Enhancing institutional governance: Four strategies to develop and maintain a well-functioning investment committee

*This is the first of a three-part series focused on the attributes and benefits of effective institutional governance.*

Creating an effective institutional investment committee is a nuanced and critical process that significantly impacts an organization's financial health and ability to fulfill its mission. In my role as Senior Client Advisor, I have had the opportunity to work with the investment committees of many not-for-profit and corporate organizations. Based on this experience, I've identified four pivotal strategies that are instrumental in building and sustaining a high-performing investment committee.

1. Choose the Right Size and Committee Composition for Your Organization

A great deal of academic research has been conducted on committee size, effectiveness and efficiency. Larger committees tend to have a greater collective memory and broader knowledge than smaller committees, but groups with more members can also slow down decision-making, which may lead to problematic results. Evidence suggests that committees of five to eight are large enough for diversity of thought but still allow for decisive behavior.

Smaller organizations with fewer available members and less complex portfolios may choose to have fewer committee members, while larger organizations with more potential members and more complex portfolios may prefer to have more committee members. Committee candidates should have relevant professional backgrounds, no personal agendas, a willingness to engage and learn from others, and sufficient time to dedicate to the committee.

2. Determine the Term Length for Members

Committee member tenure can be a sensitive subject. High turnover means a higher potential for erosion of institutional memory about why certain decisions have been made, and the factors that led to such decisions. Periodically onboarding new members can add a fresh perspective, but too much change increases the risk of altering the strategic asset allocation at the wrong time, potentially harming long-term results.

Terms of five to seven years are reasonable, with possible re-election for a few key members. Some organizations require committee members to leave the board for a period of time before returning in order to help avoid control issues. Staggered terms can also help maintain institutional memory. It’s important to have a seasoned group of committee members, but reserving space for younger members ensures the viewpoints of multiple generations are incorporated into decisions. With this approach, future leadership can be nurtured, increasing the likelihood of successfully employing a long-term, consistent investment process.

3. Develop a Comprehensive Investment Policy

A strong investment committee begins with an understanding of the organization's mission and goals, and an investment policy that governs all aspects of managing the organization’s investment assets. The policy is intended to maintain the committee’s focus on executing investment activities over the long term and instilling discipline during times of market extremes.

A well-formulated policy outlines and prescribes a prudent and acceptable investment philosophy, defines long-term goals, and establishes appropriate investment management procedures. It includes long-term and short-term investment objectives, tolerance for risk, distribution/spending requirements, and a time horizon for performance measurement. These items should be the primary determinants of the policy’s target asset allocation, including the selection of asset classes and the appropriate allocation to each. This important topic will be discussed in further detail in the second part of this series.

4. Adopt a Disciplined Approach to Investing

There are a few guiding principles to maintain a disciplined approach to investing: set clear and measurable goals, identify the appropriate level and types of risk, control expenses, and invest for the appropriate time horizon. Understanding the organization's mission will help determine appropriate goals, such as achieving a long-term return equal to the spending policy plus inflation. Creating a diversified portfolio with proper exposure to the appropriate asset classes will be critical in the risk management effort, ensuring the organization benefits from segments of the market that are best suited for its objectives. A well-diversified portfolio creates a more predictable risk/return profile and is less likely to experience losses due to unfavorable results from overly concentrated investment positions. Expense control is also critical to improving investment outcomes. Higher costs don’t necessarily lead to higher returns and every dollar paid to fees is a dollar less of return.

Finally, it’s essential to have the discipline to maintain an asset allocation over time (and through what may be difficult market environments) in order to achieve long-term investment goals. Abandoning a planned investment strategy can be costly, and behavioral finance research highlights some of the most significant detractors: the failure to rebalance, the attraction of market timing, and the temptation to chase performance. Committees must take a disciplined approach to investment decision-making to avoid overreacting to market volatility or failing to rebalance after the portfolio allocation has shifted.

Building and maintaining an effective investment committee is an ongoing challenge for every organization with investable assets. The roles and responsibilities will vary by committee, but the strategies discussed in this article will lead investment committees to better decisions for the organization and the assets they oversee.

Sources: Diversified Trust, “Optimal Investment Committees,” 2013; Greenwich Roundtable, “Best Governance Practices for Investment Committees,” 2014; Goldman Sachs, “Charitable Organizations: An In-Depth Discussion of Investment and Governance Trends,” 2015; Callan Institute, “Strategic Guidance for Effective Investment Committees,” 2016; Vanguard, “Investment Committee Best Practices,” 2017; FEG, “The Importance of Investing for Non-Profit Organizations,” 2019; Trust Company of the South, “Look to Higher Ed for Higher Returns,” 2021.

The content in this blog post is provided for informational purposes only, and should not be construed as personalized investment advice. The data and information used in the preparation of this blog post are obtained from third-party sources believed to be reliable, but Alesco Advisors does not guarantee the accuracy, completeness, or timeliness of the data and information