Many enterprises have organized groups of executives and managers into what are called investment committees. Not all such groups make actual investment decisions. Some committees function as an oversight board charged under various pension and trust laws to select third parties that actually make the investment decisions.
On the other hand, other groups actually make decisions about which investment securities will be embraced in their mutual funds, nonprofit asset management programs, and public pensions.
Individuals who are cast in an institutional investment decision-making role fit in one of two general categories, which are depicted in this post by the colors orange and green.
Orange or Green?
The “Orange” category is comprised of individuals that make direct investment decisions within the universe of options available in the global securities markets. Examples of which include mutual fund managers, members of committees that serve nonprofits, participants on public pension investment committees, and executives of enterprises that sponsor defined-benefit retirement plans for employees.
Orange investors are accountable for addressing risk factors in their decision-making that include the following:
- Market risk. The risk of investments declining in value because of economic developments or other events that affect the entire market. …
- Liquidity risk. The risk of being unable to sell your investment at a fair price and get your money out when you want to.
- Concentration risk. The risk of loss because your money is concentrated in one investment or one type of investment.
- Credit risk. The risk that the government entity or company that issued a bond will run into financial difficulties and won’t be able to pay the interest or repay the principal at maturity.
- Reinvestment risk. The risk of loss from reinvesting principal or income at a lower interest rate.
- Inflation risk. The risk of a loss in your purchasing power because the value of your investments does not keep up with inflation.
- Horizon risk. The risk that your investment horizon may be shortened because of an unforeseen event
- Longevity risk. The risk that the need will outlast the principal.
- Foreign investment risk. The risk of loss when investing in foreign countries
The “Green” category consists of individuals who are charged with the duty to manage a decision-making process. Such individuals do not make direct investment decisions, which are in the purview of the Orange category. Instead, they are enterprise leaders that are expected to monitor the conduct and performance of third parties such as mutual fund managers for retirement plans. Human resources managers and finance executives dominate the Green category.
Green investors are not accountable for achieving any particular rate of return generated by the third parties they select. The risk factors they face are very different from the risks that confront the Orange category. Examples of those factors include:
- Selection of investment managers. Thorough due diligence is required in order to demonstrate required prudence.
- Selection of investment advisors. Advisor must demonstrate an ability to customize its advice.
- Monitoring investment managers and investment advisors. Ongoing evaluation of capabilities, conflicts, and care.
- Reasonable fees for investments and advice. Compensation must be properly balanced between services rendered and fees paid.
Use the Knowledge of your Role to Your Advantage
Once you know what color represents your true role, use that knowledge to your advantage. In order to control your category risks, be aggressive in evaluating the behavior of the investments and third parties that drive your enterprise’s investment complex. An annual risk assessment is a good place to start.