Charity Revenue Portfolio Optimization: Incorporating Asymmetric Risk and Dependence

• In Event: Non-profit finances 2

Abstract

Charities’ revenue structures have commonly been understood from the perspective of diversification and concentration. This is based on Markowitz’s portfolio theory, used to identify the optimal mix of investment assets based on estimates of their likely return and risk. Revenue diversification has been suggested as one way nonprofit organizations can mitigate the risk of over-reliance on one or a few funding sources and increase survivability (Chang and Tuckman 1991, Hager 2001, Carroll and Stater 2009). Work has highlighted potential substitution effects among revenue streams (Mayer, Wang, Egginton, and Flint 2014) as identifying “efficient” portfolios for some subsectors (Grasse, Whaley, and Ihrke, 2016).
Scholars identified positive and negative correlations between revenue streams, leading to theories of “crowding out” or “crowding in” (for example, Brooks 2003). Revenue streams also vary in their degree of risk and potential growth, so it makes sense that certain combinations might maximize return for a given level of risk. Kingma first noted that nonprofit revenues could be combined more or less efficiently, with the expectation that an efficiency frontier could be used to identify the maximum return possible at any chosen acceptable level of risk (1993). This has been tested empirically in one sector (Grasse, Whaley, and Ihrke, 2016), and the inherent tradeoffs have been examined more broadly (Mayer, Wang, Egginton, and Flint, 2014).
This research will be valuable to practitioners who must make difficult choices regarding where to direct their efforts in the pursuit of revenues and to the literature on nonprofit finance by extending our knowledge of portfolio-based models by leveraging new data and improving the measurement of risk. Work on portfolio optimization has primarily relied on data from the United States and utilized panels of between five and eight years. This study introduces a new research dataset of the population of Canadian charities that includes eighteen years of observations. While prior studies have treated risk symmetrically, this study uses asymmetric measures. This better captures the risk-aversion inherent in charitable financial management while also identifying and accounting for revenue streams that introduce disproportionate risk into charities’ revenue portfolios. We also test the assumption of symmetric dependence among charities’ revenue streams (Hatherley and Alcock, 2007). The analysis will include models for specific subsectors and organizational types, as these are likely to condition organizations’ revenue portfolios (Young 2008) and their characteristics.

References

References
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Brooks, Arthur C. (2003) “Do Government Subsidies To Nonprofits Crowd Out Donations or Donors?”Public Finance Review. 31:166-179
Carroll, D. A., & Stater, K. J. (2009). Revenue diversification in nonprofit organizations: Does it lead to financial stability? Journal of Public Administration Research and Theory, 19(4): 947-966.
Grasse, N.J., Whaley, K & Ihrke D. (2016). Modern portfolio theory and nonprofit arts organizations: identifying the efficient frontier. Nonprofit and Voluntary Sector Quarterly, 45(4):825-843.
Hatherley, A. and Alcock, J. (2007). Portfolio construction incorporating asymmetric dependence structures: a user’s guide. Accounting and Finance, 47 (3) (2007), pp. 447-472
Kearns, K. (2008). “Income Portfolios.” In Financing Nonprofits. D. Young (Ed.) New York: Alta Mirra Press. 291-314.
Kingma, Bruce. (1993). “Portfolio Theory and Nonprofit Financial Stability” Nonprofit Sector and Voluntary Sector Quarterly.
Mayer, W. J., Wang, H.C., Egginton, J. F., & Flint, H. S. (2014). The Impact of Revenue Diversification on Expected Revenue and Volatility for Nonprofit Organizations. Nonprofit and Voluntary Sector Quarterly, 43(2), 374-392.
Young, D.R. (2008). “Toward a Normative Theory of Nonprofit Finance.” In Financing Nonprofits. D. Young (Ed.) New York: Alta Mirra Press. 339-372.

Authors

• Nathan Grasse, Carleton University

• Elizabeth A.M. Searing, University of Texas at Dallas