feg aisne fall 2011 fiduciary responsibility of committees final slides
TRANSCRIPT
November 7, 2011 Brian T. Gray Vice President – Institutional Client Development
F I D U C I A R Y R E S P O N S I B I L I T Y O F C O M M I T T E E S
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I. Summarize the Challenges Facing Governing Fiduciaries
II. Discuss Oversight Structures
III. Provide Thoughts on Best Practices
AGENDA
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• Trustees / Investment Committee Members / Investment Advisors / Money Managers
• Varying Degrees / No Full Delegation
• Stewards – Bound by Loyalty and Good Faith
– Legal responsibility to act in best interest
• Responsible for Prudent Investment Decisions
– “Process is Prudence”
– Not defined by desirable outcomes
WHAT IS A FIDUCIARY?
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• Manager Proliferation
• Market Complexity
• Manager Selection
• Committee Dynamics
• Process Deficiencies
• Summary of Ineffective Committees
CHALLENGES FACING FIDUCIARIES
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Source: Investment Company Institute
Note: Data for funds that invest primarily in other mutual funds were excluded from the series.
The data contain a series break beginning in 1984. All funds were reclassified in 1984 and a separate category was created for hybrid funds.
PRODUCT PROLIFERATION – U.S. MUTUAL FUNDS
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
Number of Funds of the U.S. Mutual Fund Industry 1970-2009
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Source: PerTrac Financial Solutions. Numbers of new funds have not been adjusted to account for survivor bias.
PRODUCT PROLIFERATION – HEDGE FUND LAUNCHES
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• Number of managers per fund/plan
– Diversification
– Alternative investments
– Global mandates
• Increased use of derivatives
– Substitution
– Hedging
MARKET COMPLEXITY
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• Typically base decisions on “finals” presentation
• Based on claim – “we are better than others”
• Cannot prove claim
• Committees have limited time and information
• Performance is not persistent
• Presentation skills ≠ investment skills
• Yet, Committees rely on presentations and performance
MANAGER SELECTION
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HIRING / FIRING MANAGERS IS DIFFICULT
Source: The Selection and Termination of Investment Managers by Plan Sponsors, Goizeuta Business School, Emory University, 2004 & Why Do Institutional Plan Sponsors Fire Their Investment Managers?, Heisler, Knittel, Neumann, Stewart, 2004
Pe
rce
nta
ge P
oin
ts
3 Year Excess Return Before and After Manager Termination
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C R E AT E S I N V E S T M E N T S L I P PA G E
• Delays
• Inappropriate decisions
• No accountability
COMMITTEE DYNAMICS
VOLUNTEERS/ NOT FULL TIME
VARYING DEGREES OF INVESTMENT KNOWLEDGE
SEEK CONSENSUS QUARTERLY MEETINGS
DECISIONS BASED ON COMFORT /
REPUTATION
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PROCESS DEFICIENCIES
Barriers to Excellence 1
1 Pension Fund Excellence, Keith P. Ambachtsheer and D. Don Ezra
98%
48%43%
35% 35%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Poor Process Inadequate Resources
Lack of focus on Mission
Conservatism Insufficient Skills
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INEFFECTIVE COMMITTEES 1
1 Pension Fund Excellence, Keith P. Ambachtsheer and D. Don Ezra, and Investment Committees: Vanguard’s View of Best Practices, Catherine D. Gordon, June 2004
S t r u c t u r a l
Confer membership as a reward
Don’t take time to understand what they don’t know
Evaluate using wrong benchmarks
Rely too heavily on one person
Don’t consider
conflicts of interest
Act as portfolio managers, not
fiduciaries
Confuse opinions with facts
Support compensation system fails to align interests
Crave certainty
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INEFFECTIVE COMMITTEES 1
1 Pension Fund Excellence, Keith P. Ambachtsheer and D. Don Ezra, and Investment Committees: Vanguard’s View of Best Practices, Catherine D. Gordon, June 2004
B e h a v i o r a l
Confuse opinions with facts
Fail to recognize investment
theory
React rather
than lead
Postpone decisions
Crave certainty
Take credit for
good things
Assign blame for bad things
Gravitate to those who promise it
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I. Summarize the Challenges Facing Governing Fiduciaries
II. Discuss Oversight Structures
III. Provide Thoughts on Best Practices
AGENDA
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Three levels of fiduciary responsibility 1
• Governing
• Managing
• Operating
FIDUCIARY RESPONSIBILITY
1 Pension Fund Excellence, Keith P. Ambachtsheer and D. Don Ezra
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THE OVERSIGHT STRUCTURE
Investment Committee
Chief Investment Officer and Staff
Investment Managers Custodian Actuaries
Other Vendors
GOVERNING FIDUCIARIES
MANAGING FIDUCIARY
OPERATING FIDUCIARIES
Source: Pension Fund Excellence, Keith P. Ambachtsheer and D. Don Ezra
Asset Allocation Manager Selection Risk Management
Day-to-day Supervision Performance Analysis Top Down Strategy
HIGH
Security Selection Trading Data Management
Strategy Research Accounting Reporting
LOW TO MODERATE
Mission/Objectives Investment Policies Asset Allocation Spending
Overall Compliance Defining Liquidity &
Risk Tolerances
Accountability Impact on Portfolio
HIGH
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3-TIER CAPTIVE
Investment Committee
CIO and Staff
Investment Managers Custodian Actuaries
Other Vendors
THE OVERSIGHT STRUCTURES EMPLOYED
Adapted from: Pension Fund Excellence, Keith P. Ambachtsheer and D. Don Ezra
2-TIER COMMITTEE DRIVEN
Governing Fiduciaries Investment Committee,
Staff, and Consultant – Supporting
Fiduciary Managing Fiduciary
Operating Fiduciaries
Investment Managers Custodian Actuaries
Other Vendors
3-TIER OUTSOURCED
Investment Committee
Staff and Outsourced CIO
Investment Managers Custodian Actuaries
Other Vendors
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I. Summarize the Challenges Facing Governing Fiduciaries
II. Discuss Oversight Structures
III. Provide Thoughts on Best Practices
AGENDA
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COMMITTEE STRUCTURE AND PERFORMANCE
EFFECTIVE INEFFECTIVE
Cognitive Diversity Correlated Judgments
6-8 People 10+ People (Ringelmann Effect)
Focus on Process / Big Picture Lack Process Enables Distractions
Strong Leadership: • Reinforces Process / Objectives • Focus and Time Allocated Effectively • Extracts Unshared Information and Options • Decision Method (quorum/majority/consensus)
Weak Leadership: • Social Conformity / Groupthink • Distractions and Wanderers • Suppresses Discovery • Weak Decision Methods
Identify & Classify Problems Effectively Trouble Indentifying Problems
Document/Journal Decisions No Decision Journal
Seek Feedback Weak Feedback Loop
Buy Low, Sell High Buy High, Sell Low
Adapted from Sources: Michael J. Mauboussin – Mauboussin on Strategy: Investment Committees. Sept 1, 2009 and Think Twice – Harnessing the Power of Couterintuition.
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• Investment policy statement
• Asset allocation approach
• Manager team
• Implementation shortfall (slippage)
• Define risk (unique to institution) vs. measuring risk of portfolio
• Define liquidity parameters
• Other sensitivities (debt covenants, funded status, etc.)
DECISION MAKING FRAMEWORK
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SELF ASSESS
• Have your past decisions contributed or detracted from results?
• Do you have a plan for responding to extreme events?
• Do you chase performance?
• How long does it take to implement a decision you make?
DECISION MAKING FRAMEWORK
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GOVERNANCE (Structural)
• Select appropriate oversight structure
• Define “decision rights” and delegate appropriately within structure
• Maintain strong investment process and focus – “Process is Prudence”
• Understand risk in context of institution
• Understand investment horizons required to achieve results
COMMITTEE (Behavioral)
• Leadership fosters open communication and alternative opinion sharing
• Focus on high impact items
• Avoid blame-seeking activities
• Identify and avoid conflicts of interest
• Seek ongoing education
BEST PRACTICES – EFFECTIVE GOVERNANCE
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This presentation was prepared by Fund Evaluation Group, LLC (FEG) − an investment adviser registered under the Investment Advisers Act of 1940, as amended − providing non-discretionary and discretionary investment advice to its clients on an individual basis. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser.
The information herein was obtained from various sources. FEG does not guarantee the accuracy or completeness of such information provided by third parties. The information in this report is given as of the date indicated and believed to be reliable. FEG assumes no obligation to update this information, or to advise on further developments relating to it.
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DISCLOSURE
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