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The importance of a good investment policy

3 min read

Why you should have an investment policy
Investment policies make sense for a number of reasons:

  • An investment policy should remind your organisation’s board of the longer term goals of its financial assets, which can easily be forgotten in times of economic exuberance or more presently, crisis. As Nobel Laureate James Tobin famously reminded third sector board members: they are “the guardians of the future against the claims of the present”.
  • From a practical point of view, an investment policy can give board members a guide, not a prescriptive recipe, on how investments should be managed. Board turnover in the third sector remains high, so an investment policy is a common sense way to ensure that procedures, prohibitions and contact details are not lost when board members move on.
  • Good asset management is more than just an end in itself. As any fundraising professional knows, potential donors place a lot of emphasis on the quality of management and a strong record in investment management is essential.
  • If Board members are not sufficiently aware, they have a fiduciary duty to ensure they take reasonable steps to manage and/or be aware of the financial assets of their organisation.
  • Having an investment policy might make you more money or minimise the likelihood of any foolish investment decisions.

The evidence speaks for itself
The UK’s Institute for Philanthropy has published a thought provoking study called ‘Investment Matters – In search of Better Charity Asset Management’. The institute surveyed charitable organisations with substantial funds to invest and found a wide discrepancy in returns, which are positively correlated with the degree of diversification and the presence of investment committees.

Asset allocation makes a big difference. In an often quoted academic article, ‘Determinants of Portfolio Performance: An update’, leading finance academics argue that the overwhelming majority of the variability in long term investment performance can be attributed to asset allocation. Conceptually, it is easy to show that being fully invested in Australian property throughout the late 1990s and in Australian Equities until late 2007 was the key determinant of good returns, not individual investment choice known as ‘stock picking’, or aggressive buying and selling, known as ‘timing the market’.

Studies of investment returns of university endowments in the UK and US found that even a modest gap in annualised performance can have substantial impact over the long haul. Yale’s investment returns of 16 per cent per annum produced a 2005 endowment value of more than ten times that of 1985. As such, academics argue that governance and management structures matter if they can improve asset allocation decisions that result in superior long term performance.

So if you don’t have an investment policy, draw one up!

What makes a good investment policy?
Keep it simple. It is not rocket science. A quick Google search will find you a number of variants on the theme. To paraphrase General George S. Patton, a good plan today is better than a perfect plan tomorrow. The important thing is to have one.

Keep it brief. Two to three pages should be plenty. While doing some research in early 2007, I came across an investment policy written for Australian municipal authorities. The document is comprehensive and well written, clearly with the input from someone involved in asset allocation and financial markets, but at 27 pages it is too long.

Be prepared. Collateralised Debt Obligations (CDOs) were the first casualty of the credit crunch. We were advising in March 2007 that the CDOs marketed in Australia did not pay a high enough rate of return for the high risks involved in the lower tranches. While this was correct, we, and the market, underestimated the degree of ‘downside’ risk investors faced. The market for these securities completely evaporated. Unfortunately many third sector investment portfolios, to which these CDOs were aggressively marketed, are now facing substantial or complete capital loss on what they thought were stable, high yielding investments.

Investment preferences. Creating an investment policy is a good opportunity to incorporate your not-for-profit’s investment preferences. If you spend a little bit of time detailing your ethical criteria on an investment policy, you will have a far more tailored ‘ethical investment’ than any of the off-the-shelf ‘ethical investment’ funds on offer.

Ask for help. If you are unsure or would like some professional advice get your financial adviser to help draft an investment policy with you.

I hope this encourages you to get interested in your organisation’s investment issues. While an investment policy alone will not prevent losses in a volatile market, it will sharpen your focus on issues in the portfolio and minimise the chance of losing money.

Charles Heerey is an Investment Adviser at Bell Potter Securities and can be contacted at or 03 9235 1950.

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