Foundations and Endowments
IFC's Outsourced Chief Investment Officer Services (OCIO)
For foundations and endowments, there are substantial benefits and protections that are provided by partnering with an investment fiduciary to whom portfolio selection and implementation can be delegated. The appropriate fiduciary will bring a prudent and efficient process that will closely align with the overall goals and objectives of the hiring organization and the particular portfolio over which the fiduciary takes discretion.
IFC will accept responsibility and potential liability for investment selection, monitoring and replacement of funds in the account. IFC will accept all responsibility and potential liability for trading the account, including initial trades, withdrawals to meet spending needs, capital inflows, and rebalancing the portfolio(s) to maintain the targeted risk exposure. IFC will accept responsibility and potential liability for implementing the portfolio in keeping with the process agreed upon by the decision makers at the Diocese. This process will be documented in the Investment Policy Statement, and delegated to IFC. As a registered investment adviser, IFC is able to accept the trustees' delegation of fiduciary responsibility and potential liability for these matters. Delegation to IFC will effectively eliminate the need for investment committee decision-making and time- consuming meetings and in-depth analysis. Such matters will be effectively delegated to IFC and its internal investment committee and portfolio managers. As a practical matter, delegation will also save valuable time as day-to-day management will be effectively delegated, also saving staff members' time and attention.
Fiduciary Protection with an "Outsourced CIO"
Investment committee members cannot personally perform every necessary function, nor can they be expected to possess all of the required expertise to do so. However, various laws provide protection to those who delegate in accordance with safeguards. Those who have the ultimate fiduciary responsibility can delegate, but they cannot abdicate. In other words, prudent selection and monitoring of the discretionary provider is required.
Guiding language for proper delegation is found in Section 9 of the Uniform Prudent Investor Act (UPIA), with items (a) and (b) setting forth the parameters for delegation, while item (c) articulates the benefits for delegation of investment discretion:
- (a) A trustee may delegate investment and management functions that a prudent trustee of comparable skills could properly delegate under the circumstances. The trustee shall exercise reasonable care, skill, and caution in:
- (1) selecting an agent;
- (2) establishing the scope and terms of the delegation, consistent with the purposes and terms of the trust; and
- (3) periodically reviewing the agent's actions in order to monitor the agent's performance and compliance with the terms of the delegation.
- (b) In performing a delegated function, an agent owes a duty to the trust to exercise reasonable care to comply with the terms of the delegation.
- (c) A trustee who complies with the requirements of subsection (a) is not liable to the beneficiaries or to the trust for the decisions or actions of the agent to whom the function was delegated.
As item (c) articulates, compliance with the requirements as addressed in the Act will effectively relieve investment committee members of potential liability associated with the actions of the discretionary agent. IFC acts as such a discretionary agent. Such delegation is a key protective feature committees may wish to seek, but with careful consideration to, and an understanding of the agent's process for investment selection and monitoring, and rationale for same.
Investment Policy Development
Guide and direct the investment policy with an understanding of the portfolio's objectives, time horizon and cash flows in accordance with the Investment Policy Statement (IPS).
- Establish the policy portfolio and proper benchmarks.
- Select investments for implementing the policy portfolio.
- Implement the portfolio with low-cost, diversified funds.
- Monitor the portfolio for fees and performance relative to properly identified peer funds.
- Provide performance monitoring reports at regular intervals.
- Monitor the process and fund managers in keeping with best practices and the rules outlined in the IPS.
The IPS is a governing document, a business plan, if you will, for the investment selection and management process. One of the primary tests for determining how well a fiduciary is managing the investment process is to establish how well they adhere to the IPS. Therefore, the IPS should be clearly written, understood, maintained, adhered to, and updated to properly reflect changes in process. Failure to adhere to the policies articulated in the IPS could result in a fiduciary breach.
IFC develops the IPS in collaboration with the investment committee, establishing the roles and responsibilities of all parties, defining the parameters for fund selection, setting expectations for performance and establishing a process for selection and monitoring of investments.
The IPS will serve as the committee's guidepost not only for making asset allocation and fund decisions, but also for monitoring service providers and benchmarking the results of investment managers and consultants.
IFC's investment philosophy has remained constant since day one. We have always held to implementing purely passive, evidence-based portfolios that are steeped in long- term historical risk and return data that characterizes an expected range of outcomes. New ideas may arise from time to time for ways to reduce risk, enhance asset class exposure, diversification and/or expected return. These are based on rigorous third-party research that has been tested across long time periods and efficacy is well documented. Our investment strategy is based on strategic asset allocation models with long-term risk and return characteristics.
IFC's evidence-based investment strategy is designed to keep fees as low as possible, while maximizing diversification and exposures to the asset classes that have a long history of rewarding investors for risks taken. IFC's asset allocation models are based on long-term risk and return data, and our investment philosophy is rooted in Nobel Prize- winning research.
IFC seeks to provide excellent portfolios that provide fiduciary protection for Committee members and optimal risk and return objectives. IFC's strategy is designed with the single-minded pursuit to meet the ongoing growth and distribution goals of the organization, while minimizing volatility along the way.
Setting Spending Policy
When assessing an appropriate spend rate, it is important to start with what spending rate is required. This is different for every organization as some may have flexibility to reduce spending in volatile market climates by either capping spending or pulling from other sources. Traveling hand- in-glove with the spend rate question and flexibility or non-flexibility thereof, are also the questions of risk preferences and growth objectives. Because our firm has 101 asset allocation models, we are able to target the optimal portfolio implementation that carefully weights all of these considerations. Additionally, our firm, by virtue of the enormous amount of long-term data we generate, is able to provide advice on the viability of various spend rates by providing an expected return for each asset allocation, as well as the range of outcomes over various time periods. In other words, we have all of the data required to discuss spend rate viability in any scenario that is postulated by the organization.
Setting Asset Allocation
How much risk a committee can manage is a primary question that needs to be answered. This decision-making process weighs a variety of factors, which IFC will vet with the committee. The optimal portfolio will most sufficiently seek to achieve the delicate balance of meeting short-term obligations while fueling the portfolio for long-term growth. Once those priorities are established, a discussion regarding risk preference will take place. For example, the data may support that objectives can be met through a fairly conservative portfolio, but understanding the perpetual nature of the institution, does it make sense to move to a more moderate portfolio—or vice versa. Ideally, the optimal portfolio will accomplish the goal of meeting spending needs and growth objectives in a manner that is acceptable to the committee. With 89 years of historical data, and with various rolling time periods that incorporate any time period addressed, IFC will narrow the scope from 101 asset allocation models to those that match the criteria set forth. With all of the data IFC has, we will easily facilitate the discovery of the optimal portfolio for committees.
IFC has never advised our clients to engage with alternative investments such as hedge funds, private equity funds, or funds of private funds, and for many reasons including high fees, opacity, leverage, and liquidity provisions. A recent alert from the Securities and Exchange Commission (SEC) reinforces our stance, but also addresses the due diligence processes among advisors who do work with alternative investments. One problem is that there is no central clearinghouse of information such as Morningstar that would readily allow comparisons among alternative investments. For example, while an investor can easily learn how much cash drag his equity fund currently has, there is no reliable way to do that for a hedge fund. Even more importantly, there is no way to see how much leverage is currently employed. Advisors who use alternative investments are completely at the mercy of the investment providers.
The SEC alert noted certain deficiencies that were found in audited investment advisory firms that use alternative investments such as:
- Omitting alternative investment due diligence policies and procedures from their annual reviews
- Providing potentially misleading information in marketing materials about the scope and depth of due diligence conducted
- Having due diligence practices that differed from those described in the advisers' disclosures to clients. This issue brief is highly reminiscent of the Fairfield Greenwich Group, which was implicated in Bernie Madoff's Ponzi scheme. Their Website was filled with extensive language, including how they “employ a significantly higher level of due diligence work than typically performed by most fund of funds and consulting firms.” As it turned out, they were nothing more than a feeder fund to Madoff.
Moreover, alternative strategies such as those listed above come with a lack of transparency as to holdings, as well as a lack of quantifiable and reliable returns reporting, a high expense structure, and significant liquidity constraints. Instead, the pursuit of diversification can be easily satisfied by implementing a globally diversified portfolio of fully liquid investments with a very low expense structure and ease of reporting and understanding for donors, committee member and accountants, alike.
IFC's portfolio construction process is carefully engineered to maximize diversification to dampen a portfolio's volatility, while increasing expected returns by incorporating funds that capture deeper exposures to the discreet markets that increase a portfolio's expected return relative to the market portfolio. IFC currently constructs its Catholic faith-consistent portfolios with funds that capture exposures to the total U.S. Market, International Developed Markets, Emerging Markets, Global REITs, and the high quality global bond market with average durations of approximately 5 years.
IFC's portfolio construction process is guided by long-term empirical research and a time-tested evidence-based investment strategy that incorporates Nobel Prize-winning research. Notably, Modern Portfolio Theory (MPT), the body of work for which IFC's Academic Advisor, Harry Markowitz earned a Nobel Prize for in 1990. MPT is the cornerstone of the investment guidelines for prudent investing for both the Uniform Prudent Investor Act (UPIA) and the Uniform Prudent Management of Institutional Funds Act (UPMIFA). In particular, IFC seeks to add funds that sufficiently fulfill a role in the portfolio to provide diversification and asset class exposure in a low-cost way relative to peer funds.
Generally speaking, low-cost asset class exposure can be most easily accessed through passive investments or index-style mutual funds. These types of funds serve as the building blocks for IFC's portfolio construction process. IFC also chooses from among the faith-based investment universe to ensure faith consistency. IFC also draws heavily upon the work of Nobel Prize winner, Eugene Fama and Kenneth French. Fama and French are known for having identified the specific additional sources of expected return beyond the Capital Asset Pricing Model. Their Multi-Factor Model has paved the way for structured index fund products that capture exposures to the corners of the market that carry increased expected returns, namely small, value, and a profitability factor. IFC implements its portfolios with asset class funds that incorporate these findings.
IFC knows that proper benchmarking is the key to identifying investment success. As such, IFC reviews the prospectus benchmark as well as the Morningstar analyst assigned benchmarks for accuracy. If neither accurately reflects the investment, IFC will run custom regression analysis and style drift analysis to comprehensively assess the performance of the portfolio against that custom benchmark. IFC creates custom benchmarks that properly reflect the actual factor exposure representative in the portfolio itself.
IFC's manager search process focuses on identifying the managers who efficiently capture the asset class exposures identified in the IPS's asset allocation. Because IFC seeks managers who implement a style-pure asset class exposure, our search is limited to the roster of passive managers that may include ETF's, index funds, and passively managed funds. Cost and style- pure asset class exposure are primary criteria for vetting fund managers, with careful attention to ensuring that fees are reasonable relative to the asset class exposure achieved. IFC assesses fund manager's history of adhering to the rules of construction of their particular fund, and net of fee returns relative to the asset class indexes they track. IFC not only considers performance relative to the Morningstar-assigned benchmark, but also the asset class exposure as identified through a 3-factor regression so as to account for exposure to market, size and value that may be reflected in the fund's rules of construction, but not necessarily in the assigned benchmark.
Prudent Catholic Values Investing for Catholic Institutions
At Investing for Catholics, or as we like to call it IFC, we have an innovative solution — one that marries faith-consistent investments with leading financial science. Our Catholic Values index portfolios incorporate the findings of Nobel Prize winners Eugene Fama and Harry Markowitz who are renowned for identifying strategies for maximizing expected returns for risks taken.
A Higher Calling for a Greater Standard of Fiduciary Care