According to the website for Fiduciary Counselors, Attorney Nell Hennessy passed away on February 4, 2011. I did not know Nell too well but found her to be amazingly generous with her knowledge of the employee benefits industry. She took time from what I'm sure was always a busy schedule to share her passion for best practices. An industry leader, she worked tirelessly throughout her distinguished career on behalf of plan participants. Interested persons can read the statement posted by her colleagues by visiting In Remembrance, Nell Hennessy.
Thanks to my husband's astute coaching, I'm becoming a big fan of bridge. Each hand presents a new challenge. In addition to deciding how to play my cards, I have to take my partner's thirteen into account as well as what we need to successfully complete the rubber. I confess that scoring remains a mystery and I'm still unclear as to how to execute certain plays. For example, the other night, I had four aces, three kings and a few queens and jacks but not much of a long hand in any suit. Somewhat of a novice, I took the safer road of bidding a particular suit rather than pursuing a "no trump" course of action. Much like bridge, institutional investors often face choices about what to do.
- Having adequate resources does not necessarily equate to easy choices about asset allocation. I had a terrific start (lots of face cards) but did not want to risk losing the hand by following a strategy with which I was unfamiliar. Additionally, I did not want to let my bridge partner down. In pension land, having lots of money to invest should not equate to a "bet the bank" mentality (i.e. adopting an overly complex approach). Moreover, the interest of beneficiaries (like other partners) must be taken into account.
- Some losses are imminent. Sometimes a few cards are purposely lost in early rounds as a way to gain a superior position for an ultimate win. In investing, markets can bounce around, tempting institutions to pull and run. Establishing trading limits that comport with pre-established goals and risk tolerance levels makes sense. Confusing long-term goals with short-term actions can sometimes be costly and ill-advised.
- Switching partners from time to time offers fresh insights but is likewise hard work. Bridge takes a round robin approach that rattled me at first. After all, if I was winning with a particular partner, why should I have to change? What I've learned is that each new pairing requires a re-examination of the relationship, especially a focus on how to properly communicate with one another. While some investment relationships are ongoing, many are not. The need to clearly exchange mission-critical information is an important skill. Just as any failure on my part to discern my bridge partner's intent during the bidding process can lead to ruin, so too can a breakdown in communication between asset owner and advisor. As the consulting industry consolidates in favor of larger organizations, client communications will be tested as parties get to know each other from scratch. (Note: Interested readers may want to check out "Consultant market set for further contractions," Professional Pensions, April 30, 2010.)
- Skill is essential but sometimes luck dominates. As much as I focus on learning the game, bridge can frustrate. If you are dealt a bad hand, you simply have to get through it, be patient and know that discipline is not a guarantee of high returns. Investing is much the same. A good process is paramount but does not mean that a portfolio's return in any given quarter is going to outbeat a particular target.
- Know where you are going. Journalist Chuck Palahniuk observes that "If you don't know what you want, you end up with a lot you don't." If I stop thinking ahead several plays in bridge, I will unlikely miss my chance to win a particular hand. If an asset owner falls short in proper goal-setting, achieving objectives is going to be hit or miss and could certainly induce all sorts of unpleasant consequences - economic and regulatory.
Finally, bridge requires thought and hard work but can be tremendously rewarding. I learn new things all the time. The life of an investment decision-maker is challenging at best and exposes individuals to tremendous fiduciary liability at worst. Yet numerous professionals make pension stewardship their life's work because it is fulfilling, interesting and satisfying.
According to the U.S. Department of Labor's website, plan sponsors will soon have a fiduciary checklist about how to evaluate and select target date funds as part of the 401(k) plan mix. Given that nearly one out of two plans offer target date funds as an investment choice and that there are numerous questions about related investment best practices, the guidance comes none too soon. Click here to read more about the Spring Regulatory Agenda of 2010.
Law scholar, author and derivatives pundit Frank Partnoy had an interesting piece in the Financial Times on April 19, 2010. In "Wall Street beware: the lawyers are coming," Mr. Partnoy warns that the floodgates of litigation are about to open with the SEC's filing of a fraud lawsuit against Goldman, Sachs & Co. He asserts that the regulatory enforcement takes complex financial alchemy and spins a "morality tale." A second take is that litigation picks up where regulations stop with Wall Street heretofore having interpreted "detailed rules as a shield from liability."
Leaving the Goldman case aside (as only those involved can opine with the clarity of full information), Professor Partnoy provides food for thought. Indeed, as I have written lo these last four years since the inception of this blog, Main Street pain invites legal and regulatory action. Investment losses are vote killers for elected officials who turn a deaf ear to calls for change.
I agree emphatically with the notion that regulations can only do so much.Worse yet, regulations could lull market participants into having a false sense of security. Post implementation of new rules and regulations, investors might think that all is good with the world when the truth could be the polar opposite, i.e. "compliance" having masked a host of bad practice nasties. I've often made the point in print and at the podium that onerous mandates induce the Law of Unintended Consequences, leading to a costly and counterproductive outcome that is antithetical to the original problem. Pick any accounting rule or regulation and it's possible to show the costs and benefits in terms of changed behavior.
There are noble-minded regulators and attorneys alike who really want to make a difference on behalf of the ultimate beneficiaries - retirees, shareholders, taxpayers, working families and so on. They are going to be beyond busy in the coming months and years unless, and until, investment stewards in need of improvement snap to. The wagons are circling. Count on luck or hunker down and get a good fiduciary risk management process in place ASAP. Otherwise, start preparing for deposition.
Editor's Note: Click here to read "Tips From the Experts: Working Effectively With A Financial Expert Witness" by Susan Mangiero (Expert Alert, Summer 2008, American Bar Association). While we prefer by far to help asset owners and their advisors before the fact, call us if you need help with "after the fact" analysis.
I had the great pleasure of attending a dinner the other night to honor university professors who have been working at Iona College for more than 20 years. My husband's tally is 30 (teaching finance). One gentleman came in at 50 years, inspiring young minds with the written word as a professor of english. Somewhat curious, I asked attendees over dinner why they stayed in one place. The response was pretty much the same across the board with answers that referenced colleagues as a second family or the satisfaction of helping students come into their intellectual own.
At a time when some employees at various organizations are treated as temporary visitors, rather than partners in building a better mousetrap, something as seemingly simple as a celebratory dinner of service, past and future, touches the heart. While teaching is often thought to have its own intrinsic value, it is worth noting that any job well done is likewise worth a round of applause. As I've said many times, the notion of service applies to the many men and women who take their jobs as investment stewards seriously. They understand that their every action makes a difference. Bravo!
Mary Poppins came to mind the other day during a panel discussion about governance and the role of the institutional investor.
Part of a conference about fiduciary obligations, I joined Mr. Stephen Davis (Executive Director of the Millstein Center for Corporate Governance & Performance - Yale School of Management) and Ms. Janice Hester-Amey (Portfolio Manager, Corporate Governance - CalSTRS) for a discussion about governance. I believe we were successful in kicking off the day long event with some thought-provoking tidbits. We covered new rules that, if passed into law, should empower pensions, endowments and other asset owners. We opined on regulation versus voluntary action. We had a lengthy exchange about what motivates institutions and whether governance was now considered a "must do" that contributes to return versus a "try to ignore" because it is seen as a drain on resources.
In the words of this famous nanny, find the fun and the job's a snap. I'm not sure that governance will ever top the list of jollies but one does wonder when best practices will stop getting lip service and instead merit the attention it so richly deserves. Chief Governance Officer anyone?
I added commentary about what I believe fervently is an inevitable industry move towards scoring with respect to process (not the same as outcome). Several legal professionals in the audience suggested that any type of benchmark would necessarily offer limited value because of subjective bias (their words, not mine) on the part of those who construct the ABC report card.
I don't necessarily concur. There are MANY points on which rational investment stewards would agree as no-brainer elements of what is right.
For those readers who want to get my specific take on what they are and how to monetize what I think is a great opportunity, contact me. Our firm is looking for solid partners on a few initiatives that we believe break the mold in anticipation of the brave new world of indexing procedural prudence.
In my September 11, 2008 testimony before the ERISA Advisory Council, I described two buckets of organizations - those which deserve a gold star and those who don't. I went on to explain that the size of the "everybody else" bucket might be very large but that current reporting requirements make it nearly impossible to know about red flags in advance. This is cold comfort for shareholders and taxpayers who would prefer to know about financial runaway trains beforehand.
Unfortunately, those who attempt to provide more sunlight about their activities are not always rewarded. In a recent conversation with the CEO of a major asset management firm, I was told that this firm had provided detailed information about its fee structure to institutional clients. Instead of being rewarded, and because there are wide variations with report to how asset managers present performance data, sunlight led to storm clouds. Endowments, foundations and pensions responded by asking why the fees were so high. The reality was that the costs were in fact lower than those of comparable traders but, since competitors were not providing more than basic feedback, their costs were interpreted as lower and therefore "better." It's no surprise that the executive with whom I spoke expressed frustration. Here they were trying to do what they thought was the right thing and come clean with a detailed decomposition of what they charged. Instead of a reward, they were kicked in the proverbial shins.
In "Type-A-Plus Students Chafe at Grade Deflation" (January 29, 2010), New York Times reporter Lisa W. Foderaro describes a similar phenomena in the university sector. Where Princeton sought to minimize grade inflation by limiting the number of A's, top quality students found it harder to compete for jobs when graduates from other schools flashed their scores. Never mind that Princeton arguably tried to impart higher integrity data.
Is the message that transparency is window dressing and that no one really wants to have the low down on "true" outcomes? Alternatively, should we conclude that heightened disclosure rules are inevitable but it is incumbent upon providers of information to educate their recipients, i.e. make sure that underlying assumptions are clearly explained? If that does not occur, might well-intended parties (those who provide more detail than necessary) be impugned instead of rewarded for their forthrightness?
Editor's Note: Click to read "Testimony by Dr. Susan Mangiero to ERISA Advisory Council Working Group on Hard to Value Assets," September 11, 2008. (Note that Pension Governance, LLC is now part of Investment Governance, Inc.)
Etiquette is important but sometimes more an art than a science. Consider my close encounter today with a gentleman whom I respect and like as a perfect example of trying to figure out what to do, without offending anyone or seeming "uncool."
Here's what happened.
In between meetings, I stopped by a local cafe to pick up a sandwich. To my delight, I spied said gent having lunch with colleagues, deep in conversation. When he saw me, he signaled to his colleagues that he was taking a break, came over to say hello and gave me a kiss on my cheek. If memory serves, I think my face grazed his, I passed him a business card (reflecting new contact information), offered a 60 second update on our business and held out my hand for an exit that may have been, in hindsight, anything but graceful.
Paying for my take-out order, I wondered if his buss, followed by my handshake, was an insult. Keep in mind however that this is suburban CT, not Paris. Should we have pecked cheeks again as a more appropriate sendoff, simply said goodbye or nixed the face action to begin with?
It's all so complicated.
I'm sure Jerry Seinfeld could get a lot of chuckles with this topic. Apparently, he had an episode about the "Kiss Hello" though I did not see it.
According to New York Times reporter Elizabeth Olson, "the cheek, or social, kiss is displacing the handshake, once the customary greeting in American social and business circles" but just make sure you get the positioning right. See "Better Not Miss the Buss" (April 6, 2006).
In "Do you shake hands, hug or kiss?" (April 12, 2006), Today Show anchor Al Roker and now prime time news gal Katie Couric acknowledge that a kiss is okay when you know the colleague well but head for the right cheek. Leaning left is outre. Their guest Peggy Post suggests a firm grasp of the hands instead, but "no pumping." Grasp the hand and be done with it. Other suggestions include an air kiss or double peck.
I'm not sure I will remember all of these greeting "do's and don'ts."
It was a special surprise to bump into this smart, funny and high integrity colleague, even if I didn't get the hello and goodbye parts down right.
Linking this topic back to investment matters, is there a protocol for the buy side - service provider reviews that take place every quarter? For example, if an asset manager has lost money for an institutional investor, does that nip any chance of a hug or smooch, no matter how long the relationship? Are puckers prohibited for service contracts above a certain amount or when a discussion is unduly serious? When is the double or triple cheek kiss appropriate? What if two parties are from different countries and the buss rules conflict with each other?
Let's see if Miss Manners can help.
I have the great pleasure of being one of two keynote speakers as part of Audit World 2009. My speech, entitled "Navigating the Auditor Hot Zone: Helping Investors Through Volatile Financial Markets," will include case studies from the trenches with respect to prudent process, hard-to-value investing, modeling and much more.
Always important, auditors are increasingly finding themselve in a position of providing pro-active guidance to their clients about complex rules and markets alike. It's no surprise then that institutional investors tell us that what, when and how auditors opine is of critical importance. Lack of uniformity in what auditors advise is a stated concern. On the flip side, auditors worry that pensions, endowments and foundations are asking too much of them, forcing an uncomfortable situation that blurs oversight with execution of essential duties.
Please join me for what should be an exciting and topical event. Sponsors of Audit World 2009, the MIS Training Institute, have put together a "case study-driven, information-rich program in four defined tracks: Financial Services, Non-Financial Services, Manufacturing and Best Practices."
Click to download the conference brochure for Audit World 2009 from September 15 through 17, 2009 in Boston, Massachusetts. If you register before August 29, 2009, you are entitled to a 10% discount off the regular conference fee.To take advantage of this special discount, you must contact MIS Training Institute’s Customer Service and reference the following priority code when registering: AW09/PRM. The discount offer cannot be used in conjunction with any other discount offer or on previous registrations. Contact the MIS Training Institute by telephoning 508-879-7999 or sending an email to email@example.com.
According to "Detroit pension trustees take flight on funds' tab" (June 14, 2009), Detroit Free Press journalist Jennifer Dixon ponders how much is too much when it comes to trustee travel. I agreed to speak on the record about general best practices and want to add that I am not familiar with the situation in Detroit. I have excerpted my comments below:
"Susan Mangiero, president of Pension Governance Inc., an independent research, analysis and training company in Trumbull, Conn., said public pension plans need 'a clear policy about travel...It's public money, and taxpayers and plan participants would like to know the money is being properly spent.'"
I further suggested that an effective policy should address whether vendors are allowed to pay for trips, adding that "It's important to have policies on what is deemed to be a legitimate and reasonable expense, from a governance aspect and budget aspect."
Given the current environment of cutbacks and layoffs, a review of what constitutes prudent and necessary travel is a no brainer. An effective policy should also lay out rules for travel, conference attendance and so on when the fund has hired an outside consultant or fund of funds manager who is supposed to be doing some of the legwork along the way.
We've heard anecdotally that many pension decision-makers are being discouraged if not outright banned from taking trips right now, urged to fly coach, share hotel rooms and/or otherwise drastically reduce cash outlays.
For those who have yet to adopt a comprehensive travel policy for investment fiduciaries, bon voyage!
In case you missed it, April is National Humor Month. Created by "best-selling humorist Larry Wilde, Director of The Carmel Institute of Humor," 2009 marks the 33rd anniversary of this celebration of fun and merriment.
For those who live in Nebraska, they must really be rolling in the aisles. What? You didn't hear?
According to a survey conducted by MainStreet.com, the home of Cliff Notes ranks top for its low number of foreclosures, low unemployment rate and low percentage of non-mortgage debt by income. Not surprisingly, Connecticut, where I call home, is number 28 out of 50 on the Happiness Index (not a good thing by the way). Being close to Wall Street, we are feeling the pinch of financial layoffs and plummeting portfolio values. California, Florida and Oregon rank 48, 49 and 50, respectively.
Along the lines of "feel good" action, I read an interesting article in the May 2009 issue of Reader's Digest in which Stanford University psychologist Carol Dweck advocates the benefits of failure. According to "How Failure Makes Us Stronger," psychology and neuroscience professor Antoine Bechara has identified two parts of the brain that are responsible for the "fear of failure" and the "lure of success." For certain individuals, the physiological response to failure is a chance to learn.
At a time when many professionals feel under siege for economic losses or sub-par performance or both, one silver lining may be new math, i.e. Failure = Second Chance.
Unfortunately, recent research suggests that not every one is ready to act anew. According to "Managers fail to control hazards" (April 6, 2009), Financial Times reporter Sophia Greene says "not so fast." Citing results of a new risk management study, certain factors such as liquidity risk have not yet "been built into risk models," possibly leaving portfolio managers (and therefore pensions, endowments and foundations) unduly exposed. In contrast, investors are described as committed to asking asset managers about risk management policies, with 10 pages of a typical Request for Proposal ("RFP") being dedicated to "risk of all sorts." In its press release, survey sponsor SimCorp describes "the lack of monitoring of strategic risk" as a concern, along with a less than robust commitment by senior management as reflected in its analysis. For an overview of other findings, read "Global survey reveals that risk function has lost status despite financial crisis" (April 1, 2009).
Recall that Pension Governance, LLC (now Pension Governance, Incorporated) and the Society of Actuaries discovered a similar lack of enthusiasm about risk management and fiduciary duties in its research. Click to access the 69-page study entitled "Pension Risk Management: Derivatives, Fiduciary Duty and Process" by Susan Mangiero. For an overview of that research, read "New Study Addresses Pension Risk Management Gaps" (October 13, 2008).
Can looking the other way make for a happy institutional investor or asset manager? Hopefully, the final answer is "no" and "open to improvement" wins the day.
Today was the end of the first calendar quarter and the deadline for mailing the annual $250 business entity tax check to the State of Connecticut. No longer Pension Governance, LLC (we are now organized as Pension Governance, Incorporated), this little act marked our final payment of what I call the "just because we can" tax. But I digress.
As I got to the local post office, minutes from their 5:00 p.m. closing, I asked the nice man behind the counter to postmark it for today, evidencing that I mailed the check on time, like a good business doobie. As he processed my letter, Bob remarked how much he liked my new hair style. Taken aback a bit (because I had not combed my hair before I jumped in the car), I realized that Bob perceived my do as new and hip (some version of the wild gal look). For those who know me, my favorite outfit is yoga pants, a teeshirt and sneakers, with minimal time spent on fancy makeup and coiffs. (Men are so lucky - no heels, no mascara.)
This humorous encounter (Bob is a nice man, always friendly and helpful.) got me to thinking about investment best practices and the extent to which so few organizations publicize their good deeds.
If a plan sponsor or service provider is going to spend time, money and other resources to embark on a robust fiduciary-focused process (regardless of plan design focus), why not flaunt it? No doubt plan participants, shareholders and taxpayers alike want to know that their money is in good hands. On the flip side, how many organizations come to mind that do a poor job but are perceived as being "good guys and gals" (i.e. didn't comb)?
Wouldn't it be great to go beyond numbers and instead have information such as:
- Who persons the investment committee (experience, education, relationships with vendors)
- How often they meet
- How they make decisions on managers, strategies and so on
- What internal controls are in place to avoid conflicts of interest and potential runaway losses...?
Isn't it time that we separated the good hair from the bad hair?
Wall Street executive compensation is a big story these days. Given the importance of the topic and the impact on institutional investors, I accepted the invitation to write a guest op-ed piece on the topic for Fund Fire, an Information Service of Money-Media, a Financial Times Company. I've included the article below and welcome your feedback. Click to send an email with your opinion about this topic. Shown below is my piece entitled MoneyVoices: "2008 Bonuses Deserve Scrutiny" (February 12, 2009).
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Fund Fire Editor’s note: This MoneyVoices column is a follow-up to last week’s editorial, Money Voices: "A Case for 2008 Bonuses." That article provoked a record number of reader comments, with many stating their disapproval of bonuses amid the downturn.
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"2008 Bonuses Deserve Scrutiny" by Dr. Susan Mangiero
As an advocate of free markets and industry-self regulation, I find myself in a real philosophical pickle on the issue of Wall Street compensation during this economic downturn.
I fervently believe that compensation should be determined by supply and demand, even if the resulting payouts are deemed “too high” by persons outside a particular industry. At the same time, I am disturbed by what seems to be a material disconnect between employee performance and monetary compensation in the financial industry.
Rewarding individuals for doing a bad job is never a good idea, regardless of whether taxpayers or shareholders are footing the bill. At least company investors get a say on pay structure in the form of one vote per share. The average taxpayer has no immediate voice, other than to complain to legislators or use the ballot box at the next election.
The status quo is almost surely a populist no-go. Change in some fashion is inevitable. The good news is that institutional giants – pensions, endowments and foundations – can and should play a role in leading serious discussions with their Wall Street service providers, including money managers and consultants, about their staff’s compensation.
One might even suggest that it’s an institutional investor’s fiduciary duty to inquire about how much of their fees are being used to reward portfolio managers, traders, analysts and other key persons, and on what basis. If they don’t like what they hear, they vote with their feet, engaging other firms they deem less egregious in terms of pay. Capitalists can sleep at night with this approach since it links buyers’ demands (for compensation transparency) with supply (payment of reasonable, risk-adjusted, performance-linked pay).
Remember, though, that asymmetric payoffs do little to properly motivate workers, so their banishment is good news to anyone who believes in a job well done. In an ideal world, professionals reap the fruits of their labor by selling their bundle of skills to willing buyers at an agreed upon price. The buyer takes into account education, experience and willingness to accept certain work conditions (long hours, deadline pressures, etc.).
Compensation comparisons to national norms make no sense unless adjusted on an “apples to apples” basis. A successful trader who makes a million dollars is likely worth every penny. However, it would be insanity to continue paying people for a job not done well, especially when bad results are subsidized with federal dollars. Hiring and retaining effective workers is always a challenge, perhaps never more so than now. Widespread attention, focused on compensation standards, opens the door to improved practices. Those Wall Street professionals who refuse to budge may end up losing the very institutional clients that indirectly pay their bills.
Thanks to financial planner David Boczar for sending along a thought-provoking quote from famed commodities trader Ed Seykota. Described as someone who turned $5,000 into $15 million over a dozen years, this uber trend follower Seykota cautions: "Surrender to the reality that volatility exists, or volatility will introduce you to the reality that surrender exists."
As I've written many times, risk management is not the same thing as risk minimization. Risk is neither inherently "good" or "bad" but rather a reality, with potentially crushing economic impact if ignored or given short shrift. As we've seen in recent days, some attempts to tame the risk lion have resulted in serious casualties.
It is no surprise then that pundits and reporters are asking about the whereabouts of risk managers, part of the frenzied blame game afoot. (Is there a "Where's Waldo" equivalent here?) New York Times blogger Saul Hansell pressed a lot of hot buttons with his September 18, 2008 post entitled "How Wall Street Lied to Its Competitors." My response, now one of more than 100 posted responses, is shown below.
<< I concur with much of this article. Effective risk management is much more than quantitative analysis. Many individuals are lulled into false security when given a bunch of computer printouts, accepting numbers as gospel truth. Like the fictional Detective Columbo, decision-makers must search for “hidden” information, not reflected in computer printouts. I recently testified before the ERISA Advisory Council about “hard to value” assets. Click here to read my comments. http://www.pensionriskmatters.com/2008/09/articles/valuation/testimony-of-dr-susan-mangiero-about-hard-to-value-assets/
P.S. Some of the quants sat on boards of financial institutions. It would be helpful to know more about their role as relates to oversight of risk management activities. >>
To my last point (above), it should be noted that litigation risk could be a deterrent for prospective directors with risk management experience. For example, Ms. Leslie Rahl (who is quoted in Hansell's blog post about the perils of underestimating risk of complex mortgage backed-securities) is, according to the Financial Post, named in a lawsuit filed against Canadian Imperial Bank of Commerce (CIBC), along with others such as the former Chief Risk Officer and the current Chief Risk Officer. Journalist Jim Middlemiss quotes the bank as denying allegations and expressing confidence that their conduct was appropriate. (See "CIBC hit by suit over subprime lending," July 24, 2008.) Additionally Rahl, a former Citibank derivatives division head, is listed on the Fannie Mae website as a "Fannie Mae director since February 2004."
For interested readers who want to follow the mounting litigation related to sub-prime activities, check out attorney Kevin LaCroix's blog entitled The D&O Diary. Be forewarned that Kevin posts volumes about Director and Officer (D&O) liability. Should we be disturbed that he has so much news about which to write?
What does this mean for institutional shareholders? Run, don't walk, to the closest risk management analysts who can help you decipher whether a company is doing a "good" job of identifying, measuring and managing a panoply of financial and operational pain points. Send us an email if you want some help.
On the topic of models, my article entitled "Asset Valuation: Not a Trivial Pursuit" (FSA Times, The Institute of Internal Auditors, 2004) still rings true. Check out the 10 prescriptives discussed therein. (This is by no means an exhaustive list.)
- Gain an intuitive understanding of the model.
- Ask questions of the model builders.
- Determine whether or not a model meets regulatory requirements.
- Inquire whether or not different models are being used for tax reporting versus financial statement presentation.
- Understand the data issues.
- Ask about model access.
- Evaluate the asset portfolio mix.
- Ascertain the extent to which a model incorporates embedded derivatives.
- Determine the simulation approach used to value path-dependent securities.
- Enlist senior management to assign someone from the finance team to work closely with the auditing team.
In a recent interview, Mr. Stanley Goldstein announced the creation of an industry watchdog group, led by the New York Hedge Fund Roundtable. Its goal is to self-enforce otherwise voluntary and "weak" hedge fund practices. (As I wrote in "Doris Day, Scarlett O'Hara and Financial Market Tumult," July 19, 2008, a July 17, 2008 Financial Times editorial refers to such guidelines as cosmetic, meant to attract institutional investors and to keep regulators at bay.)
Goldstein, a CPA and founder of several hedge funds, explains that the aim is "not to start a separate organization but to use the existing one to compile and disseminate standards for hedge funds to follow," adding that "We do not see enforcement as practical or desirable but rather, hope that 'industry usage' will evolve along the lines which we, and others like us, deem appropriate."
Goldstein's support of the free market to act as the ultimate enforcer is laudable, especially at a time when global regulators are far from silent about the need for more stringent rules. Will Adam Smith's "invisible hand" really work? Let's hope so. As this blogger as written many times before, regulations no doubt change the way market participants behave, often leading to the "Law of Unintended Consequences."
Goldstein strongly believes in the power of collective self-policing. "By analogy, you will notice that more and more not-for-profit organizations are beginning to create audit committees on their boards and some have adopted "whistle blower" policies. There was no mandate nor promulgation forcing them to do this. What happened? Donors asked questions and boards had no choice but to make sure the right boxes could be checked off or risk losing contributions, the lifeblood of funding. These charities are run by smart people who are taking the hint. They want to be good players. With luck, time and some coordination, we can edge hedge funds in the same direction."
In the absence of a serious industry attempt to do better (for those funds who are not already at the top of their game), new accounting rules (FAS 157 or IAS 39 for example) and/or regulators' admonitions (such as the U.S. Department of Labor's recent letter to a plan sponsor, urging them to do their own valuation homework) could cause institutional investors to shy away from alternative investments such as hedge funds. If true that alternatives might help to diversify a portfolio, then a rejection due to a statutory artifice (versus an economic exigency) would be yet another example of the "Law of Unintended Consequences." (Read "Regulators Tell Pensions to Independently Value Positions," August 9, 2008, to access the aforementioned letter about valuation.)
This blogger says "bravo" and wishes the New York Hedge Fund Roundtable the best of luck. If Pension Governance, LLC can be of assistance, count us in. We agree that volitional "best practice" attempts are almost always far superior to a "one size fits all" authoritative mandate.
- According to economist Adam Smith in his Wealth of Nations, "Every individual...generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention." Click for more quotes by Adam Smith.
- According to the Library of Economics and Liberty, the "Law of Unintended Consequences" states that "actions of people - and especially of government - always have effects that are unanticipated or 'unintended.'" The concept is related to Adam Smith's invisible hand theory wherein the famous economist wrote "It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own self interest."
- In aftermath of mandates such as FAS 133 (U.S. derivatives accounting standard) or FRS 17 (UK retirement benefit plan accounting standard), experts documented a clear change in the way impacted parties went about their business.
- Interested readers can download "The Failings of FRS 17 and the Impact of Pensions on the UK Stock Market" by SEI researchers and Laurence Copeland (Cardiff Business School). The assertion is that, several years after its 2001 implementation, "the majority of UK pension schemes have closed to new entrants." In an attempt to promote transparency about retirement plans, the unintended effect is a diminution of aggregate employee benefits.
- Another interesting publication is "The Impact of FAS 133 on the Risk Management Practices of End Users of Derivatives, "Association of Financial Professionals, September 2002. Researchers conclude that reduced hedging activity is likely due in part to the implementation of what users describe as an "excessive burden" in order to comply.
- Regulators have called for more rules to govern non-profit boards, leading some to suggest that improvements are part "stick" as well as "carrot." For example, the Pension Protection Act of 2006 mandates enhanced disclosures and distribution limits for non-profits. Read "The Pension Protection Act of 2006 and Nonprofit Reforms" by Eileen Morgan Johnson, Whiteford, Taylor & Preston, LLP, January 2006. Also click to read "Nonprofit Governance In the United States" by Francie Ostrower, The Urban Institute, 2007. Click to access the Appendices to this paper.
Remember the 1939 epic classic "Gone with the Wind" wherein Scarlett O'Hara protests serious conversation? Interrupted by news of an imminent Civil War, this party gal (with the famous 17-inch waist) complains. "Fiddle-dee-dee. War, war, war: this war talk's spoiling all the fun at every party this spring. I get so bored I could scream."
As I read "Why No Outrage" by James Grant (Wall Street Journal, July 19, 2008), I wonder if this southern belle might now be heard to say "Loss, loss, loss: this loss talk is spoiling all the fun..." About structural reforms (a 2007-2008 equivalent of losing Tara, the family homestead), Scarlett might encourage delayed action. "After all...tomorrow is another day." Why fuss now?
Well, as we all know, Main Street and Wall Street are inextricably linked. Unlike Las Vegas, what happens in the financial markets, does not "stay here." (Read "Slogan's run" by Newt Briggs, Las Vegas Mercury, April 8, 2004.) When huge losses roil capital markets (not just in the U.S. but around the world), real people can get hurt:
- Employees lose jobs
- Shareholders see their portfolios plummet in value
- Pension plans that allocate big money to equities and bonds scramble to improve funding
- Retirees who depend on the financial health of plan sponsors pinch their pennies further
- Vendors who do business with financial institutions tighten their belts and/or layoff staff
- Businesses, seeking to grow, borrow at higher rates, if they can borrow at all...
It is therefore a mystery to the editor of Grant's Interest Rate Observer that relatively few bad players are taken to task "in the wake of the 'greatest failure of ratings and risk management ever,' to quote the considered judgment of the mortgage-research department of UBS." Grant conjectures that high gas prices and an election-focused Congress may be to blame or that "old populists" have hoisted themselves by their own petard, having pushed for paper money, federal insurance subsidization of higher risks and government intervention with respect to credit decision-making. From the tone of this long, yet fascinating, commentary, Grant rants about big government at the same time that, ironically, big government seeks to become even bigger in the form of new financial market regulations.
For my two cents as an advocate of free markets (not faux capitalism as exists around the world), a return to the gold standard merits serious consideration. Improperly priced federal insurance of bank deposits and pension liabilities (and much more) induces adverse selection and moral hazard. Riskier organizations get subsidized by more prudent market participants and have little incentive (arguably no incentive) to get their risk management house in order. Regarding government intervention as to how credit is allocated, plenty of empirical studies quantify the economic "bad" that results from information asymmetry. When buyers and sellers are not fully informed, supply and demand cannot intersect at the"correct" price of money or the optimal level of borrowing/lending.
Then there is the shame factor. In an era of reality shows, can we expect honor and accountability? Grant has few kind words for market behemoths (current and now extinct) who watch(ed) the Titanic sink "under the studiously averted gaze of the Street's risk managers." Will today's villains of excess rise, Phoenix-like, as have infamous names of yore, now reincarnated as media superstars? (Nick Leeson of Baring's fame has his own website and earns a living as a consultant and speaker. Henry Blodget pens "Internet Outsider" and e-newsletter, Silicon Alley Insider - a fun read for this bloggerette.)
Related to Grant's provocative piece, a recent article about voluntary standards caught my eye with its suggestion that industry attempts may be more show than reality. In its "agenda-setting column on business and financial topics," the Financial Times' Lex states that such guidelines receive little scrutiny and are put in place as a way to attract risk-averse institutional investors and/or to avoid the harsh spotlight of global regulators. (See ""Funds of hedge funds," Financial Times, July 17, 2008.) An easy way to check is simply ask each hedge fund manager about his/her reliance on published guidelines. Inquire how traders are compensated. Are they encouraged to take pure risks or are they instead benchmarked on the basis of risk-adjusted returns (with "risk" referring to the holistic assessment of uncertainties)? Don't stop with hedge funds. Ask any service provider or trader about their controls and how they monitor the quality of their processes.
The creation of an effective reward system and "best practices" are favorite topics of this blog. Our team (Pension Governance, LLC) and fiduciary community colleagues decry the status quo that makes it difficult to reward good players, at the same time that questionable practices are frequently left untouched. Poor quality disclosure is just one factor that inhibits the design of a better mousetrap.
Two hours into this post, I'm going to conclude with the notion that "freedom is not free" (anonymous). To enjoy flexibility and regulatory latitude, people of great courage must buck the existing system and both demand and assume accountability. At a minimum, interested parties (retirees, shareholders, taxpayers) want to better understand what went wrong and how internal controls will be strengthened post-haste as a result of introspection. Leaders at troubled institutions do a great service by informing the public about corrective actions underway.
For pension fiduciaries, a critical lesson learned is this. If you are not already doing so, waste no time in getting an operational review. This extends to tough and detailed interviews with your external money managers and service providers about all things risk management. Communicating your process to plan participants (for all types of plans) and shareholders/taxpayers gets you brownie points and helps to raise the "best practices" bar.
Doris Day's sentiment may be great for meditation class but has no place in a discussion about financial system reform and governance of individual organizations, plan sponsors included. "What will be, will be" is the wrong answer (though "Que Sera, Sera" is a favorite tune).
The power of one keeps us in awe. Who will step up to the podium and say - "The buck stops here?"
Please email us with examples of pension and financial service leaders whom you believe inspire and lead the way in terms of governance. Let us know if we may attribute your comments or should post them anonymously.
- To read about the pros and cons of a post 1971 return to the gold standard, check out "What Was the Gold Standard? The Gold Standard vs. Fiat Money" by Mike Moffatt, About.com or "Why Not the Gold Standard?" by Professor Brad DeLong or "The Gold Bug Variations" by Professor Paul Krugman.
- To read about federal insurance problems, click to access the testimony given by Federal Reserve Governor Randall S. Kroszner before the Committee on Financial Services, U.S. House of Representatives, April 9, 2008 or the testimony provided by Sheila C. Bair, Chairman of the Federal Deposit Insurance Corporation before the Committee on Financial Services, U.S. House of Representatives, April 9, 2008 or "On asset-liability matching and federal deposit and pension insurance" by Professor Zvi Bodie, July 2006.
- The Nobel Prize in Economic Science was awarded in 2001 to Professors George A. Akerlof (famous for his "lemons" paper), A. Michael Spence and Joseph E. Stiglitz, respectively, for their research about information asymmetry and related market impact. (This blogger's doctoral dissertation addresses information asymmetry and bid-ask spread decomposition as a function of equity analyst coverage and institutional ownership. While not available in file form, I'm happy to provide hard copies of the published short version to interested parties. Click to email your request.)
Today's post and the next few that follow focus on pension governance (the name of our new website and a term that is often used to describe fiduciary duties and best practices). For a discussion of what pension governance means, click here to read interviews with market leaders. It's such an important topic yet often overlooked. In fact, the U.S. Department of Labor created an educational program ("Getting It Right") in order to help individuals understand their duties. (The results of countless audits apparently left examiners nervous about the folks who did not properly self-identify as fiduciaries.)
"Hot off the press" is a set of standards devoted to the topic of pension governance. Newly published by the Stanford Law School, the so-called Clapman report urges pension funds, endowments and charitable funds to adopt principles that reflect prudence, ethics and transparency. Citing some big dollar "no-no's" on the part of institutional decision-makers, chief architect of the report, Peter Clapman,and others rightly point out that giant institutions must walk the walk if they admonish corporations to do the same. CEO of Governance for Owners USA and former chief investment counsel of TIAA-CREF, Clapman adds that “Bad governance also weakens funds by eroding public support for them." One element of the report calls for funds to provide clear (and make public) information about governance rules.
A few of us sometimes feel as if we've been screaming in the wind about the urgent need to know who is in charge and how they are running the show. (I'm sure Clapman and others would agree.) To read how bad things are in terms of NOT being able to easily identify where the buck stops, check out "In Search of Hidden Treasure." More than a year ago, I wrote "that a systematic identification of who does what and why with respect to employee benefits is simply not a reality as things stand today. This makes it difficult (perhaps impossible) to effect change."
The Clapman Report suggests that funds hire "trustees who are competent in financial and accounting matters." Read "Practice What You Preach" for our list of basic questions about pension fiduciary selection, training and performance evaluation. Anecdotally, I've often queried trustees and other types of fiduciaries - "How do you become and stay a fiduciary? Do you take a quiz? Do you possess a certain amount of relevant experience? Do you get paid what you're worth in terms of liability exposure and hours spent on plan-related tasks?"
Scary to say, selection is frequently a function of who is seen as having a few hours of free time. Unfortunately, being a plan fiduciary is arguably a full-time job. Moreover, with so many complex decisions to make, someone with a limited background in topics such as investing may truly struggle to understand basics, let alone nuances of evaluating risk-adjusted return expectations. Even when an external consultant is used, a fiduciary still retains oversight responsibilities (a topic deserving of its own separate post).
Another proffered recommendation from the Clapman Report is to "establish clear reporting authority between trustees and staff" and to "define appropriate responsibilities and delegation of duties among fund trustees, staff, and outside consultants." We couldn't agree more. Check out our earlier discussion about the importance of incentives in "Paper Clip Theory of Pension Governance."
One thing is clear. Pension governance is starting to attract attention. That's great news for the many fiduciaries already doing things the right way. (You deserve recognition.) For those who need to improve, perhaps the spotlight on practices, good and bad, will encourage change. That would be a huge plus for plan beneficiaries, taxpayers and shareholders.
Here are a few resources for interested readers.
1. Committee on Fund Governance: Best Practice Principles -"Clapman Report" (Stanford University)
2. Prudent Practices for Investment Stewards (Fiduciary 360, AICPA, Reish Luftman Reicher & Cohen)
3. Asset Manager Code of Professional Conduct (CFA institute)
4. Standards of Membership and Affiliation (The National Association of Personal Financial Advisors)
5. CFP Certification Standards (Financial Planning Standards Board)
6. Regular Member Code of Ethics (National Investor Relations Institute)
7. Code of Professional Responsibility (Society of Financial Service Professionals)
8. Also check the site for the Financial Planning Association. I understand that they are soon to release a new set of standards for financial advisors.
When I was a little girl, the spring holidays were a big deal. My sister and I would spend hours in search of hidden jellybeans and chocolate eggs. My favorite flavor was licorice and, once found, I would indulge. One year, to my delight, I found what I thought was a black jellybean. Luckily, upon closer inspection, I realized it was a gift from the cat (and of course I threw it away).
So what's the moral of the story for plan sponsors?
Look closely and act wisely. What looks like a bonus could be a nasty surprise in disguise.
More specifically, sponsors who only look at the positive impact of short-term market conditions on funding status, without addressing long-term structural issues, miss the mark. What looks like a favored treat (relief from having to do anything now as long as nominal numbers "look good") could turn out to be just the opposite (a situation left untouched until it's too late to take corrective action in a cost-effective manner).
An examination of the short-term versus long-term also begs the question. Should the funding of benefit plans be considered strategic or tactical? Those organizations that address risk management on an enterprise basis are starting to more fully incorporate the cost and design of benefit programs as part of their planning. Unfortunately, there is evidence that things remain in disrepair.
"Corporate Directors May Not Be Providing Sufficiently Robust Enterprise Risk Oversight," published by the Conference Board in conjunction with the McKinsey & Company and KPMG's Audit Committee Institute, states that "Corporate directors could find themselves exposed to liability if they fail to keep pace with evolving best practices in enterprise risk management (ERM)." The study also found that "While 71.8% of directors believe they have the right risk metrics and methodologies in making strategic decisions, 47.6% of directors would like to see more data analysis related to the company's risk profile." Click here to read our prior blog post about Enterprise Risk Management entitled "Enterprise Risk Management in the Boardroom."
Enjoy what April has to offer but don't get lulled into false security.
Creator of this pension blog, Dr. Susan M. Mangiero, CFA and Accredited Investment Fiduciary Analyst, joins a terrific roster of speakers at the FI 360 2007 Conference.
Being held in San Diego this year, the "Conference offers attendees the opportunity to learn from the foremost minds in the fiduciary world, gain knowledge and skills to better serve clients, and network with their peers. In addition, it offers the opportunity to participate in demonstrations and hands-on workshops for the Fiduciary Analytics tools."
Click here to read the FI 360 2007 Conference agenda.
Click here for more information about the Accredited Investment Fiduciary Analyst designation.
Regulation of financial service companies has long been a catalyst for pro-active risk management. Banks, for example, are obliged to address risk controls and measurement of risk as they ready themselves for Basel II compliance and related capital charge calculations. (The Bank for International Settlements describes the Basel II Framework as a "more comprehensive measure and minimum standard for capital adequacy that national supervisory authorities are now working to implement through domestic rule-making and adoption procedures.")
So results from a recent Deloitte survey of global financial institutions are surprising and a bit worrisome. Interviewing Chief Risk Officers at more than 130 global financial institutions, the "Accelerating Risk Management Practices" report finds that only 47 percent of respondents describe their institution as "extremely or very effective in managing risks associated with business continuity/information technology (IT) security, 43 percent each for operational and vendor risk, and 35 percent for geopolitical risk." This is in contrast to more than 70 percent who report good standing in the areas of market, credit and liquidity risk. The survey results also suggest a need for additional work in the area of credit products and commodity derivatives, including energy.
Noteworthy is the migration of risk issues to the board level, something we think makes sense for pension plans as well. While the Deloitte survey finds that 84 percent of reporting institutions have a Chief Risk Officer in place, little information is available about this role at plan sponsors. (The just released survey, co-sponsored by Pension Governance, LLC and the Society of Actuaries, asks about the existence and responsibilities of a Chief Risk Officer.)
Surveys like this are good reminders that a risk manager's work is never done!
1. Click here to read the March 26, 2007 press release issued by Deloitte.
2. Click here to read an article about the job of Chief Risk Officer entitled "Life in Financial Risk Management: Shrinking Violets Need Not Apply" by Susan M. Mangiero
With all the talk about problems (and there are plenty of them), I think it's important to focus on solutions (and there are plenty of them too).
What pension problem would you most like to solve? Click here to email us with your input. Please let us know if we have permission to post your response and, if so, whether you want us to include your name. (We will post comments anonymously unless you tell us expressly we can use your name.)
In an effort to expand my horizons and better understand the dynamics of team-building, I recently spent several hours with an expert in PI. Also known as the Predictive Index, this self-described "unique, in-house management tool" is used to "effectively motivate, lead and leverage a person's strengths to achieve company goals." (Click here for more information.)
I started off as somewhat of a skeptic. (I am after all a Ph.D. in finance with a minor in math.) By the end of the meeting, I think I came away with a much better understanding of how I can improve my communication and leadership skills, something that no doubt is well worth the cost of time and money.
While each individual needs to seek counsel from behavioral experts as they deem appropriate, anything that enhances team-building may merit more than a peek. A wide variety of other tools include Myers Brigg, Raymond Cattell's 16 personality factors, Strong Interest Inventory and Johnson O'Connor aptitude analysis.
This topic is broad and well beyond the scope of any blog post. An interesting takeaway is the extent to which effective team-building can help pension decision-makers in 2007 and beyond. After all, how do we characterize the benefits situation in modern times? A few thoughts follow.
1. Responsibilities involve multiple departments such as Human Resources, Operations, Compliance, Treasury, Accounting and Investor Relations.
2. The need to contain costs while trying to attract, retain and motivate productive workers is often seen as mutually exclusive and is therefore a possible cause for intra-organizational friction.
3. Competing and often disparate compensation rewards for benefit plan decision-makers exist and vary across functions and titles.
4. Penalties for getting the benefits mix "wrong" vary across functions and titles.
5. There is an alarming increase in personal and professional fiduciary liability that could encourage a counter-productive "blame game" unless everyone understands and adheres to a unified set of goals.
Team-building is tough, especially for complex issues. While critics disparage assessment tools as "warm and fuzzy," the reality is that "we're all in this thing together" when it comes to benefit plan decision-making.
Behavioral science and the bottom line? Not such an odd couple after all.
Where is Dr. Phil when you need him? According to a recent pension study, courtesy of the Toronto-based Rotman International Centre for Pension Management, problems "range from poor practices in board member selection to organizational dysfunction such as the lack of delegation clarity between board and management responsibilities. Weak oversight functions also have led to difficulties in sorting out the competing financial interests of differing stakeholder groups and self-evaluation of board effectiveness continues to be the exception rather than the rule."
Okay, so maybe we won't be holding hands and singing Kumbaya any time soon. However, failure to recognize behavioral impediments is a recipe for disaster. Since many companies accept the importance of employee benefit plans as a means to attract and retain talent, yet wince at their cost, HR and Treasury must find a way to work together. This is especially true as new accounting rules take effect, motivating shareholders to examine financials in a new light.
Public funds don't get a free ride. Taxpayers are frustrated and unhappy. With GASB 45 about to give the word deficit new meaning, public plan executives are going to hear the howls of protest in city halls throughout the U.S.
Working across disciplines and functions is the new mantra in employee benefits land. Pension decision-makers will need to coalesce or risk doing an incomplete or poor job of navigating stormy waters. A possible result? Increased personal and professional liability, coupled with a host of nasty financial outcomes for plan sponsors.
This is no time to argue over turf!