Pension Risk Matters : Pension Risk News & Analysis : Investment Governance, Inc. : Pension Risk & Investment

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.

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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.

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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.

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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.

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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.

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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.

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