Foundation Investment Policy: Does a Foundation Need One and What Should It Include?

An investment policy is particularly important when several people are involved in investing the foundation's assets or when decisions are delegated to banks, asset managers or fund managers. It establishes a shared understanding of the role the assets are intended to perform and the risks the foundation may accept in pursuing its objectives.

A short and clearly written framework can also be useful for a small foundation. Its scope should be proportionate to the size of the assets, the complexity of the investments and the resources available. A foundation with only a small number of liquid investments does not need a framework designed for an internationally diversified institutional portfolio.

An investment policy does not release the foundation board from its responsibilities. Under the German Civil Code, a member of a foundation body must exercise the care of a prudent manager when conducting the foundation's affairs. In principle, no breach of duty occurs if the member, while complying with statutory requirements and the governing documents, could reasonably assume on the basis of adequate information that the decision was in the foundation's best interests. A clearly documented basis for decision-making can play an important role in this context.

Continuity is another important benefit. Without a written framework, the portfolio positioning may change whenever the composition of the foundation board changes. Personal preferences may then take the place of a long-term strategy. An investment policy helps ensure that the investment of the foundation's assets remains aligned with lasting objectives rather than individual decision-makers.

It can also help limit emotional decisions during difficult market periods. If the foundation only begins discussing its capacity for losses after a substantial market decline, decisions are often made under considerable pressure. A risk budget defined in advance provides guidance, even though it cannot prevent losses.

A foundation investment policy template can serve as a checklist and starting point. It should not, however, be adopted without modification. Governing documents, foundation purpose, asset structure, funding requirements and organisational circumstances differ from one foundation to another. The Association of German Foundations therefore emphasises that investment policies must be tailored to the individual foundation.

An investment policy should begin not with individual funds or asset classes, but with the foundation's overarching investment objectives. These objectives must be derived from the foundation's purpose, the founder's intent and its governing documents.

For a foundation established for an indefinite period, the endowment assets, referred to in German law as the Grundstockvermögen, form part of the assets that are permanently committed to the foundation. Under Section 83c of the German Civil Code, or BGB, these endowment assets must generally be preserved intact, and the foundation's purpose is to be fulfilled using the income they generate. Different requirements apply to spend-down foundations because their governing documents expressly provide for the use of their assets.

The statutory requirement to preserve the endowment assets does not automatically result in an identical investment strategy for every foundation. Nor can the question of whether capital preservation should be understood in nominal or real terms be answered uniformly. The founder's intent as documented in the governing documents and the foundation's individual circumstances are particularly relevant.

The investment policy should therefore define the importance of capital preservation, offsetting inflation, generating ongoing income and achieving capital growth. It should also make clear that capital preservation is a long-term objective and not a guarantee against temporary losses.

Liquidity requirements are equally important. The foundation should determine the funds it regularly requires to fulfil its purpose and identify any foreseeable extraordinary expenditure. This makes it possible to establish which proportion of the assets must remain available at short notice and which proportion can be invested over a longer period.

The investment horizon should also be defined. A foundation established for an indefinite period can generally plan across generations. However, the investment horizon for individual parts of its assets may be considerably shorter, for example where funds have already been allocated to an approved project.

The investment objectives, investment horizon and liquidity requirements together determine the foundation's risk budget. This describes the fluctuations in value and temporary losses that the foundation can bear financially and organisationally. The assessment should not be limited to a mathematical calculation of loss-bearing capacity. The experience of the governing bodies and their ability to maintain a long-term strategy during difficult market periods are also relevant.

The foundation's existing total asset structure must also be considered. If the foundation already owns substantial real estate or equity interests, it may already be exposed to considerable concentration and liquidity risks. The liquid portfolio should not unintentionally amplify these risks.

An investment policy should specify which asset classes are generally permitted and which are excluded. It may, for example, distinguish between equities, bonds, cash, real estate, commodities, liquid alternative strategies and private markets.

A list of permitted investments alone is not sufficient. Investments within the same asset class can involve very different risks. A short-dated government bond differs substantially from a long-dated corporate bond with increased credit risk. Additional requirements relating to credit quality, maturity, currency, tradability and diversification may therefore be necessary.

The use of investment funds, derivatives and illiquid investments should also be addressed. Derivative instruments can be used for hedging or efficient portfolio management, but they may also introduce additional market, liquidity and counterparty risks. The investment policy should therefore define not only whether derivatives are permitted, but also the purposes for which they may be used.

Allocation ranges are often more appropriate than rigid portfolio weights. At first glance, a fixed allocation may appear particularly controlled. However, it may cease to be economically appropriate when market values, interest rates or the foundation's asset structure change.

Allocation ranges provide flexibility without abandoning the risk budget. They can, for example, define minimum and maximum allocations for individual asset classes. The responsible decision-makers can then adjust the portfolio positioning within these limits without requiring the entire investment policy to be approved again whenever market conditions change. The Association of German Foundations expressly recommends establishing this type of scope for action.

Flexibility must not be confused with discretion without limits. The investment policy should define the principles governing changes and the circumstances in which a deviation from the allocation ranges is permitted. It should also specify the period within which breaches caused by market movements must be rectified.

In addition to allocation limits, risk-based limits may be appropriate. These can include requirements relating to individual-security risk, issuer concentrations, foreign currencies, maturities, credit quality and liquidity. The metrics that are appropriate will depend on the complexity of the foundation's investments.

Where sustainability criteria are relevant to the foundation, they should also be defined in specific terms. General descriptions such as "sustainable" or "responsible" are usually insufficient for binding implementation. The foundation should specify the exclusions, selection criteria or impact objectives that apply and how compliance will be monitored. Sustainability requirements must remain consistent with the foundation's purpose and governing documents.

A good investment policy does not merely answer the question of what the foundation may invest in. It also defines who prepares, approves, implements and monitors investment decisions.

The foundation board is generally responsible for managing the foundation's affairs. It may delegate operational tasks to another governing body, an asset manager or other service providers, but it remains responsible for their appropriate selection, appointment and supervision.

The investment policy should therefore allocate responsibilities clearly. This includes defining who approves the strategic asset allocation, who may make tactical adjustments and who monitors compliance with the investment limits.

Where external asset managers are appointed, the scope of their decision-making authority should be defined. The investment mandate must be consistent with the investment policy and should not give the asset manager greater discretion than the foundation itself has approved.

Approval processes should also be described. Particularly complex, illiquid or substantial investments may require an additional resolution or review by more than one person. This can help clarify responsibilities and limit conflicts of interest.

Reporting should be regular and understandable. It should cover not only performance but also fluctuations in value, distributions, costs, liquidity, risk metrics and compliance with the investment limits.

A simple comparison with a benchmark is often insufficient for a foundation. The decisive question is whether the portfolio is performing its specific function. This includes, in particular, whether sufficient funds are available to fulfil the foundation's purpose and whether risks remain within the approved framework.

Deviations from the investment policy should be documented and explained. A distinction should be made between a deliberate decision and a breach caused by market movements. In both cases, the policy should define who must be informed and which measures are required.

The investment policy does not replace the documentation of individual investment decisions. Particularly in the case of material changes, it should remain clear which information formed the basis of the decision, which alternatives were considered and why the decision was regarded as being in the foundation's best interests.

An investment policy should provide long-term direction. It should not, however, be treated as an immutable document. Changes in the foundation's assets, funding requirements, governing documents or organisational structure may make an adjustment necessary.

The foundation should therefore establish a regular review process. This does not mean that an entirely new investment policy must be approved every year. However, the foundation should assess whether its objectives, risk budget, allocation ranges and responsibilities remain appropriate.

Event-driven reviews are also advisable. A substantial inflow of funds, a material addition to the foundation's endowment, the acquisition or sale of real estate, a change of asset manager or a lasting change in the grant-making budget can materially affect the foundation's total asset structure.

Short-term market movements alone should not automatically lead to changes in the foundation's long-term principles. An investment policy is not an instrument for short-term market timing. Instead, it should provide sufficient flexibility for the portfolio to be managed within a reliable framework.

When the composition of the foundation board or an investment committee changes, the policy should be expressly reaffirmed and explained. This ensures that new decision-makers understand the objectives, risks and decision-making processes.

External mandates and contracts should also be reviewed following any amendment. When the investment policy changes, asset managers, banks and other service providers must be informed in good time. Contradictions between internal requirements and external agreements should be avoided.

A good investment policy is therefore neither a rigid straitjacket nor a non-binding statement of intent. It defines the strategic guardrails while allowing professional portfolio management within those guardrails.

A foundation should not allow its investment decisions to depend on changing personal views or short-term market movements. A written investment policy creates a transparent framework that connects the foundation's purpose, governing documents and long-term financial objectives.

It should cover investment objectives, the risk budget, liquidity requirements, permitted asset classes, investment limits, sustainability requirements, responsibilities and reporting obligations. Allocation ranges tailored to the individual foundation are often more appropriate than rigid portfolio weights.

The investment policy replaces neither the careful assessment of individual investments nor the ongoing monitoring of the portfolio. It does, however, ensure that decisions can be made in a structured and documented manner and remain consistent when the composition of the governing bodies changes.

A general template can assist in developing the policy. Its final design must, however, be tailored to the individual foundation, its governing documents, the founder's intent and its total assets.

• What Are Foundation Investment Funds and Who Are They Suitable For?
• How Should a Foundation Invest Its Assets?
• Comparing Foundation Investment Funds: What to Look For
• How Can a Foundation Generate Income and Preserve Its Assets Over the Long Term?

¹Distributions are not guaranteed.

This article is provided for information purposes only. The legal and tax information contained herein is not intended to constitute or replace legal advice, nor does it purport to cover all legal or tax considerations that may be relevant to the subject matter of this article. The information is not exhaustive and does not take into account the individual circumstances of any particular investor or group of investors. It cannot replace advice from a tax adviser based on the circumstances of the individual case. Although the information has been compiled with due care, no representation, warranty or guarantee is given as to its accuracy, completeness or currency.