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Remaining Committed to a Strong Governance Process Can Lead to Improved Investment Outcomes
By: Michael Chase, Partner, Senior Consultant
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The COVID-19 pandemic had – and continues to have – a significant and often detrimental impact on many nonprofits, impacting their operating activities and their ability to fulfill their mission statements while increasing the demand for their vital services. Many of these nonprofits justifiably looked to their investment program to help fulfill near-term funding gaps; unfortunately, they have been confronted with a difficult question:
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Overlay this challenge with the current investment landscape of rich valuations, multiple macroeconomic and geopolitical headwinds and heightened volatility, and you will undoubtedly see that those tasked with overseeing perpetual investment programs are in a very challenging position.
Institutions that implemented and continuously follow a structured governance process are better equipped to navigate this unique and difficult landscape as a structured methodology helps keep committee members and other stewards focused on aligning the investment program with the objectives of the organization, both near-term and long-term. As a result, an established governance process not only solidifies the committee’s commitment to their fiduciary responsibilities but can also lead to improved investment outcomes.
DiMeo Schneider & Associates, L.L.C. takes a proactive approach toward helping our clients establish structured governance processes. We found success in a calendar-based approach, whereby each quarterly deliverable includes a detailed evaluation and discussion of important governance topics. Our approach ensures that investment fiduciaries review key considerations on a regular basis and integrate a commitment to governance into each meeting. The following is a summary of the topics covered in our Fiduciary Governance Calendar, shown below, and their critical role in driving both an improved governance process and better investment outcomes.
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Fee and Spending Focus
Expense oversight is certainly an important component of a sound fiduciary process; in fact, it can have a meaningful impact on the outcome of the investment program overall. However, excessive fees can gradually decrease returns and, for the long-term, make it difficult to preserve the corpus. A comprehensive review of fees is not intended to be an absolute exercise but rather an evaluation to ensure that the fees and expenses borne by the investment program are justified, aligning with its unique structure and objectives. A regular review of manager, custody and advisory fees often provides insights into opportunities to improve net returns.
Two issues must be considered during the process of determining a spending policy and focus:
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• Spending policy is the lone input to the creation of intergenerational equity over which an institution has full control.
• This policy is also vital to the institution’s ability to fund operations in support of its mission.
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These two considerations are frequently at odds with one another but must be considered in tandem to ensure the effectiveness of a prudent investment strategy. Regular review of the spending policy, the institution’s reliance on the draw to support operations and the success of the investment program in meeting long-term objectives is vital to ensuring long-term success.
Investment Focus
Setting a regular review of program investments is an opportunity to review the portfolio at a more granular level. The focus should be on the unique role each asset class and investment manager plays in the portfolio and the risks associated with the various strategies. Committee members with a strong structural understanding of the portfolio they oversee are more likely to remain at ease and stay the course in volatile markets.
An important step in achieving this is to review performance attribution. In so doing, you will be able to:
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• Understand why your institution may be underperforming over a certain time period
• Recognize which types of market environments could lead to relative outperformance or underperformance
• Maintain confidence in your strategic allocation
• Be encouraged to stay the course with individual strategies that are employed in the portfolio
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The ultimate goal of the investment-focused review is not to opine on short-term headwinds or opportunities in the market but to ensure all committee members are comfortable with the long-term strategy and risks of the portfolio. The result is a commitment to the portfolio’s long-term approach to delivering investment results that meet objectives.
Governance Focus
As stewards of the institution’s investment program, the investment committee’s primary goals are threefold and should include:
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• Supporting the institution’s mission
• Preserving the corpus
• Promoting intergenerational equity.
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It can be easy for committee members to become somewhat complacent in their role and begin to direct their attention toward short-term topics like capital markets or quarterly returns. Proper stewardship is about remaining focused and disciplined in the pursuit of the institution’s goals. Taking the time to reflect on both successes and potential shortcomings is vital for a committee to achieve this objective. Regularly reinforcing responsibilities and best practices allows committees to stay committed to maintaining a long-term, goal-oriented emphasis and remain disciplined in the face of uncertainty.
Characteristics of a Strong Investment Policy Statement
The investment policy statement is the blueprint for the investment committee’s prudent oversight. As such, this document should be:
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• Detailed enough to provide clear guidance to all parties involved
• Broad enough to enable flexibility to make any decisions deemed prudent
• Thoughtful enough to encourage a committee to adhere to its long-term, strategic objectives.
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In addition, a periodic review of the policy is necessary to ensure continued alignment with the institution’s enterprise goals, as those may change over time. This review is as much an opportunity to refresh committee members’ understanding of the goals and specific guidelines detailed in the document as it is to confirm the appropriateness of the policy statement.
Allocation and Strategy Focus
It has been widely documented that strategic asset allocation is the primary determinant of long-term investment results. Incorporating a formal allocation review is an important step toward establishing a structured governance process. This regular review of risk and return expectations is not necessarily about making short-term tactical shifts; rather, it serves as an opportunity to evaluate the institution’s evolving goals and objectives in conjunction with current capital market conditions and expectations.
The asset allocation review has the potential to do either of the following:
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• Provide confirmation that the investment program reflects those goals, offering a reasonable probability of achieving them
• Suggest a disconnect between the investment program and the goals of the institution
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Embedded in this long-term approach to asset allocation should be an understanding that market volatility can – and likely will – result in the investment program failing to meet that goal over some shorter-term periods. A regular and thorough review should help your committee stay grounded in the long-term and reduce the potential of reactionary decision-making, which may impact the ultimate investment outcome.
Following a structured and comprehensive governance process allows committees to properly evaluate and respond to near-term demands yet remain committed to the long-term objectives. The underlying theme in each topic discussed in our governance calendar ensures the committee’s focus remains framed around the institution and its mission. Endowments and foundations are perpetual pools of capital, and short-term shifts in market sentiment or near-term fiscal challenges should not impede those long-term objectives. As such, the more relevant topics of discussion are those items outlined above. Whether the process results in finding an opportunity to reduce fees, formalizing a revison to the strategic asset allocation or commiting to the investment thesis and portfolio strategy, directing your efforts to the institution’s long-term goals through an established governance framework can produce a superior long-term investment outcome.
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For more information, please contact any of the professionals at DiMeo Schneider & Associates, L.L.C.
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| This report is intended for the exclusive use of clients or prospective clients of DiMeo Schneider & Associates, L.L.C. The information contained herein is intended for the recipient, is confidential and may not be disseminated or distributed to any other person without the prior approval of DiMeo Schneider. Any dissemination or distribution is strictly prohibited. Information has been obtained from a variety of sources believed to be reliable though not independently verified. Any forecasts represent future expectations and actual returns, volatilities and correlations will differ from forecasts. This report does not represent a specific investment recommendation. Please consult with your advisor, attorney and accountant, as appropriate, regarding specific advice. Past performance does not indicate future performance and there is a possibility of a loss.
Michael Chase is Partner, Senior Consultant of Fiduciary Investment Advisors, LLC, which is a wholly owned subsidiary of DiMeo Schneider & Associates, L.L.C.
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