7. Guidelines for Financial Advisors
7.1. Investment Purpose - The investment purpose of the long-term investment funds is to provide financial stability and operating revenue in support of the Association mission. Income and gains from all these funds, in addition to spending guidelines of each fund as listed above, may be spent to support the prescribed functions of the respective fund.
7.2. Investment Objectives - The primary investment objective of the long-term investment funds is to achieve absolute positive return over a complete market cycle of rolling 3-5 year periods. For all AACRAO Funds (Endowment, Infrastructure, and Strategic Initiatives), this objective shall be defined as the ability of the portfolios to meet or exceed the performance of the respective blended benchmarks, net of all fees and expenses.
7.3. Investment Objective - The long-term objective of the total portfolio (all Funds combined together) is to pursue income and growth with equal emphasis on principal preservation and maintaining purchasing power over time. Whereas it is understood that fluctuating rates of return are characteristic of the securities markets, the greatest concern is long-term maintenance of purchasing power and consistency of total portfolio return over time. Objectives will be measured by results achieved over a three-year rolling period.
7.4. Risk, Volatility and Loss - AACRAO recognizes that risk (i.e. the uncertainty of future events), volatility (i.e. the potential for variability of asset values), and the potential loss in purchasing power due to inflation are present to some degree with all types of investment vehicles. The assumption of a level of risk that is commensurate with AACRAO's objectives is warranted in order to allow the investment portfolio the opportunity to achieve satisfactory results consistent with its objectives and characteristics. AACRAO will accept the exhibition of portfolio volatility characteristics that approximate the appropriate index as outlined below in section 7.13 below. Nonetheless, it is AACRAO's preference that the maximum losses incurred by the portfolio in any one year not exceed that of the comparative index. The financial advisor(s) should take actions to minimize losses.
7.5. Asset Allocation “ Each of the long-term investment funds will have its own specific asset allocation in order to serve its purpose effectively. The specific asset allocation for each long-term investment fund is listed in Addendum I, A-C. From time to time and with the advice of the financial advisor(s), the Investments Committee may amend the asset allocations in Addendum I, A-C. However, the mix of assets in any of the long-term investment funds should fall within the following tactical ranges:
7.5.1. Cash - 0-20%
7.5.2. Equities “ 30-85%
22.214.171.124. Large Cap Value “ 2-30%
126.96.36.199. Large Cap Growth “ 2-30%
188.8.131.52. Small/Mid Cap Value “ 0-20%
184.108.40.206. Small/Mid Cap Growth “ 0-20%
220.127.116.11. International (Developed) “ 2-30%
18.104.22.168. Emerging Markets “ 0-20%
7.5.3. Fixed Income “ 15-70%
22.214.171.124. Fixed Income (International) “ 0-10%
126.96.36.199. Investment Grade (Domestic) “ 15-70%
7.5.4. Alternative Investments “ 0-30%
During the first 18-24 months after changing portfolio advisors or during drastic economic periods (as determined by the Investments Committee), portfolio allocations may be gradually brought to tactical allocations as listed above. Therefore, allocations for any asset class may deviate significantly from the tactical ranges above during such periods, and will not be considered a violation of this investment policy.
7.6. Rebalancing Procedures - It is understood that market movements and tactical adjustments may cause the actual allocation of assets to vary from the tactical allocations listed in Addendum I, A-C or future revisions of that Addendum. Therefore, it will be necessary to rebalance the portfolios to those tactical allocations periodically. Gains and losses will be recognized during the implementation of rebalancing whether the total portfolio return is positive or negative during such rebalancing periods. The tactical ranges set forth in 7.5 are thresholds that should be reviewed quarterly by AACRAO after receipt of quarterly investment reports from the financial advisor(s), who will regularly monitor the portfolio for any variations from tactical allocations. The following discipline will be followed for rebalancing:
7.6.1. If the actual allocation in any of the four major asset classes (Equities, Fixed Income, Alternatives and Cash) varies from the tactical allocation by at least 5% in absolute terms, it will call for rebalancing of the portfolio back to the tactical amounts as soon as is practicable. The financial advisor(s) will provide information regarding such variations as quickly as is practicable to the Executive Director or any other authorized signatory and obtain verbal authorization to implement the necessary rebalancing of the portfolio to the tactical allocation.
7.6.2. Once the initial transition into the tactical asset allocation is complete, the portfolio will be evaluated at the end of every calendar quarter and any variations of 5% or greater, in absolute terms, will generate a rebalancing recommendation. The Executive Director will approve the rebalancing recommendations.
7.6.3. If possible, new cash flows should be used for rebalancing. If new cash is not available, current investments should be bought and sold to achieve the tactical asset allocation. Such transactions will result in recognition of gains and losses in the investment manager accounts and other pooled investment funds.
7.7. Diversification, Marketability, Yield and Quality Consideration - Seeking to establish a diversified program of investments, assets shall be invested under the management of one or more registered investment advisors in alternative investments, index-linked exchange traded funds (ETF) in portfolios of U.S. domestic equities, domestic fixed income, and international equities. Investment vehicles and amounts allocated to each vehicle may change after a thorough review of the capital markets.
The types of stocks and market capitalization of the companies purchased for the portfolio are within the discretion of the financial advisor(s). The financial advisor(s) is expressly permitted to invest in small, medium and large capitalization stocks.
7.8. Equity Portfolio
7.8.1. Equity holding in any one company in each investment advisor's portfolio may not exceed 5% of portfolio at cost or 10% of account value.
7.8.2. Equity holding in non-U.S. investments, including emerging markets, may not exceed 45% of the market value of the portfolio.
7.8.3. Equity securities shall in general possess value and quality corroborated by accepted techniques and standards of fundamental and technical analysis.
7.9. Fixed Income Portfolio
7.9.1. Investments in bonds should be actively managed. Active management is meant to include shifting sector emphasis as well as effecting other prudent strategies that enhance the portfolio or decrease the volatility or exposure to capital depreciation. However, the weighted average maturity of the portfolio must be 10 years or less with a maximum of 30 years for individual securities.
7.9.2. The diversification of fixed income securities by maturity, sector, and geography is the responsibility of the financial advisor(s), with final approval provided by the Investments Committee.
7.9.3. Fixed income securities shall be marketable, intermediate-term maturity securities with an average portfolio rating of no less than "BBB" as rated by Standard and Poors or Moody's. The following instruments are acceptable:
188.8.131.52. Commercial paper or variable rate notes of P-1 or equivalent rating.
184.108.40.206. Certificates of deposit and bankers acceptances (A-rated or above).
220.127.116.11. United States Treasury bonds, notes, and bills.
18.104.22.168. Repurchase agreements with U.S. Treasury securities and agencies of the U.S. Government as collateral.
22.214.171.124. Debt instruments of the U.S. Government or its agencies.
126.96.36.199. Corporate debt issues with an investment grade rating from a major bond-rating agency such as Moody's or Standard and Poors (BBB-rated or higher).
7.9.4. Standard and Poors or Moody's must rate bonds as "BBB" or higher to be purchased for the portfolio. Bonds that are split rated will, for the purposes of this portfolio, be considered investment grade and thus eligible for purchase. Split rated bonds are defined as bonds that have an investment grade rating with Standard and Poors and a non-investment grade rating with Moody's or vice versa.
7.9.5. The portfolio's fixed income exposure to any specific industry group may not exceed 20% of the market value of the portfolio.
7.9.6. The fixed income holding of a single issuer may not exceed 10% of the market value of the portfolio.
7.9.7. The portfolio diversification requirements do not pertain to investments in debt securities issued by the U.S. Government or its fully guaranteed agencies.
7.10. Alternative Investments Portfolio
7.10.1. A range of alternative investments may be considered prudent to be included in the overall asset allocation with the objective of creating favorable risk-reward characteristics for the overall portfolio. These alternative investments may include private equity, managed futures (limited partnerships), hedge funds or hedge fund replication strategies, inflation-indexed securities, real assets/natural resources, real estate or REITS, and commodities.
7.10.2. The tactical allocation for such alternative investments may range from 0%-30% of the total market value of the portfolio. This allocation is limited due to the high risk, long-term, illiquid nature of such commitments.
7.10.3. AACRAO recognizes that while such alternative investments may carry a higher degree of risk if considered on their own, they may potentially reduce total portfolio risk and enhance total portfolio return since they may be uncorrelated to other asset classes in the portfolio mix.
7.11. Cash Equivalents Portfolio - While it is desirable that the financial advisor(s) use interest-bearing money market funds and other cash equivalent securities with a maturity of one year or less, AACRAO understands that attractive opportunities might arise with securities with longer maturities from time to time. The financial advisor(s) is permitted to invest in such securities.
7.12. The financial advisor(s) shall not purchase assets other than those expressly allowed in this statement without the written consent of AACRAO. The following are prohibited (except if executed in Alternative Investments portion of the portfolio).
7.12.1. purchase of securities on margin
7.12.2. options of all types
7.12.3. letter stock
7.12.4. private placements
7.12.5. securities whose issuers have filed a petition for bankruptcy
7.12.6. short sales
7.12.7. specific industries or sectors as set forth by AACRAO Investments Committee or a designated sub-Committee
7.12.8. tax exempt securities
7.12.10. foreign stocks (with the exception of American Depositary Receipts for the International allocation) unless the international investment advisor(s) deems such exposure appropriate and suitable.
7.13. Fund Performance Benchmarks
7.13.1. Domestic equities should achieve a rate of return that equals or exceeds the relevant and recognized market index for the investment style as follows:
188.8.131.52. Large Cap Growth - Russell 1000 Growth or Barra Growth or S&P 500 for Large Cap Core or comparable index
184.108.40.206. Large Cap Value - Russell 1000 Value or Barra Value or comparable index
220.127.116.11. Mid Cap Growth- Russell Mid Cap Growth or comparable index
18.104.22.168. Mid Cap Value - Russell Mid Cap Value or comparable index
22.214.171.124. Small Cap Growth - Russell 2000 Growth or comparable index
126.96.36.199. Small Cap Value - Russell 2000 Value or comparable index
7.13.2. International equities should achieve a rate of return that equals or exceeds the MSCI EAFE Index or MSCI World Index, as appropriate and relevant.
7.13.3. Emerging market equities should achieve a rate of return that equals or exceeds the MSCI Emerging Markets Free Index.
7.13.4. Domestic fixed income should earn an average annual return from income and capital appreciation that equals or exceeds the Lehman Brothers Government/Corporate Intermediate Bond Index or CITI 1-5 Year Government/Corporate Index.
7.13.5. Alternative investments should achieve a rate of return that meets or exceeds a relevant benchmark based on the choice of alternative investments placed in the portfolio.
7.13.6 The custom index is defined as a mix of relevant indices in the same proportion as the strategic allocation of each asset class in the portfolio. For example, a 10% allocation to the large cap value investment manager will require that the custom index include 10% of Russell 1000 Value or another appropriate index in the mix. This target of return would be accomplished through long-term capital appreciation, principal preservation, and achievement of returns consistent with each category of investment.
7.14. Review and Reporting
7.14.1. Annual Review - The Investments Committee will review, on an annual basis, written evaluations of the net-of-fee performance against the investment policies and benchmarks set forth above. The evaluation shall include a report of performance for each investment manager for past periods including the last quarter, last twelve months, last three years, and period since inception (both absolute and relative to appropriate indices). Returns shall be annualized and calculated on a time-weighted basis for the total portfolio. All returns should include income and dividends.
7.14.2. The financial advisor(s) will provide a quarterly performance summary and a detailed quarterly evaluation of the four funds to the Investments Committee.
7.14.3. The Investments Committee or its designee(s) shall meet with the financial advisor(s) at least semi-annually or as requested to review fund investments and the current investment environment. At such meetings, the written and oral presentations shall cover the following:
188.8.131.52. The quarterly performance and asset allocation report described above, and an annual fee disclosure; and
184.108.40.206. Discussion of the rationale for performance results by relating them specifically to investment strategy and tactical decisions implemented during the current review period; and
220.127.116.11. Discussion of the financial advisor's specific strategy for the portfolio over the next period with specific reference to asset allocation and portfolio characteristics, as appropriate; and
18.104.22.168. Supporting discussion of the next period's strategy with reference to financial advisor's capital market and economic assumptions, as appropriate; and
22.214.171.124. Discussion of AACRAO's needs, goals, and objectives, if different from previous quarter.
7.15. Changes to Investment Guidelines “ The Board reserves the right to make any changes to these guidelines as deemed necessary. All such changes will be made in writing and financial advisor(s) will be duly informed.