By Nicole Bailey, RBC Wealth Management
Boards of directors and community managers rely on policies and procedures to guide community operations. The governing documents serve as the law of the land and the policies provide the roadmap. Each area of community operations likely has a corresponding policy to see that the board can make decisions fairly and efficiently. Just as covenant enforcement and assessment collections processes are guided by their respective policies, investment decisions are guided by the investment policy.
The use of investment policies is not specific to community associations. Many other entities use policies to guide their decisions. Some examples include college endowment funds, pension funds, and charitable organizations. All of these organizations have one thing in common: they are responsible for other people’s money. The board of directors of a community association is elected by the homeowners to make decisions in the best interest of the association. With this responsibility, each director assumes a fiduciary duty of the association – not unlike those that govern the entities listed above.
In order for a policy to be valid and enforceable, the policy must be consistent with the governing documents and within the board’s rule making authority. The board’s rule making authority is specifically outlined within the governing documents and should be cited within the policy. The policy should also state the purpose or objective and any restrictions. Confirming that essential components are contained in each policy reduces ambiguity and provides for fair and consistent processes.
The goal of the investment strategy should be detailed in the policy so that all parties subject to the policy (the board, the finance committee, and the investment advisor) are able to work towards a shared objective. Sometimes the investment objective is to preserve principal. This means that the priority of the investment strategy is to preserve the original investment. Another example of an investment objective could be moderate growth. In this situation, assuming a level of risk to the original investment may be necessary in order to achieve a moderate level of growth in the account. Clarifying the purpose of the investments informs the other considerations within the investment policy.
When defining the investment objective, it is important to consider the types of risk and how risk is defined. Most define risk as the potential for loss of principal. Loss of principal can be a result of market fluctuations, however it can also be a result of the loss of purchasing power due to inflation. If the investment objective is preservation of principal, the advisor and the board need to discuss the difference between market risk and inflation risk. If the objective is moderate growth, a level of market risk might be required in order to achieve that objective. Discussing the potential impact of each type of risk is critical to establishing a risk profile. The risk profile for an association is often established in a conversation with the board and an investment professional who specializes in community association investment strategies.
Just as the objective guides the determination of the risk profile, the risk profile can guide the investment selections. By establishing the level and type of risk the association is willing to expose the funds to, the investment professional can provide recommendations that are in accordance with the objective and the risk tolerance of the association.
An important consideration when investing community association funds is the timeframe in which the funds will be spent. Whether the funds are earmarked for reserve expenses or repairs resulting from an insurance claim event, the schedule of spending and the liquidity needs will impact the investment strategy. Some policies outline provisions for short term funds and long term funds. Doing so can help provide adequate liquidity while also targeting better returns on the funds that won’t be spent for several years.
When creating guidelines around investment decisions, boards should also be aware of market conditions. With record low interest rates at play, what impact does this have on an association’s earnings? Strategies that were proven effective in the 1980’s may no longer generate the same results on an account. Because of the dynamic nature of investment circumstances, policies should be reviewed regularly so that necessary changes can be made in order to achieve the stated objective.
Considering the board’s fiduciary duty to the association, establishing a comprehensive investment policy encourages a proactive and thoughtful approach to community association financial management.
Nicole brings a broad background in community management in the Atlanta and Denver areas to her role on the West Wealth Management team. She actively volunteers with the Rocky Mountain Chapter of Community Associations Institute on the Marketing and Membership Committee.
Disclaimer: Investment and insurance products offered through RBC Wealth Management are not insured by the FDIC or any other federal government agency, are not deposits or other obligations of, or guaranteed by, a bank or any bank affiliate, and are subject to investment risks, including possible loss of the principal amount invested. RBC Wealth Management does not provide tax or legal advice. All decisions regarding the tax or legal implications of your investments should be made in consultation with your independent tax or legal advisor. RBC Wealth Management, a division of RBC Capital Markets, LLC, registered investment adviser and Member NYSE/FINRA/SIPC.
