We continue to live in turbulent economic times and the challenging road ahead that we predicted for investors last year still exists. Investment professionals at all levels have to make tough decisions in a volatile, uncertain, complex and ambiguous (VUCA) world. There isn’t much clear sight of what could possibly happen – let alone what will happen – and we often deal with questions that have no single right answer.
Despite this, there are some general themes I believe investors should be wary of in 2019 that, if not well-managed, could make the journey ahead even more difficult. Here is our list of five key topics investors should think about in 2019.
- Value creation as a further dimension of sustainability
Yes, sustainability is back again as a top theme for investors. In a recent Willis Towers Watson paper, sustainable investment is described as an unstoppable train. While to some the train is still slow-moving, it has been gathering momentum in recent years with no signs of slowing up. Regulatory pressure, reputational risks and opportunities, and evidence of improved risk-adjusted returns come together with public awareness and media mainstreaming to push sustainable investment up many asset owners’ and asset managers’ agendas.
Over the last year, we introduced a further dimension to sustainability in our work at the Thinking Ahead Institute: the need for organisations to better understand the value they create for stakeholders. There is increasing demand for organisations to provide positive social contributions to maintain their social licence to operate. It is not enough for organisations to focus narrowly on creating financial value without noting the effect of their activity on wider stakeholders (including society and the planet). Understanding what stakeholders value is a critical input for determining an organisation’s vision, strategy and culture, with the aim of improving organisational policies and practices and better monitoring outcomes. In our paper, Connecting the Dots: Understanding purpose in the investment industry, we suggest that understanding purpose and value creation is necessary for investment organisations wanting to maintain their social licence to operate – signalling a shift from economic legitimacy to societal legitimacy based on trust. We believe it is essential for institutional investors not only to understand value creation, but also to report regularly on the value they create, using an agreed upon framework.
- Multifactor diversity
At a dinner I recently attended, I was struck by the clear message of the New York City Comptroller’s office on diversity. As an asset owner responsible for about $200 billion, the office has defined a series of explicit policies focused on increasing participation from women and ethnic minorities, with the aim of creating an even playing field. These policies address manager selection, board structure, capital allocated to projects, improved access by underrepresented groups, and decision-makers at the fund. Central to this effort was the assignment of a chief diversity officer (Wendy Garcia), who reports directly to the comptroller and board executives and has influence not just on people policies but also on investment policies.
This is a marker of the dramatic shift in the mindset of many organisations on the issue of diversity. But as noted in my recent article, “Stronger theory: we need deeper thinking on diversity”, the investment industry as a whole is struggling to catch up. Why? Because for too long, both structural and unconscious bias have limited opportunity for individuals who go against the ‘norm’ (those who are non-white, non-male, non-private school educated). Organisations need to be wary of this and employ deeper thinking on diversity, in all of its forms, whilst making a sustained and systematic commitment to diversity and inclusion in all aspects of their business models.
Over the last year, investment organisations have produced an uptick of activity designed to codify culture. One example close to us is how Willis Towers Watson has used Thinking Ahead Institute research to develop its research team’s culture assessment model for selecting investment managers for asset owners. This is based on three pillars: how a firm delivers value to its employees, how a firm delivers value to its clients, and how leadership provides overarching guidance and oversight of culture. More on this framework can be found in WTW’s paper “Measuring culture in asset managers”. We believe well-managed investment organisations should and will continue to consider this issue more deeply in the future.
- Total portfolio approach (TPA)
Asset owners are increasingly conscious of the limitations of the strategic asset allocation (SAA) approach. Large asset owners are showing much interest in the total portfolio approach (TPA) as a potentially better way of working. Central to this revised approach is the improved ability for governance boards to act quickly and tailor portfolios to achieve specific goals. TPA is not yet used widely but has emerged over the last decade and is practised by a small number of large asset owners. CPPIB, Future Fund and New Zealand Superannuation are examples.
We define TPA as an approach in which:
- There is a continuous and dynamic focus on achieving the fund’s investment goals
- Decision rights reside with the CIO/executive team, while ownership of the risk budget or reference portfolio resides with the board
- The portfolio is managed in real-time; all investment opportunities compete for capital at a whole-fund level but only the best ideas get into the portfolio.
This is in contrast to traditional SAA, which is based on a set meeting schedule loosely connected to the fund’s investment goals. Strategy in SAA is updated infrequently as decision rights often reside with the board, whilst the CIO/executive team may have some implementation decisions delegated to them. Additionally, asset class buckets must be filled, with little room for deviation from pre-established weightings.
TPA has a number of advantages over such an approach, including a more dynamic decision-making process, better quality of decision framing and better quality of decision-making.
- Better decision-making
Institutional investing is increasingly a team activity and collective decision-making is a skill that can be nurtured. During 2018, the Thinking Ahead Institute conducted research on institutional decision-making, focusing on how a group can successfully integrate individual thought processes, communication patterns, relationships and other aspects of interactions into effective collective decision-making. In our paper, How to choose?, and in our wider research, we explore some tools that investors can use to make more effective decisions together. These tools range from those that improve the quality and processing of decision-making inputs or improve group dynamics for decision-making meetings, to tools that help you make the actual decision.
So that’s our list for the new year. We believe a focus on these topics will serve you well in 2019.
Marisa Hall is a director at the Thinking Ahead Group, an independent research team at Willis Towers Watson and executive to the Thinking Ahead Institute.