The Family Investment Committee Today

Many families (along with virtually all pension plans, charitable foundations, and endowed institutions) use investment committees to provide oversight of the management of their investment portfolios. Unfortunately, history has shown that most investment committees do a poor job of stewarding the assets entrusted to them. There are many reasons why the investment committee has proved to be such an unreliable tool. Let's take a look at some of them.

The Origin of the Investment Committee

The investment committee originated not out of the investment world but out of the world of board governance. Most boards, rather than acting at all times as a “committee of the whole,” delegate much of their important activity to committees—smaller groups of board members that are really subcommittees of the “committee of the whole.” This process of delegation improves the efficiency and productivity of a board, and has been enthusiastically supported by good governance groups such as the Association of Governing Boards of Universities and Colleges (known as the AGB).¹

The trouble is that the investment committee is fundamentally unlike other board committees. Virtually any board member, no matter what his or her professional background, can be a productive member of such committees as nominating (sometimes called the committee on trustees), executive, advancement, buildings and grounds, presidential search, and so on. Our general experience of life and business suit us well for service on these committees. Even the finance committee, although more typically requiring some technical knowledge of accounting, bookkeeping, and financial statements in general, can be easily mastered by anyone with a desire to do so.

But successful service on an investment committee requires knowledge so specialized and experience so extensive that it will be a rare board that can produce even one or two such people, much less an entire committee-full. This is a point that is usually ill-understood by boards and board chairs, who generally appoint to the investment committee anyone with a generalized background in “finance.” Hence, investment committees typically include accountants, attorneys, bankers, investment bankers, brokers, and similar professionals, none of whom is likely to possess the specialized skills and experience required to design, implement, and effectively monitor an investment portfolio for a substantial pool of capital. That experience would include a sound understanding of modern portfolio theory, asset allocation, manager selection, performance monitoring, and a host of other skills that are very narrowly distributed through the population of any governing board. When families establish investment committees, they tend to follow the institutional model, placing on the committee individuals who are unlikely to possess the appropriate skills.

Hence, the first and fundamental reason investment committees fail is that the demands placed on them are fundamentally incompatible with their capabilities. The demands on investment committees are different from the demands on other board committees, yet the investment committee is assembled and operated as though it were no different than any other board committee.

Committee Dynamics

Anyone who has served on a governing board is familiar with the often-dysfunctional internal dynamics of committees. Virtually all board committees consist of volunteers devoting their time to board work as a philanthropic endeavor. Hence, committees of such boards necessarily operate largely by consensus. No one wants to make waves or offend anyone else. Decisions almost always reflect the lowest common denominator, because to do otherwise would necessarily offend some committee member. (And that member may be the largest financial contributor to the organization!) Unless the committee chair is highly experienced in managing committees and a good leader, committee meetings will meander here and there, wasting large amounts of time on side issues, running out of time to deal with more pressing matters. Family investment committees operate according to identical dynamics. Indeed, because families don't exactly qualify as charitable enterprises, the challenge of attracting good people and motivating them to do a responsible job is especially perplexing.

In the operation of some committees, this dynamic is something less than disastrous. On the nominating committee, for example, lowest-common-denominator thinking is often the best way to ensure collegiality among board members. Fighting to nominate an individual who is actively disliked by another board member is likely to lead to disruption, not improved productivity. But in other committees the unavoidable process of committee dynamics and decision-by-committee can be devastating, and this is decidedly the case with the investment committee. Successful management of a large pool of capital requires incisive thinking; a willingness to go against the grain of perceived wisdom; and an ability to behave counterintuitively, avoid acting on the basis of short-term events, and take the long view.

But, as currently operated, it is virtually impossible for the voting plurality of an investment committee to act in any of these ways, much less all. Instead, investment committees engage in woolly thinking (often because they are not experienced in the management of capital), tend to follow the conventional wisdom in adopting investment strategies, fail to recognize that much of the process of successful investing is counterintuitive, and typically act (usually in at least a mild state of panic) in reaction to short-term market events that will quickly reverse themselves, whipsawing the investment portfolio.

Making an Impact

The natural desire to contribute, to make an impact, means that even when investment committee members are acting on the best possible motives, their impact on the performance of the portfolio is likely to be negative. Consider, for example, an investment portfolio that has been designed and implemented in a first-rate manner. The best thing an investment committee can do with such a portfolio is to leave it alone, perhaps rebalancing it on occasion. But no member of an investment committee wants to be perceived as lazy or lacking in ideas or motivation. As a result, even if each member of the committee tosses out his or her idea only once a year, the aggregate effect is that the portfolio will find itself constantly being rejiggered. This is the opposite of a sound approach to portfolio management.