Trust, Institutional Investors and Their Service Providers


Financial scandals, decimated 401(k) plans and significant fallout on Wall Street are only a few of the pain points that leave one longing for halcyon days of yore. There is a lot of talk about broken promises and attempts to regain client trust.

Even outside the financial services sector, long known for its reliance on interpersonal relationships, sellers are working hard to rekindle the love with their consumers. In "Corporations work to regain customers' trust" (September 18, 2009), Business Week reporters David Kiley and Burt Helm write that "In the world of branding, trust is the most perishable of assets." Adding to marketers' woes, recent polls suggest gross unhappiness with business in general, something that slick ads are unlikely to fix.

Closer to home, "Can You Trust Your Consultants and Service Providers? (Human Resources, October 2009) addresses the critical relationship between service providers and consultants and 401(k) plan fiduciaries. The article quotes Nixon Peabody attorney Sherwin Kaplan as saying that "trust with providers should be earned, not implied" and that sponsors must properly select and then monitor each vendor. Aside from the obvious problems associated with conflicts of interest and fees, Attorney Kaplan mentions new worries in the form of fiduciaries suing each other over questions about suitability and due diligence.

In yet another related item, uber venture capitalist Fred Wilson opines on "Ten Characteristics of Great Companies" (September 3, 2009) with attribute number 10 being that "Great companies put the customer/user first above any other priority." We concur absolutely but know that more than a few service providers are challenged to deliver above and beyond the call of the duty at the same time that sales and client relationship management budgets are being cut to (in some cases) unsustainable levels. 

In "Broker's World: Fiduciary-Like Process Could Become Voluntary" (September 23, 2009), Wall Street Journal reporter Annie Gasparro describes the inevitability of a national (U.S.) focus on new broker-dealer rules. Boston University law professor Tamar Frankel is quoted as saying that "If the clients can trust them, they won't have to do all the freebies like lunches to get their business."

As both a buyer and seller of services, I like to think that my perspective considers both sides of the aisle. In the spirit of open conversation, I've listed a few thoughts below. I welcome your comments.

  • Integrity (a precursor to building a relationship of trust) must be a core element of an organization's enterprise-wide culture.
  • Customer service does not have to deteriorate with budget cutbacks.
  • Discounting of fees does not necessarily translate into automatic trust, especially if it encourages a service provider to cut back on quality or lose money instead.
  • Clients should be willing to provide constructive feedback to service providers before calling it quits. A reasonable period of "remedy" should be decided upon before pulling the plug.
  • The compensation structure on both the buy and sell side should encourage long-term value maximization on behalf of relevant constituencies.
  • Conducting assessments as to what remains critically important to institutional investors versus "nice to have" or "waste of time" should occur on a regular basis.

It is undeniably a brave new world. Without trust and a focus on long-term relationship building, new business for investment service providers may end up costing a bundle. Instead of being hired to "rescue" institutional investors such as pensions, endowments and foundations by granting advice, an absence of trust could induce more risk in the form of litigation and harm to reputation, resulting in service providers themselves asking for a safety net.

Do Institutional Investors Have More Clout Now?


This week has been an eye opener in terms of customer service. As I've been signing off on more than a few big purchases related to the opening of a new office, I've noticed that some companies are definitely better than others when it comes to the care and feeding of those who fund their paycheck.

Take Company A for example. Since certain of their models are forced into obsolescence by top management (though still functional), they no longer sell spare parts so one has no choice but to toss otherwise viable products in the trashbin. It seems wasteful to this budget-focused gal but the vendor leaves me little room to maneuver. 

Then there is Company B. A purveyor of premium communication accessories, their service representative took down copious details about shipping location and what products we wanted to order. However, to pay for the merchandise, we were directed to a separate billing clerk who had us repeat all the gory details because the two departments had systems that did not talk to one another.

Company C has limited customer service hours and no "Contact Us" email address posted on their website. Hence, we were forced to take precious time during the next work day to call the vendor after we missed reaching them during a limited client care window. It would have been so much nicer to be able to call during extended hours or send a quick email.

The list goes on. I'm sure readers have their own tales to tell.

Anyhow, this repeated angst got me to thinking about client service in buyside land, fiduciary asymmetries and balance of power when it comes to large-scale purchasing. We've conducted enough market research studies to know that things are definitely changing in favor of institutional investors for a bunch of reasons.

Yet, and somewhat puzzling to some (though not to us), there still seems to be a disconnect between how certain products and services are sold to buy side executives. Some transactions that should make immediate sense are not necessarily causing the cash register to kaching for vendors.

Take risk management information technology or due diligence audits for example. Arguably a no-brainer to buy a product or service that helps one better identify, measure and manage risk, whether monies are being managed internally or not, some areas of IT and consulting spending have dipped according to recently published industry reports. While this may change (risk control is the new cool and budgets are being relaxed a bit), a reasonable person logically asks about barriers that currently inhibit sales. VERY importantly, part of the conundrum is the proper identification as to who makes for a logical buyer - Asset Manager? Consultant? Institutional Investor? All of the Above? None of the Above? Other?

When we've dug deep with organizations on both sides of the fence, we've heard variations of the following (with a gigantic caveat that there are some terrific companies in the vanguard when it comes to infrastructure that explicitly embraces their sensitivity to the fiduciary duties for which their institutional investor clients are responsible to discharge):

  • From a hypothetical service provider - "We aren't going to implement best practices X, Y and Z until the institutional investor requires us to do so. Otherwise, we're spending money we don't have to spend." 
  • From a hypothetical consulting firm - "We couldn't possibly engage in all of the best practices you recommend because of the costs to implement. We can't charge our clients enough to recoup our outlays."
  • From a hypothetical institutional investment executive - "We just assumed that our vendors are doing what they need to do in order to vet qualitative and quantitative risks appropriately.

No doubt lasting changes are underway with respect to industry participants, pricing structure and investment governance policies and procedures. With turmoil, there is tremendous opportunity to do well by doing good. We are excited about what the future holds in terms of investment best practices.

Can Risk Management Be Deemed Strategic?


As a veteran risk manager, I was encouraged to read that risk management is starting to receive the attention that I've long advocated as mission critical. In "Risk becomes focus for trustees trying to rebound from crisis" (9/4/09), Pensions & Investments reporter Drew Carter writes that pension decision-makers are more than ready to confront the volatility beast. In particular, the goal now seems to be a choice between matching liabilities or "keeping many of the asset classes that burned them in the crisis." 

Risk management comes in many different forms. Ask a dozen retirement plan executives how they define risk and you are likely to get twelve different answers. In a way, that's part of the problem. For some, risk management might take the form of portfolio diversification via investing in absolute return strategies. For others, risk control could mean the creation of a dynamic hedging program. Which one is right?

Unfortunately, for those seeking a simple answer, there is no universal risk management panacea since every situation is different. Are there common best practices? Yes indeed and I could easily construct an optimal risk management program that embeds "must do" items versus "facts and circumstances" recommendations.

While I think we have a long way to go before risk management is front and center the way it should be, it is encouraging to know that risk is no longer a four-letter word, banished to the hinterlands of theory and geekdom. It would be grand if fiduciaries deemed effective risk management as a strategic advantage and not a burden. Good controls help to mitigate losses, sub-performance and lost opportunities. Robust risk management can also produce a goldmine of information that is otherwise unattainable unless one is carefully measuring what might go awry.


Asset Allocation Alchemy


Asset allocation seems to be on the minds of many these days. This is not surprising since empirical studies repeatedly suggest that how monies are apportioned across sectors and instruments is a primary driver of returns.

Some states such as North Carolina are legislating more choices for state retirement funds. According to "Pension fund to get new options" by The News & Observer reporter David Ranii, the Tar Heel State Treasurer will soon have the ability to allocate to junk bonds and Treasury Inflation Protected Securities ("TIPS").

In "Asset allocation survey 2009," Mercer LLC queried European pension funds and uncovered a "continuing focus on risk management and recognition that good governance can improve the investment performance of institutional investors." Notable is the result that mature defined benefit plans tend to reduce their exposure to equity markets in favor of fixed income.

In contrast, Dr. David Gulley, Managing Director at Navigant Consulting, suggests that an exit from equity could be ill-advised for investors seeking returns over many years. In "A Surprising Bear Market Lesson About Bullish Projections" (Law360, July 2009), Dr. Gulley writes that "a substantial and objective body of evidence shows that equity returns are reliable in the long term" and that a positive equity risk premium is "actually a requirement enforced by the market's ability to deny money." If true, the impact is potentially sweeping. For one thing, a migration to Liability-Driven Investing ("LDI") which tends to favor fixed income might prove costly later on. Pension plan decision-makers seeking to reallocate away from long only strategies might incur transaction costs now, only to add opportunity cost to the mix if and/or when the sun rises again in stock land. The net result could be a doubling up of bad news bears (or worse).

Absent a universal acceptance about the role of stocks versus everything else, the debate about optimal strategic and tactical asset allocation mix will no doubt continue for many years to come.


Investment Blogger at Work


A few weeks ago, I promised to get back in the swing of things regarding more regular blogging. It is a promise I intend to keep. There is SO MUCH to say about the state of investment governance. Alas, our team has been working around the clock on "best practices" initiatives. We'll be saying more about our progress in short order. Many thanks for your patience. 

We'd love to get additional feedback about topics of interest. Please send an email with your suggestions.