Investment committees face complex challenges overseeing institutional investment funds. They must navigate myriad laws and regulations, select the right managers and strategies, monitor their portfolios, and ensure their funds can deliver the returns needed for their beneficiaries.
To help guide these committees, Callan Chairman and CEO Ron Peyton and Consultant Brady O’Connell, CFA, CAIA, developed these 10 tips. (For a deeper dive into the subject readers are invited to review their paper. And Callan’s Elizabeth Hood, CFA, and Cody Chapman, CFA, CAIA, wrote a companion piece on the topic, “Built to Last: Strategic Guidance for Effective Investment Committees.”) Underlying the 10 tips is a guiding principle for institutional investors: focus on avoiding losses, not trying to achieve extraordinary gains.
1. Commit to a long-term investment strategy—then stick to it
The most successful Callan clients make a long-term strategic decision and stay with it over many decades. This is not easy, but the secret is to select a strategy that satisfies the long-term return needs of the plan. Importantly, this strategy must be understood and maintained by future administrations, which leads us to No. 2…
2. Understand the investment strategy
Do not employ investment strategies the committee does not fully understand. A good way to follow that principle is to employ a strategy that can be maintained, explained, or defended by the next CIO, investment committee, administration, or the participants—at its worst possible moment.
3. Hire and fire managers for the right reasons
Committees should hire managers for their investment strategy and their perceived ability to achieve the strategy rather than recent performance ranking. They should be fired when the manager’s investment philosophy or process is faulty, or the competence of its people to achieve the strategy no longer exists in the manager’s organization. From time to time, institutions should formally reflect upon their decision-making process and their effectiveness in making active manager hiring and firing decisions. Those unable (or unwilling) to ignore shorter-term cycles of underperformance from active managers should strongly consider use of an index fund.
4. Develop proper controls and oversight
Fiduciaries need to remember that they retain the responsibility to oversee delegated activities. While it is nearly impossible to insulate an institution from fraud entirely, strong controls to monitor external advisers and internal players can reduce its potential.
5. Vigorously monitor costs
Tracking and managing investment-related costs is critical, especially in an environment of modest return expectations. This is of particular importance in the alternative investment world, where costs come in different forms and are often indirectly assessed.
6. Create well-defined rebalancing practices
This is a critical risk management function. Rebalancing is often counterintuitive to human nature, but it is the only proven way to buy low and sell high successfully over time. Failure to rebalance can result in taking on too much—or too little—investment risk.
7. Understand the strategy’s investment restrictions
A well-diversified portfolio can be hurt by restrictions on the types of investments allowed. Investors need to understand how restrictions can impact the investment opportunity set and the potential effect these restrictions can have on long-term returns. And institutions that adopt restrictions should periodically review the costs of these decisions.
8. Attract and retain a qualified investment team
As institutions have increasingly embraced more complex alternative investments, the need to attract and retain talent has grown in importance. This is a particularly hard factor to quantify, but institutions with stability in investment decision makers often have long-term success.
9. Delegate strategy and policy implementation to the CIO and staff
If the investment committee has been successful in attracting and retaining a qualified investment team, it should delegate as much of the implementation of the investment program as possible to that team.
10. Prepare for turnover
Excessive changes in decision-making bodies can destroy institutional knowledge and result in excessive changes to the investment strategy. Committee members for institutions with higher turnover should design an investment program that can endure changes in decision makers.