Investment committees of higher education institutions face a daunting task of meeting their fiduciary responsibilities. In other words, they bear the brunt of ensuring that the investment portfolio is properly managed. The committee has the legal responsibility for managing the school's money.
Many factors add to the above challenge. Investment committees are built to act too slowly. Usually, they have too many members. They often fail to understand institutional strategy. The investment environment continues to become increasingly complex, due in part to the spread of globalization. College and university endowments have been increasing in size and importance in terms of providing badly needed financial support to the parent organization. Many now hold assets of hundreds of millions of dollars. The income provided from them continues to increase as a percentage of the total operating budget.
No longer can trustees function, for the most part, on their direct experience in handling investments held in their personal portfolios.
Instead, they must work hard to learn the unique characteristics of assets classes that are now available to large institutional portfolios. It is not unusual for large endowments to hold as many as 30 different asset classes in their portfolios, compared to six or so as recently as 15 years ago. Another key factor is the spread of alternative assets, which can be very complex and often misunderstood.
Committee members must also be prepared to deal with the various parties who are influenced by the endowment's return and income, including: donors, parents, students, faculty, administrators, and other non-committee members of the governing board.
An investment policy should document the many factors this committee must address, focusing on defining the desired outcomes and setting a plan of action to achieve them. Another important document: the operating policy, which serves as an operational blueprint for action, or "who does what."
The investment policy's main focus is on the asset mix of the endowment. It should address the following:
The asset classes to be included in the portfolio
A methodology for rebalancing the portfolio
The asset mix ranges of the portfolio's various asset classes
The return objective
The level of risk tolerance
Before the portfolio is constructed, it's essential that the members of the committee have a clear understanding and agreement about the desired return of the endowment and the acceptable level of risk necessary to achieve it.
Everyone should also understand how the modeling process works and be aware of its shortcomings and limitations. Members should be cognizant of the goal of the process-to achieve superior results and not merely to beat the market.
The investment policy is intended to develop and adhere to appropriate investment strategies on a long-term basis. Such consistency in investing enables a portfolio to remain well positioned to benefit from the long-term returns available from the capital markets.
This all leads to the development of what could be called a "reasonable return expectation."
One should start the process with the long-term return of the equity markets (S&P 500 or MSCI World), which is the historical equity risk premium of about 6 percent plus the current Treasury bill return of 4 percent or so. This serves as the expected return of what is considered the "normal asset mix" or strategic asset allocation, considered the most appropriate portfolio to maintain over time. The committee must understand, too, that the projected return is subject to variation due to risk, and that it represents the projected average annual return over a full market cycle.
Turning to the operating policy, investment performance is expected to be divided as follows:
Execution - 20%
Asset Mix - 35%
Rebalancing - 25%
Manager Selection - 20%
Execution is how well the investment process is managed. This includes such things as an effective strategy, decision-making, tactics, education, performance review, committee orientation, voting process, hiring of managers, communication, committee selection/retention, and attribution analysis.
Another key factor for committee effectiveness is the development of a series of core beliefs, which serve as a guide for decision-making and to ensure that all members of the committee share common values and assumptions. Lacking core beliefs laid out in writing usually results in disagreements that often cause uncoordinated actions. An effective committee is one that shares written core beliefs and relies on them to guide the investment process.
To be effective, the committee should:
Focus on its strategic mission.
Function as a team.
Set a proper agenda.
Select the senior investment officer.
Set an objective measure of success.
Be properly informed.
Have a cooperative relationship with institutional management.
Understand the role and importance of the endowment to the financial well-being of the institution.
Appoint taskforces when appropriate.
Understand the role of outside consultants and their performance.
Be appointed based on the abilities of its members.
A more effective investment policy committee is essential for every institution. The critical elements in assuring this are the careful selection of committee members, an effective program of education, and good communication.
Louis R. Morrell is vice president for investments and treasurer at Wake Forest University (N.C.).