A PRIMER FOR

INVESTMENT TRUSTEES
Understanding Investment Committee
Responsibilities

Joanne M. Hill, Dave Nadig, Matt Hougan

Jeffery V. Bailey, CFA, and Thomas M. Richards, CFA
With an appendix on international ETFs by Deborah Fuhr
A PRIMER FOR
INVESTMENT TRUSTEES
Understanding Investment Committee
Responsibilities

Second Edition

Jeffery V. Bailey, CFA, and Thomas M. Richards, CFA

 Statement of Purpose

The CFA Institute Research Foundation is a

not-for-profit organization established to promote
the development and dissemination of relevant
research for investment practitioners worldwide.

Neither the Research Foundation, CFA Institute, nor the publication’s edito-
rial staff is responsible for facts and opinions presented in this publication.
This publication reflects the views of the author(s) and does not represent
the official views of the CFA Institute Research Foundation.

The CFA Institute Research Foundation and the Research Foundation logo are trademarks
owned by the CFA Institute Research Foundation. CFA®, Chartered Financial Analyst®,
AIMR-PPS®, and GIPS® are just a few of the trademarks owned by CFA Institute. To view
a list of CFA Institute trademarks and the Guide for the Use of CFA Institute Marks, please
visit our website at www.cfainstitute.org.
© 2017 The CFA Institute Research Foundation. All rights reserved.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted,
in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise,
without the prior written permission of the copyright holder.
This publication is designed to provide accurate and authoritative information in regard to
the subject matter covered. It is sold with the understanding that the publisher is not engaged
in rendering legal, accounting, or other professional service. If legal advice or other expert
assistance is required, the services of a competent professional should be sought.
Cover Image Photo Credit: istocksdaily/Getty Images
ISBN 978-1-944960-29-2
Dedication

In memory of my mother, Joyce Keller

JVB

To Diane
TMR

© 2017 CFA Institute Research Foundation. All rights reserved.  iii

Biographies

Jeffery V. Bailey, CFA, previously served as senior director, Benefits, at

Target Corporation, where he supervised the investment programs and
administration of the company’s defined-benefit and defined-contribution
plans, nonqualified retirement plans, and health and welfare plans. Formerly,
Mr. Bailey was a managing partner of Richards & Tierney, a Chicago-based
pension consulting firm specializing in quantitative risk control techniques.
Prior to that position, he was assistant executive director of the Minnesota
State Board of Investment, which manages the pension assets of Minnesota
public employees. Mr. Bailey has published numerous articles about pension
management. He co-authored the textbooks Investments and Fundamentals
of Investments with William F. Sharpe and Gordon J. Alexander and co-
authored the Research Foundation of CFA Institute publication Controlling
Misfit Risk in Multiple-Manager Investment Programs with David E. Tierney.
Mr. Bailey received a BA in economics from Oakland University and an MA
in economics and MBA in finance from the University of Minnesota.
Thomas M. Richards, CFA, is co-founder of Richards & Tierney, an
investment consulting firm that provided investment analytical services to
institutional investment organizations. In 2007, Nuveen Investments acquired
Richards & Tierney. During his investment career, Mr. Richards has pub-
lished a variety of papers in the investment finance literature and has been a
frequent speaker at investment conferences and seminars. He is a co-author of
the chapter on performance evaluation published in the textbooks Managing
Investment Portfolios and Investment Performance Measurement. Mr. Richards
has been a trustee of the Research Foundation of CFA Institute and served
as chair from 2009 to 2012. He earned a BS in mathematics from Bucknell
University and an MS in finance from the Pennsylvania State University.

© 2017 CFA Institute Research Foundation. All rights reserved.  v

 Contents

Acknowledgments.................................................................................. xi
Foreword................................................................................................. xiii

Introduction............................................................................................ 1
Our Target Audience. . ..................................................................... 1
Organization of the Book. . .............................................................. 3
Takeaways....................................................................................... 9
Session 1. Governance Structure............................................................. 11
Governance Basics.......................................................................... 11
Roles and Responsibilities. . ............................................................. 13
Lines of Authority........................................................................... 19
Accountability Standards. . .............................................................. 21
Fiduciary Duty.. ............................................................................... 22
More on the Trustees...................................................................... 24
Takeaways....................................................................................... 25
Questions Molly Should Ask........................................................... 26
Session 2. Investment Policy................................................................... 30
The Importance of Investment Policy............................................. 30
Defining Investment Policy. . ........................................................... 30
Policy Asset Mix: Selection and Rebalancing. . ................................ 32
Investment Policy as a Stabilizer..................................................... 33
Reviewing Investment Policy.......................................................... 34
The Investment Policy Statement................................................... 35
Takeaways....................................................................................... 37
Questions Molly Should Ask........................................................... 38
Session 3. The Fund’s Mission. . ................................................................ 40
The Fundamental Conflict.............................................................. 41
Liabilities......................................................................................... 44
Contributions. . ................................................................................ 45
Takeaways....................................................................................... 47
Questions Molly Should Ask........................................................... 47
Session 4. Investment Objectives............................................................ 49
Criteria for Effective Investment Objectives.. .................................. 49
Examples of Investment Objectives. . .............................................. 52
Takeaways....................................................................................... 54
Questions Molly Should Ask........................................................... 54
Session 5. Investment Risk Tolerance...................................................... 56

© 2017 CFA Institute Research Foundation. All rights reserved.  vii

A Primer for Investment Trustees

Returns Are Only Half the Story ..................................................... 56

Types of Investment Risk.. ............................................................... 57
Measuring Risk. . .............................................................................. 58
Relationship between Risk and Expected Return........................... 60
Managing Risk through Diversification. . ......................................... 61
Risk Budgeting. . .............................................................................. 62
Investment Risk Tolerance.............................................................. 63
Takeaways....................................................................................... 65
Questions Molly Should Ask........................................................... 66
Session 6. Investment Assets. . ................................................................. 68
Types of Investment Assets. . ........................................................... 68
Diversifying across Asset Classes.................................................... 69
Market Indexes.. .............................................................................. 69
External and Internal Investment Management............................. 72
Active and Passive Management.................................................... 73
Separate Accounts and Commingled Funds.. ................................. 75
Alternative Investments. . ................................................................ 76
Fees and Expenses. . ........................................................................ 78
Takeaways....................................................................................... 80
Questions Molly Should Ask........................................................... 81
Session 7. Defined-Contribution Plans.................................................... 84
Investment Policy for the DC Plan.. ................................................. 85
The Fund’s Mission for the DC Plan. . ............................................... 87
Investment Assets in the DC Plan................................................... 87
Takeaways....................................................................................... 89
Questions Molly Should Ask........................................................... 89
Session 8. Performance Evaluation.. ........................................................ 91
The Importance of Performance Evaluation................................... 91
Performance Measurement............................................................ 92
Performance Benchmarks . . ............................................................ 94
Performance Attribution. . ............................................................... 95
Performance Appraisal................................................................... 97
Putting It All Together. . ................................................................... 99
Takeaways....................................................................................... 100
Questions Molly Should Ask........................................................... 101
Session 9. Ethics in Investing................................................................... 103
Recognized Principles of Trustee Ethical Conduct.......................... 103
Creating a Culture of Ethical Behavior............................................ 104
Takeaways....................................................................................... 106
Questions Molly Should Ask........................................................... 106

viii © 2017 CFA Institute Research Foundation. All rights reserved.

Appendix A. Lurinberg University Endowment Fund Governance
Policy Statement................................................................................. 109
Investment Committee. . ................................................................. 109
Investment Staff. . ............................................................................ 111
Investment Consultant(s)................................................................ 111
Investment Managers..................................................................... 112
Custodian Bank............................................................................... 113
Appendix B. Lurinberg University Defined-Benefit Plan
Investment Policy Statement ............................................................. 115
Background.. ................................................................................... 115
The Fund’s Mission. . ........................................................................ 115
Roles and Responsibilities. . ............................................................. 116
Risk Tolerance................................................................................. 117
Investment Objectives.................................................................... 117
Policy Asset Mix.............................................................................. 118
Rebalancing the Policy Asset Mix................................................... 120
Asset Class Targets.......................................................................... 120
Investment Manager Structure....................................................... 120
Performance Evaluation. . ................................................................ 122
Fee Policy. . ...................................................................................... 123
Additional Investment Policy Issues.. .............................................. 124
Appendix C. Lurinberg University Defined-Contribution Plan
Investment Policy Statement ............................................................. 126
Background.. ................................................................................... 126
The Fund’s Mission. . ........................................................................ 126
Roles and Responsibilities. . ............................................................. 127
Investment Options........................................................................ 127
Selection of Investment Managers................................................. 129
Performance Evaluation. . ................................................................ 130
Additional Investment Guidelines .. ................................................ 130
Fee Policy. . ...................................................................................... 131
Glossary of Investment Terms................................................................. 133
Further Reading.. ..................................................................................... 141
Must-Reads..................................................................................... 141
Further Education........................................................................... 141
Resources for Investment Committees........................................... 142
Ethical and Professional Standards................................................. 142
Textbooks and Articles................................................................... 143
This publication qualifies for 5 CE credits under the guide-
lines of the CFA Institute Continuing Education Program.
Acknowledgments

Since the first edition of A Primer for Investment Trustees (the Primer) was
published, in 2011, we have participated in numerous meetings and seminars
with investment committee members from all types of funds and others who
work directly or indirectly with investment trustees. We have discussed the
Primer and received positive feedback that confirmed our belief in the need
for and value of investment trustee education. In the process, we enhanced our
understanding of the perspectives, circumstances, and constraints that invest-
ment trustees face. Those insights led us to believe that additional material
should be added to the Primer, including addressing the needs of smaller
fund sponsors and the unique issues faced by trustees of defined-contribution
retirement plans. We agreed that a second edition of the Primer would be a
worthwhile effort.
We would first like to again thank all those who provided invaluable
assistance in completing the first edition, including Beth Dubberley, Bruce
Duncan, John Freeman, Doug Gorence, Scott Kennedy, Ed Kunzman, John
Mulligan, John Nagorniak, and Dave Tierney. In particular, we would like
to thank Jesse Phillips, who was a co-author of the first edition and whose
contributions are greatly appreciated. This time around, we benefited from
the comments, research, and reviews provided to us by a variety of inter-
ested individuals and organizations. For their assistance and support, we
thank Ann Posey, Callan Associates; John Griswold, Commonfund; Matt
Fleishman, COPIC Insurance; Gary Brinson, the Brinson Foundation; Bob
Seng, Dorsey & Whitney; Henrik Sterin, Zibetto Espresso; and Larry Siegel,
the CFA Institute Research Foundation.

© 2017 CFA Institute Research Foundation. All rights reserved.  xi

Foreword

Approximately six years ago, I was asked to write the foreword for A Primer
for Investment Trustees (the Primer). It was a monograph directed at invest-
ment trustees—in particular, those individuals who sit on investment com-
mittees and are responsible for the investment policy and strategy decisions
of funds that have been set aside for the benefit of others. Such funds include
retirement funds, endowments, and foundations. I agreed to write the fore-
word for two primary reasons.
First, for more than 40 years, I have had a strong commitment to support
the CFA Institute Research Foundation. I believe their work in producing in-
depth, high-quality discussions of topical investment issues is of great value
to the investment community. Second, I believe that investment trustees are
a very important but underserved constituency in the investment community.
Most investment trustees have had successful careers—but not necessar-
ily in the investment field. In their capacities as trustees, they are not respon-
sible for the day-to-day decision making of the funds they serve, but they do
bear responsibility for setting investment and governance policy, understand-
ing the fund’s mission, establishing objectives, and assessing performance.
Very few publications discuss these responsibilities, and there is a dearth of
education programs available for interested trustees.
The Primer is a powerful text that provides a comprehensive discussion
of investment issues relevant to investment trustees. It examines these issues
from the perspective of the investment trustee and avoids the use of complex
investment terminology. The Primer is an “easy read,” which is particularly
helpful to trustees who probably have other full-time jobs.
Although the Primer’s main audience is investment trustees, it also can
be beneficial to investment professionals and other parties who work directly
or indirectly with investment trustees. For example, the fund’s staff, outside
consultants, professional investment managers, actuaries, accountants, custo-
dian banks, lawyers, and others who interact with fund trustees can benefit
by understanding the investment trustee’s perspective, circumstances, and
responsibilities. Such an understanding will facilitate communications and
allow all parties to work together more effectively.
Since the Primer was first published, in 2011, it has become one of the
most popular monographs the CFA Institute Research Foundation has pub-
lished. That popularity does not mean, however, that it cannot be improved.
New investment products are created. New investment issues arise. And
new insights are developed. In this second edition of the Primer, the authors

© 2017 CFA Institute Research Foundation. All rights reserved.  xiii

A Primer for Investment Trustees

address these types of developments together with other issues identified by

interested readers. Such issues include the needs of smaller funds with spend-
ing constraints and funds in which the beneficiaries bear the investment risk.
In addition, this edition contains an expanded discussion of governance,
investment risk tolerance, and investment assets.
As I did with the first edition, I wholeheartedly recommend the Primer.
I believe it can be of great value to all investment trustees, to investment
professionals who work with trustees, and to those who have an interest in
understanding the role and responsibilities of a very important constituency
of the investment community.

Gary P. Brinson, CFA

Chicago, Illinois
November 2016

xiv © 2017 CFA Institute Research Foundation. All rights reserved.

Introduction

As the old saying goes, what wise men do in the beginning, fools do
in the end.
—Warren Buffett
Let’s face it. Few business assignments are more intimidating than being
placed in a position of responsibility outside your area of expertise. Surrounded
by subject-matter experts awaiting your direction, you find yourself actually
expected to make decisions. Even though you are told in the beginning that
there are no dumb questions, you don’t want to provide the exception to the
rule. A multitude of technical reports full of unfamiliar and complex con-
cepts are quickly thrown at you. Your real day job keeps you busy and offers
few opportunities for learning about your new position. So, you sit silently at
meetings, lacking confidence, frustrated and concerned about your ability to
contribute productively. Welcome to the world of the newly appointed invest-
ment trustee.

Our Target Audience

Over the years, we have been fortunate to work with trustees coming from
many walks of life. Often, these individuals, although quite successful in their
respective professions, possess little investment knowledge or experience. Yet,
they take on responsibility for the oversight of financial assets that have a
material impact on the welfare of their funds’ beneficiaries. If you count your-
self as one of these diligent laypeople, then you belong to the target audience
for this book.
From the start, we want to put your mind at ease on one critical point:
Extensive investment expertise is not required for you to serve effectively in a
trustee role. Nevertheless, for you to exercise good judgment in making deci-
sions, you should possess at least a working understanding of basic investment
principles and concepts. We believe that you can acquire this knowledge with
a modicum of effort. The purpose of this book is to provide trustees, par-
ticularly if they are new to their positions, with a primer that will help them
begin to successfully fulfill their responsibilities.
Throughout the book, we use the term “trustee” broadly (and not in the
legal sense of the word) to describe any person serving on a governing body
who is charged with high-level supervision of investment assets. This gov-
erning body could be a pension investment committee at a corporation, an
investment advisory council at a public retirement system, a board of trustees

© 2017 CFA Institute Research Foundation. All rights reserved.  1

A Primer for Investment Trustees

at an endowment fund, or something similar. If you are a member of such

a group, then for our purposes, you are an investment trustee, regardless of
your particular title. Importantly, we recognize that you do not have day-
to-day responsibility for managing investment portfolios. Instead, you peri-
odically receive reports from and meet with the staff or outside adviser of the
fund that you oversee to discuss broad issues related to investment policy and
performance results. Therefore, the challenges and opportunities you face are
quite different from those of the staff who must manage ongoing operations.
Our audience also extends to the investment professionals who directly
interact with you and to other parties who have a special interest in your
fund. These persons include the fund’s staff, outside consultants, professional
investment managers, actuaries, accountants, custodians, lawyers, and impor-
tantly, the beneficiaries of the fund. In most cases, the topics that we cover are
familiar to investment professionals. Other interested parties may have little
or no such knowledge. Nevertheless, both groups can benefit by taking your
perspective and considering the learning curve and questions that you face,
thereby gaining useful insights into how to work with you effectively.
Although many of the standard issues in investment finance have quanti-
tative aspects, we avoid the use of formulas in this book and, instead, describe
the relevant issues in a conceptual, straightforward manner (which, in many
cases, is a harder task than presenting mathematical relationships). Our
discussion will proceed as though we are having a conversation with a new
trustee who has just become a member of a fund’s investment committee. We
will refer interchangeably to the “trustees” and the “investment committee.”
The new trustee could be a representative of a company’s human resources
department who has been appointed to the retirement fund investment com-
mittee. She could be a retired judge who has been asked to serve as an invest-
ment trustee for a special asbestosis trust fund. He could be a college alumnus
who started a successful technology company, earned a vast sum of money (a
considerable amount of which he donated to his alma mater), and now serves
on the board of directors of the school’s endowment fund. She could be a
union shop steward who has been chosen to serve on the investment commit-
tee of a union retirement fund. Or he could be a former professional wrestler
who, as governor of a US state, has the responsibility of chairing the invest-
ment board of a multi-billion-dollar state pension fund.
We have had personal experience over the years with each of these types
of individuals and many more. All of the trustees with whom we have worked
earnestly desired to do a good job during their “watch.” Just as you do, they
wanted the fund to be in as sound or even better shape when they left the
investment committee as it was when they joined it. Of course, this outcome

2 © 2017 CFA Institute Research Foundation. All rights reserved.

 Introduction

often depends on the performance of the capital markets, something over

which you have no control. Nevertheless, favorable investment markets have a
way of masking uninformed and poor trustee oversight, and weak investment
markets often expose deficiencies and magnify a trustee’s fiduciary risk. Our
objective is to help you understand important investment issues and ensure
that appropriate philosophies, policies, processes, and people are in place so
that the fund may succeed regardless of the investment environment.

Organization of the Book

In this book, we focus on subjects critical to your success as a trustee. We
believe that to create and maintain a well-managed investment program, you
and your fellow trustees should have, at a minimum, a solid grasp of the fol-
lowing foundational topics as they apply to your fund: governance structure,
investment policy, the fund’s mission, investment objectives, investment risk
tolerance, investment assets, performance evaluation, and ethics in investing.
We have divided this book into “sessions” dealing with each of these top-
ics. In each session, we present the material in the form of an overview that the
chair of the investment committee for the fund is providing to a new trustee—
Molly Grove. Molly started a very successful company providing high-tech
information services to medical doctors in small communities. Because of
her success and philanthropy, she is held in high regard and has been named
a regent of the state’s university system. As part of her responsibilities as a
regent, she has been assigned to serve on the university’s investment commit-
tee. The investments of the university system include a defined-benefit (DB)
retirement plan, a defined-contribution (DC) retirement plan, and an endow-
ment fund. The investment committee has oversight responsibility for all of
these funds. We refer to Molly and the rest of the investment committee as
dealing with “the Fund.” For the most part, the Fund may be any of the uni-
versity’s investment pools, because the trustee’s role usually is not materially
different among the specific types of funds involved. When we need to make
a distinction regarding one fund or another, we specifically point out which
fund is being discussed. We also devote a separate session to the DC plan to
highlight some of the unique issues faced by trustees who oversee that type
of fund.
Our conversation with Molly on each of the topics is followed by a ses-
sion recap, called Takeaways. We then offer a set of questions that we believe
would be useful for Molly to ask the investment committee chair, the invest-
ment staff, or the fund’s outside advisers. Although these questions are not
meant to be exhaustive, they do provide you with an opportunity to drill
down further into each session topic. New trustees are often uncomfortable

© 2017 CFA Institute Research Foundation. All rights reserved.  3

A Primer for Investment Trustees

asking questions of experienced investment staff or outside advisers. We want

to assure you that not only are the example questions we provide (and others,
of course) appropriate to ask but also the staff members or outside advisers
may not necessarily have ready answers. Thus, both parties can learn through
intelligent questions.
Before we begin the discussion between Molly and the investment staff,
let’s first conduct a brief overview of the topics that we will cover.
Governance Structure. Governance structure encompasses the respon-
sibilities of the various types of decision makers within an investment pro-
gram and how these decision makers relate to one another. In addition to you
and the other trustees, decision makers include such groups as the investment
staff, consultants, investment managers, custodians, and actuaries.
You will find that a solid governance structure effectively addresses three
key areas: responsibility, authority, and accountability. Numerous questions
flow from an examination of the governance structure, including the follow-
ing: What functions are required to successfully run an investment program?
What is their importance to the investment program? Who typically per-
forms these functions? What sorts of reporting relationships exist among the
decision makers? What are the incentive arrangements? Where does the buck
stop—that is, where does the ultimate authority for making decisions and
taking responsibility reside?
Within the governance framework, you, as a trustee, are positioned at the
top. Trustee responsibilities may vary considerably from fund to fund. In part,
these differences relate to the size and resources of the fund. Nevertheless,
how you carry out your responsibilities does affect investment program per-
formance. Trustee approaches can range from an unhealthy involvement in
the smallest operational decisions to a similarly unproductive disengaged atti-
tude. In our discussion, we will consider what your oversight responsibilities
should entail, which decisions you should be responsible for, and which ones
you should delegate.
As a trustee, you bear a fiduciary duty to act in the best interests of the
fund’s beneficiaries. You fulfill that duty by attending meetings, being fully
informed, avoiding conflicts of interest, acting in a prudent and transparent
manner, and establishing a reasonable decision-making process. In fact, the
process by which you arrive at decisions is, in many ways, as important as the
actual decisions. In particular, you should take ownership of your oversight
responsibilities. You should clearly delegate to those who have the required
expertise and experience the authority to do their jobs. And you should
hold all parties accountable for actions that they take (or fail to take). We

4 © 2017 CFA Institute Research Foundation. All rights reserved.

 Introduction

believe this basic philosophy distinguishes strong governance structures from

weak ones.
Investment Policy. Your most valuable contribution as a trustee will be
setting investment policy for the fund. Although you don’t manage the fund
on a day-to-day basis, you do determine the key strategic priorities for the
fund that are encompassed in the investment policy. Others may assist you in
drafting that policy, but only the trustees can establish it as the roadmap for
the fund.
In broad terms, investment policy defines how the investment program
will be managed. Investment policy specifies the procedures, guidelines, and
constraints for decision making and management. Ideally, you will thor-
oughly document those decisions in a written investment policy statement.
Your focus in setting investment policy should be on how you trade off
expected return and risk in seeking to achieve the fund’s objectives—essen-
tially, the creation of a risk budget. A risk budget is a statement or policy
expressing how much investment risk the fund is allowed to take in pursuit of
return. In establishing this trade-off, you will be required to specify how the
fund should be allocated to various types of assets and, within each of those
types, what sorts of investment strategies should be used and what bench-
marks the investment results will be assessed against.
You will find that investment policy serves its most useful role as a sta-
bilizer in stressful markets. In good times, pressure rarely builds to change
the investment program. Not so when the storm clouds roll in. People have
a natural tendency to predict the worst will happen when times are bad and,
conversely, to extrapolate good times and believe that they will last forever.
The ability to stick to your established strategic priorities in periods when the
temptation to alter the investment program is most intense will save you from
counterproductive changes at just the wrong time.
The Fund’s Mission. Among the key elements of investment policy is
establishing the mission of the fund. A fund is a pool of assets created to
accomplish certain society-enhancing goals. Simple as the task may sound,
your first important job as a new trustee is to understand the fund’s pur-
pose. In a broad sense, all funds exist to provide payments to beneficiaries.
For example, corporations and public entities establish DB or DC retirement
plans to provide benefits to employees. Civic-minded persons contribute to
endowment funds to grant long-term financial support to worthwhile causes.
Insurance companies establish investment funds to pay future loss claims.
Parents set up education trusts to fund their children’s future schooling.

© 2017 CFA Institute Research Foundation. All rights reserved.  5

A Primer for Investment Trustees

In simple terms, regardless of what type of fund you are working with,
three things happen: (1) money—that is, contributions in various forms—
flows into the fund from external sources, (2) the value of the fund increases
or decreases depending on how the investment markets perform and how the
fund’s assets are invested and managed, and (3) money flows out of the fund
to pay the fund beneficiaries—that is, benefit payments in various forms are
made. There are differences among funds with regard to the amount and cer-
tainty of the inflows and outflows, but you should understand how, why, and
when money is expected to flow into and out of the investment fund.
A fund typically has numerous stakeholders, and their needs and desires
may conflict with one another. Thus, a fundamental responsibility of a trustee
is to articulate and prioritize these conflicting aspects of the fund’s mission.
Investment Objectives. Investment policy outlines the path that you
wish your investment program to follow. As part of setting that direction, you
need to express how you, as a trustee, define success for the program—that
is, its objectives. You should specify what sorts of investment outcomes sig-
nal that the investment program has been successful. To avoid confusion and
second-guessing, you will want these investment objectives to possess cer-
tain characteristics. Specifically, they should be clear, objective, measurable,
attainable, reflective of the trustees’ willingness to bear risk, and specified in
advance of the evaluation period.
Investment objectives play both a prospective and retrospective role.
Prospectively, they help you structure your investment program in terms of
the rewards that you expect and the risks that you are willing to take in order
to meet the fund’s mission. Retrospectively, they assist you in assessing the
effectiveness of the investment program and thereby suggest when to take
corrective action and when to continue with current practices.
Investment Risk Tolerance. Many trustees focus solely on invest-
ment returns earned by their funds without taking the time to understand
the investment risk involved in producing those returns. By “risk,” we mean
the potential for serious losses in pursuit of the fund’s mission. The myopia
regarding risk occurs because returns are visible but risk is not. Yet, you have
little control over the returns earned by the fund. Instead, your responsibility
is to engage with the other trustees to establish the investment committee’s
collective risk tolerance and ensure that processes are in place to manage the
fund’s risk consistent with that risk tolerance.
The staff and consultants will assist you in expressing the investment com-
mittee’s risk tolerance. They should also present you with procedures for mea-
suring and controlling the amount of risk the fund is assuming. The process

6 © 2017 CFA Institute Research Foundation. All rights reserved.

 Introduction

of setting this risk budget can be formal and quantitative, or it can be sub-
jective and qualitative. The key is that you recognize that higher expected
returns come at the price of increased risk. Furthermore, taking more risk
does not guarantee higher returns; it only makes such returns possible. You
should periodically review reports that indicate whether the risk-budgeting
procedures are being followed and whether the fund’s risk management
efforts are effective.
You will need to differentiate between your views about the appropri-
ate risk level for your own investment portfolio and the appropriate risk level
the investment committee should take as it invests the fund’s assets. Your
personal financial circumstances and investment time horizon will not be the
same as those of the fund that you oversee. As a trustee, you must be able to
set aside your personal opinions and consider only what is best for the invest-
ment program over the long run.
Investment Assets. You will want to be familiar with how different
assets are categorized and managed. For investment policy purposes, fund
decision makers divide the investment world into various asset types, called
“asset classes.” Typical asset class designations include equities, fixed income,
real estate, and so on. The granularity of the categorizations varies widely
among funds.
The grouping of investments into classes is supported by the availability
of a broad array of market indexes representing publicly traded equity, fixed-
income, and other types of securities, with each of these classes divided into
seemingly uncountable variations. These indexes serve the valuable functions
of defining the opportunity set for the investment program and providing a
window on the risk-and-return history of specific asset classes. That history,
in turn, becomes an important input for developing allocations to the various
asset classes.
Regardless of the types of assets held, you will need to make decisions
about the broad structural aspects of how the investment program is man-
aged. You have the choice of assigning staff members to manage directly
all or a portion of the fund’s assets (internal management) or using outside
investment firms (external management). Each type of management offers
certain advantages and disadvantages, although external management tends
to be the prevailing model.
Another important issue involves whether to manage the fund’s asset
class investments passively or actively. You can choose either to seek to match
the performance of a given index (i.e., indexing or passive management) or
to attempt to exceed the performance of that index (active management).

© 2017 CFA Institute Research Foundation. All rights reserved.  7

A Primer for Investment Trustees

The higher expected returns of active management must be weighed against

the associated additional risk and incremental cost.
In addition to the traditional investments in publicly traded stocks and
bonds, funds often hold positions in various forms of less liquid assets, which
are commonly referred to as “alternative investments.” These assets include,
to name a few, real estate, venture capital, and hedge funds. Although these
investments are more complex, less liquid, and more expensive to manage
than the traditional kind, funds use them in the hope of earning a premium
return by bearing the associated illiquidity risk and taking advantage of the
opportunity to search among assets that are, potentially, less efficiently priced
than traditional assets.
Defined-Contribution Plans. Defined-contribution (DC) plans dif-
fer from defined-benefit (DB) plans primarily in that DC plan participants,
rather than the fund sponsor, bear the risk of the investment assets. The spon-
sor may make a regular contribution to the participants’ investment accounts
during employment. The participants, however, decide how much they will
contribute and how their accounts are invested. When the participants leave
the workforce, the value of their available account balances will help pay for
their retirement spending.
Although the fund sponsor is not directly responsible for the investment
outcomes in the participants’ investment accounts, the sponsor, through its
investment committee, does have a responsibility to offer investment options
that provide the participants with the opportunity to achieve a variety of rea-
sonable investment objectives.
Just as you should thoughtfully develop and document the investment
policy for your DB plan, so too should you create a similarly thorough invest-
ment policy for your DC plan. The fundamental differences between DB and
DC plans concern the focus of their respective investment policies. The focus
of your DC investment policy will be on providing a high-quality, diversified,
and cost-effective set of investment options to participants. What types of
investment vehicles, whether to offer passive or active management, the num-
ber of investment options and how diversified those options will be—these
are all issues that your DC investment policy should address.
Performance Evaluation. Performance evaluation provides a regular
assessment of the fund’s results relative to your investment objectives. Properly
conducted, performance evaluation reinforces the hierarchy of accountabil-
ity, responsibility, and authority defined in the fund’s governance structure.
Performance evaluation serves as a feedback-and-control mechanism by high-
lighting the investment program’s strengths and weaknesses.

8 © 2017 CFA Institute Research Foundation. All rights reserved.

 Introduction

Performance evaluation can be broken down into three primary

components:
•• Performance measurement—calculation of the returns earned by the
fund and comparison of those returns with the returns of appropriate
benchmarks.
•• Performance attribution—identification of the factors that led to the fund’s
performance relative to the benchmarks.
•• Performance appraisal—assessment of the sustainability of the fund’s
returns relative to those of the benchmarks.
Trustees sometimes confuse performance measurement with performance
evaluation. But simply measuring returns is only the beginning of the evalu-
ation process. By asking what caused the performance of the fund relative to
that of appropriate benchmarks and by inquiring into the quality (i.e., magni-
tude and consistency) of that relative performance, you gain valuable insights
into the effectiveness of the investment program.
Ethics in Investing. Trustees, together with all the other parties
involved in the fund’s governance structure, should always be conscious of
the question: Is this [action being contemplated] in the best interests of the
fund’s beneficiaries? Unfortunately, the answer is not always obvious. Certain
actions can be construed to profit a particular party other than the fund’s
beneficiaries. A fine line often exists, which calls for carefully exercised
discretion.
Our discussion of ethical investment practices is meant to create aware-
ness of the subject’s importance. You don’t need an exhaustive list of “dos and
don’ts.” Rather, your emphasis should be on the importance of the policies
and procedures designed to be most advantageous to the fund’s beneficiaries.
You should ensure that the fund has management controls that motivate ethi-
cal investment behavior—not only behavior of the trustees and investment
staff but of all parties involved in the fund’s governance structure.

Takeaways
•• We use the term “trustee” to broadly refer to any person serving on a gov-
erning body charged with high-level supervision of invested assets.
•• Extensive investment experience is not required to serve effectively as a
trustee.

© 2017 CFA Institute Research Foundation. All rights reserved.  9

A Primer for Investment Trustees

•• Nevertheless, a working knowledge of basic investment principles and

concepts will help you exercise good judgment in making decisions in
your trustee role.
•• This book is divided into sessions dealing with the following foundational
topics: governance structure, investment policy, the fund’s mission, invest-
ment objectives, investment risk tolerance, investment assets, defined-
contribution plans, performance evaluation, and ethics in investing.

10 © 2017 CFA Institute Research Foundation. All rights reserved.

Session 1. Governance Structure

Knowing others is wisdom; knowing the self is enlightenment. Mastering

others requires force; mastering the self needs strength.
—Lao Tzu
Welcome, Molly, to the Lurinberg University Investment Committee. We
have a lot of material to cover with you in this orientation. We will stick to
the basics and avoid going into too much detail on any particular topic. You
will have plenty of opportunities outside of this meeting to discuss the ideas
that we cover today.

Governance Basics
Molly, let’s begin our discussion of your role as an investment trustee by con-
sidering how the Fund’s decision makers interact with one another. Many
persons and organizations make investment-related decisions at various levels
for the Fund. The framework that connects these decision makers is the gov-
ernance structure. A strong, well-articulated governance structure provides
the mechanism for decision makers to function together effectively. A weak,
ill-defined governance structure breeds confusion and acrimony.
Nothing can guarantee that the Fund won’t experience disappointing
investment outcomes. A strong governance structure is your best assurance,
however, that if such a result does occur, it won’t have been caused by pre-
ventable weaknesses inadvertently designed into the investment program.
Because the trustees sit at the apex of the Fund’s organizational hierarchy,
familiarity with your role and with that of others in the governance structure
is essential. Moreover, if you can satisfy yourself that the governance struc-
ture is sound, then you will rest easier knowing that you have fulfilled an
important fiduciary duty to the Fund.
We like to think of the Fund’s governance structure as a three-legged
stool. Each leg of the stool provides support and balance for the investment
program. And like a stool, the investment program cannot stand without all
three of these legs. The three legs of the Fund’s governance structure are as
follows:
•• Roles and responsibilities—a delineation of functions that the various deci-
sion makers are assigned to perform.

© 2017 CFA Institute Research Foundation. All rights reserved.  11

A Primer for Investment Trustees

•• Lines of authority—a description of the latitude that decision makers have

to carry out their responsibilities and a specification of their reporting
arrangements.
•• Accountability standards—a statement of expectations regarding the
effectiveness of the decision makers combined with a set of procedures
for reviewing and, if needed, responding to the actions of those decision
makers to whom responsibility is delegated.
There are other aspects of the Fund’s governance structure that keep it
strong:
•• Due diligence—appropriate oversight of the investment program’s
operations.
•• Checks and balances—decentralized decision making and the ability of one
set of decision makers to challenge others.
•• Reporting and monitoring—adequate and timely distribution of informa-
tion to decision makers.
•• Transparency—access to the details behind the Fund’s investment trans-
actions, fees, expenses, and cash flows.
•• Compliance with industry best practices—periodic review of other funds’
operations and modification of the investment program when appropriate.
The investment committee articulates the Fund’s governance structure
in a formal policy document called the “governance policy statement” (GPS)
or “committee charter.” In particular, Molly, you will use the Fund’s GPS
to delineate the roles and responsibilities of all the parties involved in the
investment process. The clarity provided by this document reduces misper-
ceptions and confusion. It promotes an open dialogue among the Fund’s deci-
sion makers and permits them to concentrate on their specific assignments.
The investment committee bears responsibility for periodically reviewing
and, as appropriate, updating the GPS. As an example, Appendix A in your
materials contains a copy of the Lurinberg University Endowment Fund’s
GPS. Unfortunately, most funds do not clearly document their governance
structures. Instead, they base their structures on a set of organizational prec-
edents and practices, some of which have been written down and some of
which simply follow tradition. For funds in this situation, it is important that
regular discussions take place among the decision makers to ensure that they
understand and remain in agreement regarding the governance structure’s
key features.

12 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 1. Governance Structure

Roles and Responsibilities

Five primary groups of decision makers have a significant impact on the
investment program: you and your fellow trustees, the investment staff,
investment management firms (we will refer to them as “investment
managers”), the custodian bank, and the investment consultant(s). A sixth
group, investment outsourcing firms, may also play an important role, espe-
cially for smaller funds. Other persons and organizations, such as legal, actu-
arial, and accounting groups, affect the design and function of the investment
program less than these primary groups. We generally won’t consider them as
we review the governance structure. So, let’s first introduce the principal par-
ties and briefly describe their roles within the investment program.
Trustees. As we mentioned, the trustees reside at the pinnacle of the
investment organizational pyramid. The buck, so to speak, stops with the
Lurinberg University Investment Committee. In essence, you and the other
trustees are responsible for the overall success of the investment program.
However, because you have no hands-on involvement in implementing the
Fund’s investments, you fulfill your responsibility by determining an appro-
priate direction for the investment program, by empowering experienced
people to carry the Fund in that direction, and finally, by monitoring and
evaluating investment results.
Specifically, the trustees hold the responsibility for setting broad invest-
ment policy and overseeing its implementation. (We will discuss investment
policy in Session 2.) You carry out that responsibility in three primary ways.
First, the trustees appoint an investment operations manager, often with the
title “chief investment officer” (CIO), who reports directly to you. On an
annual basis, the investment committee conducts a formal review of the CIO’s
job performance, the results of which determine his or her compensation for
the following year. You share that review with the CIO in a frank discus-
sion behind closed doors. You also approve the CIO’s selection of senior staff
members and sign off on his or her evaluation of those staff members. This
leadership team is critical to effectively translating your vision of investment
policy into a concrete investment program.
Second, the trustees work with the CIO to develop and, on occasion,
update the investment policy statement, which describes the key aspects
of the Fund’s investment policy. Typically, the staff initiates these updates,
but in the end, the investment committee alone decides whether to alter the
investment policy.
Finally, the investment committee periodically reviews investment results
as presented by the CIO and determines whether the Fund is on course to

© 2017 CFA Institute Research Foundation. All rights reserved.  13

A Primer for Investment Trustees

achieve its objectives as envisioned in the investment policy. If the trustees

believe that the Fund is performing appropriately, then you act to reinforce
the positive aspects of the organization and encourage corrections of any
weaknesses. If significant changes are warranted—a rare occurrence—then
you can step in and make key senior staffing and policy changes to maintain
the integrity of the investment program.
Before leaving the discussion of trustees, we would be remiss if we did
not mention an issue that complicates governance in many funds. It is the fact
that governance is often divided between two or more groups of trustees. For
example, there may be an investment committee to make investment deci-
sions, a benefits committee to determine the level of spending or the structure
of benefits, and a finance committee responsible for the level of contribu-
tions that flow into the fund. (The names of these committees vary among
organizations.) Without clear communication and cooperation among these
committees, promises to spend or pay benefits may be incompatible with the
investment environment or risk-bearing capacity of a fund or they may be
inconsistent with a fund’s expected cash inflows.
Investment Staff. We use the title “investment staff” for those indi-
viduals providing operational support to the trustees in implementing and
managing the Fund in accordance with the Fund’s investment policy. The
size of a staff differs widely among organizations. Generally, funds with more
assets can afford to, and do, hire larger staffs than funds with fewer assets.
Funds that manage assets internally retain even larger staffs. A small fund
may have only one or two professionals on the staff and may devote only a
portion of its time to investment operations. Also, in even smaller funds,
trustees may take on certain staff jobs or solicit assistance from a consultant,
record keeper, investment manager, or other service provider to perform these
responsibilities.
The investment staff at Lurinberg University carries out the day-to-day
operations of the Fund’s investment program. Our staff of analysts is led by
the CIO. The staff converts the investment policy established by the trustees
into specific implementation procedures, such as keeping the Fund’s alloca-
tion to each relevant asset class and investment manager at assigned target
levels. The staff also maintains appropriate liquidity to meet the Fund’s obli-
gations; performs oversight of the Fund’s investment managers, both individ-
ually and in aggregate; and makes modifications to the investment manager
lineup as deemed necessary.
The Lurinberg trustees have delegated the authority to hire and fire
investment managers to the CIO, although at some other funds, the trust-
ees retain that discretion. The staff has responsibility for maintaining bank

14 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 1. Governance Structure

custodial relationships and also for periodically preparing reports for the
investment committee and other interested parties regarding the activities
and performance of the investment program. The managers regularly report
their investment results to the staff; they offer explanations for those results
and discuss current strategies. As part of the due diligence process, the staff
typically meets with the managers at least once a year to discuss their current
investment strategies and investment performance results. The staff periodi-
cally visits the managers’ offices to gain a greater awareness of the managers’
operations and personnel.
Although it is not the case with most organizations, at some funds, the
staff directly invests some or all of a fund’s assets. If the organization is large
enough and has the ability to pay sufficient compensation to attract talented
people, this approach can be cost-effective. Such in-house investment man-
agement presents its own unique governance issues, however, because risk
control responsibilities become intertwined with incentives to maximize
returns. That arrangement puts added responsibility on the trustees to actively
monitor the decision making and risk management of the investment staff.
For that reason alone, many funds choose not to manage assets in-house.
We’ll return to external and internal management in Session 6.
Investment Managers. Investment managers, whether represented by
external organizations or by internal staff, make decisions regarding which
particular assets to buy and sell. The staff members at most funds prefer to
hire a variety of managers, largely organized around various types of finan-
cial assets, such as publicly traded equities, fixed-income securities, and pri-
vate equity. Some “absolute return” (or hedge fund) managers operate under
broader mandates and may choose among various asset types in search of
attractive returns.
The investment committee at Lurinberg University has directed the staff
to use active management as opposed to indexing. The active managers use
their investment analysis and portfolio management skills to attempt to out-
perform, after fees and expenses, benchmarks representing the asset class,
style, or sector in which they are invested. (Passive managers, in contrast,
attempt to match the performance, before fees and expenses, of their bench-
marks.) Although active managers bring with them the opportunity to exceed
the return of their benchmarks, they also carry with them the risk of under-
performance. This active management risk, combined with the higher man-
agement fees and transaction costs associated with active management, has
led trustees at some funds to index part or all of their assets. We’ll talk more
about active and passive management in Session 6.

© 2017 CFA Institute Research Foundation. All rights reserved.  15

A Primer for Investment Trustees

Within their designated investment mandates, the Fund’s active man-

agers have broad discretion to construct portfolios. The staff develops, and
the investment committee approves, investment guidelines that specify the
types of securities that will be held in the managers’ portfolios, the level of
risk that the managers are expected to take, and the benchmarks with which
their investment results will be compared. In some cases, the managers’ com-
pensation is based on their performance relative to their benchmarks. Well-
constructed investment guidelines place enough restrictions on the managers’
investment activities to prevent large negative performance “surprises”—those
in which results fall far below expectations. Still, well-designed guidelines
should not seriously constrain the active managers’ exercise of their invest-
ment judgment within their areas of expertise.
Custodian Bank. The Fund’s custodian bank supplies important safe-
keeping, record-keeping, and valuation services. It thereby offers one of the
important checks and balances in the investment program. For many of the
Fund’s investment managers, the bank holds ownership of the publicly traded
securities in which the managers invest and settles trades that they execute.
Periodically, the bank reports details of the Fund’s recent transactions and
current holdings. The valuation of those holdings can be a trivial task in the
case of public equities, but it can be difficult with esoteric assets, such as com-
plex fixed-income securities that rarely trade. The Fund’s custodian bank also
offers ancillary services, including securities lending and performance mea-
surement. It also provides the raw material for any audits the Fund undergoes.
With the requirements in recent years for greater financial-reporting trans-
parency, the custodian bank has taken on broader reporting responsibilities.
Consultants. The investment committee retains investment consul-
tants to provide a variety of services. These consultants offer an extension of
resources and expertise that would be too costly to maintain full time. Funds
differ in their use of consultants. Some rely heavily on them, whereas others
use them for narrow and specific purposes. Many organizations use consul-
tants for two primary tasks: to advise on strategic issues, such as investment
policy, and to provide manager selection and performance evaluation. In the
case of strategic issues, consultants provide independent information and
opinions to the trustees.
Consultants do not serve as a parallel staff but, rather, complement the
staff’s work. In the case of manager selection and performance evaluation,
consultants have specialized resources, skills, and experience that are difficult
for an investment staff to acquire and maintain. When requested, consultants
attend investment committee meetings to offer their insights. Some of the

16 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 1. Governance Structure

trustees meet regularly with the consultants, just as the CIO and other senior
staff members do, to seek advice on issues facing the Fund.
The investment committee periodically evaluates its relationships with
its consultants. The trustees insist on full transparency from its consultants
regarding their sources of income and any conflicts that those income sources
might have with respect to the consultants’ ability to offer objective advice. For
example, a consultant would have to reveal any fees or commissions received
or expected to be received from a manager that the consultant is reviewing.
(In most cases, of course, such a conflict of interest would render that consul-
tant unacceptable.) The committee carries out market surveys to ensure that
the consultant fees paid by the Fund are competitive. Furthermore, the com-
mittee reviews whether the consultants’ advice and services meet its expecta-
tions for quality and timeliness.
Investment Outsourcing Services. Molly, we understand that you
recently agreed to serve on the governing board of a small charitable foun-
dation. In that role, you are wearing many hats, and one of them requires
you and the other board members to oversee the investment of the founda-
tion’s modest pool of assets. As you will appreciate, although the principles
of investment policy and management at your foundation are similar to what
you face here at the university, there are material challenges that a small
fund encounters by trying to implement an investment program with limited
resources.
The university has an experienced investment committee whose members
understand the key investment issues facing the Fund. Just as important, the
university has the financial capability to hire a CIO and a strong professional
staff as well as to retain prominent consulting firms to provide industry knowl-
edge as needed. The same cannot be said for many smaller funds, such as your
foundation. For them, assigning the roles of staff, consultant, and investment
manager to one organization serves as a cost-effective alternative to acquir-
ing those services separately. Because there are many thousands of relatively
small funds, the number of these “outsourcing” relationships is estimated to
be quite large and growing. Even some larger funds, which could afford to
hire an investment staff, have chosen to use these outsourcing services.
Consultants, investment management firms, and custodian banks typi-
cally provide these investment outsourcing services. Also, individual invest-
ment brokers participate in this market, generally working with very small
funds. The outsourcing service is commonly referred to as an “outsourced
chief investment officer” (OCIO), although investment brokers providing
these services are typically considered investment advisers and may subcon-
tract the OCIO functions to a third party.

© 2017 CFA Institute Research Foundation. All rights reserved.  17

A Primer for Investment Trustees

A fund that outsources its investment oversight and management respon-

sibilities relies heavily on the OCIO for developing and implementing an
investment policy and strategy and for hiring investment managers to imple-
ment that strategy. Commonly, the OCIO and the investment committee
jointly determine the plan’s investment policy, subject to the trustees’ risk
tolerance. This policy leads to agreement regarding investment objectives and
strategic asset allocation, which are expressed as an investment policy portfo-
lio of approved asset classes, target allocations, and benchmarks. The OCIO
then holds the authority, responsibility, and accountability to implement and
manage the fund consistent with that policy portfolio. Note, however, that
although the OCIO has fiduciary responsibilities for much of the fund’s
investment activities, the trustees do not escape their status as co-fiduciaries
of the fund.
Outsourcing provides some significant advantages for a small fund,
especially one with limited or no staff. Ideally, the OCIO brings an exten-
sive understanding of investment markets, particularly an expertise in asset
allocation and in investment manager selection and monitoring. Moreover,
through the economies of scale available to the OCIO and its broad access to
the investment manager marketplace, the fund gains exposure to a wide array
of sophisticated investment strategies, asset classes, and investment managers
at a lower cost than it could otherwise. The OCIO also offers the trustees
assurance of proper fiduciary oversight, regulatory compliance, and sound
governance. Arguably, the OCIO may also have the ability to implement
investment decisions in a nimbler and timelier manner than the trustees.
You should be aware, however, that the outsourcing model is not without
its disadvantages. Outsourcing providers’ fees are much higher than what a
consultant would charge for simply offering investment recommendations.
Furthermore, although OCIO providers do have access to more invest-
ment options than a small fund normally would have, outsourcing may lead
to more complicated and expensive active investment solutions than those the
fund could achieve with a simpler passive approach to investing. Retaining
an outsourcing provider is not a license for the trustees to abdicate their fidu-
ciary duties. Simply hiring an OCIO is no guarantee of a quality investment
program. The trustees need to assure themselves that they have retained a
knowledgeable and engaged OCIO.
The outsourcing solution lacks some of the natural checks and balances
inherent in standard solutions (those involving an internal CIO). The trust-
ees must clearly delineate the delegation of roles and responsibilities between
themselves and the OCIO. Importantly, the trustees are obligated to care-
fully monitor the OCIO, both in terms of due diligence prior to hiring and in

18 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 1. Governance Structure

terms of oversight of the OCIO’s activities once retained. The trustees have
a duty to guard against hidden costs and conflicts of interest and to assess
whether the OCIO provides sufficient value for the fees paid.
Trustees of small funds need to assess whether they have the resources to
adequately oversee the investment of the funds’ assets. If not, they should con-
sider an OCIO. That decision can be a difficult call to make. Going it alone
or relying on access to possibly ill-informed—or worse, conflicted—invest-
ment advice can turn out to be counterproductive. Whether the solution is to
hire an independent consultant to provide recommendations or outsource all
or part of their investment oversight and management responsibilities to an
OCIO, trustees should understand their own limitations and seek help where
needed.

Lines of Authority
Molly, as you well know from your own professional experience, responsi-
bility and authority must go hand in hand. To give certain decision makers
the responsibility for performing aspects of managing investments but not to
provide those decision makers with the authority to carry out their profes-
sional judgments is a sure means of creating a dysfunctional organization.
Investments, with their highly quantifiable results, are exceedingly prone
to various forms of second-guessing that undermine official delegation of
authority.
Unfortunately, this problem most commonly occurs in the relationship
between the trustees and the investment staff. Explicit authority may be del-
egated by the trustees to the staff while some or all of the trustees retain
implicit authority. The Lurinberg investment staff has been fortunate to main-
tain a positive working relationship with the trustees.
For example, the trustees authorize the staff to retain and dismiss invest-
ment managers, a common arrangement at many funds. The trustees have
been careful in the past not to second-guess staff decisions concerning man-
ager retention. They constantly remind themselves that they are acting as
fiduciaries, not investment professionals.
At some other funds, the trustees constantly ask probing questions about
the individual investments undertaken by the managers and then pass judg-
ment on the results of those investments. In many of those instances, the
clear intent is not simply to understand how those managers are operating but
to suggest that the staff’s decisions in hiring or retaining those managers were
not appropriate. The implied message in such situations is that, despite the
explicit hiring authority granted to the investment staff, the trustees hold the
final authority to hire and fire managers.

© 2017 CFA Institute Research Foundation. All rights reserved.  19

A Primer for Investment Trustees

The staff may, inadvisably, interpret this message as a warning not to act
too independently of the trustees. Staff members may, for example, termi-
nate some managers whom they approve but judge to be in disfavor with the
trustees. Or the staff members may fail to hire an attractive manager out of
concern that the trustees may not approve of that manager. But the trustees
at these funds generally do not possess the expertise to identify successful
managers prospectively, and in the end, the implicit withholding of author-
ity from their staff corrodes the manager selection process. The trustees may
ultimately be correct about a particular manager, but unless they can suggest
fundamental deficiencies in their staff’s processes, their after-the-fact criticism
of the processes’ results can disempower and demoralize the staff.
The Lurinberg University Investment Committee wisely avoids this prob-
lem by focusing its evaluations on the performance of the Fund’s aggregate
assets as opposed to the individual managers’ investment results.
Of course, a similar problem can exist between the staff and invest-
ment managers. Managers are explicitly delegated authority to make port-
folio construction decisions for their clients’ accounts within specified
investment guidelines. Again, the staff can implicitly withhold that authority
by frequently questioning portfolio decisions after the fact. However, because
investment managers are more diversified in their client bases than a fund’s
staff, the managers are better positioned to fend off these efforts on the part
of the staff than the staff is prepared to hold the line against meddling trust-
ees. Nevertheless, if the staff or investment committee constantly picks away
at individual decisions on the part of a fund’s managers, the managers may
withhold their more unconventional ideas from the portfolios, to the ultimate
detriment of the fund.
The solution to these problems is conceptually simple but, at times, dif-
ficult to put into practice. It is that (1) the lines of authority must be clearly
specified and (2) the supervising decision makers must scrupulously refrain
from reaching down to the reporting decision makers and attempting to
control decisions. Furthermore, the reporting decision makers need to feel
empowered to push back and remind the supervising decision makers in
those instances when the line between explicit and implicit authority becomes
blurred. Documenting the lines of authority through the GPS is the ideal
solution, but even if such documentation exists, a culture of full and frank
discussions must be maintained.
Like most organizations, the Lurinberg University Investment
Committee has authorized an organizational chart that identifies the Fund’s
lines of authority. We have attached that chart to your presentation materi-
als as Figure 1. In addition to simply specifying the lines of authority, the

20 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 1. Governance Structure

Figure 1. Lurinberg University Investment Committee Organization Chart

Funding Trustees Investment Committee Trustees Benefit Trustees

Legal Staff
Consultants
Compliance CIO

Auditors Members of Staff

Risk Manager
Public Market Manager
Nonpublic Market Manager
Accounting/Administration

Investment Managers Bank Custodian

investment committee has incorporated the other elements of a strong gov-

ernance structure mentioned earlier—due diligence, checks and balances,
reporting and monitoring, transparency, and keeping abreast of the practices
of leading fund sponsors—to align implicit with explicit authority.

Accountability Standards
Accountability provides the third leg of a strong governance structure.
A committee may assign responsibility for an investment function to a per-
son or a group and give that person or group the authority to carry out that
function, but those steps, although necessary, are not sufficient. Everyone
wants responsibility and authority; few, however, want accountability. Yet, if
the appropriate level of accountability is missing, the trustees cannot expect
a person or group to be properly motivated to carry out the function in a way
that best meets the goals of the Fund.
As a result, the Lurinberg University Investment Committee has man-
dated that accountability standards be established throughout the governance
structure. Wherever key decisions are being made, the trustees have insisted
that accountability standards be set for the decision makers. Regardless of
their specific design, those accountability standards have common character-
istics. They are
•• appropriate and realistic (i.e., commensurate with the given authority),
•• established in advance,

© 2017 CFA Institute Research Foundation. All rights reserved.  21

A Primer for Investment Trustees

•• agreed to by both the supervising and subordinate persons or groups,

•• evaluated in the context of the expected range of outcomes, and
•• designed to provide formal procedures for supervising authorities to
review the results of subordinates’ decisions.
Consider the set of accountability standards that the investment com-
mittee assigns to the CIO for use in an annual evaluation. Those standards
include both a “personal results” component and an “investment results”
component. The personal results component relates primarily to how well the
CIO interacts with the staff and trustees. Topping this list must be open and
direct communication. For example, appropriate expectations, Molly, are that
you and the other trustees be comfortable asking the CIO any question that
comes to mind and that you receive a prompt and understandable answer.
Timely reporting, effective management of the staff, and productive relation-
ships with other stakeholders and outside organizations will also factor into
this personal evaluation.
The investment results component is based on the Fund’s management
relative to defined expectations. The CIO cannot guarantee investment out-
comes, and the investment performance objectives (see Session 4) recognize
that fact. Still, you should want the CIO to benefit financially if the Fund
performs well relative to appropriate expectations. For example, the trustees
have decided that the Fund’s return relative to established benchmarks and
the maintenance of the asset mix within policy guidelines should factor into
the CIO’s investment results component.
In an investment program, surprises will always occur, some of them
potentially quite disappointing. Often, how to evaluate them is unclear, even
with a solid set of accountability standards in place. Among other questions
you will probably want to ask are whether the CIO had the authority to make
a different outcome happen and whether the process under which the adverse
outcome occurred was prudent and properly implemented. In addition, you
should consider whether the bad result could reasonably have been predicted
and prepared for.
Molly, your conclusions are likely to involve a fair amount of subjectivity.
One of the primary reasons you were invited to be a trustee, however, is that
you have a history of good judgment. In an uncertain investment world, that
characteristic is of critical importance.

Fiduciary Duty
Molly, as an investment trustee for the Fund, you bear an important obliga-
tion to act in the best interests of the Fund’s beneficiaries. We’ll leave it to

22 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 1. Governance Structure

our legal representatives to talk to you about the specific laws that pertain to
your fiduciary responsibilities. Nevertheless, it is worthwhile for us to spend a
moment to consider how the general concept of fiduciary duty applies to you
in your role as a member of the investment committee.
A fiduciary is someone to whom property or power is entrusted for the
benefit of another. When it comes to the university’s retirement plans and
endowment fund, you are entrusted with overseeing the investment of the
assets to most effectively serve the people and institutions that benefit from
the existence of the funds and the income the funds generate. As straight-
forward as that idea sounds, in practice, it is not so simple. For example,
as you consider the endowment fund’s investment policy, how do you bal-
ance the needs of the current beneficiaries and those of future beneficiaries?
Conservative investments today appear good for the current beneficiaries, but
that approach reduces the resources available to future beneficiaries.
Despite the ambiguity surrounding application of your fiduciary duty,
you can focus on several principles. First, as a trustee, you have a duty of
loyalty to the Fund’s beneficiaries. You should avoid conflicts of interest that
might interfere with making decisions in the best interests of the Fund’s ben-
eficiaries. In Session 9, Ethics in Investing, we discuss this topic further, but
for the moment, keep in mind that you should carefully examine how your
relationships with various persons and businesses might possibly sway your
decisions. Your fiduciary duty requires you to wall off those relationships from
your work as a trustee and ensure that you don’t profit financially or otherwise
from your trustee position.
Second, being a fiduciary requires that you act in a prudent and reason-
able manner in making decisions. You should strive to understand the key
investment issues confronting the trustees and thoughtfully weigh the feasi-
ble alternatives. Establishing a reasonable decision-making process is impor-
tant here. You should seek the advice of experts, whether staff members, the
Fund’s consultants, or other parties. As a fiduciary, you may be forgiven for
a decision that turns out to be wrong, but such forgiveness is less likely if the
bad outcome is the result of your failure to follow procedures or seek advice
when needed.
Finally, you should act in a transparent and accountable manner. Regardless
of your good intentions, beneficiaries and other interested outsiders must be
able to clearly see that you are performing properly as a trustee. To the great-
est extent possible, disclosure of the investment committee’s actions and the
reasons for those actions will help create an environment of trust and support.
Preparing an investment policy statement (see Session 2), keeping minutes of
all meetings, reviewing and retaining reports by staff and other advisers, and

© 2017 CFA Institute Research Foundation. All rights reserved.  23

A Primer for Investment Trustees

adopting and abiding by a written code of conduct are all actions that, if done
consistently, foster transparency and accountability. That culture of openness
will go far in creating goodwill with the Fund’s stakeholders and make it
easier to weather difficult situations.

More on the Trustees

Your fellow trustees recognize that appropriate organizational design of the
investment committee can enhance the Fund’s governance structure. As a
result, the trustees have focused on several key aspects of membership and
meeting format, including
•• number of members,
•• member selection,
•• diversity of experience,
•• member tenure,
•• leadership,
•• frequency of meetings,
•• meeting length, and
•• meeting agendas.
Seven trustees sit on the Lurinberg University Investment Committee.
Having too many trustees makes scheduling meetings difficult; having too
few trustees increases the potential for one or two persons to dominate the
decision making. A subcommittee of the Board of Regents takes nomina-
tions and ultimately recommends trustees to the full board for approval. This
independent selection process prevents current trustees from controlling the
choice of new members. As a result, new trustees join without owing an alle-
giance to existing committee members.
In recruiting attractive trustee candidates, the regents look for individu-
als with a wide range of career experiences. Although the regents consider
investment knowledge to be a highly positive attribute and insist that a major-
ity of the committee have investment expertise, they don’t view that expertise
as a prerequisite for being selected as a trustee. In fact, several trustees have
been chosen because of their experience in areas outside of investing—human
resources, for example. The regents prefer to strike a balance on the invest-
ment committee between investment experience and other backgrounds.
A diverse membership makes it less likely that “groupthink” will dominate

24 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 1. Governance Structure

the board’s decisions regarding investment policy. Because of their diversity,

the trustees are an active group who vigorously debate the relevant issues and
are open to dissenting but constructive ideas.
The trustees may serve up to two three-year terms before they must leave
the investment committee for at least three years. In this way, the trustees do
not become too comfortable in their positions but have enough time to under-
stand the university’s funds and to function effectively. Moreover, this forced
turnover periodically brings in fresh ideas through new members. Terms
are staggered to avoid wholesale membership change and a resulting loss of
institutional knowledge. The investment committee’s chair and vice chair are
appointed by the regents—again, to prevent one individual from holding too
much power within the group.
The investment committee members hold in-person meetings at least
three times a year and arrange for conference call meetings as necessary. The
in-person meetings are important because they promote effective discussion
among the trustees and between the trustees and the investment staff. The
trustees prefer quarterly meetings to keep on top of pressing issues and to
review investment results on a timely basis. The CIO, in consultation with the
investment committee chair, controls the meeting agenda. The trustees favor
meetings that last no more than half a day, thereby allowing the participants
to remain fresh and productive throughout the meeting.
Funds take varying approaches toward membership and meetings, but the
investment committee at Lurinberg is fairly conventional. Institutional situa-
tions cause some differences (e.g., a public retirement plan may have statutory
membership requirements). Other differences may be the result of decisions
made long ago that the funds have grown accustomed to. Regardless, trustees
should review the membership and meeting guidelines periodically to stay in
line with changing practices.

Takeaways
•• The governance structure is the framework that connects a fund’s various
decision makers to one another.
•• The key elements of the governance structure are described in a formal
governance policy statement.
•• A sound governance structure has three primary components: roles and
responsibilities, lines of authority, and accountability standards.
•• Roles and responsibilities define the functions the various decision mak-
ers are assigned to perform.

© 2017 CFA Institute Research Foundation. All rights reserved.  25

A Primer for Investment Trustees

•• Lines of authority both describe the power given to decision makers to carry
out their responsibilities and specify to whom those decision makers report.
•• Accountability standards state the expectations regarding the effective-
ness of the decision makers and the procedures for reviewing their actions.
•• Sound governance also requires
— appropriate due diligence procedures,
— checks and balances with regard to the various decision makers,
— timely reporting and monitoring,
— transparency of decisions and details of investment transactions and
holdings, and
— compliance with industry best practices.
•• Outsourcing certain investment responsibilities can be a viable option for
a fund, particularly a small fund with limited resources.
•• The trustees have a fiduciary duty to the beneficiaries of the fund, which
includes a duty of loyalty, prudence, reasonableness, transparency, and
accountability.
•• Important trustee membership issues include the number of trustees,
selection process, diversity of experience, tenure, and leadership.
•• Meeting schedules also deserve consideration, including meeting fre-
quency, meeting length, and meeting agendas.

Questions Molly Should Ask

About governance policy
•• Is the Fund’s governance structure formally documented? If so, may I
see the document? If a GPS does not exist, how is the Fund’s governance
structure understood and communicated?
•• How is the governance of the Fund organized? Who are the key par-
ticipants in the structure? How do they relate to one another in terms of
accountability and authority?
•• Are responsibility, accountability, and authority appropriately aligned in
all areas of the Fund’s governance structure? Are there any areas of con-
cern? If so, what are the issues involved?

26 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 1. Governance Structure

The investment staff

•• How is the staff organized? What are the professional backgrounds of the
CIO and his or her senior managers?
•• What sort of succession planning is in place for key leaders?
•• How is the CIO evaluated? What have been the recent results of his or
her evaluations?
•• Does the staff have the resources to adequately carry out its responsibilities?
If not, what are the concerns?
•• What is the compensation structure (e.g., base salary, bonus, deferred
compensation, perquisites) for the CIO? Who determines staff
compensation?
•• How is the staff budget determined? What is the size of that budget?
How is it allocated by major account?
•• What investment management decisions are delegated solely to our CIO
and the staff? Do we have a set of performance expectations for these
persons with respect to those decisions?

Relationships among key decision makers

•• What investment management decisions does the investment commit-
tee retain in whole or in part? What is the purpose of retaining these
decision-making responsibilities?
•• What regular reports do the staff, the custodian, and the consultant pro-
vide to the investment committee?
•• Are the trustees relatively involved as a group in terms of managing the
staff, or do they tend to be “hands-off”?
•• When there are disagreements between the trustees and the staff, how
are they resolved? Are there any issues that continue to fester?
•• Where are the Fund’s assets held? Who has authority to access those
assets? What types of safeguards do we have to prevent unauthorized
access to the Fund’s assets?
•• What valuation methods does the custodian use to value the assets? What
sorts of quality checks are applied to the reported numbers?

© 2017 CFA Institute Research Foundation. All rights reserved.  27

A Primer for Investment Trustees

•• Do we retain a consultant? If so, how do the trustees and the staff use our
consultant? What do we pay the consultant? What is our record of fol-
lowing the consultant’s recommendations?
•• How long has it been since the consultant and the custodian relationships
were reviewed? What were the results of those reviews?
•• Have we investigated the possibility of outsourcing certain investment
program governance responsibilities to an OCIO or investment adviser?
If so, what were the results of that investigation? If the answer is no, why
do we believe such an assignment is unnecessary?
•• If we do use an outsourcing solution, how and why did we choose the
OCIO over other options?
•• What investment program responsibilities have we assigned to the
OCIO?
•• How did we go about selecting the OCIO? How does the OCIO interact
with the trustees?
•• How do we monitor the OCIO? What metrics do we use to assess the
OCIO’s performance? How do we assess the OCIO’s expertise and expe-
rience with the various asset classes of the Fund, particularly, alternative
investments?
•• What do we pay the OCIO, both in absolute amounts and as a percent-
age of assets?
•• Are the OCIO’s fees biased in favor of active versus passive management
or in any other way? Are the OCIO fees based on the total value of the
Fund’s assets? How can we ensure that no hidden fees or self-dealing
relationships exist? If the OCIO’s parent organization offers investment
management services, should the OCIO be precluded from using them?
•• Does the OCIO provide a report that details all external cash flows into
and out of the Fund as to amount, date, and purpose? Can we indepen-
dently and randomly check portfolio values and returns to ensure the
integrity of the OCIO’s reports?

The trustees
•• Who are the current trustees? How long have they been on the invest-
ment committee? What are their backgrounds?

28 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 1. Governance Structure

•• Who selects the trustees? What is the selection process? What criteria are
considered most important in selecting a new trustee?
•• What types of training are provided to new trustees?
•• How is the leadership of the trustees chosen? Are there informal leaders
who differ from the officially chosen leaders?
•• How are the trustee meetings usually run? What topics tend to domi-
nate the agendas? Is the focus largely on reviewing past performance as
opposed to addressing forward-looking strategic issues?
•• Are the minutes of the past trustee meetings available for review?
•• How do the trustees protect against groupthink?
•• What are the core investment beliefs of the trustees as a body?
•• How are the trustees evaluated, both individually and as a group?

© 2017 CFA Institute Research Foundation. All rights reserved.  29

Session 2. Investment Policy

Once the “what” is decided, the “how” always follows. We must not make
the “how” an excuse for not facing and accepting the “what.”
—Pearl S. Buck
Virtually all well-run investment programs are built on the foundation of a
thoughtful investment policy. Molly, in our discussions, we should be clear
that the most important function that you and the other trustees perform is
establishing and maintaining the Fund’s investment policy.

The Importance of Investment Policy

Why is investment policy so important? If the trustees can’t develop and con-
vey a clear sense of what the Fund is attempting to achieve and how they
expect staff members or outside advisers to go about reaching those objec-
tives, then the investment program will be directionless and the trustees and
staff will be prone to pursuing ineffective approaches that lead to unsatisfac-
tory results. Yogi Berra’s succinct wisdom aptly applies to investing: “If you
don’t know where you’re going, you’re liable to end up somewhere else.”
Some funds fail to adopt sound investment policies. Others adopt sound
investment policies but fail to follow them diligently. In either case, these
funds typically rely on ad hoc approaches to investment management. The
manifestations of these inadequate investment practices include a short-term
focus (often on issues of secondary importance, such as the hiring and firing
of managers) and inattention to important long-run issues. These behaviors
generate a hodgepodge of frequently changing and inconsistent investment
strategies. Ad hoc management also hinders trustees in conducting realis-
tic appraisals of their objectives and keeps them from implementing stable,
productive investment programs that achieve their objectives.

Defining Investment Policy

We should clearly define the term “investment policy.” The Lurinberg
University Investment Committee thinks of its investment policy as a com-
bination of philosophy and planning. It expresses the trustees’ collective atti-
tudes toward important investment management issues: Why does the Fund
exist? How does the investment committee define success? To what extent
are the trustees willing to accept the possibility of large losses? How do the
trustees evaluate the performance of the investment program?

30 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 2. Investment Policy

The investment committee also considers the investment policy to be a

form of long-range strategic planning because the policy delineates the trust-
ees’ investment goals and how they expect those goals to be realized.
Essentially, any relatively permanent set of procedures that guides the
management of a fund’s assets can be deemed the fund’s investment policy.
Nevertheless, a comprehensive investment policy will address many of the
issues that we are covering in our discussions, including
•• the fund’s mission,
•• investment risk tolerance (i.e., the ability and willingness of the trustees
to bear investment risk),
•• investment objectives,
•• the policy asset mix,
•• investment management structure, and
•• performance evaluation.
Different financial circumstances and attitudes toward seeking returns
and bearing risk cause funds to adopt different investment policies. There is
nothing wrong with that. Simply put, there is no “correct” investment policy.
However, an effective policy tailors the issues we just identified to a fund’s
specific circumstances, whether that fund is a corporate defined-contribution
retirement plan, a public defined-benefit (DB) retirement plan, an endow-
ment, or a family office.
The investment committee often speaks of the Fund’s investment policy
as the “rule book” for the investment program. Despite the fact that there is
no single solution to the challenge of investment policy design, the “rules”
for all types of funds appropriately contain many of the same essential ele-
ments. That is because an investment program can be successful over the
long run only if it operates under a well-defined plan, and success can be
evaluated only in light of clearly stated investment objectives. An investment
policy incorporating the fundamental elements covered in this discussion
provides the necessary planning framework. Molly, that may sound like com-
mon sense—or, rather, good business practice—and it is. And like any sound
business practice, it should be universally applicable to the Fund’s investment
program, regardless of how the composition of the staff or the investment
committee changes over time.
Investment policy identifies the key philosophies, objectives, and long-
run strategic approach defining the management of the Fund’s assets. Not
only does the investment policy establish accountability; it also helps to

© 2017 CFA Institute Research Foundation. All rights reserved.  31

A Primer for Investment Trustees

minimize conflicting interests. For example, the university’s DB plan exists to

provide post-retirement income to plan participants, but it is partly funded by
the state’s taxpayers (or shareholders in the case of a private plan). The trustees
may feel accountable to taxpayers in some way, even though they are supposed
to be loyal solely to the plan participants. Similarly, the investment staff cares
about the participants but also thinks about job protection and maybe earn-
ing a bonus. External investment managers worry about their businesses and
their fees while, at the same time, they try to serve the participants effec-
tively. Although no set of rules can eliminate these conflicts, a sound invest-
ment policy can contribute to a solution by stating clear accountabilities and
enhancing the transparency of an investment program.

Policy Asset Mix: Selection and Rebalancing

A central part of a fund’s investment policy is to select asset classes and
investment strategies within those asset classes that, in aggregate, produce
a well-diversified portfolio consistent with the fund’s mission. To begin, the
trustees need a workable understanding of the underlying risk and expected
return characteristics of these asset classes. (We will discuss the term “asset
class” more thoroughly in Session 6; for now, think of asset classes as broad
categories, such as stocks, bonds, and real estate.)
From that understanding, the investment committee can determine the
desired allocation to each asset class so that, in total, the investments reason-
ably can be expected to produce the required return over the long run with an
acceptable level of volatility in results. This process is referred to as “setting
the policy asset mix,” and it directly relates to the level of investment risk
considered appropriate for the Fund by the trustees. (We will discuss how the
investment committee determines the appropriate level of risk in Session 5.)
The investment committee approves the policy asset mix as a list of asset
classes, a target percentage allocation for each, and (usually) a range around
that target allocation within which the actual allocation may fluctuate before
rebalancing back to the target is required. As an example, you can review the
policy asset mix of the Lurinberg University DB pension plan in Appendix B
to these materials. Again, we will have more to say on the particular asset
classes in the policy asset mix during Session 6.
Obviously, nothing in life or business is perfectly obvious all the time.
Nor will any set of rules, however robust, always point to the most profitable
course of action. The investment committee does not expect its policy asset
mix to generate the desired returns year in and year out. Rather, the trustees’
approach is that when others are greedy and bidding up the price of certain
asset classes and the expected return on those asset classes decreases, the

32 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 2. Investment Policy

trustees are willing to take a little less risk by selling off some of those appre-
ciated asset classes if their allocation has moved above the top of the approved
range. Conversely, over the course of a market cycle, when markets plunge
and investors are fearful, certain asset classes tend to be shunned. These asset
classes then become cheaper and thus have higher expected returns. At those
times, the investment committee is willing to take on more risk and buy those
asset classes if their allocation has moved below the approved range. This pro-
cess is called “rebalancing back to the policy asset mix.” Because the trustees,
staff, and consultants are all human, the Fund’s investment policy seeks to
overcome cognitive biases that cause decision makers to fear and avoid these
rebalancing opportunities just at the time when they offer the Fund the great-
est potential returns.
Investment policy helps manage risk by starting with a clear statement of
the mission and objectives of the Fund, identifying the key risks faced by the
Fund, assigning accountability for those risks, setting up metrics for deter-
mining success, and then defining procedures for evaluation, oversight, and
management of the Fund. Molly, as a trustee, you cannot be expected always
to make correct investment decisions, but you are always expected to carefully
consider the relevant risks and how they should be managed before making a
decision.

Investment Policy as a Stabilizer

The investment committee established the Fund’s investment policy indepen-
dent of current market conditions. Although the trustees allow for discretion
on the part of the staff and the investment managers to take advantage of
attractive near-term market valuations, the trustees, in setting the invest-
ment policy, have accepted as given the long-run opportunities afforded by
the capital markets and the Fund’s obligations to its beneficiaries. A consis-
tently applied investment policy produces successful results not because of any
unique investment insights but because of its concentration on the Fund’s pri-
mary goals and the continuity of its investment strategies.
Investment policy would be of little significance if it were merely a per-
functory description of the investment program. Instead, it derives its impor-
tance from the complex and dynamic environment that the trustees confront
in setting a direction for the Fund. The trustees and staff need a logical and
consistent framework within which to make decisions.
The Fund’s investment policy is an “autopilot” setting for normal times
and a stabilizer for the investment program during stressful markets. The
Fund’s investment policy needs to be flexible, but in the past, the trustees have
made changes only during periods when fundamental conditions changed

© 2017 CFA Institute Research Foundation. All rights reserved.  33

A Primer for Investment Trustees

significantly, either externally or internally. The investment committee has

always maintained that the threshold for conditions to qualify as “significant
changes in conditions” should be quite high. If not, the urge to change policy
in response to short-run market conditions can be overwhelming. Following
this urge will, in turn, defeat one of the key virtues of investment policy—
namely, to keep decision makers from acting rashly, from succumbing to
either greed or, particularly, fear.
That last point bears repeating. Trustees sometimes fail to appreciate that
adherence to the investment policy will produce its greatest benefits during
periods of adverse market conditions. At these times, the temptation builds to
alter a sound investment program as the fear of even worse future calamities
increases.
Emotional decisions to change course in these situations inevitably prove
costly. The investment committee has been fortunate to avoid those out-
comes. The existence of a well-thought-out investment policy has forced the
Fund’s decision makers to pause and consider why the existing policy was
established in the first place and whether the current adverse market condi-
tions were actually predictable—not in their timing but in their intensity and
(paradoxically) their unexpectedness. That type of review has made it possible
for cooler heads and a longer-term outlook to prevail on the investment com-
mittee. It has allowed the trustees to stay with their long-term policy during
market downturns and avoid locking in current losses so as to eliminate the
possibility of reversing those losses when markets recover.

Reviewing Investment Policy

As we discussed, investment policy is not immutable. The investment com-
mittee periodically reviews—and, on occasion, modifies—the Fund’s invest-
ment policy. Think of a business plan, Molly. When would you change your
company’s strategic plan? Certainly if the basic structure of competition were
to change (such as if key suppliers gained pricing power or a shift occurred in
the customer base), disruptive technologies appeared, or big changes occurred
in government regulation. Any of these circumstances would call for a review
and possible modification of your business plan.
You and the other trustees might find it appropriate to alter the Fund’s
investment policy if the Fund’s obligations change materially. If changes in
the investment landscape, such as new practices or products, occur, then you
also might want to alter the investment policy to ensure that potential oppor-
tunities are not missed. If the investment committee truly were to conclude
that the long-run expected risk–reward relationships among asset classes had
fundamentally changed, that change too might warrant a modification in

34 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 2. Investment Policy

investment policy. (That conclusion is, of course, quite different from merely
observing that particular asset classes have recently performed poorly or well
relative to one another.) Nevertheless, the investment policy rarely requires
alteration, mostly because the factors that could justify a change in the policy
are themselves not generally prone to near-term transformations.
Regular discussions of the investment policy aimed at educating the
Fund’s decision makers serve a productive purpose. These discussions help
bridge the different attitudes that trustees may have toward risk taking and
investment management. They reinforce the logic of the current policy and
thereby reduce the chances of unnecessary alterations. Conversely, reviews
directed toward the constant reassessment of existing policy are counterpro-
ductive. Frequent investment policy changes take on the tone of active man-
agement, thus blurring the distinction between policy and operations, to the
detriment of the investment program.
If the trustees believe that a change in investment policy is warranted,
then you should recognize that the modifications are almost never time sensi-
tive and should not be hurried. In fact, the greater the seeming urgency of
proposed policy changes, the more likely that those changes are really active
management decisions posing as policy issues.

The Investment Policy Statement

The investment committee has formalized the Fund’s investment policy
in a written document called the “investment policy statement” (IPS). An
IPS summarizes a fund’s key investment policy decisions and explains the
rationale for each decision. The level of detail in an IPS will vary among
investment organizations. Some organizations may prefer to provide more
information than others, particularly those with more complex investment
programs. Nevertheless, an IPS serves the same role for all funds: It enforces
logical, disciplined investment decision making, and it limits the tempta-
tion to make counterproductive changes to an investment program during
periods of market stress. (Recall that Appendix B is a copy of the Lurinberg
University DB retirement fund’s IPS for your inspection.)
The Fund’s IPS is not a set of broad statements such as, “Look both
ways before you invest.” Rather, it contains an explicit recipe for the invest-
ment program stated in terms of minimum and maximum allocations to
various asset classes, levels of allowable risk, and so forth. The IPS also con-
tains guidelines for investing within an asset class. Those guidelines may be
stated as a list of requirements or prohibitions or in terms of a budget for
various types of investment risk. Another key element is the establishment
of performance objectives for the Fund and for individual asset classes. These

© 2017 CFA Institute Research Foundation. All rights reserved.  35

A Primer for Investment Trustees

objectives provide a reference point for evaluating the success of the Fund’s
investment strategies.
The IPS serves three primary functions:
•• It facilitates internal and external communication of investment policy.
•• It ensures continuity of policy during periods of turnover among the
Fund’s trustees, staff, and outside advisers.
•• It provides a baseline against which to evaluate proposed policy changes.
Regarding the first function, the IPS communicates the Fund’s invest-
ment policy to insiders (the trustees and staff) and interested outsiders (e.g.,
the Fund’s investment managers or its beneficiaries). The IPS helps prevent
confusion over interpretation of the Fund’s investment policy. A regular
presentation of the IPS keeps investment policy fresh in the minds of the
Fund’s decision makers. For that reason, the investment staff includes the
Fund’s IPS in the set of materials for at least one investment committee meet-
ing every year.
Regarding the second function, the IPS serves as a permanent record that
enhances continuity in the investment program. Turnover among the trustees
and top staff members is inevitable. For newcomers, the IPS provides a con-
cise and accessible reference. Its existence also makes clear that the policy is a
product of a thorough and deliberate process; thus, the IPS reduces the urge
on the part of new decision makers to impulsively propose revisions to the
DB fund’s existing investment policy. For that reason, Molly, as part of your
orientation, you should take the time to carefully review the IPS of each of
the Lurinberg University funds and ask questions about the contents.
Finally, the IPS serves as a baseline against which to consider proposed
changes to the Fund’s current investment policy. Any such potential changes
can be directly compared with existing policy, making the merits of the
changes easier to evaluate and limiting the chances that emotional appeals
for change will sway decision makers. Over the years, the existence of the
Fund’s IPS has prevented a number of potentially ill-advised alterations to
the investment strategy.
Only the trustees can establish investment policy for the Fund. You
and the other trustees are the primary fiduciaries, and it is your responsi-
bility to provide the investment philosophy and long-term direction for the
Fund. True, in many organizations, the investment policies are drafted by the
investment staff, sometimes with the aid of a consultant, or are prepared by
an OCIO. But in the end, the trustees have the responsibility, authority, and
ultimate accountability for the Fund’s investment policy. If the trustees are

36 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 2. Investment Policy

ever sued for losing money, a properly crafted IPS—and documentation that
the policy has been scrupulously followed—is a strong defense.

Takeaways
•• The most important functions that the trustees perform are to establish
and maintain the fund’s investment policy.
•• Investment policy is a combination of philosophy and planning.
•• Investment policy expresses the trustees’ attitudes toward important
investment management issues.
•• Investment policy is also a form of long-range strategic planning that
delineates the trustees’ specific investment goals and how the trustees
expect those goals to be realized.
•• A comprehensive investment policy addresses
— the fund’s mission,
— risk tolerance,
— investment objectives,
— the policy asset mix and rebalancing policy, and
— performance evaluation.
•• Investment policy acts as a stabilizer for the investment program and
thereby helps avoid costly shifts during stressful market conditions.
•• Investment policy is changeable, but the case for modifications should
be held to a high standard and should be based on truly fundamental
changes, not simply transitory movements in market conditions.
•• Central to investment policy is the policy asset mix—the long-run desired
allocation of a fund to designated asset classes.
•• The investment policy statement formalizes investment policy in a writ-
ten document, summarizing a fund’s key policy decisions and explaining
the rationale for those decisions.
•• The IPS serves three primary functions:
— To facilitate communication of investment policy
— To ensure continuity of policy when trustees, staff, or outside advisers
change

© 2017 CFA Institute Research Foundation. All rights reserved.  37

A Primer for Investment Trustees

— To provide a baseline against which to evaluate proposed policy

changes

Questions Molly Should Ask

•• Do we have a formal written IPS? If not, why not? If so, may I have a
copy to review?
•• Does our IPS discuss the underlying rationale for the policies that we
have adopted? If not, how can I obtain some background context regard-
ing the development of the IPS?
•• Is our IPS broadly disseminated to key stakeholders?
•• What duties do I have as a trustee under our investment policy?
•• As a group, do the trustees understand our investment policy well? Is the
investment policy thoroughly covered in new trustees’ orientations?
•• What are the key factors that could cause us to rethink and revise our
investment policy?
•• Of the primary components of the investment policy, which ones have
the broadest agreement among the trustees? Which ones have the most
divided opinions?
•• Are there investment policy changes that have been proposed but that the
trustees have ultimately opposed? If so, what is the background behind
those desired changes?
•• When was the Fund’s investment policy changed materially, and why was
it changed?
•• Do we have a record of the changes that have been made to our invest-
ment policy with a description of what, when, and why we made the
changes?
•• When was the current version of our investment policy adopted? Who
wrote the current version of our investment policy? Who reviewed this
version? Our legal counsel? Our consultant? Did they make substantive
comments, and if so, what were they?
•• Is there a regular review of the investment policy? Who takes the lead in
those discussions?

38 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 2. Investment Policy

•• If our investment policy is considered the rule book for running our
investment program, would you say that our rules are comprehensive and
prescriptive in design or more informal and advisory?
•• What is the policy asset mix of the Fund? What was the process by which
it was determined?
•• What rebalancing rules does the staff follow to ensure that the Fund’s
actual asset allocation is in line with the policy asset mix?
•• Are those rebalancing rules implemented without question or does the
staff have discretion over when and how to implement them?
•• Are there legal restrictions that govern the investments of the Fund over
which the trustees have no discretion?
•• Can you cite instances in which our investment policy has actually acted
as a stabilizer in periods of distressed financial climates? Have the trustees
always followed the investment policy during those periods?

© 2017 CFA Institute Research Foundation. All rights reserved.  39

Session 3. The Fund’s Mission

Choose always the way that seems best, however rough it may be; custom
will soon render it easy and agreeable.
—Pythagoras
Molly, as a trustee serving on the university’s investment committee, you have
oversight responsibility for the assets of the defined-benefit (DB) retirement
plan, the defined-contribution (DC) retirement plan, and the endowment
fund. Broadly speaking, each fund has an investment mission, which is to
provide financial benefits to certain parties. Also, a common feature of these
funds is that they invest pools of monies that were contributed from particu-
lar sources for particular purposes. The differences among the funds consist of
the timing and certainty of the benefits that flow out of the investment pool,
the contributions that flow into it, and the specific uses to which the benefits
will be put.
To help you understand the concept of a fund’s mission, we decided to
focus on the Lurinberg University DB fund. We based this choice on the fact
that the investment policies of DB funds, in general, involve interesting and
diverse missions. Also, a legally binding commitment exists to pay defined
benefits at specific times and in specific amounts.
The DB plan that the university provides to its employees is quite similar
to your own company’s plan, Molly. A notable difference, however, is that
the state’s taxpayers stand behind the university’s promise to pay retirement
benefits whereas it is your company’s stockholders who guarantee your com-
pany’s benefit obligations.
With respect to the university’s endowment fund that you also oversee
as a trustee, note that contributions to it vary over time and that the with-
drawals, or benefits, typically are based on a percentage of the fund’s value.
However, you should appreciate, in particular, that the endowment fund
makes a material contribution to the university’s operating budget and that an
unwritten rule exists that the possibility of a decline in the amount of money
the endowment provides should be minimized.
As for the DC plan that the university offers to its employees, you do
not have any direct responsibilities relating to the actual allocation of assets.
Rather, the trustees have a responsibility to provide employees with an appro-
priate set of cost-effective investment options that allow employees to create
and manage their retirement assets in a manner consistent with their needs
and circumstances. We will have more to say about DC plans in Session 7.

40 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 3. The Fund’s Mission

With that background, let’s begin our discussion of the DB fund.

The Fundamental Conflict

So, exactly what is the mission of the university’s DB fund? At first, the
answer to that question might seem obvious. However, on further reflection,
Molly, you may find that it is much more complicated.
At the most basic level, of course, the DB fund exists to ensure the avail-
ability of sufficient assets to pay the retirement benefits promised to the plan
participants. (The term “participants” refers not only to current employees and
retirees but also to former employees whose benefits are vested—that is, the
employees have become entitled to the benefits.) There would be no reason
to maintain the pool of assets if these obligations did not exist. Because the
university places assets in the DB fund, it backs its promise to pay retirement
benefits with more than simply its good faith. Plan participants can rely on
the assets held in the DB fund if the university should ever become insolvent.
The DB fund’s mission is far more complex, however, than this simple
directive would imply. The university (and, by implication, the investment
committee) has other important stakeholders in the fund in addition to the
plan participants. At the top of the list are the taxpayers. (The correspond-
ing stakeholders for funds in the private—that is, corporate—sector are the
fund sponsor’s shareholders.) Despite the overriding importance of securing
the benefits promise, decision makers and stakeholders should never forget
that a financially healthy organization is required for benefits to continue to
be offered. If the DB fund’s mission doesn’t take into account the financial
needs of the university, then the plan may eventually be neglected, poorly
funded, or possibly even terminated. None of these outcomes would serve the
interests of plan participants.
The university generally prefers to contribute as little money as possible to
the DB fund without diminishing its ability to pay benefits. The cost of pro-
viding benefits equals the present value of all contributions made over the DB
plan’s life. The university wants the investment committee to minimize that
cost. Private-sector plan sponsors also want to keep contributions as low as
possible. They often have an additional objective in that they desire to mini-
mize the volatility of the accounting expense associated with operating their
DB plans.
You can imagine situations in which other groups view themselves as
stakeholders in the fund, including labor unions, legislatures, social activ-
ists, and so on. Although these groups may not have a direct impact on the
DB fund’s core mission, the university and investment committee should not
neglect the concerns of those stakeholders.

© 2017 CFA Institute Research Foundation. All rights reserved.  41

A Primer for Investment Trustees

Given the complexity of the DB fund’s mission, it is not surprising that

various aspects of that mission come into conflict. The primary conflict is
between the intent to ensure the security of the promised benefits and the
desire to minimize their cost—that is, the present value of plan contributions
made over the long run. Plan participants want security of benefits, but they
have to realize that the university has many pressing expenditures and must
keep DB plan costs down. Conversely, the university wants DB plan costs
to be as low as possible, but it must recognize the value that the DB plan
provides a means for attracting and retaining a productive and motivated
workforce.
By far the most direct means of securing the benefits promised to plan
participants is to maintain a well-funded plan. The ratio of plan assets (i.e.,
the value of the DB fund) to plan liabilities is called the “funded ratio.” A
plan that has more assets than liabilities is considered overfunded, and one
that has fewer assets than liabilities is underfunded. The higher the funded
ratio, the greater the protection offered to plan participants. The greater the
extent to which the ratio exceeds 100% (full funding), the more cushion the
trustees have to protect against shocks to the value of assets or liabilities eat-
ing into the security of benefits.
Now, if the investment committee were solely concerned with benefit
security, the trustees would place the DB fund in low-volatility investments.
That approach would likely entail holding much of the fund in high-quality
bonds with interest rate and inflation sensitivity similar to that of the plan’s
liabilities. In that approach, the value of the assets and the liabilities would
move in the same direction and magnitude regardless of the market environ-
ment. If that were the case, the university and the plan participants could be
highly certain that there would always be assets of sufficient amount to pay all
benefits. The funded ratio would fluctuate little over time.
The problem with that approach is that it is likely to result in considerably
higher contributions. A simple rule expresses the essence of the situation:

Benefit payments = Contributions + Earnings on contributions.

The source of benefit payments is simply whatever the university puts into
the DB fund plus any earnings that can be generated on those contributions.
If you assume for the moment that the benefit payments are fixed, then the
higher the returns that the fund earns, the lower the contributions the univer-
sity has to make, and vice versa. Just as importantly, if the university wants to
increase benefit payments in the future, then either the university must make

42 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 3. The Fund’s Mission

more contributions or the fund must earn higher returns—or some combina-
tion of the two must occur.
In general, the university prefers to minimize contributions over the
long run, which frees up financial resources that can be put to other produc-
tive purposes. To keep the university’s contributions to the DB fund as low
as possible, the investment committee creates an investment portfolio with
relatively high expected returns. So, in addition to bonds, the trustees have
chosen to invest in higher returning assets, such as common stocks. But the
returns on those stock investments tend to be volatile. That volatility will tend
to cause the level of fund assets to fluctuate in the short run, making the
funded ratio less stable than if the fund invested only in bonds. The result will
be more instances in which the university will have to make a contribution to
offset unexpected declines in the funded ratio. (For private-sector plan spon-
sors holding stocks in their funds, the DB expense reported in the company’s
accounting statements will also be less predictable.)
So, even though the investment committee recognizes that the primary
aspect of the DB fund’s mission is to ensure benefit security, the committee
still faces a conflict between secondary aspects of the fund’s mission: Avoiding
volatility in contributions and the funded ratio versus keeping the costs of fund-
ing benefits low. How do the trustees go about reconciling these contradic-
tory goals? There is no easy answer. The trustees have to arrive at a consensus
regarding how much risk they are willing to bear in the near term. (This
decision is the central aspect of investment policy, which we discussed in
Session 2. We’ll return to it later in the discussion of investor risk tolerance in
Session 5.) Depending on the membership of the investment committee, the
answer may change. You will have to decide for yourself how much risk you
will tolerate in fulfilling the fund’s mission and will continue to discuss that
point of view with the other trustees.
Keep in mind, Molly, that as a fiduciary, your willingness to take risk
should relate to the circumstances of a particular fund, the sponsor (the uni-
versity), and the beneficiaries, not to your personal feelings about risk. Given
the primary aspect of the DB fund’s mission, the trustees should be careful
never to take so much risk as to endanger the security of the plan participants’
promised benefits. An investment portfolio with high equity allocations may
experience a considerable decline in value, resulting in a materially dimin-
ished funded ratio. As a result, required contributions skyrocket. Yet, the
history of capital markets indicates that equity investments far outperform
fixed-income investments, on average, over long periods of time, so choosing
not to hold sizable equity positions would present a large potential opportu-
nity cost to the university.

© 2017 CFA Institute Research Foundation. All rights reserved.  43

A Primer for Investment Trustees

Liabilities
The DB fund is an ongoing entity from which the university expects to pay
a stream of retirement benefits to plan participants for a long time. All the
stakeholders in the fund prefer to have one measure that summarizes the value
of those future benefit payments today. To compute that number, the plan’s
actuaries estimate the future benefit payments to be made to each current
plan participant. They base their calculations on the participants’ wages, ages,
and lengths of service today and the participants’ estimated retirement dates
and life expectancies. Reflecting the fact that a payment tomorrow is worth
less than an equal payment today, the actuaries then take into account the
time value of money. They apply a market-based discount rate to the esti-
mated future benefit payments. The sum of these discounted payments is the
amount that, if invested today at that discount rate, could finance all the esti-
mated benefit payments currently owed to the plan participants. The plan’s
actuaries refer to that amount as the plan’s “liabilities.”
The plan’s liabilities, thus derived from the discounted future benefit pay-
ments, can be compared directly with the DB fund’s assets to determine how
well funded the DB plan is. As we discussed, the funded ratio equals the
fund’s assets divided by the plan’s liabilities.
In a very real sense, a DB plan’s liabilities are a form of debt. The uni-
versity has made legal promises to pay the plan participants their retirement
benefits. In lieu of giving them additional cash compensation while they are
or were working, the university has substituted a promise to make a series
of future payments. As a result, you can think of the liabilities as a nonmar-
ketable bond issued to DB plan participants. The value of the participants’
deferred compensation is the “purchase price” of this retirement bond. The
benefit payments represent the principal and interest payments made on
the bond. Like any bond, this retirement bond’s value depends on the level
of interest rates—in particular, the discount rate used to discount the esti-
mated benefit payments. If the interest rate or discount rate rises, the value
of this bond (like that of any bond) falls; if the rate falls, the bond’s value
rises. A change in the bond’s discount rate can have a large impact on the DB
bond’s value and hence on the value of the plan’s liabilities.
The value of the DB plan’s liabilities can, of course, change in ways
beyond the effect of variations in the discount rate. As the university adds
participants to the plan, or as the participants’ income and service with the
university grow, so will the plan’s liabilities grow. The investment staff peri-
odically works with the plan’s actuaries to prepare a report on the size of the
existing liabilities in light of the best available information at that time.

44 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 3. The Fund’s Mission

These concepts of liabilities and funded status apply to an endowment

fund as much as to a DB plan. However, you won’t find a liability value
reported for the university’s endowment fund that is comparable to what you
find for the DB fund. The DB fund’s liabilities, despite relying on a number
of estimated inputs, are determined through a formulaic valuation process,
whereas the endowment’s liabilities are not.
The benefit payments of the endowment fund are determined by the
endowment fund’s spending policy—the percentage of the fund’s assets that
are paid out each year to its beneficiaries. That spending policy is based on
such factors as peer practices, competition for donors, intergenerational equity
(today’s spenders versus tomorrow’s), and perhaps most importantly, expecta-
tions regarding long-term inflation-adjusted returns available in the capital
markets. Payments to the endowment’s beneficiaries will vary over time in
ways that are difficult to forecast. As the endowment fund’s asset value fluc-
tuates, given the relatively fixed spending rates, so also do the payouts.
Endowment beneficiaries expect to receive future benefit payments that,
at the very least, are stable in real (inflation-adjusted) terms. This expec-
tation is in contrast to the fixed nominal (unadjusted for inflation) benefit
payments that are legally obligated in the case of most DB plans. This differ-
ence between real and nominal liabilities causes the objectives and strategies
used for investing the university’s endowment fund assets to differ signifi-
cantly from the objectives and strategies used for investing the DB plan’s
assets. In addition, because an endowment fund cannot pay out more (or, in
the very long run, less) than its market value, the endowment fund is always
fully funded.
In a less direct sense, DC plans also have liabilities. Each of our partici-
pants has some unique future retirement spending plan (thus, each has his or
her own liabilities). Participants fund that future spending, in large part, with
the assets they hold in our DC plan. Although participants do not commonly
follow this practice, they could calculate their own funded ratios by compar-
ing their DC plan assets (plus any other retirement funding assets) with their
liabilities. Such a practice would give participants a good understanding of
how financially secure their retirement financing is. The university holds no
responsibility for the DC plan participants’ personal funded ratios, but as we
will discuss in Session 7, the university has ways to encourage participants to
pay more attention to their retirement financial well-being.

Contributions
The university has established a funding policy for the DB plan that determines
the timing and amount of contributions to the plan. That funding policy sets

© 2017 CFA Institute Research Foundation. All rights reserved.  45

A Primer for Investment Trustees

thresholds for the funded ratio that trigger consideration of contributions.

The funded ratio thresholds set by the university are meant to be advisory
in nature. In determining its funding policy, the university’s administration
weighs the relative importance of keeping the funded ratio near 100% against
the importance of conserving cash for other university purposes.
Three factors affect the funded ratio and may trigger the need for the
university to make contributions. First, as discussed, the liabilities of a pen-
sion plan grow as the number of participants and their years of service grow,
so the funding policy must consider how to fund these increases in liabilities.
Second, as we also mentioned, changes in the discount rate may cause the DB
plan’s liabilities to increase or decrease over time. Third, the DB fund may,
depending on the returns earned by the Fund, grow or decrease.
To the extent that the investment committee holds equity and equity-like
securities in the Fund, the Fund’s value will grow in good markets and the
funded ratio will improve, reducing the need for contributions. In poor mar-
kets, the Fund’s value will decline, depressing the funded ratio and creating a
need for contributions—and possibly at a time when the university’s ability to
make such contributions is diminished.
In difficult economic periods, discount rates may also be declining, which
pushes up the value of liabilities and has a negative impact on the funded
ratio. This confluence of declining assets and rising liabilities has occurred
twice in the first decade of this century. It accentuated the conflict in the
Fund’s mission between holding assets with high expected returns in order to
lower financing costs and holding assets with lower expected returns to avoid
severe fluctuations in the funded ratio and in contributions.
Previously, when we spoke of governance structure, we referred to the
notion of a three-legged stool. We can use the same analogy here to conclude
our discussion of the Fund’s mission. This analogy applies whether a fund
is associated with a private or public DB plan, an endowment, or any pool
of assets for which there are beneficiaries and for which there has been and
may continue to be a source of contributions. Broadly speaking, three types of
policies control the management of a pool of assets: investment policy, which
defines the level of investment risk required to meet return objectives; fund-
ing policy, which defines the level and source of contributions into a fund;
and benefits policy, which defines the amounts and timing of retirement ben-
efits. (For an endowment, as discussed, benefits policy is usually referred to
as “spending policy,” which determines the amount to be distributed to the
beneficiary entities.) Our conversations focus, of course, on investment policy.
Nevertheless, the financial health of a DB plan, endowment fund, or any
other pool of assets with a long-term horizon depends on all three policies.

46 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 3. The Fund’s Mission

Takeaways
•• The primary aspect of a fund’s mission is to have enough assets to pay all
promised or expected benefits when due.
•• A fund’s mission should recognize the interests of all stakeholders, par-
ticularly those providing the benefits, those making contributions, and
those receiving benefits from the fund.
•• The best single measure of a fund’s financial health is the funded ratio,
defined as the ratio of fund assets to fund liabilities.
•• Various aspects of a fund’s mission can come into conflict with one
another.
•• The primary conflict is between reducing volatility in the funded ratio
and contributions versus keeping the costs of financing benefits low.
•• Plan liabilities equal the present (or discounted) value of all future ben-
efits expected to be paid to plan beneficiaries.
•• The most important variable in calculating liabilities is the discount rate:
The value of liabilities is inversely related to the discount rate.
•• The set of directives determining the amount and timing of payments to
beneficiaries is called “benefits (or spending) policy.”
•• The timing and amount of contributions to a fund are determined by a set
of formal and informal rules called “funding policy.”

Questions Molly Should Ask

•• When was the last time the mission for our DB fund was thoroughly
reviewed? For our DC fund? For our endowment fund? What was the
outcome of these reviews?
•• Whom do we consider the primary stakeholders for the funds for which
our investment committee has responsibility? How do we engage the
stakeholders and understand their perspectives?
•• How is funding policy and benefits policy set for our various funds? Who
are the parties responsible for these policies, and how do we interact with
them?
•• Are any significant changes anticipated regarding benefits policy or fund-
ing policy for any of our funds?

© 2017 CFA Institute Research Foundation. All rights reserved.  47

A Primer for Investment Trustees

•• How do we define the liabilities for our various funds, and how do we
assess their funded status?

The DB fund
•• What range in the funded ratio do we feel comfortable with for our DB
plan? By how much should the funded ratio be allowed to fall below 1.0?
How sensitive are we to fluctuations in its level?
•• What is the current funded ratio of the DB plan, and how has it fluctu-
ated over time?
•• How do the trustees view the conflict between benefits security and lower
funding costs for our DB plan?
•• How sensitive are our DB liabilities to changes in the discount rate?
•• Does the university have sufficient resources and liquidity to make con-
tributions to our DB fund if the funded ratio should fall below a mini-
mum threshold?
•• Is the DB plan open to new participants? If not, have benefit accruals
been frozen for current participants? If the plan is closed to new partici-
pants and new benefit accruals, how has that status redefined the Fund’s
mission?
•• Do we have strategies in place to protect the DB plan’s funded ratio from
fluctuations in liability values caused by interest rate changes?

The endowment fund

•• How are liabilities defined for the endowment fund?
•• How is the mission of the endowment fund defined? What considerations
have gone into making those decisions?
•• What are the projected net cash flows of the endowment fund? Do fund-
raising efforts provide material cash inflows?
•• What expectations do the university’s financial managers have regarding
the endowment fund’s spending rate?
•• How does the investment committee interact from an investment pol-
icy standpoint with the decision makers who set the endowment fund’s
spending policy?

48 © 2017 CFA Institute Research Foundation. All rights reserved.

Session 4. Investment Objectives

You must have long-range goals to keep you from being frustrated by short-
range failures.
—Charles C. Noble
Molly, we now want to take the next step by declaring what the investment
committee intends its investment program to accomplish—that is, what sort
of investment outcomes would signal that the program has been successful.
The trustees express those outcomes in a set of investment objectives.

Criteria for Effective Investment Objectives

The Fund’s investment objectives contain both prospective and retrospective
elements. In a prospective sense, the Fund’s investment objectives assist in
defining the structure of the investment program. The investment staff stays
mindful of the established investment objectives when it implements the asset
allocation policy and selects managers. The Fund’s mission, on the one hand,
provides a high-level sense of direction. The Fund’s investment objectives,
on the other hand, offer considerably more detail than the Fund’s mission
about the path that the investment committee expects the staff to follow. The
objectives provide specific guidance regarding the critical trade-off between
expected reward and risk that is reflected in the Fund’s investment policy.
In a retrospective sense, the Fund’s investment objectives play an impor-
tant role in the assessment of the investment program’s results. The Fund’s
investment objectives are part of the feedback-and-control mechanism
embedded in the performance evaluation process. If the investment program
fails to achieve the Fund’s investment objectives, then it loses credibility,
which, in turn, may bring about changes; if the investment program suc-
ceeds in achieving the Fund’s investment objectives, then current practices
are reinforced.
Whereas the Fund’s mission involves a set of broad purposes, the
Fund’s investment objectives are a quantifiable set of investment results that
the investment committee expects to achieve over specified time periods.
Therefore, effective investment objectives meet several criteria. They should be
•• unambiguous and measurable,
•• specified in advance,
•• actionable and attainable,

© 2017 CFA Institute Research Foundation. All rights reserved.  49

A Primer for Investment Trustees

•• reflective of the investment committee’s risk tolerance, and

•• consistent with the Fund’s mission.
Let’s consider each of these criteria.
Unambiguous and Measurable. Simply put, the investment commit-
tee attempts to be clear about what it expects the staff to accomplish when
investing the Fund’s assets. Therefore, the trustees develop unambiguous and
measurable goals. Subjective or difficult-to-measure objectives typically result
in confusion and are open to conflicting interpretations. In the end, they are
often ignored, to everyone’s consternation. For example, statements such as
“the fund should generate returns commensurate with the risk assumed” are
of little value in selecting investments or in determining whether the invest-
ment results were indeed satisfactory. These types of objectives fall under the
category of “do good and avoid evil.” Obviously, no one can argue with their
positive intent, but they are more aspirational than practical.
In contrast, investment objectives expressed in clearly defined terms, par-
ticularly relative to a specified benchmark, help the staff design an effective
investment program and allow the investment committee to evaluate the
program’s performance. For example, one of the Fund’s investment objectives
is to add (after fees) 100–200 basis points (bps) annually of active management
value while taking no more than 300–400 bps annually in aggregate active
management risk in the public equity asset class, evaluated over a five-year
period. (One basis point is 1/100 of 1%, so 200 bps equals 2%.) The staff can
clearly comprehend and discuss this objective and measure results relative to it.
The objective strongly influences how the staff constructs the lineup of
equity managers. It obviously necessitates hiring active managers for at least
a large portion of the fund’s equities, and it also requires relatively aggressive
active managers for that portion. In addition, the objective affects the alloca-
tions to individual managers within a portfolio of managers. Furthermore, as
the staff analysts prepare performance evaluation reports for the investment
committee, they structure those reports to provide information as to what the
Fund’s public equity managers have done relative to this objective and why
the desired outcome has or has not occurred.
Specified in Advance. The investment committee defines the Fund’s
investment objectives in advance of the time period over which the invest-
ment program is to be held accountable for meeting those objectives. To do
otherwise would run the risk of revisionist analysis, a truly dangerous activity
from a governance standpoint. Whether it is the investment committee
critiquing the investment staff or outsiders evaluating the decisions of the

50 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 4. Investment Objectives

trustees, investment objectives defined after the evaluation period has ended
are contentious and fundamentally unfair. The process of investing, because
it produces measurable results, is always subject to unconstructive second-
guessing, regardless of what preventive practices the trustees put into effect. It
thus makes little sense for the trustees to compound the problem by delineat-
ing one set of expected outcomes prior to the investment activity taking place
and then holding the staff responsible for other outcomes not communicated
until later. Molly, you certainly realize that, although all decision makers have
a responsibility to be aware of changes in the environment and recommend
modifications when necessary, in the conduct of business affairs, you don’t
instruct someone to do A and then wonder why he or she didn’t do B.
Actionable and Attainable. The investment committee sets actionable
and attainable fund investment objectives. The staff must be able to influence,
in some way, the outcomes that are being evaluated in light of the objectives.
Investment objectives that cannot be acted upon produce frustration and a
sense of powerlessness on the part of the staff. Instead of being an incentive to
drive the investment program in a particular direction, those types of objec-
tives can generate a bunker mentality with staff members fearful that they
will be held accountable for results over which they have no control.
At many organizations, investment objectives come stated in the form of
absolute return targets, which in many cases, are not actionable. Consider a
common defined-benefit plan objective: Earn a return in excess of the liabil-
ity discount rate of 8%. Rarely are investment products available that offer a
guaranteed fixed return of 8%. Still, over the very long term, that objective
might appear attainable. With sufficiently aggressive investments in equities,
an investment program could have achieved that result over certain past time
periods. There have also been many extended periods, however, when the
capital markets simply did not produce returns of that magnitude. In those
periods, that absolute return target was not actionable. Nothing the staff at
those funds could do would have achieved that goal.
Investment objectives expressed relative to investable benchmarks, such
as a market index, are more likely to be actionable. (We will talk more about
benchmarks in Session 8.) Superior active management programs, for exam-
ple, can be expected to outperform appropriate benchmarks regardless of the
market environment. Thus, assigning a realistic return objective to active
managers should allow the staff to focus on hiring the most productive man-
agers. Staff members can feel confident that if they do their jobs effectively,
the intended result can be achieved.
The trustees should design investment objectives for the Fund that also
are attainable. Although an investment objective involving a return relative

© 2017 CFA Institute Research Foundation. All rights reserved.  51

A Primer for Investment Trustees

to a particular benchmark might be actionable, to state that the Fund’s active

managers should produce active results 500 bps above the benchmark is unre-
alistic. In setting attainable investment objectives, the trustees should review
what other comparable investment programs have been able to accomplish
and what the capital markets and investment managers have offered investors
over varying time periods.
Attainable investment objectives also avoid unrealistic precision. The
investment committee prefers objectives involving a range of desired out-
comes as opposed to a single numeric target. Such a range better captures the
trustees’ understanding of the variability inherent in investment management.
Reflective of the Investment Committee’s Risk Tolerance. The
Fund’s investment objectives should reflect the risk tolerance of the trustees
in pursuing the Fund’s mission. The investment committee must be comfort-
able with the investment objectives that it establishes. As a trustee, Molly, you
need to understand the amount of risk those objectives will lead the invest-
ment program to take. Investment objectives that translate into an aggressive
investment program may produce uncomfortable results in periods of poor
market performance. You have to be able to tolerate those results. Suppose
the investment objective calls for high positive real rates of return and thus a
large allocation to equities. If the trustees decide after a period of significantly
negative returns in the stock market that they cannot bear the risk, the con-
sequences will be counterproductive. They will likely sell at a low point in the
market and preclude the opportunity to benefit from a future rebound.
Consistent with the Fund’s Mission. The investment committee has
designed the Fund’s mission to be consistent with the trustees’ collective risk
tolerance. Because the investment objectives should also reflect that level of
risk tolerance, it follows that if the Fund achieves its investment objectives,
the Fund’s mission will similarly be fulfilled. At first, that logic might seem
obvious, but it is quite easy to end up with investment objectives that convey
different messages from what one might understand from a fund’s mission.
For example, suppose a fund’s mission strongly emphasizes maintaining a
funded ratio at or above 100% with little tolerance for volatility in that ratio.
Establishing an investment objective that involved taking considerable risk in
the pursuit of returns higher than those necessary to maintain full funding
would be inconsistent with that fund’s mission.

Examples of Investment Objectives

To give you a sense of what constitutes viable investment objectives and
what does not, we have provided in Exhibit 1 some examples of what other

52 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 4. Investment Objectives

Exhibit 1. Examples of Investment Objectives

Investment Objective Comment Assessment

Achieve an investment return in Actionable and attainable by use of active Good

excess of the policy asset mix’s management. Consistent with the trustees’
return over a five-year time willingness to bear risk and the fund’s mission.
period. Unambiguous. Specified in advance.
Generate active management Actionable and attainable by use of active Good
performance in excess of an management. Consistent with the trustees’
appropriate benchmark over a willingness to bear risk and the fund’s
five-year time period. mission. Unambiguous. Specified in advance.
Maintain a funded ratio (assets/ Appropriate for funds in which liabilities or Good
liabilities) in excess of 0.9 expected fund outflows have been specified
measured annually. (e.g., DB plans, insurance companies).
Actionable and attainable so long as the
fund has access to sources of contributions.
Unambiguous. Specified in advance.
Realize investment performance Pertains primarily to endowments and Good
that allows annual spending or foundations. Based on the idea that fund
fund withdrawals to equal or beneficiaries have an aversion to declines in
grow relative to the prior year’s benefits.
spending.
Maintain projected investment Acknowledges the existence of different Good
risk consistent with investment types of investment risk and a policy to
policy specifications. incur certain ones, in approved amounts.
Actionable and attainable.
Outperform the returns of the Ambiguous and not actionable (median fund Poor
median fund in a peer group is unknown); possibly inconsistent with the
universe. trustees’ willingness to bear risk or the fund’s
mission.
Attain return equal to or greater Possibly achievable over a long time period Poor
than the actuarial rate of return. but certainly not annually.
Attain return equal to or greater Unlikely to be attainable; possibly Poor
than the S&P 500 Index + 3%. inconsistent with the trustees’ willingness to
bear risk.
Incur no negative investment Achievable only with low-risk, low-return Bad
performance years. investments, which is likely to be inconsistent
with the fund’s mission and investment
policy.
Attain US Consumer Price Not actionable. No such investable alternative Bad
Index + 3% exists. Purely aspirational.
“Beat Harvard.” Not actionable (Harvard’s investment policy Bad
and process are not known). Not necessarily
consistent with the trustees’ willingness
to bear risk or the fund’s mission. Purely
aspirational.

© 2017 CFA Institute Research Foundation. All rights reserved.  53

A Primer for Investment Trustees

organizations have used. Some of the examples are valid investment objec-
tives. Other examples, despite being widely accepted, actually violate many of
the criteria for acceptability.

Takeaways
•• A fund’s investment objectives are a quantifiable set of investment results
that decision makers believe are achievable over specified time periods.
•• Investment objectives play both a prospective and retrospective role in
directing the investment program.
•• A fund’s investment objectives should be unambiguous and measurable,
specified in advance, actionable and attainable, reflective of decision mak-
ers’ risk tolerance, and consistent with the fund’s mission.
•• The most useful investment objectives generally are those expressed rela-
tive to an investable alternative (such as a market index).
•• Investment objectives are best specified as a range of desirable outcomes
as opposed to a single number.

Questions Molly Should Ask

•• What are the Fund’s investment objectives? When were they last
reviewed?
•• If the investment objectives are attained, do we expect that the Fund’s
mission will likewise be achieved?
•• Are the investment committee and staff satisfied that all of our invest-
ment objectives meet the criteria of being actionable and attainable?
•• What investable benchmarks are used in expressing the investment
objectives?
•• Have there been times in the past when poor performance or turbulent
markets caused the trustees to question the Fund’s investment objectives?
Discuss those situations.
•• Has the investment committee modified the investment objectives over
time to reflect changes made to the investment program? If so, describe
those changes.
•• Are the Fund’s investment objectives consistent with the trustees’ collec-
tive risk tolerance?

54 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 4. Investment Objectives

•• Do the Fund’s investment management strategies (e.g., policy asset allo-

cation, active versus passive management) appropriately reflect its invest-
ment objectives?
•• Are the Fund’s investment objectives integrated into the reporting for
purposes of performance evaluation?
•• How has the investment program performed relative to the Fund’s invest-
ment objectives?

© 2017 CFA Institute Research Foundation. All rights reserved.  55

Session 5. Investment Risk Tolerance

I think we should follow a simple rule: If we can take the worst, take the
risk.
—Dr. Joyce Brothers
Novice investors commonly focus on returns and give only passing con-
sideration to risk. Even sophisticated investors are prone to this myopia at
times. Molly, you’ve probably observed this phenomenon simply by reading
mainstream financial press reports reviewing investment results at year-end.
These articles highlight the star performers and invariably display the top
managers’ performances only in terms of rates of return. The stories make
no reference to the amount of risk the managers took in the pursuit of those
stellar outcomes.

Returns Are Only Half the Story

Let’s first distinguish between actual and expected returns. Actual returns
are a tangible, after-the-fact number. The trustees and staff can clearly see the
effect of actual returns as they periodically examine the Fund’s asset state-
ment and observe changes in the Fund’s value. Expected returns represent the
projected future values of the Fund’s various investments. These future values
have a range of potential outcomes. Investment risk describes that range of
possible future values. Expected return is an intangible, before-the-fact idea.
The impact of risk on the Fund can be only vaguely discerned by observing
the volatility of actual returns over time. Nevertheless, at the end of any given
measurement period, the Fund has one and only one value, and that value was
generated by the Fund’s actual return, regardless of what the range of possible
values was before the measurement period. In that sense, we actually experi-
ence returns but we only forecast risk.
Yet, in fulfilling your duties as a trustee, you need to recognize that risk
plays a much more important role than do returns. Actual returns are the
past; risk is the future. The investment committee can attempt to influence the
direction of the Fund only in the future, not in the past. Benjamin Graham,
the father of security analysis, once said, “The essence of investment manage-
ment entails the management of risk, not the management of returns.” The
trustees can’t control the Fund’s returns, Molly, but it is your responsibility to
manage risk by ensuring that robust investment policies and processes are in
place, with proper controls, accountability, oversight, and reporting.

56 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 5. Investment Risk Tolerance

Types of Investment Risk

From the trustees’ perspective, risk involves the possibility of not achieving
the Fund’s mission or, equivalently, not being able to provide the Fund’s ben-
eficiaries with the benefits they expect or have been promised. The Fund and
the trustees face various forms of risk that might affect the Fund’s ability to
accomplish its mission—to name just a few, funding risk, operational risk,
legal risk, regulatory risk, and reputational risk. In this session, we will focus
on only one category: investment risk.
The ways investment risk is defined and experienced depend on a fund’s
mission. The mission of a public defined-benefit (DB) fund that is partially
funded and open to new participants differs from that of a corporate DB fund
that is fully funded and closed to new entrants. The missions of both DB
funds, in turn, differ from the mission of an endowment fund for an institu-
tion with growing programs needing financial resources in inflation-adjusted
terms. All of these funds face the same opportunities in the investment mar-
kets, but each will view its mission differently and have a different perspective
on investment risk.
Risk to the public DB fund involves equity market outcomes that pre-
vent the high returns needed to fill the funding gap. Risk to the corporate
DB plan involves the mismatch of the interest rate sensitivity of the assets to
that of the liabilities. Risk to the endowment fund involves the possibility of
steep long-term losses that permanently impair assets and prevent the fund-
ing anticipated for designated programs.
The investment committee has chosen to bear certain risks purposely
because it expects to earn a return commensurate with the uncertainty in
outcomes caused by those risks. The trustees have attempted to identify and
minimize other risks, those for which they expect to receive no reward.
The investment risks to which the trustees intentionally expose the Fund
fall into three primary categories:
•• Capital market risk
•• Active management risk
•• Liquidity risk
First, capital market risk arises because investing in the capital markets
(e.g., the stock and bond markets) brings with it an uncertainty in returns
caused by a common sensitivity of the markets to broad economic events.
When the economy is doing well, all risky financial assets tend to ben-
efit to some degree, and the opposite occurs when the economy is doing
poorly. Because, as a whole, investors in the capital markets cannot avoid

© 2017 CFA Institute Research Foundation. All rights reserved.  57

A Primer for Investment Trustees

this sensitivity, they will hold risky assets only if they are paid to do so. The
investment committee expects that the markets will reward long-term inves-
tors who bear this capital market risk.
The second risk that the investment committee expects to be rewarded
for bearing is active management risk. We introduced this type of risk in our
discussion of governance structure in Session 1. The term refers to the uncer-
tainty of a manager’s performance relative to the manager’s benchmark. We’ll
talk more about passive and active management in our next session, but for
the moment, recall that on the one hand, passive managers expect to gener-
ate performance roughly equal to that of their benchmarks. Active manag-
ers, on the other hand, produce returns that are different (either positively
or negatively) from their benchmarks’ returns. The difference in a manager’s
performance from that of the benchmark is referred to as “active manage-
ment return.” The trustees are willing to incur the uncertainty associated with
this active management return because they believe that the staff can identify
managers with investment skill who will generate, over time, performance in
excess of their benchmarks. (Many investment committees have come to the
opposite conclusion and forgone active management.)
The third compensated source of investment risk is liquidity risk. For
example, the Fund invests in various forms of private equity that are similar
to the Fund’s common stock investments in many respects, but the private
equity holdings are much more illiquid. The investment committee invests in
private equity partly because the trustees believe that the market will pay an
incremental return to investors willing to take the chance that they will not be
able to quickly convert the value of their private equity investments into cash.
Other investment risks create uncertainty in the Fund’s investment per-
formance, but for those risks, the investment committee does not expect any
return as compensation. For example, if the staff is not careful how assets
are allocated to the investment managers, they may introduce a “style bias”
(i.e., an unintended concentration of assets in a particular investment strategy,
such as small-company growth stocks) that can have a material impact on the
Fund’s returns in a particular asset class. Because this concentration is unin-
tentional, the Fund has no reason to expect to be rewarded for bearing that
risk. As a consequence, the investment committee has directed the staff to
minimize exposures to this style bias risk and other forms of uncompensated
risk as cost-effectively as it can.

Measuring Risk
How do we quantify risk? Some practitioners don’t even try. They contend
that investment risk is too dynamic and subtle a concept to summarize

58 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 5. Investment Risk Tolerance

numerically. They prefer to rely on intuition, experience, and rules of thumb

to control investment risk. The Lurinberg University Investment Committee
has directed the staff to attempt to define risk quantitatively, although the
committee members realize the inherent difficulties of doing so and thus
never blindly rely on numerical estimates. However, whether one uses a
qualitative process, a quantitative process, or a mix of the two doesn’t matter.
What is crucial is that the process be structured, comprehensive, and proac-
tive rather than ad hoc, narrow, and reactive.
The investment staff’s risk quantification process begins with an estima-
tion of the distribution of potential returns for the investments under con-
sideration. That distribution describes the range and associated probabilities
of various outcomes. Typically, the staff uses historical return information to
provide the starting point for estimating this return distribution. From there,
the staff calculates the distribution’s standard deviation, which measures the
size of fluctuations around the distribution’s most likely, or expected, value.
High-risk investments tend to be more volatile than low-risk investments and
will have a wider dispersion of outcomes (hence, a larger standard deviation).
For a normal (bell-shaped) distribution, the standard deviation fully describes
the dispersion of the return distribution and is a key descriptor of invest-
ment risk.
For example, consider an investment in common stocks compared with
an investment in government bonds. Stocks may conceivably lose their entire
value, but they may also increase several multiples in value. US government
bonds, however, although they may decline in value in the near term because
of increases in interest rates, will never explicitly default—or at least we hope
not. Similarly, although government bonds may temporarily rise in value
because of a fall in interest rates, they will never return more at maturity
than their principal value. One need only look at the history of equity mar-
ket returns versus government bond returns over virtually any multidecade
time frame to see the periods (sometimes months, sometimes many years) of
sharp losses on common stock investments and the much more muted loss
experiences for government bonds. As a result, government bonds are less
risky than common stocks; the standard deviation of common stock returns is
greater than the standard deviation of government bond returns.
Of course, what the staff is really looking for is a measure of the size
and frequency of potential losses, especially large losses, not simply a measure
of volatility. Certainly, there are numerous conceptual problems involved in
using standard deviation as the measure of risk. Indeed, you should be skepti-
cal, Molly, of any single statistic used to summarize risk. For example, you
should question whether investment returns are normally distributed; if not,

© 2017 CFA Institute Research Foundation. All rights reserved.  59

A Primer for Investment Trustees

standard deviation could be a poor gauge of risk. The returns on some types
of investments, such as options, most certainly are not normally distributed.
One can make the case that returns on even such “plain vanilla” invest-
ments as stocks and bonds are not normally distributed. Moreover, standard
deviation doesn’t differentiate between upside and downside results; it only
measures volatility, and volatility per se is not risk. Still, despite its flaws, for
largely practical reasons, standard deviation has long maintained its place as
a primary risk metric. Virtually all the reports you will see from investment
managers and the staff will use standard deviation as the most common risk
measure.
Risk involves the chance of loss taken with the hope of earning an
acceptable profit. More precisely, risk incorporates both the probability and
the magnitude of potential loss. Some practitioners, therefore, express risk
by using both standard deviation and a measure of the size of the investment.
The combination of the two factors is used to create a risk metric called “value
at risk” (VaR), which indicates the amount that the investor might lose, at a
minimum, with a given probability (e.g., a 5% chance of losing at least a quar-
ter of the value of the portfolio over a given time period).
The staff also estimates risk by conducting stress tests that evaluate the
potential impact of adverse investment environments on the Fund’s invest-
ments. Other practitioners focus on more intricate measures of risk that char-
acterize the return distribution in complex ways, but those measures are well
beyond what we can cover in this session.

Relationship between Risk and Expected Return

As you are probably aware, risk and expected return tend to go together. That
is, investments with high risk levels will typically have high expected returns.
Why? Well, it is generally assumed that investors as a group tend to prefer
less risk to more risk for the same expected return. Molly, suppose you were
asked to choose between an investment with a guaranteed 8% return and one
with an expected 8% return but a chance to earn between 4% and 12%. Most
likely, you’d take the certain return. You probably can be enticed to own risk-
ier investments only if you anticipate earning higher returns. You would give
up the guaranteed 8% return only if the risky investment had an expected
return higher than 8%.
It makes sense that this relationship should hold true. That is, if investors
truly dislike risk, then the greater the potential for loss associated with the
risky investment, the more return investors will demand (or expect) in order
to hold that security or a portfolio of those securities. Notice we don’t say
that the greater the potential for loss, the more return investors will earn. If a

60 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 5. Investment Risk Tolerance

riskier investment always earned a greater return, then it wouldn’t be risky.

So, the extra reward on a risky investment has to be prospective, and the pos-
sibility must exist that the extra payoff may not actually occur.
This relationship between risk and expected return is observed when
we examine actual (historical) capital market returns. Asset classes with
higher standard deviations (such as common stocks) actually have earned
higher returns over reasonably long periods of time than have asset classes
with lower standard deviations (such as government bonds). In any given
month or year, bonds can and do outperform stocks, sometimes by consid-
erable margins, but when we look at returns over decades, we see that the
capital markets have rewarded taking on risk.

Managing Risk through Diversification

There are ways to directly insure some types of investments against certain
types of losses, but this insurance involves paying a hefty premium. A much
cheaper and simpler technique to protect against risk is diversification—
building a portfolio out of investments whose returns do not move in the
same direction at the same time (i.e., whose returns are not highly positively
correlated).
The old saying, “Don’t put all your eggs in one basket,” alludes to the
wisdom of diversification. Suppose you have two assets, A and B, with the
same expected return and the same risk. If their returns don’t always move in
lockstep, then the combination of the two has the same expected return but a
lower risk than either one of the two assets individually. Bad things happen-
ing to Asset A tend to be offset at the same time by good things happening to
Asset B, and vice versa. Adding uncorrelated asset classes to a fund tends to
reduce the fund’s risk. For this reason, many funds include real estate, com-
modities, distressed bonds, and so on, in addition to stocks and bonds in their
investment programs. Finding and managing low-correlated or uncorrelated
asset classes is not simple and has numerous potential pitfalls, but the benefits
can be substantial.
Diversification has been referred to as the one “free lunch” in investing.
Of course, after the fact, it will turn out that one asset had a higher return
than the others, so if you had known that outcome in advance, you wouldn’t
have diversified. In that sense, the lunch isn’t really free. But as noted, when
we began this discussion, investment management is about managing risk,
not managing return.
As a trustee, Molly, you should assure yourself that the Fund takes full
advantage of available diversification opportunities. You should inquire
about concentrated allocations to particular asset classes or even individual

© 2017 CFA Institute Research Foundation. All rights reserved.  61

A Primer for Investment Trustees

investments and question the assumptions behind those decisions. When the
staff requests to add new asset classes, you should ask whether the staff has
considered how those investments correlate with the Fund’s existing invest-
ments and whether their addition improves the Fund’s diversification.
But beware on two counts. First, many asset classes display a low correla-
tion with one another in normal economic environments. When the market
climate turns sour, however, some of these asset classes actually experience
high correlations—perhaps all going down at once, thereby producing neg-
ligible diversification benefits. For example, in economic expansions, high-
yield debt acts like other bonds; in recessions, it acts more like equity, which
severely diminishes its diversification value. As a result, there is a saying that
“the only things that go up in a down market are correlations.” Still, govern-
ment bonds usually do go up in value in a down market for stocks because
government bonds are perceived as “safe havens.” It is important, therefore,
not to overlook this “boring, old-fashioned” asset class.
Second, some asset classes that appear to be good diversifiers involve con-
siderable costs, in terms of both management and transaction expenses, and
they may also be illiquid. The benefits of the diversification they offer can be
outweighed by the cost drag on investment returns.
Diversification offers a simple and generally low-cost means of manag-
ing investment risk. It requires no special knowledge of the trustees’ col-
lective risk tolerance or the Fund’s investment objectives. As a result, it is
a widely used risk control procedure. However, many funds have deployed
more sophisticated techniques of managing their risk levels while targeting
expected returns. Those methods have become widely referred to as “risk
budgeting.”

Risk Budgeting
The ability to bear risk is a scarce resource in the same way that capital (i.e.,
money) is a scarce resource. Thus, risk should be allocated to investments
that offer the greatest expected return for the amount of the resource (risk)
invested. The investment committee budgets, or allocates, capital to vari-
ous investments. The same amount of capital can be invested in a six-month
US T-bill or a venture capital fund with considerably different consequences
for the Fund. As a result, you can see that the trustees are allocating more
than simply dollars; they are really allocating risk. The idea of risk budgeting
requires quantifying the risk of various types of investments and combina-
tions of investments. This process allows the trustees, staff, and other advisers
to use a common language, or metric, for allocating risk, measuring whether

62 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 5. Investment Risk Tolerance

too much or too little risk has been allocated, and comparing actual results
with expectations.
The risk-budgeting process allows an evaluation beforehand of how much
individual-security risk to allow, how much capital to give any one manager,
how much of the portfolio to hold in particular asset classes, and so on. Risk
budgeting permits an analysis of the trade-offs in terms of risk and expected
returns among available portfolio choices. The amount of risk budgeted to
any particular investment (e.g., an asset class or a manager) should have a
close relationship to the expected return on that investment. Indeed, part of
the value added by a risk management program is to help frame investment
decisions in terms of the return required to justify taking on a particular type
of risk.
Risk budgeting involves the use of quantitative risk models that provide
insight regarding allocations to asset classes, managers, and even individual
investments. Inputs into these models include estimates of the standard devi-
ations of the available asset classes, the correlations among those asset classes,
and the returns expected to be produced by those asset classes. The output
of a risk model is a set of allocations to asset classes and/or managers within
asset classes with risks and potential rewards consistent with the trustees’
preferences.

Investment Risk Tolerance

We have taken a roundabout way to get to the subject of this session—namely,
investment risk tolerance. Perhaps the most important part of managing risk
is the human element. The markets are unpredictable in unpredictable ways.
There will always be more unknowns and chaos to confound us. Molly, your
risk tolerance as a trustee reflects your willingness to handle the ups and
downs of markets and their impact on the Fund. High risk tolerance doesn’t
mean you can watch market volatility without emotion. Rather, it means that
in those periods when markets are volatile and serious losses are occurring,
you are likely to be confident that the capital markets do reward patient risk
takers over the long run. Low risk tolerance implies that you are uncomfort-
able with market volatility and would prefer to forgo higher expected returns
in exchange for more predictability and reduced chances of serious losses.
We should first make an important distinction between risk tolerance and
risk capacity. The term “risk capacity” refers to the financial ability of a fund
to withstand adverse investment returns. What level of negative outcomes
could cause a fund to become impaired to such an extent that its mission
would be put in jeopardy? Risk capacity is an objective, measurable concept.
The term “risk tolerance” is a much more subjective concept. It indicates how

© 2017 CFA Institute Research Foundation. All rights reserved.  63

A Primer for Investment Trustees

risk averse the trustees are, which is a function of the collective willingness
of the trustees to experience bad outcomes. Investment committees of some
funds may find that their risk tolerance leads them to protect against adverse
returns at a level that the funds could actually handle financially. More of a
problem is the situation where the trustees have greater risk tolerance than
the funds can financially accommodate.
Why is investment risk tolerance important? As we discussed, expected
returns are directly related to risk. The higher the returns that the invest-
ment committee targets for the Fund, the more risk the Fund will have to
incur. The trustees implement their decisions primarily through their choice
of the Fund’s policy asset mix. Consultants and the staff can offer you and
the other trustees advice regarding the risk level needed to achieve the Fund’s
investment objectives. In the end, however, only the trustees can establish
the appropriate risk level for the Fund and only the trustees collectively must
be able to tolerate that risk level. If in a time of calm market conditions, the
investment committee sets a risk level for the Fund that is inconsistent with
what the members can actually tolerate when adverse market conditions
arrive, then bad decisions will invariably be made at the worst possible times.
When market volatility hits the Fund and significant losses occur, the trust-
ees don’t want to fall victim to fear and propose reducing risk at the wrong
time. To sell at the bottom, out of an inability to contemplate further losses,
simply locks in those losses and makes it much less likely that the Fund can
recover.
Molly, you should understand the difference between your personal risk
tolerance and the investment committee’s risk tolerance. Your own invest-
ment time horizon and financial situation undoubtedly differ from those of
the Fund. As a trustee, you must be able to set aside your personal concerns
and focus on what is best for the Fund over the long run. Consequently, it is
likely that the risk level that the investment committee assigns to the Fund
will differ from what you would apply to your personal portfolio, whether
that involves more or less risk in the Fund than in your portfolio.
We can’t easily specify investment risk tolerance. As a trustee, you may be
asked to provide opinions as to the maximum volatility in the Fund’s returns
that you would accept or the maximum loss that you might be willing to
experience over a year or multiyear period. Aggregated across the investment
committee, the answers help convey a sense of how much risk the trustees
will bear. In the final analysis, however, no formula can determine the trust-
ees’ collective risk tolerance and the associated “right” policy asset mix to
achieve the Fund’s investment objectives. The staff and the consultants will
portray the range of investment outcomes associated with any particular asset

64 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 5. Investment Risk Tolerance

strategy, but it is up to the trustees to imagine how they, as a group, would

feel in a market crisis and, more importantly, to imagine how they should—or
shouldn’t—react.

Takeaways
•• Trustees often focus on returns and fail to consider the risk involved in
generating those returns.
•• A fund’s decision makers purposely take on certain investment risks with
an expectation of receiving a positive return over time. A fund’s primary
compensated investment risks are capital market risk, active management
risk, and liquidity risk.
•• Additional risks for which there is not an expected return can have a
material impact on an investment program. These risks should be identi-
fied and minimized, but it may not be possible to completely eliminate
them.
•• Quantifying investment risk usually begins with an examination of his-
torical returns and a calculation of the dispersion (often expressed as the
standard deviation) of the distribution of those returns.
•• Higher expected returns are associated with higher risk. Investors need
to be compensated for bearing more uncertainty with an expectation of
realizing higher returns.
•• The simplest and cheapest way to manage risk is through adequate
diversification.
•• Asset classes whose returns display low or zero correlations are attrac-
tive because, when combined, they enhance diversification and reduce a
fund’s risk.
•• The ability to bear risk is a scarce resource that should be managed
carefully.
•• Risk management is like any other management process: It involves
thinking about what might happen and what to do if bad things happen.
•• Some fund sponsors manage risks through formal risk budgeting, which
involves evaluating the trade-off between risk and expected return of var-
ious combinations of investments. The evaluation leads to an allocation
of the portfolio among various risky investments to achieve the highest
expected return for a targeted level of risk.

© 2017 CFA Institute Research Foundation. All rights reserved.  65

A Primer for Investment Trustees

•• Risk capacity measures the financial ability of a fund to withstand adverse

outcomes.
•• Risk tolerance indicates an investor’s willingness to bear losses in the pur-
suit of higher returns.
•• A fund’s decision makers need to be able to set aside their personal con-
cerns and arrive at a collective risk tolerance for the fund that is consistent
with the fund’s mission and investment objectives.

Questions Molly Should Ask

•• What risks do I face as a fiduciary for the Fund?
•• What are the most important risks faced by the Fund? Who is respon-
sible for managing each of them? What are we doing (or not doing) to
mitigate those risks?
•• How does the Fund’s mission influence our view of investment risk?
•• Do we have an established process for identifying, quantifying, and man-
aging investment risk?
•• Who on the investment staff is responsible for our risk management
efforts?
•• How are historical data used to form risk-and-return expectations for
various asset classes? How are the asset classes likely to perform in vari-
ous environments?
•• Do we engage in any formal type of risk budgeting? If so, what is that
process? If not, why not?
•• Does our risk management focus only on the Fund’s assets, or does it also
take into account the Fund’s liabilities?
•• Given the current investment policy, how much could the Fund lose in a
“worst-case” scenario?
•• What market events could cause serious liquidity concerns for the Fund?
•• In what areas of the investment program, if any, do we purposely concen-
trate our investments, and what is the rationale for doing so?
•• Do we feel that we have explored all cost-effective diversifying
investments?

66 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 5. Investment Risk Tolerance

•• Do we have an understanding about how the asset classes in our pol-

icy asset mix will correlate with one another during stressful market
environments?
•• Is there a regular risk report to the investment committee that discusses
each risk and the management/mitigation process?
•• How do the Fund’s consultants contribute to the risk management
process?
•• Have we considered the risk capacity of our Fund?
•• What types of discussions and studies have been carried out by the trust-
ees, the staff, and the consultants to determine the investment commit-
tee’s collective risk tolerance?
•• What was the reaction of the investment committee during recent peri-
ods of severe market volatility?
•• Is there general agreement among the trustees that the level of risk in the
Fund is consistent with the Fund’s mission and investment objectives?
Where has there been disagreement?

© 2017 CFA Institute Research Foundation. All rights reserved.  67

Session 6. Investment Assets

Know thy opportunity.

—Pittacus
The Lurinberg University Investment Committee has chosen to invest the
Fund in a variety of asset types. As we discussed in Session 2 on investment
policy and Session 5 on investment risk tolerance, we refer to those asset
types as “asset classes.” Asset classes are simply collections of securities that
have common attributes. Although the distinctions among asset classes are,
admittedly, somewhat arbitrary, the designation of asset classes helps the
trustees and the staff develop intelligent approaches to setting the Fund’s
policy asset mix and the Fund’s risk level. The trustees do not (and should
not) deal with decisions involving individual securities. Instead, they address
issues at a higher policy level. Without asset class distinctions, conversations
among the trustees and the staff about how to implement the investment pro-
gram would be cumbersome and unproductive.

Types of Investment Assets

Broadly speaking, the investment committee has authorized investments in
three primary asset classes: common stocks (also called “equities”), bonds (also
called “fixed income” or “debt”), and so-called alternative investments. In the
simplest of worlds, we could argue that the trustees’ most important asset
allocation decision boils down to a choice of how much to invest in equities
versus fixed income. However, the various types of equities and fixed-income
instruments available to investors have important nuances. So, the trustees
have further broken down these two classes into additional asset classes. For
example, the Fund holds the common stocks of companies located across
the globe—in countries with well-developed capital markets and those with
maturing markets. Some investors distinguish between the stocks of compa-
nies domiciled in their own (home) countries and those located outside their
home countries. Similarly, bond holdings can be segregated into government
and corporate securities and further classified by home or nonhome country.
The corporate securities can be further divided into investment-grade bonds
and high-yield bonds. Trustees at other funds may use even finer distinctions
in the equity and fixed-income asset classes.
Recall that Appendix B contains the Lurinberg University defined-benefit
fund’s investment policy statement and provides an example of the various
asset classes in which the investment committee has authorized the staff to

68 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 6. Investment Assets

invest. We won’t have time in this session to consider each asset class (although
we will discuss alternative investments in more detail later), but you can find a
description of the Fund’s asset classes in most standard investment textbooks.

Diversifying across Asset Classes

The investment committee’s primary investment strategy is to diversify widely
among risky assets. As discussed in the previous session, diversification offers
a cost-effective and simple means of controlling risk. The Fund does not
invest in only one security. It invests in a portfolio of securities. The staff does
not retain only one investment manager. The staff hires a group of investment
managers using multiple investment approaches. And the managers do not
invest in only one type of stock or bond. They invest across a wide spectrum
of financial securities—from publicly traded stocks and bonds to a variety of
less liquid investments that we categorize as alternative investments.
The Fund’s potential investable universe of publicly traded equities
includes common stocks with sufficient trading volume to qualify for inclu-
sion in major global indexes. That adds up to literally many thousands of secu-
rities. The Fund’s investment managers will never own most of these stocks.
For various reasons, such as size, liquidity, and lack of freely tradable shares,
a considerable portion of these stocks are not actually investable. Thus, the
managers have to contend with an opportunity set that is much smaller than
the potential universe.
The manner in which the staff approaches the Fund’s investments in pub-
licly traded bonds is quite similar to how it handles investments in publicly
traded stocks. There are, however, subtle but important differences. Most
notable is, as you know, the fact that stocks are issued by corporations but
bonds are issued not only by corporations but also by a wide variety of other
organizations, including, to name a few, governments, agencies of govern-
ment, and not-for-profit institutions. In addition to the many entities, there
are numerous types of fixed-income securities that any one entity can issue.
Whereas corporations typically issue only one type of common stock, the
many entities that issue bonds can also issue many different types of bonds or
fixed-income securities—backed (or not) by certain assets, maturing at differ-
ent times, and with their own terms and conditions.

Market Indexes
To understand the breadth and performance of the investable stock and bond
universes, the trustees and staff turn to market indexes that represent the pub-
licly traded equity and fixed-income markets. These indexes identify a large
number of investable stocks and bonds that are representative of a particular

© 2017 CFA Institute Research Foundation. All rights reserved.  69

A Primer for Investment Trustees

market. A security’s weight in the index is typically based on its market capi-
talization (share or bond price times number of shares or bonds outstanding)
as a percentage of the total market capitalization of all the securities in the
index. Inclusion in an index is most often determined by an objective set of
rules, but the decision is sometimes also subject to the discretion of a selection
committee.
Perhaps the primary advantage of a market index is that it provides a per-
formance history. By observing the returns earned by the index in the past,
the trustees and staff get an indication of the risks and returns of the mar-
ket that the index represents and the correlations of that market with other
investments. As we noted in Session 5, this historical information is valuable
in developing the risk-and-return expectations used in setting a risk budget
for the investment program. The indexes also represent important account-
ability standards for assessing the Fund’s performance, as we will discuss in
Session 8.
For your convenience, Exhibit 2 provides a list of commonly used equity
and fixed-income market indexes and their key characteristics. As you can
see, in selecting an index to represent the Fund’s investments in a particular

Exhibit 2. Sample of Widely Used Market Indexes

Asset Class Representative Benchmark Description
Public equity
US equity • S&P 500 Index 500 blue-chip, mostly large-cap US stocks
• Russell 2000 Index 2,000 small-cap US stocks
• Russell 3000 Index Largest 3,000 US stocks by market cap
(large, mid, and small)
Non-US, developed- • MSCI World ex US Index Approximately 85% of the market cap of
market equity 22 developed equity markets, excluding the
United States
• MSCI EAFE Index Same as above but excluding Canada
Emerging-market MSCI Emerging Markets Approximately 85% of the market cap of
equity Index 22 emerging equity markets
Global equity MSCI All Country World Combines developed- and emerging-
Index market equity indexes (including the
United States)
Fixed income
Core fixed income Bloomberg Barclays Capital Investment-grade, government-sponsored,
Aggregate Bond Index corporate, mortgage-backed US bonds
and other asset-backed securities issued in
US dollars
(continued)

70 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 6. Investment Assets

Exhibit 2. Sample of Widely Used Market Indexes (continued)

Asset Class Representative Benchmark Description

High yield Bloomberg Barclays High Debt securities issued by US corporations

Yield Cash Pay Index rated lower than investment grade by one
or more of the major rating agencies
Emerging-market • J.P. Morgan Emerging Dollar-denominated debt securities issued
debt Markets Bond Index by emerging-market countries
Global
• J.P. Morgan Government Local-currency-denominated debt securi-
Bond Index—Emerging ties issued by emerging-market countries
Markets
Global sovereign Citigroup World Sovereign bonds (all investment grade)
debt Government Bond Index issued by 23 developed countries
TIPS Bloomberg Barclays Capital All inflation-linked bonds issued by the
US TIPS Index US Treasury
Alternative investments
Real estate • F TSE EPRA/NAREIT All real estate investment trust (REIT)
Developed Index securities issued in developed markets in
North America, Europe, and Asia
• NCREIF Property Index A noninvestable index that tracks
unlevered returns on more than 6,000 US
properties held by institutional investors in
the office, retail, industrial, and apartment
sectors
Private equity • Cambridge Associates US A noninvestable index based on return data
Venture Capital Index compiled on funds representing more than
three-quarters of the total dollars raised by
venture capital managers since 1981
• Cambridge Associates A noninvestable index based on return data
Buyout Index compiled on funds representing more than
two-thirds of the total dollars raised by
leveraged buyout, subordinated debt, and
special situations managers since 1986
Absolute return • HFRX Global Hedge A noninvestable, non-value-weighted index
Fund Index of liquid, transparent hedge fund separate
accounts engineered to achieve representa-
tive performance of a larger universe of
hedge fund strategies
• HFRI Fund of Funds A noninvestable equally weighted index of
Composite Index more than 800 hedge funds of funds
Notes: HFR = Hedge Fund Research; NCREIF = National Council of Real Estate Investment
Fiduciaries; MSCI = Morgan Stanley Capital International; TIPS = Treasury Inflation-Protected
Securities. All indexes are market-cap weighted unless indicated otherwise.

© 2017 CFA Institute Research Foundation. All rights reserved.  71

A Primer for Investment Trustees

asset class, the investment committee has a variety of choices. The market
indexes selected by the investment committee to represent the Fund’s asset
class investments are called the “asset class targets.” These asset class targets
serve as the overall benchmarks for the Fund’s investment results in each
asset class.
To examine how a particular asset class target is selected, let’s look at
the Fund’s publicly traded equity investments as an example. The investment
committee could adopt only one index, such as the MSCI All Country World
Index, as a benchmark for all tradable stocks in accessible global markets, or it
could treat these markets as separate asset classes and select one market index
for the Fund’s home country (in this case, the United States) and one or more
for non-home-country stocks.
There is no one right answer. You’ll find a variety of approaches at vari-
ous funds. With the increasing globalization of investments, many funds have
decided simply to refer to global equities in their policy asset mixes. As you
can see in Appendix B, the policy asset mix chosen by the investment com-
mittee displays a combination of asset class targets for the home-country and
non-home-country equity investments.
The trustees’ rationale for this approach was their familiarity with the
home-country equity market and the long history of investment performance
available for these particular market indexes, which allows a good under-
standing of their risk-and-return characteristics. The investment committee
may revisit that decision in the future.

External and Internal Investment Management

After the investment committee establishes a structure for the Fund’s public
equities and fixed-income investments, the trustees need a strategy to imple-
ment the Fund’s investments. Who will manage the investments and how the
investments will be managed are two important questions.
Regarding the first question, the Fund’s investments can be managed
externally or internally. That is, the investment committee can instruct the
staff to hire outside professional investment management firms or it can
employ an on-site staff of investment professionals operating under the chief
investment officer (CIO). Most funds use external investment managers to
some degree to manage their assets, and many have all of their assets man-
aged externally. The Lurinberg University Investment Committee has chosen
this latter approach. There are solid reasons to use internal investment man-
agement, primarily related to lower cost and more direct investment control.
Those advantages are typically offset, however, by fewer degrees of freedom in
making investment management changes and the large size of assets required

72 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 6. Investment Assets

to acquire top investment talent cost-effectively. (Of course, if trustees use an

outsourced chief investment officer [OCIO] solution, the question of internal
versus external management is moot. The OCIO will select managers exter-
nal to the fund sponsor.)
Employing external investment managers requires the investment com-
mittee to seek skillful external investment organizations. One of the down-
sides of using external managers is that their organizations change over time.
Individuals come and go, and the organizations themselves undergo changes,
sometimes being acquired by other investment management firms, sometimes
even dissolving. This dynamic marketplace requires constant monitoring to
ensure that the Fund’s interests are protected. The investment staff spends a
considerable amount of time on manager monitoring; the staff often asks the
Fund’s consultant to assist in the process.
The staff monitors the Fund’s managers carefully, but it also seeks to avoid
manager turnover. The staff recognizes that hiring and firing managers is
expensive, time-consuming, and typically unproductive. The staff maintains
clear policies, which it periodically reviews with the investment committee,
regarding criteria for hiring managers and procedures to dismiss them. The
staff maintains a high threshold for both actions.
Of course, internal investment managers also come and go. Therefore, all
funds that use internal management face the challenge of competing in the
marketplace for qualified investment management talent. The compensation
for internal managers is often too high for funds to accept on a staff level.
Furthermore, internal investment management requires considerable technol-
ogy infrastructure and back-office support. In the end, external managers are
typically no cheaper, yet most funds prefer to pay external managers, who are
also easier to dismiss than internal managers if performance is unacceptable.

Active and Passive Management

Directly related to the question of who will manage the Fund’s investments
is the issue of how the investments should be managed. In a broad sense, the
investment committee has two choices. First, it could instruct the manager
to invest the assets passively. That is, the manager could be directed to hold
a portfolio designed to match the performance of a particular market index.
This process is referred to as “indexing.” For example, the trustees could
instruct the manager simply to match (or “index to”) the performance of a
market index representing the publicly traded equities asset class.
Indexing is a simple, low-cost form of investment management.
Essentially, the manager holds all or most of the securities contained in the
market index in the same proportions as the securities are held in the index.

© 2017 CFA Institute Research Foundation. All rights reserved.  73

A Primer for Investment Trustees

A manager cannot match the performance of the index exactly for a variety
of reasons, including trading costs and management fees. Nevertheless, pas-
sive management offers the promise that the Fund’s investment results will
always be near those of the selected market index, with little variation around
the index return. In exchange for this consistency of results, of course, the
trustees can never expect the passive manager’s results to exceed the returns
reported for the market index by any appreciable amount.
Alternatively, the investment committee can direct the staff to hire active
managers assigned to outperform particular benchmarks. (We will discuss
benchmarks in Session 8. For the moment, you can think of a manager
benchmark simply as a market index.) To produce this outperformance, the
managers must hold portfolios that differ in composition from their bench-
marks. Of course, underlying the use of active managers is the assumption
that the managers’ investment processes can identify investment opportuni-
ties that will produce a positive excess return relative to their benchmarks.
An active manager’s decisions will not always be correct; as a result,
returns above and below the benchmark will be greater (perhaps much
greater) than will those of a passive manager. Although the staff can give the
manager instructions regarding how much volatility relative to the benchmark
the staff will accept, this risk is an unavoidable part of active management.
Furthermore, active manager fees generally exceed fees charged by passive
managers by considerable amounts, and that difference represents a major
hurdle that active managers must clear if they are to surpass passive manag-
ers’ performance results after all fees and expenses are taken into account.
The use of active management in an asset class requires a series of beliefs
on the investment committee’s part. The trustees must believe that
•• managers exist who can produce a positive excess return relative to an
appropriate benchmark,
•• the decision maker hiring the managers (the trustees, staff, or OCIO) can
identify these managers,
•• the decision maker can hire these managers to manage the Fund’s assets,
•• the trustees have the risk tolerance to endure extended periods of time
when the managers underperform their benchmarks, and
•• the decision maker can structure a team of these managers to reach the
Fund’s investment objectives.
The decision to hire active managers in a particular asset class requires
the trustees to answer “yes” to all of these belief statements. A “no” answer to

74 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 6. Investment Assets

any of the statements implies that the Fund should not engage in active man-
agement in that asset class. By implication then, passive management ought
to be the default position where it is available. (Some asset classes, such as
private equity, can be accessed only through active management.)
Regarding the last belief statement, Molly, note that we could have a
team of value-added active managers yet not achieve the investment objective
of outperforming the asset class target. Such an outcome would occur if the
aggregate performance of the active managers’ benchmarks is different from
the Fund’s asset class target. For example, if the Fund’s asset class target for
publicly traded equities is a broad equity market index and if the staff has
hired only one active manager and that manager’s benchmark is an equity
value index, then the manager may outperform its benchmark but underper-
form the Fund’s asset class target. (In Session 5, we referred to this mismatch
between the managers’ benchmarks and the asset class target as “style bias.”)
The point is that the staff must ensure that the implementation of the invest-
ment program is consistent with the Fund’s investment objectives and policy
asset mix.

Separate Accounts and Commingled Funds

The investment committee must also determine in what type of account
the Fund’s assets will be managed—either a separately managed account or
a commingled fund. A separately managed account is legally owned by the
Fund and managed solely in the Fund’s interests. Typically, a bank trustee
holds custody of the assets. The manager makes investment decisions sub-
ject to investment guidelines established by the investment committee. Both
the bank and the manager maintain valuation and accounting records of the
account, which serves as an important check in the Fund’s governance process.
Furthermore, the flow of money into and out of a separately managed
account can occur only with the approval of the trustees or the staff. Most
importantly, a separately managed account can implement investment guide-
lines that are unique to the Fund. For example, the trustees might want to
restrict investment in certain stocks, such as tobacco stocks or stocks in par-
ticular countries, conditions that the manager can accommodate in a sepa-
rately managed account.
In a commingled fund, the Fund’s assets are combined with assets of
other investors. The manager invests the commingled assets in a particu-
lar manner that is described in a legal document. The Fund does not hold
shares of individual stocks; instead, it holds units in the commingled fund,
which represent a pro rata share of all the commingled fund’s investments.
Mutual funds provide a familiar example of a commingled fund. In addition

© 2017 CFA Institute Research Foundation. All rights reserved.  75

A Primer for Investment Trustees

to mutual funds, there are other types of commingled funds, such as bank
collective trust funds and unit trusts.
Many managers require high minimum balances for separate accounts,
but relatively small amounts of money can be invested in commingled funds.
The primary advantage of a commingled fund is that it allows small investors
to have access to top investment talent and resources at a reasonable cost.
Even for large funds, in some situations (e.g., investments in countries with
developing capital markets), commingled funds offer a much cheaper invest-
ment vehicle than other vehicles. The main disadvantage is the inability of the
investor in a commingled fund to customize the portfolio to the individual
fund investor’s unique needs and circumstances.

Alternative Investments
In addition to investing in publicly traded stocks and bonds, the investment
committee has chosen to invest in a variety of less liquid asset classes, col-
lectively referred to as “alternative investments.” The underlying investments
represent various forms of equities and fixed income or hybrids of the two.
Some of the more prominent types of alternative investments include the
following:
•• Real estate—equity and mortgage interests in various forms of commer-
cial and residential properties, including office buildings, hotels, storage
facilities, shopping malls, and apartments.
•• Commodities—investments in agricultural products, metals, and energy
sources (such as crude oil) through futures or cash market purchases.
•• Timber—ownership of land and/or harvesting rights for various species of
lumber products.
•• Venture capital—investments in early- and late-stage startup companies.
•• Buyouts—investments in private companies undergoing spinoffs, recapi-
talizations, or other forms of restructuring.
•• Distressed debt—purchases of the debt of financially troubled companies,
often with the intent of gaining control of the companies in a bankruptcy
proceeding.
•• Mezzanine debt—purchases of the junior, unsecured, non-publicly-traded
debt of companies.
•• Hedge funds—investments in and across a variety of asset classes exploit-
ing market inefficiencies identified by the manager and often using lever-
age, short selling, and derivative financial instruments.
76 © 2017 CFA Institute Research Foundation. All rights reserved.
 Session 6. Investment Assets

Funds have a few opportunities to access these alternative investments

through public markets (e.g., publicly traded real estate investment trust
[REIT] shares). Generally, however, the Fund makes its alternative invest-
ments through legal structures known as “limited partnerships.” A business
entity called a “general partner” (GP) raises financial commitments from a
group of limited partners (LPs), of which the Fund is one. The GP man-
ages the assets of the partnership. The LPs agree to supply a fixed amount
of capital that must be “called” by the GP for investment within a certain
time period.
During that investment period, the GP searches for attractive investment
opportunities and, when it finds them, calls capital from the LPs. The GP
manages the investments until it believes the appropriate time for harvest-
ing has arrived, at which point the investments are sold and the proceeds are
distributed to the LPs. (A prominent exception is hedge funds, which are not
intended to be dissolved but, rather, to continue to operate indefinitely; the
LPs take their money out by selling their shares back to the GP or a third
party.) The GP is compensated through management fees and a share of any
profits realized in the transactions. The ownership interests in the LPs are not
publicly traded and are transferable only with considerable effort.
The Fund’s ownership interests in alternative investments are highly illiq-
uid. The illiquid nature of these investments creates potential benefits but
also concerns. On the benefit side are higher expected investment returns.
As we discussed in our previous session, all other things being equal, inves-
tors generally require a higher return from an illiquid investment than from a
liquid one. To the extent that the Fund does not have to be fully invested in
liquid assets, these alternative investments provide an opportunity to improve
the Fund’s expected return by investing a portion of its assets in illiquid
investments.
Alternative investments also hold the promise of higher returns because
of a less efficient market for the underlying investments. For example, many
investors believe that once an issuer of debt runs into financial difficulty, hold-
ers of the bonds tend to sell them at significantly discounted prices. Skillful
managers of distressed-debt funds contend that they can identify when the
bonds are trading at unduly depressed prices, buy them, and then later sell
them as the troubled issuer’s finances and business organization are restruc-
tured. Each type of alternative investment offers reasons why skillful and
knowledgeable investors ought to earn a premium.
Alternative investments do, however, have their drawbacks. Managers
of these investments charge high fees and share substantially in any profits
earned, thereby driving down expected net returns to investors. It may also be

© 2017 CFA Institute Research Foundation. All rights reserved.  77

A Primer for Investment Trustees

difficult to gain access to the top-tier managers, whose funds are often closed
to new investors. We find the dispersion of investment results among alterna-
tive investment managers to be far wider than is the case with managers of
publicly traded securities.
Moreover, the values of these investments are typically reported at
appraisal values with a considerable time lag, which tends to understate the
actual investment risk. As a result, other methods are needed to assess the
risk-and-return characteristics of these investments and to determine how
they fit into the investment program.
Another concern is the difficulty of establishing appropriate accountabil-
ity standards. There is often little transparency regarding the GPs’ investment
strategies, which hinders potential investors from performing due diligence
on the GPs. Furthermore, in the Fund’s publicly traded stock and bond
investments, market indexes and submarket indexes serve as useful bench-
marks for the investment managers. Unfortunately, comparable benchmarks
are not readily available for the alternative asset classes. In place of indexes,
many funds use comparisons with peer groups formed from “similar” invest-
ments. (For reasons that we will discuss in Session 8, peer group comparisons
can be problematic.) As a result, it is often difficult to demonstrate that alter-
native investments add value to our Fund after adjusting performance for fees
and risk incurred.
A final note on alternative investments: We view our hedge funds as con-
centrated doses of active management. Unlike the Fund’s other alternative
investments (e.g., real estate or venture capital), hedge funds don’t represent
an asset class so much as an investment strategy within or across certain
types of asset classes. Hedge funds “hedge” (avoid) unwanted sources of
capital market risk, which allows their returns to be driven largely by active
management decisions. For example, the manager of the Fund’s long–short
equity hedge fund identifies attractively and unattractively valued common
stocks. By owning the undervalued stocks and selling short the overvalued
stocks, if done in the “correct” proportions, the manager hedges away the risk
of broad stock market movements and earns returns based on the manager’s
stock-picking skill. Other hedge fund managers pursue more complex invest-
ment strategies. The staff has difficulty identifying appropriate benchmarks
for these managers and incorporating their active management risk into the
Fund’s risk budget.

Fees and Expenses

Molly, you will exercise little influence over the outcome of most aspects of
the Fund’s investment program. Markets move in ways that are inherently

78 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 6. Investment Assets

unpredictable. A key element of the Fund’s investment performance over

which you actually do exert considerable control, however, is the issue of fees
and expenses. As an investment trustee, you have the responsibility for seeing
that the Fund’s investments are managed in the most cost-effective manner
possible. Although the staff maintains direct day-to-day control of the invest-
ment program, the trustees receive regular reports not only on the overall
investment performance of the Fund but also on how much it costs to carry
out the program.
To highlight the significance of these charges, they are reported both
as a percentage of managed assets and in the amount of money paid out of
the fund. These expense reports break down fees and expenses by provider.
The staff works with the Fund’s consultant to benchmark the various provid-
ers’ fees and expenses relative to the Fund’s peers. This benchmarking pro-
cess recognizes that funds vary in terms of size, complexity, and investment
approach, which, in turn, affects the level of fees and expenses.
Investment managers, record keepers, custodian banks, consultants and
advisers, auditors, attorneys, and other third parties charge the Fund for per-
forming various services. The internal staff also represents an expense to the
Fund. Most, if not all, of these services are required to operate the invest-
ment program. Each category of fee or expense expressed as a percentage of
assets might seem small, perhaps well below 1% or even a tiny fraction of that
amount for certain types of expenses. Combined, however, the costs of these
services can add up to a surprisingly large percentage of the Fund’s assets.
When these costs are compounded over time, they can significantly reduce
the Fund’s net returns. For example, a 1% expense ratio applied for 50 years
amounts to about half of the fund’s value.
The investment committee works with the staff and the Fund’s consultant
to ensure that all the Fund’s fees and expenses are appropriate and correctly
calculated and that the various service providers are charging competitive
prices. Because of the emphasis on expense control, the trustees have incor-
porated a fee policy as part of the Fund’s investment policy statement. That
statement holds the staff accountable for following a disciplined approach to
achieving competitive costs for investment management services.
We emphasize an important caveat to end this discussion. Particularly
for active investment managers, the largest expense can be trading costs,
which are quite difficult to measure and benchmark. The staff works with the
Fund’s managers and the consultant to understand the Fund’s trading costs.
Nevertheless, the analysis varies in quality among managers and can be dif-
ficult for the trustees to decipher.

© 2017 CFA Institute Research Foundation. All rights reserved.  79

A Primer for Investment Trustees

Takeaways
•• Investors segment the universe of potential investment securities into
various asset classes. Those designations facilitate intelligent approaches
to managing a fund’s policy asset mix and establishing the fund’s risk
posture.
•• Market indexes represent particular asset classes, such as publicly traded
equities.
•• Market indexes are valuable in that they provide an indication of an asset
class’s historical risks, returns, and correlations with other asset classes.
•• Funds typically select certain market indexes to serve as asset class tar-
gets, which aid decision makers in setting their asset allocation policies.
•• Internal investment management may be cheaper than external manage-
ment and allows for more direct control of the investment process.
•• External management offers greater economies of scale than internal
management. Thus, external management allows fund sponsors access to
top investment talent and resources. It also typically allows more flexibil-
ity in changing managers, if needed.
•• Passive management (indexing) attempts to match, with low tracking
volatility, the returns on an assigned market index by holding all or most
of the securities in the index in similar proportions to security weights in
the index.
•• Active management involves holding portfolios that differ from an
assigned benchmark in an attempt to outperform that benchmark. The
variability in performance relative to the benchmark is called “active
management risk” or, for short, “active risk.”
•• The use of active management requires that a fund sponsor hold a series
of beliefs:
— Managers exist who can produce a positive excess return relative to
an appropriate benchmark.
— A fund’s decision makers can identify these managers.
— The decision makers can hire these managers to manage the fund’s
assets.
— The trustees have the risk tolerance to endure extended periods when
the managers underperform their benchmarks.

80 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 6. Investment Assets

— The decision makers can structure a team of these managers to

accomplish the fund’s investment objectives.
•• A separately managed account is legally owned by a fund and managed
solely in the fund’s interests.
•• In a commingled fund, assets of many investors are combined. Investors
in a commingled fund do not hold shares of individual stocks; rather, they
hold units in the commingled account, which represent a pro rata share of
the entire account.
•• Alternative investments are investments in nontraditional assets (i.e.,
other than publicly traded stocks and bonds), such as real estate, venture
capital, buyout funds, and hedge funds.
•• Alternative investments tend not to be readily tradable and come with
relatively high management fees and sharing of the fund’s profits between
the investor and the fund manager. In exchange, investors expect to
earn returns greater than those available through investments in publicly
traded asset classes.
•• Fees and expenses are material and controllable elements of a fund’s
investment results. They should be monitored by the trustees and bench-
marked against peers. Wherever possible, the services provided to the
fund should periodically be put out for competitive bid.

Questions Molly Should Ask

•• What asset classes has the investment committee designated for invest-
ment? Why do we categorize our investment opportunities as we do?
•• What role does each asset class play in our investment program?
•• How do we acquire the expertise to evaluate, invest in, and monitor new
asset classes?
•• What asset class targets have been selected? How were they chosen?
When did the investment committee last review those selections?
•• Have we discussed the merits of active and passive management as an
investment committee? Have we developed a position on each of the
active management belief statements?
•• Does the investment committee use predominantly active or passive man-
agement in certain asset classes? How was the decision reached regarding
the proportion of active versus passive management used in the Fund?

© 2017 CFA Institute Research Foundation. All rights reserved.  81

A Primer for Investment Trustees

•• What proportion of the Fund’s assets is managed internally? How was

the decision reached regarding the proportion of internal versus external
management?
•• Given the size and complexity of our investment program, are the costs of
running it reasonable? How do we determine “reasonableness”?
•• Does the staff have authority to hire and fire managers independent of
the investment committee? If not, how are the trustees involved in those
decisions?
•• Does the staff use our consultant to help select managers? If so, is
the Fund’s consultant independent with respect to the managers it
recommends?
•• What do we believe we gain by using alternative investments?
•• What considerations go into determining which types of alternative
investments the Fund should own?
•• What return and risk expectations do we have for our alternative invest-
ments, and how do they compare with the expectations for our publicly
traded investments?
•• What limits do we place on the illiquidity that our alternative invest-
ments bring to our investment program?
•• What is the size of the commitment made to alternative investments
that the Fund is obligated to invest but has not yet been called by the
managers?
•• How do we evaluate the potential introduction of a new asset class? What
considerations should be involved? Do we have the expertise to select and
monitor a new asset class?
•• How well do we understand the investment strategies pursued by our
hedge fund managers?
•• How do we evaluate the performance of our hedge fund managers?
•• What if a potential new asset class is without a long history? How does
that aspect affect our analysis?
•• What is the total amount of all fees and expenses incurred by the Fund
in a year relative to the value of the Fund’s assets (i.e., the Fund’s expense
ratio)? Do we break out those fees and expenses by service provider?

82 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 6. Investment Assets

•• Do the trustees receive a fees-and-expenses report on at least an annual

basis? May I see a copy of the latest report? How has the expense ratio
changed over time?
•• How do our fees and expenses compare with those of the Fund’s peers?
How often do we review the competitive nature of our fees with our ser-
vice providers?

© 2017 CFA Institute Research Foundation. All rights reserved.  83

Session 7. Defined-Contribution Plans

If you would be wealthy, think of saving as well as getting.

—Ben Franklin
Molly, as we discussed previously, Lurinberg University maintains a defined-
contribution (DC) plan for the benefit of its employees. The DC plan has
sufficient unique aspects that we thought it appropriate to set up a separate
session with you to discuss the oversight of that plan.
The DC plan provides an important source of retirement income for our
employees. Combined with our defined-benefit (DB) pension plan and Social
Security benefits, the DC plan allows our employees to build a solid base
of retirement income that should replace a high percentage of their working
years’ income for the rest of their lives. The university believes that establish-
ing these foundational sources of retirement income is one of the principal
obligations of a responsible employer. As a trustee for both the DB and the
DC plans, you have the obligation to see that the assets of these plans are
invested wisely.
The DC plan differs in design from the DB plan in several important
ways. The DB plan promises to pay lifetime monthly annuities to our employ-
ees upon their retirement. It can also make those payments to the employees’
spouses if they should outlive the retired employees. The size of the annuity is
based on the years that our employees have worked for the university and the
compensation that they received during that time.
In addition, employees are automatically enrolled in the DB plan after
working here for a prescribed period of time. They become entitled to the
benefit (i.e., the benefit vests) after they have worked for another specified
time period. The plan participants directly contribute nothing to the plan; the
university is solely responsible for funding the plan. (At some other employ-
ers, the participants are required to make contributions to the plan together
with the employers.) The university bears the responsibility and risks for
accumulating sufficient assets to pay the benefits promised to the participants.
The DC plan, in contrast, is a discretionary program that our employees
must actively elect to enroll in. If they do nothing, they will not participate
in the plan, despite being eligible. (Many employers automatically enroll their
employees and require the employees to opt out of the DC plan if they do
not wish to participate.) The participating employees determine how much
money to contribute to the plan. Up to a certain percentage of pay, the univer-
sity will also match those contributions. But if employees do not participate,

84 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 7. Defined-Contribution Plans

they do not receive matching funds. (Some employers contribute to their DC

plans regardless of whether the employees put in any money. But even in
those plans, the employees must take action if they wish to make their own
contributions.)
The DC plan participants determine how their contributions and those
made by the university are invested. In doing so, they select from a set of
investment options established by the trustees. Instead of receiving an annu-
ity upon retirement, the participants have account balances from which they
can withdraw money to fund their retirements. The size of their account bal-
ances will depend on how much they (and the university) have contributed
and what those contributions earn over the time the funds are invested in the
plan. As a result, the participants bear the investment risk in the DC plan.
The differences between the DC and DB plans affect how you as a trustee
approach the oversight of the two plans. That being said, the basic principles
of an investment trustee still apply to overseeing the DC plan’s investment
program. For example, we care about the governance, investment policy, and
performance evaluation, but the emphases within those topics differ between
the DB and DC plans.
Why? The primary reason is that the asset allocation of the DC plan is
controlled by the plan participants—or, more properly, each participant sets
the asset allocation for his or her part of the plan. The trustees set the invest-
ment options from which the participants may select, but in the final analy-
sis, it is the risk preferences, saving behavior, and investment decisions of the
individual participants that determine the outcome of each employee’s own
DC investment program. As discussed, for the DB plan (and the endowment
fund, for that matter), the trustees’ decisions regarding investment policy,
together with the DB funding and benefits policies of the university, primar-
ily determine the outcome of the investment program.
Of the six topics that we have visited so far, we will focus on three in
distinguishing oversight of the DC plan from that of the DB plan and the
endowment fund. Those topics are investment policy, fund mission, and
investment assets.

Investment Policy for the DC Plan

In our previous discussion of investment policy, we spent considerable time
on the policy asset mix of the Fund. We pointed out how a well-conceived
and consistently applied policy asset mix that accurately reflects the risk toler-
ance of the investment committee is the primary driver of successful invest-
ment outcomes. The DC plan has no single policy asset mix. Participants in
the plan select their own asset allocations on the basis of their unique risk

© 2017 CFA Institute Research Foundation. All rights reserved.  85

A Primer for Investment Trustees

tolerances and evaluation of the available investment options. Molly, as much

as you as a trustee might believe that an asset mix is appropriate for certain
demographic groups of participants, you have no direct control over the
participants’ choices. Only through the set of investment options that you
provide to participants do you exercise indirect control over their asset mix
decisions. We will talk more about determining that group of investment
options momentarily.
What is investment policy for a DC plan? Effectively, it reflects the
approach that the investment committee takes when designing the set of
investment options to be made available to the plan participants. The follow-
ing questions are among those that may arise:
•• What types of fund structures (such as retail mutual funds or institu-
tional collective investment trusts) should be offered to plan participants?
•• Should both active and passive funds be made available?
•• Should only well-diversified investment options (such as funds that com-
bine investments in various types of equity and fixed-income assets into
one option) be offered so that participants will, effectively, be required to
hold diversified investments?
•• Or should only funds that have specific investment mandates (such as
long-term fixed income or large-company equities) be offered and the
participants encouraged to build their own diversified portfolios by allo-
cating among the single-mandate investment options?
•• Should a combination of these two types of options be offered?
•• How many investment options should be available?
•• Should participants be allowed to select investments outside the standard
plan options (i.e., have a so-called brokerage window)?
Making these decisions creates the opportunity set for plan participants.
The choices will ultimately determine the terminal values of their accounts
and hence their retirement income. So, these decisions are not insignificant.
As with our DB plan and our endowment fund, the trustees have prepared
a written investment policy statement (IPS) for the Lurinberg University
DC plan that reflects their collective positions regarding important aspects
of the DC plan’s investment program. It is included here as Appendix C. It
is a relatively abbreviated version of the statements developed for the other
funds because the asset allocation decisions are borne by the participants in a
DC fund. In addition to the approach that the trustees take toward selecting

86 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 7. Defined-Contribution Plans

investment options (as in its counterparts for the DB plan and endowment
funds), the DC plan IPS lists the policies that the trustees have adopted
toward selecting and evaluating investment managers, assigning appropriate
benchmarks, and so on.

The Fund’s Mission for the DC Plan

The Fund’s mission for the university’s DC plan is simple. It contains none of
the potential conflicting elements of the DB plan. The mission of the Fund for
the plan is to provide a set of high-quality, cost-effective investment options
that allow plan participants to build a solid retirement income base, subject to
their own risk preferences and investment objectives. In establishing this set
of investment options, the trustees follow three broad themes:
•• Focus—each investment option must pursue a consistent, clearly defined
investment strategy that is understandable by unsophisticated investors.
•• Diversification—each investment option, as a standalone investment,
must be sufficiently diversified that plan participants, if they chose only
that option, would not be at serious risk of unsustainable investment
losses because of a relatively small segment of the capital markets experi-
encing distress.
•• Low cost—the investment options must offer the lowest expenses compat-
ible with a high-quality investment program.

Investment Assets in the DC Plan

The central themes that constitute the mission of the DC plan have led the
committee to several principal conclusions regarding the types of investments
that should be offered to plan participants. In keeping with the desire to pro-
vide investment options with a clear and consistent focus that also charge the
lowest possible expenses, the committee decided wherever possible to make
only passive management options (index funds) available to our plan partici-
pants. The trustees believe that the vast majority of DC plan participants do
not have the investment sophistication necessary to choose, first, between
passive and active management and, then, choose among active managers. By
offering only index funds, the trustees believe they are appropriately simplify-
ing the investment decision for participants. The offerings expose participants
to the broad market factors that are the primary influence on investment
returns.
The trustees have also decided to offer both (1) highly diversified invest-
ment options that span a broad range of asset types and (2) more focused

© 2017 CFA Institute Research Foundation. All rights reserved.  87

A Primer for Investment Trustees

investment options that hold only one type of asset (e.g., inflation-protected
bonds). Given the value that the committee places on diversification, the
investment committee has urged staff to develop education programs that
emphasize the need to have a well-diversified portfolio of investments and to
encourage participants to choose the multiasset investment options. (A popu-
lar type of multiasset investment option, and one selected by the investment
committee, is target date funds. Participants select a fund corresponding to
their anticipated retirement date. The risk of a target date fund decreases over
time as the target retirement date approaches.) Nevertheless, the investment
committee wants to allow knowledgeable participants to emphasize certain
asset types in their accounts if they so wish. So, the trustees have made avail-
able the options that focus on one asset class.
The trustees have also considered how many investment options to offer
participants. When both highly diversified, multiasset options and single-
mandate options are offered, the number of options could exceed 15, but
the trustees are aware that too many choices can paralyze a decision maker.
Therefore, the trustees keep the number of options to the minimum needed to
cover the primary investment asset classes.
The trustees have directed the staff to search out the lowest-cost invest-
ment vehicles for each investment option. In many cases, those options are
collective investment trusts (a form of commingled fund), which tend to be far
cheaper than retail mutual funds. These trusts are created by financial insti-
tutions and typically offer the same strategies as comparable mutual funds
but at lower costs. Investment management fees for passive products have
come down considerably in recent years. In addition to aggressively seeking
out low-cost providers, the staff negotiates to obtain the lowest costs for plan
participants.
Finally, the investment trustees do not have direct responsibility for
determining various plan features (e.g., how much the university matches par-
ticipants’ contributions). That responsibility belongs to the university admin-
istration. Nevertheless, the trustees have encouraged the plan administrator
to consider various plan enhancements that help persuade participants to
increase their DC plan savings. For example, the trustees have endorsed auto-
matic enrollment of all employees in the DC plan and automatically increas-
ing their contribution percentages by small amounts each year. Showing
participants what their account balances translate into, in terms of lifetime
income streams, gives participants a realistic perspective on retirement-fund-
ing adequacy. Research has shown these “nudges” to be extremely effective in
terms of increasing participation and level of savings. Of course, participants
are still free to decline those plan features and ignore the messaging.

88 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 7. Defined-Contribution Plans

Takeaways
•• DC retirement plans differ in meaningful ways from DB plans, which
affects how investment trustees conduct oversight of the two types of
plans.
•• In a DC plan, employees and/or the employer contribute money to the
plan and the investment results are tracked separately for each participat-
ing employee. The accumulated invested value in a participant’s account is
available (net of taxes) for spending in retirement.
•• In contrast to a DB plan, for DC plan investments, the employer makes
no promises about how much money will ultimately be held in the
account. Effectively, the participants bear all the investment risk.
•• Because DC plan participants typically can choose how their account
balances are invested, the set of investment options made available to par-
ticipants is the primary investment policy decision made by investment
trustees.
•• Regarding those investment options, trustees must develop investment
policy positions with respect to active and passive management, the
amount of diversification in the options, and the number of options.

Questions Molly Should Ask

•• Do we have a separate investment policy statement for our DC plan? If
not, why not? If so, may I have a copy?
•• How knowledgeable do we believe our plan participants are when it
comes to making investment decisions?
•• How do we decide whether to offer actively managed versus passively
managed investment options to participants?
•• How do we determine which types of investment options are appropriate
for participants?
•• How do we go about determining the managers for the various invest-
ment options?
•• What types of investment vehicles do we use to deliver the investment
options?
•• What is our process for considering changes to our investment options?
•• What is the process for ensuring that our fees are competitive?

© 2017 CFA Institute Research Foundation. All rights reserved.  89

A Primer for Investment Trustees

•• What types of educational guidance do the plan administrators provide

to participants?
•• What types of automatic default features have the plan administrators
built into the DC plan’s design?
•• Which management and administrative expenses are borne by the plan
participants and which expenses are borne by Lurinberg University?

90 © 2017 CFA Institute Research Foundation. All rights reserved.

Session 8. Performance Evaluation

He who would search for pearls must dive below.

—John Dryden
How is the Fund performing? That’s a simple and seemingly obvious ques-
tion, Molly, which undoubtedly you’ll want to ask at your first investment
committee meeting. That question is open to different interpretations, how-
ever, and as a result, you’ll probably receive a wide variety of answers. Before
you can make any sense of those answers, you’ll want to familiarize yourself
with some of the key concepts that underlie investment performance evalua-
tion. The investment committee likes to phrase those concepts in the form of
several questions:
•• Why is performance evaluation important?
•• How should performance be measured?
•• How is performance judged to be good or bad?
•• What caused the observed performance?
•• Is the performance the result of luck or skill?
•• What should be done with all this performance information?

The Importance of Performance Evaluation

From the trustees’ perspective, performance evaluation is important because
it assists in exercising appropriate oversight of the investment program. It
provides a regular assessment of how the Fund is performing relative to estab-
lished investment objectives. When conducted properly, performance evalua-
tion offers a valuable “quality control” that not only describes the investment
results of the Fund and its constituent parts relative to objectives but also
explains the sources of that relative performance. The sources of investment
performance can, and should, be directly linked to decisions relating to the
Fund’s investment policy and investment strategies.
Performance evaluation helps reinforce the hierarchy of accountability,
responsibility, and authority in the Fund’s governance structure. Investment
managers have accountability, responsibility, and authority for investment
decisions relating to the securities they hold in their portfolios. Similarly, the
Fund’s staff, perhaps together with the Fund’s consultant, has responsibil-
ity, accountability, and authority for decisions relating to the allocation to

© 2017 CFA Institute Research Foundation. All rights reserved.  91

A Primer for Investment Trustees

investment managers and asset classes. Ultimately, you and the other trustees
have accountability, responsibility, and authority for the decisions relating to
long-term performance of the entire investment program.
Performance evaluation enhances the effectiveness of the Fund’s invest-
ment program by acting as a feedback-and-control mechanism. It identifies
and focuses on the program’s strengths and weaknesses. It assists in reaf-
firming a commitment to effective investment policies, strategies, processes,
people, and organization. Moreover, performance evaluation provides a
demonstration that a successful investment program is being conducted in
an appropriate and effective manner. In addition, it helps direct attention to
poorly performing operations.
Molly, you’re busy with your day job and don’t have time to familiar-
ize yourself with every aspect of Lurinberg University’s investment decision
making. So, you may have difficulty in your trustee role of assessing the effec-
tiveness of the Fund’s investment program. Properly presented, performance
evaluation should help point you to the right questions regarding the invest-
ment program and assist you in taking corrective action when necessary.

Performance Measurement
At its most elementary level, performance evaluation requires measuring
investment results, which leads to the question of what metric to use. A rea-
sonable first response might be to focus on changes in the value of the Fund.
Is there more or less money in the Fund at the end of the period than at the
beginning? The investment committee certainly needs to pay close attention
to the Fund’s asset balance. However, because the trustees have limited con-
trol over the timing and amount of contributions to and withdrawals from the
Fund, the change in its value fails to provide an accurate indicator of how its
investments are performing. The staff could be doing a superior job of invest-
ing the Fund’s assets while the value of the Fund has declined because of
large withdrawals and a lack of recent contributions. Alternatively, the staff
could be doing a poor job of investing the Fund’s assets while its value has
increased because of a large contribution and a lack of withdrawals.
Because the change in the value of the Fund is not necessarily a good
measure of investment performance, what metric should be used? The invest-
ment community typically uses rate of return as the metric to measure invest-
ment performance. The rate of return calculates the percentage increase or
decrease in the value of the Fund after removing the effects of various non-
investment-related changes.
However, things are not quite that simple. There are different methods
of calculating rates of return. During your investment committee meetings,

92 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 8. Performance Evaluation

you will hear mention of time-weighted rate of return (TWR) and money-
weighted rate of return (MWR). We don’t need to go into the math behind
calculating these rates of return, but it would be helpful for you to understand
why these different rates of return are used. The concise explanation is that
the appropriate use of these methods depends on who controls the timing and
size of money flows into and out of an investment account. Importantly, all
of our return measures are stated after accounting for all fees and expenses
incurred by the investment program.
The staff reports the TWR when the investment manager has little or no
control over the flow of external funds into and out of the manager’s account.
It effectively measures the rate of return as if $1 were invested in the account.
That $1 is deposited at the beginning of the period and left to grow or shrink
according to the investment results alone, with no money subsequently put
into or taken out of the account during the period.
In most cases, the investment committee has delegated to the staff con-
trol of the amount of money to be entrusted to an investment manager and
the time period over which the investment manager will manage those assets.
Typically, when a manager is hired, the staff decides how much money to give
the manager and when to make contributions and withdrawals. For various
reasons, the staff may choose to withdraw money from or add money to the
manager’s investment account. If so, the timing and amount of money flow-
ing into and out of the manager’s account should not affect the calculation of
the rate of return. Hence, the TWR is the appropriate performance measure
in this situation (as it also is in the case of measuring the performance of the
entire Fund).
Contrast these circumstances to an investment with a private equity
manager. The staff makes a commitment to invest a certain amount of money
with the manager over a particular period of time. When the manager identi-
fies an attractive investment opportunity, the manager makes a call on the
Fund for a portion of the money that the Fund has committed. In this case,
the manager determines the timing and amount of the investment contribu-
tion. The manager also controls when and how the investment proceeds are
returned to the Fund. Because the investment manager has control of contri-
butions and withdrawals, the staff reports the MWR.
We can think of the MWR as the average growth rate of all dollars
invested in the manager’s account. If a contribution is made prior to a period
of relatively strong investment results, that action will enhance the MWR.
Conversely, investments made prior to a weak performance period will drag
down the MWR. As a result, unlike with the TWR, the size and timing of

© 2017 CFA Institute Research Foundation. All rights reserved.  93

A Primer for Investment Trustees

the cash flows will affect the MWR. (The MWR is also known in finance
textbooks as the “internal rate of return,” or IRR.)

Performance Benchmarks
Once the rates of return for the managers’ accounts, the asset classes, and the
total Fund are determined, attention naturally turns to whether those returns
are good or bad. To assess the “goodness” of a rate of return, we need a stan-
dard or benchmark with which to compare the result. Although there may
be many candidates for a benchmark, we believe that the most informative
assessment of investment performance occurs when the benchmark has cer-
tain basic properties. The benchmark should be the following:
•• Unambiguous—the benchmark should be clearly understood by all parties
involved in the investment program.
•• Investable—the benchmark should represent an investable alternative;
that is, the trustees could choose to hold the benchmark rather than hire
the particular manager.
•• Measurable—the benchmark’s rate of return should be readily calculable.
•• Appropriate—the benchmark should reflect the manager’s typical risk
characteristics and area of expertise.
•• Specified in advance—the benchmark must be specified prior to the evalu-
ation period and known to all interested parties.
•• “Owned”—the benchmark should be acknowledged and accepted as
an appropriate accountability standard by the party responsible for the
performance.
Benchmarks that possess these properties provide the investment com-
mittee with a fair standard to use in assessing an account’s performance.
Many organizations use published market indexes (e.g., the S&P 500 Index)
as benchmarks for their individual managers. Those indexes may or may not
satisfy the quality criteria. The staff works closely with the Fund’s manag-
ers to develop acceptable benchmarks, which in some cases, results in cus-
tom benchmarks designed specifically for a manager. At the asset class level,
however—say, for global equities—the staff is likely to use a published index.
To evaluate the total Fund, the staff uses a policy portfolio, which is a
combination of the asset class targets, weighted by the policy allocations
assigned to the asset classes. (In Session 2 on investment policy and Session 5
on investment risk tolerance, we call these policy allocations the “policy asset

94 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 8. Performance Evaluation

mix.”) This policy portfolio represents the amount and type of investment risk
that the investment committee believes will give the Fund the best chance of
fulfilling its mission, meet its investment objectives, and provide consistency
with the trustees’ collective risk tolerance.
You may wonder why we need benchmarks in the performance evaluation
process. Why not simply compare how the investment program is doing rela-
tive to the Fund’s peers? After all, businesses constantly “benchmark” their
operations against those of their competitors. Indeed, peer group compari-
sons are quite popular in the investment community.
Despite their seeming simplicity, however, peer group comparisons fail to
satisfy a number of the properties required of a valid benchmark. For example,
peer groups are likely to contain accounts that have different missions, invest-
ment objectives, and risk tolerances. Also, peer groups are neither investable
nor specified in advance. What investment strategy within the peer group
will deliver top-quartile performance? Our staff might be able to discern that
strategy after the fact, but the staff does not know prior to the evaluation
period which funds will be the most successful.
As a result, peer groups represent alternative decisions that could never
be selected in advance. Moreover, they tend to be subject to “survivor bias,”
wherein the worst-performing funds drop out of the index, artificially push-
ing up the reported returns of the peer group. Finally, peer groups are ambig-
uous. The staff has little knowledge of the constituents of the peer group.
Therefore, comparisons say nothing about why the Fund performed better
or worse than other funds. One would need a detailed understanding of the
other funds’ investment policies, objectives, and strategies to ascertain what
factors produced those funds’ results.
Because of these deficiencies, the investment committee has been careful
about how it uses peer group comparisons. Success should not be measured by
performance relative to a peer group but, rather, by how well the investment
results contribute to the mission of the Fund. As a result, the trustees have
requested that the staff emphasize comparisons with thoughtfully selected
and investable benchmarks designed to represent the risk tolerance and objec-
tives of the Fund’s investment program.

Performance Attribution
Performance evaluation involves not only measuring performance by calcu-
lating a rate of return and assessing performance by comparing that rate of
return with an appropriate benchmark, but it also entails identifying the fac-
tors that caused that relative performance. This process is known as “perfor-
mance attribution.” Molly, you can think of performance attribution as an

© 2017 CFA Institute Research Foundation. All rights reserved.  95

A Primer for Investment Trustees

informed look at the past. As a trustee, you would like to understand why the
Fund’s managers performed better or worse than their benchmarks or why
the Fund in aggregate has produced its results. Identifying the factors that
caused an investment result is an important first step.
Because many factors can explain a particular investment outcome,
the investment committee finds it helpful to identify and attribute per-
formance to those factors that are linked to the investment management
process. That type of analysis provides the trustees with valuable feedback
that will either reinforce the effectiveness of the management process or
cause a rethinking of it. Essentially, the method by which performance is
explained or attributed should directly relate to the management process
by which investment decisions are made. This link will, in turn, provide
valuable messages about the management process. These connections are
depicted in Figure 2. The more relevant the performance attribution to
the management process, the more likely that it will influence that process
positively in the future.
For example, the staff has retained an investment manager who assigns
analysts to research companies in particular industries. The analysts, in turn,
recommend companies to buy, sell, or hold based on their analyses. Portfolio
managers use these recommendations, together with their own assessments
of which industries are attractive and unattractive, to build their investment
portfolios. An attribution method that identifies the contributions of the
individual analysts and portfolio managers helps the staff determine whether
the manager’s investment process is effective and whether we should continue
to employ that manager. Performance attribution conducted at the level of the
individual-manager account is called “micro attribution.”
Performance attribution at the asset class and total fund level is termed
“macro attribution.” The investment committee finds macro attribution par-
ticularly valuable because that analysis explains the impact of investment pol-
icy decisions on the Fund’s success. At the total fund level, macro attribution

Figure 2. Performance Attribution Feedback Loop

Management
Process

Method of
Message Attribution

96 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 8. Performance Evaluation

allows the investment committee to examine the impact of important imple-

mentation decisions, including setting a policy asset mix, hiring managers,
and allocating assets to the managers.
Dropping down one macro attribution level to the performance of the
Fund’s investments within an asset class relative to its “asset class target” (i.e.,
the benchmark assigned to represent that asset class), we find performance
depends on much more than how the underlying investment managers per-
formed. The relative performance of an asset class investment is also the result
of decisions about the allocation of assets to the investment styles of the indi-
vidual managers within each class and of the performance of the individual
managers’ investments. These are the decisions involved in structuring and
managing a team of managers.
The investment committee uses performance attribution for purposes
broader than simply accepting a numerical report submitted periodically.
Instead, the attribution reports help develop a dialogue with the staff about
the primary elements that have driven investment results. The reports serve to
highlight certain aspects of the investment program, and the trustees use that
information to ask informed questions of the staff. You’ll find the attribution
reports to be one of your most useful tools in understanding the workings of
Lurinberg University’s investment program.

Performance Appraisal
Investment management operates in an environment of uncertainty.
Unforeseeable events may drive investment returns. Because neither the staff
nor the managers are omniscient in their investment decision making, the
challenge of performance evaluation is to distinguish between luck and skill.
We refer to that process as “performance appraisal.”
You can think of investment skill as the ability of an active manager to
outperform an appropriate benchmark consistently over time. As mentioned
in Session 5 on investment risk tolerance, we call returns relative to a bench-
mark “active management returns.” All managers’ returns (even the returns
of passive managers) tend to fluctuate around their benchmarks, generating
positive relative performances in some periods and negative relative perfor-
mances in others. As we discussed, active managers display more variability in
their returns relative to their benchmarks than do passive managers; we refer
to this variability as “active management risk.” Importantly, superior active
managers tend to produce larger positive active management returns more
frequently than do inferior active managers. Similarly, superior passive man-
agers tend to closely track the benchmark’s return (i.e., produce zero active
management returns) more consistently than do inferior passive managers.

© 2017 CFA Institute Research Foundation. All rights reserved.  97

A Primer for Investment Trustees

To identify skillful managers, the staff compares the active manage-

ment returns earned by the managers with their active management risk.
Skillful managers will demonstrate higher active management returns per
unit of active management risk that they take on. A number of risk-adjusted
performance measures are in common use. During your investment com-
mittee meetings, you are likely to hear mention of two of the more popular
measures—namely, the Sharpe ratio and the information ratio. Both weigh
rewards earned per unit of risk taken.
The Sharpe ratio compares an account’s excess return (actual return less
the risk-free return) with the total risk of the account, where risk is measured
as the standard deviation of the account’s returns. The information ratio is a
variation of the Sharpe ratio. It compares an account’s active management
return (actual return less the benchmark return) with the active management
risk of the account, where active management risk is measured as the standard
deviation of the account’s active management returns.
Because it is often difficult for the trustees to examine the details behind
these risk-adjusted measures, the staff uses quality control charts as a presen-
tation tool. An example is shown in Figure 3. The solid line in the middle is
the manager’s cumulative return over the entire evaluation period. In this case,
it is a manager’s cumulative active return (actual return less the benchmark

Figure 3. Quality Control Chart: Cumulative Performance of Actual Portfolio vs.

Benchmark

Value Added (cumulative annualized percent)

5
4 Upper Edge of
Confidence Band
3
2
1 Value-Added

0
−1
−2
−3
Lower Edge of
−4 Confidence Band
−5
1 2 3 4 5 6 7 8 9 10 11 12
Year

98 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 8. Performance Evaluation

return). The dotted lines are statistically derived confidence bands. When the
return line is at or above the top dotted line, the performance has been excep-
tionally good. When it is at or below the bottom dotted line, the performance
has been exceptionally bad. It is difficult to draw conclusions about a man-
ager’s skill if the solid line consistently falls well within the dotted lines, other
than that performance has been insignificantly positive or negative relative to
the benchmark.

Putting It All Together

Trustees frequently feel a need to “do something”: fire a manager, hire a man-
ager, invest in a new strategy, or terminate an existing one. You didn’t achieve
your professional success by sitting on your hands, after all. Unfortunately, for
a trustee, a do-something attitude can be counterproductive. It often leads to
“buy high, sell low” investment outcomes.
Trustees (and the staff) receive an overwhelming amount of performance
data, all of it having to do with the past. Although nothing can be done about
the past, a number of questions can be raised about applying all this informa-
tion to future decisions: What can be learned from performance evaluation
to help improve the management of the Fund? When should the investment
committee revisit and rethink its policies? What changes or decisions should
the trustees make? When should those actions be taken?
Relying solely on past performance to determine what to do is like driv-
ing a car by looking through the rearview mirror. As a trustee, Molly, to do
something that will have a reasonable chance of improving future perfor-
mance, you need to put past performance in proper perspective and then aug-
ment that knowledge with additional insights and information.
Even skillful managers and effective investment programs will have peri-
ods of unusually bad performance, possibly extending for multiyear periods.
What should trustees and staff members do when risk-adjusted performance
has been unusually bad? Relying solely on past performance, even when prop-
erly adjusted for risk, can be counterproductive. Negative returns relative to
the benchmark cannot be ignored, of course, and should be discussed, but the
review needs to be augmented with other information, much of it qualitative
in nature. As a start, the investment staff finds it helpful to review the ratio-
nale and decision process that was used to implement the particular invest-
ment in the first place. Such a review involves asking what may have changed
and what has been learned.
For example, when hiring or firing an investment manager, the staff con-
ducts an assessment of a range of qualitative and quantitative management
factors, including the following:

© 2017 CFA Institute Research Foundation. All rights reserved.  99

A Primer for Investment Trustees

•• People—experience, expertise, organizational structure.

•• Process—philosophy, resources, decision making.
•• Procedures—trading, quality control.
•• Price—fees and expenses.
•• Performance—discounted for risk, deflated by the benchmark, and net of
fees.
Also, regardless of whether the investments are performing well or
poorly, the staff regularly assesses investment strategy decisions relative to
their economic rationale, diversification value, and liquidity characteristics.
Managing an investment fund is similar to piloting an aircraft. The
pilot receives a tremendous amount of information about the location of the
plane and current flying conditions. Once a course is set, however, there are
typically few changes that should be made. Similarly, once the trustees have
determined the Fund’s investment objectives and how best to achieve them,
the investment path is set. Although the journey may be a bit bumpy, the
question you continually face is whether the Fund is “on course.” There is no
one right answer, but in general, keeping a focus on the Fund’s planned route
and making only modest midcourse corrections has served the Lurinberg
University investment program well in the past.

Takeaways
•• Performance evaluation is important because it
— informs trustees how the Fund is doing relative to its mission and
objectives,
— establishes a hierarchy of responsibility, authority, and accountability,
— identifies the investment program’s strengths and weaknesses,
— reaffirms a commitment to successful policies and decisions,
— focuses attention on poorly performing operations, and
— provides evidence as to whether the investment program is being
managed properly.
•• Performance measurement is the process of calculating the rate of return
of an account (i.e., a fund, an asset class, or a manager).

100 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 8. Performance Evaluation

•• Two measures of rate of return are common: time-weighted rate of

return and money-weighted rate of return. Both should be reported after
accounting for all investment-related fees and expenses.
•• The TWR is unaffected by the timing of money flows into and out of a
fund. The MWR is sensitive to those flows.
•• The TWR is the appropriate return measure when the account manager
has no control over money flows. When the account manager can deter-
mine when money comes into or goes out of an account, the MWR is the
proper return measure.
•• Assessing investment performance is done by comparing it with a bench-
mark that is unambiguous, investable, measurable, appropriate, specified
in advance, and owned.
•• Performance attribution involves crediting performance to factors that
caused the actual outcome relative to the benchmark.
•• Performance attribution at the level of the investment manager account
is micro attribution; at the asset class and total fund level, it is macro
attribution.
•• Performance appraisal involves assessing the skill of an investment man-
ager by examining the consistency of returns relative to the benchmark.
•• Patience and a focus on investment policy can help avoid expensive and
unproductive responses to near-term performance disappointments.

Questions Molly Should Ask

•• How do we calculate performance measurement for our individual man-
agers, asset classes, and the Fund?
•• Who is responsible for the Fund’s performance measurement (i.e., the
staff, the custodian bank, the consultant, or some other organization)?
•• What are the benchmarks we use to evaluate our publicly traded equity
and fixed-income investments? Do our benchmarks satisfy the criteria for
valid benchmarks?
•• What benchmarks do we use for our various alternative investments?
•• Can you provide examples from the past when performance evaluation
identified particular strengths and weaknesses in our investment pro-
gram? What were our responses to those observations?

© 2017 CFA Institute Research Foundation. All rights reserved.  101

A Primer for Investment Trustees

•• How would you sum up how our investment program is performing? Do

our investment results indicate that we are fulfilling our investment mis-
sion and objectives?
•• What elements of our investment program are performing well? Which
might be performing poorly, and in both cases, why?
•• What various performance measurement, attribution, and evaluation
reports does the investment committee receive? How frequently are they
produced? May I see examples of past reports?
•• Do we integrate performance evaluation information with decisions
regarding investment policy? Asset classes? Investment managers?
Investment risk?
•• How do we evaluate investment performance for products with a short (or
no) track record?
•• If individual investment managers leave a firm and go to another firm or
start a new firm, should we view their track records from their previous
firms as portable?
•• What standards do we use to evaluate asset classes with nonmarketable
investments, such as private equity?
•• What qualitative criteria do we use to evaluate investment managers?
•• What role does the consultant play in interpreting performance attribu-
tion and evaluation reports for the staff and trustees?
•• How do we evaluate the performance of the staff when we change asset
allocations and require a large transition of assets from one class to
another?
•• How do we take into account the impact of unique market events when
evaluating performance?

102 © 2017 CFA Institute Research Foundation. All rights reserved.

Session 9. Ethics in Investing

Few things are harder to put up with than the annoyance of a good example.
—Mark Twain
Molly, one of the important reasons the regents selected you to be a Lurinberg
University investment trustee is that you have a strong record of integrity.
Even the best-intentioned trustees, however, should be versed in the ethi-
cal standards appropriate for their role on the investment committee. Your
ethical conduct reflects on not only the investment committee but also the
university. In this session, we want to give you a brief overview of some ethi-
cal considerations that you should bear in mind as you prepare to join the
investment committee.

Recognized Principles of Trustee Ethical Conduct

You can access a number of publications that address ethics and standards of
professional investment conduct. For example, CFA Institute has published a
code of conduct for investment professionals and a code of conduct for trust-
ees of pension and endowment funds. We encourage you to review them.
The ethical principles recognized in these publications can be summarized as
follows:
•• Act in the best interest of the Fund’s beneficiaries.
•• Act with prudence, competence, independence, and objectivity.
•• Adhere to the Fund’s mission and all related legal requirements.
•• Act in a transparent manner in all official activities.
•• Maintain confidentiality with regard to the Fund sponsor, beneficiaries,
and investments.
Several years ago, one of the investment committee members asked per-
mission to attend a conference to increase his understanding of investment
issues. That request seemed to be reasonable, and the trustee’s expenses were
paid out of the Fund’s assets. The trustee continued to attend conferences,
however, almost every quarter, some of which were halfway around the world.
The associated expenses were not insignificant, and other trustees began to
wonder whether this trustee was “acting in the best interest of the Fund’s
beneficiaries” or in the best interest of the trustee. Although this individual
is no longer an investment trustee at Lurinberg University—and for that, the

© 2017 CFA Institute Research Foundation. All rights reserved.  103

A Primer for Investment Trustees

committee heaved a sigh of relief—in one sense, he performed a valuable ser-

vice. He made questions of ethical conduct and conflicts of interest a reality
for the rest of the trustees and increased their dedication to establishing and
practicing strong ethical standards.
Unfortunately, Molly, not all ethical questions are black and white. At
times, the difference between acceptable and unacceptable ethical conduct
is obvious, as would be the case if one of the Fund’s investment managers
offered trustees an expensive gift. Yet, other situations, like the case of the
trustee and his conferences, can be a matter of “shades of gray,” making it dif-
ficult to determine where to draw the line. Such cases will require your good
judgment and your own solid ethical principles.
Typically, these situations cannot be clearly resolved by referring to spe-
cific standards of ethical conduct. Instead, you might ask whether you would
be comfortable if the university newspaper reported on a particular action
taken by you or the investment committee. Do you expect that the action
would be perceived positively by persons not entirely familiar with the facts?
If the answer is no, then you might question whether the action is appropri-
ate, even if you could make a case that it violates no particular ethical stan-
dard. Perception is crucial in creating trust, and it is best to err on the side of
conservatism and avoid the possibility of a seemingly innocent action being
misinterpreted.

Creating a Culture of Ethical Behavior

The trustees have adopted their own code of conduct, which reflects the ethi-
cal principles listed earlier. The code serves to focus specifically on the Fund’s
particular circumstances. As a rule, the more thorough the documentation of
policies and procedures is, the less likely the trustees are to encounter con-
cerns about ethical conduct.
The trustees have mandated that training regarding the contents of the
code of conduct be held not only for new investment committee members
but also for current members. The objective is to ensure that the provisions
of the code remain fresh in the minds of all trustees. The training involves
confirming that the trustees have reviewed and discussed the code on at least
an annual basis.
The investment committee has also engaged a third party to create an
online review program that summarizes key features of the code and pres-
ents a set of scenarios designed to highlight ethical issues that trustees might
encounter. The scenarios allow the trustees to see how the code is applied to
particular situations. In addition to highlighting specifics of the code for the
trustees, the scenarios provide solid evidence that the investment committee

104 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 9. Ethics in Investing

has made a “good faith effort” to promote ethical practices. Moreover, each
trustee is required annually to sign a conflict-of-interest certification that
states that the trustee has faithfully followed the code of conduct and has not
engaged in any actions that would violate the code.
The investment committee revisits the issue of ethical practices peri-
odically. The trustees’ approach has been to (1) encourage a discussion and
identification of ethical issues and dilemmas, (2) solicit input and recommen-
dations from various sources, and (3) adopt guidelines specific to the situa-
tions under consideration. These guidelines add detail to the general tenets of
the investment committee’s code of conduct (e.g., showing how to distinguish
between personal and committee expenses while traveling). The investment
committee’s guidelines are updated from time to time. Issues may surface that
need to be addressed. What never changes, of course, are the core ethical
principles upon which the code of conduct is based.
Most of the ethical issues that the trustees wrestle with involve either
the expenditure of the Fund’s assets (other than for beneficiary payments)
or relationships with the organizations with which the staff and trustees do
business. The investment committee has direct responsibility, authority, and
accountability for the ethical conduct of individual trustees and the staff. That
situation is not the same, however, for the external organizations providing
services to the Fund. Although the trustees have responsibility for the ethical
conduct of these organizations, the investment committee has only limited
authority over their actions.
Accordingly, the trustees seek assurances that these organizations are
conducting their business activities in a manner consistent with the invest-
ment committee’s ethical principles. The trustees require that these organi-
zations—primarily, our investment managers, consultants, and custodian
bank—provide the staff with their own codes of ethical conduct. The staff
reviews these documents, and if the documents are acceptable, assures the
trustees that the ethical policies are acceptable. The staff then monitors the
organizations to ensure that the organizations’ conduct is consistent with
their codes.
The investment committee’s interest in ethical conduct goes beyond a
mere concern about its reputation and that of the university. The trustees sin-
cerely believe that positive ethical conduct is a necessary condition for a well-
managed fund; without it, the investment program is unlikely to produce
results consistent with the Fund’s mission and investment objectives.
Achievement of a commitment to ethical conduct depends largely on the
interest and integrity of the individual trustees, which comes back to where
we started. We are delighted to have a trustee like you: a person with high

© 2017 CFA Institute Research Foundation. All rights reserved.  105

A Primer for Investment Trustees

integrity, moral values, good judgment, and a serious commitment to making

a positive contribution to the Fund.
Welcome aboard, Molly.

Takeaways
•• A number of publications address ethics and standards of professional
investment conduct. In particular, CFA Institute has published a code of
conduct for investment professionals and a code of conduct for trustees of
pension and endowment funds.
•• The following ethical principles are appropriate for trustees to focus on:
— Acting in the best interest of the Fund’s beneficiaries
— Acting with prudence, competence, independence, and objectivity
— Adhering to the Fund’s mission and all related legal requirements
— Requiring transparency of all involved parties
— Maintaining confidentiality with regard to the Fund sponsor, benefi-
ciaries, and investments
•• The trustees should adopt a code of conduct specific to the Fund’s
situation.
•• Ethical guidelines can help clarify specific situations and circumstances.
•• Ongoing training can play an important role in educating new and cur-
rent trustees about ethical standards and how to act in difficult scenarios.
•• In addition to maintaining an ethical code of conduct and guidelines for
individual trustees and the staff, the committee believes it is important
to assess the ethical conduct of organizations with which the Fund has a
relationship.
•• The best assurance of ethical investment conduct is the integrity, prin-
ciples, and moral values of trustees and staff members.

Questions Molly Should Ask

•• May I have a copy of the CFA Institute codes of conduct and also a list of
other publications dealing with ethical conduct for trustees?
•• May I have a copy of any principles and guidelines that we have adopted
as a code of conduct?

106 © 2017 CFA Institute Research Foundation. All rights reserved.

 Session 9. Ethics in Investing

•• Does the staff have a code of conduct? How does that code differ from
the one that applies to the trustees?
•• What types of training do the trustees and staff receive regarding ethical
practices?
•• Do the trustees periodically sign a conflict-of-interest form certifying
that they have avoided unethical behavior in carrying out their duties?
•• Have there been serious ethical issues in the past involving trustees other
than the one you described? If so, what were those issues and how were
they resolved?
•• Is there a facility for staff members to report confidentially any ethical
problems that they observe or experience?
•• Is it viewed as a conflict of interest for a trustee to discuss positive and
negative experiences that he or she may have observed as a trustee of
another fund?
•• Should a trustee suggest a manager for potential hiring if the trustee has
a business relationship (now or in the past) with that manager?
•• What guidelines do we have regarding items of value that can be accepted
from an outside organization?

© 2017 CFA Institute Research Foundation. All rights reserved.  107

Appendix A. Lurinberg University
Endowment Fund Governance
Policy Statement
The purpose of a governance policy is to delineate clearly the delegation of author-
ity, accountability, and responsibility of the investment committee and investment
staff in the policies and operation of the fund’s investment program. Governance
policy focuses on those organizational design elements critical to effective decision
making. Effective decision making can be achieved only in an environment of
mutual trust and respect, in which decisions are made and implemented quickly
and lines of authority and responsibility are clear to all.
The Lurinberg University Board of Regents (the Regents) has delegated to the
Lurinberg University Investment Committee (the Committee) the authority
and responsibility for management and oversight of assets of the Lurinberg
University Endowment Fund (the Fund). The Committee recognizes that
there are different types of fiduciary roles in the management and oversight
of the Fund.
The Committee is the governing fiduciary with the ultimate responsi-
bility for the investment program. To fulfill its fiduciary responsibility, the
Committee requires the support of, and expertise from, other groups of deci-
sion makers, each of whom has a particular role and responsibilities. These
primary decision makers include (1) an investment operations staff, headed by
a chief investment officer (CIO), (2) an investment consultant, (3) investment
managers, and (4) a custodian bank.
The CIO and his or her investment staff are the managing fiduciaries of
the investment program. They are charged with the day-to-day management
responsibility for the Fund. The investment program also includes several
operating fiduciaries, such as outside investment managers, who are given the
authority to make decisions, albeit with respect to only a portion of the Fund
assets and within the scope of approved mandates.

Investment Committee
The Committee seeks a diverse group of individuals who are known for their
integrity, interest in the Endowment Fund, and willingness to commit time
and energy to the Committee. The Committee consists of seven individual
trustees who are appointed by the Regents and serve staggered three-year
terms. The initial term can be followed by another three-year term at the

© 2017 CFA Institute Research Foundation. All rights reserved.  109

A Primer for Investment Trustees

option of the Regents. The Committee is headed by a chair, designated by

the Regents, who serves a two-year term. The Committee meets quarterly to
review the Fund’s performance relative to its policy and to address relevant
strategic issues.
In general, the Committee’s responsibilities are focused on expressing the
Fund’s mission and choosing the investment policies most likely to achieve it.
The Committee is also responsible for monitoring staff effectiveness and see-
ing that its policies are properly implemented by the managing and operating
fiduciaries to which it has delegated specific authorities. The Committee
•• defines the Fund’s mission,
•• establishes performance goals and investment objectives for the Fund and
monitors actual performance versus these goals and objectives,
•• determines the acceptable level of capital market risk,
•• establishes the policy asset mix and acceptable asset allocation ranges
around that policy asset mix,
•• approves or rejects asset allocation deviations from approved ranges,
•• determines the acceptable level of active management risk,
•• determines acceptable asset classes and subcategories (e.g., emerging mar-
kets, absolute return strategies),
•• approves asset class targets,
•• approves the investment staff’s annual operating budget,
•• reviews governance procedures and makes recommendations to the
Regents,
•• approves consultant, custodian bank, legal, and audit relationships,
•• approves securities-lending arrangements,
•• evaluates and retains the CIO,
•• ensures resources adequate to perform the Fund’s mission effectively,
•• provides information and recommendations to the Regents as required,
and
•• conducts business in an ethical manner, including establishing and fol-
lowing a code of conduct consistent with industry practices.

110 © 2017 CFA Institute Research Foundation. All rights reserved.

 Appendix A. Lurinberg University Endowment Fund Governance Policy Statement

Investment Staff
The Committee recognizes that its professional investment staff is best situ-
ated to make day-to-day investment decisions. The staff is managed by a CIO
to whom the Committee has delegated authority to implement key policy and
operational decisions for the Fund. The CIO
•• evaluates, retains, and terminates investment managers,
•• determines asset allocation deviations within approved ranges,
•• evaluates and recommends retention and termination of consultants, cus-
todian banks, and other service providers,
•• acquires sufficient internal staff and resources to meet objectives and fidu-
ciary responsibilities,
•• establishes performance benchmarks and investment guidelines for indi-
vidual investment managers,
•• establishes and implements manager-monitoring procedures,
•• determines asset class and manager-rebalancing strategy,
•• provides liquidity for payments to beneficiaries and to fund operations,
•• provides recommendations to the Committee as needed to aid in the
decision-making process,
•• provides the Committee with adequate information and resources to
make policy decisions and monitor fund performance,
•• provides the Committee with analytical data regarding cost-effectiveness
issues, and
•• conducts business in an ethical manner consistent with guidelines estab-
lished by the Committee.

Investment Consultant(s)
The general purpose of the consultant or consultants is threefold: First, to
provide additional in-depth analytical support to the staff; second, to be a
source of industry best practices; and third, to serve as a check and balance
with respect to staff. The consultant is expected to attend all Committee
meetings and meet with Committee members when requested. The consul-
tant is expected to work with staff on a continuous basis, addressing issues
of importance regarding the implementation and management of the Fund’s

© 2017 CFA Institute Research Foundation. All rights reserved.  111

A Primer for Investment Trustees

investment policy. The consultant’s performance is reviewed annually by the

Committee with input from the staff.
The consultant
•• provides analytical support in the evaluation, retention, and termination
of investment managers,
•• provides analytical input on the risk, return, correlation, and liquidity
characteristics of asset classes,
•• assists in determining appropriate asset class and manager benchmarks,
•• assists in determining an investment policy portfolio that consists of spe-
cific allocation amounts (percentages) to asset class targets and manager
benchmarks,
•• provides independent performance measurement, attribution, and
evaluation,
•• provides input regarding the economic and market outlook,
•• provides information regarding new investment ideas, strategies, and
vehicles that could benefit the Fund,
•• provides an independent source of information regarding the investment
policies, governance, objectives, strategies, and performance of similar
organizations,
•• updates the staff on any pertinent changes in its organization, and
•• conducts business in an ethical manner consistent with accepted, indus-
trywide practices.

Investment Managers
The investment managers are responsible for the actual investment of the
Fund’s assets. The Committee has approved the use of managers who invest
in securities within the Fund’s approved asset classes. The staff is responsi-
ble for the manager retention and termination decisions, but the staff relies
heavily on the consultant for analytical (quantitative and qualitative) input in
making these decisions. Managers are expected to meet with the staff regu-
larly, often at the managers’ offices, to review the managers’ performance,
process implementation, organizational changes, and any unusual develop-
ments. Occasionally, managers are invited to Committee meetings, primarily
to discuss unusual developments or situations and to familiarize Committee

112 © 2017 CFA Institute Research Foundation. All rights reserved.

 Appendix A. Lurinberg University Endowment Fund Governance Policy Statement

members with their organization, investment process, and performance. The

managers
•• invest fund assets consistent with an investment mandate mutually agreed
upon with the staff,
•• transact in portfolio securities in a cost-efficient manner,
•• adhere to the Fund’s investment portfolio guidelines,
•• maintain the portfolio’s specified risk exposure,
•• specify or agree to an appropriate, investable benchmark,
•• produce performance consistent with expectations,
•• provide transparency with respect to portfolio holdings, transactions, and
external fund flows,
•• provide investment performance measurement, attribution, and assess-
ment of results,
•• provide analysis of how expected economic and market conditions could
affect investment performance,
•• update staff on any pertinent changes in their organizations, and
•• conduct business in an ethical manner consistent with accepted, indus-
trywide practices.

Custodian Bank
The purpose of the custodian bank is to ensure safekeeping of the Fund’s
assets and to be a check and balance with regard to the managers’ investment
activities. The custodian facilitates the flows of cash into and out of the Fund,
and it is a primary source of portfolio valuation information for the Fund.
The bank
•• ensures safekeeping of Fund assets that are assigned to the bank,
•• coordinates and settles managers’ security transactions where appropriate,
•• produces monthly valuation and transaction reports,
•• facilitates external cash and security flows into and out of the Fund,
•• provides a secure short-term fund for managers’ cash holdings,
•• assists in reconciling portfolio valuation differences with managers,

© 2017 CFA Institute Research Foundation. All rights reserved.  113

A Primer for Investment Trustees

•• offers a safe securities-lending facility,

•• produces reports as required by regulatory agencies,
•• reports valuations and transactions of Fund assets not assigned to the
bank and assists in independent confirmation of those valuations and
transactions,
•• updates the staff on any pertinent changes in its organization, and
•• conducts business in an ethical manner consistent with accepted, indus-
trywide practices.

114 © 2017 CFA Institute Research Foundation. All rights reserved.

Appendix B. Lurinberg University
Defined-Benefit Plan Investment
Policy Statement

Background
Lurinberg University (the University) sponsors the Lurinberg University
Defined-Benefit Plan (the Plan), which is funded from assets held in the
pension fund (the Fund). The University offers retirement benefits to eligible
employees under the Plan, which is solely funded from contributions made by
the University. All employees meeting established service requirements are
eligible to participate in the Plan.
The Lurinberg University Investment Committee (the Committee) is
charged with fiduciary oversight of the Fund. As part of its responsibilities,
the Committee has established this Investment Policy Statement (IPS). The
purpose of the IPS is to assist in the management and monitoring of the
Fund’s assets.
The Committee intends to periodically review this IPS. Those reviews
serve primarily to formally incorporate enhancements made to the Fund’s
investment program. The Committee views this IPS as a robust set of guide-
lines and procedures and, therefore, does not anticipate major revisions unless
the financial conditions of the Plan or the University change significantly.

The Fund’s Mission

The mission statement defines the purposes for which the defined-benefit (DB)
plan exists as a financial entity. Typically, a DB plan will have multiple missions,
and those missions will be assigned different priorities. In total, these missions
provide the framework around which detailed elements of the fund’s investment
policy are established.
The mission of the Fund is to secure and protect the retirement benefits
promised to Plan participants. All University employees meeting minimum
age and service requirements are eligible for a pension benefit. The University
finances the Plan’s benefits through both periodic contributions and the
investment earnings on the Fund’s assets. The Committee recognizes that a
sound investment program implemented through the Fund is essential to the
University’s ability to meet its pension promise.
The excess of the Fund’s assets relative to the Plan’s liabilities (the Plan
Surplus) provides crucial security for the employees’ retirement benefits.

© 2017 CFA Institute Research Foundation. All rights reserved.  115

A Primer for Investment Trustees

Therefore, the Fund’s primary mission is to accumulate and maintain a suf-

ficient Plan Surplus to protect and sustain currently promised benefits.
The Committee acknowledges the material impact that funding the pen-
sion promise has on the University’s financial performance. To enable the
University to continue offering secure pension benefits to Plan participants,
the Committee believes that the Fund should pursue the following secondary
missions:
1. To minimize the present value of the contributions that the University
must make to the Fund over the long term
2. To avoid both substantial volatility in cash contributions and sizable fluc-
tuations in the Plan Surplus
These two secondary missions affect the Fund’s investment strategies and
often represent conflicting goals. That is, minimizing long-run funding costs
implies an aggressive investment program whereas dampening the volatility
of contributions and avoiding large fluctuations in the Plan Surplus imply a
conservative set of investments. The Committee places greater emphasis on
the strategy of reducing the present value of contributions made to the Fund
because this strategy is most consistent with the University’s long-run goal of
conserving money to apply to other important University projects.

Roles and Responsibilities

Effective fiduciary oversight of a DB plan requires the active involvement and
cooperation of various persons and organizations. Each of these entities has dis-
tinct roles and responsibilities that contribute to the achievement of the DB plan’s
mission. Delineating those entities’ roles and responsibilities assists in coordinating
their actions.
The Committee, whose members are appointed by the Lurinberg
University Board of Regents, has the fiduciary responsibility to prudently
select and monitor the investment of the Fund. The Committee has estab-
lished this IPS to assist the Committee in making investment-related deci-
sions in a prudent manner.
Other important roles and responsibilities with respect to the Fund
include the following:
•• University investment staff—implement Committee investment deci-
sions, provide performance reporting, make recommendations to the
Committee, and negotiate contracts with service providers.
•• Consultant—assist the staff and the Committee in fulfilling their
responsibilities.

116 © 2017 CFA Institute Research Foundation. All rights reserved.

 Appendix B. Lurinberg University Defined-Benefit Plan Investment Policy Statement

•• Custodian—hold title to Fund assets as trustee and calculate valuations

for each investment portfolio.
•• Investment managers—be responsible for investing the Fund’s assets in
compliance with investment guidelines established by the Committee.
Investment managers may also be responsible for relaying pricing infor-
mation for the portfolio to the Fund’s custodian to enable the valuation
mechanism to function smoothly.

Risk Tolerance
Risk tolerance refers to an investment committee’s willingness to bear adverse
outcomes in pursuit of the DB plan’s missions. It indicates the trade-off that an
investment committee will accept between, on the one hand, the likelihood and
costs of failing to achieve the goals set out for the DB plan and, on the other hand,
the likelihood of and rewards derived from exceeding those goals.
The Committee’s risk tolerance with respect to the Fund’s primary mis-
sion is extremely low. The Committee is unwilling to undertake investment
strategies that might jeopardize the ability of the Fund to finance the pension
benefits promised to plan participants.
However, funding the pension promise in an economical manner is criti-
cal to the University’s ability to continue to provide pension benefits to plan
participants. Thus, the Committee actively seeks to lower the cost of fund-
ing the Plan’s benefit promise by taking on types of risk for which it expects
to be compensated over the long run. The Committee understands that an
aggressive investment approach to risk taking can result in periods of disap-
pointing performance for the Fund in which the Plan Surplus may decline.
These periods, in turn, can temporarily lead to higher required contribu-
tions. Nevertheless, the Committee believes that such an approach, prudently
implemented, best serves the long-run interests of the University and, there-
fore, of plan participants.

Investment Objectives
A DB plan’s investment objectives identify the set of portfolio management results
that an investment committee believes would signal a successful investment pro-
gram. Unlike the broad goals described in the fund’s mission statement, invest-
ment objectives are specific, quantifiable investment results expected to be achieved
over specific time intervals. Those investment objectives should be unambiguous
and measurable, specified in advance, actionable and attainable, and consis-
tent with the fund’s mission and should reflect the investment committee’s risk
tolerance.

© 2017 CFA Institute Research Foundation. All rights reserved.  117

A Primer for Investment Trustees

The Committee’s investment objectives are expressed in terms of reward

and risk expectations relative to investable benchmarks. The Committee spec-
ifies investment objectives at three investment management levels: (1) total
fund, (2) asset classes, and (3) individual investment managers. At each level,
benchmarks have been established that represent the returns and risks that
could be achieved through passive management (for assets for which pas-
sive alternatives exist). Performance at all levels of the investment program
is always expressed net of all fees and expenses. Performance of the bench-
marks is reported without deducting the costs of passive management. As
a result, active management can add value to the investment program by at
least matching the benchmark’s performance.
At the total fund level, the Committee expects that its investment pro-
gram will at least match (net of fees and expenses) the returns produced by
a combination of the asset class targets over a minimum evaluation period of
five years. The weights used to compute that combination represent alloca-
tions to each asset class in the policy asset mix. The Committee expects that
total fund returns will be produced without assuming more capital market
risk than is implied by the Fund’s policy asset mix.
At the asset class level, the Committee expects that its investments in each
asset class will at least match the performance of the respective asset class tar-
get over the five-year evaluation period. Because of the mix of manager styles
within each asset class, the Committee understands that individual manager
returns relative to those of the asset class target may vary considerably over
time. Therefore, the Committee focuses on the aggregate performance of
the investment managers relative to the asset class target. Furthermore, the
Committee recognizes that, because of the uncertain nature of active man-
agement, even the aggregate of the investment managers’ returns may fall
below the returns of the asset class target for extended periods.
At the individual-manager level, the Committee expects that each of its
investment managers will at least match the performance of the manager’s
assigned benchmark over a five-year evaluation period. The Committee insists
that the investment managers follow investment styles similar to their bench-
marks and maintain active management risk within agreed-upon bounds.

Policy Asset Mix

A DB plan’s policy asset mix is its long-run allocation to broadly defined classes
of investable assets. Decisions about the policy asset mix are based on expecta-
tions regarding the fundamental rewards and risks offered by the capital markets.
The policy asset mix must be consistent with the fund’s mission statement and the
risk tolerance of the investment committee. The policy asset mix is a significant
determinant of the fund’s future performance. There is no one right policy for all

118 © 2017 CFA Institute Research Foundation. All rights reserved.

 Appendix B. Lurinberg University Defined-Benefit Plan Investment Policy Statement

pension plans. Differences in missions, risk tolerances, and the financial strength
of the sponsoring organizations—all these factors affect the asset mix decision.
For purposes of asset allocation, the Committee considers both tradi-
tional and alternative asset classes and strategies. Traditional asset classes
include publicly traded stocks and bonds, traded in both US and non-US
markets. Alternative investments are all other investments and comprise a
range of nontraditional, privately held assets, including but not limited to the
following: private equity, real estate, natural resource investments, high-yield
debt, distressed securities, and absolute return strategies.
In general, the Committee takes a strategic approach to the policy asset
mix decision. To determine the impact of various asset allocation alternatives,
the Committee reviews a formal asset allocation study using both qualitative
and quantitative inputs. The purpose of this study is to help the Committee
evaluate the risk–return trade-offs of various asset mix policies. The qualita-
tive factors include peer practices and staff expertise. After consideration of all
the inputs and a discussion of its own collective risk tolerance, the Committee
approves the appropriate policy asset mix for the Fund. The current policy
asset mix is detailed in Table B1.
The Committee believes that the substantial equity allocation and the
diversified composition of the Fund’s policy asset mix are consistent with
the Fund’s primary mission of securing the University’s pension promise.
Moreover, the Committee believes that the Fund’s policy asset mix permits
the Fund to appropriately balance its secondary missions of minimizing the
present value of future contributions while avoiding extreme volatility in con-
tributions and large fluctuations in the Plan Surplus.

Table B1. Current Policy Asset Mix

Long-Term Policy Rebalancing
Asset Class Weight (%) Range (%)
US equity 30 25–35
Non-US developed-market equity 20 15–25
Emerging-market equity 10 5–15
US fixed income 20 15–25
US inflation-linked bonds (TIPSa) 10 5–15
US real estate 5 0–10
Alternative investments 5 0–10
Cash 0 0–5
Total 100
Treasury Inflation-Protected Securities.
a

© 2017 CFA Institute Research Foundation. All rights reserved.  119

A Primer for Investment Trustees

Rebalancing the Policy Asset Mix

The Committee has established a policy of maintaining the Fund at its policy
asset mix over time. To the extent that the Fund’s actual asset allocation devi-
ates from the currently specified ranges, assets will be redistributed to achieve
the desired allocation. This redistribution may be accomplished by reallocat-
ing among the Fund’s investment managers, through a synthetic approach
using financial futures, or by a combination of these methods. The use of
financial futures avoids frequent adjustments to the investment managers’
portfolios that are not economically justifiable. The Committee has autho-
rized the use of financial futures to overlay the assets of the Fund to bring
about a more exact match with target allocations.
Nonmarketable investments, such as private equity, are not included in
the Fund’s procedures for rebalancing back to the policy asset mix because
of the illiquid nature of these investments and the fact that capital flows into
and out of these investments are uncontrollable. The Committee endeavors
to maintain the allocations to nonmarketable investments near their policy
weights but recognizes that deviations may occur from time to time because
of the uneven nature of capital drawdowns and distributions.

Asset Class Targets

An asset class target is a benchmark that characterizes the scope and nature of
available investments within a whole asset class. In general, asset class targets
are capitalization-weighted indexes representing a significant percentage of the
investable universe of securities in a particular asset class. For example, the S&P
500 Index is commonly used as the asset class target for US common stocks. Asset
class targets are important yardsticks for evaluating investment performance and
for managing the style risk of programs that use multiple-specialist active invest-
ment managers.
The Committee has selected asset class targets for all of its publicly traded
investment portfolios. The current targets are specified in Table B2.
The Committee has not chosen asset class targets for the Fund’s non-
marketable investments, which include private equity, real estate, and natural
resources. The illiquidity of those investments and the lack of market pricing
have hampered the development of widely accepted market indexes for any of
the types of nonmarketable investments that the Fund holds.

Investment Manager Structure

Investment manager structure refers to two aspects of investment policy within
asset classes. First, the investment committee must determine the role that active
management will play in its investment program. Second, to the extent that the

120 © 2017 CFA Institute Research Foundation. All rights reserved.

 Appendix B. Lurinberg University Defined-Benefit Plan Investment Policy Statement

Table B2. Current Asset Class Targets

Asset Class Asset Class Target

US equity Russell 3000 Index

Non-US developed-market equity MSCI World ex US Index
Emerging-market equity MSCI Emerging Markets Index
US fixed income Bloomberg Barclays Capital Aggregate Bond Index
US inflation-linked bonds (TIPS )a
Bloomberg Barclays Capital US TIPS Index
US real estate NCREIF Property Index
Alternative investments NA
Cash 90-day T-bills
NA = not applicable. aTreasury Inflation-Protected Securities.

investment committee uses active management, it must allocate funds among

the managers hired to invest the DB plan’s assets. In that respect, the investment
committee must develop policies designed to control the amount of “style bias” and
active management risk in the investment program.
As a general philosophy, the Committee endorses the use of active man-
agement to enhance the returns generated by the Fund’s policy asset mix. The
Committee recognizes the highly competitive nature of the capital markets
and the corresponding fact that active management cannot be guaranteed to
add value to the Fund’s investment program. Nevertheless, the Committee
believes that the potential rewards from active management are sufficiently
large to justify the search for superior investment organizations.
The Committee has chosen to invest the Fund’s actively managed assets
with outside investment managers. Presently, the Committee does not view
the investment in people required to adequately staff an internal money man-
agement operation as cost-effective. The Committee has provided the chief
investment officer with the authority to make active investment decisions on a
limited and opportunistic basis.
With respect to active strategies, the Committee believes that people
and process are at the very heart of a sustainable competitive advantage in the
business of investment management. The Committee prefers to retain only
those investment managers with experienced people and tested processes
whose interests are aligned with those of the Fund. In terms of strategy, the
Committee prefers to retain specialist investment managers who focus their
efforts on selecting securities within asset classes and pursue well-defined
investment approaches based on fundamental principles of security valuation.

© 2017 CFA Institute Research Foundation. All rights reserved.  121

A Primer for Investment Trustees

Except in nonmarketable asset classes, each manager is required to desig-

nate or make available an appropriate benchmark. The manager’s benchmark
will be evaluated relative to six basic criteria. The benchmark should be the
following:
•• Unambiguous—the names and weights of securities composing the
benchmark are clearly delineated.
•• Investable—the option to forgo active management and simply hold the
benchmark is available.
•• Measurable—the benchmark’s return can be readily calculated on a rea-
sonably frequent basis.
•• Appropriate—the benchmark is consistent with the manager’s investment
style.
•• Specified in advance—the benchmark is constructed prior to the start of an
evaluation period.
•• Owned—the manager accepts accountability for the composition and
performance of the benchmark.
A manager’s benchmark is used to evaluate the manager’s capability to
add value, to characterize the manager’s investment style for purposes of
clarity, and to allocate assets efficiently among investment managers within
the asset class.
Within an asset class, assets are allocated to investment managers so that
the total risk of the combined manager group relative to the asset class tar-
get is maintained within acceptable bounds. In particular, the Committee
desires to cost-effectively minimize the risk posed by unintended deviations
in the aggregate investment style of the investment managers from that of the
asset class target (i.e., style bias). The Committee allows for aggregate style
deviations from the asset class target as a potential source of added value (e.g.,
tilting toward value stocks). However, the long-term source of added value
is expected to derive from the active decisions of the investment managers.
Therefore, the level of risk (return) from style management is targeted below
the level of risk (return) expected to result from the aggregate effects of the
investment managers’ active strategies.

Performance Evaluation
Performance evaluation refers to the process of measuring and interpreting the
performance of the investment program. It provides valuable information con-
cerning the investment program’s strengths and weaknesses and identifies areas

122 © 2017 CFA Institute Research Foundation. All rights reserved.

 Appendix B. Lurinberg University Defined-Benefit Plan Investment Policy Statement

of potentially profitable enhancements. Performance evaluation carried out in the

context of investment policy acts as a feedback-and-control mechanism.
The Committee advocates a comprehensive approach to performance
evaluation. The Committee regularly collects and reviews pertinent perfor-
mance information regarding its investment program. Changes in the value
of the total Fund are broken down into specific key policy decisions. The
Committee then examines how those decisions contributed to or detracted
from the Fund’s investment results. Through this process, the Committee
seeks confirmation that its investment program is being carried out according
to plan.
For evaluating individual managers, the Committee has approved an
evaluation process, implemented by the investment staff, that specifies key
qualitative and quantitative evaluation criteria and the procedures for applying
those criteria. As part of its ongoing manager review, the staff considers vari-
ous indicators of the stability and effectiveness of its investment managers. If
serious concerns arise from these reviews, the staff examines the investment
managers of concern and makes determinations as to their continued viability
as part of the Fund’s investment program.

Fee Policy
A DB plan’s fee policy outlines the philosophy and criteria established by the plan
sponsor both for negotiating fees paid to the investment management and admin-
istrative service providers and for determining how those fees are allocated to the
plan and the sponsoring employer.
The Committee seeks to understand the breadth, depth, quality, and
necessity of the investment management and administrative services relative
to the fees paid for those services. The Committee strives to balance reason-
able investment management and administrative expenses against the services
received. Factors such as the Plan’s objectives, the Plan’s unique characteristics
and level of complexity, the experience of the service provider, and the breadth
and unique capabilities of the service provider, among others, are considered
by the Committee in retaining and compensating service providers.
Administrative expenses and investment management expenses are
reviewed periodically to assess the competitiveness of fees (both direct and
indirect) for the services provided by the service providers to the Plan. This
review includes a determination of whether a lower-cost share class or invest-
ment vehicle is available and feasible. The Committee may also consider
whether the fees are within a reasonable range compared with the market
and/or applicable benchmarks.

© 2017 CFA Institute Research Foundation. All rights reserved.  123

A Primer for Investment Trustees

Administrative expenses for services provided to the Plan include record

keeping, website operation, call center operation, participant search, commu-
nications preparation and delivery, communications consulting, investment
consulting, banking and trusteeship, auditing and actuarial services, and help
with fulfilling regulatory requirements.
Plan participants do not pay any expenses of the Plan.
The Plan pays for the following:
•• Investment management expenses of the Plan
•• Administrative expenses of the Plan
•• Regulatory fees due from the Plan
•• Services of the selected investment consultant of the Plan
•• Forfeitures by participants, which are retained by the Plan to reduce
expenses
The University pays for the following:
•• Salaries, overhead, training, and travel expenses of the Committee
•• Salaries, overhead, training, and travel expenses of the staff assigned to
administer and monitor the Plan
•• Salaries, overhead, training, and travel expenses of legal counsel to the
Plan
•• Costs related to fidelity bonding and fiduciary insurance
•• Costs related to the Plan’s design studies and changes

Additional Investment Policy Issues

Investment Policy Review. The Committee may review elements of its
investment policy from time to time. These reviews serve primarily to for-
mally incorporate into the policy any enhancements and additions made to
the Fund’s investment program. The Committee views its investment policy
as a robust set of guidelines and procedures and, therefore, does not anticipate
major revisions unless the financial conditions of the Plan or the University
change significantly.
Investment Guidelines. The Committee requires that investment
guidelines be maintained for all of the Fund’s investment managers who
hold publicly traded securities. At a minimum, an investment manager’s

124 © 2017 CFA Institute Research Foundation. All rights reserved.

 Appendix B. Lurinberg University Defined-Benefit Plan Investment Policy Statement

investment guidelines include specifications, mutually agreed to by the man-

ager and the investment staff, related to the following:
•• Return and risk objectives
•• Benchmark portfolios
•• Authorized investments
•• Portfolio composition constraints
•• Various investment and administrative practices
The investment staff reviews manager guidelines on an ongoing basis to
ensure compatibility and consistency with investment goals and objectives.
Proxy Voting. The Committee views the voting of proxies as an integral
part of the investment decision-making process. Therefore, the Committee
delegates the voting of all proxies to its investment managers.
Securities Lending and Swap and Other Derivative Transactions. The
Committee believes that swap and other derivative transactions that are con-
ducted under appropriate guidelines offer attractive incremental returns for the
Fund relative to the risk incurred. The Committee has authorized the chief
investment officer (CIO) to engage in securities-lending arrangements and
swap and other derivative transactions with respect to all or some portion of the
securities held by the Fund. Such authorization covers, without limitation, rate
swap transactions, equity or equity index swaps, credit default swaps, repur-
chase transactions, or any other similar transactions recurrently entered into in
the financial markets, any of which transactions may include a forward contract,
swap, future, option, or other derivative on or with respect to one or more rates,
currencies, commodities, equity securities, debt securities, economic indexes, or
other measures of economic risk or value.
Reporting. Because the Committee has delegated authority to the CIO
to implement key policy and operational decisions for the Fund, the CIO is to
provide the Committee with periodic reports that inform the Committee about
the investment decisions made by the staff. On a quarterly basis, the CIO shall
provide a report to the Committee that highlights the changes to the invest-
ment portfolio with respect to investment managers. The report should iden-
tify the firm(s), strategy(ies), assets managed, and a brief rationale underlying
the decision(s). On an annual basis, the CIO shall provide the Committee with
a complete listing of the Fund’s investment managers, the format of which will
include the manager’s categorization, a brief strategy description, assets man-
aged, and investment performance relative to appropriate benchmarks.

© 2017 CFA Institute Research Foundation. All rights reserved.  125

Appendix C. Lurinberg University
Defined-Contribution Plan Investment
Policy Statement

Background
Lurinberg University (the University) sponsors the Lurinberg University
Defined-Contribution Plan (the Plan). The University offers retirement
benefits to eligible employees under the Plan, which is funded from payroll
deferrals made by the plan participants and matching contributions made by
the University. All employees meeting established service requirements are
eligible to participate in the Plan.
The Lurinberg University Investment Committee (the Committee) is
charged with fiduciary oversight of the Plan. As part of its responsibilities,
the Committee has established this Investment Policy Statement (IPS). The
purpose of the IPS is to assist in the management and monitoring of the
Fund’s assets.
The Committee intends to periodically review this IPS. Those reviews
primarily serve to formally incorporate any enhancements made to the Plan’s
investment program. The Committee views this IPS as a robust set of guide-
lines and procedures and, therefore, does not anticipate major revisions unless
the financial conditions of the Plan or the University change significantly.

The Fund’s Mission

A defined-contribution (DC) plan’s mission statement defines the purpose for
which the plan exists as a financial entity. It also highlights the prominent finan-
cial issues that influence how the plan sponsor goes about offering investment
options to achieve the plan’s mission. A DC plan’s mission statement provides the
framework around which the more detailed elements of its policy are established.
The Plan is designed to provide plan participants with a cost-effective
vehicle for accumulating assets to meet retirement financial needs. The Plan
offers participants and beneficiaries a variety of investment options represent-
ing various asset classes with materially different risk-and-return character-
istics. Each investment option is expected to maintain its investment risk at
an appropriate level in relation to its expected return and charge reasonable
expenses. Participants must determine their own asset allocations in light of
their individual investment objectives.

126 © 2017 CFA Institute Research Foundation. All rights reserved.

 Appendix C. Lurinberg University Defined-Contribution Plan Investment Policy Statement

Roles and Responsibilities

Effective fiduciary oversight of a DC plan requires the active involvement and
cooperation of various persons and organizations. Each of these entities has dis-
tinct roles and responsibilities that contribute to the achievement of the DC plan’s
mission. Delineating those roles and responsibilities assists in coordinating their
actions.
The Committee, whose members are appointed by the University’s Board
of Regents, has the fiduciary responsibility to prudently select and monitor
the investment options to be made available to participants and beneficiaries
under the Plan. Other important roles and responsibilities with respect to the
Plan include the following:
•• University investment staff—implement decisions, provide performance
reporting, make recommendations to the Committee, and negotiate con-
tracts with service providers.
•• Consultant—assist staff and the Committee in fulfilling their
responsibilities.
•• Custodian—hold title to Plan assets as trustee and calculate valuations for
each investment option.
•• Investment managers—invest the participants’ assets in compliance with
investment guidelines established by the Committee. Investment manag-
ers may also be responsible for relaying portfolio pricing information to the
Plan’s custodian to enable the valuation mechanism to function smoothly.
•• Record keeper—maintain participant account values, transaction summa-
ries, and investment selections; calculate and report participant account
values.

Investment Options
A DC plan makes available a set of investment options for the plan participants
to select from in investing their account assets. Those investment options offer par-
ticipants the opportunity to create a well-diversified portfolio by including a range
of asset types and investment strategies.
Participants in the Plan vary considerably in terms of their investment
sophistication, risk tolerance, and willingness and ability to spend time
making investment decisions. The Committee has selected a broad range of
investment options designed to appeal to the diverse participant population
and meet the needs of the vast majority of participants at a competitive cost.

© 2017 CFA Institute Research Foundation. All rights reserved.  127

A Primer for Investment Trustees

The Committee has focused on three primary criteria in selecting investment

options for the Plan: low cost, diversification, and focus.
The Committee has determined that index funds should form the core
of the investment options. Most Plan participants have little investment
experience and, as a result, have difficulty understanding the costs and risks
of actively managed funds. Index funds, which are passively managed, pro-
vide the lowest-cost means of investing in a particular investment style.
Furthermore, passively managed funds offer significant diversification within
an investment style. These funds also avoid the potential to drift away from
a particular investment style. Additionally, the investment objectives of pas-
sively managed funds are readily communicated to Plan participants.
The Committee has divided the Plan’s investment options into three
groups for communication purposes. The three groups are as follows:
•• Target Date Funds—Investment options in this group are designed to be
investment solutions for participants who wish, for all or a portion of their
Plan assets, to delegate asset allocations across asset classes and invest-
ments within asset classes. A series of investment options with varying
time horizons, expressed in terms of years to retirement, is offered. These
funds use a diversified set of asset classes to provide diversification and
allow for reduction in risk level as a participant approaches the retire-
ment date. The participant may choose the fund with a target retirement
date that most closely matches his or her own working horizon and/or
level of risk tolerance. The investment manager manages the asset alloca-
tion to shift away from more risky asset classes, such as equities, toward
more conservative asset classes, such as fixed income, as the target date
approaches.
•• Core Group—The Core Group investment options allow a participant to
choose diversified asset class funds and to blend them in an asset alloca-
tion of the participant’s own design. The Plan offers these funds across a
range of major asset classes. All the Core Group investment options are
passively managed. Each investment option is evaluated on the basis of its
appropriateness in a well-diversified portfolio and performance over the
appropriate time period (which may vary by asset class). The current Core
Group investment options are listed in Table C1.
•• Specialty Group—The investment options in the Specialty Group are
not considered core asset categories and are intended to be used in addi-
tion to the Core Group investment options. Each investment option is
evaluated on the basis of its appropriateness in a well-diversified portfolio

128 © 2017 CFA Institute Research Foundation. All rights reserved.

 Appendix C. Lurinberg University Defined-Contribution Plan Investment Policy Statement

Table C1. Target Date Funds

Group Funds Description

Core Group
Money market fund Cash and short-term high-quality bonds
Intermediate-term bond fund Short- and intermediate-term high-quality bonds
Inflation-protected bond fund US Treasury Inflation-Protected Securities
US large-company stock index fund US large-company stocks
US small-company stock index fund US small-company stocks
International developed-market stock Stocks of non-US countries with developed
index fund capital markets
Specialty Group
International emerging-market index fund Stocks of countries with emerging capital markets
US real estate stock index fund Publicly traded US real estate investment trust
stocks

and performance over the appropriate time period (which may vary by
asset class). The current Specialty Group investment options are listed in
Table C1.
The Committee periodically reviews the appropriateness of the Plan’s
investment options. The Committee considers the use of options by partici-
pants and participants’ comments conveyed to the Plan’s record keeper about
current or prospective investment options. The Committee may decide to add
new investment options or delete existing investment options at any time.

Selection of Investment Managers

A DC plan’s investment managers implement the plan’s investment options.
A plan sponsor identifies and retains managers that provide competitively priced,
high-quality services that offer plan participants cost-effective access to their des-
ignated investment strategies.
With respect to passively managed investment options, the Committee
seeks organizations that have considerable experience in managing DC plan
assets and that have a large base of assets and clients. Those attributes enhance
the ability of the investment managers to offer a wide variety of invest-
ment options at low management fees. Furthermore, these managers must
demonstrate the ability to manage passive portfolios that adequately track
assigned benchmarks after accounting for fees and expenses. With respect to
actively managed investment options, the Committee places emphasis on the

© 2017 CFA Institute Research Foundation. All rights reserved.  129

A Primer for Investment Trustees

perceived ability of the manager to add value to the investment of a pool of

assets when compared with an assigned benchmark.

Performance Evaluation
Performance evaluation refers to the process of measuring and interpreting the
performance of a plan’s investment options. In the context of investment policy,
performance evaluation acts as a feedback-and-control mechanism.
The Committee considers qualitative and quantitative criteria when eval-
uating the stability and effectiveness of its manager organizations. Criteria
include firm philosophy, process, people, price, and performance. To the
extent that serious concerns arise from these reviews, the Committee con-
ducts examinations of managers and makes determinations as to their contin-
ued viability as managers of the Plan’s investment options.
The performance of the manager for each investment option is evaluated
relative to the benchmark agreed to by the manager and the Committee.
Managers of passively managed investment options are expected to maintain
adequate tracking relative to the assigned benchmarks. Managers of actively
managed investment options are expected to exceed the performance of the
assigned benchmarks while maintaining agreed-upon levels of active man-
agement risk over a long-term time horizon. The Committee does not change
the Plan’s managers unless absolutely necessary in order to avoid costs and
confusion for the Plan’s participants.

Additional Investment Guidelines

Manager Investment Guidelines. The Committee requires that
investment guidelines be maintained for all the Plan’s investment managers.
Each manager’s investment guidelines include specifications, mutually agreed
to by the manager and the Committee, concerning the following factors for
the manager:
•• Return and risk objectives
•• Benchmark portfolio
•• Authorized securities
•• Portfolio composition constraints
•• Various investment and reporting practices

Securities Lending. Currently, the Committee believes that the incre-

mental returns offered by securities lending do not justify the risks involved.

130 © 2017 CFA Institute Research Foundation. All rights reserved.

 Appendix C. Lurinberg University Defined-Contribution Plan Investment Policy Statement

The Committee does not allow managers of the Plan’s investment options to
engage in securities lending. The Committee intends to periodically review
the appropriateness of securities lending for the Plan’s investment programs.
Fund “Mapping.” If an investment option is eliminated, participant
assets are transferred or “mapped” to an alternative investment option whose
investment goals are as similar as possible to the eliminated investment option
in terms of risk-and-return characteristics.

Fee Policy
A DC plan’s fee policy outlines the philosophy and criteria established by the plan
sponsor for negotiating fees paid to investment management and administrative
service providers and for determining how those fees are to be allocated to plan
participants and the sponsoring employer.
The Committee seeks to understand the breadth, depth, quality, and
necessity of the administrative and investment management services relative
to the fees paid for those services. The Committee strives to balance reason-
able investment management and administrative expenses with the services
received. Such factors as the Plan objectives, the Plan’s unique characteristics
and level of complexity, experience of the service provider, and breadth and
unique capabilities of the service provider, among others, are considered by
the Committee in retaining and compensating service providers.
Administrative expenses and investment management expenses are
reviewed periodically to assess the competitiveness of fees (both direct and
indirect) for the services provided by the service providers to the Plan, includ-
ing a determination of whether a lower-cost share class or investment vehicle
is available and feasible. The Committee may also consider whether the fees
are within a reasonable range as compared with the market and/or applicable
benchmarks.
Administrative expenses for services provided to the Plan include record
keeping, website operation, call center operation, participant search, commu-
nications preparation and delivery, communications consulting, investment
consulting, banking and trustee services, auditing, and help with fulfilling
regulatory requirements.
The Committee seeks to periodically evaluate whether the method
of allocating the expenses of the Plan to participants continues to be rea-
sonable. The Committee has determined that asset-based fees are prefer-
able to per-participant fees for administrative and investment management
expenses. These fees are paid through a reduction in net returns on invest-
ments. Participant-selected financial management service fees, loan fees, and

© 2017 CFA Institute Research Foundation. All rights reserved.  131

A Primer for Investment Trustees

withdrawal fees are allocated to a participant on the basis of the expense of

providing these transactions to the participant.
Participants pay for the following:
•• The investment management and administrative expenses of the Plan
•• Their own individual plan expenses (including loans, withdrawals, and
financial adviser account management)
•• The services of the Plan’s selected investment consultant
Forfeitures by participants are retained by the Plan to reduce expenses
charged to participants.
The University pays for the following:
•• Salaries, overhead, training, and travel expenses of the Committee
•• Salaries, overhead, training, and travel expenses of staff assigned to
administer and monitor the Plan
•• Salaries, overhead, and travel expenses of legal counsel to the Plan
•• Costs related to the Plan’s design studies

132 © 2017 CFA Institute Research Foundation. All rights reserved.

Glossary of Investment Terms

absolute return fund. See hedge fund.

active management. A form of investment management that involves buying
and selling financial assets with the objective of earning returns greater than
a specified benchmark.
active management return. The difference between a portfolio’s return and
the benchmark’s return.
active management risk. The risk taken by an active portfolio manager
to earn active management returns by taking positions different from the
benchmark; typically measured by the standard deviation of active manage-
ment returns.
actuary. A person or firm that specializes in estimating the liabilities associ-
ated with a benefit plan or an insurance trust.
agency conflict. The potential for a conflict of interest between an agent and
the person or organization for whom the agent is acting.
alternative investment. A term used to categorize assets other than tradi-
tional publicly traded stocks and bonds, including but not limited to private
equity, real estate, hedge funds, commodities, timber, and infrastructure.
annuity. A contract that guarantees a series of future payments to a party, the
annuitant, beginning at a specified point in time and continuing to a specified
future point in time or terminating at the date of the annuitant’s death.
arbitrage. The simultaneous purchase and sale of the same security, or a
security so similar as to be essentially the same, in two different markets at
different prices so as to profit from the difference.
asset allocation. The process of determining the desired division of an inves-
tor’s portfolio among available asset classes.
asset class. A broadly defined generic group of financial assets, such as stocks
or bonds.
basis point. One one-hundredth of a percentage point, or 0.01%; 100 basis
points (bps) add up to 1%.
benchmark. A portfolio with which the investment performance of an
investor can be compared for the purpose of determining investment skill.

© 2017 CFA Institute Research Foundation. All rights reserved.  133

A Primer for Investment Trustees

A benchmark portfolio represents a relevant and investable alternative to

the investor’s actual portfolio and, in particular, is similar in terms of risk
exposure.
benefits. Periodic payments promised or expected to be made to the desig-
nated beneficiaries of a pool of assets.
benefit security ratio. See funded ratio.
beta. A relative measure of the sensitivity of an asset’s return to changes in
the return on the market portfolio.
bond (fixed-income security). A type of investment in which the holder
lends money to another entity and is then entitled to periodic payments of
interest and a return of the capital at a specified time in the future.
buyout. A form of private equity in which a partnership buys all the shares of
a public company, usually taking on a large debt, to operate the company pri-
vately with the intention of eventually making a profit by taking the company
public again or selling part or all of it to another business.
commingled fund. An investment vehicle that sells units of ownership in
itself to one or more investors and uses the proceeds to purchase financial
assets for the benefit of the investors. The investors have a pro rata claim on
the assets of the fund proportional to their unit ownership.
commodity. A physical (real) asset used as an input to a production pro-
cess. Many commodities are traded in cash (spot) markets or on organized
exchanges in the form of futures contracts.
common stock (equity; stock). Legal representations of an ownership posi-
tion in a corporation.
conflict of interest. A situation in which the actions of a person who has a
duty to one party could benefit that person (or a related party) at the expense
of the party to whom the duty is owed.
contributions. Money added to a pool of assets for the purpose of investment
and, eventually, payment of benefits.
correlation. A statistical measure of the covariation of two random variables
(i.e., how much two asset returns change together).
custodian bank. A type of bank that provides safekeeping of financial
securities for an investor, including the related accounting and reporting
services.

134 © 2017 CFA Institute Research Foundation. All rights reserved.

 Glossary of Investment Terms

defined-benefit plan. A retirement plan in which the participants are prom-

ised a fixed benefit. The sponsoring organization takes the risk that its invest-
ments will be sufficient to provide these benefits.
defined-contribution plan. A retirement plan in which a participant (and
perhaps a sponsoring organization) makes fixed contributions and the par-
ticipant bears the risk that the assets will be sufficient to provide adequate
benefits upon retirement.
diversification. The process of investing in more than one type of asset to
reduce the risk of the entire portfolio.
EAFE index. An equity market index that includes securities from countries
in Europe, Australasia, and the Far East with well-developed capital markets.
US and Canadian securities are not included.
endowment. A gift, usually to an educational institution, whose purpose is to
provide funding for a particular mission in perpetuity; collectively, an aggre-
gate of such gifts being managed in a single strategy.
equity. See common stock.
expected return. The return on a security (or portfolio) that an investor
anticipates receiving over a given time horizon.
expense ratio. Annual fee that a mutual fund or exchange-traded fund
charges its shareholders for fund administration, management, operating,
and distribution services, expressed as a percentage of the market value of the
fund’s assets.
fiduciary. A person or entity that assumes responsibility to manage or oversee
a pool of assets on behalf of some other person or entity, such as a defined-
benefit plan or endowment. The fiduciary has a duty to act solely for the ben-
efit of that entity (not for himself or herself or some other entity).
fiduciary duty. A legal or ethical relationship of confidence or trust between
one party and another party or parties.
financial asset (security). A legal representation of the right to receive pro-
spective future benefits under stated conditions.
fixed-income security. See bond.
foundation. An entity that has some public mission (e.g., to cure a given dis-
ease) and provides grants to other entities to further that mission (e.g., by
conducting scientific research to find a cure). It owns a pool of assets that are
invested to provide income to fund that mission.

© 2017 CFA Institute Research Foundation. All rights reserved.  135

A Primer for Investment Trustees

funded ratio (benefit security ratio). Ratio of the value of a fund’s assets to
the value of the fund’s liabilities.
general partner. An individual or firm that sources and obtains financing
for the purchase of an asset and then manages that asset on behalf of other
providers of capital (the limited partners).
governance structure. A set of processes by which a fund is managed for the
benefit of some group of beneficiaries.
growth stocks. The stocks of companies that have experienced or are expected
to experience earnings-per-share growth higher than the market as a whole.
Growth stocks also tend to display high price-to-earnings ratios relative to
the market. Also called “glamour stocks.”
hedge fund. A form of active management distinguished by a lack of tra-
ditional guidelines or benchmarks; a hedge fund typically uses derivatives,
leverage, and/or short selling. The term is often synonymous with absolute
return fund.
high-yield (junk) bonds. Below-investment-grade bonds that have higher
yields (coupon payment divided by price) than other investment-grade bonds
of similar maturity because of greater uncertainty of coupon and principal
payment.
indexing. See passive management.
information ratio. A risk-adjusted measure of portfolio active management
performance. Mathematically, over an evaluation period, it is the annualized
ratio of active management return to active management risk, where risk is mea-
sured as the standard deviation of the portfolio’s active management returns.
internal rate of return. See money-weighted rate of return.
investable universe. The aggregate of securities that is appropriate and avail-
able for selection under a particular investment mandate.
investment committee. A group of individuals who are responsible for deter-
mining the investment policy of a fund.
investment consultant. A professional (usually associated with a firm) who
offers advisory services to a fund, most often in the areas of asset allocation,
investment policy, and manager selection.
investment-grade bonds. Generally, bonds that possess bond ratings of BBB
(Standard & Poor’s) or Baa (Moody’s Investment Services) or higher. Such

136 © 2017 CFA Institute Research Foundation. All rights reserved.

 Glossary of Investment Terms

ratings permit them to be purchased by regulated financial institutions, such

as banks.
investment manager. A person or entity that creates and manages portfolios
of securities for clients with money to invest.
investment policy. A component of the investment process that involves
determining a fund’s mission, objectives, and attitude toward the trade-off
between expected return and risk.
investment policy statement. A formal written document describing a fund’s
investment policy.
investment return. The percentage change in the value of an investment in
a financial asset (or portfolio of financial assets) over a specified time period.
investment risk. The potential for loss accepted by an investor in the pursuit
of investment return; alternatively, the uncertainty associated with the end-
of-period value of an investment.
investment skill. The ability of an active manager to select portfolios
that consistently have average returns greater than a given performance
benchmark.
liability. The present value of the accrued benefits promised to the beneficia-
ries of a fund.
limited partner. An individual or entity that provides equity financing to a
general partner for the purchase of an investment but does not participate in
the ongoing management of the investment.
liquidity. Property of a security that allows investors to convert the security
into cash at a price similar to the price of the previous trade in the security
(assuming that no significant new information has arrived since the previous
trade).
mandate. Strategy or performance benchmark used by an investment man-
ager on behalf of and at the direction of a client.
market capitalization. Aggregate market value of a security, equal to the
market price per unit of the security multiplied by the total number of out-
standing units of the security.
market cycle. A period of time over which a particular security market moves
from one peak to another or from one trough to another.

© 2017 CFA Institute Research Foundation. All rights reserved.  137

A Primer for Investment Trustees

market index. A collection of securities whose values are averaged to reflect

the overall investment performance of a particular market for financial assets.
money-weighted rate of return (internal rate of return). The rate of return
on a portfolio over a particular period of time. It is the discount rate that
equates the present value of cash flows into and out of the portfolio, plus the
portfolio’s ending value, to the portfolio’s beginning value.
mutual fund. A managed investment company, with an unlimited life, that
stands ready at all times to purchase its shares from its owners and usually
will continuously offer new shares to the public.
outsourced chief investment officer. A service offered by investment organi-
zations to actively assist sponsors of retirement plans, endowment funds, and
foundations in carrying out a range of governance and management respon-
sibilities, including investment policy design, asset allocation, manager selec-
tion and monitoring, and performance reporting.
overfunded. The status of a fund whose assets are greater in value than the
associated plan’s liabilities.
passive management (indexing). The process of buying and holding a well-
diversified portfolio designed to produce substantially the same returns as a
specified market index.
peer group. A set of investors (funds or managers) whose returns are used
for a comparison with those of a given fund to determine how the given fund
ranks among similar funds.
performance appraisal. The part of the performance evaluation process that
attempts to determine whether the investment returns over an evaluation
period have been achieved by skill or luck.
performance attribution. The part of the performance evaluation process
that identifies sources of returns for a portfolio relative to a designated bench-
mark over an evaluation period.
performance evaluation. A component of the investment process involv-
ing periodic analysis of how a portfolio performed in terms of both returns
earned and risks incurred.
performance measurement. The part of the performance evaluation process
that calculates a portfolio’s rate of return over an evaluation period.
plan participant. A member of a defined-benefit or defined-contribution
plan to whom benefits are promised or are being paid.

138 © 2017 CFA Institute Research Foundation. All rights reserved.

 Glossary of Investment Terms

policy asset mix. A set of asset classes and desired percentage allocations
to each class such that the total portfolio displays the investor’s desired risk
and expected return profile; also referred to as the “policy portfolio,” “policy
benchmark,” “policy asset allocation,” or “strategic asset allocation.”
private equity. A broad asset class generally involving buyouts, venture capi-
tal, and distressed debt converted into equity.
real estate. An investment in land and physical structures intended to pro-
vide a stream of rental or lease income and possibly capital appreciation.
rebalancing. The process of buying and selling assets to restore a fund to its
policy asset mix after market movements or net cash flows have changed the
actual market weights of the various asset classes.
record keeper. An investment organization responsible for maintaining the
financial and investment details of the individual participants’ records in a
retirement plan.
relative performance. The difference between a portfolio’s return and the
benchmark’s return.
risk budgeting. A risk management technique in which assets are allocated
efficiently so that the expected return of each asset is proportional to its con-
tribution to portfolio risk.
risk capacity. Financial ability of an investment organization to withstand
adverse investment results.
risk management. A part of the investment process in which the risks of a
portfolio are identified and quantified; strategies are then developed to con-
trol those risks.
risk tolerance. The trade-off between risk and expected return demanded by
a particular investor.
scenario analysis. A process whereby, for the purpose of designing appropri-
ate investment strategies, an investor considers a number of possible future
economic investment environments and the likelihood of those environments
occurring.
security. See financial asset.
separately managed account. An investment vehicle that takes in funds
from a single investor and uses the proceeds to purchase financial assets for
the sole benefit of that investor. The investor directly owns all assets held in
the account. Also called “separate account.”

© 2017 CFA Institute Research Foundation. All rights reserved.  139

A Primer for Investment Trustees

Sharpe ratio. A risk-adjusted measure of portfolio performance in which

risk is measured by the standard deviation of the portfolio’s returns.
Mathematically, over an evaluation period, it is the annualized ratio of the
excess return (the actual return less the risk-free return) of the portfolio
divided by the portfolio’s standard deviation.
staff. The professionals who, on a day-to-day basis, administer the investment
program of a fund.
standard deviation. A statistical measure of the variability (range of poten-
tial outcomes) of investment returns.
stock. See common stock.
stress test. A form of analysis in which one estimates the impact of various
adverse situations on the returns of a portfolio.
time-weighted rate of return. The rate of return on a portfolio over a par-
ticular period of time. Effectively, it is the return on $1.00 invested in the
portfolio at the beginning of the measurement period.
trustee. A person who has fiduciary responsibility for a pool of assets.
uncertainty. The state of incomplete knowledge about the present and future
with respect to an investment.
uncorrelated. The condition in which the returns of two or more assets do
not go in the same direction at the same time.
underfunded. The status of a fund whose assets are less in value than the
liabilities for which those assets exist.
value stocks. The stocks of companies that have experienced poor past price
performance or whose issuing companies have experienced relatively poor
past earnings compared with the market as a whole. Value stocks tend to
display low price-to-earnings ratios relative to the market. Also called “dis-
tressed stocks.”
venture capital. A form of private equity involving non-publicly-traded
equity investments in which a general partner provides capital to an entrepre-
neur to begin or grow an enterprise with the intention of eventually making a
profit by taking the company public or selling it to another business.
volatility. The characteristic that financial asset returns vary over time in
unpredictable ways or amounts. This term is often used interchangeably with
“standard deviation of the asset’s returns.”

140 © 2017 CFA Institute Research Foundation. All rights reserved.

Further Reading

Must-Reads
Four top-notch general-interest books on investing that provide a basic edu-
cation in sound investment principles (start with Malkiel):
Bernstein, Peter L. 1996. Against the Gods: The Remarkable Story of Risk.
New York: John Wiley & Sons.
Chancellor, Edward. 2000. Devil Take the Hindmost: A History of Financial
Speculation. New York: Plume.
Kahneman, Daniel. 2011. Thinking, Fast and Slow. New York: Farrar, Straus
and Giroux.
Malkiel, Burton G. 2007. A Random Walk Down Wall Street: The Time-Tested
Strategy for Successful Investing, revised and updated ed. New York: W.W.
Norton.

Further Education
The following are well-written, highly regarded books about investing.
Swensen’s book, in particular, deals with setting up a superior investment
management process (actual investment results, of course, are not guaranteed):
Ambachtsheer, Keith P., and D. Don Ezra. 1998. Pension Fund Excellence.
New York: John Wiley & Sons.
Bernstein, Peter L. 2005. Capital Ideas: The Improbable Origins of Modern Wall
Street. New York: John Wiley & Sons.
Bogle, John C. 2010. Common Sense on Mutual Funds, fully updated 10th
anniversary ed. Hoboken, NJ: John Wiley & Sons.
Bookstaber, Richard. 2007. A Demon of Our Own Design: Markets, Hedge
Funds, and the Perils of Financial Innovation. Hoboken, NJ: John Wiley &
Sons.
Ferguson, Niall. 2008. The Ascent of Money: A Financial History of the World.
New York: Penguin Press.
Graham, Benjamin. 2003. The Intelligent Investor, revised ed. updated with
new commentary by Jason Zweig. New York: HarperCollins Publishers/
HarperBusiness Essentials.

© 2017 CFA Institute Research Foundation. All rights reserved.  141

A Primer for Investment Trustees

Swensen, David F. 2000. Pioneering Portfolio Management: An Unconventional

Approach to Institutional Investment. New York: Simon & Schuster/Free Press.
One journal article on investing that we highly recommend is by a Nobel
Prize–winning economist and comes to a startling conclusion that should
keep all of us humble:
Sharpe, William F. 1991. “The Arithmetic of Active Management.” Financial
Analysts Journal, vol. 47, no. 1 (January/February): 7–9. doi:10.2469/faj.v47.
n1.7

Resources for Investment Committees

Many short articles on investment committee processes are available, but few
publications take an in-depth and comprehensive look at the role of groups
charged with overseeing the investment of pools of capital. Three books are
worth a read:
DiBruno, Rocco. 2006. Best Practices for Investment Committees. New York:
John Wiley & Sons.
Greenwich Roundtable. 2014. Best Governance Practices for Investment
Committees.
Olson, Russell L. 2005. The Handbook for Investment Committee Members.
New York: John Wiley & Sons.
Shorter articles of note include the following:
Drew, Michael E., and Adam N. Walk. 2016. “Governance: The Sine Qua
Non of Retirement Security.” Journal of Retirement (Summer): 1–10.
Ellis, Charles D. 2011. “Best Practice Investment Committees.” Journal of
Portfolio Management, Winter: 139–147. doi:10.3905/jpm.2011.37.2.139
Vanguard Group. 2004. Investment Committees: Vanguard’s View of Best
Practices.
Wood, Arnold S. 2006. Behavioral Finance and Investment Committee Decision
Making. Charlottesville, VA: CFA Institute.

Ethical and Professional Standards

The first two publications in this list deal with standards for investment
managers and staff; the other two cover standards for trustees:

142 © 2017 CFA Institute Research Foundation. All rights reserved.

 Further Reading

CFA Institute. 2014. Code of Ethics and Standards of Professional Conduct.

Charlottesville, VA: CFA Institute (http://www.cfapubs.org/doi/pdf/10.2469/
ccb.v2014.n6.1).
Schacht, Kurt, Jonathan J. Stokes, and Glenn Doggett. 2009. Asset Manager
Code of Professional Conduct, 2nd ed. Charlottesville, VA: CFA Institute
(http://www.cfapubs.org/toc/ccb/2009/2009/8).
Schacht, Kurt, Jonathan J. Stokes, and Glenn Doggett. 2010. Investment
Management Code of Conduct for Endowments, Foundations, and Charitable
Organizations. Charlottesville, VA: CFA Institute (http://www.cfapubs.org/
toc/ccb/2010/2010/15).
CFA Institute. 2015. Code of Conduct for Members of a Pension Scheme
Governing Body. Charlottesville, VA: CFA Institute (http://www.cfapubs.org/
doi/abs/10.2469/ccb.v2008.n3.1).

Textbooks and Articles

The following small volume expands on many of the topics in Sessions 4, 6,
and 8 and offers trustees a nonquantitative discussion on evaluating invest-
ment performance:
Siegel, Laurence B. 2003. Benchmarks and Investment Management.
Charlottesville, VA: Research Foundation of CFA Institute.
A useful discussion of performance evaluation is also presented in this
book chapter:
Bailey, Jeffery V., Thomas M. Richards, and David E. Tierney. 2009.
“Evaluating Portfolio Performance.” In Investment Performance Measurement.
Edited by Philip Lawton and Todd Jankowski. Charlottesville, VA: CFA
Institute.
For those trustees with the time and interest, this textbook sponsored
by CFA Institute provides comprehensive and in-depth—but largely
nontechnical—coverage of all aspects of institutional investing:
Maginn, John L., Donald L. Tuttle, Dennis W. McLeavey, and Jerald E.
Pinto. 2007. Managing Investment Portfolios: A Dynamic Process, 3rd ed.
Hoboken, NJ: John Wiley & Sons.

© 2017 CFA Institute Research Foundation. All rights reserved.  143

 The CFA Institute
Research Foundation
Board of Trustees
2017–2018
Chair JT Grier, CFA* Fred Lebel, CFA
Joachim Klement, CFA Virginia Retirement HFS Hedge Fund
London, England System Selection S.A.

Ted Aronson, CFA Joanne Hill Mauro Miranda, CFA

AJO, LP ProShares CFA Society Brazil
Jeffery V. Bailey, CFA* George R. Hoguet, CFA Sophie Palmer, CFA
Tonka Bay, MN Chesham Investments, Jarislowsky Fraser
LLC
Heather Brilliant, CFA Paul Smith, CFA
First State Investments Jason Hsu, PhD CFA Institute
Rayliant Global Advisors
Bill Fung, PhD
Aventura, FL Vikram Kuriyan, PhD, CFA
Indian School of
Diane Garnick Business
TIAA

*Emeritus

Officers and Directors

Executive Director Secretary
Bud Haslett, CFA Jessica Critzer
CFA Institute CFA Institute
Gary P. Brinson Director of Research Treasurer
Laurence B. Siegel Kim Maynard
Blue Moon Communications CFA Institute

Research Foundation Review Board

William J. Bernstein Paul D. Kaplan, CFA Krishna Ramaswamy
Efficient Frontier Morningstar, Inc. University of
Advisors Pennsylvania
Robert E. Kiernan III
Elroy Dimson Advanced Portfolio Andrew Rudd
London Business School Management Advisor Software, Inc.

Stephen Figlewski Andrew W. Lo Stephen Sexauer

New York University Massachusetts Institute Allianz Global Investors
of Technology Solutions
William N. Goetzmann
Yale School of Alan Marcus Lee R. Thomas
Management Boston College Pacific Investment
Management Company
Elizabeth R. Hilpman Paul O’Connell
Barlow Partners, Inc. FDO Partners
 Named Endowments
The CFA Institute Research Foundation acknowledges with sincere gratitude the
generous contributions of the Named Endowment participants listed below.
Gifts of at least US$100,000 qualify donors for membership in the Named Endow-
ment category, which recognizes in perpetuity the commitment toward unbiased,
practitioner-oriented, relevant research that these firms and individuals have ex-
pressed through their generous support of the CFA Institute Research Foundation.

Ameritech Miller Anderson & Sherrerd, LLP

Anonymous Nikko Securities Co., Ltd.
Robert D. Arnott Nippon Life Insurance Company of
Theodore R. Aronson, CFA Japan
Asahi Mutual Life Insurance Company Nomura Securities Co., Ltd.
Batterymarch Financial Payden & Rygel
Management Provident National Bank
Boston Company Frank K. Reilly, CFA
Boston Partners Asset Management, Salomon Brothers
L.P. Sassoon Holdings Pte. Ltd.
Gary P. Brinson, CFA Scudder Stevens & Clark
Brinson Partners, Inc. Security Analysts Association
Capital Group International, Inc. of Japan
Concord Capital Management Shaw Data Securities, Inc.
Dai-Ichi Life Insurance Company Sit Investment Associates, Inc.
Daiwa Securities Standish, Ayer & Wood, Inc.
Mr. and Mrs. Jeffrey Diermeier State Farm Insurance Company
Gifford Fong Associates Sumitomo Life America, Inc.
Investment Counsel Association T. Rowe Price Associates, Inc.
of America, Inc. Templeton Investment Counsel Inc.
Jacobs Levy Equity Management Frank Trainer, CFA
John A. Gunn, CFA Travelers Insurance Co.
John B. Neff, CFA USF&G Companies
Jon L. Hagler Foundation Yamaichi Securities Co., Ltd.
Long-Term Credit Bank of Japan, Ltd.
Lynch, Jones & Ryan, LLC
Meiji Mutual Life Insurance
Company
Senior Research Fellows
Financial Services Analyst Association
For more on upcoming Research Foundation
publications and webcasts, please visit
www.cfainstitute.org/learning/foundation.
Research Foundation monographs
are online at www.cfapubs.org.
 RESEARCH FOUNDATION
CONTRIBUTION FORM
✓Yes, I want the Research Foundation to continue to fund innovative
research that advances the investment management profession. Please
accept my tax-deductible contribution at the following level:
Thought Leadership Circle..................... US$1,000,000 or more
Named Endowment....................... US$100,000 to US$999,999
Research Fellow............................... US$10,000 to US$99,999
Contributing Donor. . ............................US$1,000 to US$9,999
Friend........................................................... Up to US$999
I would like to donate US$______________________.

My check is enclosed (payable to the CFA Institute Research Foundation).

I would like to donate appreciated securities (send me information).
Please charge my donation to my credit card.
VISA MC Amex Diners

Card Number

—— /——
Expiration Date
_______________________________
Name on card    P L E A S E   P R I N T

Corporate Card
Personal Card __________________________________
Signature

This is a pledge. Please bill me for my donation of US$______________

I would like recognition of my donation to be:
Individual donation Corporate donation Different individual

____________________________________________________
PLEASE PRINT NAME OR COMPANY NAME AS YOU WOULD LIKE IT TO APPEAR

PLEASE PRINT Mr. Mrs. Ms.   MEMBER NUMBER_______________________________

Last Name (Family Name) First (Given Name) Middle Initial

Title

Address

City State/Province Country ZIP/Postal Code

Please mail this completed form with your contribution to:

The CFA Institute Research Foundation • P.O. Box 2082
Charlottesville, VA 22902-2082 USA

For more on the CFA Institute Research Foundation, please visit

www.cfainstitute.org/learning/foundation/Pages/index.aspx.
 ISBN 978-1-944960-29-2

Available online at www.cfapubs.org 9 781944 960292