Effective investment management requires clear communication. Everyone involved needs to know what return they’re searching for and what risks they’re taking. But the amorphous quality of some key investment concepts, particularly investment risk, often makes this communication difficult to attain.
In this primary a part of our three-part series, we discuss the necessity for clear communication within the early stages of the investment process and the way goals form the premise for fundamental investment strategy decisions.
The setting
In any major institution, the investment process requires collaboration. The ideas and opinions of participants, from executives and board members to outside investment managers and advisors, should be heard and evaluated, even in the event that they are usually not necessarily acted upon. Comprehensive and intensive communication is important.
However, communication is difficult within the investment world. The language of investing just isn’t all the time intuitive and may seem opaque, often obscuring as much because it reveals. Some concepts will be expressed simply and accurately to the third decimal place. Others are tougher to define and capture. As a result, the consultations happen in what may look like a foreign language to non-practitioners, and a few participants may consider that they understand and are understood when neither is the case.
The success or failure of those dialogues influences vital decisions at every stage of the investment process.
From purpose to investment objectives
For most large investment pools, the overall purpose seems clear enough. The money is used to generate funds to support charitable activities, provide retirement income, pay future insurance claims, or provide income for relations now or in the long run.
Once the aim is established, an in depth goal discussion must occur to find out how financial resources will likely be invested to support that purpose. For example, a nonprofit foundation should establish specific program goals since it cannot do every little thing for everybody.
For example, once the inspiration has committed itself to supporting the humanities, it must first determine how long it should exist. Should it give away all of its money as quickly as possible to fulfill critical needs in the humanities after which exit of business? Or should it commit to supporting its mission in perpetuity? Either is a good choice, but when the latter is the case, the inspiration must create a grant program supported by an investment program that ensures it lives inside its means.
Decisions about what goals to pursue require difficult and sometimes painful conversations, and the vocabulary of investing can sometimes hide goals or cloud the choices. Furthermore, such decisions are never unanimous. Mid-price corrections are sometimes obligatory responses to changes in investment results or changing circumstances. In the nineteenth and early twentieth centuries, quite a few foundations were founded to support orphanages. But after all the variety of orphans and the best way they’re cared for is totally different today than it was a century ago. These foundations have responded accordingly, changing their purpose and investment objectives to adapt to the times and the changing needs of their mission. Therefore, regular confirmation of the investment purpose and regular setting of investment goals are essential parts of the investment process.
One practical approach is to set investment goals over continuous or rolling “investment planning horizons.” These can last as little as one yr or as much as 10 years and are often updated annually. For example, the next table shows typical components of goal return objectives over a five-year investment planning horizon for a $50 million public foundation, a $100 million private foundation, and a $1 billion defined profit pension plan.
Example of five-year investment return targets
| Public foundation valued at $50 million | $100 million private foundation | $1 billion defined profit pension plan | |
| Annual expected funding needs/payments | 3.00% | 5.00% | 3.50% |
| Expected inflation | 2.50% | 2.54% | 2.75% |
| Investment management fees | 0.75% | 0.50% | 0.55% |
| Portfolio growth | 0.50% | 0.00% | 0.20% |
| Investment return objective | 6.75% | 8.04% | 7.00% |
Each of those investment organizations has various degrees of discretion and precision in setting their goal return objectives. A personal foundation must pay out not less than 5% annually to take care of its tax-exempt status, while an outlined profit pension fund requires only an estimated payout and a public foundation can have significant discretion over its spending. However, every organization has a goal return on investment for the five-year horizon, even when it expects to satisfy its purpose indefinitely.
Once investment return objectives are estimated, investors should proceed to developing the investment strategy. Maximizing returns may look like a smart goal, but that is easier said than done. This can mean taking significant risks, which may result in setbacks that limit a company’s ability to attain its goals.
This balancing act is further complicated by the shortage of symmetry in investment language. Risk and return are the yin and yang of investing. Return measurements are concrete and enable meaningful comparisons over time and across a spread of portfolios. But the chance is unclear and difficult to evaluate. Is it volatility? Tracking error? Any lack of value? A catastrophic decline? Do something that others think is silly?
For this reason, identifying investment objectives and obtaining stakeholder buy-in is the critical first step in linking objectives to portfolio construction. And that requires overcoming the inherent inadequacies in the best way we speak about risk and other investment concepts.
The communication challenges related to traditional investment decision frameworks and risk concepts, comparable to: B. standard deviation will likely be the subject of the subsequent a part of this series.
1. is published by the Investments & Wealth Institute®.
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