The Family Investment Committee, Tomorrow

Like well-crafted riddles, capital markets events are usually perfectly comprehensible after the fact. But while they are happening there is so much “noise,” so much emotional resonance (and dissonance), that we can't make out what will later become clear. Most events in the markets, however important they may seem at the time, are merely noise, and attempting to act in reaction to them is a very sound way to reduce our wealth.

Thus, it was perfectly obvious in the late 1990s that equity valuations had become disconnected from reality. The “justifications” for those prices—it's a whole new paradigm; things are different this time—were specious on their face. But there was so much noise and confusion going on, and the short-term pain of missing out on the almost daily price appreciation was so much more intense than the longer-term prospect of a market crash, that perfectly sensible people continued to pay higher and higher prices for stocks that were pretty obviously (but retrospectively!) worth only a tiny fraction of those valuations.

Even events that are truly substantive are often not actionable in a way that will improve returns. The valuation disparity between growth and value stocks, for example, became compelling in the mid-1990s, but anyone who attempted to profit from that disparity was hammered by the continued, almost mystical, appreciation among growth and technology stocks. In other words, it is often possible to “know” that valuations in one sector or another are attractive, but it is never possible to know when the value will be recognized.

Thus, the challenge for investment committees is to maintain their discipline and patience when everyone else has long run out of both. Yet, as noted at length above, investment committees are ill-equipped to act in a disciplined manner or to demonstrate patience in the face of capital markets provocations. As we have seen, traditional attempts to control dysfunctional committee behavior—written investment policy statements and asset allocation guidelines—don't work, and alternatives to investment committees—committees of outside experts and separate investment management corporations—are beyond the reach of most families and institutions. So what can be done? One promising option is the investment committee operating manual.

The Investment Committee Operating Manual

Most very wealthy families have little choice but to manage their capital by using the traditional vehicle of the investment committee. Moreover, most families have little choice but to populate those investment committees with individuals who, however competent in other areas, are likely to have little experience in the management of large pools of capital. The point of using an investment committee operating manual is to build on the strengths of the traditional investment committee—namely, common sense and a desire to contribute to the sound risk-adjusted growth of the portfolio—while avoiding many of the defects of the traditional investment committee approach described previously.

The companion website (www.wiley.com/go/stewardshipofwealth, password: curtis2012) includes samples of many kinds of policy statements, including a sample investment committee operating manual.