The Four P’s of Investment Decisions: Lessons from the Commonfund Institute (2024)

Three days after becoming Executive Director of the Commonfund Institute, I found myself at Yale University in New Haven giving welcoming remarks at our annual educational program. Although I will now oversee the program going forward, like the trustees, investment teams, and staff members in attendance, I went to learn. And having spent the last ten years specializing in the endowment model as a writer, speaker, educator and investment committee member, I still learned a great deal.

Each day focused on the key responsibilities and decisions investment overseers must make, starting with policy decisions and leading into execution. Following are the most important lessons I learned, organized into a framework that may guide institutional investors in their role as fiduciaries. The Four P’s of Investment Decisions.

Policy

We kicked off the Institute with conversations on policy. Asset allocation is often described as the most important decision investment committees can make, but the spending policy decision impacts the entire institution. I took away these new ideas for approaching these decisions

1. Avoid the “Deficient Frontier” in Asset Allocation Decisions: Commonfund’s Deborah Spalding, Deputy CIO and John Delano, Head of Research and Analytics, presented research showing that although certain portfolios along the Efficient Frontier[1] may have the same risk and return profile, extensive quantitative analysis indicates that some of those portfolios may actually be deficient. Traditional asset allocation analysis has not accounted for the likelihood of extended drawdown periods. Optimizing asset allocation to reduce the length of time from drawdown to recovery can move institutions off what I’m calling “the Deficient Frontier”, because it allows for more consistent spending and improved likelihood of maintaining intergenerational equity into the future.

2. Avoid the Spending Policy Iceberg: Most institutions follow a spending model that’s based on a rolling average of endowment performance. But, as Tim Yates, Managing Director at Commonfund and Verne Sedlacek, AGB board member and former Commonfund CEO, explained, the investment portfolio is just the tip of the iceberg. Look at what lies beneath to establish your spending policy. Understand your institution’s underlying ecosystem – the operating and fund-raising environment – and analyze your unique operating metrics such as investment costs. By doing so, institutions can decouple spending policy from investment returns and achieve more consistent spending.

People

Day two focused on Governance, where people and policy intersect. Because human behavior, emotions and relationships strongly influence our ability to make decisions, one of the most important tools institutional overseers can have in place is an Investment Policy Statement. Our speakers shared these thoughts:

1. Make your IPS your Sword and Shield: Steve Snyder, Managing Director, and Brian Cohen, Director, from Commonfund described the Investment Policy Statement as both a sword and a shield. Ideally committees prepare the statement during times of calm so they can rely on it during times of crisis. It’s your sword for establishing investment parameters and carving out decision-making guidelines. It’s your shield for guarding you from making panicky decisions in times of trouble.
2. Make this your Governance Motto: The best advice for constructing your IPS, overseeing the institution, and leading your committee came from Commonfund’s former board chair, Myra Drucker. The best governance structure is “The right people making the right decisions on the right issues.”

Portfolio

On the third day, we shifted from policy decisions to execution decisions, studying overall portfolio construction techniques and specific asset classes. Here are my takeaways:

1. Apply Portfolio Construction Principles: Commonfund’s CEO, Mark Anson, taught us four principles for making portfolio construction decisions:

   1. Source alpha

   2. Diversity beyond beta

   3. Manage risks actively

   4. Align your interests with your asset managers

2. Apply Analytics and Pattern Recognition Skills: Building sub-portfolios –whether in equity, fixed income or private capital – requires deep analytics capability, access to quality managers, strong pattern recognition skills and specialized expertise.
3. Apply Willingness when you have the Ability: Many institutions have the ability to handle more illiquidity in their portfolios, but may not have the willingness. For institutions that can handle the illiquidity, becoming more willing may benefit the organization in the long run as it provides the opportunity to capture a premium above public equity markets.

Perspective

With so many decisions to make, it’s tempting to avoid new information and ideas. In thinking back on the Institute, the most important lesson I learned is that investment fiduciaries need to make it a policy to broaden their perspective in order to incorporate new developments into their policies and portfolios more readily. At the Institute, experts gave us fresh perspectives on important issues:

1. Broaden your Perspective on ESG: Commonfund board members, Bob Litterman and Doug Breeden, both leading risk management experts with many years of investment experience, consider climate change a serious risk management issue. Litterman urged investors to commit to the U.N.-sponsored Principles of Responsible Investment.
2. Broaden Your Perspective on Diversity: Although institutional investors have led the movement for more diverse corporate boards, panelists said non-profit organizations have lagged in bringing diversity to their own boards. Yet the same imperatives for diverse boards and workplaces – better innovation, talent and performance – apply. Accomplish diversity by searching outside your existing networks or hire experts to identify candidates. Our panelists disagreed with standard excuses. As one of them told us, “There still aren’t enough diverse candidates, but there are plenty.”

This Four P’s of Investment Decisions framework helped me absorb the lessons from the Institute and can serve as a guide for fiduciaries overseeing long-term investment funds. My week at the Institute broadened my perspective and reminded me of the value of continuous learning. I will use the Four P’s to develop plans and ideas for future programs. To apply for future programs, click here. I hope you will join us.

[1] The efficient frontier is the set of optimal portfolios that offers the highest expected return for a defined level of risk or the lowest risk for a given level of expected return. Portfolios that lie below the efficient frontier are sub-optimal because they do not provide enough return for the level of risk. Source: Investopedia.