J. Timothy Jester, CAIA®, AIF®
Director, Institutional Advisory Practice & Senior Investment Counselor
April 7, 2016
As a volunteer for your non-profit, you are passionate about its mission. You have seen the good it does in your community. Six years ago, you joined the investment committee because you realized the importance of the endowment. While not an investment professional, you feel your personal experience provides you with the knowledge to best serve the non-profit in this role.
At your annual retreat for the committee, you are reviewing performance glumly. At the same retreat five years ago, working with your advisor/consultant, the committee decided to change the rather simple investment policy to a diversified global policy and to use alternative investments to mitigate risk. You are beginning to question the wisdom of that decision. International equities have lagged domestic equities four out of the last five years and your alternative investments, while reducing risk, have disappointed. A simple 60/40 portfolio has done much better. Other committee members are wringing their hands and remarking that we can’t sit here and do nothing. You are concerned about making any change. By changing your policy, are you saying that you possess information that you didn’t have when you set the policy and that new information leads you to conclude that a change is needed? Or are you simply forgetting the endowment’s long time horizon and reacting to a short term dislocation?
These questions typically appear when one or more of the following things happen.
Making reactionary changes to your investment policy threatens the success of your endowment and the ability to meet the long term needs of the organization. The emotional reasons behind such reactions are well documented in the field of behavioral finance. The knee-jerk reaction to change policy in the situation described above is known as extrapolating, meaning that the investor expects return patterns from the past to continue into the future. While tactical shifts may be justified, investors have a difficult time successfully identifying market tops and bottoms and this difficulty is magnified in the committee structure of typical non-profits.
Committee members often feel a different type of pressure to perform than that felt by individual investors. Foundations and endowments are often high profile in a community and there is an element of “fishbowl” risk. There is often the concern that poor performance reflects badly on the committee members as prudent investors and fiduciaries. Secondly, non-profits must be perceived as good stewards to attract new and repeat donors. No member wants poor performance to result in donations going to another organization.
An important way to avoid this dilemma is to properly address the issue of risk well in advance of any of the scenarios listed above occurring. Underperformance between asset classes, such as what has been occurring recently when comparing domestic to foreign equities, is highly cyclical. Recognizing this cyclicality before it happens allows committee members to discuss risk rationally rather than during the stress of a market downtown.
Another, and likely the most effective, is through the implementation of best practices and the documentation of a prudent investment management process. Although not the only source of guidance on this issue, we utilize the Global Fiduciary Standard of Excellence (GFSE), a process developed by Fi360 and the Center for Fiduciary Studies. The GFSE defines best practices that investment stewards should implement in the investment process. While no set of standards guarantees a successful outcome, we believe implementing the GFSE offers the highest probability. In addition, it offers peace of mind for the investment stewards and can provide confidence for potential donors and those that benefit from the mission of the foundation. You learn about the GFSE at www.fi360.com.