A key ingredient for success in any organisation is strong leadership. It is common in the corporate world for the chief executive to change every five to 10 years as the organisation evolves. Are the same principles true for large institutional investors?

 

 

Roger Urwin, global head of investment content at Towers Watson, who also leads the firm’s change consulting to asset owners says external market conditions regularly drive companies to reassess their strategy and re-focus their activities. Asset owners face the same challenges and should look at how their organisations can evolve.

“Asset owners are facing the same pressures to adapt to a changing environment and we have helped a number of them around the world to be more flexible, nimble and prepared for change,” Urwin says.

Similarly, Graeme Miller who is head of investment for Towers Watson in Australia says, different skills and experience is needed in leadership as an organisation becomes larger and more complex.

“In the corporate world it would be relatively unusual for CEOs to stay in the role longer than five to 10 years. In all top companies in the world, change is necessary and the same principles apply to institutional investors.”

Miller says it is possible for individuals to develop and grow their skill sets, so it less about organisations out-growing an individual, and more to do with the needs of the organisation evolving.

“If you think of any organisation that you admire – GE, Apple, Ford – you almost always identify the organisation with an outstanding leader, the same should be true in the context of institutional investors,” Miller says.

The qualities of leadership include passion and vision, commitment, integrity, and the ability to form and articulate a strategy and take the organisation along a journey.

In the institutional investment context Towers Watson considers investment leadership as a triangular relationship structure between the chief investment officer, chief executive and the chair.

“All three individuals are points on the triangle and we believe the strong leadership structures are where there are very sharp points and there is a symmetrical structure with competent, visionary, strong leadership at each point.”

While he says there is an exception to every rule, in general these three functions should be separate and delineated, as different roles with different skill sets.

The institutional investment industry is dynamic, and organisations should look for leaders that are energetic and have different perspectives, and in the war for talent there is a convergence between organisations that have traditionally been funds managers and those defined as institutional investors

“Is AustralianSuper a fund manager or an institutional investor? The same could be said of AMP,” he says.

“The two organisations are converging. The days of fund managers having a monopoly to attract and retain staff are gone. There is an artificial distinction between whether the salaries are paid indirectly to the fund manager or directly to the fund’s own employees.”

 

It is Towers Watson’s belief that the asset owners that adapt to change, and enhance their decision making, will succeed.

“Those asset owners whose decision making has become more flexible and efficient at handling uncertainty and ambiguity will be more adept at exploiting the potential opportunities available,” Urwin says.

But Miller says typically pension funds find it difficult to make material changes.

Also most superannuation funds in Australia have experienced substantial growth because of the compulsory nature of the industry.

“These funds look around themselves and see they must be doing something right, but it is mandated growth. There are clear examples of success but the rising tide raises all boats, I wouldn’t look at assets under management as a measure of success.”

Instead, in the defined contribution world, Miller says risk-adjusted investment performance in the long-term is a better measure of success.

Further he says there other measures that get little attention are important gauges of organisational success. In particular retention of members when they change employment, or move through retirement or when their account balances become material, would be a measure of success.

“If I was ranking the success of superannuation funds it would be their ability to retain members,” he says.

The asset owner industry has grown up in an environment where many investors have operated in a relatively uncompetitive un-commercial environment, this has meant the creative destruction that exists in a commercial and competitive environment hasn’t been present.

“The fact today’s structures don’t fit tomorrow’s challenges, could also be seen that yesterday’s structures don’t fit today’s challenges and they need updating. The structures of 10 years ago are not fit for today,” he says. “One simple fact is that many organisations are now very large investors but they started off small, and they haven’t put structures in place along the way.”

Towers Watson believes “with absolute certainty” that the most reliable predictor of outperformance is the strength of investment governance.

“It is present in everything we have seen working with organisations that the key differentiator of successful investors – which all have different investments, asset allocations and attitudes to risk – is the strength of their governance.”

With this in mind it is prudent for investors to reassess their organisational leadership and decision making structures for competitive positioning.

 

Which developed world pension fund will become the first to have a Chinese national sit on its board?

The debate on board diversity has focused on gender, race and age, but in future it could extend to having representatives of the countries your fund would most like to invest in.

As funds travel along the path of reducing their exposure to domestic equities to growing international assets as a way of accessing a greater scope of opportunity and to diversify risk, they are taking a greater amount of decisions in-house too. The next step for those competing for the best international assets would be to have foreign nationals on boards.

Jeff Hauswirth, co-head of Asia Pacific at international executive search firm Spencer Stuart, has already seen the requests come in for international board directors.

He cites a recent discussion with a fund chairman who is looking to increase international investments and to acquire skills that will help make decisions of greater insight.  Another of Hauswirth’s searches is for a North American fund spreading its search for the best possible chairman overseas.

The trend to internationalise boards is most evident in North America, Europe and the Middle East where it has grown markedly over the last five years, particularly in countries with relatively small populations, but large funds, such as Canada.

“You see international directors sitting on Canadian boards, because you get a whole different set of experiences than you would just looking at the domestic market,” he says. “The same is true of the UK where there is an increasing international representation on large funds.”

The move is being partly driven by the anxiety that domestic markets in developed countries will see low growth over the next five years and that there will be ever more fierce competition for the best international assets.

China is one of the most talked up destinations for capital, but the first use of Chinese nationals who can help with access to opportunities in their homeland looks likely to be taken by a company rather than a fund.

“Australian companies need to rely on China for the future, so they are thinking about bringing Chinese nationals on their boards,” says Hauswirth. A board member that is a past or present member of the Chinese Communist Party could be highly influential, he adds.

The trend towards international board directors is also being driven by the drive towards more professional directors or those that help fill a skills gap on the board.

In Australia, where Hauswirth is based, the government is likely to insist that super funds have a third of their boards made up of independent directors. Some funds are already compliant with this, but others have none and Hauswirth calculates that the market will need an extra 200 independents to fill the gap. Many wonder if there are enough people suitably qualified in domestic markets and one possibility for funds is to look abroad.

 

It is a measure of the experience of the Australian fund, Local Government Super, on ESG that it will instruct its managers on which companies to omit from portfolios. The New South Wales fund started its policy of applying environmental, social and governance filters to its investments by omitting tobacco companies in 2000.

Today, it has progressed to omitting any company involved in armaments, nuclear power, old growth logging or those that derive their income from gambling outlets. Companies in other non-specific areas of unethical, unsustainable behaviours or poor senior management practices will also be omitted or shorted out of portfolios.

Some of this activity is based on its own research, some is from ESG specialists in the area and it means it can tell a firm such as State Street, which runs a passive equity mandate with an ESG filter for the fund, to tailor its mandate to exclude further companies.

The fund’s chief investment officer, Craig Turnbull, says: “[Our researchers] might say ‘we really think a company is a high risk because of poor governance or board composition’; and if it rates very poorly under our policy, we take that stock out as well. In State Street’s research, they might think the company was fine”.

Currently more than half of the AS$7.5 billion fund is invested in responsible strategies, across the asset classes of Australian and international shares, property, absolute return, private equity and fixed interest and the experience and confidence it has gained in this activity is applied to how it hires fund managers.

“We will only use those that think about ESG factors when making their investment decisions, so that it is making a difference to their portfolio,” says Turnbull. “We like them to report those issues to us too.”

In a virtuous circle, the research findings of the managers it hires feeds into the research it uses to omit companies or to short them out of portfolios.

Since 2004 it has shorted out Australian companies with poor ESG practices from any pooled fund it invests in. This is done through a prime brokerage account which allows the fund to track the profit and loss of the activity.

This practice has gained it an average return of 10 basis points over the last 10 years, which has been enough proof of success to extend the practice to international shares, where it has also seen a positive return after two-and-a-half years.

The process of deciding which company to short follows a decision tree.

“We have set it up so there is no one person making these moral and ethical judgments,” he says. “It is either based on the activities the firms are in or in the case of the ESG research, it has to rank to a certain level; then it is just taken out.”

Public displays of moral judgment are also taken where necessary. It became the first Australian super fund to sign the ‘Investor Statement on Bangladesh’, joining over 190 global shareholders and investors, representing more than $US1.5 trillion, in calling on brands and retailers to implement an internationally recognised core labour standard.

The fund also entered into dialogue with Wesfarmers (an Australian conglomerate with ownership of several leading cut price clothing retailers) over the issue.

While LGS can see an investment return from its activities, one of its returns is just a feelgood factor in terms of the support it receives from individual members and councils that represent its employer base, who like the activism their retirement fund is involved with. There is also professional kudos too.

The fund was recently ranked second globally for its sustainable investment practices by the Climate Institute’s Asset Owners Disclosure Project, an award which assesses how 458 of the world’s largest investors are managing the risks and opportunities associated with climate change.

 

The outlook for economic growth this year is markedly positive, compared to last year, but capital market integrity is not improving, according to the opinions of more than 6,000 CFA Institute members.

The CFA Institute global markets sentiment survey, measures the views of its members on market integrity and economic issues. This year’s survey, which went to the entire universe of more than 119,000 CFA members, returned 6,561 responses.

This year’s survey showed there is more optimism for the prospect of the global economy with 63 per cent of respondents expecting an expansion this year, up from 40 per cent last year, and 34 per cent the year before.

This positivity is even more marked in Europe, where 69 per cent of the respondents believe the global market will expand.

The biggest positive impact on global economic growth will be the resolution of sovereign debt issues. Growth rates among emerging market economies was also a large contributing factor to global economic expansion.

The CFA member respondents, which were both on the sell and buy side, thought the US market provided the best investment opportunities for equity market returns, followed by China and Japan.

In 2013 the list was the US market, followed by China and then Brazil.

The biggest threat, or risk, to global markets is political instability, especially in the US, South Africa, China and Brazil, the respondents said.

In terms of the effect on local markets the biggest impacts were the progress of recovery in Europe (79 per cent said it was a positive impact) and the unwinding of quantitative easing (where 68 per cent said it would have a negative impact).

In terms of public policy reforms, the new liquidity requirements were seen as a positive, with 66 per cent of respondents believing those requirements will help prevent any future crisis.

But while positivity has returned to economic and market outlook, the same cannot be said of the CFA members’ outlook for market integrity. They don’t think the integrity of capital markets is improving.

The CFA Institute is promoting market integrity, with the belief that reforms can help improve trust and strengthen the financial system’s ability to resist shocks in the future.

It defines market integrity as the fairness of opportunities in the market.

Globally the CFA members in the survey cite improved regulation and of global systemic risks as the most important action needed to build investor trust and market integrity.

Lack of ethical culture within financial firms was seen as the biggest contribution to lack of trust in the financial sector.

The future of finance project now has a permanent place on the research agenda of the CFA Institute, with pension reform also a new workstream.

Too many companies are unprepared for the growing threat of a cyber attack. Investors have a role to play in ensuring this risk is firmly on the agenda.

In this edition of the Gemologist, we’ll look at the likely trajectory of the world’s second biggest economy in the light of this, argue why low growth could be better for investors – and show where we are finding value.