Including Risk Management in Your Investment Policy Statement – Where to Begin

May 11, 2023 |
2 minute read
|

Investment policy statements usually contain a section that purports to define the institution’s risk tolerance. But they frequently only gesture in the direction of risk, without actually examining its reality as a matter of investment policy and practice for the institution.

References to risk typically speak of it as something to be “managed” in a general sense. Now, with powerful financial models available to enable fiduciaries to estimate the probability and range of possible losses associated with given investment strategies over time, risk is no longer treated as a byproduct of investment decisions but, rather, a primary input. Moreover, the widespread use of consultants and outsourced chief investment officer (OCIO) advisors provides institutions with the ability to perform the requisite quantitative modeling, thus reducing the complexity associated with factoring risk into the portfolio construction and monitoring process.  

At a strategic level, measurable risks include potential outcomes that could impair the institution’s ability to accomplish its mission over a significant period. Examples might be:  

  • Unacceptably large declines in the market value of the endowment followed by extended periods of recovery in which the endowment is unable to provide the expected support to the institution. 
  • The inability to maintain sufficient liquidity to meet the institution’s ongoing mission or operating budget obligations in the event that, during bear markets, investments cannot be sold at or near their expected value and credit is not available. 
  • Insufficient understanding of the behavior of the portfolio under stress, leading to unexpected losses. This can be especially true when securities and portfolio strategies exhibit higher correlations with each other during market downturns.  

Apart from these risks, a range of additional concerns may include the legal, operational, credit, environmental, competitive and reputational risks that accompany the portfolio management process. These risks generally can be said to exist at the level of the individual institution or its investment portfolio but can also be exacerbated by the macroeconomic environment and events in the broader financial market.  

Risks that are specified, defined and accepted become the product of a set of conscious decisions rather than a byproduct of stated return objectives. By striking an appropriate balance between risk and return, fiduciaries can obtain a better understanding of the relationship between the various types of risks that they have accepted and the returns sought for the portfolio, including the potential negative outcomes associated with their asset allocation and investment policy decisions. 

Risk Management Comes to the Fore in Periods of Stress. Investment policy statements (IPS) are typically written and updated during periods of relative calm in financial markets. But they are tested when investment, economic, financial and/or geopolitical events lead to a crisis atmosphere. The IPS can be a shield protecting trustees from the pressure to make unwise decisions in such an environment. As a supplement to the IPS, a crisis playbook may help boards and investment committees identify stress points or triggers where operations may no longer be sustainable and then identify the actions they would feel comfortable taking.  

Hypothetical questions could include,: What programs might we cut? What expenses could we control? What fundraising opportunities, if any, might be available to us? In short, the playbook is a sound way to guide actions when storm clouds are spotted on the horizon without risking the ship. 

How does your IPS account for risk? Has your institution given thought to a Crisis Playbook?  If you would like to learn more about risk management in your IPS and more about crafting a strategic investment policy statement download our whitepaper “The Investment Policy Statement: Guiding and Guarding Nonprofit Endowments.”  

The Investment Policy Statement 2023

George Suttles

Author

George Suttles

Executive Director

George Suttles

Author

Allison Kaspriske

Director

Disclaimer

Certain information contained herein has been obtained from or is based on third-party sources and, although believed to be reliable, has not been independently verified. Such information is as of the date indicated, if indicated, may not be complete, is subject to change and has not necessarily been updated. No representation or warranty, express or implied, is or will be given by The Common Fund for Nonprofit Organizations, any of its affiliates or any of its or their affiliates, trustees, directors, officers, employees or advisers (collectively referred to herein as “Commonfund”) or any other person as to the accuracy or completeness of the information in any third-party materials. Accordingly, Commonfund shall not be liable for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on any statement in, or omission from, such third-party materials, and any such liability is expressly disclaimed.

All rights to the trademarks, copyrights, logos and other intellectual property listed herein belong to their respective owners and the use of such logos hereof does not imply an affiliation with, or endorsement by, the owners of such trademarks, copyrights, logos and other intellectual property.

To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated herein. 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. Market and investment views of third-parties presented herein do not necessarily reflect the views of Commonfund, any manager retained by Commonfund to manage any investments for Commonfund (each, a “Manager”) or any fund managed by any Commonfund entity (each, a “Fund”). Accordingly, the views presented herein may not be relied upon as an indication of trading intent on behalf of Commonfund, any Manager or any Fund.

Statements concerning Commonfund’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 Fund. Such statements are also not intended as recommendations by any Commonfund entity or any Commonfund employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. 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. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information or statements. Past performance is not indicative of future results. For more information please refer to Important Disclosures.

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Disclaimer

Certain information contained herein has been obtained from or is based on third-party sources and, although believed to be reliable, has not been independently verified. Such information is as of the date indicated, if indicated, may not be complete, is subject to change and has not necessarily been updated. No representation or warranty, express or implied, is or will be given by The Common Fund for Nonprofit Organizations, any of its affiliates or any of its or their affiliates, trustees, directors, officers, employees or advisers (collectively referred to herein as “Commonfund”) or any other person as to the accuracy or completeness of the information in any third-party materials. Accordingly, Commonfund shall not be liable for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on any statement in, or omission from, such third-party materials, and any such liability is expressly disclaimed.

All rights to the trademarks, copyrights, logos and other intellectual property listed herein belong to their respective owners and the use of such logos hereof does not imply an affiliation with, or endorsement by, the owners of such trademarks, copyrights, logos and other intellectual property.

To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated herein. 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. Market and investment views of third-parties presented herein do not necessarily reflect the views of Commonfund, any manager retained by Commonfund to manage any investments for Commonfund (each, a “Manager”) or any fund managed by any Commonfund entity (each, a “Fund”). Accordingly, the views presented herein may not be relied upon as an indication of trading intent on behalf of Commonfund, any Manager or any Fund.

Statements concerning Commonfund’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 Fund. Such statements are also not intended as recommendations by any Commonfund entity or any Commonfund employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. 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. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information or statements. Past performance is not indicative of future results. For more information please refer to Important Disclosures.