UK Survey Highlights Fiduciary Management Trend

According to a September 8, 2014 press release, a survey of 359 UK pension professionals by Aon Hewitt suggests that investment complexity and a busy schedule are driving the increase in demand for outside help. Notably, researchers found that strategies such as liability-driven investing require a lot of analysis and that "trustees are spending less time dealing with these decisions, with 73% of trustees devoting no more than five hours each quarter to investment issues, up from 67% in 2013." Other highlights include an observation that larger plans may opt for some help whereas smaller plans, i.e. those with assets of 500 million GBP or less "are the most likely to opt for full fiduciary management." See "Aon Hewitt Fiduciary Management Survey 2014 finds the majority of schemes opting for tailored measurement of provider performance."

The issue of time and a long list of tasks that must be carried out is not unique to the UK. In "Beyond the Beauty Contest" (June 2014), Russell Investments describes its Outsourced Chief Investment Officer ("OCIO") solution for a Canadian defined benefit plan committee that was "spending most of their time hiring and firing managers."

Acknowledging that firms with third party service offerings have a vested interest in being hired by overloaded pension executives (many of whom have full-time jobs on top of committee work), the issue as to how persons with fiduciary responsibilities spend their time is an important one to discuss.

In "The Investment Committee: Pitfalls to Avoid," the Association of Governing Boards recommends that there not be "too many" members and to adhere to an agenda. Group think is discouraged as it "can result in bad decisions that reflect the prevailing consensus of what has worked recently..." Organizations with strong support staff enjoy the advantage of having a lot of time-consuming analyses done ahead of oversight and strategy meetings. Creating and then following documents such as a clear Investment Policy Statement and Committee Charter likewise has value.

There never seems to be enough time for any investment professional. When billions of dollars are at stake, effective scheduling and use of available resources is critical.

Brown M&Ms and Investment Service Provider Due Diligence

 

According to marketing guru Steve Jones, parties seeking to do business with one another can learn a lot from rock musician David Lee Roth. As explained in "No Brown M&M's: What Van Halen's Insane Contract Clause Teaches Entrepreneurs" (Entrepreneur Magazine, March 24, 2014), each of their agreements included a rider that was designed to force a promoter to pay attention to the band's true objective about ensuring safety. By adding what may have seemed like a silly provision about "melt in your mouth" candies being unwelcome, Van Halen was testing whether the promoter had read the contract in its entirety and was therefore more likely to install equipment properly. "If any brown M&M's were found backstage, the band could cancel the entire concert at the full expense of the promoter," leaving him or her with a possible loss in the millions of dollars.

In institutional investment land, there are intriguing parallels. For one thing, there is the safety issue. If a pension plan is poorly managed, beneficiaries may suffer. Second, if there is confusion or ambiguity about who is supposed to do what, when, how and at what price, there are likely to be disputes and economic consequences. There is a growing number of lawsuits and regulatory investigations that are scrutinizing service providers and/or the pension plan trustees who are tasked with diligently selecting them.

The developing market in outsourcing various services to a third party is yet another reason for paying close attention to the quality of engagement letters and vendor contracts. Earlier this year, the ERISA Advisory Council announced its plan to study "current contracting practices with respect to outsourced services, including provisions such as termination rights, indemnification, liability caps, service level agreements, etc. that might assist plan sponsors and other fiduciaries in negotiating service agreements."See "Outsourcing Employee Benefit Plan Services."

As someone who has done business intelligence research and trained investment fiduciaries and their advisors, I often hear the same frustration being expressed about a gap in expectations. Budget-strapped buyers want more for less. Consultants, asset managers and banks say they are searching for ways to satisfy their clients while still being able to earn a reasonable rate of return for their efforts. One solution is to streamline operations, to the extent possible, while acknowledging any fiduciary implications associated with prevailing law and governance standards. If cutting corners to preserve a profit margin ends up sacrificing requisite quality, trustees could be at risk of being investigated for anemic oversight of service providers. Vendors could be at risk for failing to deliver contractual services.

Based on my work for both defense and plaintiff counsel (depending on the matter and whether there is a counterclaim), a poorly worded agreement can be a potential trouble spot. Another hugely important issue is whether a service provider has self-identified as a fiduciary. An attorney or judge may categorize a particular service provider as a functional fiduciary even if a written contract is silent on that point. Trust counsel can play a critical role in assisting with negotiations before authorized persons sign on the dotted line.

ERISA attorneys David C. Kaleda and Theodore J. Sawicki address the issue of fiduciary status in a 2012 article for the National Society of Compliance Professionals. See "Should You Have a Formal ERISA Compliance Program?" In a recent discussion about the best practices for creating and adhering to service level agreements, ERISA attorney Howard Pianko expressed his strong view that there are numerous ways to ensure "plausibility" and still be able to hire affordable outside organizations to assist. He went on to describe the advantages of having a systematic mechanism in place such as the Six Sigma type model that his firm employs. Click to read about Seyfarth Lean. (Having earned a Green Belt in Six Sigma, I can attest firsthand to the upside of developing a process to control quality.) 

For those involved in the selection and oversight of service providers or the delivery of said services, ask yourself if you know as much about an existing or anticipated contract as you should.

ERISA Advisory Council Investigating Fiduciary Management

According to a 2014 statement, the ERISA Advisory Council intends to investigate the nature of retirement plan outsourcing and report its research to the U.S. Department of Labor ("DOL"). "Outsourcing Employee Benefit Plan Services" cites objectives to include the following:

  • Discussion about current practices in outsourcing and whether variables such as plan size or type impact the services provided to ERISA plans;
  • Clarification of "the legal framework under ERISA for retaining outsourced service providers..." and possible areas for regulatory guidance;
  • Getting suggestions about the management of potential conflicts of interest;
  • Further discussing the "scope of co-fiduciary liability in the outsourcing context" for 3(16), 3(21) and 3(38) relationships;
  • Discussion about how contracts are put together between an ERISA plan and a service provider to address issues such as termination rights, indemnification, liability caps; and
  • Examination of insurance coverage and ERISA bonds when an outsourcing arrangement exists.

This news is not particularly surprising. The topic of fiduciary management continues to attract attention, in part because it appears to be growing as a business model in the United States, United Kingdom and elsewhere. According to a survey of 73 pension plans and their advisors, Buck Consultants found that 70% "had at least considered going down that route." For those schemes that that had engaged a fiduciary manager, they cited motivations such as "improved speed in the decision making process, greater focus on the end game, and improved expertise." At the same time, UK-based Brian McCauley, Head of Fiduciary Evaluation at Buck Consultants, added that the governance burden is still "huge." In "Perceptions of Fiduciary Management," Stephenson Harwood attorney Fraser Sparks addresses concern about conceivable conflict of interest trouble spots when "an advisor turns into a provider." One offered solution is to engage an independent third party to evaluate the qualitative and quantitative characteristics of fiduciary manager short list candidates.

Stateside, ERISA legal experts debate the pros and cons of the outsourced fiduciary approach. In "New flavor of outsourced fiduciary for retirement plans hits the market" Investment News reporter Darla Mercado writes that "This latest service offering is popping up in an era when plan sponsors have a heightened awareness of their fiduciary responsibilities and are looking to offload some of them so that they can get back to the day-to-day work of running their business." Drinker Biddle & Reath attorney, C. Frederick Reish, talks about "3(16) lite" and the need to "[r]ead the fine print." The April 2, 2014 piece emphasizes that "...plan sponsors still have the responsibility of choosing and monitoring their service providers."

In "Expert Q&A on Outsourcing Fiduciary Investment Responsibilities" (Practical Law, February 2014), Groom Law attorneys David N. Levine and Allison Tumilty explain the legal dimensions of outsourcing fiduciary investment responsibilities and the advantages and disadvantages of passing the baton for certain delegated tasks. They add that outsourcing "can be appropriate for defined benefit and defined contribution plans of all sizes."

From my perch as a forensic economist who is sometimes hired to give expert testimony, I have observed a larger number of cases being filed that address the relationship between plan sponsor and service provider. Whether that trend continues remains to be seen. Given the foregoing, the ERISA Advisory Council inquiry is likely to be both timely and informative.

Pay to Play and Pension Funds

Having just co-authored an article about the Foreign Corrupt Practices Act ("FCPA") and its application to pension plans, the topic of economic inducements and fiduciary duties is fresh on my mind. As part of my research, I investigated what "pay to play" rules currently exist and what initiatives are underway to avoid inappropriate monies being paid by vendors to persons who control or have influence over the public purse. Certainly the topic is attracting attention. On October 8, 2013, the Superintendent of the New York State Department of Financial Services ("DFS"), Benjamin M. Lawsky, wrote to the Honorable Thomas P. DiNapoli, Comptroller of the State of New York, about the auditing of government pension plans and their service providers. "Controls to prevent conflicts of interest, as well as the use of consultants, advisory councils, and other similar structures" was listed as one of several areas of emphasis.

Jump ahead to this week's headlines and, not surprisingly, "pay to play" appears once again. With his June 9, 2014 press release, New York City Comptroller, Mr. Scott Stringer, announced the approval by all five New York City pension plans (with roughly $150 billion in assets) to ban the use of placement agents. This extends the prohibition of placement agents for all asset classes and not just the restriction imposed earlier for private equity investments. Click to read "New York City Pension Funds Enact Placement Agent Ban" for a list of the current trustees for the New York City Employees' Retirement System, Teachers' Retirement System, New York City Police Pension Fund, New York City Fire Department Pension Fund and the Board of Education Retirement System.

The "thumbs up" from New York City pension plan trustees follows Comptroller Stringer's six point plan that he announced on January 30, 2014. Besides putting the kibosh on the use of placement agents, his office intends to "...dramatically reform policies and procedures governing [Bureau of Asset Management] by appointing senior risk and compliance officers to strengthen, monitor and continually improved operations..." Investment disclosures about personal trading of in-house fiduciaries is part of the game plan for New York City pension plans.

On a separate note, disclosure mandates about personal trading for members of the U.S. Congress and their aides and federal employees making more than $119,554 appears to have taken a step backwards with respect to government sunshine. According to "Insider Trading in DC Just Got Easier" by John Carney (CNBC.com, April 16, 2013), a modification of the Stop Trading on Congressional Knowledge ("STOCK") Act was passed by lawmakers on April 12, 2012 and then signed into law on April 15, 2013. As a result, any disclosures about personal trades that are part of the public record "aren't readily available...and have to be requested from individual agencies using the names of the individuals about whom information is sought." When asked about the change in disclosure requirements for all but the President, the Vice President, Members of and candidates for Congress and certain appointed officers, White House Press Secretary Jay Carney referred to recommendations made by the National Association of Public Administration ("NAPA") as the basis for "indefinite suspension" due to "substantial national security, personal security, and law enforcement issues on this matter." You can decide for yourself. Click to download "The STOCK Act: An Independent Review of the Impact of Providing Personally Identifiable Financial Information Online - A Report by a Panel of the National Academy of Public Administration Submitted to the Congress and the President of the United States" (March 2013).

Golf Course RFPs and Other Mistakes That Retirement Plan Fiduciaries Make

Litigation attorney and uber ERISA blogger, Steve Rosenberg, recently shared his slide deck entitled "Common Mistakes of Plan Sponsors."  Part of an educational presentation to U.S. Department of Labor examiners, Steve addressed the importance of getting competitive bids, thoroughly investigating service providers before selecting one or more individuals or firms and avoiding what he coins the "Golf Course RFP." He worries that members of a retirement plan investment committee could bypass best practices in selecting a bank, advisor, consultant, third party administrator and/or asset manager and instead rely too much on a vendor's brand name or overly friendly relationship with someone who works at a company before considered. Deciding to hire someone on the basis of a handshake over a glass of beer or chatting on the greens is ill-advised if it shortcuts proper research about the abilities of a service provider, fees they intend to charge and whether their offerings are likely to meet the needs of a particular defined contribution or defined benefit plan.

Steve warns about other mistakes to avoid, including the identification of who will do what tasks, how often they will be performed and whether a service provider contracts to be a fiduciary. In particular, he frets that members of an ERISA plan committee may select a provider to serve as an investment fiduciary and then incorrectly assume that they have passed the baton and no longer have any liability.

Other errors he cites are part of what he calls the "ESOP Private Company Valuation Problem." These concerns include "insufficient reliance on outside experts" and not hiring an independent fiduciary to oversee a transaction when there are clear conflicts of interest or further expertise is needed.

Interested readers may want to investigate the following educational resources to include:

Institutional Asset Allocation

My comments about institutional asset allocation, along with those made by Mr. Ron Ryan (CEO, Ryan ALM) and Lynn Connolly (Principal, Harbor Peak, LLC), were well received on January 8, 2014. Part of a joint program that was sponsored by the Quantitative Work Alliance for Applied Finance, Education and Wisdom ("QWAFAFEW") and the Professional Risk Managers' International Association ("PRMIA"), our audience of investment professionals added to the lively debate about topics such as strategic versus tactical asset allocation, fees, role of the pension consultant and the likely capital market impact due to the implementation of strategies such as liability-driven investing ("LDI") and/or pension risk transfers ("PRT"). 

With the size of the U.S. retirement market at $20 trillion and counting, big money is at stake. Bad asset allocation decisions can lead to a cascade of economic woes. It is no surprise that fiduciary breach allegations in the form of ERISA lawsuits are increasingly focused on questions about the appropriateness of a given asset allocation mix and whether an investment consultant or financial advisor has helped or hindered the way that pension monies are allocated. Noteworthy is that scrutiny about the efficacy of the asset allocation process and resulting money mix can, and has been, applied to both defined benefit and defined contribution plans. Keep in mind that asset allocation decisions are likewise central to assessing popular financially engineered products such as target date funds. Accounting issues and how changing rules influence asset allocation decisions are yet another topic that we will tackle in coming months.

Click to access Susan Mangiero's asset allocation slides, distributed to members of the January 8 audience, and meant to peturb a discussion about this always essential topic. Interested readers can check out "Frequently Asked Questions About Target Date or Lifecycle Funds" (Investment Company Institute) and "Annual Survey of Large Pension Funds and Public Pension Reserve Funds: Report on pension funds' long-term investments" (OECD, October 2013).

If you have a specific question about asset allocation and/or the procedural process associated with asset-liability management, send an email to me.

Fiduciary Management For Pension Plans

Besides being knowledgeable about medicine, nutrition and state-of-the-art health research, my doctor has a great sense of irony. He says things that make me laugh out loud. When I saw him recently, I mentioned how much I was enjoying reruns of some older television shows like Quincy, M.E. He replied, in typical clever fashion, "yea, but Sam did all the work and Quincy took the credit." It struck a chord because his statement is mostly true. In case you never watched the popular series about a coroner who helps the police solve crimes, veteran actor Jack Klugman (now deceased) applies Criminal Scene Investigation ("CSI") like smarts and tenacity in pursuit of justice. Sam Fujiyama (played wonderfully by actor Robert Ito) is likewise a medical doctor. He works alongside Dr. Quincy and is portrayed as an integral part of uncovering the truth.

In pension land, it is often the case that sponsors think they have hired someone to play the role of helpful Sam. The notion is that the advisor, consultant or fund of funds professional will be paid a fee to carry out a certain level of due diligence about action items such as setting up or revising an appropriate investment strategy, selecting or terminating an asset manager, redesigning a plan or evaluating pension transfer structures. Once the engagement letter is signed and a retainer fee is in place, the plan sponsor, like Dr. Quincy, can breathe a sigh of relief. Help is supposedly on the way - maybe. The safety net concept attached to bringing a third party on board, combined with what a colleague of mine describes as fiduciary fatigue, is reflected in the global growth of firms that describe themselves as fiduciary managers. While the retirement plan regulatory regime varies by country, the investment outsourcing model is gaining sway in the United States, the United Kingdom, the Netherlands and elsewhere. The undeniable trend to delegate merits discussion.

Before employers get too comfortable and think that their pension problems now belong to someone else, it is noteworthy to acknowledge that there are more than a few lawsuits that have been filed against third parties. Some of them allege breach on the basis of a failure to properly oversee and respond accordingly.

My observations come from firsthand experience. I have served as an economic analyst or testifying expert on disputes between an institutional investor such as a retirement plan, endowment, foundation or family trust. For other matters, I have provided due diligence training to fiduciaries and board members or reviewed the risk practices in place prior to a vendor being selected or as part of a later review of said vendor, once hired. As the founder of an educational start-up company a few years ago, I had a front row seat to the ongoing discussions between buyers and sellers of investment, risk and valuation services. Information in the form of repeated and in-depth surveys and numerous conversations about what pensions, endowments, foundations, family offices and other types of trust investors want and need from those who provide advice is telling. One issue that came up often from institutional investors was how to benchmark the quality of the work being provided by a delegate. This is a critical subject, especially for those outsourced professionals who are doing a terrific job and want their clients to be satisfied.

The topic of service provider due diligence is timely, important and the focus of my presentation on October 25, 2013 as part of the American Conference Institute's 6th Annual ERISA Litigation Conference. Interested readers are welcome to download my fiduciary due diligence slides.

Pension Liability Price Tag For Private Equity Funds and Their Investors

I have long maintained that any individual or organization that invests in a company needs to check under the employee benefits hood before allocating money initially, and regularly thereafter. I can give you countless examples where incomplete due diligence led to an overly rich acquisition or investment that resulted in a new owner having to deploy cash to write checks to retirees and/or incur the costs of restructuring an otherwise untenable situation.

Failure to carry out a comprehensive ERISA-focused due diligence of a target portfolio company is not good for numerous reasons. Having done economic analyses of companies with underfunded pension plans, I know firsthand that it is often a rude awakening for investors such as private equity funds when they are confronted with the reality that what they want and what they end up with in terms of buying forecasted growth are not always the same. Reasons to worry include, but are not limited to, the following:

  • A private equity fund may not be able to realize its target rate of return because a portfolio company cannot sufficiently grow without cash that is now redirected to support employee benefit plans.
  • A pension plan that has invested in said private equity fund will be none too happy if performance falls short of expectations, especially for something that arguably should have (and could have) been considered and addressed as part of the original deal.
  • An unhappy pension fund investor may turn around and sue a private equity fund for alleged failure to have properly researched "what if" situations, taken on "too much" risk and disclosed too little information. Litigation in turn can be an expensive proposition for a private equity fund, making it even more difficult to achieve even minimum hurdle rates.

The issue of private equity ownership and portfolio company pension liabilities was heavily discussed as the result of a 2007 Appeals Board of the Pension Benefit Guaranty Corporation ("PBGC") decision about ownership, control and responsibilities for portfolio company pension plan gaps. In "Private Equity Funds: Part of the ERISA Controlled Group?" (December 19, 2007), O'Melveny & Myers LLP attorneys Wayne Jacobsen and Jeff Walbridge explained that "[i]f the PBGC's position endures, it could have significant ramifications for private equity fund investments in portfolio companies that sponsor defined benefit pension plans...[t]he fund could be required to use any or all of its assets, including the ownership interests of the fund in any or all of its portfolio companies, to fund the pension obligations of the bankrupt portfolio company."

Imagine the happy faces in private equity land when the U.S. District Court of Massachusetts opined on October 18, 2012 in favor of Sun Capital Partners III, LP and related parties. According to "Potential ERISA Title IV Liabilities of Private Equity Firms - Eliminated by the Sun Capital Decision?" (November 2012), Edwards Wildman attorney Mina Amir-Mokri describes the decision as a "significant victory for private equity firms" but explains that Sun Capital Partners v. New England Teamsters & Trucking Industry Pension Fund was to be appealed.

On July 24, 2013, the U.S. Court of Appeals for the First Circuit reversed the earlier decision and put private equity funds in a potential liability position once again. According to "Private Equity Funds Further Exposed to Portfolio Company Pension Plan Liabilities" (July 29, 2013) Latham & Watkins attorneys Jed Brickner and Austin Ozawa offer post-opinion practical hints such as the need for private equity firms to "carefully consider how to structure their funds and acquisition structures to avoid characterization as a trade or business and avoid inclusion in the same controlled group as their portfolio companies." Additionally, they urge private equity funds to pay attention to the "structure of their funds' investments"...possibly "dividing their investment between two or more of independently managed funds with distinct portfolios to support a finding that no individual fund (or group of 'parallel' funds) controls any portfolio company (and no set of funds is treated as a joint venture). Paul Hastings attorneys Stephen H. Harris, Eric R. Keller, Ethan Lipsig and Mark Poerio assert that private equity funds would do well to own "less than 80% of a portfolio company"...perhaps via "thoughtful adjustments to ownership structures and management operations" that can help to reduce the exposure to portfolio company pension liabilities. See "Private Equity ERISA Alert: Consider ERISA Pension Liability Risks from Portfolio Plans" (July 2013).

While legal experts weigh in on the important issue of what responsibilities belong to private equity funds, if any, to portfolio company ERISA plan participants, institutional investors such as pensions, endowments, foundations and family offices - and their investment consultants and advisors - should take heed. If a private equity fund's exposure to a portfolio company with a problem pension plan ends up shrinking the wallets of institutional investors, serious questions will understandably be asked about who should have done what and when.

The Importance of Clear Communications

A funny thing happened the other day while having a snack in a Paris bakery. I am here for a few days, tagging along with my husband who is teaching for a month. Shortly after we sat down, a Japanese family arrived, went to the counter and asked in English for a sandwich to be heated before serving. As the woman at the cash register only spoke French, she did not respond right away. I think she was trying to understand what they wanted. The new arrivals asked again, in English and speaking a bit louder. Again, no reply. Then another customer, already seated and chatting with her friend, began speaking in Japanese to the family and subsequently translating into French for the bakery worker. As a result, the lady behind the counter was able to respond that they had no way to heat a sandwich and thereby allow the family to choose what they wanted to do as a result. Minutes later, four hungry customers were enjoying cold bread and hot beverages, with gratitude for the translator all the way around.

My take away points from observing this encounter is that the world is getting smaller. Speaking a second language is a plus. When you cannot speak the "right" language, access to someone who can translate is an advantage. When individuals are not communicating, opportunity loss occurs. Had the friendly passerby who spoke Japanese and French not played an active role, a family would have gone hungry for awhile and the bakery owner would have lost a sale.

Applied to the investment industry, similar lessons exist.

Investors often complain that contracts with managers, brokers, advisors, insurance companies and other service providers are too complex to understand. The ambiguity or absence of clarity as to who should be doing what and in what manner typically shows up as part of a dispute resolution. Something has gone awry and one party is bringing action against the other, based on facts and circumstances that include each party's interpretation of words.

Complexity of a product or service is another consideration. In "Don't Make Investing Too Complicated" by Matthew Luke (The Motley Fool website, May 10, 2013), readers are urged to focus on companies with simpler business models. Luke writes that "The more complicated an investment however, the more things can go wrong." While his statement may not apply to all investors, there is merit for everyone in being able to identify risk factors that can potentially destroy value.

As an independent risk governance and prudence expert, I am often in the position of having to ask service providers and investors alike to tell me what risk factors they deem most significant as potential destroyers of long-term value. We then talk about the likelihood of something going wrong and how risks are being mitigated. Those conversations cannot take place if information is overly complicated and/or unclear.

In other situations, a "translator" such as an informed consultant or advisor can assist both managers and investors in closing a sale and keeping a relationship alive. Like the bakery clerk and the hungry family, someone may need to intervene so that various parties are understood.

As new regulations are put into place, what investors will read likely reflects the need for the seller to comply. Compliance text is not necessarily the type of plain language that would better aid buyers in making an informed decision. This is not good. Investors need to understand what is at stake. Investment management service providers can benefit, sometimes materially so, by conveying concepts in plain language.

Pension Advisors: A Percentage of What?

I visited a local department store tonight after work. In search of new rain boots, I ended up buying a navy blue jacket but that's another story for another day. What irked me and ended up costing me time was ignorance on the part of the sales lady about simple math and the amount to which the markdown percentage should be applied.

Here is what happened.

The jacket was originally priced at $150 but marked down by 40 percent - good designer but last season's color. A sign atop the rack said that another 25 percent would be deducted from the ticketed price. A quick calculation on my part led me to believe that a $90 jacket would be sold at $67.50. Instead the woman behind the register insisted that the price of $90 was final and that it reflected a 25 mark down from the original price of $150. As hard as I tried, I could not convince her that $90 differed from 75 percent of $150. Finally, out of sheer frustration I am sure, she referred me to the manager and abruptly left her station. When I checked out, my receipt reflected a 25 percent discount from $90.

Walking home from my mini shopping spree, I wondered about the state of math education in this locale and why a simple calculation did not resonate. Worse yet, this lady was supposed to know better. It would be one thing to say "I don't know" but it is quite another thing to insist on being right when she was obviously wrong.

In the world of investing, it is arguably even more important to get expert advice. Instead of a few dollars at stake, inexperienced and/or ill-informed financial intermediaries could put $17.1 trillion in U.S. retirement industry assets at serious risk. In addition, countless financial advisers are retiring alongside their clients with worries that inexperienced persons will take their place. This could be troublesome since most experts predict that the complexities of a retirement crisis are unlikely to go away anytime soon.

According to "A talent shortage loom as the industry booms" by Jeffrey Schoeff , Jr.(Investment News, April 28, 2012), individuals in need of help may end up spending lots of time on a search for experienced and knowledgeable advisers who likewise have the patience to educate clients and recommend an appropriate long-term investment strategy as a result of getting to know needs, risk tolerance levels and constraints.

At the institutional level, staff budgets are being cut at the same time that certain investment strategies require careful diligence as relates to the use of leverage and a financial engineering component. One answer is to outsource to an independent fiduciary and/or external consultant or advisor. Interestingly, numerous firms have the budget to hire contractors but don't have the approval to hire a full-time person(s) even when salary and benefits could cost less than what a consultant or advisor will charge.

Good service provider due diligence is critical at any time but certainly if a plan sponsor is relying mostly on the capabilities of others, they need to feel confident that their advisors and consultants have a good handle on critical issues and potential solutions. Competency can help to save time and money and reduce stress. The converse is true too. Incompetency can cost an organization time and money and widen any funding gap. Either way, the role of the independent third party is expected to soar.

While robust due diligence takes time, it can help to stave off unwanted inquiries into the nature of risk-taking. Working with someone who is knowledgeable, earnest and dedicated to delivering requisite help should be seen as a big plus.

Pensions and Real Estate Manager Due Diligence

Dr. Susan Mangiero, CFA, FRM is pleased to join a panel entitled "Manager Monitoring & Ongoing Due Diligence" on March 30, 2011 in New York City. Part of IMN's "Real Estate Investment & Search Consultants Congress: Meet the Gatekeepers" event, Dr. Mangiero will participate in a discussion about the following topics:

  • Factors used to evaluate fund managers;
  • Asset manager - client communication best practices;
  • Organization and strategies as relates to style shifts;
  • When to consider replacing a manager;
  • Duties of a limited partner;
  • Benchmarking against the agreed upon scope of work; and
  • Performance reporting pitfalls.

According to statistics published by the Pension Real Estate Association ("PREA"), real estate equity accounts for an average of roughly 4.6 percent of surveyed plans that control about $5 trillion in assets (including single-employer public and corporate pensions, endowments, foundations and Taft-Hartley plans). About 90 percent of surveyed institutional investors state that they expect no change in allocation to this asset class. Given the size of monies being deployed to real estate and the various mechanisms used (including but not limited to commingled funds, direct investments, real estate investment trusts, joint ventures), a detailed discussion about manager due diligence is timely and helpful.

Use online registration code SP10 if you plan to attend this conference in the Big Apple on March 30.

BP Investments - The Role of Ethics and Risk Management

The current situation with British Petroleum ("BP") raises a bevy of thorny questions, not the least of which is how pensions and other types of institutional investors should deal with the asset allocation fallout.

Let's start with the facts about institutional ownership of BP. According to Yahoo Finance and as excerpted in the table below, over 1,000 institutions owned stock in BP as of late March 2010. A relatively high dividend payout rate and dividend yield likely held great appeal for organizations seeking stability.

Things have changed materially, leaving large owners of BP stock to determine whether they should short, double up for a long-term play or exit altogether. Those that outsource their money management function rightly ask whether third party traders did enough to vet the issues associated with energy sector exposure. Additionally, one now deals with the question as to whether BP and similar types of stocks should be analyzed in the context of socially responsible investing. One organization - Fair Pensions - wants Shell and BP board members to beef up their disclosure about oil sands project risks. Lawsuits loom large too. According to "New York Pension Fund Considering Suit Against BP" by Jillian Mincer (Wall Street Journal, June 17, 2010), the New York State Common Retirement Fund owns 17.5 million shares indirectly, via its index fund allocation.

At the same time, anything that further erodes the price of BP shares could put parent company employees, gas station owners and related vendors out of work.

The oil spill in the Gulf is an environmental tragedy of major proportions. It may soon become a further financial debacle as well.

Getting to Know Your Friendly Venture Capitalist

On March 1, 2010, Dr. Susan Mangiero, CEO of Investment Governance, Inc. sat down to talk to financial and strategy expert, Mr. Pascal Levensohn. In this seventh question of ten, read what this Investment Governance, Inc. Advisory Board member has to say about how institutional investors can connect with venture capital ("VC") fund managers. Click here to read Mr. Levensohn's impressive bio.

SUSAN: Should institutional investors directly contact venture capital fund managers or work through traditional investment consultants, assuming that the latter parties have the background to conduct due diligence on the VC funds?

PASCAL: First, nothing beats direct contact with managers.  I think the VC industry conferences in specific industry sectors provide a great forum for institutional investors to meet directly with VC funds. Historically the two largest conferences have been sponsored by IBF and DowJones.  There are also sector specialty conferences, such as the IT Security Entrepreneurs Forum held annually on the Stanford campus that bring out domain experts. I think that it also makes sense for institutional investors who don’t have the resources to do a full search to work with consultants. However, I will say that, in my experience, many consultants become gatherers of statistics and information—meaning paper pushers—and few of them actually bother to have a deep and current understanding of what is really going on in the market. I’ve actually been shocked at how clueless some consultants are about what is really going in the VC industry. I think the evidence supporting this point is in the fact that, because of the long-term nature of the VC business, consultants will choose to back a certain fund and then assume that they can sit back and wait for five or ten years to see if they made the right choice. This is a big mistake and one of the root causes is because there is a low probability that the same analyst or partner in the firm that made the original “commit” decision is still going to be the engagement consultant even four years after the original decision to recommend the fund was made.  So I am suggesting that a lot of the “standard” recommendations by the consultants in VC are stale. A pension, endowment, foundation, etc needs to do research on the consultant’s process as well as directly meet with the venture firms. Any venture firm that won’t meet with you probably doesn’t need your money and won’t give you the kind of respect in a relationship that you should expect, so that’s a great first cut in your process.

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.