5 steps for a great investment committee


5 steps for a great investment committee

Originally published in American City Business Journals

By Mark Dixon

These are the times that truly can test investment committees for endowments and foundations.

As they prepare to assess their annual performance amid a stock market relishing record highs, many committees might be tempted to adopt more aggressive strategies to boost returns.

Rather than wading into such discussions, investment committees should use this time to ensure they are prepared for the inevitable market volatility that is part of every market cycle. An investment committee has a great deal of responsibility — establishing an investment strategy, documenting the investment process, evaluating and hiring managers, monitoring investments, and undertaking ongoing due diligence. With so many details, it would be easy to lose sight of the big picture.

The key is to not become overly exuberant during good times or panic in downturns. Clear-headed assessments are the hallmark of good committees.

Following these five practices gives committees a roadmap for good times and bad.

1. Prioritize education

In his book The Stewardship of Wealth, Gregory Curtis writes about why many investment committees fail. Curtis contends that many committees tend to operate in groupthink rather than the type of long-term, against-the-grain thinking that has made some endowments, such as Yale’s, a success.

To enjoy the type of success Yale has enjoyed, investors must cope with bouts of short-term discomfort. The key to that is having an educated investment committee that understands the portfolio.

Committee members should know why the portfolio has made every investment and what role each plays in the context of the overall investment strategy. Armed with that knowledge, the committee should set a range of expectations.

What might happen if the economy tanks or interest rates spike unexpectedly? What impact could a war with North Korea have on markets? Committees can then judge results against those expectations.

It’s always a challenge for investment committees to deal with poor performance, but knowing that even weak results fall within the forecast range makes managing the situation easier.

2. Be consistent

Even in the world of investments, there are trends that swing back and forth over time — active vs. passive, growth vs. value, domestic vs. international. However, these trends are often driven by investor behavior, which can be irrational. For example, more than 40 percent of endowments and foundations increased exposure to passive investment strategies in the past three years, according to a survey by Boston-based consulting firm NEPC.

That shift came as passive investment strategies have performed very well in comparison to actively-managed strategies, most notably high-fee hedge funds that posted weak performance. However, since hedge funds are intended as a hedgeagainst markets, eliminating them after years of strong stock market returns may prove shortsighted.

There’s more than one way to construct an investment portfolio. Many smaller endowments prefer the “less is more” approach focusing on stocks and bonds, higher liquidity, and lower costs. Some try to mimic the “endowment model” pioneered by Yale and other large universities, emphasizing alternative investments that can generate superior returns as a result of their illiquidity premiums.

There’s no single right way to build a portfolio, and there’s certainly any number of ways that can lead to success. Most importantly, committees must be consistent and stick with decisions. The worst mistake is abandoning a chosen long-term investment strategy at the first sign of trouble.

3. Focus on what you can control

Committees should never engage in market timing, try to predict the turning point in the economic or market cycle, or chase the performance of an asset class/sector/fund/security. Instead, they should focus efforts on what they cancontrol — monitoring portfolio costs, minimizing potential conflicts of interest, planning for future liquidity needs, and assuming an appropriate level of risk, all within the context of a well-conceived long-term strategy.

Since success is most often determined by sticking to the plan rather than trying to beat a benchmark, committees should regularly evaluate progress toward the organization’s financial goals. Among those may be achieving a targeted rate of return, providing sufficient income to support operations, or a host of other objectives. Hitting those goals is not always entirely dependent on investment performance.

4. Delegate

With so much work to be done — assessing the financial goals of the organization; setting an investment framework to meet those goals; monitoring results, costs and changes to the regulatory environment; and being ready to make changes as needed — it makes sense for committees to delegate specific, specialized tasks to a person or to a sub-group of the committee. Ideally, this individual will be knowledgeable in his or her area of responsibility, making that person well suited to handle decisions quickly and effectively.

5. Plan for committee turnover

A successful investment committee should be able to withstand turnover among members and should make that churn part of its plans. While excessive change can lead to an inconsistent investment approach, some turnover is helpful because it reduces the risk that dominant members may unduly influence outcomes.

Staggered terms for members, with term renewals for critical decision-makers, mitigate the risk of dramatic membership changes. And maintaining strong documentation, from a well-constructed investment policy statement to rigorous meeting minutes, as well as training and an orientation for new members to help them understand the goals and objectives set forth in these documents, helps new members join the committee without undue disruption.

There’s no perfect way to structure an investment committee. Different groups follow rules best suited for their organization. Some endowments like an odd number of committee members to avoid hung votes, while Yale has a rule that only three members of their board work at the university while the seven others are investment experts.

Whatever the finer points of the approach, successful committees follow these five best practices so they can focus on what really matters — supporting the long-term financial health of their organizations.

As the leader of the Plante Moran Financial Advisors institutional investment consulting practice, Mark specializes in providing consulting services to institutional investors and family offices while also overseeing training. With more than 23 years of experience in the industry, he’s known for his creativity combined with a deep, technical knowledge of investment consulting and wealth management.