How to Select Investment Managers and Evaluate Performance

An informative guide to selecting and evaluating external investment professionals

This book-one of the very few of its kind-is an invaluable aid to trustees of pension plans, endowments, and trusts who seek to chart and navigate courses for governing and overseeing the investment of the trillions of dollars under their care. It covers many aspects of this essential endeavor, including return measures, fixed income and duration, manager searches, committee meetings, and much more.

G. Timothy Haight (Atherton, CA) is President of Menlo College in Silicon Valley. Stephen O. Morrell, PhD (Coral Springs, FL) is Professor at Andreas School of Business of Barry University. Glenn Ross (Baltimore, MD) is a Managing Director and cofounder of Archstone Portfolio Solutions.

Preface ix

About the Authors xi

CHAPTER 1 Investment Sponsors 1

The Investment Committee 4

The Variety of Investment Sponsors 7

Taxable Investment Sponsors 24

Summary 29

Chapter 2 Investment Policy Statement 31

Investment Philosophy and Goals 31

Investment Return Objectives 32

Risk Tolerances 32

Constraints 33

Investment Strategy 33

In-House or Outside Manager 34

Investment Policy 34

Securities Types and Risk Characteristics 35

Asset Allocation Guidelines 39

Evaluation of Performance 41

Benchmark Portfolios 51

Periodic Review 52

Summary 53

Chapter 3 Investment Overview 55

Capital Appreciation versus Current Income 55

Active versus Passive Investment Approaches 57

Investment Styles-Equity Managers 57

International Investing 65

Investment Styles-Fixed Income Managers 65

Summary 68

CHAPTER 4 Alternative Investment Vehicles 71

Hybrid Securities 72

Derivative Contracts 75

International Investment Vehicles 81

Real Estate Investment Vehicles 91

Investment Vehicles for Accredited Investors 93

Commodities and Collectibles 102

Summary 104

Chapter 5 Return Measures and Reporting Techniques 105

Dollar-Weighted Rate of Return 105

Time-Weighted Rate of Return 108

Annualized Rates of Return 110

Geometric Mean 111

Total Return and its Components 112

Compound Growth 115

Summary 118

Chapter 6 Return-Risk Measurement 119

Return Relative 119

Standard Deviation 121

Portfolio Risk Measure 124

Scatter Diagram 127

Coefficient of Variation 128

Regression Analysis 129

Portfolio Size and Diversification Levels 131

Regression Analysis of Fund I 132

Additional Performance Indexes 133

Summary 134

Chapter 7 Portfolio Performance Evaluation 137

Performance Results 138

Composite Index 139

Return Risk Analysis 140

Universe Comparison 141

Evaluating the Asset Allocation Decision 143

Summary 155

Chapter 8 Equity Performance Evaluation 157

Equity Performance Criteria 158

Sector Analysis 159

Return-Risk Comparison 163

Market Characteristics 164

Attribution Analysis 169

Summary 171

Chapter 9 Fixed Income Performance Evaluation 173

Asset Allocation Ranges and Anticipated Contributions 174

Issuers of Fixed Income Securities 174

Bond Indexes 176

Bond Prices and Yields 177

Term Structure of Interest Rates 180

Quality of Fixed Income Securities 181

Credit Risk 181

Interest Rate Risk 184

Duration 186

Convexity 189

Maturity Characteristics 191

Return Analysis 191

CFA Institute Standards 195

Fixed Income Management Styles 196

Passive Fixed Income Management 196

Active Fixed Income Management 198

Performance Analysis 199

Summary 202

CHAPTER 10 Investment Companies as Investment Vehicles 203

Investment Companies 205

Regulation of Investment Companies 207

Types of Investment Companies 208

Selecting Mutual Funds 215

Performance Evaluation 216

Summary 217

Chapter 11 Investment Manager Search Process 219

Search Committee 219

Establishing Goals 220

Number of Managers 220

Candidate Identification 222

Management and Related Fees 223

Firm Size and Ownership 225

Request for Proposals (RFP) 225

Screening of Candidates 230

Candidates Presentations 234

Verification and Reference Checking 236

Cost of Switching 239

Administration of Change 240

Summary 240

Chapter 12 Conducting Investment Committee Meetings 243

Meeting Preparations 243

Agenda and Meeting Materials 245

Setting the Agenda 245

Responsibilities of the Chairperson 246

Investment Consulting Services 246

Investment Performance Review and Outlook 247

Old Business 250

New Business 251

Summary 251

Index 809

"These guys know how to check their facts." (Albourne Village - village.albourne.com, Tuesday 22nd January 2008)

"...this useful guide for professionals is timely." (Pensions World, Ferbruary 2008)

G. Timothy Haight, DBA, is the President of Menlo College, Chairman of the Board of Commonwealth Business Bank, and a member of the Board of Advisors of St. Cloud Capital Partners, LLC. He also serves as a member of Southern California Edison's Nuclear Power Decommissioning Fund Committee. Dr. Haight earned a Doctorate in Business Administration (DBA) with a major in business finance and investments from George Washington University. He received his MBA and BS degrees from the University of Dayton.

Dr. Stephen O. Morrell is Professor of Economics and Finance in the Andreas School of Business of Barry University. He has been a visiting professor at the Monterey Institute of Technology and the Georg-Simon-Ohm University in Nuremberg, Germany. Dr. Morrell also serves as a consultant specializing in portfolio strategies for endowment funds, and has served as senior vice president and chief economist for Southeast Banking Corporation; as a financial economist for the Federal Reserve System; and as chairman of the Board of Directors of First State Bank of Ft. Lauderdale, Florida. Dr. Morrell received his BS degree from Virginia Commonwealth University, and his MA and PhD degrees in economics from Virginia Polytechnic Institute.

Glenn E. Ross serves as a member of Towson University's College of Business and Economics Board, and its Alumni Board, and has been an adjunct professor in Towson University's Finance Department. Mr. Ross is President of the Board of Directors of the Albert P. Close Foundation and is a member of the Board of Directors of the Upper Chesapeake Health System Foundation. Mr. Ross earned his undergraduate degree from Towson University and his MBA at Loyola College in Baltimore. Mr. Ross is a Registered Investment Advisor Representative with the SEC.

People charged with the governance and oversight of pension plan, endowment, and trust investments for corporations, nonprofit institutions, and state and local governments face substantial and varied responsibilities. The processes of developing investment policies and strategies; selecting investment managers to implement policies and strategies; and evaluating investment manager performance are critical to success. All too often, however, the individuals with ultimate responsibility for selecting investment professionals and evaluating their performance—pension plan trustees, endowment fund board members, and investment committee members of boards—lack even the most basic knowledge and understanding of the processes and criteria involved in selecting investment professionals and evaluating their performance.

How to Select Investment Managers & Evaluate Performance provides an invaluable aid to trustees of pension plans, endowments, and trusts who seek to chart and navigate courses for governing and overseeing the investment of the trillions of dollars under their care.

Individuals who are in such roles must be well versed in the full range of techniques used to evaluate the effectiveness of investment professionals. This book—one of the very few of its kind—offers detailed, clear advice on improving the effectiveness of those who are entrusted with the oftentimes daunting responsibility of selecting, overseeing, managing, and evaluating investment professionals. The expert authors cover all facets of selecting managers and evaluating performance, including information on investment vehicles such as hedge funds, FOFs, and alternative investments; international investments, including currency impact between country investments; return measures, including a detailed discussion of net of tax calculations; measuring the sensitivity of a bond to interest rate moves; mutual funds and their cost-effectiveness for diversification purposes; manager searches using questionnaires; committee meetings and investing consulting services; and much more.

The passage of the Sarbanes-Oxley Act of 2002 combined with explosive growth in the number and types of financial instruments has raised the bar on what is required for those entrusted with oversight responsibilities. How to Select Investment Managers & Evaluate Performance provides those individuals with a comprehensive, yet easy-to-understand guide to being a successful trustee.

How To Select Investment Managers & Evaluate Performance

The key to successful investment management is to select investment professionals who can best meet clients' investment goals, objectives, and needs.

How to Select Investment Managers & Evaluate Performance provides those who are responsible for the investment performance of their institution's funds—including pension plan trustees, endowment fund board members, and investment committee board members—with the essential knowledge and skill set required to properly select investment managers and to evaluate their performance in a systematic manner.

This book describes cutting-edge techniques used to evaluate the performance of investment funds and their managers and provides valuable insight into the roles and responsibilities—in light of the Sarbanes-Oxley Act of 2002—of those charged with this oversight. In a clear and understandable fashion, the authors offer key advice on such topics as establishing investment policy statements, alternative investments, investment approaches and styles, return-risk measurements, how overall portfolio performance is evaluated, how to conduct a search for investment managers, and much more.