William F. Jarvis
Rather than being separate, institutional governance and investment management are intertwined, with one affecting the other.
The model in which volunteers manage both the investable and defined benefit plan assets of healthcare organizations may be stretched to its limits. The complexity of today's investment strategies, an increasingly rigorous regulatory regime, and the difficulty of recruiting experienced and talented individuals to volunteer their time are serious obstacles to the traditional system of private citizens acting on behalf of public-benefit institutions (a problem not confined to health care). Compounding the difficulty for healthcare organizations-especially in the wake of a withering recession-are the rising demands on endowments that have stressed many institutions' resources and, hence, their ability to fulfill their mission.
A New Level of Complexity
A primary challenge is greatly increased complexity. A world that once seemed familiar and comfortable no longer exists. Forty years ago, when endowment management practices began to break away from traditional trust law concepts, the bulk of institutions' funds were invested in domestic equity and fixed income instruments. Today, highly complex investment strategies and financial instruments have created a world moving at very high speed, littered with unintended and unknown risks, not to mention a legal and regulatory environment that is increasingly complex. Moreover, many healthcare organizations have not one, but two substantial pools to manage: their investable assets and their defined-benefit pension plans. Some organizations have separate committees managing each, while many assign responsibility to a single finance or investment committee. Either model, however, complicates governance at these healthcare organizations.
Given limits to the traditional governance model to cope with today's complexity, time constraints, and liabilities, are there any attractive options? Can an investment or finance committee create alpha, that much-sought-after excess return above market averages or benchmarks? Better governance practices alone can add value to investment portfolios-but only if investment committees are willing to recognize the need for change in their structure, process, and behavior.
Governance comes from a Greek word that means "to steer." Although we would like to think that governing boards are steering their organizations toward the fulfillment of their mission through time, boards today are all too often steering to avoid shoals and currents that hold potential threats to their institution.
In light of today's challenges, institutional investors may want to consider three options in place of the traditional model:
- Establishing a fully staffed, fully capable, internal investment management team
- Outsourcing most of the investment management function while retaining strategy and policy-making
- Accepting that options one and two are not viable for the organization and, as a consequence, pursuing simpler portfolio construction strategies consistent with the organization's capacity to appropriately manage the risks of more complex portfolios
A Look at the Options
Looking at option number one, those entities with any interest in or capability of establishing a the fully staffed internal team in all likelihood have already done so. And in health care, these organizations are few and far between. Building and maintaining a staff of talented investment professionals is a challenge fraught with difficulties, chief among them being the enormously high cost and considerable effort involved with attracting and retaining an experienced, skilled leader. As to option three, that approach is something that boards will have to decide for themselves.
That leaves option two, outsourcing, which a healthcare organization can accomplish using one of the following:
- The outsourced investment office
- Multiproduct firms
Consultants. Consultants advise on establishing and maintaining the investment policy-including asset allocation, rebalancing, and spending formulas-and screen investment managers for the investment or finance committee to consider for implementing the policy. The committee thus is responsible for the manager relationships and for tracking the managers' performance-not the consulting firm.
A new form of consultant practicing also has emerged recently called "crossover consulting" or "implemented consulting." In this blended model, the consultant advises on policy matters but also selects the investment managers to implement the policy. A variable factor is the degree of discretion the consultant is granted; it runs the gamut, and the more discretion the consultant has, the greater the consultant's accountability for performance.
Outsourced investment management office. A number of healthcare organizations and their foundations have chosen this approach, in which the committee and board assign responsibility for day-to-day investment management to a qualified external provider that manages all or a portion of the institution's investment funds. For example, some organizations outsource a portion of their assets-like their alternatives allocation-to the external manager. Typically, such a move is undertaken to lower costs, generate greater efficiencies, and free up resources. Perhaps most important, outsourcing discretion in investment decision-making allows the organization to increase its focus on strategy, policy-making, and core governance issues.
One way to think about this approach is to consider the answers to two questions: How can trustees exercise their responsibilities in a manner consistent with those expected of a fiduciary? And how can a group of individuals focus their limited resources in a way that allows them to fully address the range of issues spanning everything from high-level policy to manager selection?
Multiproduct firms. With this approach, the committee puts its investment policy to work through a single adviser/fund manager relationship. The adviser may implement the asset allocation or rebalancing or may recommend subadvisers to manage various allocations within the portfolio, often in a multi-asset structure.
In this model, the investment committee is able to make a single decision-selecting the adviser that best suits its needs from several multiproduct firms-instead of performing the due diligence and monitoring of many individual managers. Reporting is consolidated as well, and there may be complementary services, such as advice concerning fund-raising and philanthropy management, that the multiproduct firm can offer. A potential drawback of the multiproduct firm model is that it could limit the investor to the firm's own funds or to investment managers and funds that are on the firm's "platform." That said, some firms do offer separately managed accounts that can provide flexibility and customization to meet client needs.
A New World for Investment Management
The model for managing long-term funds on which healthcare organizations depend to fulfill their mission is distinctly different from what it was just a decade ago. The changing demands of society, a vastly different legal and regulatory environment, and a substantially more complex investment industry have permanently altered the traditional investment committee structure and process and, in a great many instances, have left the committees overmatched. Further, the sharp downturn in securities markets and the accompanying deep recession in 2007-08 exposed fissures in existing governance
Trustees would do well to reexamine alternatives that may be much more effective in today's environment, including outsourcing much of the investment management process. In doing so, they may be able to increase their own effectiveness and better utilize institutional resources in pursuit of their mission.
William F. Jarvis is managing director, Commonfund Institute, Wilton, Conn, (firstname.lastname@example.org).
Publication Date: Monday, January 03, 2011