2 Kinds of Investment Policies

The Wizard of Oz

 

 

 

 

 

 

Everyone “knows” that organizations that invest should have an investment policy. Why is this so important? As Yogi Berra says (and the CFA Institute’s primer for investment trustees relays), “If you don’t know where you’re going, you’re liable to end up somewhere else.”

Faced with the potentially challenging task of developing a policy, many trustees turn to professionals for help. Perhaps one of their investment managers will pull something together. Others may look to duplicate policies of other boards that they sit on. Finally there is always the internet, where an example of almost anything can be found. While it is possible to find a perfectly fine policy through any of these channels, there will be an essential element missing. Board ownership, or the full engagement of at least a subset of the full Board, is a critical ingredient of any sound and relevant Investment Policy Statement. Without the thoughtful participation of fiduciaries, an investment policy runs the risk of being the wrong kind of policy for an organization: namely, the kind that gets perfunctorily blessed by the Board and then resides forgotten in someone’s drawer. Perhaps this is being a bit overly dramatic, but the point is that an Investment Policy should be a living breathing thing that fiduciaries refer to in order to make decisions rather than a vacuous document that gathers dust in between decennial revisions.

Why is Board engagement so crucial to effective Policy? First of all, even if the policy adopted is sound, there is little likelihood that it will be adhered to if there is a lack of member “buy-in”. Typically in these situations, an ad hoc approach will be adopted that emphasizes short-term decision-making such as the hiring and firing of managers, rather than an approach based on a thoughtful process of long-term thinking that will guide groups through difficult times.   Secondly, the lack of commitment from members frequently results in a default to policies that may not have their best interests at heart (e.g. one that is drafted by a manager with a conflict of interest on portfolio review process) or that do not address the unique characteristics of the organization.

Once engaged, committee members would be well served to think about issues such as “Why does the Fund exist?”; “How does the investment committee define success?”; “To what extent are the trustees willing to accept the possibility of large losses?”; “How do the trustees evaluate the performance of the investment program?” By addressing these questions in the policy statement, trustees will have set forth a philosophy, a set of objectives and a plan for achieving those objectives.

A good policy should define the mission of an organization, describe the risk tolerance, state its goals and objectives and lay out the policy asset mix. Equally important, it should describe the process by which asset allocation decisions are made and the process by which performance is evaluated. Indeed part of the purpose of a policy statement is to develop and guide the manner in which an investment committee operates and to provide a reasonable basis for decision making. A key aspect is to design a policy so that it survives current members and acts as an organizational stabilizer during unusual market conditions. In a sense, investment policy statements communicate philosophy and planning to all participants in the investment process, from investment managers to board members, both present and future.

Adopting a policy is not just a “check the box” act so that an organization can say that it has an investment policy. As consultants, we have found that choosing to develop and implement a comprehensive policy that is driven by fiduciaries leads to a more transparent and effective investment program. Since even those policies that end up in someone’s drawer generally provide for investment policy review, perhaps it is time to take that policy out of the drawer and breathe some life into it.

About Jim Jeffery, CFA

Jim Jeffery, the founder and principal of Jeffery Asset Management has joined Solaris Advisors LLC as Managing Director where he will lead the non profit senior living effort. Jim is a Chartered Financial Analyst (CFA) with more than 20 years experience in the financial services industry. Have a question about your financial plan? ASK JIM
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