The current economic climate

Q. What impact has the current economic environment had on the Annual Programs Fund?

A. Due to the current world economic climate, The Rotary Foundation's investments have experienced an unprecedented decline in market value. This decline in value is reported as an investment loss in the Foundation's statement of activities, in accordance with U.S. accounting rules. The market loss was so severe in fiscal year 2008-09 that it eliminated the full value of the operating reserve.

Historically, the Foundation has controlled risk by having well-diversified portfolios comprised of assets that behave differently in different types of markets. Unfortunately, in periods of extreme market distress, as experienced this fiscal year, diversification did not work. All asset classes suffered losses. The Foundation's Investment Advisory Committee will be reviewing the investment policy statements for the Annual Programs Fund at its September meeting and for the Permanent Fund at its March 2010 meeting. Having experienced the results of this extreme market environment, the Foundation needs to revisit how much risk it is willing to assume, and to structure portfolios in accordance with the Foundation's current risk tolerance.

Q. What impact has the current economic environment had on the PolioPlus Fund?

A. Due to the immediate funding needs of the polio eradication initiative, the PolioPlus Fund is short term in nature and requires a lot of liquidity. Hence, the Foundation invests those funds in high-quality, short-term fixed income securities. In addition, the grants from the Bill & Melinda Gates Foundation are invested in only U.S. treasury securities. The grant from the Google Foundation was invested in a money market fund prior to its utilization.

This investment strategy is not appropriate for the Permanent Fund, which has an indefinite time horizon, or the Annual Programs Fund, which has a longer time horizon given the three-year investment cycle and relatively low liquidity needs. For additional information on the Foundation’s investment structure, investment policies, and historical information, see The Rotary Foundation Investment Information .

Q. How have the Foundation's operating reserve and programs been affected?

A. The Rotary Foundation has a funding cycle that uses donations for program awards three years after contributions are received. The three-year cycle gives districts time for program planning and participant selection and allows the Foundation to invest the contributions. The accumulated earnings from these investments make up the operating reserve, which pays for administrative and fund development costs. If investment earnings are sufficient and exceed the minimum operating reserve requirement, they will also be used to pay for program operations. The target operating reserve shall equal the sum of (1) budgeted operating expenses for the current year, (2) forecasted operating expenses for the next two fiscal years, and (3) 50 percent of the budgeted Annual Programs Fund awards for the current year. The Foundation Trustees established the operating reserve to provide adequate funds to support the Foundation's operating expenses in the event that investment income is inadequate, to provide funds to cover a decline in the value of Rotarians' contributions due to adverse market conditions, and to define parameters that will determine when surplus funds must be used to support programs or when operating spending should be constrained. The Trustees must take action to re-establish the reserve or reduce expenses if the level of the reserve falls below 50 percent of the targeted reserve level. Please see Operating Reserve .

As of April 2009, the significant decline in the market value of the Foundation's investments has eliminated the Foundation's operating reserve and, therefore, its ability to fund operations. Actions taken in fiscal year 2008-09 to re-establish the reserves or reduce expenses have included:

• Reducing the fiscal year 2008-09 World Fund expenditures by US$16.3 million

• Canceling all nonessential discretionary spending, including staff and volunteer travel, overtime expenses, temporary help, consultants, and staff development

• Reducing staff and volunteer costs while traveling on Foundation business

For additional information, see Trustee Chair Jonathan Majiyagbe's 6 May letter to Rotarians.

In April, the Trustees established a subcommittee to review methods to restore the operating reserve, which will report its findings at the October meeting of the Trustees.

Q. Why was the Annual Programs Fund not invested more conservatively?

A. The Rotary Foundation's investment policies reflect industry best practices that feature long-term investment strategies and portfolio diversification. The Foundation invests in accordance with the Uniform Prudent Investor Act , which governs the investment management of institutional funds. Unfortunately, the losses we are experiencing are across most investment categories. This is an extraordinary year in history for investments. The Foundation knows of no other institutions such as ours that had the foresight to predict what is currently happening in the global financial markets.

Q. Why aren't the assets of the Annual Programs Fund invested in deposit accounts, given the three-year spending cycle?

A. The primary objective of the Annual Programs Fund (APF) is to fund the programs of The Rotary Foundation. Additionally, a portion of the assets will be used to fund the general administrative, program operations, and fund development expenses of The Rotary Foundation that are associated with the fund. APF contributions are invested for a three-year period before becoming available to fund programs. The purpose of this investment cycle is to generate sufficient investment earnings to fund the Foundation's operations (general administration, fund development, and, if additional funds are available, program operations) so that Rotarians' contributions can be spent entirely on the Foundation's programs. The APF assets need to be invested in securities that will generate sufficient earnings to operate the Foundation. Investing primarily in assets such as U.S. treasury bills and deposit accounts does not generate sufficient investment earnings to pay for all of the Foundation's operations. It is for this reason that the APF's assets are invested in a diversified portfolio that is expected to generate the level of income needed to operate the Foundation. In normal financial markets, a diversified portfolio of uncorrelated assets will sustain an investor through periods of declines in any particular area of the market. However, the financial markets have not been normal during the past year; diversification has not provided the protection it usually does, as the value of all asset classes has declined. The above strategy has served the Foundation well for over 30 years; that is, investment earnings have been sufficient to pay for the Foundation's operating expenses, and Rotarians' contributions were spent entirely on programs. Additionally, investment earnings were so strong in the late 1990s that nearly US$100 million of investment earnings was spent on polio eradication and other APF programs ("TRF Historical Investment Return Information," in The Rotary Foundation Investment Information ).

From a cash management standpoint, the Foundation does not separately invest the contributions received each year for a three-year period. Given that APF contributions have typically grown from year to year, the Foundation was able to use current cash flow to pay for current year program expenses and therefore keep the APF assets invested longer. As long as contributions to the APF continue to grow, the Foundation is able to follow this practice. However, if contributions to the APF decline, APF assets may need to be sold to pay for current year program expenses.

Q. With reduced program spending, will the Foundation reduce administration spending proportionately?

A. The general secretary has reduced spending in several areas, such as staffing and travel expenses. Projects related to open grants, however, must be monitored regardless of current year budget reductions. Also, funding is required to support Rotary’s US$200 Million Challenge . Finally, the Trustees are committed to investing in the Future Vision Plan. These important endeavors are offsetting cost reductions in other areas.

Q. Has the Investment Advisory Committee been active?

A. The Investment Advisory Committee met in April and June 2009 and is making recommendations to the Trustees at its June meeting. Also, the committee will be reviewing the investment policy statements for the Annual Programs Fund at its September meeting and for the Permanent Fund at its March 2010 meeting. Having been in this extreme market environment, the committee will revisit how much risk the Foundation is willing to assume and structure portfolios accordingly.

Q. Why is it still important to give to the Annual Programs Fund even after program budgets were reduced?

A. The need now is even greater than before in the 33,000 communities served by Rotary. While investment earnings helped the Foundation provide extra services in the past, our ability to meet these pressing needs is even more dependant on the continued generosity of Rotarians today. In difficult times, people look for leadership. Rotary has a strong tradition of providing such leadership and, as evidenced by the strong contributions to the Foundation this year, Rotarians are responding again.