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E&F Advice & Administration

August 16, 2022

How Nonprofits Can Mitigate the Impact of Inflation on Operations

Summary

• By planning five or ten years in advance, organizations will be better prepared to weather inflation and difficult economic periods. Understanding operational costs and revenue streams is key.

• Development staff should remind donors of the organization’s goals in meeting operational needs both today and in the future. Know which donors you can ask for an increased commitment and which ones you need to ask to maintain their annual level of support.

• Trusted advisors help to produce returns that withstand inflation risks, and, during times of economic stress, they can help organizations navigate the economic and behavioral pressures.


 

When inflation spikes, nonprofits are squeezed as demand for their services rises while their purchasing power diminishes. Higher interest rates add to the financial pressure.

Nonprofits may find it more difficult to pass along their increased costs to the individuals and communities they serve when compared to for-profit companies. So, what can nonprofits do to mitigate the impact of inflation on their operations?

Revenue streams are crucial

Organizations should, if possible, have diversified revenue streams they can tap during difficult economic times while avoiding taking outsized draws from their endowments. Organizations with development teams can emphasize fundraising, while others could derive a revenue stream from their operations. Schools, for instance, often have tuition income, fundraising and endowment income. Those three revenue streams work as a diversified base to mitigate the impacts of rising costs.

Ideally, organizations take a long view of their operations and plan five or even ten years in advance. Most nonprofit leaders understand there will always be periods when plans are disrupted by unexpected events, such as higher inflation, employee turnover or a lengthy market downturn. A long-term view is critical to weather periods of economic stress. And, importantly, they need to understand potential costs to the organization as well as the variability in potential revenue streams.

Meeting operational expenses

During hard economic times, needs multiply while societal support tends to lessen from individual donors, nonprofits and even government programs. Organizations struggling with their own operations should “stick to their knitting” and fund their core programs. They should prioritize their must-haves versus their nice-to-haves, and determine ways to retain employees and talent.

Some of the toughest decisions involve choosing between service needs and staff needs. Should services be cut back? How can an organization retain talent and address staffing needs? The tight job market has pushed some nonprofit organizations to raise wages to attract and retain talent, but not every organization can afford to pay its staff more. Organizations may consider making a strategic shift in their operations to address these considerations, and have a plan in place in advance of a period of increased volatility.

Role of donors

Sometimes donors can help to balance the competing short-term needs within an organization. When approaching donors, it is helpful to show the impact of inflation on their giving. For instance, on a real basis, it takes a $108 gift to have the purchasing power of a $100 gift when the rate of annual inflation is 8%. It helps to report on the purchasing power of donor gifts in the current year versus past years. For instance, if a charity runs a shelter for communities in need, the cost of providing shelter for one night, year over year, could be demonstrated.

The charitable community tends to rally during times of need as it did during the early stages of the COVID-19 pandemic, and tax breaks can be available for individuals who donate. It goes back to framing the organization’s stewardship of its assets and how it is trying to accommodate for the elevated inflationary environment. Reiterate the goals of not only meeting the needs of your nonprofit’s beneficiaries in today’s environment, but also of continuing to do so in the future.

When approaching donors, it is important to talk to the right people. Know which donors you can ask for an increased commitment and which ones you need to ask to maintain their annual level of support. Donor development staff often ask for multiyear commitments to produce reoccurring revenue streams that will persist in difficult economic times. No gift is too small, but communicating is the key.

Prepare your endowment for inflation

An endowment serves several purposes, including:

• To support the needs of the organization, it should grow more than the institution spends and more than inflation over the long run.

• With a prudent spending policy in place, it can function as a rainy-day fund to support operations during difficult times. The goal is to be able to grow in real terms over longer time periods.

Part of long-term planning is to prepare your endowment portfolio for inflation. The good news is that it is never too late to make portfolio changes to protect your operations from inflation. While five- and ten-year inflation expectations are between 2.5% and 3%, inflation over the past year has been closer to 9%. It is unclear how long this high inflationary period will last. But we expect that, over time, inflation will return to more normal levels. During ordinary economic times, organizations with an endowment can maintain the real level of spending by generating an investment return of about 7% to 8% per year while spending about 4% to 5% of its assets. The return in excess of spending allows the endowment to keep up with inflation, and during good times, creates a buffer to spend in bad times. It is most prudent to have a spending policy in place that calculates an annual withdrawal on a rolling period of market values, such as an average of the prior 20 quarters. This ensures spending remains in check during strong market environments and allows for consistent spending during market downturns.

Trusted advisors help to produce returns that withstand inflation risks

During periods of market stress, trusted advisors are more important than ever to help institutions navigate the economic and behavioral pressures an organization faces. Our Glenmede Relationship Managers can counsel organizations about the future impact of dipping into their endowment or investment portfolio when an elevated price environment creates a near-term need. Active management can have advantages over passive index investing, particularly during periods of economic change, but careful selection and monitoring are required. There are investment tools and strategies to help generate real returns in the face of inflation over the coming years.

The risk with unexpected inflation is that the overall market can quickly trade at lower multiples of earnings, as we have seen in 2022. While falling investment values are painful, this is a short-run risk. Over time, equities are still a good long-run inflation hedge as businesses adjust their revenues and cost structures to maintain their real value. When equities are down significantly over a short period of time, we advise selling “insurance” asset classes like fixed income to support spending from endowments. This strategy avoids selling equities while companies are adjusting over the short run to the new inflationary reality. We also advise de-emphasizing investments in companies that provide “nice to have” or discretionary goods and services in favor of those that provide necessities. In an unexpected inflationary environment, as consumers adjust their budgets, necessary products and services hold their real value and allow those companies to adjust more quickly.

Conclusion

Nonprofits and foundations need a long view of their operations and should plan five or even ten years in advance. To avoid disruption of their services by unexpected events like inflation, they need to understand the costs of the organization as well as its potential revenue streams.

A trusted investment manager can help them to choose investments that will help weather market dips and unexpected inflation, and advise on spending policies that can support the long-term growth of endowments.

For more information on how Glenmede can help your nonprofit mitigate the impact of inflation, please contact EFSolutions@glenmede.com.


 

CONTRIBUTORS:

Nicholas Warren
Chief Investment Officer, Endowment & Foundation Management

Stephen Burns, CFA
Relationship Manager, Endowment & Foundation Investments

Michael C. Crow
Portflio Manager, Endowment & Foundations

 

This presentation is intended to provide a review of issues or topics of possible interest to Glenmede Trust Company clients and friends and is not intended as investment, tax or legal advice. It contains Glenmede’s opinions, which may change after the date of publication. Information gathered from third-party sources is assumed reliable but is not guaranteed. No outcome, including performance or tax consequences, is guaranteed, due to various risks and uncertainties. Clients are encouraged to discuss anything they see here of interest with their tax advisor, attorney or Glenmede Relationship Manager.