Endowment funds typically have two governing bodies: the board of trustees, which has ultimate institutional responsibility, and the endowment investment committee, which has responsibility for the fund’s investment performance. A best practice investment committee ensures that the optimum investment result for the endowment is achieved by focusing on good governance.
The author outlines the important characteristics and functions of a best practice investment committee (BPIC) for an endowment fund. To achieve diversification of experience without becoming impersonal, the optimum size of a BPIC is five to nine members. The majority of the members should have significant investment experience, and the committee should not operate in a vacuum. Two-way communication between the BPIC and the organization’s president is of the utmost importance. To ensure that the BPIC benefits from having an institutional memory, its members should not be rotated too frequently and service on the committee should be staggered. In addition, the chairman needs to ensure that a situation in which one or two members dominate does not occur.
The role of the BPIC is not to manage the endowment’s investments but to define and review investment policy and organizational governance, including but not restricted to the definition of risk levels, portfolio structure, and spending rules. In addition, the BPIC is responsible for the selection and ongoing review of the endowment’s investment managers.
The process for selecting and terminating investment managers is defined by the BPIC and should include such criteria as the number of managers, minimum and maximum investment mandates, and review criteria. Another focus of the BPIC is risk management of the fund. Regular self-evaluation is required within the BPIC to ensure that the endowment meets its criteria for diversification as well as for the number and caliber of managers, is not overly reliant on investment consultants, and does not have an excessive turnover of investment managers. Both observable and hidden costs, as well as the overall performance of the fund, should be reviewed regularly as part of the committee’s self-evaluation process. All policies set by the BPIC need to be clear, decisive, and in writing.
As regards the spending rule applied to the endowment, the BPIC should ensure that it is set at a level that is sustainable throughout the economic cycle and that the difference between income and spending allows for any adverse effects from inflation to be covered by reinvestments. The BPIC should always be wary of increasing the spending rule on an exceptional basis, such as the requirements of the current budget or optimism as a result of a prolonged bull market.