New is Not Necessarily Better and Could be Worse

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.

2nd Annual Tri-State Institutional Investors Forum

I have the pleasure of moderating a timely and topical panel on June 11 for US Markets Center for Institutional Investor Education. Entitled "Fiduciary Responsibility for Management & Trustees," this session will focus on the importance of the Board in creating good governance practices. Topics to be discussed include the role of audits as a way to monitor activities, creating proper standards that allow for stakeholder transparency and lines of authority and reporting. The role of staff, the investment consultant and investment manager will likewise be covered. Panel participants are shown below:

Moderator:

  • Dr. Susan Mangiero, Managing Director, Fiduciary Leadership

Panelists:

  • Charles Tschampion, Director of Special Projects, CFA Institute
  • Edward M. Cupoli, Board Member, New York State Deferred Compensation Plan
  • Patricia Demaras, Senior Counsel, Xerox Corporation.

Click to download the entire program for the 2nd Annual Tri-State Institutional Investors Forum. Click to register. I hope to see you there!

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:

Yoga Lessons For Investment Fiduciaries

I have been practicing yoga for about five years. I try to take four or five 75 minute classes each week. The combination of strength training, balance, meditation and aerobic activity is a time-effective way to exercise, strive for self-improvement and level set, especially after a busy day.

Aside from the personal benefits, I keep coming back to the invaluable lessons one can learn from yoga for an investment fiduciary. Here are a few thoughts.

Persistence matters. Even advanced practitioners recognize the need for care and diligence on a regular basis. Part-time habits seldom generate results. I was thrilled that I could finally succeed at the L-pose against the wall (pictured here, courtesy of instructor Elsie Escobar from Pittsburgh). Indeed, I was able to hold this pose twice in a row last night, after numerous attempts in the last year during yoga class. In addition, I began adding arm and leg weights when at the gym. According to "Yoga Bears: It's No Stretch to Say Traders Are Taking Deep Breaths" by Cassell Bryan-Low (Wall Street Journal, July 24, 2008), "Value the process of hard work..."

Pay attention to limits. Someone who is flexible can take a pose to a different level than someone who is stiff or has an injury. For pension fiduciaries, each plan is different for a variety of reasons. An investment that makes sense for one portfolio may be imprudent for another organization. The composition of the sponsor's talent pool, trading limits and risk tolerance are a few of the factors that could preclude certain securities, service providers and financial structures from being considered.

Focus on posture and form. Not paying attention to alignment could set someone up for an unwanted injury. Luckily, I take classes at a studio with instructors who regularly walk about the room and assist students as needed. An investment fiduciary must focus on process and take care to do sufficient homework before making important decisions such as allocating monies, selecting an asset manager and/or undertaking a liability-driven strategy.

Acknowledge the benefits of learning from others. While movements are necessarily a function of each individual's comfort level and abilities, there is a benefit from watching others strike a pose. Sometimes, an instructor will ask an individual to explain to the rest of the class how he or she has been successful in achieving a certain level of mastery and how long it took that person to realize the goal. Investment fiduciaries need to allocate sufficient time and energy for continuing education, ask questions of others who have "been there, done that" and be bold about watching what governance leaders are doing that makes them effective stewards of other people's money. The converse is to understand what ineffective fiduciaries have done and avoid their mistakes, whenever possible.

Give yourself time to think. When I first started yoga, I found it difficult to quiet my mind. I used the meditation part of class to review my "to do" list in my head. Gradually, I began to focus more on how my body felt in a pose, the sound of the music or the colors in the garden outside the studio. This "forced" effort to relax has been tremendously helpful. I feel refreshed after a class and often find myself with a renewed burst of energy by having taken a time out. For those investment fiduciaries who face continued market volatility, complex product structures and new rules and regulations, taking time to reflect on the primary objectives is a good thing. If guiding documents such as an Investment Policy Statement, Risk Management Policy Statement and/or vendor selection questionnaires by asset class are not yet in place or need revisions, concentrate on the big picture fiduciary obligations first. Getting bogged down with details and ignoring the constructs such as prudence and loyalty could pave the way for litigation, poor performance and worse.

Recognize the importance of what you are doing. While I gain personal satisfaction from the discipline and growth I have experienced as a yoga practitioner, I recognize that there are material health benefits associated with this activity. For investment stewards who get plucked from their everyday tasks and are asked to add fiduciary responsibilities to an already jam-packed day, know that your work - if done well - has a highly positive impact on countless individuals.

For those investment professionals who are interested in exploring the potential gains from practicing yoga, best of luck and "namaste."

Pension Risk, Governance and CFO Liability

My November 2011 presentation about pension risk, governance and liability to financial executives struck a chord. Part of a Chief Financial Officer ("CFO") conference held at the New York Stock Exchange, attendees alternatively listened with interest while adding their insights from the front lines here and there. It is no wonder.

With ERISA litigation on the rise and 401(k) and defined benefit plan decisions often driving enterprise value in a material way, CFOs and treasurers have accepted the obvious. Corporate governance and pension governance are inextricably linked. Make a bad decision about an employee benefit plan and participants and shareholders alike may suffer. As a result, the CFO is exposed to fiduciary liability, career risk and the economic consequences of an outcome with broad impact.

Rather than rely on luck, there is no better time to apply discipline and rigor to employee benefit plan management for those companies that have not already done so. With trillions of dollars at stake, properly identifying, measuring and mitigating pension risks continues to be a critical element of fiduciary governance.

The complexity and ongoing nature of the risk management process is sometimes overlooked as less important than realizing a particular rate of return. Recent market volatility, large funding deficits and pressures from creditors, shareholders, rating agencies and plan participants make it harder for pension fiduciaries to avoid the adoption of some type of pro-active risk control strategy that effectively integrates asset and liability economics.

In "Pension risk, governance and CFO liability" by Susan Mangiero (Journal of Corporate Treasury Management, Henry Stewart Publications, Vol 4, 4, 2012, pages 311 to 323), the issues relating to a panoply of risks such as actuarial, fiduciary, investment, legal, operational and valuation uncertainties are discussed within a corporate treasury framework. Article sections include:

  • Enterprise risk management, employee benefit plans and the role of the CFO;
  • Conflicts of interest and pension plan management;
  • Risk management principles and 401(k) plans;
  • Pension liability and mergers, acquisitions and spinoffs;
  • Prudent process;
  • Pension risks; and
  • Benchmarking success.

Click to download "Pension risk, governance and CFO liability" by Dr. Susan Mangiero, CFA, FRM.

Information Rights for Limited Partners Invested in Venture Capital

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 first question of ten, read what this Investment Governance, Inc. Advisory Board member has to say about information rights. Click here to read Mr. Levensohn's impressive bio.

SUSAN: How much information are limited partners entitled to (pensions, endowments, foundations, etc) receive from a venture capital ("VC") fund?

PASCAL: Section 17-305 (b) of the Delaware Revised Uniform Limited Partnership Act, which governs LP information rights according to DE law, specifically allows the GP to withhold from LPs “any information the GP reasonably believes to be in the nature of trade secrets or other information the disclosure of which the GP in good faith believes is not in the best interest of the Fund or could damage the Fund or its business or which the Fund is required by law or by agreement with a third party to keep confidential.” This would include the GP’s fiduciary duties and confidentiality obligations with respect to not disclosing portfolio company information without the consent of such company. The Act provides for a specific list of information that LPs are entitled to, and funds historically disclose that same information to their LPs—the top law firms in Silicon Valley model their LP agreement forms to be pretty consistent with Delaware law.

Specifically, Section 17-305 of the Act provides for the following:

(a) Each limited partner has the right, subject to such reasonable standards (including standards governing what information and documents are to be furnished, at what time and location and at whose expense) as may be set forth in the partnership agreement or otherwise established by the general partners, to obtain from the general partners from time to time upon reasonable demand for any purpose reasonably related to the limited partner’s interest as a limited partner:

(1) True and full information regarding the status of the business and financial condition of the limited partnership;

(2) Promptly after becoming available, a copy of the limited partnership’s federal, state and local income tax returns for each year;

(3) A current list of the name and last known business, residence or mailing address of each partner;

(4) A copy of any written partnership agreement and certificate of limited partnership and all amendments thereto, together with executed copies of any written powers of attorney pursuant to which the partnership agreement and any certificate and all amendments thereto have been executed;

(5) True and full information regarding the amount of cash and a description and statement of the agreed value of any other property or services contributed by each partner and which each partner has agreed to contribute in the future and the date on which each became a partner; and

(6) Other information regarding the affairs of the limited partnership as is just and reasonable.

The current state of the art for Agreements of Limited Partnership in venture capital allows the GP to override the information rights LPs have pursuant to the Delaware Revised Uniform Limited Partnership Act (the “Act”) as permitted pursuant to the Act and allows the GP to “adjust” identifying information given to the LPs in order to protect the identity of the Fund’s portfolio companies, which often is an issue in the case of Freedom of Information Act (FOIA) LPs. In addition, the partnership agreement allows the GP to restrict / withhold information from LPs if “the General Partner reasonably determines [such LP] cannot or will not adequately protect against the [improper] disclosure of confidential information, the disclosure of such information to a non-Partner likely would have a material adverse effect upon the Partnership, a Partner, or a Portfolio Company.” Other elements of the well drafted agreement do provide the LP’s with disclosure rights to their advisors, equity holders, etc. and provide remedies and protections to the GP with respect to GP withholding rights and improper LP information disclosure.

Career Risk and Action: Chicken or the Egg?

 

In a recent Virtual Town Hall about what governance means in the investment world, guest speaker Mr. Wayne Miller mentioned a relationship between career risk and fiduciary reform. Chairman Emeritus of Denali Fiduciary Management, Miller said that many people abide by the status quo, however ineffective, rather than innovate and improve their fiduciary practices. The fear is loss of one's job by taking prescription actions to better manage how monies are allocated and monitored. My response was to suggest the opposite. Why would a professional willingly adhere to bad practices when doing so could imperil his or her job and the related ability to get a bonus and/or promotion?

Which is the chicken and which is the egg? Does doing the right thing jeopardize one's climb up the career ladder or immensely help someone advance?

Click here to access the full transcript and enjoy all FiduciaryX subscriber benefits. If you think you qualify for a free 90-day trial as an institutional decision-maker, email Sales@InvestmentGovernance.com.

 

Benchmarking the Investment Industry

 

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.)