Charities asking the right questions of investment managers
There are three key stages in the relationship you have with your investment manager. All are important. When you choose your investment manager, you need to ask key questions at every stage to ensure your goals are met and that they are as focused on them as you are.
STAGE ONE – APPOINTING YOUR MANAGER. it is best to start with your charity’s end goal when you are choosing your investment manager. In order to help you and your trustees frame this, here are my top five key questions to ask:
- Please confirm the expected targeted return, suggested time horizon, liquidity, expected volatility and maximum drawdown (a peak to trough decline in an investment during a specific recorded period) and the actual cost (OCF – ongoing costs figure plus any other costs) of your proposed portfolio?
- How do you propose to invest our funds to achieve our objectives and protect value in periods of market volatility?
- How will you diversify risk in the portfolio through strategic and tactical asset allocation?
- How have you managed investments in uncertain times or through prolonged periods of volatility? (Please illustrate with actual examples) and how will you manage our investments in similar circumstances?
- Can you demonstrate you have hit our target in the past using the strategy you recommend?
These questions are designed to ensure your portfolio is properly structured to support your charity’s needs. Nonetheless, you should also review the answers closely. Please keep referring back to the questions as you read the next few paragraphs.
When responding to your first question, that of expected targeted return, you should expect managers’ replies to focus on your target.
Your investment manager’s target should be your target. If you want Inflation plus 3% for example that is how your portfolio should be managed and the investment selection within should reflect this. Therefore - unless it is your goal to beat a certain benchmark, index or peer group - do not be fobbed off with a portfolio that isn’t designed with your target in mind.
Actual costs
The last part of the expected targeted return question drills down into what the actual costs are. This is important as all costs create a drag on performance. An OCF (ongoing costs figure) calculation should give you transparency on costs and a clear idea of what you are paying for. The cheapest isn’t necessarily best but, if you are being charged for “active” management, you need to know what it will cost and if it will add value.
It is worth asking your potential manager to show how they have achieved your target return (after fees) using the same strategy. While managers will never agree a fee they aren’t happy with, always negotiate!
In answering the second question on how funds will be invested your manager should acknowledge that diversification has to be a core principle in investment for charities. Asset classes are like the legs of a stool. In simple terms, the more legs it has the more stable it is. Whilst not guaranteed, generally the more asset classes your investment manager can utilise with your portfolio the less volatile its performance should be. This is because not all asset classes are closely correlated and they would not move in the same direction, at the same time and to the same extent.
Modelling an illustrative or likely drawdown is an important part of this response on the volatility aspect. Unless you can buy a guaranteed return, your level of reserves will fall if markets downturn. That said, understanding how your proposed portfolio might react, or has responded to moves historically is vital in order to make an informed decision.
Asking how the manager performed in actual crises, as in the fourth question, ensures you know what the reality could be. It is easier to make rational decisions on what level of fall in your reserves is acceptable before it happens rather than learning what it might be when it happens.
Timely reporting
Once you have appointed your manager, you need to ensure they report on your portfolio in a timely and effective manner. During the relationship it is important they deliver on your goals and ensure you have a clear understanding of their strategy and the risks they are taking.
Most investment managers are well supported enough to come to trustee investment meetings with a glossy presentation pack. Generally, it will likely set out what they will see as the positive story of your portfolio’s performance since your last meeting. It rarely outlines what has gone wrong and how they intend to “fix it” going forward.
STAGE TWO – INVESTMENT UPDATE MEETINGS. An important part of managing your investment manager effectively is to ensure that you, not they, control the agenda. In order to ensure you get the entire “portfolio picture” and not just the positive spin it is a good idea to ensure you ask the right questions ahead of the meeting. This isn’t just a box ticking exercise it is important in ensuring that you discharge your duty of stewardship properly.
These are the first questions I would ask:
- What investments have not performed as you expected and why have they performed the way they have?
- Has it made you question your original rationale for making the investment and if not why not?
Poor performance
These questions make your investment manager talk about their poor performers rather than their successes. It also helps confirm they have reviewed the investment rationale for holding poor performing investments rather than simply hoping they will “come right”.
Whilst we are all entitled to make mistakes, you need to ensure your investment manager is learning from theirs. A basic first step in doing this is to accept they have got something wrong. It could just be market timing or a fault in analysis, but they should be able to demonstrate they have learned from the experience and adjusted the strategy accordingly.
The next questions are designed to ensure that the investment manager continues to keep your target and charitable objectives in the front of their mind:
- How well has the longer term performance met the aims set out in our investment policy?
- Will our current strategy continue to meet those aims?
Maintaining value
These questions are important. If your charity needs to maintain the real value of its reserves and support a programme of spending or grant making, this is more important that out performing any benchmark or peer group. This aim is what your investment portfolio needs to deliver, regardless of what benchmark it is run against or what other investment managers are doing.
The fourth question earlier on - about demonstrating that your target has been hit by the recommended strategy - ensures that your investment manager has considered whether your current strategy will continue to deliver returns which meet your started aim. If the answer is effectively “No”, because of changes in asset class returns or market valuations for example, it should trigger a review of the benchmark and a potential change in strategy.
My final key question is:
- What are the current threats to your achieving the return we need and how are they being mitigated in the portfolio?
This question ensures that any discussion of markets and economies is relevant to your aims rather than a general discussion of global macro-economic trends. It also ensures you know what the risks to achieving your aims are and how those risks are being managed in the portfolio.
A charity’s investment committee chairman should always ensure their investment managers know in advance the questions the committee would like them to address.
My final tip is to always make sure the presentation is sent to the committee at least 48 hours in advance. It means you can review it properly and ask relevant questions. If you are handed it at the beginning of the meeting this task is impossible.
Periodic review
Once this arrangement is underway, I would suggest a review at least every three to five years, unless an event - such a fund manager leaving, a change of investment strategy or a sustained period of poor performance - makes your trustees decide to change sooner.
STAGE THREE – REVIEWS AND BEAUTY PARADES. Remember that a review need not involve a full “beauty parade”. it may simply be a detailed conversation amongst trustees, recorded in the meeting minutes, at which point they decide whether they are satisfied with the status quo or not.
As we have already discussed, your starting point, when reviewing performance must be your own target. If you asked for CPI +3% per annum that is what your manager(s) need to achieve and be assessed against. Benchmarks and peer group rankings are interesting but nothing like as important as achieving your goals.
Using consultants
It can be helpful to use a consultant in the manager selection process and in setting your investment target. They can help you clarify your risk appetite and objectives and identify lower profile but innovative managers, and not simply the best known and largest in the sector that most people already know of.
Any good investment manager will be used to working with consultants, and these should be able to streamline the process and direct you to a cohort of suitable managers without the need to research and interview a large number of them. This can be helpful where a charity does not have a finance director or permanent staff member(s) and relies on volunteers giving up their spare time.
Clearly using consultants will incur greater cost although in a few cases they expect the successful investment manager(s) to cover their fees (so called “pay to play”) which can give the impression of a conflict of interest. It is also worth bearing in mind that whilst some consultants are authorised by the FCA and can give investment advice, others are not and their service is more akin to guiding trustees through a selection/review process, still leaving trustees to make the final decision alone.
However you choose to make your final decision, in the end your investment manager should focus on your charity’s objectives and aims. They should work in collaboration with you to create the right investment solution. They should deliver performance commensurate to the risk parameters agreed and they should communicate with you in a way that works for you and your charity. If this sounds sensible and it isn’t your current experience then you should consider moving to a review and beauty parade and then appointing a new manager.
