On February 27, 2024 has been published, capping my four-year, comprehensive effort documenting the financial history of the United States. The book begins with Alexander Hamilton’s good financial programs in 1790 and ends with post-COVID-19 inflation in 2023. Now that the promotional process for the book is coming to an end, I’m returning to my second passion, which is serving as an advisor to trustees of institutional investment plans.
This blog post draws on several chapters of my book in addition to my 12+ years of experience as an investment advisor. It is predicated on five quotes that relate to the achievement of a trustee’s fiduciary duties.
If you function a fiduciary of an institutional investment plan, these quotes can enable you to make your decisions for the good thing about those that rely on your stewardship.
Uniform Law on Prudent Investors (1994)
A trustee’s most precious asset is never present in the portfolios they manage. In fact, their most precious commodity is their time. Trustees typically meet quarterly for a couple of hours, forcing them to rely heavily on the recommendation of investment advisers, skilled staff and asset managers. Over the past few a long time, these advisers have encouraged trustees so as to add actively managed funds and expensive alternative asset classes.
The Uniform Prudent Investor Act (UPIA) requires fiduciaries to guage whether these incrementally higher costs are value it, but few take into consideration their obligation to make such decisions. Perhaps reciting this quote before making any decision—especially people who end in substantially higher fees—can function an affordable but effective hedge against unintended financial waste.
— Nobel Prize winner William Sharpe (1991)
Investment advisors and investment personnel often recommend the extensive use of energetic managers without considering the overwhelming body of evidence that shows that energetic management is unlikely so as to add value. Skeptics of this approach need only take a look at the exceptional performance of Nevada Public Employees Retirement System (PERS) to verify their concerns.
Nevada PERS employs just two people and invests about 85% of its portfolio in index funds. The company boasts 10-, 15- and 20-year returns that exceed those of about 90% of public pension plans with assets over $1 billion. Given these extraordinary results, advisers and employees may deny the truth of the mathematical principles underlying them or argue that they’re exceptions to the rule.
Trustees, in turn, often take such explanations at face value, although the arguments are rarely backed up by credible track records. Unless advisers or staff can convincingly explain why they’re uniquely positioned to pick out one of the best fund managers repeatedly and consistently over a long time, it is generally most reasonable to assume that they usually are not.
Allan S. Bufferd, former Treasurer of the Massachusetts Institute of Technology (2008)
In 2000, David Swensenthe previous CIO of the Yale Investments Office, published The book describes intimately most of the techniques he used to realize returns that far exceeded those of his peers.
Key to Yale’s success was the presence of an especially talented CIO, stable and prudent leadership, and a singular learning culture that enabled team members to emulate Swensen’s talents. The critical importance of those often neglected skills is addressed in a subchapter entitled “Pioneering Human Resource Management.”
Yale relied on this rare ecosystem and repeatedly chosen one of the best fund managers – particularly in alternative asset classes reminiscent of enterprise capital, buyout funds and absolute return funds. Instead of concluding after reading that Yale’s ecosystem was exceptionally rare and difficult to copy, investment staff, advisors and OCIOs falsely assumed that simply gaining access to alternative asset classes was a reliable path to Yale-like returns.
The problem with this assumption is that it was clear 15 years ago that Yale’s returns trusted consistent and sustainable top-quartile fund manager selection. Without a Yale-like ecosystem, it is very unlikely that this feat will probably be achieved in the harmful and expensive space of other asset classes, and failure to deliver top-quartile returns is a recipe for mediocrity or worse.
Therefore, before establishing or continuing alternative asset classes, fiduciaries should consider whether or not they and/or their advisors have Yale’s capabilities. In just about all cases, the honest answer is “no.”
David Swensen, former CIO of the Yale Investments Office (2012)
No one understood higher than Swensen himself how difficult it’s to outperform ruthlessly efficient markets and dangerously opaque alternative asset classes. That’s why he concluded that nearly all institutional and retail investors would achieve higher long-term results in the event that they invested exclusively in low-cost index funds.
The foremost reason this message unfortunately never makes it into boardrooms and investment committee meetings is that the individuals who advise trustees almost at all times suffer from a deep-seated fear that doing so will make them redundant. One of the best tragedies is that the other is true.
Once advisors let go of the hope and dream that they’re a part of the tiny subset of investment professionals who can outsmart the merciless efficiency of the markets, they will refocus fiduciaries’ scarce time on the true financial challenges which are often neglected.
J. Pierpont Morgan, financier
Fiduciaries are sometimes reluctant to alter their portfolios in ways in which significantly differentiate them from their peers. Even those that consider that low-cost index funds are essentially the most prudent approach often succumb to fear of underperforming their competitors within the short term.
It is a fantastic irony of monetary history that trustees often view large allocations to low-cost index funds as a riskier enterprise, when actually the other is true. At the basis of this misconception is an age-old axiom articulated by the good financier of the Gilded Age: J. Pierpont MorganOvercoming the instinctive envy that comes from watching one’s neighbors get richer is an emotional obstacle that trustees must overcome in the event that they are to turn into prudent stewards of their capital.
I hope these quotes will help fiduciaries, in whose hands taxpayers and beneficiaries place their trust, make their future decisions. Internalizing these principles requires no financial outlay and only a small investment of a fiduciary’s most respected asset – their time. But by applying them confidently and repeatedly, fiduciaries can reduce costs, minimize unnecessary portfolio complexity, and focus their time on resolving previously neglected financial challenges. In doing so, they will move further along the trail to fulfilling their fiduciary duty.
