By Mark Barnicutt on October 29, 2011
The Historical Focus:
Over the past three decades, institutional investors – such as group retirement plans, foundations & endowments – have gradually been lured into the erroneous belief perpetuated by the global wealth management industry that the relative investment performance of the assets that have been entrusted to their care, is actually important. As we’ve discussed before, this relative investment performance problem appears in comparing portfolio performance against both Market Indices (ie: S&P 500, TSX, etc.) as well as Peer Groups.
What Have Been The Results?
By obsessing about this relative performance, Boards & Investment Committees of such institutional investors have been focusing on the wrong results. In other words, instead of focusing on preserving their capital bases and paying attention to ensuring that their future consumption requirements are being met, it’s been our experience that Board and Investment Committees spend countless hours examining relative performance statistics that have absolutely nothing to do with their own future funding realities. As a result, we’ve witnessed over the past decade:
– Pension plans who have seriously unfunded liabilities because their portfolios were designed to ”perpetually chase relative returns” through high investment manager turnover instead of focusing on matching their assets to future pension obligations.
– Foundations & Endowments who have had to cut their spending policies because their asset bases — and subsequently income generating capabilities — were impaired due to their focus on trying to find investment managers who “consistently beat the indices” or following the portfolio construction patterns of other foundations & endowments (ie: the Yale and Harvard approach to alternative investments).
Who Is Responsible?
Although the ultimate responsibility for these funding issues rests with the investment fiduciaries who sit on these Boards & Investment Committees, we don’t believe that the real blame rests with them; instead, it rests with the wealth management industry. Most investment fiduciaries who sit on such Boards & Investment Committees are not investment professionals, nor have they typically been trained on the basics of investment management & how to effectively govern the wealth that has been entrusted to their care. As a result, they rely upon the advice & expertise of the investment professionals who service them.
Unfortunately, because the wealth management industy has become so obsessed with chasing relative returns and/or the short-term profits of their own firm through the creation of an endless stream of proprietary investment products, too much of our industry is focused on getting institutional boards to buy their products and/or change investment managers every 18 months, with future promises of big returns instead of actually taking the time to design an Investment Policy that truly reflects the organization’s investment objectives, funding requirements and real tolerances for risk.
As a result, it’s incredibly challenging for such investment fiduciaries to find investment professionals who are not only objective in the advice that they provide but also focused on architecting portfolios for the long-term versus selling products or investment managers.
On What Should Boards & Investment Committees Focus?
So what should Investment Committees be focused on? The short answer is five (5) things:
1. Defining Their Investment Objectives & Goals:
– Identify & quantify investment goals by short, medium & long-term time horizons.
2. Defining Their Tolerance For Risk:
– Defining how much downside (both in dollar & percentage terms) for both portfolio capital & income/cash flows that investment fiduciaries are prepared to accept.
3. Establishing A Customized Investment Policy Statement:
– Design a tailored IPS that addresses their investment objectives, risk tolerances and any unique constraints that should be placed on portfolio structure through the creation of a set of goals-based portfolios.
4. Monitoring Adherance To Investment Policy:
– Monitor, on a regular basis, the performance of their portfolio against the objectives of the Investment Policy Statement as well as the structure of their portfolio against the constraints that have been established in the IPS (ie: how much will be allocated to equities vs fixed income vs cash). If investment managers are not fullfilling their adherance to the long-term investment policy of the organization, then the Board/Investment Commitee must ensure that appropriate managers are engaged.
5. Reviewing Investment Objectives & Risk Tolerances:
– As every organization’s goals & objectives can change over time, Investment Committee should have at least an annual forum for ensuring that their objectives & tolerance for risk remains the same. If not, the Investment Policy Statement needs to be updated.
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