CFA Institute Primer for Investment Trustees

The CFA Institute published a second edition of its primer for investment trustees a couple of years ago. The book begins by emphasizing governance structure.

We like to think of the Fund’s governance structure as a three-legged stool. Each leg of the stool provides support and balance for the investment program. And like a stool, the investment program cannot stand without all three of these legs. The three legs of the Fund’s governance structure are as follows:

      • Roles and responsibilities—a delineation of functions that the various decision makers are assigned to perform.
      • Lines of authority—a description of the latitude that decision makers have to carry out their responsibilities and a specification of their reporting arrangements.
      • Accountability standards—a statement of expectations regarding the effectiveness of the decision makers combined with a set of procedures for reviewing and, if needed, responding to the actions of those decision makers to whom responsibility is delegated.

There are other aspects of the Fund’s governance structure that keep it strong:

      • Due diligence—appropriate oversight of the investment program’s operations.
      • Checks and balances—decentralized decision making and the ability of one set of decision makers to challenge others.
      • Reporting and monitoring—adequate and timely distribution of information to decision makers.
      • Transparency—access to the details behind the Fund’s investment transactions, fees, expenses, and cash flows.
      • Compliance with industry best practices—periodic review of other funds’ operations and modification of the investment program when appropriate.

A Primer for Investment Trustees: Understanding Investment Committee Responsibilities, CFA Institute

It then describes endowment payouts.

The benefit payments of the endowment fund are determined by the endowment fund’s spending policy—the percentage of the fund’s assets that are paid out each year to its beneficiaries. That spending policy is based on such factors as peer practices, competition for donors, intergenerational equity (today’s spenders versus tomorrow’s), and perhaps most importantly, expectations regarding long-term inflation-adjusted returns available in the capital markets. Payments to the endowment’s beneficiaries will vary over time in ways that are difficult to forecast. As the endowment fund’s asset value fluctuates, given the relatively fixed spending rates, so also do the payouts.

It also elaborates what trustees should believe in before hiring external fund managers.

The use of active management in an asset class requires a series of beliefs on the investment committee’s part. The trustees must believe that:

      • managers exist who can produce a positive excess return relative to an appropriate benchmark,
      • the decision maker hiring the managers (the trustees, staff, or OCIO) can identify these managers,
      • the decision maker can hire these managers to manage the Fund’s assets,
      • the trustees have the risk tolerance to endure extended periods of time when the managers underperform their benchmarks, and
      • the decision maker can structure a team of these managers to reach the Fund’s investment objectives.

The decision to hire active managers in a particular asset class requires the trustees to answer “yes” to all of these belief statements. A “no” answer to any of the statements implies that the Fund should not engage in active management in that asset class. By implication then, passive management ought to be the default position where it is available. (Some asset classes, such as private equity, can be accessed only through active management.)

Finally, the book’s Investment Policy Statement template in the appendix lists the responsibilities of an investment committee.

In general, the Committee’s responsibilities are focused on expressing the Fund’s mission and choosing the investment policies most likely to achieve it. The Committee is also responsible for monitoring staff effectiveness and seeing that its policies are properly implemented by the managing and operating fiduciaries to which it has delegated specific authorities. The Committee:

      • defines the Fund’s mission,
      • establishes performance goals and investment objectives for the Fund and monitors actual performance versus these goals and objectives,
      • determines the acceptable level of capital market risk,
      • establishes the policy asset mix and acceptable asset allocation ranges around that policy asset mix,
      • approves or rejects asset allocation deviations from approved ranges,
      • determines the acceptable level of active management risk,
      • determines acceptable asset classes and subcategories (e.g., emerging markets, absolute return strategies),
      • approves asset class targets,
      • approves the investment staff’s annual operating budget,
      • reviews governance procedures and makes recommendations to the Regents,
      • approves consultant, custodian bank, legal, and audit relationships,
      • approves securities-lending arrangements,
      • evaluates and retains the CIO,
      • ensures resources adequate to perform the Fund’s mission effectively,
      • provides information and recommendations to the Regents as required, and
      • conducts business in an ethical manner, including establishing and following a code of conduct consistent with industry practices.

If you are serving as an investment trustee, go study the book.

The Rose Main Reading Room inside the New York Public Library.
Photo by Vinicius Amano on Unsplash

Post by Marcelino Pantoja