1 A Roadmap FOR THE Roadmap : creating an investment policy statement for endowments and foundations Simon C. Krinsky, CFA. Kathryn A. Hall March 2012. San Francisco | New York March 2012 A Roadmap for the Roadmap Introduction 4. Keep it updated. Schedule an annual review The purpose of this white paper is to offer of the IPS. investment committees and staff members a guide for creating an investment policy Objectives statement (IPS) to meet their institution's Our fundamental view is that every institution is specific objectives and constraints. distinct. As a result, there is no single objective, set of constraints, or target asset allocation that An IPS is intended to help an endowment or can be applied broadly across all institutions. foundation: Instead, investment objectives and asset 1. Outline the purpose and goals of the allocation should reflect and be designed to investment portfolio.
2 Support the mission of each specific organization. It is impossible to cover the entire 2. Identify and articulate relevant constraints. universe of organizations in this white paper, 3. Set an appropriate investment structure and therefore we have tried to articulate a broad target asset allocation. framework which can be applied across most 4. Establish guidelines to monitor performance institutions. and risk. 5. Define roles and responsibilities for the A commonly stated objective for perpetual investment committee, board of directors, endowments or foundations is to preserve and investment managers, consultants, enhance the real purchasing power of the custodians, and/or chief investment officer investment assets over time, while providing a (CIO). predictable contribution to the annual operating 6. Provide continuity across changes in board budget.
3 In other words, maintain or grow the of trustees, investment committee or chief portfolio after adjusting for spending, fees, and investment officer. inflation, while generating reasonably predictable cash flows. This objective might fit This paper is intended to cover these and other your institution, but here are some questions to considerations, as well as provide a sample IPS consider before reaching that conclusion: for further context. What percentage of the institution's operating budget does the endowment Before delving into the specifics, however, support? below are four general suggestions for creating How predictable and steady are your an effective IPS: institution's expenses and sources of income 1. Use a vocabulary that all constituents of other than transfers from the endowment? your institution understand. Keep the Is this investment pool intended to be investment jargon to a minimum.
4 Perpetual or spent down over a period of 2. Review your institution's governing years? documents; much of what you are looking Might your endowment or foundation be for might already be defined in those called upon for a major Capital expenditure documents. (either planned or unplanned)? 3. Less is more. An IPS is most effective if an Is your institution's endowment cash flow investment committee can digest the positive (does the institution add more material and apply the key principles to money to the endowment from gifts and/or constructing, managing, and reviewing a operations than it draws each year)? portfolio. Is your institution able to access the Capital markets ( , by raising debt)? Hall Capital Partners LLC 2012 Page 1. March 2012 A Roadmap for the Roadmap It is important to think about the actual purpose Board and/or investment committee of your investment funds, and to articulate that interpretations of their fiduciary obligation purpose clearly and succinctly.
5 Investment with regard to control, diversification, and committees often find that individual constraints transparency necessitate a change to the generic objective Board- or donor-designated restrictions listed earlier. For some institutions, consistent Socially responsible investing (SRI). support of the operating budget trumps long- objectives term growth; to others, managing the investment pool to meet a social objective is the most important factor. Finally, it is worth noting that Some constraints are inherently rigid, such as institutions may have more than one investment legal or donor designated restrictions, while pool and a different IPS may be appropriate for others are subject to interpretation. All different pools. For ease of review, this paper constraints impact asset allocation and portfolio refers to only one endowment fund. implementation.
6 It is therefore advisable to fully understand and clearly articulate these Constraints constraints in the IPS. Unsurprisingly, endowment and foundation Asset Allocation constraints are more varied than their objectives, and are typically broken out between the Many institutions define asset classes by spending policy and other considerations. The structure, style, and geography. Others attempt institution's spending policy is usually one of to segment the investment universe by return the most important portfolio constraints. Many pattern or theoretical role in the portfolio. The organizations adopt a total return policy with examples below and on the following page respect to the source of funding for annual reflect each approach. distributions from their endowment. In other words, the amount to be withdrawn to fund the Example A: (structure, style, and geography).
7 Operating budget is defined as a percentage of endowment Capital , and the source for funding Cash and Equivalents the portfolio's contribution to the annual budget Fixed Income can come from income, realized or unrealized Investment Grade Bonds gains, principal, or some combination of those. High-Yield Bonds In addition, as most endowments and Global Bonds foundations need reasonably consistent cash US Equity flows from their portfolios, many adopt Large Value smoothing mechanisms, such as using a 3- or Large Growth 5-year rolling average Capital base calculation, Small-Cap Growth to minimize the impact of market fluctuations on International Equity portfolio distributions. Please see Appendix C. Developed Country for a number of spending policy examples. Emerging Markets The second set of constraints revolves around Alternative Investments governance and/or philosophical considerations, Hedge Funds such as: Private Equity Venture Capital Portfolio liquidity considerations Real Estate Legal or regulatory restrictions Commodities Hall Capital Partners LLC 2012 Page 2.
8 March 2012 A Roadmap for the Roadmap Example B: Example C: (return pattern and/or portfolio role) (Hall Capital Partners ). Liquidity Cash/Fixed Income Cash and Equivalents Cash and Cash Equivalents Fixed Income Investment Grade Bonds Capital Appreciation Global Equities Global Public Equity Global Distressed Credit US/International Hedged Equity Emerging Markets Global Private Equity Hedge Funds Inflation Sensitive Equity Hedge TIPS Absolute Return Real Estate Hybrid/Opportunistic Commodities Private Equity (Global). Independent Return Venture Market Neutral Growth Relative Value Control Multi-Strategy Real Assets Real Estate At Hall Capital Partners , we define asset classes Timber by drivers of return and risk. At our firm, we Oil and Gas choose to concentrate portfolios in five broadly defined asset classes: Cash/Fixed Income, At Hall Capital Partners , we believe that Global Equities, Hedge Funds, Private Equity, authentic diversification requires allocating and Real Assets.
9 We also use one catch all Capital across different asset classes, assuming Hybrid/Opportunistic to capture investments an organization can accommodate the illiquidity which do not fit neatly into one of the other asset associated with private equity and real assets. classes. We organize balance sheets in roughly Within each asset class, we are comfortable with descending order of liquidity and characterize a relatively small number of investment the role of each asset class in terms of return strategies, with each serving a specific purpose. expectation, time horizon, and risk. Establishing ranges around asset class exposure Investment committees should not be trapped by is strongly recommended. It is important to asset class segmentations. It is important to strike the right balance of appropriate asset class capture the best investment opportunities limits while maintaining the flexibility to tilt the available to the institution, even if these portfolio towards the most compelling opportunities fall between the definitions found investment opportunities.
10 Wholesale moves in or in the IPS. So while we emphasize the out of asset classes rarely make sense; instead importance of understanding returns and risk shifts within ranges and composition of associated with each investment, we encourage investments within asset classes can you to think about the asset class section of the accommodate appropriate responses to changing IPS as a guide, rather than a strict bucketing environments. mechanism. Hall Capital Partners LLC 2012 Page 3. March 2012 A Roadmap for the Roadmap Framework for Rebalancing Performance for each manager should be A sensible rebalancing policy is good discipline analyzed against an appropriate benchmark as for a number of reasons. First, it adds an well, both quantitatively and if possible unemotional constraint by encouraging qualitatively. Major variances both positive committees to trim investments which have and negative should be cause for review.