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Fiduciaries are Only Human

Posted by BoardSource on Oct 31, 2014 11:12:25 AM

photo (4)By Heather Myers, managing director – nonprofits, Russell Investments

As a board member, one of your most important roles is to serve as a steward and fiduciary of your organization’s assets. We all know this is crucial. Without assets, your organization, and the great work you do, wouldn’t exist. Over the years, working with nonprofits, I have learned some important lessons about what it takes to be an effective fiduciary. It can be easy if you follow three simple rules:

  1. Set clear objectives.
  2. Don’t try to predict your future results based on your past performance.
  3. Focus on the big picture.

BUT, there is one problem holding us back. We are human. And as humans, sometimes we are distracted by things that aren’t important. Or our behavior doesn’t match the environment we are in. Or we have so many built-in biases that we are frequently trying to second guess the markets and ourselves. And sometimes, we make rash decisions. These behavioral biases have been so well documented that the Nobel Prize winning economist, Daniel Kahneman, focused much of his work on the psychology of decision making.

Despite knowing that simply being human can result in bad decisions, no one really believes that they actually behave like this. The recent market turmoil is a good example. If everyone is selling, you follow-suit (the bandwagon effect or group think), and this kind of behavior doesn’t always pay off. We have seen some volatile days and plenty of concerning news in the markets stemming from crises like Ebola to conflicts in Ukraine. We obviously cannot stop being human, and we can’t always control our environment, so what can we do?

We can try to follow those three simple rules. First, establishing clear objectives does make a difference. Prioritize what is most important to your organization and focus on that. For instance, if your organization is truly a long-term investor and has taken the time to go through a detailed asset allocation study and that allocation meets your long-term objectives, then stick with it. Don’t set conflicting multiple objectives, which, as humans, we are tempted to do; we aren’t good at managing to that.

Second, for years, studies have shown us that past performance does not predict future results, and yet our gut, our emotions tell us otherwise. You see a winning streak and you want to try and capture it — this is extrapolation bias, inferring the future from past results. Academically, we have been shown that this is not a good way to invest, and yet human behavior leads us down this path.

Third, as a fiduciary, you need to stay focused on the big picture. Have faith that those in charge of managing your assets are keeping track of the small details. Your focus shouldn’t be on individual stock holdings or day-to-day movements in the portfolio; you should remain focused on whether the portfolio is operating within established risk parameters, the asset allocation is within bands, and your total portfolio is expected to meet objectives. The reports you look at should be focused on these critical items, which can help you avoid many of the other behavioral biases that humans fall prey to.

For fiduciaries, it’s important to recognize potential biases and employ processes to protect from these behaviors. We need to manage our ingrained tendencies to deliver better outcomes. By setting clear objectives, staying focused on the big picture, and not making decisions based on past results, you should have a better chance of growing your portfolio and providing long-term funding for your organization.

BoardSource thanks Russell Investments for its sponsorship of the 2014 BoardSource Leadership Forum.

Topics: Perspectives on Board Service

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