If Disbursement Quotas Rise, What Could That Mean for Nonprofit Investment Portfolios and Strategies?
The nonprofit sector is recognized as one of the most important contributors to Canadian society, not only because of its role in improving social outcomes, but also because of its impact on the economy.
The charitable sector contributes 8.7% to Canada's Gross Domestic Product, an estimated $189 billion, according to the charity Imagine Canada1. It estimates that 86,000 registered charities employ 2.5 million Canadians full-time, approximately 10% of the Canadian workforce, and 13 million volunteers work 1.7 billion hours a year2.
To ensure that tax-supported donations are effectively deployed, registered charities are required to pay out a minimum of 3.5% on charitable programs that fulfill their mission. This is known as the disbursement quota.
The federal government is currently reviewing the disbursement quota and soliciting views from stakeholders on whether to increase it, starting in 20223. This has become the subject of much discussion in Canada as a whole and the charitable sector specifically.
TD Asset Management Inc. has just published an insightful in-depth article about what a potential disbursement quota hike could mean for the investment portfolios of nonprofit organizations.
The article provides calculations about the investment impact of different levels of increase to the disbursement quota.
It notes that raising the quota over 5% could jeopardize the future sustainability of the nonprofit sector, which is already facing challenges in generating adequate returns as interest rates have fallen to historic lows.
Given the prospect for lower investment returns in the foreseeable future - particularly from fixed income - and the erosive effects of rising inflation, the nonprofit sector may have to modify its investment strategies so it could maintain real capital value over time in the face of a higher disbursement quota, according to the article.
It argues that adding alternative assets to a portfolio of equities and fixed income is likely to be a crucial component of success for nonprofits in an environment of low yields and higher disbursement requirements. Alternative investments such as real estate, private equity and private debt have the potential to offer attractive returns with low correlation to public markets and to provide diversification.
An important consideration when including alternatives in a portfolio is how they affect its liquidity profile, as alternatives are usually less liquid than publicly traded securities such as stocks or bonds. The good news is that charitable endowments and foundations typically have low liquidity requirements - and thus can benefit from harvesting liquidity premiums - because they are usually designed to exist in perpetuity. As a result, less liquid alternative assets can potentially help nonprofit portfolios achieve a higher return for the same level of market risk or the same return with lower market risk, according to the article.
It notes that the potential increase in disbursement quotas provides an opportunity for nonprofit organizations to review their investment policies – and to consider whether they are well positioned for today's low-yield environment and what impact a higher disbursement quota would have on their long-term viability.
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TD Wealth Asset Allocation Committee (WAAC)