Most disagreements between an investor and a manager are not disagreements about markets. They are disagreements about what the portfolio was supposed to be doing. When objectives are held informally, every market environment becomes an opportunity to reinterpret them, usually in the direction of whatever has recently performed well.
A written mandate removes that flexibility deliberately. It states the horizon, the purpose of the capital, the tolerance for loss, the liquidity that must be preserved, and the constraints that apply. It also states what would cause the mandate itself to be revisited.
The components that carry weight
Certain elements do most of the work. Horizon determines how much volatility the portfolio can absorb without forcing a sale. Liquidity requirements determine how much illiquidity can responsibly be held. Drawdown tolerance, expressed as a figure the investor has genuinely considered, determines allocation more reliably than any stated return target.
- Purpose of the capital, in the investor's own words.
- Investment horizon, and the dates on which funds may be required.
- Tolerance for decline, stated as a magnitude rather than a sentiment.
- Liquidity that must remain accessible at all times.
- Constraints: legal, tax, regulatory, concentration or otherwise.
- Review cadence, and the conditions that trigger an unscheduled review.
Why return targets are the weakest element
A return target is the part of a mandate most often stated first and relied upon least. Markets do not deliver a required return because a portfolio requires it. A target is useful as a test of whether objectives and constraints are internally consistent. If the required return cannot plausibly be reached within the stated risk tolerance, something in the mandate has to change before capital is committed.
That conversation is uncomfortable at the outset and considerably less uncomfortable than having it after a difficult market period.
The test of a good mandate
A mandate is working when it can be used to evaluate a decision that has already been made. If a position cannot be explained by reference to the mandate, either the position was wrong or the mandate is incomplete. Both are useful things to discover.
This note is general information about investment process. It is not investment, legal or tax advice, not a recommendation, and not an assessment of suitability for any particular investor. Investment involves risk, including the possible loss of capital.