Investment Committees – focusing on the game changers for performance and risk

Families and endowments benefit from genuinely long-term time horizons – an investment committee can bring fresh perspectives to this strategic advantage and enhance performance.   

The first quarter is always busy for investment managers with annual client review meetings happening thick and fast. The rhythm of these meetings is important but routine or immediate challenges may suppress fresh thinking and perspectives. An overload of jargon-filled information can distract from an essential razor-sharp focus on the ‘game changers’ for performance and risk that will drive investment outcomes.

Here we take a deep dive into investment committees and explore how they can add value, particularly to the cycle of review meetings for clients, specifically families and trustees.

After many years managing money and investment businesses, we know how portfolio managers can, almost sub-consciously, hijack a review meeting by focusing on the short term. This is typically immediate portfolio successes, rather than long-term asset allocation decisions, where most value is usually added or destroyed and therefore of utmost importance for the family or trustees. This need to balance current performance as well as the long-term horizon is where an investment committee can make a significant difference.

At Acorn Capital Advisers we are often asked if a family should appoint an investment committee and we believe there are three clear benefits:

• Gaining insight into best practices

• Driving performance and long-term strategy

• Visibility on new ideas - across assets, strategies, managers, risk measures and sustainability

Here we look at these three benefits in turn, drawing on our experiences from ‘both sides of the fence’ as former investment managers and current members of investment committees for families and endowments. We also turn the spotlight on the views of other committee chairs and members.

Gaining insight into best practices

Let’s look first at best practice around the fundamentals:

• When to establish an investment committee?

There is no hard and fast rule here – it depends not just on size but also on the available investment resources and approach used. Overseeing a single multi asset manager is a quite different role to being responsible for deciding on allocations to specialist managers or where some assets are managed by an in-house team.

For many families, an investment committee starts to make sense for investible assets of around £75 million or higher when there is usually more than one investment mandate. In the charitable sector however, with pro-bono rather than remunerated committee members and less in-house investment resource, we see committees looking after £10 million, or even less.

• Creating strong governance

A robust and transparent governance structure removes ambiguities around responsibilities and defines roles, including the degree of discretion given to managers. Having a clear decision-making structure aligned with this governance framework is essential. If there is a family office – being clear about respective roles is important to get the best out of both. Governance protocols should extend to family members too - to stop them promoting and investing in ‘pet’ projects without appropriate diligence and financial scrutiny.

Any in-house investment team must retain and attract talent, so a supportive committee able to challenge constructively without ‘point scoring’ is needed here. Whilst prominent high performing former portfolio managers can add a lot of value to a committee, they should be careful not to stray into implementation - it confuses accountability. Clarity around responsibilities is paramount whether re-balancing to targets or communication with external managers.

• Where should an Investment Committee focus?

The role of every investment committee depends upon the investment structure in place – internally or externally managed assets, multiple specialist managers or a single manager, amongst others. However, all should focus on robust, well-documented governance and investment policies and to adhere to them, preferably over multiple years. At the governance level, distinguish between advisory and decision-making responsibilities and their scope - the role should not include implementation, which is the remit of the in-house team or external managers.

Also, focus on understanding the objectives for the assets; the role in the overall family wealth or endowment; the time horizon and the expected pattern of any capital flows and distribution needs in the future – both regular and any one-off requirements. This forms the basis for setting investment objectives and a policy statement with realistic expectations for long-term returns and risk. The policy statement should also include liquidity constraints, currency strategy, environmental, social and governance considerations as well as the target strategic asset allocation and ranges.

A word of caution though, committees should avoid spreading themselves too thinly – seek advice and delegate. If needed, appoint a retained consultant or independent adviser for strategic asset allocation modelling and on-going advice. It is not the committee’s role either to do the ‘heavy lifting’ on researching, overseeing and monitoring managers, look for external help.

On the flip side, terminating managers is costly, so it’s important to be very clear and focus from the outset about the intended role a manager will play in the overall portfolio and record it in their objectives and guidelines. 

‘A committee needs to be fully aware of the market conditions in which the manager will out or underperform to understand overall risks and maintain confidence during periods of underperformance’

Sarah Arkle, former CIO Threadneedle

Driving performance and long-term strategy

• Using investment practitioners thoughtfully on the investment committee

We believe appointing external members with current investment knowledge or industry experience adds value. Teamwork is really important though. If an investment practitioner is appointed, consider where their skill set lies. A private equity specialist may not have the perspective of a fund of funds manager in making solid asset allocation decisions.

It all depends upon the current and future needs and blend of skill sets. Applying a skills matrix is a good idea to ensure new members enhance the whole. Also, always have at least one member who is not an investment professional. They can add to the diversity of thought and are often the first to challenge unnecessary complexity.

• Focus on the long-term

In meetings, try to focus on at least annual and three yearly intervals, not quarterly results. Successful tactical asset allocation judgement is rare and often time consuming unless there is an in-house CIO to drive this. Without this resource, it is better to keep the long-term horizon in mind but introduce a really good discipline around re-balancing so that market dislocations trigger adjustments. This helps prevent reductions in risk assets at times of stress and portfolios then lacking enough risk to meet long-term goals in the recovery phases. Keep managers focused on where they can add value and, for large, complex investment structures consider adding an overlay manager with tactical expertise.

•  Challenging managers’ performance

The committee needs benchmarks to measure on-going performance over shorter time frames. Choosing investible benchmarks consistent with the overall long-term goals in the policy statement supports effective monitoring over economic cycles.

A transparent attribution analysis is key in assessing if a manager’s returns were achieved by luck or exercising skill and judgement The unpicking of risk-adjusted returns helps understand how managers view risks within their portfolios and if risk, whether measured as volatility or drawdown’ has been managed effectively.

•  Extended oversight

Monitoring other providers is also important. This may include custodial arrangements, manager operational due diligence, stock lending programs and overall costs and hidden fees. To monitor these effectively requires good MI, controls, and delegation.

•  Fees

Oversight of fees needs rigour– compounding high fees without added value is toxic. Experienced investment practitioners on the committee should know where to look – FX spreads, fees hidden within fund structures and complex custody fees for starters. They can sometimes help in negotiating competitive fees too.

•  Underperforming managers

Changing managers is often costly. At times of stress or cyclical underperformance trust in the appointed managers and a deep understanding of their approach is critical. Unnecessary complexity or manager strategies that are not readily understood may serve no purpose, even if other families and endowments have adopted them. Robust modelling of a strategy prior to appointment in stressed market scenarios is invaluable in preventing surprises.

Visibility on new ideas

Looking ahead, away from the day to day, external members can add thoughtful insights on current and emerging trends.

•  Including the next generation

Anticipating the implications of family generational changes well in advance is important, not just in refining asset allocations but also thinking through the next generations’ values and perspectives e.g., on ESG. We have seen committees welcoming the next generation as observers at meetings to beneficial effect – often benefitting family cohesion, sparking debate and introducing new concepts.

•  Investing in new(er) asset classes

An investment committee can really add ideas here. For example, identifying uncorrelated risk diversifying assets to complement growth assets is an increasingly niche landscape. Understanding infrastructure or social housing with government backed income streams requires in-depth knowledge and members’ established networks are often effective sounding boards initially.

•  Taking advantage of patient capital

Families and endowments benefit from genuinely long-term time horizons. The best investment committees provide prudently for any liquidity needs and then exploit the illiquidity premium including through larger and earlier stage commitments in private markets. Endowments may be less aggressive than families in private assets but often take advantage of their horizon to tolerate the short-term volatility of higher public equity weightings, particularly if smaller scale impedes diversification.

•  Private Markets

With allocations to private markets increasing, there is a lot more to consider than the expected return premium. There is the vintage and liquidity profile, then whether to invest in funds, co-investment, buyout, venture or private debt, to name a few.  The funding and management of cashflows and commitment ratios can also become complex. Larger families can be attracted by the lower costs associated with co-investments but their investment committees are worried about the oversight of due diligence. Understanding liquidity requirements, including potential capital calls is critical. In the global financial crisis, even the Harvard endowment was caught out by unexpected cash calls.

’With illiquid investments it’s all about managing cash flows’

Ethan Hall, CIO Guy’s & St Thomas’ Foundation

• Sustainable Investing

Sustainable investment has shot up the investment committee agenda, very often driven by the next generation; charities themselves or by trustees anticipating wider fiduciary responsibilities. Whether active or passive, we urge committees to closely examine ESG strategies and not to skimp on due diligence. There is unfortunately some ‘green-washing’ around as participants try to ride the ESG wave. Taking short cuts on ESG manager scrutiny is not an option – besides the financial risks there are reputational ones, which most families and endowments are keen to avoid.

There is certainly more interest in impact investing. Whilst every investment has an impact, it is the intentionality and measurability that is important here. It is a challenging area though – and some committees find concessionary returns hard to grapple with unless trustees and beneficiaries sign off on the risk to financial return. For those that do invest in impact, measuring the effect, both positive and negative, over time is important. There are lots of excellent measurement tools out there, such as IRIS+ and IMP. The key thing is not to let impact become a tick-box exercise, instead over time apply measurable targets on a bespoke basis.

Our final tips:

• Undertake an independent strategic review of the overall asset allocation and manager line up every three to five years.

• Avoid taking short-term decisions during market downturns that may unnecessarily crystallise permanent capital loss.

• Carefully consider before placing too many restrictions on managers as it can impede outperformance. Further, introducing them at times of market stress typically limits upside in the recovery phase.

• Don’t always throw out unfamiliar ideas - passive investing is cost effective in efficient markets, where information advantages have been eroded.

• The key to success is a thoughtful strategic asset allocation, conservatively reflecting liquidity needs and a long-term horizon over which to compound returns.

Above all, avoid being distracted by short-term events – focus on the longer-term trends and don’t step over the line from governance into implementing investment strategy.

We believe a well-balanced, experienced investment committee focusing on investment governance can make a material contribution to successful long-term results. We are happy to tell you more and if we can support you in any way please get in touch.