Wednesday, April 13th, 2011
for the prudent fiduciary

The financial crisis served as a wake-up call after a quarter century of generally favorable markets.  There had been other notable events during that time, including a stock market crash, the dot-com bubble and popping thereof, and several smaller but painful episodes of panic, although none of them shook the faith of investors as did the events of 2008 and 2009.

It is tempting to say that things are back to normal.  The markets have recovered (albeit with the heavy lifting having come from the extraordinary fiscal and monetary stimulus that remains in force) and investment firms have returned to business as usual.  However, many individual investors remain skittish, and those who serve as fiduciaries are faced with a particular challenge.

They make investment policy decisions for pension plans, foundations, and the like — and assume a fiduciary duty as a result.  That is quite a burden to bear, especially now, when many of those fiduciaries don’t know what to believe or in whom to trust.  On any given committee or board, there are individuals with a fair amount of investment training and others for whom many of the principles are fuzzy and the details unfamiliar, yet they all carry the responsibility for the decisions that are made.

Thankfully, a new monograph from the Research Foundation of CFA Institute provides a great platform from which to address many of the issues.  Authored by Jeffery Bailey, Jesse Phillips, and Thomas Richards, it is entitled, A Primer for Investment Trustees.CFA Institute | This page includes a link to the PDF. And it is a primer, written for Molly, a new member of the investment committee at Freedonia University,A nice tip of the hat to the Marx Brothers and Duck Soup. which oversees “a defined-benefit (DB) plan, a defined-contribution (DC) plan, an endowment fund, a foundation, and a self-insurance trust.”

The monograph walks Molly through governance structure, investment policy, investment objectives, risk tolerance, asset classes, performance evaluation, and ethics.  Each section ends with a nice list of “takeaways” and “questions Molly should ask.”  It provides a terrific summary of the basics for any trustee (the book’s use of that word is synonymous with my use of “fiduciary”), although even its relative simplicity hints at the amazing range of knowledge that a prudent fiduciary should have.research puzzle pix | The title of this posting comes from a subhead that I use when doing items in pix that are of special interest to fiduciaries.  This link takes you to editions that include them.

The authors hew a bit more to the status-quo line than I would have had I been given the assignment to instruct Molly, but you have to start somewhere.  An intermediate-level companion piece should question more forcefully some of the underpinnings of current methods that deserve further scrutiny — “best practice” is not static and fiduciaries should be constantly questioning the norms of the day rather than playing along with the crowd.

There are inherent tensions that face Molly:  She must learn from the past but not let it blind her to other possibilities; recognize her own risk tolerance versus that of others on the committee and the overall mandate; think about whether she is being too quantitative or not quantitative enough in evaluating investment performance and managers; wrestle with the hard issues of relative performance versus absolute; evaluate the positives and negatives of “somewhat arbitrary” asset class distinctions and benchmarks; allow the various actors (staff, consultants, investment managers, etc.) to fulfill their roles while knowing when to address shortcomings; and be aware of the social dynamics that can destroy the ability to come to agreement and just as readily lead to the dangerous territory of groupthink.  And that’s just for starters.

It is true that “favorable investment markets have a way of masking uninformed and poor trustee oversight, and weak investment markets often expose weaknesses and magnify a trustee’s fiduciary risk.”  The members of an investment committee — be they new to it like Molly or as confident as the person who has been there for years and thinks he’s seen it all — would benefit from reading this book and using it as the foundation for a discussion about the opportunities and perils they face together.

Believe me, it’s a much better use of their time than listening to an investment manager drone on about the state of the economy or the stocks that are sure to do well.