Key Components of Effective Investment Policy Statements for Non-Profit Organizations. May 2018

Transcription

1 Key Components of Effective Investment Policy Statements for Non-Profit Organizations May 2018

2 Introduction The investment policy statement (IPS) is a critical document that serves as the foundation for managing an investment program. In practice, however, we have found that the IPS is often casually dismissed and rarely used as a living document to guide oversight of an asset pool. Sometimes having an IPS feels more like a formality. Why should nonprofits care about the IPS? A successful and effective IPS: Articulates the organization s long-term investment objectives and outlines policies and procedures to help achieve those goals. Provides guidance about the risk tolerance and beliefs of the governing bodies and the organization. Assists as a feedback loop to help monitor the investment program and measure outcomes against objectives. Serves as a resource to help new staff, board and investment/finance committee members get up to speed on the organization s investment program, and provides guidance in both good times and bad. Allows the organization to maintain focus on important strategic issues and take a holistic view of how the investment program ties back to goals and activities. Serves as a road map for the fiduciaries of the fund. A successful and effective IPS articulates the organization s long-term investment objectives and outlines policies and procedures to help achieve those goals.

3 Key Components of an Effective IPS I. Introduction, Scope and Purpose The first section of the IPS typically provides an introduction to the organization, the scope of the IPS, appropriate fiduciary standards and the purpose and intent of the IPS. Description of the organization and mission. Include a brief overview of the organization and describe its mission. The objectives of the portfolio should tie back to supporting the organization and its mission. Scope of the IPS. Clarify which asset pool(s) is/are subject to the IPS. This is particularly important when an organization has multiple asset pools. Fiduciary language. Acknowledge fiduciary standards that drive the principles and guidelines in the IPS. Make reference to appropriate law, such as the Uniform Prudent Management of Institutional Funds Act (UPMIFA), as adopted by the state in which the organization is registered. This includes referencing the fiduciary standard of reasonable care, skill and caution of a prudent investor and the concept that investment decisions should not be evaluated in isolation but rather in the context of the entire portfolio and overall investment strategy. Purpose and intent. Purpose and intent go hand in hand in setting the overarching role of the IPS and the tone for the guidelines that follow. As markets and investment needs evolve, how the IPS is implemented may also evolve accordingly. As such, it s important to highlight the need for IPS flexibility and periodic review. II. Roles and Responsibilities A clear articulation of roles and responsibilities helps ensure that funds will be managed well. The Board of Trustees has ultimate fiduciary responsibility for the organization, but often many of the ongoing responsibilities for the investment program are delegated to others. Below, we highlight the most common decision-making groups for non-profit investment programs: Board of Trustees. The board is generally responsible for approving the broad investment policy and providing oversight to the investment committee, which ensures that those policies are executed properly. This can be accomplished by establishing the IPS (and updating it as needed) and delegating responsibility for implementation to others. The board should also review the investment program periodically to confirm whether the funds are meeting the objectives laid out in the IPS. The IPS should clearly describe situations where the board wishes to retain decision-making authority. Investment committee. Depending on the type and size of the organization, the board may delegate the responsibility of investment activities oversight to an investment committee (or sometimes a finance committee). Internal management/staff. Internal management and staff involved with investment activities will vary by organization. Some organizations may have dedicated internal investment staff (e.g., chief investment officer and supporting staff), while other organizations might delegate these duties to the chief financial officer and finance department. Investment adviser and/or outsourced chief investment officer (OCIO). The role of the adviser and scope of responsibilities will depend on what the adviser has been hired to do. If an OCIO is used, their role and responsibilities should be described. The OCIO s responsibilities will vary depending on what has been delegated to them and could include functions such as hiring and firing managers and shifting asset allocations. Custodian (or other external providers). Many policy statements also reference responsibilities of the custodian, given its important role in holding and reporting on the assets. Key Components of Effective Investment Policy Statements for Non-Profit Organizations 1

4 Key Components of an Effective IPS (cont d.) III. Investment Objectives While the mission statement provides a broad vision for the organization, investment objectives offer specific guidance and articulate tangible goals for the investment program. Objectives should be realistic, attainable and consistent with the organization s mission. Organizations with multiple asset pools should identify separate investment objectives for each pool. Clearly stated investment objectives will help establish appropriate assetallocation guidelines and other policies. Investment objectives are also important when reviewing the investment results. For example: A traditional long-term asset pool for a foundation or endowment may seek to ensure that corpus growth exceeds inflation to maintain purchasing power and support the mission of the organization and its spending needs. A health care operating reserve may emphasize the ability to support operational needs and help improve the financial strength of the organization. A short-term asset pool would likely emphasize an objective of maintaining high liquidity and capital preservation. Objectives should be realistic, attainable and consistent with the organization s mission. IV. Time Horizon It is important to reference the applicable time horizon in order to set the right perspective when evaluating outcomes. Longer horizons would indicate a higher propensity to weather interim fluctuations, while shorter time horizons would tie to a need for higher liquidity and less tolerance for volatility. In addition, liquidity needs are often closely tied to time horizon (as well as spending policy, to be discussed later). A time horizon in excess of 10 years is likely to be appropriate for investment programs that are perpetual in nature, while a time horizon between one and three years would be more applicable for an organization s short-term reserves. V. Risk Tolerance Higher expected returns are usually accompanied by higher levels of volatility. Thinking through the appropriate risk language and parameters for the investment program, particularly the willingness to accept downside risk in the near term, can help when assessing portfolio choices. It is also helpful to list variables to be considered when implementing the investment strategy in order to minimize risk, such as asset-class diversification. The organization may further wish to establish more specific tolerance levels (e.g., X% absolute/relative downside tolerance in any one year or over a specified time period). If such parameters are set, the organization should be able to track and monitor them. We caution organizations to make sure that any stated risk-tolerance targets are reasonable and make sense given the time horizon and asset-allocation strategy that have been established. For example, a low risk tolerance would not align with a portfolio that has a lengthy time horizon and aggressive asset-allocation strategy. Key Components of Effective Investment Policy Statements for Non-Profit Organizations 2

5 Key Components of an Effective IPS (cont d.) VI. Spending Policy Non-profit asset pools are often relied upon to support both current and future spending needs of the organization. Stating the organization s target spending policy helps set expectations for the variability in spend. Spending policies will vary depending on the type of entity and asset pool. For example, foundations and endowments may target a spending rate of x% of the portfolio s moving average market value over a trailing period of y quarters. Some organizations may have more flexibility and establish a spending range from 0% to a maximum of x% 1. VII. Asset-Allocation Guidelines Asset allocation may be the most important determinant of long-term success for the organization s investment program and should be described in the IPS. Asset targets and ranges. Many organizations establish detailed asset-allocation targets by asset class (e.g., large-cap equity, emerging market bonds) within the main body of the IPS. Increasingly, the trend is for non-profits to move toward a less rigid approach by establishing targets and ranges by broad asset category or asset role, rather than underlying asset class. This encourages an objective-oriented allocation policy and should provide for enhanced dynamic management of the underlying portfolio. To implement the broader policy, a more specific asset allocation for each distinct asset role can be laid out in an appendix. Here is an example 2 : Asset Category Min Target Max Equity 55% 60% 65% Liquid Alternatives 0% 5% 10% Real Assets 5% 10% 15% Return-Seeking Fixed Income 10% 15% 20% Opportunity 0% 10% Risk-Reducing 5% 10% 15% For illustrative purposes only Rebalancing guidelines. It is not uncommon for a portfolio to deviate from the stated targets. Rebalancing guidelines help guide the actions of staff (and/or advisers with discretionary management oversight) without requiring additional committee approval. This is particularly important when managing cash flows in or out of the asset pool or addressing situations where an allocation may temporarily fall outside the prescribed range. 1 For a more detailed review of spending policies, see our white paper titled Raising Your Corpus From the Dead: Effective Use of Spending Policy and Investment Strategy for Not-for-Profits in Today s Challenging Markets. 2 Please see Appendix A for an example of a detailed asset-allocation chart. Key Components of Effective Investment Policy Statements for Non-Profit Organizations 3

6 Key Components of an Effective IPS (cont d.) VIII. Selection and Retention Criteria for Investment Managers or Funds It is important for the IPS to provide general criteria regarding the selection and retention of investment managers. A variety of factors should be considered, including: Consistency of the investment style. Changes in the ownership or management of the investment organization and stability of the portfoliomanagement team. Investment results compared with appropriate benchmarks and peer groups over multiple periods, usually focused on longer-term results. Suitability of the strategy. Diversification benefit to the overall portfolio. Adherence to any specific investment guidelines. Degree of liquidity. Related fees. VIIII. Strategic Investment Guidelines A section describing strategic investment guidelines for each asset category/role and their primary portfolio purpose serves as a framework for evaluating asset-allocation choices. For example, the IPS could state that equity assets are intended to serve as the portfolio s primary growth driver to generate long-term asset growth. Further, it could acknowledge that this growth opportunity does not come without significant downside risk, especially over short- and intermediate-term periods. Risk-reducing assets, on the other hand, would serve primarily as the capital-preservation component of the portfolio. This section can also be used to further describe any limitations/restrictions on investment strategies, the organization s philosophy on passive versus active investments and considerations about responsible investing (RI). 3 We recommend that organizations refrain from language that is overly restrictive. Customized investment guidelines related to specific managers or strategies, if needed, can be included as an appendix to the IPS. X. Performance Measurement and Evaluation A regular review of performance helps the organization monitor the portfolio s progress toward the stated investment objectives. Identifying benchmarks to help measure and evaluate the portfolio s performance provides tangible metrics to guide this process. Total portfolio performance is often evaluated based on a weighted benchmark consisting of broad market indices for the underlying strategies combined according to the strategy-allocation targets, while performance of the underlying strategies is compared using an appropriate market index. 4 Performance results should be reviewed on a net-of-fee 5 basis over multiple time periods. 3 See Section XI.c. for further discussion on RI. 4 See Appendix A for an example of a detailed asset-allocation chart that includes benchmarks for performance measurement and evaluation. 5 Fees should be reviewed to ensure an apples-to-apples comparison, as there may be different layers of investment fees depending on the type of investment and the vehicle used. Key Components of Effective Investment Policy Statements for Non-Profit Organizations 4

7 Key Components of an Effective IPS (cont d.) XI. Additional Considerations This section may be used to incorporate any other considerations that are important to the organization. We list a few common examples below: Proxy voting. It may be helpful to clarify procedures around proxy voting. Typically, investment managers are responsible for voting all proxies for the securities within their respective portfolios, while the organization (or the adviser, depending on the level of delegated discretion) is responsible for voting proxies related to fundlevel issues for mutual funds or other commingled vehicles. Brokerage and other investment-related expenses. It is common for organizations to include a statement regarding brokerage and other investment-related expenses, acknowledging that investment managers have discretion to select brokers and negotiate commissions but requiring them to seek best execution services. Responsible investing. RI has become a topic of discussion at many non-profits. It covers a wide range of strategies, from divestment of particular investments to active engagement in others; implementing an impact-investing program; thoughtful consideration of environmental, social and governance (ESG) issues; and identifying investments that more closely align with the organization s mission. If this is an important consideration and has not been addressed in a previous section, the IPS may include a section articulating the organization s philosophy and approach to RI. 6 Liquidity policy. Organizations may require differing levels of liquidity depending on factors such as ongoing spending needs, short-term cash needs, regulatory requirements and risk tolerance. Defining a liquidity policy helps ensure that the portfolio maintains adequate liquidity and helps the organization meet its cash needs when markets come under pressure. Example: Category Liquidity Characteristic Min Alloc (%) Max Alloc (%) Min Balance ($) Liquid Daily 30% 100% $150 million Quasi-Liquid Between daily and 1 year 0% 40% Illiquid Greater than 1 year 0% 30% For illustrative purposes only 6 See A (Re)Introduction to Responsible Investing, January 5, 2017 (retirementandinvestmentblog.aon.com), and Implications of the Ford Foundation s Big Move into Responsible Investing, Connections, Inaugural Issue, 2017 (go.aon.com/2017ahicnonprofitnewsletter_download). Key Components of Effective Investment Policy Statements for Non-Profit Organizations 5

8 Conclusion A clearly articulated IPS is a critical component of many non-profit organizations investment programs and should be viewed as a living document to guide the oversight of an asset pool. As outlined above, an effective IPS clearly lays out investment goals and objectives, roles and responsibilities, spending needs and investment parameters, as well as other considerations important to the organization. An IPS should also reflect sound governance practices and lay out policies that help ensure that portfolio outcomes are aligned with objectives. We encourage non-profit organizations to view IPS development as an iterative process, one that creates opportunities to engage in meaningful dialogue around the investment program, affirm current practices and identify potential enhancements. In today s everchanging environment, we believe this approach will help support the continued success of a nonprofit s investment program and, ultimately, the organization s mission. An IPS should reflect sound governance practices and lay out policies that help ensure that portfolio outcomes are aligned with objectives. Key Components of Effective Investment Policy Statements for Non-Profit Organizations 6

9 Appendix A Asset-Allocation Strategy Targets, Ranges and Performance Benchmarks 7 As of May 2018 Category & Asset Class Market Index Min Target Max Equity 55% 60% 65% Global Public Equity MSCI ACWI 30% 35% 40% Private Equity MSCI ACWI + 3% 10% 15% 20% Equity Insurance Risk Premia 50% MSCI ACWI, 50% T-Bills 0% 5% 10% Long/Short Equity 50% MSCI ACWI, 50% T-Bills 0% 5% 10% Liquid Alternatives 0% 5% 10% Hedge Funds (Aggressive) HFRI Composite Index 0% 5% 10% Return-Seeking Fixed Income 10% 15% 20% Multi-Asset Credit Custom (based on strategy) 2.5% 7.5% 12.5% Private Debt Custom (based on strategy) 2.5% 7.5% 12.5% Real Assets 5% 10% 15% Real Estate (Core) NFI ODCE 0% 5% 10% Real Estate (Non-Core) NFI CEVA 0% 2.5% 5% Infrastructure/Farmland/ Timberland Custom (based on strategy) 0% 2.5% 5% Opportunity Custom (based on strategy) 0% 10% Risk-Reducing 5% 10% 15% Hedge Funds (Conservative) HFRI Conservative Index 0% 5% 10% Intermediate Aggregate Barclays U.S. Intermediate Aggregate 0% 5% 10% Total Portfolio 100% Click here for index definitions 7 Asset-allocation targets and ranges shown above are provided for illustrative purposes only and should not be construed as recommendations. Key Components of Effective Investment Policy Statements for Non-Profit Organizations 7

10 Contacts Lois Suruki Senior Consultant Aon Lila Han, CFA, CAIA Associate Partner Aon Heather H. Myers Partner Aon Sheila Noonan Partner Aon Key Components of Effective Investment Policy Statements for Non-Profit Organizations 8

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