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AROUND THE WORLD WITH SEYMOUR J. MANSFIELD
Legal News with an International Perspective

Seymour J. Mansfield
Founding Partner

Melroe on Sound Investment Strategies for Foundations and Charitable Organizations

In the aftermath of the 2008 market crash, many foundations and other charitable organizations have been hard hit. This was aggravated in some cases by an unprecedented level of fraudulent investment schemes that victimized foundations and endowments funds -as well as for profit businesses, retirement plans and affluent individuals. Some of these foundations and endowments had to close down altogether; some have cut their staff and others have curtailed their programs and grant making. Even with the modest market rebound, most of these organizations are still struggling. In retrospect, what are the lessons to be learned from the market crash? How could these organizations through best investment practices have minimized their losses in portfolio values when the entire market imploded?

One local shining example of a foundation weathering the 2008-2009 market melt-down through such sound investment management practices is that of the Otto Bremer Foundation. For calendar year 2008, Bremer Foundation was rated by Common Fund, a national investment advisor firm, as having the best investment performance of all foundations in its data base, with its small loss of only -5 % versus an average loss among its peers of -36% for that year. In light of that fine track record, we are pleased this month to feature as our guest author for this month's Around the World column, David J. Melroe, Senior Vice President, Treasurer and Chief Investment Officer, Bremer Bank, and Investment Manager for the Otto Bremer Foundation.

The Bremer Foundation ranked ninth among all Minnesota grantmakers in 2007, according to the Minnesota Council on Foundations. It gave away $31.1 Million, of which $21.7 Million was to Minnesota grantees.

While banks typically own foundations, as established by the trust of the Bank's founder, Otto Bremer, when he died in 1951, the Foundation owns 92 percent of Bremer's holdings, and Bremer employees own the remaining eight percent. These holdings are now valued at approximately $680 Million. The Bank, as a for-profit business, transfers approximately 40 percent of its after-tax profits to the Foundation each year to fund charitable giving. The other 60 percent is retained and reinvested in the banking operations. Bremer is unique, the only such bank foundation structure in the United States.

In his capacities with the Bank and Foundation, Mr. Melroe manages the $1.6 billion Fixed Income Portfolio for the Bank, co-chairs the Retirement Plans Committee, having oversight of $100 Million Defined Benefit Plan Portfolio and $130 Million Defined Contribution Portfolio for Bank, and manages the Foundation's $100 Million investment portfolio.

A founding shareholder of Mansfield Tanick & Cohen, P.A., with 40 years of diverse lawyer experience, Seymour Mansfield now focuses on business, complex and class litigation, mediation, executive employment and employee benefits, trade secrets and restrictive covenants, international business law and acts as legal counsel to emerging medical device companies. He is the firm's primary representative to Lawyers Associated Worldwide and served on LAW's Executive Committee (governing board) from 2002 through 2008. LAW empowers our firm to serve the needs of our clients in domestic and foreign markets worldwide.

Choosing Sound Investment Strategies in Managing Your Foundation & Endowment Portfolios

By David Melroe

The volatility in the stock and bond markets during the past few years has shaken some of the common beliefs and strategies of managing the risk of an investment portfolio. Many individuals who have fiduciary responsibility for the oversight of the investment portfolio for foundations and endowments are not investment professionals. This article is a brief overview of the strategy of Risk Management from a fiduciary perspective and some of key lessons to be learned from the last dramatic market down cycle.

Two common investment strategies have been proven to be misguided during the past cycle:

1) The more risky the asset class, the greater the yield!

This may work in a super bull market, but the axiom is not true over market cycles. The following chart of 10-year returns on different asset classes from 1999 to 2009 shows just that.

"Real" Annualized Returns 1999 through 2009

High risk equity assets suffered in the last 10 years, while low risk cash and bonds out-performed stocks.

Foundation and Endowment Investment Portfolios exist to fund grants for charitable giving commitments. One mistake many Investment Managers/Investment Committees made was that they did not have adequate, safe, liquid investments to meet their budgeted cash flow obligations. Because of this last down cycle, many entities, such as Harvard University, which failed to include sufficient fixed income and dividend investments in their portfolio, had to borrow substantial funds to meet their obligations due to inadequate liquidity. Others have had to cut staff, shave and eliminate grantees or terminate or impose moratoriums on grant renewals or applications.

"Read the find print." All investments in LLC Partnerships have no short term market, and any investment in Hedge Funds (and even Mutual Funds) can restrict redemptions at their will leaving the foundation locked into under- and non-performing assets. Abnormal high allocations to these non-liquid investments are inappropriate for foundation and endowment portfolios.

The moral of the story is to be reasonably diversified in your portfolio. To cover such material disbursements needed from the investment portfolio, you should put in place liquid assets to cover your projected cash outflows for at least two years to create a fail safe against unexpected volatility in market values.

2) Diversification:

Yes diversify, but further refine the definition to "Non Correlated" asset classes.

Example: Investing in small caps, midcaps and foreign equities does not really diversify/insulate the portfolio from downside price risk. All equity indexes suffered in the 2008 melt-down. You should have some exposure to commodities (ETF's or Funds) such as precious metals, energy, food, and other "real" assets to protect you from inflation. Also, you should have a reasonable exposure to high-grade fixed income investments to ride out deflationary environments (like we are experiencing at the present). Many foundations plowed head first into "Alternative Assets" the past five years or so, and found they were not very liquid, and susceptible to major volatility in market prices. Also, alternative investments that contain Private Equity and leveraged Hedge Funds may actually increase the portfolio risk to downside movements. Know what you are buying! Demand absolute transparency of the underlying assets and your risk exposure in any Hedge Fund or Fund of Funds.

Further Insights for navigating market melt-downs gained from Bremer's Conservative Investment Strategies

First, let's take a look at Bremer's performance:

In 2008, the Common Fund, a national investment advisor firm, recognized the Otto Bremer Foundation as the best performing investment fund of all the Foundations and Endowments in its data base. In fact, it was an outlier with a return of -5.00% versus an average peer loss of -36% for that year.

Bremer Bank's Fixed Income portfolio also performed much better than its peers, ranking in the top quartile according to the Federal Reserve Call Reports for 2007, 2008, and 2009.

During the past three years of the banking economic crisis, as of December 31, 2009, Bremer has realized $25 Million in gains and had unrealized gains of $40 Million in the portfolio. Bremer also maintains a portfolio yield much higher than that of its peers.

How did Bremer achieve these excellent results?

The successful investment results are attributed to a discipline of hard work, research, and confidence in analyzing data versus running with the perceived "safe", "momentum," popular, or "structured" investment strategies being pushed at the time.

We recognized that the housing and related mortgage industry was far overvalued and did not make any investments in vehicles, such as CDO's, CMO's CLO's SIV's, Auction Rate PFD's, or equity investment in FNMA Preferred Stock or FHLM Preferred Stock ( that went to $0.00!). All of the above categories were over-valued and over leveraged.

We followed Dr. Robert Shiller, the renowned Economist at the Yale University, and Jeremy Grantham, CIO of GMO[m1] , who produced clear, empirical evidence of the volatility of the housing bubble well in advance of the burst.

The Bank also increased its exposure to long-term Government Guaranteed Fixed Income Investments at the top of the interest rate cycle.

The Otto Bremer Foundation also benefited because we maintained a high allocation of Fixed Income, Government Guaranteed Bonds, and avoided the standard asset class exposure to "Private Equity" and other crowded, overvalued alternative asset classes. We substantially reduced our exposure to Energy and International Investments early in 2008, and also avoided the commodity melt down.

By following these strategies, Bremer minimized the Foundation's 2008 losses to a small fraction of that of its peers and achieved significant investment gains on the Bank's portfolios during the 2008-2009 market melt down.

Conclusion:

It's still a tough investment environment even with the nice bounce back we had in the past year in equities. Stocks are high to fairly valued. Bonds are also very low yielding. Where does that leave the foundation and endowment investment manager?

Stay well diversified; prepare for bouts of both deflation (at the present) and inflation (in the future). You should lower your portfolio yield expectations and not chase the high risk sector investments to "catch up" with your prior losses. Evaluate and hire good outside Investment Managers that have a successful track record in both up and down market cycles over many years.

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