Author: Jim Jeffery

A paradigm shift is an important change that happens when the usual way of thinking about or doing something is replaced by a new or different way. Paradigm shifts very often relate to new technologies. Remember when we composed letters and papers on a typewriter? Or when we pulled an encyclopedia off the bookshelf for an authoritative explanation? Yes, the internet and smart phones have changed everything, but that’s ancient history (just check Wikipedia). Today the new emerging paradigm is artificial intelligence, or AI. With the potential to catapult progress and at the same time wreak undeterminable havoc, AI is the new shiny thing that has the potential to change the way we live, just like the internet.

But there are other kinds of paradigm shifts that occur across many disciplines that may not quite be life-changing but are important turning points nonetheless. When a group of entrepreneurs decided to lay cable into homes across America to deliver dozens and eventually hundreds of TV channels, that was game changing. As was the development of a Covid 19 vaccine. All of these things changed the way people thought about things.

What does this have to do with asset allocation, a discipline dear to our hearts and central to investment management success? Once upon a time, portfolio construction was deemed to be simple; 60% stocks and 40% bonds for many institutional and high net worth investors. We could expect stocks to return 10% vs 5% on bonds and we could expect that when the more volatile stock portion suffered, bonds would move in the opposite direction and would provide both income and a portfolio buffer as bond yields declined and their prices increased, adding to portfolio total return.

The paradigm shift that turned this on its head ironically started after the bursting of the internet bubble in the early part of this century. Internet stocks with little revenue and no earnings crashed, quickly followed by the tragic and unforgettable events of 9/11. This double blow and its portent ushered in the era of extreme interest rate cuts to bolster the economy and, importantly, to support the value of assets such as stocks. The biggest advocate of this plan to increase asset levels and thereby wealth, was former Fed Chair Ben Bernanke. As a member of the Fed under Alan Greenspan, he was referred to as “helicopter Ben” for his proclamation that we should rain dollars on the economy to avoid a fate similar to the Great Depression, which reflected a major part of his economic scholarship. This era of very low interest rates (1%) produced great speculation in residential real estate and when rates began to be lifted by Greenspan in 2004 and Bernanke (who then ascended to Fed Chair) in 2006, the roof caved in on the real estate market and led to the Great Financial Recession. Since that time, interest rates have fluctuated in a range unusually low from an historic perspective. The final blow was Covid 19 and the lessons learned from the recent past influenced the Fed Reserve to push interest rates to zero until just recently. So for almost 20 years, interest rates were at extremely low levels and asset prices of all types benefited.

The acronym T.I.N.A (“there is no alternative”, borrowed from Margaret Thatcher) evolved some time ago in asset allocation conversations and it basically posits that for investors there is no good alternative to stocks. Why? When bonds paid 5%, the interest paid on bonds could help stabilize portfolios through a rocky market. When they paid nothing that cushion disappeared. Of course, if the economy weakened, yields could still go from 1.50%to 1.00% and would produce a nice total return. But most could not imagine lower yields (and often were wrong during this long period)

The idea that super low rates could spur the economy never really played out as long-term GDP growth was lower in the 21st century than in previous periods (2.08% vs. 3.39% since 1960) But the theory that super low rates could cause stocks and other assets to increase in value did work. Think of a shopper who is comparing interest rates on bonds with potential returns in stocks. For many there was no alternative to avoiding bonds which didn’t pay anything. This temporary (if one takes a very long view!), emergency shift to zero rates changed investor behavior. And it changed the mindset for asset allocators.

Increasingly, and with good reason, investors turned to alternative investments such as hedge funds and private equity. And they increased their allocation to equities while decreasing allocations to bonds. Under normal circumstances the power of the market would have been self-correcting; bond prices would fall as investors sold into tepid demand. But Bernanke’s Fed did not stop at lowering interest rates to zero. In a herculean effort to save the world, they engaged in something called quantitative easing which entailed the Fed using its balance sheet to buy all the bonds that investors were shunning. Pretty incredible stuff when you think about it.

Whether a result of 15 years of super low rates and Fed bond buying or emergency stimulus of the pandemic and ensuing supply chain bottlenecks, our old friend inflation has entered stage right. In response, the fed has raised the funds rate 500 basis points higher than it was just over a year ago. This caused a collapse in growth stocks, a historic decline in bond prices and has cast doubt on the continued recovery from the pandemic.

So, where’s the catalyst for the next paradigm shift in asset allocation? Higher interest rates on bonds for sure! You can buy a 2-year US Treasury at about 5.00% and you should be able to find good investment grade corporate bonds at yields over 6.00%. You can buy mortgage-backed securities at 6.30% and a high yield mutual fund that yields over 8%. Let’s say that with a diversified portfolio of bonds as you might find in a highly rated intermediate term core-plus bond fund, you will have an underlying portfolio with a yield of 5.75%. How do I compare the stock market’s potential to this bond? You have probably heard a lot about price-to-earnings ratios over the past year. It measures the stock price divided by the forward earnings market forecast. Currently the P/E on the S&P 500 is just under 18. Why is this relevant to a comparison with bond yields? If you flip the P/E and turn it into E/P, or the ratio of forward earnings to stock price, we get what is called the earnings yield. The reciprocal of 18 is 5.56% and this is the earnings yield that the S&P 500 is forecasting. Again, it is the forecasted earnings consensus divided by the price you are paying for the market, and it is 5.56%. The S&P 500 pays a dividend that is currently 1.69%, so the total return forecast would be 7.25%.

Two years ago, the earnings yield plus dividend was about 5% and bond yields were skimpy to zero. Many allocators tilted portfolios further towards stocks, ignoring the risks that the 5.00% forecasted return was balanced against, namely that eventual higher interest rates would prompt a revaluation of equity P/E multiples and a tumble in stocks. But in a steady state and very simple analysis, this decision process made sense to some.

Today you can buy a 6-month T-bill at 5.50% or invest in a diversified portfolio of bonds at 5.75%. So do we take 5.50% with no risk, 5.75% with 75% less risk than equities, or do we buy the S&P 500 at 7.25% (earnings yield plus dividend)? Clearly today’s higher interest rates have changed the metrics of this very basic allocation decision!  And there is an alternative (T.I.A.A!) to equities.

The point of all this is that the basic math around comparisons of stocks and bonds broadly has changed, and that it is important. This is the perfect time to be talking about asset allocation in your investment committees. Asset allocation is about comparing relative risks and returns, but much more importantly it is about constructing a portfolio that is appropriate for an organization in terms of enterprise risk. We can attempt to measure the return expectations of asset classes and the associated risks, but how do we factor in operational risk? Generally speaking, senior living is weaker financially than it was before the pandemic. Fitch Ratings has indicated that it is negative on the sector in the near-to-intermediate term but bullish long term. Does it not make sense to look at asset allocation in the context of both the leverage in the organization and the specific weakness in the senior living sector?

We didn’t think that senior living organizations with challenging bond covenants should have been increasing allocations to equities over the past few years. And we don’t necessarily think 6-month T-bills are the answer today. What we do believe in is diversification. That means diversification of asset classes (stocks, bonds, real assets, alternative investments), diversification within asset classes (market caps, styles, indexing for stocks, duration, credit for bonds) with controlled tactical underweights and overweights to a strategic long-term allocation.

If you are a leveraged organization with significant liabilities in the form of entrance fee refunds, you should be carefully measuring the risk in your portfolio as you also consider the risks in your operations. From an enterprise standpoint these risks should be balanced.

We would love to have a conversation with you about your organization and the risks in your portfolio and how they relate to one another.

Let’s talk.


A paradigm shift is an important change that happens when the usual way of thinking about or doing something is replaced by a new or different way. Paradigm shifts very often relate to new technologies. Remember when we composed letters and papers on a typewriter? Or when we pulled an encyclopedia off the bookshelf for an authoritative explanation? Yes, the internet and smart phones have changed everything, but that’s ancient history (just check Wikipedia). Today the new emerging paradigm is artificial intelligence, or AI. With the potential to catapult progress and at the same time wreak undeterminable havoc, AI is the new shiny thing that has the potential to change the way we live, just like the internet.

To start, there’s now a more urgent existential risk for those of a certain age or with certain pre-existing conditions. From a societal standpoint, the initial fear that so many people
would need intensive medical support that our health care system would be overwhelmed and fail, created a hailstorm of additional risks.

Indeed, it’s really important to ensure that one is solving for the right problem. After all, arriving at any answer is not challenging, but arriving at the right one—one that will further your cause—is considerably more taxing. All investors can be guilty of a little tunnel vision at times—solving for a part of rather than the whole problem.

Have you seen the latest summer blockbuster? Whether it’s Avengers: Endgame or Once Upon A Time In Hollywood that first comes to mind, their directors will have thoughtfully made the film by drawing on a mix of originality as well as tried-and-tested formulas and emotional arcs that are proven to pave the way for commercial success. Just as there are patterns in movies, there are patterns in investing that can be used when crafting an ideal portfolio.


I have guided the investment portfolios of many life plan communities (LPCs) and have long been the proponent of an approach that balances portfolio risk with operational or enterprise risk. Just as a filmmaker can mine a wealth of archives, tropes and devices to devise their motion picture, I work with databases that contain a vast amount of information about LPCs. This data includes the financial statements of LPCs to compare the operational statistics of the communities to their diverse asset allocation strategies. These resources come in very handy when crafting investment portfolios designed to serve the investment policies of increasingly diverse and multifaceted communities.

The significance of bond rating
I often create peer groups that relate asset allocation to statistics that rating agencies and lenders look at so as to compare apples to apples. One easy way to create a peer group is through looking at bond rating category. From there I can segment further by community size and scope (single site vs. multi-site), contract type or geographic area, among others.

I recently looked at a peer group that shared a BBB category rating from a recognized rating agency. After rationalizing the data, I found solid consistency among group members on a range of operational statistics, but of course there are always outliers. Debt service coverage averaged 2 times but covered a range of 1.4 to 3 times. Maximum annual debt service as a percentage of total revenue averaged 12, but there were some LPCs in single digits and several in the mid-to-high teens. The takeaway? You need to drill down further beyond the credit rating to look at the nuances. How big of a safety cushion does an LPC have? One adaptation I made on the debt service coverage ratios was to look at the percentage decline in net turnover that would result in problems meeting a hypothetical 1.2 x covenant. The average for our sample was nearly 70%, but some communities were as low as 20-30%, which struck me as a thin cushion for an investment grade bond.

How are we doing for risk budget?
I was mildly surprised to see that the average allocation exposure to equities was around 50%. Perhaps this was a result of “return-chasing” and/or market run-up that has elevated risk in many individual portfolios as well. Among the peer group, allocation to equities ranged from a low of 30% to a high of 75%. But it was particularly interesting to learn how the equity allocations matched up with the operating statistics. One would think that the strongest enterprises would be able to “afford” more risk and have the most aggressive allocations to equities.  But in fact, I found that some of the highest equity allocations were associated with LPC’s that seemed more dependent on net entrance fees. On the other hand, some communities with lower allocations to equity were among the strongest financially.

Looking at fixed income allocations, I saw a very wide range (from 4% to 65%) around an average allocation of 43%. Fixed income is sometimes perceived to be the big investment conundrum today, as interest rates are low and the prospect of capital gains is diminished (a perception that ignores the surprisingly strong recent performance of the bond market!). This explains the rationale for why there has been a rise in equity allocations. Yet, it appears that equities, as an inherently more volatile asset class, are capable of doing more damage to portfolios than bonds. In other words, replacing some fixed income with equities at this time may be playing with fire.

Exploring the role of alternatives
Which brings us to alternative investments, i.e. those strategies that are designed either for absolute returns or better risk-adjusted returns. The average allocation metric for the alternative category was not as meaningful as the other statistics in the peer group study due to the fact that adoption rates were still low. This may be an educational issue or it may be that recent historical returns of these investments have not stacked up against the stock indices (What has?).  In an environment where the traditional portfolio ballast, fixed income, has a questionable risk/return trade-off and equities have been driven up in valuation in part by the comparison to fixed income prospects, one would think that alternative investments, an asset class that is more focused on risk management, would be more in demand.

Just like making summer blockbusters, asset allocation is part art and part science. While this quick data analysis does not reveal the qualitative aspects of the portfolios that are contingent on forward-thinking judgement, I suspect that additional rigor regarding the balancing of enterprise risks and opportunities with market risks and opportunities would be of real value to any LPC. Now that’s a wrap.

We invite you to contact us if you would like to see a complimentary customized peer group study for your community.

Not long ago, I was asked to make a presentation on Investment Committee Development. As I prepared for this presentation, I drew on my own experience with investment committees. I also found several interesting research sources. One was a Trustee Primer produced by the CFA Institute, which to some still remains the final word on best practices in investment management. The primer starts with a quotation from the venerable investor Warren Buffett:

“As the old saying goes, what wise men do in the beginning, fools do in the end.”

Putting yourself in the shoes of a trustee, you can interpret the saying like this: policies and strategies that have been successful for a period of time are often adopted at later stages without the insight and careful judgment of the wise man, often resulting in unfortunate outcomes. For investment committees, a key takeaway might be that committee members “own” the responsibility for prudent and thoughtful oversight of investment assets. This does not mean that you need the investment expertise of a Warren Buffet on your committee (wouldn’t it be nice). It does mean that a) you should have a thoughtful process to form an investment committee, b) charge this committee with developing investment policy, which in turn provides the framework for a prudent investment process.

It Starts With Process

Investment committee members do not necessarily need to have investment expertise, but should have the willingness and ability to learn basic principles of investing related to investment policy, asset allocation, manager selection and performance review. (A good investment management consultant should be able to convey the basic and relevant principles of investing to the committee.) It is important to note that investment committees are not charged with managing the day-to-day activities of investment portfolios but should understand the framework of the investment process in order to provide oversight on policy, asset allocation, manager selection/monitoring and performance reporting.

Separating Investment Instincts From Committee Instincts

At times, investment committees are blessed with an investment practitioner. Sometimes this is a mixed blessing, as practitioners have the difficult task of separating their investor instincts from their fiduciary role. The best investment practitioner committee members I have seen do not attempt to micro-manage the portfolio. Rather, they often serve as translators and important facilitators of debate between consulting professionals and non-expert committee members. It is important (and healthy) that all committee members feel comfortable discussing and debating all aspects of the process. In this way, committees “own” the investment process and are truly acting in a fiduciary capacity, as opposed to blindly following what wise men did in the beginning.

I’ve summarized several other takeaways from my presentation:

  • 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. Delegate to those who have the required expertise, experience, and authority to do their jobs. Hold all parties accountable for actions that they take (or fail to take). I have found that this basic philosophy distinguishes strong governance structures from weak ones (Source: Adapted from CFA Institute)
  • Trustee approaches can range from an unhealthy involvement in the smallest operational decisions to a similarly unproductive disengaged attitude (Source: Adapted from CFA Institute)
  • The best investment committees employ common sense and discipline

A Few Thoughts on Behavioral Dynamics

  • A group’s size, its members’ expertise, approach to conflict resolution and member productivity all have an impact
  • Heterogeneity is critical to group effectiveness
  • Recognize that investment theory is often at odds with potentially self-defeating behavioral tendencies. Committee members should maintain a disciplined approach, remaining focused on objectives and Investment Policy

(Source: Adapted from Investment Committees: Vanguard’s View of Best Practices)

Everyone “knows” that organizations that invest should have an investment policy. Why is this so important? As Yogi Berra says (and the CFA Institute’s primer for investment trustees reemphasizes), “If you don’t know where you’re going, you’re liable to end up somewhere else.”

Faced with the potentially challenging task of developing a policy, many trustees turn to professionals for help. Perhaps one of their investment managers will pull something together. Others may look to duplicate policies of the other boards that they sit on. Finally there is always the internet, where an example of almost anything can be found – though additional diligence is certainly required in this case. While it is possible to find a perfectly fine policy through any of these channels, there will be an essential element missing.

The Missing Link: Board Ownership and Engagement

Board ownership, or the full engagement of at least a subset of the full Board, is a critical ingredient of any sound and relevant Investment Policy Statement. Without the thoughtful participation of fiduciaries, an investment policy runs the risk of being the wrong kind of policy for an organization: namely, the kind that gets perfunctorily blessed by the Board and then resides forgotten in someone’s drawer. Perhaps this is being a bit overly dramatic, but the point is that an Investment Policy should be a living breathing thing that fiduciaries refer to in order to make decisions rather than a vacuous document that gathers dust in between decennial revisions.

Why is Board engagement so crucial to effective Policy? First of all, even if the policy adopted is sound, there is little likelihood that it will be adhered to if there is a lack of member buy-in. Typically in these situations, an ad hoc approach will be adopted that emphasizes short-term decision-making such as the hiring and firing of managers, rather than an approach based on a thoughtful process of long-term thinking that will guide groups through difficult times. Secondly, the lack of commitment from members frequently results in a default to policies that may not have their best interests at heart (e.g., one that is drafted by a manager with a conflict of interest on portfolio review process) or that do not address the unique characteristics of the organization.

Once engaged, committee members would be well served to think about issues such as:

  • 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?

By addressing these questions in the policy statement, trustees will have set forth a philosophy, a set of objectives and a plan for achieving those objectives.

Like a Rock: A Good Investment Policy Statement

A good policy should define the mission of an organization, describe the risk tolerance, state its goals and objectives and lay out the policy asset mix. Equally important, it should describe the process by which asset allocation decisions are made and the process by which performance is evaluated. Indeed part of the purpose of a policy statement is to develop and guide the manner in which an investment committee operates and to provide a reasonable basis for decision making. A key aspect is to design a policy so that it survives current members and acts as an organizational stabilizer during unusual market conditions. In a sense, investment policy statements communicate philosophy and planning to all participants in the investment process, from investment managers to board members, both present and future.

Adopting a policy is not just a “check the box” act so that an organization can say that it has an investment policy. As consultants, we have found that choosing to develop and implement a comprehensive policy that is driven by fiduciaries leads to a more transparent and effective investment program.

If your investment policy is gathering a little bit of dust, perhaps it is time to take that policy out of the drawer and breathe some life into it.

Asset Allocation for Life Plan Communities can be a tricky exercise. Unlike a charitable foundation, the core mission of a Life Plan Community involves running a business, with emphasis on financing, marketing, facility management and many other crucial functions. The enterprise risk that is at the core of most Life Plan Communities is, in essence, an equity risk.

More Risks for Smaller Institutions

Interestingly, comparisons to higher education are useful, although these comparisons are most relevant towards the lower end of the college and university spectrum. At the higher end of the spectrum (i.e., The Ivy League schools and other “elite” institutions), institutions are fortunate enough to be more focused on crafting perfectly balanced classes than on filling seats as the current gargantuan endowments ensure stability. But smaller institutions of higher learning face many of the same enterprise risk issues that Life Plan Communities do. Declining enrollments, demographics, deferred maintenance and land management issues have conspired to pinch smaller institutions at the same time as managing their investment portfolios has become more challenging (i.e., lower return assumptions for the entire market).

Investment Portfolios Provide Ballast

For institutions like Life Plan Communities and small colleges and universities, investment portfolios provide important ongoing support and ballast for future success. For this reason, investment portfolios should be managed in a way that is integrated with the operations of the organization. What exactly does that mean? Look at your balance sheet. The largest number is the value of the plant, property and equipment. The next largest number is often cash and investments. This is your portfolio of assets, and plant property and equipment is an equity asset! More to the point, it is a real estate equity asset. Equity has elements of both risk and return. Ask yourself, “Am I considering how my enterprise risk interacts with my investment portfolio risk in portfolio construction?” In other words, what happens to the enterprise when the stock market swoons or crashes? Is there an impact? What happens when interest rates go to zero? How about when interest rates return to “normal”? In fact, there is a correlation between the risk in the portfolio and the risk in the enterprise.
Portfolio theory tells us that diversification is a key to investing prudently. The old adage, “Don’t put all your eggs in one basket.” rings true here. Different asset classes can provide diversification benefits to a portfolio when an asset class has historically had a low correlation to traditional risk benchmarks such as the S&P 500. We categorize asset classes into four basic groups:

  • Equity
  • Fixed income
  • Real Assets
  • Diversifying Strategies

Among our four asset class categories, equity carries the highest level of risk. Prudent portfolio construction employs fixed income, real assets and diversifying strategies (alternative investments) to buffer that risk.

Diversification: The Key to Balancing Risks

If you are the “Harvard” of Life Plan Communities, the risk/reward profile of your enterprise equity is already very favorable. As a result, your time horizon for investment is very long. This long time horizon allows for a greater degree of flexibility in managing portfolio risk. For entities with a less favorable equity risk/reward profile, the time horizon is shorter which results in a need to try to balance enterprise and portfolio risks. Diversification is how we balance those risks.

The assets on your balance sheet have elements of both the “Real Assets” category and the “Equity” category because of the bottom line orientation. As you construct the investment portfolio, these elements should be carefully considered. In diversifying, Life Plan Communities should recognize the real estate and equity risk that is already embedded in its business model when considering overall risk parameters.

This may result in some underweighting to the “Real Assets” category. The fixed income category, long a dependable diversifier, has lost some of its buffering qualities, in that interest rates are still at a historically low level. As such, diversifying strategies deserve a close look. The team at Procyon has decades of experience in evaluating this marketplace and its role in complex portfolios. Please let us know if we can help your organization navigate these waters.

Financial ratios lie at the heart of many benchmarking studies in the CCRC and Life Plan Community industry and can be crucial elements with regard to strategic planning, financing and refinancing projects. Are these ratios also germane to how senior living investments are allocated? We have long thought so.

As consumers become more educated and conduct more intensive research into their increasing number of options, will they use these financial ratios in their decision making process? We believe they already are and that the trend will accelerate.

Which LPC is Right For Me? Let’s Look at the Numbers …

The decision to move into a Life Plan Community is complex. As consumers hand over increasingly significant refundable entrance fees to providers, they are looking for assurances that providers will in fact be able to keep their end of the bargain. To this end, many of these people will engage advisors to guide their decisions. These advisors may be lawyers, accountants, financial advisors, life coaches and adult children, all of whom will seek out data that will help rationalize their role in the decision-making process. So yes, financial ratio analysis may soon become an essential part of the toolkit used by increasingly sophisticated potential residents of Life Plan Communities.

What will they look at? For starters they should look at financial ratios (such as debt service coverage and days cash on hand) that communities have typically pledged to maintain at minimum levels. While cash to debt levels may seem important to some, others may want to know the level of total revenue relative to maximum annual debt service.

Ratio spotlight: Debt Service Coverage (Minus Net Entrance Fees)

One ratio that I think is important to both investment advisors and potential residents is debt service coverage without the benefit of counting net entrance fees. In other words this ratio shows the ability to meet debt service using only the revenues of the community. This ratio can you give you an idea of how vulnerable a community is to a slowdown in entrance fee turnover. Roughly half of all Life Plan Communities have revenue-only debt coverage that falls below 1.0, indicating that turnover is essential to meeting debt service.

What could cause turnover to change? Historically there have been several factors. A slowdown in local real estate markets, as people are unable to sell their homes and use the proceeds to move into a Life Plan Community. Higher interest rates have often precipitated a slowdown in real estate activity. Competition is another potential factor, as more senior living options appear, including some that would allow you to continue to live at home. Increases in longevity can also have an impact on turnover, especially considering the relatively small sample size found in most Life Plan Communities.

The business models of most CCRCs anticipate that refunds will be paid from new entrance fees. However, if there is a slowdown in entrance fee turnover, there is a risk that new entrance fees will fall short. If there were a slowdown in turnover and debt service became difficult to cover, where would the cash to pay those owed a refund come from? The investment portfolio is the obvious choice.

How then could ratio analysis impact asset allocation? We have often viewed portfolio risk as a counterbalance to operational or business risk in that if operational risk increases, perhaps portfolio risk should decrease. For example, if trend analysis of key ratios foreshadows the potential emergence of a turnover problem, asset allocation can be modified to create liquidity or generally reduce risk.

Financial Security Leads to Better Marketing

I have long believed that in a complex organization, investment portfolio construction should be integrated with the operating environment of the organization. Just as consumers exploring future living options are now discovering the linkage between operating strength and the financial security of Life Plan Communities, they will also want to know what steps have been taken to integrate portfolio construction and operational risk. At the end of the day, the assets of a Life Plan Community and how they are managed is very important to potential new community entrants – and by extension the marketing efforts of the community.

Benchmarking has value because it shows you what your peers are doing and how you are doing compared to them. If you feel that your organization would benefit from this type of analysis, I would be happy to chat and help further your efforts.

I recently had a prospective non-profit client share a few of the “decision points” his investment committee was concerned about in regard to their investment process. He shared that the committee was debating whether they should hire a firm whose marketing focus was both national and specific to his organization’s market niche, or a hire a local firm. He also told me that they were trying to differentiate between hiring an investment consultant or an asset manager. These decision points inspired me to write a blog on the pros and cons of each.

The National vs. Local Debate

When I was first starting out in the world of finance many years ago, a prospect told me that he would not consider becoming a client until he met me face-to-face. I appreciated this sentiment and after arranging to meet (he was in Texas and I was based in NYC), we found that we shared common interests and philosophies. I am happy to say that our friendship and business relationship has lasted to this day. Interestingly, it is a relationship I have largely conducted and nurtured by telephone and has grown exponentially to this day. So I am always a little puzzled by the desire to hire someone “local”.

What exactly are the advantages of hiring someone whose office is just across town?

  • Perhaps they understand us better as neighbors?
  • We can go over and see them whenever we want?
  • We like to support local businesses?

While these are all decent reasons, there is a flipside to every argument. My client from Texas might have been inclined to do business locally as well, but he was guided by an internal process that did not assign a high value to a local relationship. All other things being equal, it is probable he may have chosen the local firm over my firm. However, my firm bested the local alternative in terms of professional qualifications and capacity to customize his experience. His process looked to identify strengths that would translate into better performance and a better experience for him. The fact that I was not down the block mattered only in a tie-breaker.

My client’s decision process was not documented in the manner in which most organizations memorialize their Investment Policy Statement. But in fact his process represented policy. This entire line of thought supports the importance of a well-articulate policy. Policy is designed to provide guidance in decision making. Under the heading “Criteria for Selecting a Consultant/Manager/Advisor” would you find a provision to hire a local firm? What would be the rationale for that and how would that rationale relate to the best interests of the organization? Would that rationale honestly survive a conflicts of interest test?

What advantages might selection of a national firm with significant experience in your domain (private school, liberal arts college, Life PlanCommunity) have? One would expect a higher number of CFAs, CIMAs and graduate degrees. Additional consulting services that are specifically tailored to the affinity group’s needs would also be a plus. Shared knowledge of approaches to asset allocation among the group’s members would be a benefit. Knowledge of your peers’ operating financial performance, its impact on allocation decisions and their view of investment time horizon also would be helpful.

The Investment Consultant vs. Asset Manager Debate

An investment consultant can be an invaluable resource to a non-profit with a mix of significant assets and liabilities. This is largely due to the fact that a good consultant will be primarily focused on the investment process. While you cannot guarantee that all your decisions will be optimal at all times, you can ensure that the framework for making those decisions is sound and prudent.
Investment committees are fiduciaries. If you get policy right, the rest will follow. And a sound and prudent process lies at the heart of fiduciary responsibility. The first step in an investment process is a carefully designed Investment Policy Statement.

In terms of a widely acknowledged hierarchy of relevancy: policy precedes asset allocation decisions, and asset allocation in turn precedes the selection of individual managers to implement that strategy. So you can see where I’m going with this. Why would you start with the third order element of the investment process, the asset manager?

Some experts say that asset allocation is the most important driver of performance. Will an asset manager be influenced by personal interest in the allocation to categories (i.e., will a U.S. equity manager recommend more or less to proprietary products than an independent consultant)? Further, what are the chances that the asset manager is the best choice in each of the asset categories that have been decided upon? What about the reporting process? If the asset manager underperforms, will portfolio review evolve into a rationale for retaining the asset manager? In other words, where will the independent outside expert voice come from?

Part of formulating sound policy is the obligation to continually assess and refine, reflecting the importance of Investment Policy as a “living” document. Policy is the centerpiece of the process that the consultant is retained to help you manage. Investment consulting is more about being on the same side of the table whereas asset management is principally transactional. Bottom line, when the interest of the organization is front and center, a sound and prudent process trumps all else. I’m sure you will agree.