DEGREE OF ADHERENCE TO PRESCRIBED POLICIES

DEGREE OF ADHERENCE TO PRESCRIBED POLICIES

DEGREE OF ADHERENCE TO PRESCRIBED POLICIES

Some investors may not be satisfied with overall measures of successor failure or even with plausible explanations of them. Some investors may take seriously the division of responsibility between those who prescribe policy and those who execute it. Trustees of endowed funds,for example, have the responsibility for prescribing investment policyand have an understandable interest in seeing whether their prescription has been followed. There is an unverified story that Casey Stengelonce fined a player for hitting a home run when he had been orderedto bunt. The fine is understandable, since those responsible for policyneed to have confidence that it is being carried out, and they should not be pleased by departures from policy even when the departuresprove it to be successful.

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The prescription of policy is frequently so vague or ambiguous thatdetermining the degree of conformity to it is impossible. When ambiguity is avoided, the prescription is often so general that conformityis meaningless. For example, a prescription of policy in terms of proportions of portfolios to be in equities and in fixed-dollar assets iseasily adhered to, but the range of discretion remaining to the invest ment manager is often so great as to render the policy of little value.

As a result of the development of modern portfolio theory, there is an incipient but perceptible trend to prescribe investment policyin terms of beta coefficients (i.e., measures of systematic risk) and mea sures of the percent of total risk which is systematic (i.e., coefficients ofdetermination). For example, an investment manager can be directed to have a portfolio which moves up and down as fast as the market,half as fast, or once and a half as fast. Policy makers may feel that theircollective wisdom is adequate to judge the general economic outlookand to prescribe the associated appropriate investment policy. (Theymay also recognize that committees are not efficient agents for selectingparticular assets and executing particular orders.) When such policymakers expect rising corporate profits and declining interest rates, they may choose an aggressive policy which is expressed through a betacoefficient greater than 1.0. Expectations of declining profits andrising interest rates would naturally lead to specifying a defensive policy, operationally defined as a beta coefficient of, say, 0.2. Such policyprescriptions are operationally meaningful and are capable of beingcarried out. It is relatively easy for investment managers to achievealmost any specified beta coefficient, and policy makers can hold theiragents responsible for doing that. It is also possible to prescribe the amount of unsystematic risk which is to be incurred.

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