I thought my third book on pension management, Pension Revolution, published by Wiley in 2007, would be my last.

So what happened? Why has publisher Wiley just released book four, The Future of Pension Management this month?

It happened because I was a speaker at the CFA Institute’s 2015 Annual Conference in Frankfurt last April, where Wiley put the third book on display in its sales booth.

Curiosity got the better of me.

I decided to watch and see whether anyone would actually buy this ageing relic. To my surprise, there were buyers!

This got me thinking. A lot of things had happened in the pensions world since 2007, some foreseen in the book three, some not.

The time was right for a thorough review and recalibration of the challenges facing the global pension, governance, and investing sectors.

And so the idea of book four was born.

Book_Cover200px

As the subtitle indicates, the book calls for action on three fronts.

Pension design

On the pension design front, the traditional DB (defined benefit) and DC (defined contribution) formulas are converging into hybrids with names such a “defined ambition” (DA) and “target benefit” (TB).

The Netherlands and Australia offer good examples.

The former country is transforming its traditional DB plans into DA plans, while the latter is transforming its traditional DC plans into TB plans.

At the same time, workplace pension coverage is expanding.

The United Kingdom is leading the way with its National Employment Savings Trust (NEST) initiative, while the United States and Canada are now busy designing their own expansion initiatives.

 

Pension governance

On the pension governance front, the process of reconciling the opposable needs for boards of trustees to be both representative and strategic continues to slowly move in the right direction.

There is a growing understanding that it is not a question of either/or, but of how to get both ingredients into board composition.

Why both?

Because pension boards need legitimacy to be trusted, and at the same time need to be strategic to produce value-for-money outcomes for their stakeholders.

This strategic mindset addresses tough issues such as organisation design and culture, investment beliefs, incentives, and stakeholder communication and relations.

Behind these governance imperatives lies the broader question of organisational autonomy.

Unnecessary legal and regulatory constraints are increasingly seen as value-for-money destroyers in pension organisations.

Pension investing

Pension investing has been changing for the better too, starting with serious re-examinations of investment beliefs.

There is growing evidence the leadership of the global pensions sector is beginning to see their job as transforming retirement savings into wealth-producing capital.

There are a number of factors at play here. One is the simple reality that good investment returns are increasingly difficult to come by.

Another is a growing understanding of the zero-sum nature of short-horizon active management.

Yet another is that both logic and empirical evidence support the idea that long-horizon active management should, and actually does produce higher long-term returns than either short-horizon active, or passive management.

However, saying is one thing, doing another.

For many pension organisations, there is still a sizeable aspiration/implementation gap to be closed.

“Unreasonable” men

So my “Frankfurt moment” was to recognise that the significant “pension revolution” developments since 2007 in pension design, governance, and investing should be chronicled in a coherent, integrated manner, and that I was well placed to do that job.

However, I would not be doing it alone.

A good deal of the necessary insight and inspiration to write this book would come from five “unreasonable” men as defined by the Anglo-Irish playwright George Bernard Shaw in his 1903 play Man and Superman.

“The reasonable man adapts himself to the world. The unreasonable one persists in trying to adapt the world to himself. Thus all progress depends on the unreasonable man….”

This is not the place to describe the profound contributions George Akerlof, Peter Drucker, John Maynard Keynes, Roger Martin, and Jan Tinbergen made to my thinking in setting out the required 21st century actions on the three pension fronts.

However, as an early reviewer of the book noted, they made my job one of not inventing anything new, but of translating their insights into tangible action steps to raise the bar in the design, governance, and investing fronts of the ongoing pension revolution.

(I predict the noted thought-leaders of the 21st century will not all be men.)

Much work remains to be done.

 

For more information about The Future of Pension Management, click here.

Keith Ambachtsheer will speak about the book’s key messages at the upcoming Fiduciary Investors Symposium at Cambridge University from April 10-12.

With proper governance, Mercer suggests the ideal approach to creating value is to both establish an internal process to evaluate and capture market opportunities and to give external managers more flexibility. Anthony Brown, Mercer’s US director of strategic research, writes.

Volatility has returned to financial markets over the past nine months as global growth prospects have faded, and this has caused monetary authorities to grapple with stimulating growth in the absence of a coordinated fiscal response.

Bouts of volatility will likely be common in the coming years as market participants react and overreact to the uncertain macro environment.

Meanwhile, low or negative interest rates throughout the developed world and high-equity valuations make alpha generation necessary to achieving long-term objectives for many.

One way to add alpha is through a more opportunistic approach to investing – seeking to take advantage of market volatility and dislocations.

Plans can pursue a more opportunistic approach internally: as new investment ideas or opportunities arise, trustees or their delegates can evaluate and act upon them.

When contemplating internal approaches, the word “opportunistic” doesn’t imply, however, that such investments are made on a short-term basis.

Some opportunities might be relatively short-lived, but others will be longer-term in nature.

And while some opportunities will arise in traditional asset classes (for example, investment grade and high yield credit in early 2009), others could arise in previously unexploited areas of the market.

A willingness to accept illiquidity is ideal, as it broadens the opportunity set and allows institutional investors to monetise long time horizons.

One example of an opportunistic play today is European private debt to take advantage of bank deleveraging.

Looking forward, opportunities could emerge in distressed debt as the credit cycle matures, particularly in the US energy sector.

The major roadblock to an internal approach is the governance burden.

It could take anywhere from a few weeks to a few months for a typical trustee group to take an idea through to investment, with many at the longer end of that timescale, and this makes the implementation of an opportunistic investment approach extremely challenging.

One approach to resolving this issue is through the creation of an investment sub-committee that can commit a certain amount of time and resources to evaluating and implementing new ideas.

Investors can also seek external investment managers that invest more opportunistically.

In comparison to an internal approach, this should offer greater flexibility and responsiveness to market conditions and a streamlined implementation of new ideas.

However, the plan gives up a degree of control, and the impact of ideas at the total portfolio level will be constrained by the size of the allocation to the manager.

Giving managers more flexibility through broader investment mandates is one way to increase flexibility.

For example, transitioning from regional equity strategies to global mandates should increase the scope for astute investment managers to add value.

Likewise, moving from a high-yield bond strategy to a multi-asset credit strategy expands the opportunity set to include debt securities across companies’ capital structure, securitised bonds, loans and distressed securities, while in some cases providing the flexibility to hedge.

Taking this a step further, multi-asset strategies usually have the latitude to allocate across asset classes and instruments.

Multi-asset strategies come in a number of flavours.

For this purpose, those that tend to emphasise tactical or dynamic asset allocation and idiosyncratic trade ideas, with a lesser focus on a long-term asset allocation, are most suitable.

Hedge funds are another way to increase opportunism in a portfolio.

The universe includes a disparate collection of investment strategies, but their investment mandates and structures tend to give them far more flexibility than traditional, long-only investments.

Institutions with a material allocation to hedge funds will, therefore, tend to have more opportunistic investing embedded in their portfolio than those without.

Most long/short hedge fund strategies (equity and credit) have variable beta.

Other strategies look to capture cross-asset class opportunities; global macro funds and multi-strategy hedge funds stand out in this regard.

Global macro funds seek to capture cross-asset class opportunities through interest rates, credit, equities and currencies, while multi-strategy hedge funds have the scope to shift capital among hedge fund strategies as the opportunity set changes.

Measuring the success of external strategies can prove challenging, and appropriate benchmarks will vary from one approach to the next.

Investors should assess the impact of changes in asset allocation over time on a net-of-fees basis and ensure that they have a good understanding of the flexibility and complexity inherent in the strategy.

Transparency will clearly be helpful in developing an effective monitoring process.

Perhaps the most important condition for success in opportunistic investing is adopting the right mindset.

With proper governance, Mercer suggests the ideal approach to creating value is to both establish an internal process to evaluate and capture market opportunities and to give external managers more flexibility.

An internal approach is best suited to take advantage of longer-horizon ideas and illiquid opportunities, while investment managers are best positioned to capitalise on short-term dislocations and more granular opportunities.

Henrik Nøhr Poulsen joined Denmark’s biggest commercial pension fund PFA Pension three months ago, poached from local rival Industriens Pension.Over the course of his tenure at Industriens, Poulsen grew the alternative portfolio to 21 per cent of assets under management from 1.6 per cent when he first joined.

Given that PFA’s current alternative allocation accounts for just 2 per cent of the DKK550 billion ($82.1 billion) fund, coupled with Poulsen’s track record and expertise, it’s no surprise to hear alternatives will be a top priority at PFA in coming years.

“Over the next five years we will target a 10 per cent alternatives allocation,” says Poulsen, chief investment officer equities and alternatives at PFA Asset Management.

“Pension funds around the world are facing the same challenge: assets in fixed income are going to yield a return close to nothing in the short term, yet increasing equity allocations is not the solution because the risk is too high,” he says. “We expected interest rates to go up but the opposite happened.”

As the fund ventures further into alternative investments it will extend its risk analysis, which Poulsen aims to achieve via ESG integration across the entire direct, unlisted portfolio.

“Listed companies are covered by analysts and ESG screens. In the private side you have to do your homework much more thoroughly,” he says.

It will mean a bigger team, which Poulsen will build from two to five by the middle of this year, ultimately aiming for a ten-strong head count.

The unlisted focus will be on private equity, infrastructure – where the fund has so far “only dipped a toe” – and real estate.

PFA will also boost its private credit allocation via direct lending and broad, asset-backed investing.

“We want to be closer to the corporates we invest in on the equity and debt side.”

The real estate portfolio is well established but the “pricey” Danish market, where PFA has pushed into the local buy-to-let market, means it will increasingly look abroad for opportunities.

Along with alternatives, there are other areas where the fund is finding attractive risk-adjusted returns – namely, its equity portfolio.

The fund applies alternative risk premia to approximately one-fifth of its equity portfolio, with an in-house team working to systematically harvest equity premia around value, small cap and momentum.

“The equity portfolio has been boosted by active stock picking. Our returns here have been stable rather than shooting through the roof but they have been very successful,” says Poulsen.

Within the equity allocation the amount portioned to Danish stocks will be reduced gradually.

“Danish shares have performed very strongly and we will use the strong market to reduce the allocation; strong Danish companies have been taking up too much space in the portfolio,” he says.

The fund’s emerging market allocation in listed emerging market equity and debt isn’t changing for now.

“We are currently underweight emerging markets and will sit on the fence for a while still. We will eventually move into the unlisted, private space when markets pick up,” he says.

Poulsen is also quietly optimistic about European growth prospects.

“European corporations are doing well and there is the potential for good equity returns: we are overweight Europe versus US.”

The different market-based portfolios account for one-third of the total assets under management.

Eighty per cent of the fund’s current annual income, around euro 3.5 billion ($3.8 billion), flows into these portfolios.

The guaranteed portfolio accounts for the remaining two-thirds of the scheme’s assets and is closed.

Customers in the guaranteed schemes have the option to take on more risk if they want to.

Returns from the guaranteed portfolio are set between 4 per cent for long-standing members down to 1 per cent.

The market-based scheme has four different return profiles that are fashioned according to the risk appetite of the individual and the number of years until retirement.

In the market-based portfolio the typical asset allocation is a 75 per cent allocation to equity, high-yield bonds and private equity, with the remaining 25 per cent in bonds and investment grade real-estate and infrastructure.

About 90 per cent of the fund is managed in-house.

“It is much more cost efficient when you are a big fund to have internal rather than external management. It strengthens the know-how and competence in an organisation, but the main reason is cost,” says Poulsen for whom internal management is one of the most exciting aspects of his new job.

“The culture is the same but the team, and assets under management, is much bigger, and we also manage a lot more internally.”

The Future Fund knows exactly where its leadership team’s cognitive strengths, and weaknesses, lie. Does your fund?

When the Future Fund first built its team – back in 2007 – diversity was not on the agenda. But 10 years later, diversity and inclusion are at the cornerstone of the organisation’s people management strategy.

“When we built the team, we were just focusing on managing money,” says managing director David Neal.

Now, respecting and valuing difference in all its forms including diversity of background, experience and thought is actively promoted. And inclusion is seen as key to success.

The fund’s one portfolio, one team philosophy drives everything it does, so increasing the performance of its collective brain is a priority.

Speaking recently at the Thinking Ahead Institute topical day on cognitive diversity, Neal shared the experience of the leadership team at the recent offsite, aptly named “Leading into the Future”.

The group was assessed using the Herrmann Brain Dominance Instrument which explores the degree of preference individuals have for thinking in each of the four brain quadrants.

Perhaps not surprisingly given the organisation’s goal, the group was found to have a huge overweight to the A grouping with attributes of being factual, quantitative, critical, rational, mathematical, logical and analytical.

There were few that had the big-picture view, and few in the emotional category, Neal says.

Broken down by investment function, the testing found the investment team was mostly analytical and the support people were process driven.

“Maybe you would expect this, but the big question is how to get them to talk to each other without breaking down communication,” Neal says. “Our mantra is one team, one portfolio and incentives are aligned – then why is this so difficult?”

The thing is, according to Ned Herrmann who is the founder of Herrmann International and originator of “whole brain thinking”, that most people assume they are seeing the world the way it really is.

Circle_diagram_300px

 

“So with that lens you think that someone who is thinking in a different way has poor motives,” Neal says. “They’re out to get you, or there is something about them that isn’t right – and they think the same about you. But this is just a perspective. We can think differently.”

Neal says by conducting this offsite the team can now see that their preferences are just a different view, it’s just a perspective.

“Our motives are both pure so let’s have a better conversation. This is a tool that has helped us build on our strategy for gender diversity to have a wider conversation on cognitive diversity.”

The Future Fund wants to actively seek to improve the diversity of the team, especially at the decision-making levels because it knows it will support better, more holistic decision making.

“We believe in the cognitive diversity argument. We also think we need to compete for talent, which is hard – we don’t pay as much as investment management.”

The next step for the organisation is to look at what drives sustainable diversity and allow the organisation to flourish. Flexibility is at the centre of that conversation.

“Flexibility 1.0 is specific flexibility for people, like it is documented that someone leaves on Fridays at 2.00pm. We are now looking at flexibility 2.0 and considering where and how far to take it.”

Neal points to Netflix’s much-cited slide deck on its culture which is outcomes based, rather than putting a number on the amount of leave, removing the administration and bureaucracy around controlling people. (See also How Netflix reinvented HR in the Harvard Business Review)

“It basically says you are responsible so get the job done. We would love to hear from people who have done interesting things around this.”

 

Future Fund staff breakdown

At the end of June last year the Future Fund had 112 staff, with only five part-time workers. Of the total staff 57 were male and 55 were female. In the investment team 30 were male and 19 were female, and in the non-investment team 27 were male and 36 were female.

In the leadership team the ratio of men to women is 70:30, and the more senior the leadership team then the more men there are.

We have a mission and can tap into that when hiring people,” Neal says. “The nature of our mission, investing for the benefit of future generations of Australians, is an attractive employee value proposition for a diverse range of people. This will give us a better collective brain.”

Neal says it is often women that are attracted to, and tap into, the Future Fund’s purpose, which is a long-term proposition.

In terms of age, around 40 per cent of the Future Fund staff are aged 31 to 40 years, with a further 33 per cent aged between 41 and 50 years. The average age is 38.8 and the median age is 37.7.

It’s all very well to have diversity, but most people lack the tools for how to get the best out of a diverse team.

Instead the reverse is true and diversity can lead to an unlevel playing field, says Laura Liswood, secretary general of the Council of Women World Leaders, former senior advisor to Goldman Sachs and author of “The Loudest Duck”.

“We all bring ourselves, our unconscious selves to the workplace – this includes our perceptions, archetypes and biases. In the process of that, diversity has the potential to unlevel the playing field, certain people are advanced, and there is the potential to over or under-hear people,” Liswood says.

“One of the problems in diversity is people think it’s like Noah’s ark, you just get two of everything on the ark and it will all be fine. But the giraffe looks at the zebra and sees something so different. If you think like that you won’t get what you want from diversity.”

At the Thinking Ahead Institute cognitive diversity topical day, Liswood challenged the audience to think about a meeting when the way people are heard is equal. People either get under or over-heard, she says.

“We have got to Noah’s ark, we have diversity, but we haven’t taught people how to deal with it. We don’t have the tools to deal with heterogeneity.”

Liswood, who was previously managing director of global leadership and diversity at Goldman Sachs, gave some examples of how diversity can unlevel the playing field.

“You can have all the nationalities you want, but what does everyone actually think about each other? You go to Japan and what do they think about China or Korea, you go to England and what do they think about the French? What does an older generation really think about a younger generation – that they’re lazy, they don’t know anything, they need constant feedback. You get diversity but we don’t know how to deal with it.

“With regard to diversity in thinking it’s not whether you’re an extrovert or an introvert that is the issue, it’s not how you think about things, it’s how you react to people who are not like you.”

So, she says, diversity can unsettle the workplace.

“It’s about like and like. If I went to Oxford I’m more likely to look out for my new hire who also went to Oxford.”

In some ways it is up to managers to be aware of these differences, and of their own behaviours, and manage for that. While bonding is a really important part of creating a team culture, a manager is more likely to promote or give bonuses to those who they’ve bonded with. If bonding activities, for example drinking alcohol, can exclude certain people, then managers should bond in other ways so that when it comes to making decisions, it’s equal.

“That type of bonding is giving unlevel managerial access, and in a hierarchy, that has consequences,” she says.

“There is a bias to those you’ve bonded with. That doesn’t make you a bad manager, it makes you a human manager.”

Liswood also pointed out, though, that while the manager has 50 per cent responsibility to build on the relationship with employees, the individual also has a 50 per cent responsibility to further their own career, and can for example ask their manager out for a coffee.

“The point is, we all live in different worlds, and senior executives need to work out the worlds that people are living in within their organisations.”

Another example that Liswood gave was that of race. She says that research has shown people with a non-Anglo Saxon name need to send out 50 per cent more resumes to get a job.

“We all live in different worlds. A cab goes past me in NYC; an African American experiences that five times more than me. It’s a possibility for me but it’s a frequency for him. You can’t say we have the same experience,” she says.

So it’s not diversity on its own that will create a better workplace, but how people react to others that are not their archetype.

Managers need to use certain tools, like being a traffic cop and making people take turns in meetings, and if they don’t then diversity will disadvantage certain people.

“In a diverse organisation you have got to tell people they have a responsibility to get out of their comfort zone and speak up,” she says.

“If you let the conversation flow naturally the loudest person – i.e. the American – will speak the most. You need to know your people and manage them, be a traffic cop.”

Liswood advises the best tool a manager can have in their toolbox is to provide every employee with critical feedback.

“The performance difference between those that have received critical feedback and those that haven’t is massive. Managers find it easier to give critical feedback to those that are like them. It is hard to give it to those unlike them as it is unknown how they will take it,” she says. “A tool I highly recommend is three up and three down every three months. Tell employees three things they’re doing well, and three things they need to work on, and do it for everyone every three months. All critical feedback beyond the three months doesn’t change behaviour.”

Liswood says there needs to be more tools in the tool box to deal with the cognitive diversity that organisations aim to get to.

There are some circumstances where it is better to have homogeneity in a team, but Liswood says there are three requirements necessary for that to be the case: The problems are simple; communication is easy e.g. turn the screw; the environment doesn’t change e.g. if all you need to do is dig 50 holes, then just get 50 hole diggers.

Controversially, there is such a thing as too much diversity, according to research that looks at the impact of cognitive diversity among teams.

Ishani Aggarwal, research affiliate at MIT Sloan School of Management, and assistant professor, Brazilian School of Public and Business Administration, has been researching collective intelligence and cognitive diversity in teams for 10 years.

Aggarwal highlights that while there is surface-level diversity – like race or gender – the information processing attributes like education, beliefs, way of thinking, and experience provide a deeper level. She has been investigating what this deeper level cognitive thinking – knowing and processing information – brings to a team. There are three cognitive styles: spatial visualisation, object visualisation and verbalisation (and some people have cognitive flexibility).

Interestingly, while there are many benefits to cognitive diversity in a team, such as a broader perspective, the differences in processing information also bring complexity and conflict.

She says the biggest contingency factor, as to whether cognitive diversity benefits team performance, is the context of the task being undertaken.

“My research shows that team cognitive-style diversity improves team performance in a creative task, but the opposite is true in an execution task, where the more diversity the worse the performance.”

“Teams with high cognitive diversity have trouble coming to strategic consensus – so this creates difficulty in execution tasks,” she says.

“The task context is of vital importance in assessing collective intelligence, which is defined as the ability of a group to perform consistently across a wide array of tasks.”

Aggarwal hypothesises that there is a U-shaped relationship between cognitive-style diversity and collective intelligence, such that too little, or too much, cognitive diversity hurts collective intelligence.

This leads to the idea that there is a “right” level of cognitive diversity that leads to consistent performance over an array of tasks.

Further, Aggarwal says there is a strong link between intelligence and learning at the individual level and hypothesises there is a positive link between collective intelligence and the rate of team learning.

She says there is a clear relationship that cognitive-style diversity leads to collective intelligence which leads to team learning.

However, importantly, a moderate amount of cognitive-style diversity helps collective intelligence and team learning but high and low levels of cognitive diversity hurts this.

 

Investment committees and diversity

Roger Urwin, global head of content at Willis Towers Watson, says Aggarwal’s research regarding the U-shaped relationship between diversity and team performance, reinforces that there is an ultimate board size, a sweet spot.

“The less that one person dominates, and communication in general increases, the higher the collective intelligence,” he says.

And as Urwin points out, these observations are important for the institutional investment industry, which is personality driven.

“The group is a problem,” he says. “No-one ever erected a monument to an investment committee – this is a personality-driven industry.”

Urwin argues that the investment committee head room for improvement is huge.

“A lot of investment committees are representing the constituent of the fund. From that point of view there is already a problem of competency – which could be a bigger problem than diversity.”

Urwin says the investing environment is volatile, uncertain, complex and ambiguous.

“In this context domain experts are critical assets to investment committees. Often this involves an independent associated with the fund, and advanced cognitive competencies are desirable,” he says.

“High-functioning investment committees accept assessment and accountability, engage in personal development, play their part in cognitive and decision-making diversity.”

Urwin believes that the actions and behaviours of the chair are key to improving investment committee accountability and performance.

“How the chair acts and behaves is critical, the performance of the committee is their responsibility, how a chair can manage their team then becomes an opportunity – people don’t use that language,” he says. “The chair has three more roles than a committee member; that needs to be an area of development.”

Urwin believes the industry can measure more than what it already does, and that the input as well as the output could be a focus of more measurement.

“I see many situations where critical questions get blocked in investment committees. Diversity matters because diverse groups see more and have different ways of seeing the problems, and thus faster and better ways of solving them. It is about getting the right people on the bus,” he says.

But whatever an organisation’s beliefs on diversity are, Urwin says effective collaboration cultures and practices are critical to investment committees.

“With complex problems faced by investment committees, if everyone thinks the same way we get stuck in the same place. If we have diversity then we can work through the blocks,” Urwin says. “But lack of homogeneity about what truly matters is a problem, everyone needs to be aligned on values and beliefs.”

 

For more on this topic see

What different makes a difference? The promise and reality of diverse teams in organisations

Collective intelligence and Group Performance

 

The Thinking Ahead Institute topical day on cognitive diversity

The Willis Towers Watson Thinking Ahead Institute aims to improve the industry for the betterment of the end user. It wants to re order the value chain to achieve a better proposition for the end user. It’s a big ambition, and one that conexust1f.flywheelstaging.com is aligned with.

The Thinking Ahead Institute has 37 organisations as members made up of asset owners and managers, and conducts research and holds topical days for its members.