You’ve just joined the board of your pension fund, and have been entrusted to join the investment committee meeting. On the agenda for the upcoming meeting is a proposal from the asset manager hired to manage the pension fund’s investments. The investment manager lays out the proposal in nice PowerPoint sheets. This being your first meeting, you decide to play the role of observer, and see the following discussion unfolding, jotting down quotes. At the end of the meeting, you inspect the harvest.
1. “Can our participants understand this?”
After the 2008-9 crises, one of the big taboos is to invest in complex investment strategies. The board member asking this might actually be heavily involved in communicating with participants. On the other hand, it might simply be a reflection of his own (modest) level of understanding of the issue, trying to find a way to remove the proposal from the agenda. Be especially alert if this becomes a recurring question.
2. “Can we justify this to our participants?”
This is a variant of item 2 and calls upon the fiduciary duty trustees have. Justifying decisions are crucial for the “licence to operate” of a pension fund, and work well when there’s a clear, laid-out investment philosophy and investment beliefs. Any new strategy can simply be compared to these beliefs, helping in the communication. A less positive, implicit suggestion here however is that trustees better be prepared to answer difficult questions – the board better be prepared for the downside risks of this proposal, not the upside.
3. “More research is needed”
That’s a tricky one, and depends on who is asking. The suggestion is that not all information is on the table, or has not been properly digested to make the right decision. Ouch. Not something trustees warm up to. There are however plenty of cases where more research might really be needed. Compared to a few years ago, we’ve become acutely aware that risks entail more than uncertainty about expected return. A broader approach is useful. More research helps cool off enthusiasm of the investment manager, especially needed when he or she brings forward arguments like “once in a lifetime opportunity”, “the timing is right, valuations never have been so cheap” or “you’re able to profit from first mover advantages”. Let the investment manager substantiate these claims, and expand the research to follow up on what happened to similar arguments in the past.
4. “We should focus on the long term”
That’s another way of saying – what we’re discussing right now isn’t focusing on the long term, and therefore not relevant. That should finish off the investment proposal quite easily. No one wants to emphasize the irrelevant issues, other committee members will probably nod and the speaker will feel encouraged to re-emphasize his point.
5. “We’ve looked into this before, and it didn’t work, why should it now?”
A favorite argument, probably put forward by a veteran in the board. This could either mean organizational fatigue or a static belief about financial markets. The organizational fatigue argument usually follows the following storyline: we’ve spent a lot of time discussing this a few years ago, and we weren’t able to round up enough supporters. People’s opinions don’t change, so the outcome won’t be any different now. Alternatively, it could signal static beliefs about financial markets. We looked at the proposal, the conditions were unfavorable, we don’t think financial markets haven’t changed that much, so the outcome should be similar. This argument might hold, but since financial markets are dynamic, this line of reasoning should be followed with caution. Holding on to a static investment policy eventually creates opportunity losses too.
6. “It doesn’t add up”
If the whole proposal doesn’t seem right to you but you have no decisive arguments why, look closely at the figures. You’ll probably find a table where the figures do not add up. Somewhat suggestive, this problem with the figures might then be presented as just one example, since the board member hasn’t had time to redo all the math in the proposal. The message is clear: if we can’t trust the simple math, why trust the big picture. Never mind that that the only math that really should check out is that asset weightings must add up to 100 percent. For all other figures (return, risk, correlations), uncertainty rules.
7. “Pension fund x lost a considerable amount of money with this strategy”
That’s a variant of question #6. Take one example you know, and present it as the general rule, rather than the exception. Conditions could have been different, but this is conveniently left out. A variant of this analogy approach might be: because real estate is performing badly, then infrastructure investments must be in disarray too.
8. “Other funds are divesting, while we’re now looking at investing”
This is a powerful argument. Has your fund what it takes to be contrarian, deciding to succeed unconventionally, rather than to fail conventionally? The remark invokes peer group pressure. As a general rule, only the super large funds, or (smaller) funds with well laid-out investment philosophy have the ability to be contrarian. Having a well thought-out investment philosophy here is crucial, since contrarian strategies tend to be out of favor when mainstream isn’t, requiring a strong backbone and the ability to communicate clearly (see questions #1 and #2).
9. “Are you sure the timing is right?”
This goes well with question #5 (“we’ve looked into this before and it didn’t work, why should it now?”) and quote #3 (“more research is needed”). The investment manager now embarks on a mission impossible, unless one trustee helps him out with a favorable interpretation of question #4 (we should focus on the long term, and timing remains very difficult).
What Would Google Do? is the title of a bestseller, and can be applied to institutional investors with ease. How many pension funds wanted to be the next Yale and Harvard Endowment Fund? Too many, as it turns out. To base your strategy on what the (thought)leader does, works well in upward markets, and leads to spectacular problems in downward markets. So any reference to WWGD is an important warning sign. This question tends to be combined with #7 or #8.
How well did the meeting go? It depends on the number of the above mentioned phrases during the meeting. Ranging from 0 to 10, this suggests:
So whether this is your second meeting, or whether you’re a seasoned member playing the role of observer, this Top 10 might be an interesting change of scenery to consider.