The Case for Outsourcing Asset Management

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Historically, investment committees have been effective in managing the assets of foundations and endowments. But with more economic and market uncertainty, sophisticated investment products, increased regulatory scrutiny, and personal liability, the demands on and expectations of those committees have multiplied. Their roles need to be re-evaluated.

As a member of the board’s investment committee at my alma mater, Coe College, and chief executive of an investment-management firm, I am both a recipient and provider of investment-management services for endowments and foundations. One thing I’ve learned is that, despite the wide variety of missions represented among the institutions and organizations I serve, the themes explored at meetings of their investment committees are remarkably consistent: the economic outlook, its impact on various asset classes, decisions on tactical allocation, and whether new asset managers are needed. The question inevitably arises: How can we, as a group of volunteers, make decisions that are timely, informed, and consistent?

Committees can start by understanding their roles. Too often they find themselves making investment decisions for their institutions rather than establishing goals and making sure that specialized asset managers carry them out. Institutions don’t have adequate resources dedicated to helping investment committees make their decisions, and in taking the responsibility on themselves, committees can quickly become overwhelmed. One highly regarded and experienced community volunteer, who has served on numerous investment committees, said at a recent board meeting that the investment-committee management structure had become “dysfunctional.”

Whatever you think investment committees’ roles should be, look closely at your organization to ensure that fiduciary obligations are being met. The Center for Fiduciary Studies defines a fiduciary as a person who manages property for the benefit of another, exercises discretionary authority or control over assets, or is an investment adviser who renders comprehensive and continuous investment advice. Investment professionals generally agree that a fiduciary is responsible for the “investment process,” which includes establishing the goals and objectives of the portfolio as articulated in an investment-policy statement, making sure the portfolio is arranged accordingly, and monitoring the results. “Many investment fiduciaries erroneously believe they are responsible for making investment decisions, when in fact their charge is managing them,” Anat Kendal, director of financial planning for the American Institute of Certified Public Accountants, says in an article by Donald B. Trone in the January 2004 issue of the Journal of Accountancy.

So why have investment committees traditionally defined their role as decision makers rather than as managers of a process? The answer lies partly in the practicalities. According to the 2004 “Commonfund Benchmarks Study” on foundations, they have, on average, 1.36 full-time-equivalent staff members, or FTE’s, in fund-management roles, and over half of their time is dedicated to administrative functions such as reporting on investment performance. When examined by size of assets under management, the dedicated full-time resources drop off sharply, to 0.71, for foundations under $100-million. The 2005 “Commonfund Benchmarks Study” on educational endowments indicates that while those valued at more than $1-billion enjoy average staffing levels of 12.5 FTE’s, endowments of $51-million to $100-million have only 0.5 FTE’s, and those of $10-million to $50-million have 0.4.

By default, then, investment committees in organizations with endowments under $100-million must be more actively engaged with asset management, with or without the assistance of outside consultants. In the context of a complex investment environment that demands a diversified and sophisticated program, it’s no wonder that a seasoned committee member would question whether a group of volunteers is up to that task.

In wrestling with these issues as a provider of investment-management services, I have come to believe that many institutions and organizations, especially those with inadequate internal resources, should outsource the functions of chief investment officer to an organization dedicated to managing tax-exempt dollars. That frees the investment committee to focus on oversight within a well-defined, transparent, and thoroughly accountable governance system.

When considering whether to make such a move, an organization should weigh:

• Whether the change would allow access to otherwise out-of-reach asset classes, investment strategies, and top-tier managers, maximizing return and reducing risk.
• Whether sufficient scale could be achieved to drive down management costs and improve performance.
• Whether the timeliness of tactical decision making would help better manage risk and capitalize on investment opportunities.
• Whether the committee would be likelier to meet the organization’s long-term investment objectives.

By outsourcing investment management, a committee can focus on oversight and accountability rather than on the details of investment strategy. Guidelines that a committee should develop include:

• Expectations of return in the form of income or capital appreciation.
• Risk tolerance and control.
• Investment constraints: time horizon, liquidity, legal and regulatory considerations.
• Appropriate asset classes and investment vehicles.
• Assumptions about long-term capital-market performance.
• Ranges and targets for long-term strategic asset allocation.
• Measures and mechanisms to evaluate investment performance.

Investment strategy then falls to the investment manager, who should:

• Develop forecasts for market performance.
• Determine when fluctuations in the performance of various classes of assets dictate short-term deviation from long-term allocation plans.
• Establish parameters for choosing specialized managers to handle those investments, and then select those managers.
• Monitor their work.
• Report to the committee on investment performance.
• Coordinate day-to-day investment operations.

Trustees and members of the investment committee should devise investment and allocation guidelines for the manager and systematically evaluate portfolio performance on a relative and absolute basis over one-, three-, and five-year time frames.

In my experience on several investment committees, I have found that meetings are infrequent and irregular, that members vary with regard to sophistication and commitment, and that membership lacks continuity because of absenteeism and annual rotation. Committees’ decisions are sometimes based more on members’ professional and social ties than on informed, independent analysis. Outsourcing portfolio management, with meticulous oversight by an investment committee, should not only improve investment performance but also increase due diligence, disclosure, transparency, and accountability in the new Sarbanes-Oxley-influenced regulatory environment.

Christine K. Galloway is president and chief executive officer of Okabena Advisors, a Minneapolis firm that advises nonprofit groups on investing.

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Section: Endowments
Volume 17, Issue 20, Page B26