Serving on a foundation’s board or investment committee is an honor, although managing the foundation’s investment portfolio can be confusing. Understanding best practices is important in providing effective oversight of the organization’s assets. Having a defined investment policy statement, advisor selection process, fee analysis framework and performance evaluation criteria are excellent practices for foundations to follow. We examine each of these best practices below.
Investment Policy Statement
Establishing a solid investment framework is critical to success. All foundations should have an investment policy statement (IPS) that provides guidance on how the foundation’s investment portfolio will be managed. When creating an IPS, consider the following:
- Thoroughly discuss the key components of an IPS, including the foundation’s return goals, risk tolerance, asset allocation guidelines, manager selection process and allowable investments. As you develop guidelines, lean toward broad parameters because narrow restrictions can unnecessarily handcuff your investment manager(s).
- Don’t live in the past. Updating the IPS by incorporating guidelines for new investment vehicles or strategies can keep the foundation on track to reach its goals.
- Make sure to put parameters around risk! Return goals are good, but don’t forget to set guidelines for the amount of risk you are willing to take to reach them.
- Establish an annual investment policy statement review process.
Investment Advisor Selection Process
Often, the advisor you select signifies whom you trust. Consider the following questions when establishing an investment advisor selection process.
- How did you select your investment advisor? The result of a request for proposal process? Are they a friend? Result of a merger? What are their qualifications?
- What is your advisor’s compensation based on? Make sure you understand the difference between performance and fee-based agreements.
- If a foundation is managing its own assets, does it have the skills, expertise and resources to match a professional investment advisor?
- How is the investment advisor regulated? The regulations that bind your advisor may affect depth of service, transparency, objectivity and expense management.
Fee Analysis Framework
One simple way to improve performance is to control fees. Below are examples of areas to scrutinize when determining how to control fees.
- Do you know your total investment expenses? Advisor fees are typically top of mind, but underlying fund fees also must be considered.
- Don’t be penny-wise but pound-foolish. Picking the lowest-cost investment isn’t always the best course of action. Investment managers who don’t have the lowest costs may be acceptable as long as they meet your formal selection criteria and charge fees comparable to their peer group.
- Make sure you track costs and evaluate investment performance over a sufficient period of time (usually at least five years).
Performance Evaluation Criteria
Determine what criteria you’ll use for evaluations and schedule the performance review. Properly evaluating performance helps assess whether the hard work was worthwhile.
- Performance reviews should occur at least annually.
- Don’t get caught up in short-term performance. Foundation investing is a marathon, not a sprint.
- Key questions to ask include whether the portfolio is exceeding investment return goals over 5- and 10-year periods, or if you took too much or too little risk in trying to reach your goals. Taking too little risk and falling short of investment return goals can be just as harmful as taking on too much risk.
- How will you measure the performance of your individual portfolio holdings? If you measure performance at the asset class, i.e., stocks, bonds, real estate, etc., or subclass levels, i.e., U.S. large company stocks, international stocks, etc., select the appropriate market indices for each.
Overseeing a foundation’s investment portfolio is an important and ongoing process. Incorporating the best practices highlighted above can help a foundation effectively manage its assets and progress toward its goals.
Contact Andrew, Beth or your trusted BKD advisor if you have questions or want to discuss your foundation’s investment management approach.