The report notes that following what was the worst global downturn in more than a generation, many institutional investors were forced to prematurely sell the most liquid portions of their portfolios, deviate from stated investment policy targets, and/or issue debt to meet spending and cash-flow needs.
The 2008−2009 market downturn raised important questions about the effectiveness of some asset allocation structures, especially given the high level of correlation among many asset classes during that period. Understanding the relationship between investment structure and spending policy is an important criterion in setting long-term asset allocation, the report contends.
By using a flexible, integrated asset allocation model, Towers Watson believes institutions can better marry the relationship between choice of spending rule, liquidity and asset allocation. And for those institutions that became issuers of debt tied to the asset pool, an integrated framework allows for the evaluation of assets in relation to any obligations encumbering the pool.
Towers Watson believes an asset allocation approach should follow three basic steps:
- Planning – In the planning phase, Towers Watson recommends individuals and committees governing nonprofit investment pools articulate their organization’s views on investment beliefs, spending policy and gifting expectations. It is also critical to understand and articulate other factors, such as regulatory and legal requirements, and any outside commitments that may encumber the investment of the asset pool during the planning phase.
- Modeling and Setting the Risk Budget – Most nonprofits are faced with the risks of asset depletion, spending power erosion and liquidity. Evaluating and determining the appropriate balance of these risks with expected rewards is a key outcome of this phase.
- Determining Actions Based on Results and Implementation – The final phase in the asset allocation process involves deciding on the appropriate changes in the asset allocation policy and determining both timing and procedures for implementation. Any modeling of asset allocation structures is iterative by nature, and results must be reviewed in detail with buy-in from ultimate decisionmakers to ensure that appropriate risks and parameters are accurately captured. A transition or “journey” plan for moving from current policy to a new policy, particularly in light of illiquid assets, is determined during this phase.
The Towers Watson report is here.