I’ve always been frustrated by interviewing consultants and the lack of conviction they have about their decisions.

“What would your ideal model portfolio look like?” I constantly ask.

“It depends on the client” is the predictable and consistent answer.

That may be valid, even true, but it speaks to a wider problem.

Consultants are hired to give advice. But most consultants don’t seem to want to put their hand on their hearts and back that advice or stand for it. Advice with conviction, which may at times include saying they got it wrong, would surely be more sought-after than peer-group or bland advice.

Consultants have been picked on in the media for the past couple of weeks, with the New York Times column Dealbook and the Financial Times article Billions of dollars wasted on investment advice both picking up on research by Oxford University’s Said Business School, Picking winners? Investment consultants’ recommendations of fund managers.

The research analysed what drives consultants’ recommendations of institutional funds, what impact these recommendations have on flows, and how much value they add to plan sponsors.

“We find that consultants’ recommendations of funds are driven largely by soft factors, rather than the funds’ past performance, and that their recommendations have a very significant effect on fund flows, but we find no evidence that these recommendations add value to plan sponsors,” the report says.

According to Andrew Ross Sorkin’s article in Dealbook: “Ultimately, Mr Jones wrote, the lesson of his research ‘would be to require investment consultants to provide the same high level of disclosure as that which is provided by fund managers on their performance, or the same level of disclosure provided by research analysts on their stock recommendations.'”

Adding cost

One of the key points to pick up on in this conversation, is that not only do consultants not add value, at least according to this research, but they do add cost.

Ron Bird and Jack Gray have written a lot about the agency problems in the investment industry and are due to publish a paper in Rotman International Journal of Pension Management entitled Principles, Principals and Agents.

The authors surveyed the chief executives of pension funds in Australia and subsequently non-Australian funds, with the responses revealing “the depth and complexity of the agency ecosystem in which the superannuation system is enmeshed; a system that imposes substantial costs on members’ retirement benefits”.

(Interestingly there is a footnote which explains that both authors have been and continue to be agents – consultants, investment managers and advisors.)

The paper seeks to better understand the structure, role, influence and costs of agents in superannuation and asked questions of the chief executives such as who are the agents and what do they do, how do agents justify their decisions and actions, and what are their supposed benefits to members.

It looks at trustee/directors, asset consultants, internal investment staff and external investment managers.

While the research found that the costs of consultants (10 basis points) was small compared to other agents, it worryingly reported agents’ costs have increased much more than funds under management and have doubled relative to agents’ reported influence.

The high level of relatively negative views about agents suggests that the superannuation system is far from optimally structured in members’ best interests, the paper concludes.

In many jurisdictions, pension funds as institutions are a relatively new phenomenon. In Australia for instance, the system is only 20 years old, and it is common for agents, or outsourced partners, to be used by the funds as they “grew up”.

Ill equipped

In fact funds have relied on consultants as they have evolved as institutions for good reason: they can’t make decisions themselves.

It is remarkable to learn how many large investors have very poor decision-making processes.

For the most part, the sophistication of the internal decision-making, governance structure and resources is not commensurate with the asset size of large institutional investors.

There are exceptions – such as the Canadian Pension Plan, the Australian Future Fund and New Zealand Super – but on the whole pension funds are not equipped to make decisions.

As funds take responsibility and ownership of this, create the functions and fill them with the resources necessary to make good decisions, the role of agents will diminish.

A review of the number and role of agents should be on the radar of all funds as they evolve into institutions.

At the United Nations-backed Principles for Responsible Investment conference Cape Town on October 1, general secretary of the International Trade Union Confederation Sharan Burrow delivered a speech entitled Push the Reset Button – a Line Between Speculation and Investment. She discussed the stability of the global economy, the necessity for investors to shift to long-term thinking and the crucial role of pension funds in truly sustainable investment. At the heart of Burrows’ speech is the centrality of workers’ capital – the money that funds the industry that feeds us – and the respect that deserves.

Read the full report here.

Michael Brakebill had never visited Nashville, Tennessee before he interviewed for the role of chief investment officer at the $36.6-billion Tennessee Consolidated Retirement System (TCRS) back in 2008.

Landing the job at the defined benefit scheme for Tennessee’s public sector workers, he left his position as head of domestic equity at Texas’ Teachers Retirement System in Austin and headed east.

“Nashville was never on my list of places to move before but it’s a great spot,” he enthuses from TCRS headquarters off Nashville’s tree-lined Deaderick Street. “Texas Teachers is larger and with more exposure at $110 billion assets under management, but the mandates and performance of the two funds are remarkably similar.”

In a strategy Brakebill describes as “not pulling a single magic lever but lots of small levers”, Tennessee is in the process of distributing a new allocation, laid out in December 2012, that aims to keep risk low but seek returns from new allocations to real estate, credit strategies and emerging markets.

“We have taken risk out of the portfolio and have a lower risk stance than others,” he says. “In fact we have typically 10 to 30 per cent less risk measured in a standard deviation framework than other public sector funds.” The Tennessee system also stands out from its peers in its preference for active management, which extends almost across the entire portfolio.

“We are primarily active. It pays off with fixed income especially; our externally managed international equity allocation has also done especially well,” says Brakebill.

Run internally in Nashville, TCRS has a 37 per cent allocation to domestic North American equity that includes Canadian stocks and investments are in a “plain vanilla S&P 1500” active portfolio. International and developed equity accounts for 13 per cent of assets under management and, in a new allocation created by reducing the domestic equity portion, the fund now has 4 per cent of assets in emerging market equities too.

 Keeping in clean

Brakebill, who describes progress in emerging markets as “tough this year, but strategically we are looking forward,” says the allocation is internally managed using exchange traded funds (ETFs) purchased via a screening process according to Transparency International’s corruption index and The Economist’s democracy ranking. The fund then purchases ETFs benchmarked from selected countries in the MSCI Emerging Markets Index.

“We wanted to avoid investing in nations which might be corrupt or undemocratic,” he says. It’s a process that has screened out major economies China and Russia, both highlighted as “key offenders.”

Nonetheless, it’s a strategy Brakebill is convinced will pay off, with the portfolio concentrated in better governed markets including Turkey, South Korea and Taiwan. “We do believe that better governance means better returns,” he says.

Strategic lending

The Tennessee system is also in the process of portioning a new 5 per cent strategic lending allocation. Funded by a reduction in its treasury inflation-protected securities (TIPS) domestic fixed income portfolio, the allocation will include high yield and bank lending plus other “interesting” credit allocations such as mezzanine and direct loans. “We have nothing sizeable here yet,” says Brakebill, pictured right, who oversaw initial allocations of $150 million apiece to Beach Point Capital Management and Brigade Capital Management earlier in the year. The portfolio will be benchmarked 50 per cent to the Credit Suisse Bank Leveraged Loan Index and 50 per cent to the Barclays Capital 2 per cent Constrained High Yield Index in a deliberate departure from the Barclays Capital US Aggregate Bond Index, currently yielding just 2 per cent.Brakebill-Michael-150

Brakebill counters that Tennessee’s push into new fixed income and credit strategies outside the traditional benchmarks isn’t a direct result of the Federal Reserve’s policy on quantitative easing. “Rates are lower than they would have been, but it has also boosted asset prices, particularly equities.” Tennessee’s strategy, he says, is more a consequence of a realisation that a third of the fund’s assets were in short-duration securities of between 0 and 4 years, yielding just 1 per cent or less. “It became apparent that a third of our assets were in zero yield and not doing any good for us. We do not need the liquidity and we were scratching our heads, wondering why we were there at all,” he recalls.

Real estate and private equity

Tennessee has also increased its real estate allocation, now around 5 per cent of total assets, expanding the mandate to include an opportunistic, higher risk real estate fund. The fund decided to push a more bullish position in response to “good” long-term returns from plain vanilla investments, namely fully leased quality real estate, which performed well in the financial crisis. Real estate returned 10 per cent for the 2012 fiscal year compared to 15.5 per cent in 2011.

Brakebill says the fund will also steadily boost its private equity allocation in a portfolio first begun six years ago. So far only $300 million, around 1 per cent of total assets, is invested in private equity but this will grow to “north of $1 billion”, with target returns set at S&P500 plus 300 basis points. It’s an allocation that will demand “long-term effort” to cultivate relationships with managers, and Brakebill highlights climbing values of private assets as another concern. Recent private equity commitments were made with Bain Capital and KPS. There are no plans to allocate to hedge funds. “We already have a bunch of balls in the air and we don’t want any more. Many big US pension funds haven’t had favourable experiences with hedge funds anyway.” Since TCRS shelved an international fixed income portfolio for its “unrewarding” allocation to Japanese debt, the only currency exposure hedged is in the international equity portfolio.

In a state of support

Brakebill attributes the scheme’s rosy health at 91 per cent funded to robust financial support afforded the scheme by Tennessee State. As well as “always meeting the number” – a reference to Tennessee’s preparedness to fund contributions when economic conditions tighten – the sate has also nurtured TCRS’s growing pool of internal expertise, with the Nashville team of 30 now managing the fixed income allocations, domestic equity, private equity, real estate and a trading arm. “We have been beefing up staffing in areas to reduce the operational risks of the fund,” he says. “We are very lucky that our staffing is going up, while overall the State is cutting back on personnel,” he says. “They think highly of what we are doing at the treasury and decision-makers have shown great courage in supporting us through a difficult period.” In another development, the state is also restructuring its retirement provision. From July 2014 it will introduce a new hybrid defined contribution/defined benefit scheme for all new hires in Tennessee. It will likely mean Brakebill’s treasury team begin to manage new defined contribution assets in a fund with all the characteristics of TCRS’s low risk, stable portfolio.

 

Simply comprehending the myriad of national institutional investing systems, investor types and priorities can be an onerous task. Attempting to coordinate an international effort to promote an uncommon investment strategy choice is well and truly herculean.

That is the challenge facing Raffaele Della Croce and the rest of the team behind the Organisation for Economic Co-operation and Development’s long-term investing project as they seek to lengthen the time horizons of investors and get institutional money flowing from across the world into infrastructure gaps.

Della Croce, who leads the Paris-based organisation’s project and is pictured right, argues that an international effort is vital for the infrastructure drive to succeed. “Large investors are looking at global markets as they diversify portfolios and they are increasingly discarding any national biases,” he says. He adds that financial regulation, a major influence of investment strategy choices, is also becoming more and more internationally coordinated.

In explaining the background to the OECD’s push, Della Croce says that its enduring work on institutional investors and data collection on them had been leading it to focus on asset allocation trends. The financial crisis then struck, and a desire to help inform the global effort to restore growth in the aftermath got the organisation active.

Feedback from the market that long-term investment was lacking then spurred the OECD to launch its project in 2011. The OECD cites just 1 per cent of combined global pension fund assets of $20 trillion as being invested directly into infrastructure at the end of 2012.

Powerful allies

“Our approach is to have a holistic view of the different barriers investors face – from regulation to governance and specific issues on infrastructure investments,” says Della Croce. “We want to put all this within the context of a policy framework that can actually respond in a comprehensive way.”

The OECD project has enlisted some powerful allies in its quest, most notably the G20. While headlines were dominated by discussions on the international community’s response to the Syria crisis and pledges for collaboration on tax avoidance, the G20 leaders’ declaration formulated in St Petersburg in early September acknowledged the importance of long-term investing.

The OECD’s wide-ranging set of high-level principles on long-term investing by institutional investors also became endorsed by the G20 leaders. These principles cover everything from government incentives, regulation and tax to financial education. They are designed to help policy makers promote long-term investing, but their breadth arguably also indicates the sheer complexity of the initiative.

The principles call on governments to work on sustaining private involvement in long-term projects and consider “issuing appropriate long-term instruments” to investors. Risk mitigation, promoting pooled investment vehicles, setting appropriate investment regulation and accounting rules, plus avoiding “crowding-out private investments” also make the list of recommendations to governments.

Along with enhanced political will, finding the right risk/return profiles for various infrastructure possibilities the world over is essential, Della Croce stresses. He agrees that beyond all the specific obstacles, a mentality shift is needed to bring the long-term investing dream to fruition. “At times messages that seem easy to communicate are not being communicated clearly,” he reflects. “A big motivation for our project is that investors did not feel that what they were asking for on the policy side was being acted on.”

The world needs you

While the OECD project is calling on governments and regulators to do their part, it also wants to see asset managers and owners tackle obstacles. Asset managers can play their part by easing shortages of data, transparency and trust that currently restrict the potential of infrastructure investments, Della Croce argues.

Investors, on the other hand, need to ensure sufficient governance is in place if they are looking to invest in infrastructure or other uncommon long-term assets, he says.

Insights from the world’s largest investors have been vital for the OECD’s efforts to date. The project has worked closely with a select group of participant funds that rank among the world’s biggest, including APG and the Canadian Investment Pension Plan as active partners but also CalPERS, Norway’s Government Pension Fund Global, PGGM and AustralianSuper.

Investors discarding reluctance to share information on investments is highlighted by Della Croce as a vital step for the long-term investment agenda to take off. The OECD project has analysed specifically how Canadian and Australian funds have been able to take the lead internationally on infrastructure investing, and Della Croce thinks that more can be done to   share their know-how with the rest of the world.

“They have created a track record in infrastructure investing which is missing in many other countries,” says Della Croce. He argues that the direct investing typical of Canadian funds and open-ended fund vehicles in Australia show varied approaches can succeed. The fundamental differences between the two pension systems (Canadian pension funds being largely defined-benefit investors and their Australian counterparts defined contribution) meanwhile suggest there is potential in all kinds of markets.

Della Croce takes pride in the OECD helping asset owners to match the vociferousness of asset managers on the issue. Fundamentally, he feels investors willing to take the lead can benefit handsomely. “It is not about forcing investors into investing into assets they are not comfortable with, despite interest from the policy side in infrastructure,” Della Croce emphasises.

Della Croce’s team is set to publish a survey of large pension investors’ experiences and attitudes on long-term investing later in October. This should serve as another milestone in the lengthy process of shaping policy, which “won’t finish in a year or two”. Making sure the Australian presidency of the G20 next year furthers the agenda by the time of the leaders’ meeting in Brisbane in November 2014 is the next priority. With the OECD identifying a global infrastructure gap of $2 trillion per year from now to 2030, the success of the much-discussed long-term investing agenda is likely to be gauged for decades to come though.

A scathing report into the United Kingdom’s £275-billion ($441-billion) defined contribution pension sector by national watchdog the Office of Fair Trading that lambasts high charges and complexity could have gone further say modern, low-cost pension providers. The OFT has agreed a range of reforms to the workplace pension market after its study found millions of savers weren’t getting value for money. “We do not feel they have been sufficiently radical in their approach,” says Jamie Fiveash, director of customer solutions at B&CE, a provider of workplace pensions with more than $3 billion of defined contribution assets under management in schemes that include The People’s Pension, a super trust set up in 2011 ahead of auto-enrolment. “It should be much easier to make pension transfers from old and poorly governed legacy schemes into large scale, modern and well governed schemes.” Secondly, he argues policy makers should introduce an industry-wide charging structure to allow for informed choices. “This will ensure competition on products and service delivery rather than on obscure charging mechanisms, inevitably leading to the driving down of prices,” says Fiveash.

Morten Nilsson, chief executive of NOW: Pensions, a defined-contribution workplace pension scheme provider and UK subsidiary of Danish public pension plan ATP, adds: “To help employers select a scheme that is fit for purpose and is going to deliver on its promises to members, we support the OFT’s recommendations. The success of auto-enrolment will depend on the ability of providers to build trust and earn confidence among their members. If members don’t trust their provider and see their hard-earned pension pot being eaten up by high charges and their fund performing poorly, the motivation to stay enrolled with be sorely tested.”

The OFT’s findings, gathered from a six-month investigation into the defined contribution market, raised concerns around older schemes set up before 2001 in which savers are paying charges of 1 per cent or more. It is estimated that $48 billion is locked in these schemes run by insurance firms and trust boards. They account for around 190,000 savers, who could be losing around 20 per cent off the value of their pensions. Such charges contrast with the new wave of defined contribution providers, which include government-backed scheme, the National Employment Savings Trust (NEST), whose charges gravitate around 0.5 per cent of a saver’s pot. Auto-enrolment is expected to see 9 million extra people joining defined contribution schemes over the next five years.

Mea culpa

In response to the criticism, the Association of British Insurers (ABI), whose members offer many of the criticised schemes, has agreed to carry out an audit of the larger schemes, some of which are charging up to 2.3 per cent in annual management fees. Elsewhere, Legal and General has recently introduced caps on charges for auto enrolment workplace pensions at 0.5 per cent, a price cap that will not apply to members who want more investment choice than the default fund.

The report also highlighted a lack of competence among trustees responsible for running some schemes and raised concerns about savers in 3,000 smaller pension schemes, collectively worth about $16 billion and with 1,000 members or less, who may be at risk due to poor governance. Active member discounts (AMDs), which hike charges when an employees move jobs but don’t take their pensions, also came under fire. “We welcome the OFT proposal that all schemes, including contract-based ones, should have governance committees to help serve consumers’ interests. We have found that consumers are particularly reassured by NEST’s independent governance, which has members’ interests at heart, and the fact we are run on a not-for-profit basis,” says NEST chief executive Tim Jones.

Stand and deliver

But pension experts also believe the OFT was right to stop short of recommending a cap on charges levied by providers, and that charges will continue to fall. “There has been a slow reduction of charges through market pressure in the defined contribution world ever since 2001, when stakeholder pensions where introduced,” says Alan Morahan, principal at Punter Southall DC Consulting in London. “If the government had set a cap at 0.7 per cent, it would abate the downward movement. On the other side of the coin, a 0.3 per cent charge might be too low for schemes to be viable.”

The closure of defined benefit schemes and the introduction of auto-enrolment is expected to bring a “tsunami of money” to defined contribution schemes, warns Morahan. “Unless they get charges right, and also investment performance, administration and saver engagement, there is a danger they won’t deliver.”

The Robert F Kennedy Centre for Justice and Human Rights and Columbia University’s Earth Institute will run a series of high-level courses on sustainable investment focused on environmental, social and governance approaches as well as human and labour rights this autumn.

The Compass Sustainable Investing Certificate program, designed for long-term investors, will have a solutions-driven focus showing investors how to mitigate risk and improve returns. Looking at sustainable investing across all asset classes, the course aims to correct the misperception that sustainable investment underperforms and offer ways to invest sustainably with tools other than negative screening. It will feature keynote speakers from a stellar faculty and networking sections in a participation-driven approach over two weekends.

The course takes place over six days on October 18, 19 and 20 and December 6, 7 and 8 at Columbia University, New York City. Email kaul@rfkcenter.org, call 646-553-4753 or go to www.RFKCompassEd.com.