Asset owners have an obligation to their beneficiaries to be clear and explicit about the beliefs driving their policies and practices, to act on them coherently and consistently, and to review and update them regularly. The thoughtful development of Investment Beliefs Statements (IBS) can help all asset owners protect their investments and properly fulfill their important roles. The bursting of the financial bubble in 2008 and the havoc it wreaked on portfolios and assets held for long-term retirement security made clear, we believe, that the investment beliefs employed by many asset managers may not have correlated with the needs and beliefs of assets owners and their beneficiaries. Asset owners operate through a set of investment beliefs that are at least implicit in their investment practices. All too few are explicit and transparent as to the nature of these beliefs, beliefs such as how markets operate, the nature and purpose of investment, and the proper role of investors in the marketplace. Like the claim of the “end of history” in the area of political theory, investment consultants before the 2008 crisis preached that they had figured the markets out. Certainly there would be ups and downs, but modern portfolio management techniques and the principle of reversion to the mean ensured that asset owners could sleep without cares at night. The bursting of the bubble, however, made clear that many explicit beliefs of investment professionals and even asset owners themselves may have been mistaken. These included beliefs that adequate liquidity would alwaysbeen there in the markers, that certain investment decisions at a portfolio level wouldn’t contribute to systemic risk, that highly sophisticated modern portfolio management techniques and products were infallible, and that non-correlated assets could be found no matter what macro-events occurred. In addition, the importance of embedded but opaque risks has become increasingly apparent, including the deleterious effects of limited transparency in investment vehicles and of layers of embedded fees. Beliefs must be made explicit. They are crucial to an understanding of what decisions asset owners are making and why, and ultimately to helping these asset owners determine which of their policies and practices are working and which are not. A clearly formulated Investment Beliefs Statement (IBS) can help trustees, fiduciaries, and others responsible for investment decisions clarify their views on the goals of their investments, the nature of financial markets and how they function, and their rationales for the selection of investment styles and managers and related issues. Investment Belief Statements are particularly important for institutional investors serving in fiduciary capacities. Without clear guidance, asset managers for these investors may be inclined to adopt investment practices that correspond to their personal investment beliefs or financial interests, rather than to the needs and goals of the ultimate beneficiaries or investors. Specifically, the duty of loyalty requires that investment processes be aligned with the interests of beneficiaries.
The case for statements of investment beliefs is not a new one, but support for it is building. Recent academic research has bolstered this case and a number of large assets managers have developed, or are developing, such beliefs statements. An IBS differs from an Investment Policy Statement. Policy statements generally address specific asset allocation decisions and describe allowed investment vehicles. An IBS is broader. Among the issues that are often addressed in an IBS are those relating to risk, diversification, innovation, and market efficiency. We believe that an IBS can also address issues relating to the sustainability of finance and that fundamental questions about the purpose and nature of the investment process as a societal construct have a bearing on the investment process. Making a satisfactory investment return is obviously a primary part of that process, but due consideration can also be given to the social and environmental implications of investment decisions and how the investment processes can account for these implications. In addition, how investors manage their funds can have important implications for the stability of financial markets. Financial innovation should provide enhanced benefits to society, not simply to participants in the markets.Finally, an IBS will be particular to each asset owner. While certain concepts may be found in most IBS’s, such as the importance of transparency in investment vehicles and how risk is defined, others will be unique to particular funds. At the Initiative for Responsible Investment we have posted a Working Paper which describes this process more fully and gives a number of examples of existing statements.
The process of building an IBS can educate participants, improve collaboration among decision makers, and help avoid misunderstandings or conflicts of interests with service providers. The crash of 2008 reminded all investors that mindfulness in beliefs is crucial for success. The crash and the resulting recession are testing assumptions of many previously sacrosanct investment concepts. The development and rigorous application of an IBS can help asset owners protect the investments that they hold in trust for their beneficiaries and improve the chances for meaningful and effective reform of detrimental financial practices.
Jay Youngdahl is a Fellow at the Initiative for Responsible Investment at the Hauser Center at Harvard University and Steve Lydenberg is the Founding Director