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An examination of 3 associations reveals how the recession affected their operations, their reserves, and, most importantly, their investment strategies going forward. Perhaps as intriguing as the 3 organizations' investment strategies are their varying views of the purposes and uses of their reserves. Some associations view reserves exactly as what the term suggests: a pure rainy-day fund. Other associations have a much more flexible view of how reserves are to be used, actually factoring reserve earnings into their annual operating budgets.

With the longest period of economic expansion in history fueling it, the stock market surged ever higher during the 1990s, dovetailing with the Internet-- centered, infinite optimism of the time. As investment consultants repeatedly told us to pour our savings into equity-heavy 401(k) accounts for long-term growth, it follows that in this frenzied climate some associations might have rethought their traditionally conservative reserve investment strategies of CDs and fixed income in favor of ones emphasizing equities. Why not reap some of the returns of the New Economy? During that time, in fact, ASSOCIATION MANAGEMENT, in its June 1998 issue, chronicled how one association increased its investment returns by 200 percent across a 12-month period by revising its conservative investment strategy (see sidebar, "A 1990s Investment Success Story Revisited")

Three years and one recession later, have associations rethought those strategies yet again? Were associations, like many individual investors, a little too optimistic in their handling of their reserves? The examination of three organizations, in addition to the association covered in the sidebar, reveal how the recession affected their operations, their reserves, and, most importantly, their investment strategies going forward.

Perhaps as intriguing as the three organizations' investment strategies are their varying views of the purposes and uses of their reserves. Some associations view reserves exactly as what the term suggests: a pure rainy-day fund, Other associations have a much more flexible view of how reserves are to be used, actually factoring reserve earnings into their annual operating budgets. Of most significance, however, are the commonalities that the organizations share: All have significant holdings in equities, all have in place a written investment strategy, and for the most part all are sticking with their current strategies-generally asserting that they have no regrets in spite of an off year or two.

A rainy day arrives

American Physical Therapy Association (APTA), Alexandria, Virginia, is a classic example of an association that has been challenged financially during the past few years. In addition to the economic downturn taking its usual toll, the association's members were hit by the effects of federal legislation that cut down on Medicare and Medicaid payments that they were eligible to receive. As is usually the case, when members were affected economically, so was the association.

APTA takes somewhat of a traditional approach to its reserves, considering them as rainy-day funds to be dipped into only when times are tough. However, the association cannot be viewed as tight-fisted with its nest egg, for it has shown during the past few years that it will not hesitate to dip into its reserves when that rainy day does hit. After all, that's what they are there for.

"There has to be an acknowledgement, and that takes a political commitment, if you will, to say that if you do build up a reserve, there has to be a willingness to use it," says Chuck Martin, CAE, senior vice president, finance and administration for APTA. "Otherwise, the reserve will just keep getting bigger and bigger. And so I congratulate our elected leadership that they have had a willingness to use the reserve, and secondly, that they haven't put unreasonable pressures to slash and burn when we've had the resources [in reserve] to do what we're supposed to do for members."

APTA could financially afford to fulfill its mission of advocacy and maintain its member services because it had built up a nest egg of reserves that allowed it to do so. The association, which has a budget of $24 million for 2002, aims to keep a reserve within a range of 40-55 percent of its annual operating budget.

Always with an eye on the long term, APTA emphasizes diversification. Its investment strategy starts with two separate funds that are controlled by different entities: 20 percent of the association's reserves are in index mutual funds, which the association itself monitors, and the other 80 percent are invested by Fiduciary Management Associates (FMA), Chicago.

For the mutual fund assets, the association maintains a 60-40 equity-- to-fixed-income balance. Those funds are rebalanced annually to maintain that ratio.

The association, however, gives FMA a much wider range of flexibility for the assets it manages: Those assets have an 80-20 range-in either direction. "This is almost like no restriction," acknowledges Martin. "They can swing on their own [with the 80-20 rule], stocks to bonds or bonds to stocks. In other words, we don't want them to be 100 percent [invested] in anything, but the 80-20 gives them a heck of a lot of flexibility." Granted, APTA puts other restrictions on FMA by way of its investment policy, which establishes limits on stock purchases of any specific company, minimum ratings for bonds, and so forth. So while the investment policy is flexible, it is also comprehensive.

While APTA's reserves experienced losses in 2000 and 2001, Martin notes that over the long term the portfolio has performed well. "In the decade of the 1990s we basically [maintained our] current investment policy, and we were budgeting at a 10 percent return, and most years we were well above that," he points out.

Reserves as operating funds

For the National Association of College and University Attorneys (NACUA), Washington, D.C., the term reserves means something entirely different from APTA's rainy-day interpretation. In fact, that term could be viewed as only partially accurate, for the association's spending policy, which is part of its overall investment policy, allows it to regularly withdraw up to 7 percent from its reserves to support its annual operating budget, which is $2.3 million. "That is based on the premise that you are using earnings, interest, and dividends only as a payout and you're not dipping into the principal of your investment," says Paul Parsons, deputy CEO at NACUA. "The payout is used to support general operations."

Parsons, however, notes that his association has moved to lower the payout to 3 percent to preserve its reserve level given the downturn in the market value of its investment portfolio during the past year. While its reserves have declined during the past year, the association itself remains on solid footing, thanks to a strong membership retention rate of 97 percent and other stable nondues revenue sources. Still, NACUA did not ignore the economic downturn. After September 11 it created what Parsons calls a "worse-case-scenario budget" and explored measures that it might have to take if its March meeting and June annual meeting experienced severe attendance drops. Fortunately for the association, it doesn't look as though it will have to turn to the alternative budget. Nevertheless, Parsons views the development of the budget alternatives as a learning experience. "I'm very glad we did it because it was a very educational exercise," he says. "And I highly recommend that others do that."

One policy issue that the association was grappling with at press time was the level of reserves it will maintain relative to the operating budget. "That is the key question at the moment," Parsons says, adding that staff planned to recommend to the board that the association maintain reserves of at least six months of operating expenses, with any funds beyond nine months free for consideration "for future strategic initiatives."

In spite of NACUA not having such a policy as yet, Parsons stressed its importance-especially in light of the association's regular use of the funds for its budget. "What's key is to define how much you should always maintain in reserves so that you don't constantly find yourself dipping into your investments-because they'll be gone before you know it," he says.

NACUA's investment strategy, which Parsons says took more than a year to develop before being adopted in 1999, calls for equity investments to stay within the range of 40-70 percent of the portfolio, and for fixed income to remain between 25 and 50 percent. The association separates cash and cash equivalents from its fixed income category, maintaining a 5-15 percent range for them. Within the equity category, NACUA has a 20 percent cap on international securities. It rebalances its assets annually to meet all ranges. Management of its funds are also diversified: Its funds are divided among seven individual money managers held through Olcott Consulting Group at Prudential Securities, Vienna, Virginia.

NACUA's reserves did lose value recently. In light of this performance, is Parsons contemplating changing course? "I think the key is to stay diversified," he says. "As long as you're mindful of the need to rebalance and as long as you monitor the performance of your individual managers you should stay the course."

Beating the bear market-- by accident

The Eugene and Agnes E. Meyer Foundation, Washington, D.C., has no income except for its investment earnings. "We don't sell anything, we don't have memberships," points out Kristen Conte, vice president for finance and administration for the foundation. What the foundation does have, though, is an endowment of $150 million.

Still, the foundation must find a way not only to feed its annual operating budget of $1.5-$2 million. It also is vested with the daunting mission of doling out more funds each year in grants than it did the previous year-- whether the stock market happens to be up or down. The foundation has been successful at that goal every year since its incorporation in 1944. (It gave about $9 million in 2001.)

It should come as no surprise that a $150 million organization has an investment strategy that is reviewed regularly: The foundation revisits its strategy formally every two years. "This organization has seen the value of being very explicit in its objectives and handling its funds in a way that meets those objectives," says Conte.

At the moment, the foundation's range for equity is wide-40-80 percent of its portfolio-but that will change soon. That is partially due to its new investment managers, Cambridge Associates, Arlington, Virginia, having advised the foundation that the range is too wide. No final decision has been made, but Conte believes the lower end of the range will be bumped up, while the 80 percent ceiling will remain as is. Real estate is also included in the equities category. The fixed income category, meanwhile, stands at 20-40 percent.

Ironically, of the four organizations covered in this article and sidebar, the one that was the most successful with its investments through the recession is making the most changes to its strategy going forward. While most investors painfully watched their portfolio values plummet in 2001, Conte's foundation finished the year at a highly unusual positive 8.1 percent. Conte and associates, therefore, must be patting themselves on the back, right? Wrong. The foundation is extremely grateful for what happened, but the impressive results, she readily admits, happened by accident.

As it turned out, the foundation's fixed income holdings, already on the high end of its limit when the downturn began, kept performing well, further skewing the ratio of fixed income to equities. In addition, because the fixed-income side was outperforming the equities holdings, the foundation was withdrawing its cash (for operations and grants) from the equity side, exacerbating the imbalance even more. That was good for the foundation in the short term, but Conte well realizes that the imbalance just as easily could have hurt the organization.

Conte emphasizes the need for deciding on the financial goal that the reserves are trying to achieve and defining clear guidelines for investment managers to follow to prevent them from engaging in a style drift, or, starting out in one kind of investment but then gradually losing focus and drifting off into others. In that regard, Conte said that the group is not so much looking at re-evaluating its equity-fixed income ratio as it is examining what the fixed-income category's objective is. If it's invested too highly in corporate junk bonds, for example, its value would tend to track with the foundation's equity holdings, thus defeating the purpose of diversification.

Another change to the foundation's strategy will be to make sure it rebalances its portfolio on a regular basis. "We didn't do that under our previous manager's guidelines, but with Cambridge that is going to be a regular behavior," says Conte. The foundation is in the process of deciding just how often it will rebalance.

Board and staff on the same page

In addition to their each having investment road maps in place, another commonality shared by the organizations discussed in this article and sidebar is the involvement of both the staff and the board in creating and updating the strategies. APTAs Martin speaks of the board's willingness to allow the association to dip into its reserves once the rainy day hit. At PMMI (see sidebar beginning on page 44), the staff and the institute's investment adviser report to the finance committee annually on the economic climate. Finally, NACUA's Parsons, whose association went through a yearlong process revising the association's strategy (it hadn't been revised in 12 years), stresses the importance of board involvement. "I think there needs to be broad participation by the entire board," he says. "In fact, we went through a questionnaire phase of our entire board before we developed the policy, asking what the purpose of our reserves really is and how risk tolerant they were. The input at the beginning was crucial so that everybody was comfortable with it in the end."