibility are managed in-house or outsourced and, in the latter case, who at the church can sign off (the church treasurer, pastor, or someone else.) It gets very detailed and often occupies multiple pages. It’s important to note that no two Investment Policy Statements are the same. They should be written based on the specific needs of each individual Church. churchexecutive.com
“If you’re able to express to donors (especially financial leaders) that your church has these governing documents / guidelines / principles in place, it conveys to them a familiar, more business-minded approach to finances. This makes donors feel confident that their generosity will be appropriately handled. These documents are something a church leader can point to and say, “Look, this is what we do, and this is how we handle your gifts. It’s a very systematic approach. Don’t worry; no one will run away with those funds.” That drives good giving. ” That said, an Investment Policy Statement is well worth the effort, as it alleviates inconsistencies in the way a church handles its funds. It’s so important that parishioners know the church’s money is being protected, vested, and where applicable invested. Let me explain. A long-time pastor might be notoriously financially conservative. When a new pastor takes over, a lot more spending might start taking place for high-priority ministries. If the new pastor believes the children’s ministry is the most important initiative to focus on, he might decide to spend a lot of money on a new playground. Meanwhile, another member of the leadership team might believe adult Bible study is more critical. These differences can cause a lot of conflict and uncertainty. Having a written spend policy in place governs how the church will be operated and ensures the church’s funds will last longer by providing consistent, unemotional guidance surrounding spending procedures. If, for example, a church or staff member is pressuring the pastor to invest in a new bus, that pastor can consult the written spend policy, which might (depending on the church) dictate that the church can’t spend more than $15,000 per quarter on capital expenditures. Q: Beyond better management of the funds a church already has, can a written spend policy also drive ‘good giving’ to generate new funds? Regan: Absolutely! If you’re able to express to donors (especially financial leaders) that your church has these governing documents / guidelines / principles in place, it conveys to them a familiar, more business-minded approach to finances. This makes donors feel confident that their generosity will be appropriately handled. These documents are something a church leader can point to and say, “Look, this is what we do, and this is how we handle your gifts. It’s a very systematic approach. Don’t worry; no one will run away with those funds.” That drives good giving. Having said that, governance can be updated. If a new pastor disagrees with the governing documents as they’re written (depending on how a church sets them up), he can adjust them himself or work with the appointed committee to update and amend them. In fact, we recommend that governing documents be revisited every year and updated every three years. Q: How might a church’s investment options differ depending on its need to access those funds? Regan: Liquidity is a word that’s often used in the investment world. To elaborate: If your church needs money in a week (whether it’s $10,000 or $10), then you can’t afford for your investments to dip to $8,000 or $8, midweek, because you might not have time to get it back up to the original amount before you need it. The point is: liquidity needs are a major driver in the type of investments a church can sustain. Keep in mind that this isn’t an either / or proposition. For example, if your church has $50,000 in a savings account, and you know you’ll need $5,000 in two weeks for a mission trip, you could split that money into two churchexecutive.com
different investment pools. Maybe $10,000 could be invested in a very safe, liquid, low-risk way, while the other $40,000 (which you know you won’t need for a while) lends itself to a longer-term, higher-risk approach. Q: Who should a church choose to manage its investments, and why? Regan: It’s very important that whoever is in charge of the church’s investments is unaffiliated and unconflicted. Both are equally critical. If, for example, you enlist your largest donor’s brother as your broker, but then you disagree with something he’s doing, you might decide not to cut ties with him for fear of upsetting that financial leader in the congregation. Also, this could give the donor, who likely already has tremendous influence, even more influence… and make him ‘responsible’ (in the congregation’s eyes) if an investment doesn’t perform as hoped. The better approach is to choose an investment manager with experience in the faith-based and non-profit worlds. If you hire a local broker (one without this experience) and tell them the church has $10,000 in an account, they’re likely to invest that $10,000 and try to make as much money as possible so that they look good. That might sound like a good plan, but a broker with experience in the non-profit and faith-based realms will know to be more prudent with a church client’s funds. They will know to ask more questions. “OK, you have $10,000, but what’s your church’s year-over-year revenue? What is your operational overhead? Do you have any debt? Are there any upcoming capital expenditure items?” Asking (and answering) such questions identifies what that $10,000 really means to the church. Q: Members expect a certain degree of financial transparency from their churches. When a church outsources its investments management, how can the firm handling that process help the church ensure the appropriate degree of transparency for givers? Regan: A church should think really carefully about transparency in this context. I would form a committee of four to five individuals who receive the requested transparency from the investment manager, and who are involved in the stewardship of cash investments. Whether or not that committee chooses to share all the investment details with every parishioner is up to them; however, I would caution that if shared with the entire congregation, many people will have many different ideas about those investments. Another area where transparency comes into play is socially responsible investing. Churches, for example, may not want investments in fossil fuels, pornography, casinos, firearms and so on. If a mandate is in place with the proper level of transparency, the ethical committee can ensure the church’s investment criteria are being met by their investment manager. — Reporting by RaeAnn Slaybaugh
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Making the case for church investments In many churches, cash reserves are either immediately applied to ministry expansion, or deposited into a traditional savings, CD or money market account. However, do these options really represent the best possible stewardship of those funds? John Regan, Founding Partner and Chief Investment Officer at New Yorkbased Permanens Capital, believes John Regan churches should consider investing cash reserves in relatively low-risk, short-duration, highquality bond portfolios. Q: Investing cash reserves might seem counter-intuitive to the nature and mission of a church. Why? Regan: Churches are often very focused on expansion. Rather than accumulating reserves, churches often start new programs, acquire real estate or open satellite campuses. These activities add to budget expense and liabilities like maintenance capex, rather than add to reserves. As a result, there is a constant push-and-pull over creating reserves, versus starting new programs. The argument is to approach church governance in a similar fashion as to how trustees approach school governance. I serve as a trustee at one school and also serve on a number of other boards. These boards generally avoid spending endowment to hire more teachers or create new programs. Trustees often ask: What do we have to do to ensure that the school is here for the next 50-100 years? The debate can be framed by the following question: Should church leaders think like trustees or CEOs of growth companies? Growth is wonderful. However, if you build a program — an afterschool program for children or single-mothers for example — and then misjudge your budget and are forced to discontinue the program next year, does that serve the good of the community? That push-and-pull, and the balance of growing at a “measured clip” versus “rapid clip,” is something that we did not really understand until we began work with our first church client. Q: Churches often default to “investing” through a savings account, CD or money market account. In comparison, investing cash reserves might seem more time-intensive and, frankly, intimidating. What is the reality? Regan: Investing through a savings account should not be considered ‘investing.’ CDs do not offer any real rate of return and carry a penalty for redeeming early. The purpose of investing reserves is two-fold. Earning a reasonable rate of return is important while also maintaining the ability to access the money if there is an urgent need. We have seen churches purchase annuities and class these as liquid reserves. However, an annuity is not a real investment. It is not liquid. It is very common for a church to conduct business and invest reserves with a regional or community bank. However, many times that menu is limited, and so is the level of expertise. As a result, the church is presented with short-term, low-interest-rate options. These options are not the most liquid and tend to carry hidden fees and penalties for early redemption. 6
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Q: How do the costs associated with investing cash reserves compare to setting up a savings account, CD or money market account? Regan: A savings account will not cost much, but it also yields less than 0.2% of interest. An investment account will cost around 0.5% basis points but can return 4% to 5% of interest. Q: When a church does choose to invest its cash reserves, how are those resources usually divided? Regan: Our experience is that churches generally create two pools, with two very different purposes. The first is a short-term, ‘emergency’ pool, which is the church’s operating cash reserves. Typically, this will not include any equity investments, just liquid bonds paying the church a reasonable rate of interest. Then, the church will create a second, longer-term, strategic pool. With this investment pool, the church is able to run a more balanced portfolio. Since this is money the church is going to need tomorrow, that pool should be structured like an endowment or a foundation with a focus on capital preservation, asset allocation and reasonable long-term growth. Q: Why is it so important to identify an investment advisor who understands the “business” of a church and how it operates? Regan: The first mistake we see churches make is putting their reserves in the hands of someone who is a member of the board or happens to be in the flock. This presents a conflict of interest and has its own set of governance issues. You never want to be put in a position where you may have to fire someone who is a contributing member of the church. A church might also choose to hire a local or regional bank, if its options are limited. This brings a whole host of higher fees. With a bank and a broker model, there are fees and sales charges associated with having someone act as a fiduciary and asset manager. At Permanens, we do not have individuals as clients. We are not interested in finding the next person with $2 million or $3 million to plan his or her retirement fund. We specialize in institutional investing for endowment, foundation and non-profit clients. Q: As a church is vetting its options, what should an investment advisor understand, uniquely, about a church client and how it manages its operations and finances? Regan: Before recommending any investment option, an investment advisor needs to fully understand the church’s balance sheet. The investment advisor has to know what liabilities the church has coming and what, if any, real estate purchases the church might be planning to make. Understanding the potential liquidity need is paramount before any advisor can properly begin tailoring an investment program. The most important thing to convey is that there is a new option for churches, and it can give them the liquidity, low fees and access they might not get locally or regionally. This option comes with the same investment expertise that is being used to run school endowments, which have very similar balance sheet issues. Coupled with that, it is important to have the proper fiduciary oversight of those assets. There should be a real focus on capital preservation and ensuring the reserves are properly invested for the longer term benefits of the church. — Reporting by RaeAnn Slaybaugh
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