Best practices, pitfalls when serving on an investment committee

The most important attribute of a member of an investment committee is not investment expertise. Attorneys, accountants and business people are frequently asked to serve on not-for-profit investment committees because their colleagues assume they know something about managing money.

It's certainly helpful if at least some do, but investment expertise takes a back seat to other skills and attributes when overseeing an endowment. It is far more important that committee members understand the proper role of the investment committee. The essential attributes called for are prudence and common sense.

Here, then, are a few best practices to follow, or pitfalls to avoid, when serving on an investment committee responsible for overseeing an organization's endowment.

Focus on governance not investment management

Most committee members at most organizations probably know relatively little about investment management. So why are they there? Presumably, it's because they know something about proper governance.

Investment management requires an understanding of portfolio theory, the various asset classes, allocation strategies, trading techniques, investment selection, the financial markets, the regulatory environment, and on and on. Even if some committee members have that expertise, a committee that meets for an hour or two every three or four months cannot effectively manage an endowment.

The investment committee should focus on governance, and that is a very different task. Governance requires asking questions such as: what is the organization's mission, what is the investment objective, how will it spend funds, how much should it spend, how much risk is appropriate, what types of investments are appropriate for the organization and which are not, how are managers selected, and how is performance evaluated?

That's hardly an exhaustive list, but you get the idea. The investment committee governs the process by which the endowment is managed. Governance is about setting policy and then measuring performance against those policy guidelines. The investment committee's most fundamental policies should be explicitly set forth in an investment policy statement.

Act like a fiduciary

The law will hold you to that standard, so act accordingly. Board or committee members may be subject to a fiduciary duty, and that means that personal liability is always a possibility. Fiduciaries have several legal duties but in this context perhaps the most important is the duty of care.

A practical approach to the duty of care is to apply the same level of diligence that you would bring to bear if your actions, or omissions, were subject to public scrutiny. One day they might be. Read investment reports, be familiar with the investment policy, and ask intelligent, probing questions.

And avoid the scourge of committees everywhere group-think. Collective thinking can be wonderfully wise but it can also deaden critical thinking. The worst failures of investment committees are probably sins of omission caused by the failure to notice a problem or speak up.

Scale the investment program appropriately for your organization

Investment consultants are often engaged to provide needed investment expertise and to help select and monitor outside managers. For a small endowment, however, an outside investment consultant probably is not cost effective. And without an investment consultant, an investment committee will have to assume the responsibility of vetting and monitoring investment managers.

A small endowment should seriously consider limiting itself to one or, at most, two outside investment managers. The committee probably won't be capable of any more due diligence than that. Another option is to adopt the simpler yet highly effective strategy of index investing.

Avoid the revolving door of hiring and firing managers

The model of vetting "best in class" managers only to fire them when performance inevitably lags is a broken model. Unfortunately, it's still quite common.

Only a small percentage of managers are consistently top performers and they are exceedingly difficult to identify in advance. While some managers can produce market-beating performance, the percentage who can do so consistently is quite small.

Even Charles Ellis, a widely respected author and a preeminent investment consultant, says, "I don't think there's any consultant anywhere that's come up with a consistent beat-the-market capability in selecting managers." Be highly skeptical of anyone who suggests otherwise.

Keep it simple

Don't make it more complicated than it needs to be. Less can be more. Endowments large and small are probably better served by using fewer managers rather than more. Past a certain point, adding more managers to a portfolio can hurt performance. It reduces the likelihood of achieving market beating performance or even just matching the market. That's how the probabilities work out in theory and in practice.

Also keep it simple by focusing on the few things that really matter to investment performance. One is asset allocation how investments are spread across different asset classes. Asset allocation is the single biggest driver of investment performance.

Another is expenses. Keep investment expenses as lean and efficient as possible. High cost managers are on average underperforming managers because they set a higher hurdle that has to be overcome before returns can inure to the investor's benefit.

Common sense.


David Peartree, JD, CFP is the principal of Worth Considering, Inc., a registered investment advisor offering fee-only investment and financial advice to individuals and families. Offices are located at 160 Linden Oaks, Rochester, NY 14625,

Published: Wed, Aug 26, 2015


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