At any given time, most asset managers have a view about how to generate investment returns. However, their view may only be relevant for current market conditions. In contrast, a sustainable investment management process, one that can be expected to perform throughout changing market conditions, typically reflects a philosophy of asset management, the core beliefs that drive investment decisions over time. Understanding your manager's philosophy, and the principles that underlie it, should help you maintain conviction throughout various market environments, even when short-term portfolio returns are below expectations. Herein, we at U.S. Trust explain our investment philosophy and related principles that are the basis for our management of foundation and endowment portfolios.

One's philosophy describes the set of beliefs that drive behavior. Principles are truths that inform philosophy. The value of an investment philosophy and its linkage to certain principles is that it helps to establish expectations of a manager and a portfolio during periods when the landscape for investing may vary significantly. Our approach at U.S. Trust, as a manager of foundation and endowment portfolios, is important to understand, particularly when we serve clients who are acting in a fiduciary capacity, or when we are serving in a fiduciary capacity ourselves.

OUR PHILOSOPHY

Foundations and endowments are our clients and the people we work with at these organizations are often fiduciaries. Further, in most instances our clients' portfolios exist to fund expected payments (grants, operating funds, capital expenditures). Every firm that manages assets should have an investment philosophy that reflects both the needs of its clients and its beliefs about the best ways to generate investment returns. Our investment philosophy at U.S. Trust reflects the interests, concerns and circumstances of the foundations and endowments. Therefore, we believe that using multiasset class portfolios developed to benefit from multiple sources of return may help enable the portfolio and support the mission of its organization.

Our philosophy has been developed over time, including in the context of an environment of lower capital market returns, the high opportunity cost of liquidity, the opportunities from nontraditional investments, and the increased demands by institutions on their investment portfolios. Simply stated, a single investment approach no longer satisfies the needs of all investors. U.S. Trust's philosophy can serve the needs of a variety of foundations and endowments because it:

  • satisfies the expectation of a fiduciary to diversify holdings;
  • incorporates diversification of non-correlated asset classes and asset class managers to reduce portfolio volatility, which is often a concern of institutions who distribute funds;
  • is flexible enough to accommodate the biases and preferences of clients who are serving in a fiduciary capacity (active vs. passive management).

OUR PRINCIPLES

The principles that inform our asset management philosophy reflect U.S. Trust's long experience serving in the capacity of an investment manager and trustee. The principles that inform our philosophy include the following:

  • Supporting the mission for its duration is the chief end of an endowment or foundation portfolio. "Mission risk" should be the greatest concern of the board of a nonprofit organization. Failing to earn expected returns over the expected lifetime of the portfolio can put the mission at risk.
  • Diversification is a fundamental consideration of a fiduciary The Uniform Prudent Investor Act (UPIA)1 sets an expectation for private foundations that their trustee will consider diversifying portfolios unless there are special overriding circumstances. Similar diversification considerations apply to public charity (institutional nonprofit) fiduciaries under the Uniform Prudent Management of Institutional Funds Act (UPMIFA) 2. In either case, fiduciaries subject to one or the other act are expected to consider diversification of portfolio holdings.
  • Managing liquidity risk should be coupled with managing mission (deficiency) risk to balance the needs of the foundation or endowment. A fiduciary in this context needs to balance the need to grow underlying capital with the entity's distribution obligations.
  • Volatility is a particular risk to portfolios that distribute funds. Different patterns of investment returns can result in different amounts being available for spending when a spending rate is tied to the portfolio's market value. Variance in "dollar returns" can be disruptive to supporting the foundation's or endowment's mission in the near term. Since distribution of funds typically reduces the assets available to grow the portfolio, volatility can introduce risk to funding the mission over time.
  • Diversifying sources of return can help diversify risk. Investment strategies typically incorporate some combination of strategic asset allocation, tactical allocations around strategic targets, and active vs. passive management of asset classes. By diversifying the sources of return, we believe we may diversify the sources of risk to the success of the investment strategy.
  • Both active and passive strategies typically are appropriate in a portfolio's investment strategy, but their use should be actively managed Different market conditions present environments that can be more or less accommodating for active management strategies. Therefore, for a number of portfolio objectives, the use of a hybrid active vs. passive strategy may enhance the return/risk trade-off.
  • Alternative investments can be valuable diversifying assets; we prefer a diversified approach to investing in hedge funds and private equity. As traditional asset classes are expected to generate lower returns while exhibiting higher correlations, alternative investments may offer compelling benefits to a diversified portfolio structure. Though single strategies (a long-short hedge fund) may be appropriate to meet specific client objectives, generally we prefer diversified strategies to mitigate risk and allow clients to learn about the characteristics of hedge funds and private equity investments.
  • Direct ownership of real assets may be a viable alternative to investing through commingled vehicles for large foundations or endowments. Direct ownership of real assets provides exposure to the asset classes (timberland, oil & gas properties) while eliminating some of the issues related to investing through a commingled vehicle. Investment through direct ownership should reflect the liquidity needs of the portfolio, as well as the ability to diversify total portfolio holdings.
  • Not all problems are solved with an investment product. Though investments are the focus of many foundation and endowment boards, governance practices can enhance the effectiveness of fiduciaries overseeing a mission-based investment strategy. Also, by enhancing the fundraising and grant-making processes, resources may be freed to expand focus on strategic issues that may have impact on the mission of the foundation or endowment over time.
  • Specialists working with specialists can provide higher quality solutions. The needs of foundations and endowments can be quite different from those of other types of clients. Critical parts of an effective investment program are communication between the client and manager, and experience that provides insight into the foundation's or endowments potential needs. By having dedicated specialists in institutional investment strategy, asset class management, nontraditional investments, and philanthropic services contributing to the total portfolio solution, U.S. Trust's Institutional Investments & Philanthropic Solutions group personnel are regularly engaged in a dialog with the institutional clients they serve.
  • An Outsourced Chief Investment Office (OCIO) can enhance efficiency and effectiveness when implementing an investment strategy The size of the portfolio and internal resources to oversee the investment process can be meaningfully different among foundations, endowments and other nonprofit organizations. The cost of expertise may be substantial and may grow as the investment strategy expands. Windows of opportunity in the capital markets can be short-lived. The rationalization of disparate views may be so time-consuming that opportunities are missed. This OCIO process, even in partial form, tends to enhance the efficiency and the effectiveness of implementing an investment strategy, while allowing fiduciaries the level of control they want to retain.
  • The investments in a portfolio should be governed by a Spending Policy and Investment Policy. For public charities or private foundations that receive contributions, there should be a Gift Acceptance Policy. The nonprofit's portfolio should be constructed to support the current and future spending needs of the mission. Material risks should be mitigated by guidelines within the Investment Policy Statement, as should ambiguity concerning roles in the management/oversight process. Charitable gifts that might impair the effective execution of the total portfolio strategy should be mitigated by the institution's Gift Acceptance Policy.
  • A portfolio should be evaluated based on the success of its overall investment strategy, rather than on individual investment goals. Traditionally, comparing time-weighted returns to index benchmarks has been the primary approach for evaluating an investment strategy's success, but this measure alone is inadequate to evaluate the effectiveness of a mission-based investment strategy. As a result of the "stewardship risk" that many nonprofit boards want to avoid, risk metrics are relevant to evaluating the appropriateness of an investment strategy. In cases where impact investing objectives are a part of the mission, performance toward these goals should be a criterion for evaluating success.
  • Trust is critical to a successful investment management relationship. Trust is earned by adhering to an investment discipline that reflects the manager's investment philosophy. Further, trust is earned through providing written portfolio reviews that demonstrate adherence to the investment discipline, despite changing market conditions. Finally, trust is maintained by providing transparency into execution of the investment process, portfolio performance and fees paid for services.

OUR PHILOSOPHY

We believe that using multiasset class portfolios developed to benefit from multiple sources of return is the best way to have a portfolio support the mission of its organization.

OUR PRINCIPLES

 

1 Uniform Prudent Investor Act (UPIA): A U.S. law that sets the standard of fiduciary duty for those entrusted with the responsibility of managing others' money, such as trustees and estate administrators. It requires that a trustee weigh risk versus reward when making investment decisions, taking into account the income that may be generated by the investment as well as the probable safety of the invested capital.

2 Uniform Prudent Management of Institutional Funds Act (UPMIFA): a uniform act that provides guidance on investment decisions and endowment expenditures for nonprofit and charitable organizations.

This document is provided for informational purposes only and is not issued in connection with any proposed offering of securities. This Furthermore, it is not used with regard to any specific investment objectives, financial situation or particular needs of any specific recipient and does not contain investment recommendations.

IMPORTANT: The material presented is designed to provide general information about ideas and strategies. It is for discussion purposes since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances.

Investing in securities involves risks, and there is always the potential of losing money when you invest in securities.

Economic or financial forecasts are inherently limited and should not be relied on as an indicator of future investment performance.

Alternative investments are sold to qualified investors only by a Confidential Offering Memorandum or Prospectus. Alternative investments may provide limited liquidity and include, among other things, the risks inherent in investing in securities and derivatives, using leverage and engaging in short sales. An investment in an alternative investment fund is speculative, involves substantial risks and should not constitute a complete investment program. An alternative investment fund may be highly leveraged. The volatility of the price of its interests may involve complex tax structures and there may be delays in distributing important tax information. These funds may not be subject to the same regulatory requirements as registered mutual funds, and their fees and expenses may be high. Interests in alternative investments are not deposits or obligations of, or guaranteed or endorsed by, any bank or other insured depository institution, and are not federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board or any other governmental agency. An investment in alternative investments is not suitable or desirable for all investors. Investors may lose all or a portion of the capital invested.

Nonfinancial assets, such as closely held businesses, real estate, oil, gas and mineral properties, and timber, farm and ranch land, are complex in nature and involve risks including total loss of value. Special risk considerations include natural events (for example, earthquakes or fires), complex tax considerations and lack of liquidity. Nonfinancial assets are not suitable for all investors.

Always consult with your independent attorney, tax advisor, insurance agent or other professional advisors for final recommendations and before changing or implementing any financial, tax, or estate planning strategy. Client eligibility may apply.

Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns.

Diversification does not ensure a profit or protect against loss in declining markets.

Institutional Investments & Philanthropic Solutions (II&PS) is part of U.S. Trust, Bank of America Corporation (U.S. Trust). U.S. Trust operates through Bank of America, N.A. and other subsidiaries of Bank of America Corporation (BofA Corp.). Trust and fiduciary services and other banking products are provided by wholly owned banking affiliates of BofA Corp., including Bank of America, N.A.

Bank of America, N.A. makes available investment products sponsored, managed, distributed or provided by companies that are affiliates of BofA Corp.

This document may not be reproduced or distributed without prior written consent of U.S. Trust.

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