Does Your Investment Policy Statement Account for Risk?

January 20, 2017  | by Bill Jarvis

Governance and Policy | Industry Knowledge | Investment Strategy | Risk Management

Successful investing for long-term funds requires a strategic plan. This is true despite – indeed, because of – the fact that the future is unknowable.

The plan must be specific, embodying in concrete terms the best thinking of the board of trustees about the investment pool, its goals and purposes; but it also needs to be sufficiently flexible to guide the board through environments that may be very different from those prevailing at the time of its adoption.

In the past, many investment policy statements gave relatively cursory treatment to risk, its quantification and its potential impact on the asset pool. The market collapse and credit crisis of 2007-2009 demonstrated that many institutions’ portfolios carried unacknowledged risks, that their risk profiles in general were higher than they thought, and that the risk tolerance of their fiduciaries was lower than acknowledged. Today, then, it is entirely appropriate to put risk at the top of the process of investment policy development.

Financial models, as the crisis demonstrated, are anything but infallible and, when consulted, must be used with care and a healthy degree of skepticism.  It is nonetheless true that the results of an appropriate simulation or modeling study can assist fiduciaries in going beyond traditional risk definitions such as volatility to examine such critical parameters as the risk of permanent loss, year-to-year declines in spending, and recovery periods. These metrics both enable and force a discussion about tolerable levels of risk, the conclusions from which can be used to guide the construction of a range of potential portfolios that embody those risks that are deemed acceptable. Projected returns from these portfolios are an outcome which, if considered insufficient, indicate either acceptance of lower contributions for the acceptable level of risk or mandate a more robust discussion about the relationship between risk assumption and needed long-term returns.

Instead of starting with return – committees work toward it.

If, ultimately, the projected range of returns is seen as ‘too low’ compared to anticipated institutional needs, then the fiduciaries must either reconcile themselves to the fact that the target return is beyond their reach given their risk limits, or accept the necessity of embracing additional risks and explicitly acknowledge them in the investment policy statement.

To help your Board of Trustees or Investment Committee members craft an investment policy statement for your endowed nonprofit organization Commonfund has prepared two Investment Policy Statement templates.

  1. The Risk-based Investment Policy Statement template  – designed for organizations with access to financial simulation and modeling tools (sometimes called Monte Carlo models) that can be used to estimate ranges of future returns for given portfolio choices and create “stress-testing” scenarios to examine the performance of portfolios in illiquid or non-normal market environments.

  2. The Traditional Investment Policy Statement template – designed for organizations that do not have access to, or choose not to use, the financial simulation and modeling tools employed in the Risk-based Investment Policy Statement.

Interested in learning more?  Complete the form below to download the complete whitepaper, The Investment Policy Statement and get access to your own IPS templates.

Authors

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William F. Jarvis, Executive Director, Commonfund Institute, leads Commonfund’s educational, research and professional development activities. Bill is the managing editor of Commonfund Institute’s series of proprietary studies of nonprofit investment and governance practices and the author or co-author of numerous white papers and articles. He speaks at Commonfund’s annual Endowment Institute and Commonfund Forum as well as at other nonprofit and industry conferences. A financial services executive and attorney, Bill served as Commonfund Institute′s Head of Research from 2006-15. His career prior to joining Commonfund included working with J.P. Morgan, where he spent 13 years as an investment banker in New York and Tokyo; Greenwich Associates, where he advised leading investment management firms and led the fielding of the first Commonfund Benchmarks Study; and Davis Polk & Wardwell, where he provided legal advice to global banks and securities firms. He also served as Chief Operating Officer of a privately-held hedge fund manager based in New York City. Bill holds a B.A. in English Literature from Yale University, a J.D. from the Northwestern University School of Law, and an M.B.A. from the J.L. Kellogg Graduate School of Management.
William F. Jarvis
Executive Director, Commonfund Institute

The Investment Policy Statement

Successful investing for long-term funds requires a strategic plan. This is true despite – indeed, because of – the fact that the future is unknowable. The plan must be specific, embodying in concrete terms the best thinking of the board of trustees about the investment pool, its goals and purposes; but it also needs to be sufficiently flexible to guide the board through environments that may be very different from those prevailing at the time of its adoption.

This paper reviews key features needed in such a plan – the investment policy statement – and provides sample templates.

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Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund managers. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund Group’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund Group fund. Such statements are also not intended as recommendations by any Commonfund Group entity or employee to the recipient of the presentation. It is Commonfund Group’s policy that investment recommendations to investors must be based on the investment objectives and risk tolerances of each individual investor. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund Group. Commonfund Group disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.

Disclaimer

Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund managers. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund Group’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund Group fund. Such statements are also not intended as recommendations by any Commonfund Group entity or employee to the recipient of the presentation. It is Commonfund Group’s policy that investment recommendations to investors must be based on the investment objectives and risk tolerances of each individual investor. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund Group. Commonfund Group disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.