Timeless Strategies of Highly Effective Investment Committees: A Conversation with Charley Ellis

Nikki Kraus:
Welcome to Conversations with Charley. I’m Nikki Kraus from Strategic Investment Group, and I’m delighted to be with the formidable Charley Ellis, who has been involved with the Yale Investment Committee, was the founder and key partner at Greenwich Associates for more than 30 years, which advised numerous investment firms. Written 18 books, so an icon in the world of investment committees. So, let’s talk about the investment policy statement, which you’ve written a lot about and we know is so important. So, tell us why it’s so important.

Charley Ellis:
Well, it’s a roadmap to doing what you intended to do. It’s like any business plan. It will be changed, because circumstances will differ in the details, but it allows you to focus on the things that you know are really important. If you focus on the things that are really important, you’re way, way ahead. I think that the best test of investment policy statement is maybe two tests.
One is that if you’ve identified capable people, investment professionals who would do what you wanted done, you could turn it over to them and 10 years later, come back serene in the confidence that it would all have been done just the way it should have been done. That’s an extraordinary statement to make, but that is the reality.

Nikki Kraus:
I also think it’s important to read it every year as an investment committee member, to remind yourself what is in it. It’s almost taking the commitment again to the organization-

Charley Ellis:
Read and discuss it.

Nikki Kraus:
Read and discuss.

Charley Ellis:
The discussion should be rigorous and comprehensive.

Nikki Kraus:
Yes. Yes. Absolutely. Absolutely. But I like that as a way to bring any new members into the conversation and know they have the accountability for what is in the document also. So, we’ve talked about sometimes if you weren’t there when it was drafted, they don’t feel the same ownership, and it’s like, “No, no, no, no. This is a pledge. We’re reading the investment policy statement. We’re making sure we’re in agreement with what’s in there, and we’re taking the pledge to serve in this way.”

Charley Ellis:
Boy, is that exactly right. The other side that you could emphasize that is what we as a committee decide today, our successor committee maybe just five years down the road is going to have to live with or not live with. Are we setting it up in such a way that they can live with it comfortably? Or are we putting them in a position where they’re going to say, “I just don’t believe that?”

Nikki Kraus:
Absolutely. I’d love for you to talk a bit about what should be an in in an investment policy statement. It’s a very common question.

Charley Ellis:
That’s probably over my head, but let me try. First, it should be explicit as to what your long-term objective is and why that’s your objective, and some of that has to do with reasonable rate of return expectations. Some of it has to do with minimizing risk and particularly, minimizing the risk that comes out of misunderstandings. Ranges are all over the place, five to 10%, 20 to 30%, 40 to 60%. That is dreadful and should be criminalized, and not allowed, because that’s not the way life is.
That says we don’t really know, and the reason we don’t really know is because we really haven’t thought about it a lot carefully. If we haven’t thought about it all that carefully, we’ll turn it over to somebody else to take the responsibility, and then we’ll criticize them if they don’t get it right. That’s not fair. You have to be willing to be quite specific about what you really, really intend.

Nikki Kraus:
I’ll add a couple other ideas. So the roles of the various party, what’s the role of the investment committee? If you use an outside advisor, the role of the CIO and what you’re allowing should be included. Some elements perhaps on risk and risk measurement, what you’re doing relative to that, how you’re measuring success, benchmarks. Somewhere, and then a lot of times, what people are doing is the spending policy is the purview of the finance committee, but a lot of times people will reference the document because it is an important consideration relative to the investment portfolio.

Charley Ellis:
Well said. Well said.

Nikki Kraus:
I’ve now read over 1,000 investment policy statements and a lot of times-

Charley Ellis:
What a courageous person.

Nikki Kraus:
… people will give them to me to say, “Could you provide comments?” Yet then will say, “Well, this isn’t really how it works.” It’s like, “Stop right there. If this is not really how it works, then the document should be changed.” So it’s very interesting how important the document is, and should be. And how-

Charley Ellis:
Because it’s a vehicle for good thinking, and if the thinking isn’t really good, it’s not good enough.

Nikki Kraus:
I’d love to talk about the importance of institutional memory and how to think about it.

Charley Ellis:
Well, first, if you really are involved in a long-term program, which every endowment is really, really long term. We’re talking about not 10 years, 20 years, we’re talking about 100 years, 200 years. Once you realize that is the right timeframe, not that we’re going to be able to do it, but that’s what we ought to be aspiring towards, then anything you can find that allows you to get closer to that is very, very helpful. One part of that is taking an accurate record of what are the decisions that have been made?
Not what the decision was only, but what was the decision and why, and if you can explain the why, then you can go back to the decision and say, “Was it the right thing in retrospect for us to have been doing for the long, long term?” That’s a constant process of learning and relearning and constant developing of a closer and closer alignment between behavior and aspiration, and aspirations shouldn’t be just aspirations, they should be doable, achievable aspirations.

Nikki Kraus:
I think the best committees in my experience during crisis periods had very long-standing members combined with some fresher new ideas and some newer members. So I think that would be an interesting thing to talk about.

Charley Ellis:
Fair on, but it’s not just in terrible times.

Nikki Kraus:
I agree with that. I totally agree. No, no.

Charley Ellis:
The best of times is where you really need the experience because if you’ve only got a couple of years of experience base, you say, “Wow, we really must be very, very good.”

Nikki Kraus:
Yes, that’s true too.

Charley Ellis:
Not realizing how tough it can be out there. I’m a very, very big fan of people who’ve got some significant experience, maybe 10 years of experience or more, but then you’re talking about people in their mid-30s up to people in their mid-70s, mid-80s, that gets you plenty of spectrum. If you’re not getting that diversification, you ought to look carefully at why not.

Nikki Kraus:
Right. Couldn’t agree more, and there’s a lot of additional kinds of diversity. So the other kind of diversity I think about on higher education boards is socioeconomic, when they went to school. So if you had to work in the dining hall, they also think about financial aid, and loans a bit differently than students whose parents were fortunate enough to be able to write a check. So I think every kind of diversity, as you’ve mentioned, gender, age, but also additional background diversity as well as socioeconomic, I think is interesting.

Charley Ellis:
And professional backgrounds, really different. Many people think, “Oh, you really ought to have a lawyer.” Honestly, not so much for the law-ness, but as for the legal reasoning, and the quality of education that a law school provides. People who go into law as a profession learn to think in a very nicely disciplined way. I think also mathematicians have a terrific comparative advantage, because they learn to think in a particular way.
Scientists have a, “What’s the evidence? What’s the data?” And they’re comfortable looking at uncertainty, and that’s a big advantage. If you don’t think serving on the committee is a big deal, you shouldn’t be on the committee. If you don’t think it’s one of your priority missions as an individual person, you shouldn’t be on the committee. If you do think of it as being really important and a priority of a personal nature, you’ll do your homework very carefully.
Because you do your homework, the others will be encouraged to do their homework. But you should do it really carefully, and if you have any serious doubts, you should funnel those into the chair before the committee starts to meet. So the chair’s got a chance to turn around and mix it in with some other people.
The process of trying to become a useful member of a committee starts with obviously devotion to the institution. The second is skill at working with other people to bring out their best thinking. Not your best thinking, their best thinking. And that means listening. People who have developed skills at listening and others know that they are listening make an enormous contribution to the quality of the reasoning and thinking inside a committee. Plays well with others is a nice, friendly summary.

Nikki Kraus:
Yes, huge.

Charley Ellis:
But if you can’t have everybody being a member of the team, you got a real problem. I think the best illustration is in athletics, over and over and over again, the all-star team can’t compete with the best team in the league. Why? Because they don’t understand each other well enough. Only if you played together and played together through some good and easy times and some hard and difficult times can you really understand the other person.

Nikki Kraus:
We’ve talked a lot about the importance of the committee chair, so I also want to just make sure I’m amplifying the point. It’s hard to have a well-functioning… Well, let me say it more strongly. It’s almost impossible to have a really high-functioning investment committee if you don’t have a great chair.

Charley Ellis:
A great chair at doing the work of chair. Many times, people who are absolutely fabulous in talent, reputation particularly, get to be chair. They’re not focused on enabling the committee to be the best it could be, in the selection of members in the training and development members, setting the standards of expectation, to ensure that the process in every single meeting is a shared neutral teamwork process.

Nikki Kraus:
It’s a hard job.

Charley Ellis:
Yes. If life weren’t challenging, we wouldn’t be interested in doing it. And if investment committees were duck soup easy, who would want to serve on one?

Nikki Kraus:
Yes. You’re reminding me of the importance of orientation also. That’s another important role of the committee chair, and making sure anyone who comes onto the committee is capable to do the work of the committee. So what should be involved?

Charley Ellis:
Oh, well, everybody will have opinions on this, but I have a couple of opinions, so I’ll share them. Number one is it should be in writing what the role of a committee member is. It’s not a one-pager. Could be 10 pages, could be six or seven pages.
It might be less than that, but I doubt it. So it should be quite explicit about, and some of it is what I keep calling Mickey Mouse being at every meeting, being on time, and some of it would be how thoroughly prepared you should be, and how thoroughly the documentation will be developed for you, in order to be as well-prepared as you would like.
It also should be very explicit about what is not acceptable. For an example, the discussions that take place inside an investment committee belong to the institution, not to the members of the committee. Then committee members can’t help but learn as a result of participating, they really shouldn’t be taking documents that were delivered to them as members of the committee, then making them available to somebody else.

Nikki Kraus:
I also want to hit some of the basics. You get asked a lot, how many people should be on an investment committee? What’s the ideal size?

Charley Ellis:
Well, ideal size is one, and his name is Warren Buffet. And then he’d say, no, but Charlie Munger and I’d do it. Smaller is almost always better, smaller, longer term, more intense commitment is almost always better. I’m comfortable with five as a first approximation number.
I’ve seen three work, I’ve seen seven work. So, in that range. But five seems to be about right for everybody knowing jeepers, I’m really responsible here. And jeepers, I get plenty of time to say what I’ve got to say that’s worthwhile, and I’ve got plenty of time to be sure I understand what the other people are saying.
Once you get above that number, you start to realize, it’s not my job. I’m not all that crucial to the decision making. So I don’t really have to be that on the ball. I don’t have to do that much homework. I don’t have to take that serious sense of responsibility for what happens, and that’s guaranteed to lead rapidly towards an accelerating failure.

Nikki Kraus:
Yes. We’ve also talked about groups that may not have the expertise that you would want on an investment committee inside the board. We’ve both been open to the idea of recruiting outside board members.

Charley Ellis:
Well, I’m more than open. I would say if you’re not using people for your investment committee that are not members of the governing board, you’re making two mistakes at the same time, that people on the governing board should be busy enough with what they’ve already signed on to do and the chances that they really know a lot about investing, not all that great.
The second thing is the work responsibility of an investment committee to do a really classy, good job is pretty demanding, both on top of same individual, I think it’s asking an awful lot. Also, the discipline of investing is so very different from the discipline of financial management. It pretty good idea to keep them separated. How do you get the right people?
You mentioned earlier having people serve on the committee who are not in the governing board. I’d go beyond that. I would say since there are so many really talented people who would be delighted to serve on an investment committee, and they’re often younger, by the time you get on governing boards, you tend to be in your 50s and 60s. There’s a lot of talent in their 40s, and a lot of talent in their 30s. And the diversification benefits of older and younger people show up too.
I’m a very strong fan of having at least a couple members of the committee on the governing board, but people who have no connection with the institution. Just really savvy investment people can have a tremendous amount, and if you happen to live in a community where there are not that many people, okay, have your investment committee meetings taken place in a place where there are lots of those people?
You don’t have to be right on home turf. But you think about other endowments, pension funds, there are lots of sources of very, very talented people. If you get young people, they’ve got time, energy, and disposition to want to make a mark, and prove that they’re up to the job. And candidly, that’s very exciting. I believe strongly-

Nikki Kraus:
Absolutely.

Charley Ellis:
… the investment committee is a wonderful place to get bright people full of articulation, full of knowledge that’s relevant, get them involved. Particularly on the younger side, the 30s and 40s. That’s a much better source of talent for the governing board than most of us would have access to. Back to diversification, it’s really helpful. And being able to get the freshness and excitement of new ideas, even if they’re not really right ideas, but they stimulate the group to think more carefully and more rigorously, I think it’s very good.
The worst thing in the world I think is everybody be men in their 60s with some experience, but largely out of date, because they’re no longer active and involved in investment management, they’re in management. Management, that’s almost guaranteed to be a sure sign of failure.

Nikki Kraus:
Yes. So it brings up term limits. So we get a lot of questions on are term limits a good idea? If so, how should people think about structuring terms?

Charley Ellis:
Well, a lot of different thoughts about that. I think that’s partly because nobody’s figured it out. So there may not be a really good answer, but one of the things I would add to that is it’s not a bad idea to have people who are candidate for being members of the committee to have a chance to participate in the committee meetings for a year before they make a decision and before the committee makes a decision. You can learn a lot in a year-

Nikki Kraus:
Yes, absolutely.

Charley Ellis:
… of talking with someone and seeing how they participate and contribute. After that, term limits have one wonderful advantage. It’s not personal. It’s arbitrary. It’s one major problem, it’s not personal. It’s arbitrary. I do think it’s a very great help to have term limits.

Nikki Kraus:
Yes. Well, I agree with everything you’ve said of course, with one asterisk. If people have term limits, I would like them to also have some form of assessment, because I’ve heard a lot of stories with poorly behaving members and they just say, “We’re going to wait for Nikki to term out,” instead of actually having an assessment and having a conversation. You’ve been coming and you’re not prepared, you’re not engaging in the right way. So we do owe it to our institutions to still make sure the members are contributing in the right way.

Charley Ellis:
Oh, you’re way too tolerant, I think. The job of the chair is to be-

Nikki Kraus:
Exactly.

Charley Ellis:
… doing that reviewing on a regular basis. If everybody is doing a great job, they deserve to get a phone call at least, if not a lunch meeting in which they’re told, “You are doing a great job and here are the things that we really, really like about what you’re doing. And we’d like to be sure that you’re willing to keep doing a really great job. By the way, if you’d like to find a way to improve on your contribution, you might speak less often, speak more often.” Remind people that you’re listening to what they had to say.
Remind people that you heard them back two or three meetings ago, and bring it forward. So feedback, feedback, feedback.

Nikki Kraus:
Yes, absolutely.

Charley Ellis:
It’s very, very helpful. One of the things that I have done which served very nicely is a survey among the members of the committee of the other members of the committee. Everybody evaluated everybody, and sure enough, one person who was being disruptive and wouldn’t stay on the subject all that well was clearly identified.
I said, “Well, what do I do?” Instead of making it personal that I would sit with him, because I thought, “Well, our background relationship is such that I don’t think I ought to do that.” I printed up a sheet that everybody got their scores explicit, and the other people’s scores implicit.

Nikki Kraus:
Got it.

Charley Ellis:
And then sheared the sheep. Like that, the behavior changed right away.

Nikki Kraus:
That might be a great place to wrap up this session. I’ll mention a couple other additional materials. We talked about assessments, AGB has an amazing public publication by Marla Babiak and Meryl Schwartz on… It talks about board assessments. And then I also want to mention the book that Charley helped us with, Endowment Management for Higher Education that was published by AGB some time ago. So those are a couple of great resources for you as you think about building the optimal investment committee. Thank you.