Every now and then, my husband likes to remind me that older is better in terms of quality. His father's tools still get used, our washer and dryer from twenty years ago are in place and his 1989 Honda was only recently sold when I nudged him to buy a car with air bags. Incidentally, the CRV was sold with 400,000 miles to a neighbor who still drives it on a regular basis. I was reminded of his words when I read a New York Times article on the failure of "new math." More recently the concept that new can be counterproductive came to light when a meeting organizer insisted on using technology that was so "cutting edge" that a few of us could not join because we did not have the requisite equipment. As a result, we have to schedule anew, costing time that could have been avoided.
Applied to pensions, adding too much complexity by trying something untested and/or sold as "the next big thing" can spell trouble. As I wrote in "Investment Complexity Risk" (August 1, 2014), transactions that are hard to explain make it difficult for an investor to "appropriately identify the right benchmark to track performance." When that occurs, tasks such as portfolio rebalancing, assessment as to whether fees paid are "reasonable" and/or constructing an effective hedge strategy are difficult to achieve.
While "new" does not automatically mean "complex," the reality is that capital markets and service providers such as asset managers are increasingly dependent on one another. What happens with one organization can have a far-reaching impact on others. Consider Goldman Sachs Group Inc. ("Goldman"). Its plan to retract prime brokerage services to some hedge funds while increasing fees to those that remain as clients will impact the institutional investors that have exposures to asset managers that either need to look elsewhere for capital or will pay more money to Goldman. See "Goldman Sachs Cuts Roster of Hedge-Fund Clients" by Justin Baer and Juliet Chung (Wall Street Journal, August 4, 2014).
Some institutional investors are throwing their proverbial hands in the air when it comes to in-house management. Pensions & Investments reporter Douglas Appell describes a trend in seeking third party help as the result of "today's volatile markets." Refer to "Complexity of investments pushes funds to seek outsourcing help" (July 9, 2012). Asset managers are similarly outsourcing certain tasks such as performance measurement and attribution. According to "Managing complexity and change in a new landscape: Global survey on asset management investment operations" (Ernst and Young, 2014), partners Alex Birkin and Alan Fish write that "Firms are only beginning to realize the opportunity in outsourcing more complex processes."
Contracting others to augment one's core business is not bad or good on its face. Importantly, end-users must understand what they are buying and what may not be covered by the agreement. Based on my experience as a forensic economist and investment risk governance expert, disputes often arise when expectations - even those that are codified with a letter of engagement - differ. Ambiguous language is one culprit. In-house and external counsel as well as those tasked with dotting the due diligence "i's" can play a vital role in clarifying the terms of outsourcing. Similarly, attorneys can work with their institutional investor clients to ensure that a Request for Proposal ("RFP") questionnaire includes ample questions about the nature of the contracts in place between asset managers being considered and the vendors to said asset managers.
The principles of good contracting are tried and true. Some may sneer at old fashioned ideas but they have a place in one's investment risk governance toolbox. When the lights go out, a pencil has a lot more value than a computer that doesn't work.