The Prudent Fiduciary Digest
September 9, 2015
The last couple of months have certainly been exciting for asset owners. It's easy to get drawn into the gravitational pull of the markets when they become more volatile; hopefully these readings will help you to look away for a time and think about the big picture.
Janus Capital Group has published an interesting paper, "Adaptive Asset Allocation: Refocusing Portfolio Management Toward Investor End Goals." The introductory paragraph ends in this way: "Is the goal of maximizing measures like Sharpe ratio or information ratio consistent with the goal of maximizing terminal value? The answer is a resounding no."
The authors argue that "time diversification is ignored in most standard models of finance," and that the tools most often used in assessing risk are based upon "the assumption of repeatable single-period investing, while enhancing terminal value is rooted in multi-period investing, where the environment from one period to the next can be very different."
Indeed, "Investors do not have the luxury of living in a single-period, repeatable world – or a world of averages." Yet those assumptions drive the analyses that most asset owners use. The paper lays out the need for a greater emphasis on evaluating and managing tail risk over time if asset owners are to deliver better compound returns.
Whether or not the specific solutions proposed by Janus are worthy of your consideration, the simple ideas that underlie them should be on the table for discussion.
A mission of impact
There's SRI and ESG and PRI and mission investing and impact investing and . . . .
The terminology is all over the place and the definitions are imprecise, but there's no doubting that there has been a significant change in the landscape: investing in ways that look beyond the traditional risk/return framework is increasingly popular.
Propelled by a variety of factors (including demographic shifts, concern about the short-term focus of investment decision makers, and worries about climate change), products marketed under the myriad banners of social investing have been gathering assets and attention. Investment firms are scrambling to build resources and stake a claim to thought leadership in that area.
(One that has blazed the trail is Generation Asset Management, the subject of an outstanding article in Institutional Investor. I will be writing about it in depth sometime in the future.)
If you have an interest in how the ideas can shape an investment approach, I recommend reading the investment materials from the F.B. Heron Foundation. The title of the preface to the policy statement sums up the foundation's philosophy: "All investing is impact investing." For Heron, "risk" is not a one-dimensional concept; it "refers to the probability of non-performance on both social and financial dimensions, and the interaction between the two."
As I was reading, I found myself wondering, "Is this the model of the future?"
Ethics and compliance
Deloitte recently completed a series that summarizes the five ingredients it feels are necessary in a "world-class ethics and compliance program." (The links to each part and the respective PDFs are included in the final piece.) The ingredients: "tone at the top," "corporate culture," "compliance risk assessments," "the chief compliance officer," and "testing and monitoring."
The white papers provide a basic framework for thinking about issues of compliance and ethics – at your own organizations and at your providers (and their providers, etc.). Reading them might trigger an interest in pursuing some of these (admittedly hard-to-pin-down) issues.
Sometimes it's difficult to understand why a meeting of a committee or board runs aground. One of the challenges in discussing investment ideas is that there usually are varying levels of expertise and experience among the people around the table. It's easy for some to dominate the conversation, even when they aren't trying to do so.
A recent article hit on a key contributing factor: "The problem is that the powerful are often oblivious to their impact." It is especially important for committee chairs to be aware of how debate can be stifled (perhaps by themselves).
It's impossible to know when we're truly at a tipping point regarding an idea, but several issues seemed to come to critical junctures of late.
~ Private equity fees are being looked at much more carefully. Big asset owners want more fee transparency; that's part of a general move to more clarity about fee policies, as exemplified by the guidelines from PGGM. (Regulators are interested too.)
~ Risk parity is under fire. It's not often that you see asset managers this vocal about systemic problems inherent in the strategies of other organizations. The defenders of risk parity are out in force too. Expect a high-pitched battle. (A piece from Bridgewater provides some history of the strategy, if through rose-colored glasses.)
~ Cybersecurity issues are front page news, but a Pensions & Investments article said that asset owners are overconfident about it. (Which group are you in? “Those that know they have been hacked and those that don't know they have been hacked?”) And, remember: At every organization, it's not just its security protocols, but those of its agents. When you outsource, you are outsourcing your reputation.
Here are some questions that you might ask at your next meeting:
~ Are the analyses and tools that we use the right ones to create value in the long term?
~ Should our mission affect our investment approach? How have we framed the relevant issues?
~ Are we satisfied with our awareness and understanding of the compliance issues that we face?
~ Does discussion get squashed by the voices of authority?
Additional items of interest:
~ "Late Summer Beach Reading," Ashby Monk, Institutional Investor. Links to five papers co-authored by Monk on important issues for asset owners.
~ "Are 401(k) Investment Menus Set Solely for Plan Participants?" Center for Retirement Research.
~ "Hedge Funds Faced a Test in August, and Faltered," James Stewart, New York Times. (Of course, one month is irrelevant in the scheme of things, but when hedge funds "have failed to beat a 60/40 mix every single year since 2002, and they’re on track to repeat this year," each data point will be scrutinized.)
~ A couple of essays from me that might might make you think differently about your asset managers. You've seen the pages in the pitchbook about their investment process, but what happens to that process under pressure? And what does the lack of gender diversity within most asset management firms say about their decision making approach – and about a key failure of our own due diligence?
~ Speaking of due diligence, I was thrilled to be a speaker at the DoDiligence conference in August. (I'll share the white paper from it when it is issued.) By the way, you can get monthly due diligence tips by signing up for my notifications on that topic.
Many happy total returns,
Tom Brakke, CFA