3. If the research is correct and many investors make decisions based on their feelings and not
what they know…It’s important to understand how are we currently feeling?
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4. During a market downturn, the desire to minimize losses in the short term can lead to
poorly-informed decisions that may have a lasting negative effect on the value of the
portfolio. In the emotion of the moment it may seem better to take action—any action—
than to sit by and watch asset values fall.
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5. A well written IPS along with prudent execution insulates your organization from making
decisions based on short-term events that lead to poor long-term outcomes.
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6. Consistent investor behavior dating back to the Tulip Mania in 1637 makes one thing clear;
a documented investment roadmap in the form of an IPS is necessary to protect investors
from themselves…and most importantly, the last place to keep this valuable treasure is in
a file cabinet.
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7. Purpose and Scope
Broad overview of the material in the IPS
Executive Summary
Definition of Duties
Board of Trustees, Investment Committee, Investment Manager, Investment
Consultant, Custodian
Objectives
Clearly defined objectives will help set the investment strategy and asset allocation
(ex liquidity requirements, time horizon, spending policy)
Investment Strategy and Asset Allocation
Spending Policy and Liquidity Requirements (area of focus today)
Monitoring, Evaluating and Review Process (area of focus today)
Acknowledgement
“We recognize the importance of adhering to the mission and strategies detailed in
this policy and agree to work to fulfill the objectives stated herein, within the
guidelines and restrictions, to the best of our ability.”
Exhibits: Asset Allocation Table, Asset Class Strategy Statement
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8. The next three slides will paint a disappointing outlook for stock and bond returns on a go
forward basis. The most common asset allocation is around 60% equity 40% fixed income.
A ubiquitous 60/40 allocation typically has delivered over a full market cycle 6%-8.5%.
Let’s assume stocks return 8% and bonds 2.5% (due to the low entry yield) over the next
decade. The portfolio would deliver a total return of 5.8% (8%x.60 = 4.8% + 2.5%
x.4=1.0%=5.8%.
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9. Interest rates have steadily declined since the early 1980s. This created a great 35+ year
secular bull market for bonds. Remember bond values are inverse related to bond yields.
So when bond yields decline the value of bonds rises. When/If interest rates rise in the
future investors will experience declining bond values and bond yields rise.
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12. Both of these investment groups are incredibly smart, but investors need to scrutinize
forecasts about the financial markets.
GMO forecast is in real terms meaning they have adjusted returns for their inflation
expectations. William Blair’s are not adjusted for inflation. In the footnotes WB expects
inflation to run at 1.8% over the next 8 years.
GMO, LLC founded in 1977, is a privately held global investment management firm
servicing clients in the corporate, public, endowment, and foundation marketplaces. As
of September 30, 2015, we managed $104 billion* in client assets using a blend of
traditional judgments with innovative quantitative methods to find undervalued securities
and markets.
Our success in consistently providing value added performance across a broad range of
asset classes is founded on several key factors that include: discipline, value orientation,
investment research, and constant innovation (see GMO Qualities below). Our broad-based
value added over benchmarks has led many of our clients to request that we allocate assets
and advise them on a global scale.
William Blair & Company is privately held employee-owned financial services firm that
provides investment banking, equity research, brokerage, asset management and private
capital services. William Blair & Company, L.L.C. was founded in 1935. The firm has
approximately 920 employees and is based in Chicago with offices in London, San
Francisco, Tokyo, Liechtenstein and Zurich.
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13. The “smoothing” policy serves two purposes. First, it provides for more consistent and
predictable spending for the programs supported by the organization. Second, it allows the
Investment Committee to design an investment strategy which is more aggressive with a
higher expected return than
might be the case if spending were determined by annual investment performance.
Applying the moving average has the benefit of mitigating extreme market outcomes.
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14. Spending Language Example:
The College employs a total return Endowment spending policy that establishes the
amount of investment return made available for spending. The Board of Trustees
determines and implements the spending policy based on investment returns and the
needs of the College. Investment staff provides input to the Board of Trustees Finance
Committee regarding expected return of the Portfolio, a critical variable in the spending
policy.
Spending Language Example:
The Investment Committee will attempt to balance the Endowment’s shorter-term
distributions with its goal to provide for distributions in perpetuity and therefore design
a spending policy which is flexible. It is currently anticipated that contributions to the
Endowment will be greater than draws from it for a number of years, and that net draws
of 5% or more are not anticipated until FY 20XX, if not later. However, contributions and
distributions are expected to be inconsistent, and a target of at least $[X] million should
be maintained in cash equivalents in the Endowment.
Source: hallcapital.com “A Roadmap for the Roadmap, 2012
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15. Hybrid Approach Example:
Under the Endowment spending policy, the payout is set as a dollar amount and
increased by the rate of inflation each year within a band. The increase each year is the
greater of 2% or the actual rate of inflation based on the most recent CPI, with a
maximum annual increase of 5%. In addition, the annual draw from the Endowment
shall be no less than 4% and no greater than 7% based on the prior year-end market
value of the Portfolio.
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17. UCLA Spending policy is just another version of the 3 year smoothing methodology.
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18. Based on the current valuation on stocks and bonds (see the bond and stock market forecast
slides) Nonprofits would be prudent to make reasonable (conservative) spending goals on a
go forward basis.
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19. Long-term perpetual portfolios have a time frame longer than that of any other type of
investment program. Organizations should be mindful to make sure board members and
finance committees are always aware of the perpetual time horizon. It’s easy for individuals
to view the organization’s portfolio from their personal lens.
A good measure of success will be evaluated by the effectiveness of the investments in
producing a steady and growing stream of distributions that at least keeps pace with
inflation.
Inflation measures for nonprofit institutions are generally higher than those for consumers,
due in large measure to the comparatively labor-intensive nature of nonprofits’ activities.
20. These two definitions tell us very little about what’s important to the organization…namely
what’ the likelhood of achieving both the short and long term spending goals.
You should think of risk as the possibility of failing to fulfill the nonprofit’s mission not
how your individual mutual funds or investment managers are performing.
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21. These two definitions tell us very little about what’s important to the organization…namely
what’ the likelhood of achieving both the short and long term spending goals.
You should think of risk as the possibility of failing to fulfill the nonprofit’s mission not
how your individual mutual funds or investment managers are performing.
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26. A few more things to consider with your investment manager regarding benchmarking their
performance. A nominal benchmark of the expected inflation plus the spending policy rate
are particularly useful for organizations that have high spending needs.
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27. Where is the discussion of your organizations financial goals? Is the market conditions
likely to impact your short-term spending goals? What future expected return will the
portfolio have to produce to achieve your organization’s long-term goals? These questions
are usually absent during these reviews.
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29. Stock Gifts: I suggest the organization have a standard default policy that stock gifts by
donor be received and sold in a timely way. Typically the organization isn’t in a position to
determine when to sell these assets. The investment manager depending on their investment
style, resources and capabilities may not properly monitor and track the stock gift or have
the expertise advice you when to sell. It’s typically best to default towards a policy of sell
in a timely way.
Fee Agreement: The nonprofit can negotiate with the investment manager for a lower fee
structure. If the nonprofit is a large and/or strategic client of the investment manager the
nonprofits can request (and in the right situation will get) a contractually agreement they
will be lowest cost client the investment had and in the event the investment manager makes
arrangements with a new or existing client for a more favorable fee structure your nonprofit
to get the same deal.
Avoid Back Tested Strategies: An investment manager will typically not show a client or
potential client a back-tested investment strategy that doesn’t have a wonderful past track
record. Why show a strategy or investment product that does performance extremely well.
The problem is many of these back tested strategies are “data mined” there is no guarantee
that just because a strategy worked in the past it will work in the future. Caveat Emptor
when it comes to investment folks pitching “back-tested” strategies.
Sample Request for Proposal
Proposal Requirements
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30. (Source: Charles Schwab Institutional)
Organization
1. Provide your firm’s name and address and the year the firm was founded, as well as the name, title,
telephone number, and e-mail address for our primary contact with regard to this Request for Proposal .
2. Provide a brief history of your firm, including its credit rating, if applicable.
3. Provide a five-year history of:
a. Assets under management and an explanation for any significant year-to-year changes.
b. Accounts managed
c. Client relationships
4. If your firm is an SEC registered advisor, provide your most recent Form ADV
Parts 1 and 2A. If your firm is exempt from registration, provide an explanation.
5. Describe your organization’s experience in managing funds for foundations and endowments.
6. Provide a description of the investment products and services your firm offers, including for each
product:
a. Investment strategy/objectives,
b. Assets under management
c. Performance for one, three, five, and ten year periods
d. Benchmark(s)
7. Have there been any judgments against the firm or any of its employees in the last five years? Is there any
litigation pending against the firm or any of its employees? Are any governmental agencies or other regulatory
bodies investigating the firm or any of its employees? If so, explain.
8. Does your firm carry errors and omissions insurance? If so, provide:
a. Policy period
b. Limit of liability
c. Deductible amount
d. Carrier name/Carrier rating
9. What is your firm’s minimum size requirement for a separate account? What is the size of the firm’s largest,
median, and smallest separate accounts?
10. Provide the name(s) of your employee(s) who will be responsible for managing our portfolio. If your firm is
an SEC registered advisor, provide their most recent Form ADV Part 2B. If you are not an SEC registered
advisor, provide a complete biography for each employee who will be responsible for managing our portfolio.
11. Identify any other investment professionals (e.g.,research analysts) who will be involved with our
portfolio and their area(s) of responsibility. Provide a complete biography for each of these employees.
12. I f your firm plans to employ sub-advisors or other third party contractors to perform any of the services you
are proposing to provide to us, describe the functions that you are proposing to out-source and your approach
to supervising the performance of your sub-advisors and/or third parties. Provide an executed copy of
your confidentiality agreement with each of these sub-advisors and/or other third parties.
Asset Allocation
13. Describe your capabilities and recent experiences in reviewing and/or working with your clients to prepare
investment policy statements and investment guidelines.
14. Provide a sample asset allocation for the proposed portfolio.
Investment Process
15. Describe the firm’s investment philosophy and strategy. Your response should include, but not be
limited to, your research efforts (external vs. internal), portfolio construction guidelines, risk control techniques,
and sell disciplines.
16. Describe any changes or enhancements that have been made to the investment process in the last three
years.
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31. 17. Describe how your portfolio managers interact with your research analysts.
18. Describe how an investment idea is originated, vetted, and approved.
19. Describe how Investments Are Select ed for a portfolio (for example, model portfolio approach, approved
firm buy list, other).
20. Describe how research is organized and any changes in the last three years.
21. Detail the policies and procedures you have established to insure compliance with your clients’ investment
policy statements and guidelines and to assure quality control of the portfolio management process.
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32. Not all IPS documents address potential conflicts of interest. I strongly suggest your
organization consider including a conflicts of interest policy in the IPS.
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35. Investment manager charges 1.25% annual which translates into $18,750 per year. If you
factor in the $10,000 sponsorship the Nonprofit only pays $8,750 per year which translates
into $8,750/1,500,000 = .58% or 58 bps. That is much more reasonable given the fact that
this is a nonprofit client with a sizeable portfolio.
Issues:
The investment manager does not show a static benchmark (example 60% S&P 500 and
40% Barclays Bond Aggregate). The dynamic benchmarking does show how the
investment manager’s mutual fund/etf etc. has performed in the specific asset subclass
(examples: gold, commodities, international small cap stocks etc.) but fails to show whether
it was a prudent decision to allocate capital to that asset subclass in the first place. For
example, in this case the investment manager allocated aggressively to gold which
insignificantly underperformed over the last several years. So during the period of time the
investment manager held those assets they were benchmarked against a commodity index
which was appropriate, but once the asset subclass (gold) was sold it is difficult to see how
the past gold exposure impacted the overall performance. This investment manager has a
history of poor allocation decisions (they invested in gold at the top, energy near the top of
the cycle, treasury inflation protect bonds (TIPs) that have materially declined). Since they
don’t report against a static benchmark, once these asset subclasses are sold it’s hard for the
Nonprofit to see how poorly these decisions were. THE FIX: Dynamic benchmarking is
fine to review how the asset subclass managers are performing relative to their benchmarks,
but without a portfolio showing a static benchmark (Example 60% S&P 500, 10% MSCI
EAFE and 30% Barclays Bond Index) it’s difficult to determine how skilled the investment
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36. manager is at asset allocation decisions. Incorporate both a static and dynamic benchmarking
if you have an active investment manager that is rotating in and out of asset subclasses
routinely.
To finish the story on this issue. I went back and determined the investment manager
averaged about 60% stock and 40% bonds over the last 10 years. I went back and determined
that a very simple portfolio of S&P 500 (60%) and (40%) Barclays Aggregated index
outperformed this manager by about 2.5% per year. It’s pretty clear that this manager had a
lousy 10 year track record of asset allocation decisions. The investment manager did just
have one or two significantly bad allocation decisions as they made what they called
“strategic allocation decisions” to 6 out 7 trailed the S&P 500 over the time period they held
them. The underperformance costs the client about $185K over 10 years (That 10K
annual sponsorship is costing the organization more than they really know).
Before this information came to light assumed the manager did a pretty good job as they
showed a positive return during the last 10 years (the S&P 500 was up 8% and bonds did
about 5%...it’s the rising tide lifts all boats scenario). They also really like the investment
manager and appreciated the what had become an annual contribution of 10K to Nonprofit’s
annual event.
Lastly, the investment manager would switch equity benchmarks from time to time. These
changes violated the Nonprofit’s IPS but the finance/investment committee did not challenge
the investment manager on the matter. In every instance the benchmark change improved the
investment manager’s performance. The FIX: hold the investment manager accountable for
the IPS. It’s a good practice to ask the investment manager(s) periodically if the current IPS
is too restrictive in anyway. This makes for good discussions about potential future revisions
or helps galvanize the Nonprofit on their “core” investment beliefs.
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37. It’s important to hold the investment manager accountable to the written IPS. It’s also
important to periodically ask the investment manager(s) periodically if the current IPS is too
restrictive in anyway. This makes for good discussions about potential future revisions or
helps galvanize the Nonprofit on their “core” investment beliefs.
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