III: Effective Investment Processes

Institutions with appropriate policies and well-constructed boards still require effective investment processes to be successful. Boards can rely on proven practices in designing and implementing their approach.  

Articulate the Investment Philosophy & Strategy First 

At the outset, the investment committee must devote sufficient time to formulating an investment philosophy to guide their strategy discussions. These beliefs should be recorded as an explicit investment creed or mission to ensure continuity and adherence to a long-term disciplined approach.  

In defining the strategy, the committee should work through several critical questions, the answers to which will enable clearer communication of these beliefs.  

These questions encompass high-level, strategic concerns, such as determining where the investment committee, managers, consultants, and staff believe they can add value. Areas to discuss include: 

• Strategic asset allocation – setting the long-term strategic target allocation 
• Tactical asset allocation – purposefully deviating from the target allocation  
• Opportunistic investing – including investments not in the target allocation  
• Manager selection – hiring and firing investment managers 
• Active management – deviating from the benchmark (index) portfolio 

Further, the implementation of these decisions must be clarified and communicated so all stakeholders are keenly aware of their roles and responsibilities. 

A key consideration in determining investment strategy is understanding various risks and the ramifications to the institution when the portfolio does not perform as expected. Examples of risk include: 

• Permanent impairment of capital 
• Underperforming long-term investment objectives 
• Volatility 
• Probability of loss 
• Underperforming benchmarks 
• Underperforming peers 

The investment committee should prioritize which risks are of concern and seek to understand how they will respond when faced with these risks. 

Develop an Investment Policy Statement 

Once the committee has determined the appropriate philosophy and strategy, it needs to document how that approach should be executed. These issues should be formally articulated in an Investment Policy Statement (IPS). Topics and questions to consider include: 

• Investment objectives: What is the long-term goal of the portfolio, and how much short-term volatility can be tolerated? 
• Spending policy (endowments and foundations): What spending is sustainable based on the target asset allocation? 
• Asset allocation: What asset classes should be in the portfolio? What are the target weights and ranges? 

 
Further considerations include: 

• What are the rebalancing guidelines (as demonstrated by asset allocation ranges)? 
• Should there be strategic factor tilts, such as market capitalization, style (e.g., value), or geography (e.g., U.S. vs. international; developed vs. emerging markets)? 
• Do illiquid assets provide a premium, and how much liquidity is needed? 
• Which assets should be actively managed vs. passively managed? 
• Should tactical asset allocation be employed? 
• Manager evaluation: How will investment managers be selected and evaluated? This is important to understand beforehand as managers invariably will underperform at some point. Acknowledging this and determining how the committee will react to this inevitable occurrence is imperative to long-term success. 
• Guidelines and restrictions: What constraints will be in place to control risk and ensure the portfolio does not assume unintended exposures? 
• Performance and risk measurement: Which metrics will be used to determine success? 

Best Practices for Investment Committee Meetings 

Once the IPS is adopted, the investment committee is responsible for ensuring compliance with the agreed-upon provisions. Much of this work will occur in the investment committee meetings. Although monitoring portfolio performance will be a part of this process, the committee should avoid spending an inordinate amount of time scrutinizing each investment manager and their performance. 

Further, valuable committee meeting time should not be devoted to discussing members’ opinions on the economy or participating in operational decisions, such as manager selection, tactical asset allocation, opportunistic investing, and rebalancing. Yet, these are often the agenda items covered at investment committee meetings, because people typically enjoy discussing interesting topics and being part of the operational decisions. In reality, though, the quarterly investment committee meeting is ill-designed for operational decisions. Attempting to make critical decisions such as these while meeting for a couple of hours four times a year is imprudent. 

Effective committee members understand their roles as fiduciaries and recognize that they are not responsible for managing the portfolio. Rather, they focus on the following: 

• Understanding the investment process employed and determining whether it adheres to the institution’s strategic vision. 
• Evaluating staff and other fiduciaries to ensure they are properly implementing the long-term investment strategy. This requires continuous communication and clarity of the long-term objectives and short-term risk tolerance outlined in the IPS. 
• Periodically reviewing the investment philosophy and strategy to ensure the approach can achieve the institution’s mission. 

Well-run meetings begin with planning and preparation. An effective committee chair will meet with staff to discuss the agenda, understand how much time should be devoted to each agenda item, and know what items need approval and which are informational. Materials should be sent well in advance to give committee members enough time to review and prepare for the meeting. 

Discussions and decisions should be documented, and follow-up items should be identified and assigned to the appropriate parties with target due dates. Meeting minutes, including follow-up items, should be sent within a week after the meeting while the information is still fresh and not a week before the next meeting. Devoting time and effort to these simple organizational processes should lead to well-run meetings and more effective decision-making. 

Organizations seeking to adopt these practices should focus on instituting or improving these areas in a deliberate manner. Board members should not assume that just because a structure is established that it cannot be improved. Providing additional and even simple structural supports can help a fiduciary team run more efficiently and ultimately improve investment returns. 

The recommendations described above are common sense and few would disagree with adopting this course of action. Nonetheless, a surprising number of boards and committees do not follow these modest organizational practices, frequently leading to ineffective meetings and frustrated committee members. Understanding fiduciary roles and responsibilities should lead to better accountability. A more thoughtful approach to committee composition should result in members who work well together and complement each other’s skillsets. Finally, adhering to sound investment strategy processes and understanding the intent of investment committee meetings should lead to effectively- run meetings and well-reasoned decisions.