In 1905, poet George Santayana wrote that “Those who cannot remember the past are condemned to repeat it.” Was he prescient or practical, acknowledging that human behavior sometimes tends towards inertia if the challenge is deemed too hard? Unfortunately for those who favor inaction, the tide is turning in favor of transparency and investment best practices (and arguably none too soon).
A recent survey conducted by the IBM Institute for Business Value augurs poorly for those who think the past holds the key to the future. To the contrary, nearly nine out of ten surveyed financial executives said they believe that high returns are no longer achievable and that “excessive risk taking, opacity and leverage” have gone the way of the dodo bird. If true, think about the difficulties that lie ahead for institutional investors.
One asset allocation mistake or sloppy due diligence step could cut short any meaningful chance of realizing even modest yields over time as it will be harder to make up for lost ground. More than a few pension, endowment and foundation leaders will simply have no chance but to button up their procedures in order to mitigate uncompensated risk. Their very financial survival will depend on the proper identification, assessment and management of qualitative and quantitative sources of uncertainty.
New rules will come and go, forcing what regulators will invariably characterize as best investment practices. They will be wrong. Staying in business will critically depend on going well beyond the letter of the law and instead committing to a robust and comprehensive focus on economic "compliance" where it counts, i.e. preserving or growing available cash. For example, suppose an institutional investor conducts background checks on key traders but ignores lock ups or undue concentration of said traders' positions. Absent Lady Luck, the pension, endowment and/or foundation will have taken one step forward and two steps backward by spending money to address one risk factor while ignoring others.
The good news is that opportunity presents itself in these turbulent times. Enlightened organizations can differentiate themselves as advocates of buy side governance, thereby potentially reducing their exposure to litigation, lowering the chance of economic losses and/or enhancing their respective reputations with plan participants, donors, taxpayers, shareholders and other relevant constituencies.
Reform won't be easy. Diminished budgets for risk management technology systems and skilled personnel will challenge even well-intentioned institutions. Unfortunately, excuses will fall on deaf ears if promises can't be kept. A retiree or grantee won't care why the checks don't arrive on time or arrive and then bounce.
The future is here. Everyone is a risk manager now.
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