Governance delineates the functions that decision-makers are assigned to perform, provides those decision-makers with the authority to execute those functions, and gives someone the tools to monitor those decisions. While there are four primary governance models for investment funds, within each model there can be many variations, and the different sets of actors (­decision-makers) will play varying roles from organization to organization. The governing oversight also varies from model to model (we discuss these models in the next chapter).

In any business, setting a “road map” for how an organization will ­navigate the challenges ahead is a critical component to the overall success of the organization. This is particularly true within the investment management business. Fortunately, a governing document provides that road map. By ­definition, governance is the overall system by which an organization is ­managed, directed, controlled, and monitored. Although all institutional investors are using some form of governance, it’s worth revisiting what exemplifies a successful governance culture and why good governance is important to an institutional investor.

Strong governance demonstrates to the stakeholders that their assets are not only in good hands, but that internal controls and policies align with the investment objectives of the fund. Leadership, transparency, core competencies, and a strong moral and ethical compass are all required characteristics of a strong governing body. Boards that exhibit these types of traits are much more likely to meet their investment objectives and goals than organizations that do not.

Leadership can be evidenced through the establishment of strong policies and procedures that meet your organization’s goals and not someone else’s; Procrustes does not rule. Leadership is an essential element of governance. The policies and procedures essential to strong leadership are discussed in later chapters.

Transparency is another aspect of strong governance. Transparency is a simple concept, yet many organizations fail to properly implement it. Although you will not be able to share every single detail of your investment program, and rightfully so, increased transparency typically leads to increased accountability, and that accountability is also essential. By making your governance documents publicly available, your organization is demonstrating your willingness to be held accountable to your stakeholders. Fortunately, there are organizations that understand the importance of transparency, and how vital it is to a successful governance model.

Being knowledgeable and skilled is an integral part of executing your duties as a fiduciary. You can export some of that responsibility to knowledgeable and skilled professionals, or you can acquire that knowledge and skill yourself. For many, outside expertise is the wisest decision, but the rest of this book is here to help if you choose not to use professional help.

Within the actual governance plan and the document that describes it, there are a handful of key decision-makers or entities that will play a role in the management of investments. The inclusion and composition of these key players will differ from organization to organization, and it’s likely that not all of the key players will be integrated into your own management plan. However, there are some that will be frequently seen in most programs.

Board

Successful governance requires strong leadership from the board. The board defines lines of authority and establishes roles and responsibilities. It also provides strategic direction for the organization and, most importantly, bears ultimate responsibility for the success or failure of the investment program.

As I mentioned, the makeup of the board will vary to some degree, as size, complexity, and resources available to an organization will dictate its composition. In general, it will include individuals who have diverse work experiences and backgrounds. Most have an understanding of the organization’s obligations and objectives, and an interest in the purpose of the organization. They may or may not have core competencies in the investment of funds for a foundation or endowment, and therefore may or may not need to delegate some of those activities.

Ultimately, the board carries the responsibility of determining the most appropriate governing structure (more on this later), instituting lines of authority, establishing roles and responsibilities of both trustees and staff, delegating tasks, hiring or terminating key staff and/or outside service providers, and monitoring and evaluating all of these effectively.

With final discretion as to “how” the investment program will be carried out and how the governance structure is established, the board will spend a fair amount of time up front determining who the other key decision-makers will be and how tasks and responsibilities will be delegated. (Delegation is almost always required.) This includes decisions on whether or not to create an investment committee, hire an outside investment consultant, establish an internal investment officer and staff, or contract with an external investment office. These decisions are not one-time occurrences, and a “set it and forget it” attitude will not be successful. Instead, these decisions and discussions must be made on a regular basis. Even though the road might appear to be straight, the path will alter and change; the board must be flexible and open enough to alter its course when a detour is needed, because ultimately the buck stops with the board.

Investment Committee

The board can elect to delegate some of its duties and create a separate committee to oversee the investment program. This is oftentimes due to a lack of skill or time. Those boards that have other things to do at their infrequent meetings, boards that are large, or have little investment knowledge find that delegating to a committee tasked with only investments is helpful, if not essential. If the board elects to take this route, a number of responsibilities can be handed over to the investment committee. Broadly speaking, they will consist of developing the investment procedures and perhaps even the policies surrounding them. For board approval, of course.

The governance documents of the fund include not only a description of governance policy but also the policies and procedures used for investing. As a matter of practice, if the board creates an investment committee they also delegate the task of creating the entire governance document, including investment policy, to that committee. This document is important, and will be discussed in greater detail in a later chapter, but essentially it specifies how the funds will be managed, describes how they are evaluated, and establishes the investment objectives.

After both governance and investment policies have been established, the investment committee will then implement these policies. Implementation can be done through the investment committee in its entirety, through an individual (the CFO, perhaps), a consultant, an external investment office or an internal investment office. With these potential combinations (running from least effective to most effective), it is apparent that the implementation of the investment policy can and will differ from organization to organization depending on the roles and results desired, which we will discuss later.

CFO / Treasurer

The CFO plays an important role within the investment program. Typically, the CFO monitors the overall finances, liquidity, cash flows and audits of the organization. For an investment committee however, they are also often, and maybe should be, held responsible for the execution of documents as an internal control and as a best practice. This includes executing limited partnership agreements, custodial agreements, and external providers’ contracts.

Many foundations and endowments add to a CFO’s duties a collateral duty to function as the CIO. This works only if there is not much in the way of accounting during the year, and if there is a way to provide adequate internal controls, except of course during the audit or budget cycles, when there is no time for investments. One can only hope there is no need to manage investments for that period of time. It would not be a successful internal control nor would it be a best practice to have the CFO also function as the CIO. While it may be fun for the CFO, and could perhaps save the organization a few dollars by not hiring a separate investment officer, it costs significantly more in lost investment opportunity and increased risks.

Internal Investment Office

An investment office is primarily responsible for implementing the ­investment program independently, or with guidance from the investment committee. The office or officer would be responsible for performing investment ­manager due diligence, investigating new asset classes, allocating assets, ­reporting ­performance, and reporting to the investment committee. An internal ­investment officer often has varying levels of discretion, depending on the amount of control the board is willing to relinquish. It is a best practice for the investment officer to have discretion within broad guidelines with ­specific evaluation points, and for the investment committee to monitor those closely. In a situation where the internal investment officer does have complete discretion, portfolio performance falls directly on the shoulders of the ­investment officer, exporting some of the skill requirements from the board to that individual. Making the CIO responsible and accountable facilitates an environment of professionalism and gives the board a second tool with which to manage. We recommend an internal office and staff for funds able and willing to afford the added personnel.

Investment Consultant

Investment consultants are an interesting bunch, and certainly a common, if not always helpful, option. Depending on the firm and experience level of the individual investment consultant, they can engage in a wide variety of activities, including formulating an investment policy statement, performing investment manager due diligence and offering recommendations, selecting asset classes, providing reporting, and delivering unbiased and objective advice. One of the truly interesting aspects of an investment consultant is their position within the industry. Investment consultants are widely considered in the industry to be “gatekeepers” due to their large presence and the fact that they are positioned as middlemen between the fund and investment managers. It’s well known that investment managers spend an inordinate amount of time with consultants in the hopes that the consultant will elect to put that manager on their platform, which in turn helps the investment manager raise assets.

For small institutions, investment consultants are essential to “stepping-up” their programs. Consultants are able to provide the board with an investment skill set that brings added professionalism and experience to the process. In a general sense, though, investment consultants are most likely to help an organization formulate an investment policy statement and offer reporting solutions to the board. A traditional investment consultant is unlikely to make specific manager recommendations and instead will suggest a handful of investment managers (three or four) that fit some predetermined criteria (large cap value, small cap growth , etc.), on which the fund must decide. For that reason, it’s extremely difficult for investment consultants to deliver the accountability, in terms of performance, that is expected of an internal or contracted investment office. This is one of the key differentiators between an internal investment office, a contracted investment office, and an investment consultant.

Investment consultants have another common function (especially with the public pension set). They are targets to which the board can point and bellow “Off with his head!” when challenged.

Contracted Investment Office

The contracted or shared investment office is similar to an internal investment office. They can be given little discretion or total discretion. I think the best practice is to mirror what the fund would have liked to receive from an internal office. Like an internal investment office, a contracted office provides the professionalism, responsibility and accountability that shoulder much of the fiduciary responsibilities of the board. This is not an “outsourced CIO,” as it is commonly thought of in the industry. Rather than a product provider, a contracted investment office is more like a contracted employee.

A contracted investment office is responsible for implementing the investment program independently, or with guidance from the investment committee. The office or officer would be responsible for performing managerial due ­diligence, investigating new asset classes, allocating assets, reporting performance, and reporting to the investment committee. It is a best practice for the investment officer to have discretion within broad guidelines with specific evaluation points, and for the investment committee to monitor those closely. In a situation where the contracted investment officer does have complete discretion, portfolio performance falls directly on the shoulders of the investment officer, exporting some of the skill requirements from the board to that individual. Making the CIO responsible and accountable facilitates an environment of professionalism and gives the board a second tool with which to manage.