From the CIO’s chair

The trust effect

Investment management is a people business. That statement seems quite obvious, but the point is a critical one.

Investment management, whether fundamentally or quantitatively based, derives its value from the intellectual capital of the principals.

Technology, assets under management and process are used as differentiators for investment groups, but none of that matters if you do not have the right people and the culture to support their development.

In the end, the most important job of a chief investment officer is talent management. While many aspire to be the smartest person in the room, and some succeed, it is not enough. A sustainable investment program is never about one individual. It is about a team working to its potential, under the guidance and support of a policy-focused and supportive board.

Success within the investment management industry is, therefore, dependent upon execution by skilled professionals.

However, talented individuals do not always reach their potential, resulting in suboptimal execution. This means talent management is the critical element in creating excellence. This is best facilitated by establishing an environment that fosters learning, collaboration and competition as a team. Culture makes this possible.

The wrong culture will destroy a team or organisation. The right culture will create sustainability of process and allow for individuals and the organisation to thrive and grow. The organisation is as strong as its individual members, who must be able to grow with a clear vision, mission and delineation of roles.

The key elements for the development of an optimal investment management culture within a multi-asset class fiduciary pool are the following: functional governance structure; a supportive learning environment; adequate technical and research resources; aligned and reasonable incentive structures; and a long-term investment horizon.

You will notice from the above list that the focus is foundational. If you establish the proper structures to support individuals and teams, success will follow, leading to a self-renewing pattern of achievement. I will expand my thoughts on the key attributes necessary for success in the following paragraphs, with the hope of providing practical insights into optimal team structuring and management.

Functional governance

Success is not possible without functional governance. I use the term “functional” with intent. Many organisations have bloated and complicated governance structures, which often results in mission drift and poor performance.

A multi-asset class fiduciary pool’s core objective is to make money to support the mission of the organisation.

Governance should be set up to help, not hinder, that objective. Boards should set policy that supports successful asset management and allow the investment staff to invest the money.

Clear delineations of roles and responsibilities for all parties and autonomy for the investment team are essential. Checks and balances and accountability are important, but trust must underpin the entire governance structure. This ‘trust effect’ is the most critical piece of the optimal investment management culture.

Supportive and resources

The landscape is always changing, and having personnel with intellectual curiosity is critical to establishing a culture of success.

My organisation’s first foray into active equity management was in microcaps. This was a result of staff feeling empowered to conduct research independently and then having a structure that provided support, resources and, eventually, funds to execute.

If people know they are expected to learn and develop and leadership is committed to that objective, success and innovation will happen. In this case, it has led to the creation of two additional equity strategies and a fixed-income strategy.

Our internal asset management now covers more than 30 per cent of AUM and that’s increasing. Millions of dollars in fee savings and alpha have been generated for the fund. Most importantly, the team’s job satisfaction has increased and new research continues.

Staff members know they are encouraged and expected to learn and develop continually, resulting in positive structural changes to the portfolio. Retention rates are high because the work environment is positive and intellectually challenging.

Remuneration

Now to compensation.

Above I mention that a key element of success is talent aligned with appropriate compensation structures. Investment management as an industry pays its talent well and competition for that talent is fierce.

Unfortunately, the history of many pension funds was inadequate compensation for internal investment professionals and paying more than necessary for consultants and external investment management. Even though the cost-benefit analysis supports building out internal teams.

My view is that if you hire talented investment professionals internally and have established the right culture and governance structure, then additional layers of oversight prove costly and often counterproductive. Compensate your talent appropriately, allow them to operate in a challenging yet supportive environment, hold them accountable, and they will stay and produce successful outcomes.

Attracting and retaining top talent within the pension industry does not require aggressive compensation.

The asset owner side of the business is stable, mission focused, intellectually challenging, and does not generally require sales activities. It is a lifestyle assignment and, with appropriate compensation, retention is high.

With respect to alignment, incentive compensation is important. Investment professionals are competitive. The ability to earn a bonus brings the team together and focuses action on achieving the goal of higher returns.

Therefore, I remain a firm believer that incentive compensation should be linked to long-term successful outcomes and collective, rather than individual, success. Being reasonable is the key. Incentive compensation needs to be meaningful but not excessive.

A long horizon
Fiduciary pools are often perpetual in their mission.

That means embedded within their structures should be the ability to take a truly long-term approach. Maintaining this long-term view and linking it to governance, policy and incentives can be a powerful competitive advantage.

The markets are often painfully slow to reward long-term investments, so ongoing effective communication of strategy and execution between the investment professionals and the board is critical to maintain trust.

The board needs to support taking a long-term, valuation-based approach and compensation should incentivise the investment team to strive for consistent success over a business cycle, not a quarter.

Jeb Burns is chief investment officer at the Municipal Employees’ Retirement System of Michigan.

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