Christopher K. Merker, PhD, CFA, is a financial advisor and director of Private Asset Management at Robert W. Baird & Co. and an adjunct professor at Marquette University. He is also the co-author of The Trustee Governance Guide. The following are highlights from his presentation at the recent Commonfund Investment Stewardship Academy at the Yale School of Management.
There are five imperatives for trustees of nonprofit organizations. Although governance has been my area of research for the last decade, I write this not only as an academic but also as a practitioner having hands-on experience with many of the issues that trustees confront today.
1. Be well governed
Fiduciary effectiveness is built on Structure + Process + People. The key elements of Structure are board professionalism, board composition, the level of board engagement and how transparent the organization is to its constituencies and beneficiaries. Process takes place within the Structure and comprises the tasks the board must perform and the decisions it must make. People inhabit that Structure and here the keys are leadership, culture, competency, experience and diversity.
2. Be knowledgeable
How much knowledge do board members need? The same financial literacy of the general population—budgeting, savings, investing and credit—plus the competency to understand the time value of money, probability theory as it relates to risk management and the fiduciary duties of a trustee. Not everyone needs to possess the specialized knowledge of investment professionals, but they should be aware of two forms of potential human shortcomings in investing—operational errors and behavioral biases—and how to safeguard against them.
3. Be diversified
Everyone understands diversification. But we should also acknowledge the challenge of over-diversification. There’s a universe of 100,000 stocks, a million-plus bonds, myriad private investments and countless derivatives. Investments are conveniently packaged into mutual funds, ETFs, managed accounts, hedge funds and other structures. What trustees should be focused on is optimal, well-timed, not overly complicated and based on the simple proposition that the institution needs to generate cash flow to fund future obligations.
4. Be disciplined
We can segment discipline into two buckets: governance functions and investment functions. The list of governance functions is longer and should come first. These include goal-setting, reviewing and updating policies, rotating the board and board self-assessment, and occasionally changing consultants. Investment functions include overseeing the portfolio and rebalancing, avoiding market timing, and controlling costs.
5. Be impactful
There is a list of the risks to global development as identified at the annual Davos World Economic Forum. The most likely are extreme weather events, natural disasters, cyber security and data fraud or theft. The most impactful include weapons of mass destruction, extreme weather, natural disasters and water crises. Why should these matter to investors? Many of the corporate scandals or bankruptcies in recent decades can be traced to environmental, social or governance (ESG) risk factors, e.g. corporate governance failures at Enron or environmental management failures at PG&E, more recently, creating a detriment to the environment or to society at large and most certainly to investors.
I challenge nonprofit investors to “invert the pyramid”. By that I mean three key topics: mission and governance, asset allocation and manager selection. We generally spend too little time on mission/governance and asset allocation and a too much time on manager selection. I say, go for it, invert that pyramid. Spend more time on mission and governance, more time on asset allocation and less time on manager selection. By refocusing their orientation, organizations that do, should see much better results over time.