How to Overcome Three Common Investment Committee Pitfalls

Author: Amanda Black, MBA, CAIA, Chief Executive Officer and a Partner at Capital Cities, L.L.C.

 

In meeting rooms across the country, community members congregate to make impactful decisions on millions of dollars of assets entrusted to their care. They debate and scrutinize, navigating volatile markets and complex topics to arrive at consensus decisions impacting their communities. 

As a fly on the wall in these rooms over the years, we have had the opportunity to witness the inspiring spirit of volunteerism inherent in investment committees. Community members bring their time and talents to the table, with the sole purpose of prudent oversight of their local community foundation assets. While all investment committees are different, common threads among members include an immense desire to make a difference, a mutual respect for others, and a willingness to roll-up their sleeves for the greater good.

Inevitably, however, investment committees tend to fall prey to some common pitfalls. Because volunteer time is so precious, being aware of these hazards and having some strategies to combat them can increase the success of your foundation.

 

Investment Committee Pitfall #1: “Did you see what happened to Bitcoin today?”

Focusing Too Much Attention on Short-Term Market Dynamics

Community foundation investment portfolios are invested for the long-term, with the goal of meeting ongoing needs while growing the assets into perpetuity. The generally accepted notion is that over the course of long market cycles, a diversified investment portfolio will allow foundations to meet moderate distribution needs and keep pace with inflation. Accordingly, time horizons are well over ten years and investment programs are typically strategic in nature, meaning that investment committees are not attempting to “time” markets with highly tactical moves.  

However, thanks to limitless access to market headlines and a healthy dose of intellectual curiosity, we love to talk about what is happening RIGHT NOW. Committee members ask questions based on current market dynamics and consultants are eager to exude knowledge in their detailed responses. With follow-up questions and further debate, valuable time ticks away.

While awareness of the market environment is important, too much emphasis on current events or isolated market segments takes time away from more impactful decisions.

Strategies to combat this inevitable desire to focus on the short-term include:

1) Remind committee members of the investment policy:

• Establish overall objectives, including identifying the foundation’s time horizon and approach to investment oversight.

• Detail the investment committee’s roles as it relates to strategic vs. tactical decisions.

2) Construct an investment portfolio for the long-term:

• Ensure the broad asset mix of the investment portfolio is designed to meet long-term needs. In other words, can the portfolio reasonably generate a return for the long-term that meets spending needs and keeps pace with inflation?

• Diversify assets to improve market directionality. Understanding that market dynamics will impact assets differently, seek to include diversified exposure at all levels (for instance, not just stocks vs. bonds, but also different styles, regions and active vs. passive management).

3) Manage meeting dynamics:

• Set clear agendas so committee members are aware of key topics and allotted time. 

• Approach the market environment in the proper context. Discuss markets as a backdrop for understanding the portfolio’s performance and to establish patterns over time to determine if paradigms are broadly changing; but avoid going down market rabbit holes.

 

Investment Committee Pitfall #2: “Stocks have done so well this year, let’s let them run!”

Letting Human Emotion Get in the Way of Strategic Investment Oversight

Most would concur that setting a long-term strategic asset allocation, whereby the portfolio has specific target amounts to broad asset classes like stocks and bonds, is a key responsibility of investment committees and boards. Ideally, this asset allocation strategy directly corresponds to the level of return that the foundation needs, as well as the level of risk that the foundation is willing to take. Adhering to this allocation over time is intended to improve outcomes relative to objectives.

The mechanism to maintain this allocation is rebalancing. Rebalancing entails buying or selling different portions of portfolio components to return the overall mix to its original target allocations. In simple terms, rebalancing is selling the winners and buying the losers.

This is where human emotion butts in, particularly greed, fear, and indecision. While research shows that rebalancing works, we tend to think “this time” is different when asset values creep outside of their target ranges. Perhaps we are afraid of missing out, or even find ourselves getting a little greedy, when stock markets seem to be on a one-way path up. Complicating this dynamic is the fact that rebalancing also requires adding to the asset class that has not performed as well.  If left to a committee to debate, varying viewpoints could lead to indecision (or even bad decisions), hampering portfolio outcomes and wasting time.

Maintaining a long-term strategic allocation is vital for risk management.  

Strategies to keep human emotion at bay when it comes to investment decisions include:

1) Formalize a rebalancing strategy within the investment policy statement:

• Establish target allocations for each underlying portfolio component, within specific bands (we typically prefer +/-5%).

2) Enact rebalancing processes and monitoring:

• Review market values on a consistent and periodic basis to determine compliance.
• Consider delegating rebalancing authority (within the confines of the investment policy) to key staff, the committee chair, or consultant to mitigate timing delays and eliminate unnecessary committee debate.
• Utilize any portfolio flows to organically rebalance, meaning sell assets that have appreciated more than others to create liquidity for cash needs, and buy assets that are lower than targets when there is cash to reinvest.
• Formally report on portfolio allocations relative to targets, as well as any previous rebalancing activity.

 

Investment Committee Pitfall #3: “More Committee members must be a good thing, right?”

Diluting Investment Committee Effectiveness, Efficiency and Continuity

Foundations have made great strides in improving overall governance, particularly in terms of committee and board composition. Efforts to eliminate conflicts, increase diversity, and expand expertise reflect foundations’ continued desires to be prudent stewards of assets.  
All actions taken under the guise of improved governance must be beneficial, right? Not necessarily if the results cause excessive committee turnover.
Foundations must determine the appropriate balance when it comes to the number and background of investment committee members, as well as their term limits:  

• While having more committee members means access to more volunteers, meetings may be inefficient with too many chefs in the kitchen.  
• Seeking to fill a committee solely with finance/investment professionals means more relevant expertise, but potentially at the expense of groupthink.  
•  Shorter term limits provide a mechanism to strategically refresh committees over time, but can also derail continuity.

Keeping a committee fresh and engaged improves productivity. On the other hand, excessive turnover can lead to a situation where historical institutional knowledge is lacking. Continuously rehashing prior decisions and bringing new members up to speed can disrupt progress.
 

Strategies to balance governance, efficiency, and continuity within committee structures include:

1) Conduct new member orientation:

• Educate new members on the investment program. Include details on areas such as the history of the program, the oversight process, objectives and unique preferences driving the asset allocation, rationale behind underlying investment managers, material decisions made in recent years, and expectations for member involvement.
• Ensure new members have access to key documents, including recent performance reports, the investment policy statement, and by-laws.

2) Thoughtfully set term limits:

• Stagger terms so that small groups of committee members are rolling off (and on) at different times to improve continuity.
• Consider limits of at least three- to five years, with add-on potential. With committees typically only meeting formally a handful of times each year, new members need time to gain the perspective necessary to add value.

3) Balance committee size and composition:

• While there is no perfect number of committee members, we typically observe committees with too many members rather than too few. Too many members can be logistically unwieldy. 
• Effective committees include a balance of personalities and backgrounds. Seek to engage both leaders and followers, optimists and contrarians, big-picture thinkers and detail-oriented doers. Finance and investment professionals should certainly have a place on investment committees, but foundations should also look to add members with diverse backgrounds as they add unique perspectives and approaches to problem-solving.

 

About the Author

Amanda Black, MBA, CAIA is the chief executive officer and a partner at Capital Cities, L.L.C. of Indianapolis, Indiana. Her primary responsibility is to oversee the formulation of customized investments strategies for the firm's clients, matching each client's unique objectives with forward-looking portfolio construction. Ms. Black takes pride in the collaborative and educational aspects of the consulting role, always striving to help clients navigate the opportunities and risks they face in their fiduciary roles. As a member of Capital Cities' Investment Committee, Ms. Black contributes to all areas of the Capital Cities' client-centered experience, from strategic planning to investment manager due diligence to ongoing monitoring. Ms. Black brings over twenty years of investment experience to Capital Cities’ clients. She serves on the Indiana Blind Children’s Foundation Board, the Zionsville Education Foundation Board, and on the Board of Trustees for Hanover College. Ms. Black has a B.A. in Communications from Hanover College and a M.B.A. from Anderson University.

 

 

About Capital Cities

Through decades of consulting to institutions, Capital Cities’ team has had the opportunity to partner with investment committees of all shapes and sizes. Serving alongside volunteers and staff to help foundations meet their investment goals is their passion. As of June 30, 2021, they serve in a co-fiduciary capacity to $33.6 billion in client assets, spanning foundations, retirement plans, college savings funds, public funds, and university operating funds.