This article by Arthur Wilmarth from George Washington University Law School uses Citigroup as a case study to demonstrate the question of whether bank executives and regulators are able to supervise and control today’s complex megabanks.

The study shows that post-mortem evaluations of Citigroup’s near-collapse revealed that neither Citigroup’s managers nor its regulators recognized the systemic risks embedded in the bank’s far-flung operations. Thus, Citigroup was not only too big to fail but also too large and too complex to manage or regulate effectively. Citigroup’s history raises deeply troubling questions about the ability of bank executives and regulators to supervise and control today’s megabanks.

According to the article, Citigroup’s original creators – John Reed of Citicorp and Sandy Weill of Travelers – admitted in recent years that Citigroup’s universal banking model failed, and they called on Congress to reinstate the Glass-Steagall Act’s separation between commercial and investment banks. As Reed and Weill acknowledged, the universal banking model is deeply flawed by its excessive organizational complexity, its vulnerability to culture clashes and conflicts of interest, and its tendency to permit excessive risk-taking within far-flung, semi-autonomous units that lack adequate oversight from either senior managers or regulators.

The paper can be downloaded here 

 

As the chief executive of a financial services media and events business, Colin Tate* benefits from the growth in the banking sector. But at the same time he is perplexed by their bad corporate behaviour, large pay packets, and secret negotiations. It’s time, he says, for institutional investors to demand change.

 

I’m not a bank basher. To the contrary, I benefit from the financial system, arguably more than many. I am the major shareholder of Conexus Financial, which publishes five media titles and hosts a dozen conferences, and many of our clients are banks or subsidiaries of banks.

That said, I am disturbed by the seeming lack of real lessons learned, as demonstrated by a lack of behavioural change from the financial crisis.

The “greed is good” mantra that emanates from those trusted with (mostly) other peoples’ money, is disconcerting. It makes me question whether the American-mindset is out of touch with the rest of the planet.

I understand this commentary will be offensive to some of our readers and many of our advertisers. Good.

This has gone on long enough. It’s time to have a frank and open discussion about the behaviour of banks and other financial institutions, and indeed the inactivity from the institutional investors which have the ability to influence this behaviour, and don’t.

Underneath the layers of players we must remember that this is mostly workers capital; the worlds’ retirement savings.

This past month a new scam has been uncovered, in which a major global bank, the venerable Credit Suisse, has been in cahoots with US citizens in illegal tax avoidance – but it says it was the work of a small number of “rogue” bankers.

Meanwhile, RBS has announced an $8 billion loss, but somehow found the wherewithal to pay $576 million in executive bonuses, while still majority-owned by the UK taxpayer.

What is perhaps more surprising are recent comments by UBS global chief, Sergio Ermotti, who at the recent Davos World Economic Forum said critics of banks should ‘back off’.

Quoted in the Wall Street Journal a clearly exasperated Ermotti said: “Life is hard enough, and I think this constant lecturing on ethics and integrity by many stakeholders is probably the most frustrating part of the equation. Because I don’t think there are many people who are perfect. We are far from being perfect…but it’s not going to be very helpful to be constantly bashing banks.”

UBS has been bailed out by tax payers, suffered huge losses, endured a rogue trading scandal, and has admitted a central role in the manipulation of the London interbank offered rate (LIBOR) – paying a $1.5 billion fine to regulators in December 2012 as a result.

Is he for real?

But maybe the Oscar should go to JP Morgan and its chief: Jamie Dimon.

Dimon took home an 85 per cent increase in bonus in 2013, pocketing $18.5 million worth of restricted stock (his base salary is “only” $1.5 million), up from $10 million the year before, and following a period when the bank’s fines totalled a reported $18.6 billion, relating to “inappropriate or illegal” behaviour.

The bank attributed the pay increase to a number of factors including Dimon’s role in cutting a deal with Washington.

What am I missing? What are we rewarding here? Besides the staggering size of the dollars involved and the staggering size of the bonuses awarded while these organisations downsized and laid off staff globally, why are we not more strongly questioning the ethics?

There is always fertile ground for debate when it comes to ethics, an issue which in my mind goes beyond the letter of the law. Institutional investors and the value chain of investment players have a fiduciary duty to act in the best interests of those whose money they manage.

Ethics and investment is at a crossroad. The CFA Institute and others are looking to re-establish trust in the industry, but it is also up to the individual players to do their part.

Institutional shareholders must answer some serious questions. Are you caught up in a fantasy that some institutions literally are too big to fail, or even to question? Do you own shares in the parent, or run money with their investment management arm or have a custody mandate with the firm?

Or am I just out of touch? Maybe Warren Buffet is right and Jamie Dimon is worth an even larger pay-packet.

But the sad part is that even senior employees I talk with inside these organisations are often embarrassed by the behaviour, the total lack of responsibility and the conspicuous absence of individuals in jail for the spectacular failures and sometimes the outright fraud of the GFC.

And banks keep asking us to ‘back off’.

While mums and dads, the media and some governments agitate for change and reform, what are the major institutional owners of these organisations doing to say: enough is enough?

 

To make a comment on this story you can email comment@conexusfinancial.com.au or make a comment below

*Colin Tate is the chief executive of Conexus Financial, the publisher of conexust1f.flywheelstaging.com

 

Celebrating active ownership day, Simon Howard the chief executive of the UK Sustainable Investment and Finance Association, describes the business benefits of active ownership.

 

Active ownership by investors is becoming increasingly recognised for delivering a range of business benefits from helping to protect corporate reputations, to increasing share prices.

Active ownership funds, i.e. those that use voting and engagement as part of their investment strategy, are estimated to be worth at least €1.9 trillion in Europe and $4.7 trillion worldwide, according to the Global Sustainable Investment Alliance; and this year a record number of shareholder proposals on environmental, social and governance (ESG) issues at listed US firms have been reported.

To acknowledge the growing momentum behind active ownership as an investment strategy, this week investors in the UK will mark Ownership Day – an initiative dedicated to raising awareness of its benefits

 

Turning active ownership into a business benefit

There are numerous examples of the business benefits of active ownership from reputation improvements to increased shareholder value.

For example, award-winning research co-authored by London Business School Professor Elroy Dimson analysed investor engagement with US companies over 10 years to 2009.

The research concluded that share prices rose by an average of 4.4 per cent in the year after an investor engagement was concluded.

It also found that companies experienced improvements in operating performance, profitability, efficiency and governance following active ownership by shareholders.

One of the world’s most high-profile active owners is CalPERS (California Public Employees’ Retirement system), the largest pension fund in the US.

Each year CalPERS engages with a selection of companies (known as their focus list) judged to be performing poorly in areas such as corporate governance. Over a period from 1992-2005, CalPERS calculated that their focus list activism helped create shareholder value of over $3 billion.

The benefits of active ownership extend to wider society too. For example, in 2001 a group of investors in Gap submitted a resolution at the company’s AGM asking the company to address poor labour practices within its supply chain in order to avoid its brand becoming at risk from a consumer boycott.

This active ownership triggered several years of work that has resulted in steady improvements and now 99% of Gap factories being closely monitored for poor labour standards.

Starting in 2009 a collaborative engagement facilitated by the UN-supported Principles for Responsible Engagement saw investors engage with 16 major consumer electronics companies to ensure the companies’ supply chain policies and practices were transparent and sufficiently robust to address risks of involvement with conflict minerals in the Eastern Congo.

The engagement resulted in scores for overall company performance in this area increasing by an average of 23 per cent from 2010 to 2011. Improvements were seen in the area of public disclosure and in implementation of measures to monitor the activities of suppliers.

Recently Carbon Action was formed, an investor-led initiative that engages with companies to make year-on-year emissions reductions, implement carbon reduction emissions and set targets.

This targeted engagement has led to more than half of 256 targeted companies setting tougher targets for emissions. Companies with targets have been shown to achieve year-over-year absolute reductions in CO2e of more than double the rate of companies without targets, as-well as being 10% more profitable than those without targets.

 

Growth of active ownership in the UK

More than £800 billion of assets are now invested this way in the UK and over 200 asset managers, including 30 of the biggest, have now signed the Stewardship Code – a set of Principles supported by the UK Government to encourage active ownership by institutional investors.

According to a survey by the UK’s National Association of Pension Funds, over 96 per cent of pension funds now support the belief that as investors they should have stewardship responsibilities.

But much more still needs to be done. Only 21 out of 100 individual Local Authority Pension Funds have signed up to the Stewardship Code, as these are significant funds they will not only benefit from significant financial returns but also improved reputation if shareholders become active owners. It now makes business sense for all public funds to sign up or incorporate the Code’s expectations within their Statement of Investment Principles.

If it achieves nothing else, I hope that Ownership Day raises awareness about the benefits of this strategy among pension funds and asset owners, and encourages them to demand more high-quality ownership services from their managers and consultants.

That not only helps protect their returns in the long run but, ultimately, can encourage more responsible capital markets.

 

 

Superannuation funds in Australia are not putting enough emphasis on data and technology as a tool to strengthen member engagement or as a platform for their business. There is plenty they can learn from Rayid Ghani, chief scientist for the Obama for America 2012 campaign, who was the keynote at the Conference of Major Superannuation Funds this week.

 

It wasn’t data that won Barrack Obama his second term as the President of the United States, it was analytics. This might seem like a frivolous distinction, but actually it’s important, and one that superannuation funds in Australia can learn from.

The distinction is this, data on its own is not a powerful tool, it’s how you analyse it and what action you take as a result of that analysis as to where the power lies.

The Obama for America 2012 campaign analytics team has been credited with winning the election for Barack Obama, and for changing the face of campaigning forever.

Obama’s team, which included Rayid Ghani, as chief data scientist, used analysis of data to raise $1 billion, identify and target swing voters, and influence behaviour through ad campaigns and social media.

The team had a very clear goal, to win, but it used analysis of the data it collected to achieve that goal in a sophisticated way.

“We had a goal ‘to win the election’,” Ghanis says, “but beneath that our second level goal was to increase our chance of winning not to get more votes.”

A vote can be had in three ways: to register a voter, change the mind of an existing voter, or push existing supporters to vote, and Ghani and his team looked at targeting and selecting individuals on this basis.

“On an individual basis we looked at who to register or who to persuade, and then once they were identified we worked on how to persuade them. You need to break it down, and data plays a role at each level.”

It is Ghani’s belief that super funds are not tapping into this simple but powerful tool of using data to make high level decisions about the direction of the company or to achieve a particular goal.

“It is common sense but not really common that you can use more data to be more rational,” he says. “You make decisions regardless, so if you have the right data it makes you be more rational. It also means you can manage risk better. If you are taking risk you know you are and can account for it.”

For example, he says if a super fund is trying to get a new member, or get a member to switch from another fund, there are a number of ways of doing that, including persuasion.

“This means you need to identify who is persuadable and focus on them, otherwise it is a waste of resources trying to persuade people who won’t or can’t be persuaded. This is where data can be useful in breaking down the problem.”

Ghani claims not to like the term “big data” because he doesn’t like the inference of size.

“Size is independent of how useful or effective data is. We focus more on actions and using data effectively; using it to be more rational and make better decisions,” he says.

The Obama analytics team contacted 54,739 voters from paid call centres and asked them how they planned to vote. They also used existing supporters as extensions of their own work, enabling them to reach out to an enormous amount of people – more than 150 million. This data was distilled down to individual-level predictions, including a score on an individual’s likelihood of supporting Obama. The data gave them a starting point for action.

A number of actions followed depending on what the data revealed.

This flexibility is a hard concept for most business to grasp, Ghani says, adding that the ability to evolve a plan depending on the data is an essential part of useful analytics.

“You need a good conceptual idea and plan, but if data is not available, or data tells you something new, it needs to be able to evolve,” he says.

If for example, a super fund plans to increase its membership of people under 30 but once the analysis is done it is revealed that’s not possible with the available resources, the plan has to change to either put in more resources or change the goals.

“This is hard for a lot of businesses to do. Most businesses are not used to uncertainty, and it’s hard to start a project not knowing if it’s going to work.”

One of Ghani’s tips to avoiding disappointment in a project in the form of cost or failure, and something that was done during the Obama campaign, is to design short projects, typically three weeks to a month.

In addition he stresses there needs to be a willingness across the entire organisation, a top-down support, to experiment with the projects.

“If you’re looking at the case of trying to persuade new members, how do I know that people are persuadable? What we did is try different tactics on a small set of people over and over,” he says.

“We were running experiments of different types every day, it could be anything like an experiment on how to write better emails. It needs to be part of the culture.”

One of the obvious distinctions in the superannuation market at the moment is the different levels of technology between industry fund sectors and the retail providers, particularly the banks.

But Ghani doesn’t believe this war is won, or that it is too late for industry funds to have success on this front.

“Industry funds need to focus on an end goal, not on being better at technology than the banks. Technology is a means to an end not a goal in itself,” he says.

In addition, and this is the good news for industry funds, he says banks have saturated their outreach.

“From what I see there is a lot that industry funds haven’t done in individual outreach, but banks are overdone,” he says. “Industry funds can be different because they don’t have a history. This makes it easier to have a new experience as customers are not immune to the communication. The brand and communication is a new experience, you are not competing with yourself.”

 

 

For the Centrica pension fund, which adopts a liability-matching portfolio approach, last year was busy for appraising new opportunities arising out of the fact banks are no longer lending. This year its focus is on being more dynamic. Amanda White spoke to chief investment officer of the £5.5 billion ($9 billion), Chetan Ghosh.

The Centrica pension fund adopt a liability-driven approach, with a separate hedging portfolio, and growth portfolios which have slight adaptations for the three underlying pension schemes.

Fundamentally, instead of a strategic asset allocation as an investment objective, the investment committee sets a liability-related target.

“We are trying to set the optimal portfolio to best capture forward looking returns anywhere in the world in any market. We are conscious of our risk parameter so all the hedging must bring investments back to permitted boundaries,” Ghosh says. “It’s best ideas adjusted for risk.”

The fund targets excess returns over gilts which must be done within permitted volatility boundaries relative to how gilts move.

The allocations are driven by the best way to achieve return targets and investments are allocated to asset classes on a bottom up basis, aggregating up to percentage holdings in return-seeking and liability-matching, rather than the other way around.

At the moment across three schemes 20 per cent is allocated to liability-matching assets and 80 per cent in growth above the risk free.

Last year the fund looked at the top-down philosophical view, which matched with the bottom opportunities, of exploiting opportunities due to the fact banks are not, or can’t, lend anymore.

Some of the investments the fund assessed, and adopted, included mining loyalties, and social housing.

“Both of these played to the bank financing theme. Mining companies can’t get the financing they used to, and in social housing banks have pulled new finance. In liability matching we want long-dated cash-flow generating assets and these fit,” says Ghosh, who was educated at The Kings College, University of London where he received a First in Maths.

Within the growth portfolio bank financing was also a theme with the fund looking at niche, illiquid credit opportunities including direct lending, mezzanine financing and senior loans.

Within equities the fund appointed three new global unconstrained mandates as well as frontier equities and small cap.

The fund outsources all investment, and only has an internal team of three looking after operations and administration, managers monitoring and project research into new asset classes as well as the generation of new ideas.

One of the defining characteristics of its outsourced model is it works closely with managers, both for new ideas, but also to tailor mandates and opportunities.

For example Ghosh and his team have liked the insurance theme for some time, and the fund finally allocated to insurance-linked securities, but after a long search to find the right manager.

“We have liked it for a while but it took us a long time to find the right manager with the right fees,” he says. “We removed the performance fee as we think for that asset class it is not appropriate.”

Forming a network of trusted partners in asset management and banking for the generation of new ideas was one of Ghosh’s first priorities when he came on board in 2009.

“I wanted to build a network of trusted partners in the asset management and banking communities so we were not overly reliant on our consultant,” he says.

“We say the door is open if you have something relevant, but if you abuse that then the door will shut on you,” he says, adding that managers have all had a respectful manner in presenting their ideas.

“The last 10 things we have done have come from the internal team, through this process, rather than from the investment adviser,” he says, adding the consultant, Mercer, is still very much on board.

Since 2009 the governance of the fund has also evolved, with trustees setting liability related objectives. The advantage of this approach, Ghosh says, is that trustees are not in decision paralysis.

The fund has three independents on the investment committee which the team believes makes it easy to process ideas, which the CIO implements.

And there are mechanisms in place to converse between meetings, so that investment decisions can be made quickly.

“In the UK traditional pension schemes haven’t sought to be dynamic, but it is a priority in 2014 to enhance how dynamic we are. We want to focus on taking advantage of extreme valuations of asset classes or sub asset classes,” Ghosh says.

 

 

This paper estimates hedge fund and mutual fund exposure to newly proposed measures of macroeconomic risk that are interpreted as measures of economic uncertainty.

The academics, from Georgetown and Stern, find the resulting uncertainty betas explain a significant proportion of the cross-sectional dispersion in hedge fund returns. However, the same is not true for mutual funds, for which there is no significant relationship.

 

To read the paper click below

Macroeconomic risk and hedge fund returns