The challenges of investing are both technical and human. To excel, endowment stewards must be as attentive to potential land mines in governance as they are to those in global markets. Stories abound of institutions with brilliant technical investment processes, but poor governance practices that undermined the work of their investment teams.
The recently published Endowment Management for Higher Education, written as a best-practices primer for investment committee members, aims to provide a wealth of information on common symptoms of poor governance and recommends antidotes designed to create a culture of good governance.
What follows is a sampling of its key insights.
Best practices for successful endowment management
Effective governance must weave together many interconnected strands, including shared objectives and values, a commitment to high standards, a deeply ingrained code of conduct, well-defined roles and responsibilities, and clear lines of accountability. Recommendations include:
Clearly delineate and document the role and authority of all key parties involved in management of the endowment. Boards, committees, investment staff and outside advisers can work together in many different ways to accomplish the myriad tasks involved in endowment management. Above all, it is critical that committee members know what is expected of them; this orientation should take place when they are recruited to join the endowment committee.
Choose the chair of the committee carefully. A proficient chair is essential to an effective investment committee and the president and chair of the full board should be certain that the leader of the investment committee is carefully chosen. It is impossible to overstate the importance of this critical role: it can mean the difference between excellence and mediocrity.
Preserve institutional memory. Proper committee structure should seek an appropriate balance in time served by its members. Investment committees where the average tenure of committee members is short, turnover is high and institutional memory is lost are unlikely to be effective. Stability in membership is extremely important. On the other hand, a modest level of regular turnover is desirable, in order to bring fresh ideas, new energy and different perspectives to the committee.
Ensure open and regular communication with other key members of the institution — especially the finance committee and the full board. Important stakeholders should be kept abreast of the investment committee's work, results and any major changes that are taking place.
Require an orientation for each new committee member. As new members are brought onto the investment committee, the chief investment officer (if applicable), committee chair and other staff who support the committee should provide them with a formal orientation before their first meeting.
Members should be prepared to attend all meetings. While it might be impractical, if not impossible, to expect committee members to attend all meetings, the implication is that missing a committee meeting can have consequences for the performance of the committee.
Keep comprehensive minutes to document the proceedings and help the committee recall the context surrounding key decisions from meeting to meeting. Continuity demands maintaining informative minutes that include much more than simply actions taken or decisions reached. The specific rationale for major decisions should also be recorded. Committee members should not be expected to recollect why past decisions were made. Detailed minutes assist members in fulfilling their fiduciary duties to monitor the results of prior decisions. Better context should lead to better decisions.
Symptoms of poor governance
Chasing returns. Chasing performance is arguably the single largest source of underperformance by investors. It is a problem that is widely recognized, but rarely avoided. Regularly repeating this pattern produces subpar performance.
Misusing peer comparisons. Investors are often influenced by the practices of other institutions, failing to recognize that these institutions might have different circumstances, capabilities, prospects, resources and strategic goals. We recommend instead that institutions design their investment policies based on a thoughtful and pragmatic understanding of their specific situation and ability to take various forms of risk.
At the same time, endowments should be aware of what peers are doing in order to learn from them. Any college or university that underperforms its peers long enough or by a wide enough margin — and especially one where there is a high level of turnover on the investment committee — will certainly hear from donors and will feel pressure to change the investment strategy, often at the wrong time.
Failing to rigorously analyze the performance track records of managers, the CIO or the committee itself. Too often institutions uncritically accept flattering representations of performance without analyzing its key drivers and reaching a well-founded expectation for the prospects of adding value. Read the footnotes associated with performance information. The words "model," "simulated," "hypothetical" or "backtested," do not represent actual client returns. Healthy skepticism, is advised.
Taking too much or too little risk. Given the long-term horizons of endowments, committees may wisely adopt investment policies to achieve a higher level of returns over a long-term horizon. However, we have seen numerous examples of committees taking on more risk than they could tolerate and unwinding them at the wrong time. Others face the opposite problem. The natural tendency of committee members to avoid negative results during their tenure might unwittingly pressure them to shorten their time horizons and take too little risk.
Ultimately, good investment governance is a precursor to strong endowment management. Growing endowments are indispensable to maintaining higher education as we know it. Current budgetary outlays increasingly rely on regular transfers from the endowment, while at the same time, the long-term capital needs of universities and colleges depend on preserving and increasing endowment resources. Without endowments to help defray ever-rising costs, higher education may soon be transformed to an unattainable dream for far too many talented young people.
Nikki Kraus is managing director and global head of client development at Strategic Investment Group, Arlington, Va. This article is based on the book, "Endowment Management for Higher Education," written by Ms. Kraus; Hilda Ochoa-Brillembourg, founder and chairman of Strategic Investment Group; and Jay Yoder, managing director at Pavilion Alternatives Group. This article represents the views of the author. It was submitted and edited under Pensions & Investments guidelines, but is not a product of P&I's editorial team.