While the trend for most large institutional investors is to insource asset management, the $85-billion Washington State Investment Board (WSIB) has decided to take a different path.

Much-cited CEM Benchmarking research shows that funds with internal-management platforms are better performers after cost, and this is largely driven by the lower costs of internal management.

Many of the Canadian funds manage the majority of their assets in-house including OMERS, OTPP, CPPIB, and HOOPP, which manages all of its assets internally.

More broadly, AustralianSuper, New York City Retirement System and CalPERS have all made moves in recent months to bring more assets in-house, in line with CEM’s study.

However, the $85-billion WSIB is bucking the trend, which comes after much executive research on the topic and debate with the board, says executive director of the fund, Theresa Whitmarsh.

“The fundamental point is the CEM work is good but I don’t find it a definitive case for insourcing,” she says.

 

Staff in the house

One of the reasons for this is the case for talent, she says.

“Many of the funds CEM cites are unique because they are in Toronto and they can attract the talent. Toronto is like pension Mecca, like a Silicon Valley for pension funds; it has a labour market that’s reinforcing and that is completely different to Washington State and Olympia where we are based.”

In addition, many US public-pension funds are restrained by their budgets.

By way of example, CEM reports in its organisational design study of the world’s largest 19 funds, that the average salaries of investment departments in Canada was $536,000, in Europe it was $246,000, for the US$148,000, and in Australia and New Zealand $139,000.

In June, the WSIB board approved a compensation plan for investment staff, which it says will make progress in closing the 42-per-cent compensation gap between WSIB investment officers and the average investment officer of its peers.

Clearly this is an obstacle for the fund to hire more staff, which would be necessary to bring more assets in house, despite the potential future savings.

“At the board level, if we do more internally, we will need more legislative authority for budget, and that’s a non-starter in this market,” Whitmarsh says. “We’re succeeding under the current structure. I’m not completely convinced the insourced model is proven out.”

 

At a deeper level

Whitmarsh believes it is critical to look beyond peer statistics and to the circumstances that created the success.

“It’s not that simple. Success is not just governance and structure, but it is also asset allocation and the talent that could manage that. You have to look at it at a deeper level.”

She says the success of OTPP and CPPIB are often attributed to their insourced model, but it is also due to asset-allocation decisions and the organisations’ maturity.

“OTPP has had a high allocation to fixed income, which ruled last decade, and in the early 2000s CPPIB was not investing, so they missed the 2001 crash. Washington State has always been top-quartile with a largely outsourced model.

“What they’ve accomplished is excellent, but is it replicable for us just based on the insourcing model?”

The WSIB manages investments for 17 retirement plans, and at the end of June 2011, 31 per cent of its assets were in fixed income, 35 per cent public equities, 18 per cent private equity, 10 per cent real estate, and the rest allocated to tangible assets, innovation and cash.

The fund will conduct an asset allocation review in 2013.

Theresa Whitmarsh will join a panel on the insourcing debate at the Fiduciary Investors Symposium in Santa Monica. For information, click here.

To find out more about in-sourcing and other management options, click here to read The scope of financial institutions: in-­sourcing, outsourcing and off-­shoring.

There are three major behavioural shifts occurring among investors that will have significant impact on asset allocation in the next 10 years, according to a year-long study by global head of research at State Street’s Center for Applied Research, Suzanne Duncan.

An increase in investor sophistication, re-evaluation of the risk/return trade-off and more discernment over fees have been highlighted as trends in investor behaviour.

State Street’s research was derived from thousands of industry participants including retail and institutional investors, service providers such as consultants, and government and regulators from 68 countries. It is part of a one-year study looking at the investment-management industry over the next 10 years and will be released in November.

 

What exactly am I paying for?

Duncan believes the study clearly debunks the belief that investors have inertia.

“Investors are really looking for the service providers to show them the value they’re getting. On the institutional side investors are clambering for clarity with regard to value,” she says. “That’s different to price sensitivity. This is about being discerning, investors are becoming more sophisticated and they are willing to pay but only if they are shown the value they’re receiving for it.”

She says when providers demonstrate that value, it’s not necessarily commensurate with the fees being charged, and this may result in a continued movement from active to passive management.

“Investors are disenchanted for a reason. When we apply this level of sophistication of investors, we will see sizeable asset-allocation shifts.”

In other trends, the asset class with the largest allocation over the next 10 years for retail investors will be cash, while for institutional investors it will be alternatives.

Further, as alternatives allocations are increasing, so are allocations to direct forms of investments, which Duncan says shows a “disintermediation play”.

“Investors are questioning the value that professionals can provide,” she says. “There is no transparency around the value they’re receiving. Some of this is cyclically tied to the crisis, but those three behavioural trends are ongoing.”

 

Clash of best interests

Transparency continues to be a key theme for investors in terms of communication about products. Part of this is about the complexity of the products, but a lot is also about simplifying the message.

Investors thought that this problem may be exacerbated by regulators, with more than 50 per cent of them thinking current regulatory initiatives will not help to address the current problems.

“We may end up with information overload – not the right information. It’s not about volumes of information, but digestible forms of information,” she says.

The project, which has been nicknamed the “influential investor”, shows investors want to see the detail, the fine print, but they also want two sentences that are relevant to them at the macro level.

One worrying outcome of the research has been the mismatch between investors’ wish list and the preparedness of service providers.

“The investor wish list is the same list as the items listed as the top funds-manager weaknesses,” she says.

Further, only one third of investors believe that providers are acting in their best interest.

 

Restoring trust

However Duncan says the good news is that the industry recognises there is a big gap at the macro and micro level and is looking for creative ways to tackle it outside of the industry.

“This is interesting because they think the solution is not within this industry. I’ve been researching this for many years, and I’d say no one industry stands out but there are stand-out companies including Procter and Gamble, Apple and Audi, which are all about the experience,” she says. “The industry wants to look at what they’ve done and lessons learnt from them.”

The State Street research shows that what is driving the desire for transparency from investors is a restoration in trust from providers, markets and regulators.

Despite the seemingly dull future, Duncan says the research is optimistic because the industry is responding to the challenges.

“We have seen denial, then awareness, and now the industry is starting to be experimental in how we go about doing this,” she says.

The Center for Applied Research was launched in June 2011 to provide strategic insights into the issues that will shape the investment management industry.

The results of a year-long research project by State Street’s Center for Applied Research will be showcased at the Fiduciary Investors’ Symposium in Santa Monica. Click here for more details.

A research paper by MSCI examines the implications for Dutch pension plans if the country’s regulators introduce the ultimate forward rate in the construction of the yield curve used to discount pensions’ liabilities to their present value. Read all about it here: Research_Insights_Dutch_Pension_Plans_Sept_2012

There are three major behavioural shifts occurring among investors that will have significant impact on asset allocation in the next 10 years, according to a year-long study by global head of research at State Street’s Center for Applied Research, Suzanne Duncan.

An increase in investor sophistication, re-evaluation of the risk/return trade-off and more discernment over fees have been highlighted as trends in investor behaviour.

State Street’s research was derived from thousands of industry participants including retail and institutional investors, service providers such as consultants, and government and regulators from 68 countries. It is part of a one-year study looking at the investment-management industry over the next 10 years and will be released in November.

 

What exactly am I paying for?

Duncan believes the study clearly debunks the belief that investors have inertia.

“Investors are really looking for the service providers to show them the value they’re getting. On the institutional side investors are clambering for clarity with regard to value,” she says. “That’s different to price sensitivity. This is about being discerning, investors are becoming more sophisticated and they are willing to pay but only if they are shown the value they’re receiving for it.”

She says when providers demonstrate that value, it’s not necessarily commensurate with the fees being charged, and this may result in a continued movement from active to passive management.

“Investors are disenchanted for a reason. When we apply this level of sophistication of investors, we will see sizeable asset-allocation shifts.”

In other trends, the asset class with the largest allocation over the next 10 years for retail investors will be cash, while for institutional investors it will be alternatives.

Further, as alternatives allocations are increasing, so are allocations to direct forms of investments, which Duncan says shows a “disintermediation play”.

“Investors are questioning the value that professionals can provide,” she says. “There is no transparency around the value they’re receiving. Some of this is cyclically tied to the crisis, but those three behavioural trends are ongoing.”

 

Clash of best interests

Transparency continues to be a key theme for investors in terms of communication about products. Part of this is about the complexity of the products, but a lot is also about simplifying the message.

Investors thought that this problem may be exacerbated by regulators, with more than 50 per cent of them thinking current regulatory initiatives will not help to address the current problems.

“We may end up with information overload – not the right information. It’s not about volumes of information, but digestible forms of information,” she says.

The project, which has been nicknamed the “influential investor”, shows investors want to see the detail, the fine print, but they also want two sentences that are relevant to them at the macro level.

One worrying outcome of the research has been the mismatch between investors’ wish list and the preparedness of service providers.

“The investor wish list is the same list as the items listed as the top funds-manager weaknesses,” she says.

Further, only one third of investors believe that providers are acting in their best interest.

 

Restoring trust

However Duncan says the good news is that the industry recognises there is a big gap at the macro and micro level and is looking for creative ways to tackle it outside of the industry.

“This is interesting because they think the solution is not within this industry. I’ve been researching this for many years, and I’d say no one industry stands out but there are stand-out companies including Procter and Gamble, Apple and Audi, which are all about the experience,” she says. “The industry wants to look at what they’ve done and lessons learnt from them.”

The State Street research shows that what is driving the desire for transparency from investors is a restoration in trust from providers, markets and regulators.

Despite the seemingly dull future, Duncan says the research is optimistic because the industry is responding to the challenges.

“We have seen denial, then awareness, and now the industry is starting to be experimental in how we go about doing this,” she says.

The Center for Applied Research was launched in June 2011 to provide strategic insights into the issues that will shape the investment management industry.

 

The results of a year-long research project by State Street’s Center for Applied Research will be showcased at the Fiduciary Investors’ Symposium in Santa Monica. Click here for more details.

 

 

A week-long Board Effectiveness Program with peers from around the globe, including those from Canada’s HOOPP and Denmark’s ATP, has given AIMCo board member, Andrea Rosen, a new perspective on best practice.

In a business environment where most people are working harder, multi-skilling, facing lower-than-necessary resourcing, staffing and margins, a week-long course could be viewed as indulgent.

But the value of networking with global peers, discussing and implementing governance best practice, was not lost on AIMCo board member, Andrea Rosen.

Specifically, Rosen says the chance to spend time with board members of funds such as the established and prevailing HOOPP and ATP gave her a chance to expand her viewpoint.

“What was revealed to me is that HOOPP had an incredibly good track record of returns, so it was worth understanding how that happened and what they did to get that,” she says.

“I also sat next to an ATP person who said seven years ago their CEO set a mission of being the best in class in performance and service. In both of these funds it came down to structure, strategy and vision.”

Rosen, who is an experienced board member, serving on the boards of ManuLife Financial, Emera, Hiscox as well as the $70-billion AIMCO since inception five years ago, says the program provided “more data points to think about”.

 

Do things differently

What became evident through the intensive, highly interactive strategic program, Rosen says, is the importance of understanding how the funds got to where they are.

“For example, did they get the results because they spent $80 million on an attribution system to facilitate those sophisticated investments? There were some similarities between them in how they achieved their success. It was a good wake-up call for us and our management – that we have to go beyond the truism of good governance,” she says, which includes paying staff competitively.

“It showed the importance of understanding the nuances like what does the destination look like, how do we get there, and what are the signs to get there. It’s the setting of expectations.”

In addition the fact these funds have achieved their stellar results through out-of-the-box thinking and implementation, such as the use of derivatives, demonstrated that a fund doesn’t have to emulate other funds, and it is possible to do things differently.

“We are a bit myopic in the Canadian market that we talk about CPPIB and OTPP almost exclusively,” she says. “At this event it enabled me to get a better understanding of HOOPP’s success – they don’t get the same type of press as OTPP and CPPIB. As a board member of AIMCo, it intrigued me to look at more obscure cases of pension fund-management success.”

Specifically, she says the program examined the best-in-class attributes, examples of the specifics of success and how funds achieved them.

 

A higher level of responsibility

The program, which is a joint venture between the Rotman School of Management Executive Programs and ICPM and called the Rotman-ICPM Board Effectiveness Program for Pension Funds and Other Long-Horizon Investment Institutions, runs over four and a half days. In past programs it has been attended by board members from 20 funds from 10 countries.

Keith Ambachtsheer, the academic director of the program, says the program focuses less on facts and elementary board discussion, and more on the higher level responsibilities of board members to provide oversight of what is essentially a complex financial institution.

The course, held at the University of Toronto covers a history of organisation governance, rethinking fiduciary duty, a case study on boardroom dynamics, guiding and assessing investment beliefs and organisation design, a case study on OTPP, risk measurement and management, board challenges and solutions.

According to Rosen, the funds that have been successful have shown that if the mission is compelling enough, as in the case of HOOPP and ATP, it will attract the right people.

“It is management’s role to set the strategy and ours to test it,” she says. “We were doing it anyway but this program has provided us with more data points to test it. It is not good governance to put education solely in the hands of management; that is only one view. The board also needs to be responsible for education.”

AIMCo manages about $70 billion for 26 clients.

 

Using a fund of funds enabled the Future Fund to build a large exposure to hedge funds quickly during the global financial crisis, chief investment officer of the Future Fund, David Neal says.

The Future Fund, which uses a combination of fund of funds and direct hedge fund investments, decided it did not have the breadth of skill and research to entirely invest directly.

“Could we realistically, or want to, try to build a team with enough talent and size to cover the industry? It’s not consistent with our notion to keep the investment team small enough to sit around a table and talk about all of the opportunities and strategies to build our portfolio,” Neal says.

“We thought with fund of funds, and the extra edge of someone who’s actually doing it, was worth exploring. As we started, we found other benefits of fund of funds, for example, in the crisis we were able to move quickly. We had one investment-management agreement with one organisation, which has relationships, and we can throw money at them quickly and could build a large exposure quickly. There was an execution service that came from it that would have taken a long time.”

Environment-specific risk

Neal says the Future Fund, which has almost 20 per cent exposure to hedge funds, is looking to expand its exposure and invest in commodities, catastrophe bonds and macro managers.

The fund has generated 4.9 per cent since inception, well below its mandate of consumer-price index plus 4.5 to 5.5 per cent

“We are clearly behind, but we don’t think there is much more we could have done. It is very dangerous to play catch-up. If you load up more risk, you’ll blow it,” Neal says. “You have to take the right amount of risk given the environment.”

Investors must manage the risk profile to the prevailing landscape, Neal says, but he believes there will be opportunity to take more risk in the next decade.

Meritocracy for assets

The Future Fund has a “dynamic” allocation process, but it is not relative to a benchmark. Rather, all investment opportunities are assessed on their merit.

“Long-term characteristics can change quickly, the GFC showed that,” he says. “It is not about active tilting but managing risk/return and adjusting accordingly.”

Because of this dynamic nature, the funds are shifted from one opportunity to another.

“There are managers we are happy with who we take money from because the opportunity changes,” Neal says.

The Future Fund considers every investment opportunity on a hedged basis, so each investment can be compared on a like-for-like basis. The fund then decides how much currency to hold.

At the moment it has 12.5 per cent in emerging-market currencies and 18 per cent in developed-market currencies

“Currency is the risk I worry about the most – or it is the cause and solution of the risk I worry about the most – liquidity.”

Neal sits on the Hedge Fund Standards Board and encourages investors to sign the standards’ investor chapter.

“The more investors that sign, the more that managers are interested.”