The remuneration of pension fund investment executives is a sticking point in the industry.

To compete with the open market, attract and retain a certain calibre of executive, and compensate them for the peculiarities of being a fiduciary, there is a certain minimum required. At the same time this has to be balanced with communication to beneficiaries, governments and other stakeholders about what is fair, often within tight budget constraints.

Communicating what is value for money, and developing appropriate pay structures as part of this measurement is a challenge.

The ranking of performance per pay of a CIO as measured by Skorina (see the article Do you get what you pay for?) seems crude. It doesn’t consider the working environment, benchmarks, constraints and governance, or responsibilities such as reporting, staff training and motivation, technology oversight and strategic thinking.

Charles Skorina argues none of that matters; that institutions are paying their CIOs to generate a return, and so they can be measured against that return.

To some extent that is true, but life isn’t that simple. At least Skorina is bring the idea of accountability for salary to the fore, and perhaps it is a starting point.

One of the issues the industry is grappling with is an appropriate pay structure.

The 2011 Mercer Financial Services Executive Remuneration Survey in the UK shows across that sector that pay continues to move away from short-term incentives.

Mercer reveals that from 2008 to 2010, base pay for senior positions in this sector rose from 25 to 34 per cent, at the same time, the proportion of long-term incentives at the chief executive level increased from 36 to 46 per cent, with annual bonuses dropping from 39 to 23 per cent.

In the pension industry there is no formula for success, however a number of funds have spent, and are spending an increasing amount of time on this issue and developing their own ideas of performance benchmarking and appropriate compensation.

CalPERS has a performance and compensation committee, and has an elaborate measurement system for its executive pay structure.

The chief investment officer is measured against a variety of short and long-term, investment and organisational, issues. (CalPERS CIO pay structure)

Similarly the Canadian Pension Plan Investment Board has identified executive pay as a key organisational issue – this in the context it employs more than 800 people and manages all assets in house – and has developed a pay-for-performance formula within a risk framework

Keith Ambachtsheer’s paper – How should pension funds pay their own people – provides a case study of CPPIB.

More widely Ambachtsheer identifies executive remuneration as one of five critical pieces of the puzzle if a pension fund is to satisfy its tasks of investing productively, administering efficiently and advising wisely.

To do these well, he says, requires aligned interests with stakeholders, good governance, sensible investment beliefs, effective use of scale, and competitive compensation.

 

A practical guide to good governance for pension board trustees was one of the results of the Rotman ICPM Board Effectiveness Program which included participants from 21 funds from nine countries.

The program, the first of its kind to be aimed specifically at board members of pension funds and other long-horizon investment institutions, looked at the functionality of boards, examining when they get stuck and why, as well as the right way for a board to approach strategy, planning and execution.

The impetus for the program came from the desire of the program’s academic director, Keith Ambachtsheer, to provide help to pension fund boards to overcome areas where they may be dysfunctional, which he believes arise from a desire to implement rather than oversee.

The program asked participants to submit in advance the top challenges facing their boards. This revealed good governance and sensible investment beliefs as the two of the key challenges.

As a result of the program, which is collaboration between Rotman Executive Programs and the Rotman International Centre for Pension Management, a plan was developed for trustees to use as a guide.

The good governance advisory team decided on three key steps to implementing a governance improvement program:

  1. Create a current board skills/experience matrix and document board member roles and behaviours.
  2. Revisit the organisation’s mission and mandate, formalise board processes and agree on board norms and behaviours.
  3. Implement the roadmap through updating board policy documents, through internal board bonding sessions and external board training.

Similarly participants developed a step-by-step guide with regard to sensible investment beliefs and organisation design that included:

  1. Investment beliefs should be explicit
  2. If you have scale then insource
  3. Insource in stages, with public equities first
  4. Prepare the ground for the required compensation plan
  5. Build capacity for internal management.

The other challenges nominated by the board included robust risk management, effective stakeholder communications, and financial sustainability.

The program will be held again next month, and is already sold out, but to register for future offerings visit www.rotman.utoronto.ca/icpm

 

A majority of investors believe “stability bonds” could provide a partial solution to the euro zone sovereign debt crisis, but are concerned that these bonds carry a high moral-hazard risk, a CFA institute poll reveals.

The poll found 55 per cent of European investment professionals believe that the common issuance of stability bonds can help alleviate the debt crisis, but only as part of a package of structural reforms, fiscal integration, and a strong common governance framework.

The risk of moral hazard, where some member states may follow poor budgetary discipline with limited implications for their financing costs, is a key concern of CFA Institute members.

More than half of investors also believe the bonds will reinforce financial stability in the euro area and 56 per cent agree that it will facilitate the transmission of euro-area monetary policy.

“Stability bonds” are seen as an instrument to address liquidity constraints and ultimately reinforce financial stability in the euro area.

The poll of 798 investment professionals comes in the context of the European Commission’s consultation on the issuance of “stability bonds”.

The bonds are seen as creating a new way for governments to finance their debt, the European Commission says.

In a Green Paper outlining various potential models for a stability bond, the Commission says that the bonds will potentially offer a “safe and liquid” investment opportunity for savers and financial institutions.

The Commission claims that such a stability bond would be the catalyst for a euro-area-wide integrated bond market to rival the liquidity and size of its $US counterpart.

While a majority of respondents agree that resolution of the euro-area sovereign debt crisis should require common issuance of sovereign bonds, 40 per cent disagree with this strategy.

A common view from respondents is that the stability bonds could bring temporary relief in the short run, but will only postpone the problem and be detrimental in the long term, possibly fuelling the next crisis.

Some respondents believe the long-term negatives would outweigh the short-term benefits, as stability bonds would create further systemic risk, resulting in national sovereign debt crises being replaced with a Europe-wide debt crisis.

There is also a clear consensus among investors, however, on how the bonds should be issued.

Joint and several guarantees would be the most effective approach for the common issuance of stability bonds among member states of the euro area, according to 64 per cent of CFA members polled.

A partial substitution of stability bond issuance for national issuance – in which a portion of government financing needs would be covered by stability bonds, with the rest covered by national sovereign bonds – is supported by 64 per cent of CFA members.

Investors strongly advocate three key preconditions that countries wanting to access stability bonds would have to agree to. These are:

  • Significant enhancement of economic, financial, and political integration (supported by 86 per cent).
  • Increased surveillance and intrusiveness in the design and implementation of national fiscal policies (supported by 88 per cent).
  • Limited access to the Stability Bonds in cases of non-compliance with a euro-area governance framework (supported by 90 per cent).

Agnès Le Thiec, CFA Institute’s capital markets policy director, says the new financial instruments, while helping to solve the euro zone debt crisis, cannot cure structural problems of imbalances in trade and competitiveness, or public debt, in many member states.

“Stability bonds also carry a high risk of moral hazard, and would therefore have to be associated with much more extensive structural reforms, fiscal integration and a strong common governance network,” Le Thiec says.

 

Investments in credit will be a hive of activity this year as the role of banks in lending continues to fall and investors make decisions about the place of sovereign debt in their portfolios, according to Mercer.

The consultant, which has outlined economic and financial challenges for investors in 2012, says the scarcity of credit, as well as the reduced role of banks in lending, provides possibilities for investors to build and broaden credit portfolios.

Further, it says that investors need to make some “sharp judgments” on sovereign bond investing, specifically whether they want insurance or investment returns.

Mercer says the macro environment, which will continue to be fast-moving and volatile, will be challenging for stock-pickers, with manager success depending more on overall positioning than bottom-up stock selection.

This will mean investors should expect greater discipline from those we deploy their capital and seek to ensure “agents do not extract unfair rewards”, and active management fees will experience continuing pressure.

According to Mercer the economic uncertainty lends itself to portfolio flexibility, and predicts that more institutional investors will move to a floating strategic asset allocation mindset where the investment strategy evolves and morphs over time.

Mercer says that faced with a challenging and unfavourable economic backdrop, institutional investors should focus on agility, flexibility and efficiency when planning for the year ahead.

Mercer says the key economic and financial challenges for 2012 will be:

  • An improving US economy and the continued strength of emerging market economies could yet lead to respectable global growth, though significant downside risk remains. A challenged Europe however poses a very real threat to global economic prospects.
  • The Eurozone financial crisis is yet to be played out and the saga will continue as politicians try to implement a blueprint for a fiscally-responsible Europe.
  • Further coordinated policy responses from political and financial authorities could ease the sense of crisis in the short-run but could equally raise long-term inflation expectations.
  • Focus on “fair capitalism” will increase, including consideration of the rewards for capital versus labour, of principals versus agents and of inter-generational equity.
  • The scope for further shocks, from diverse sources, will remain elevated. Even if the gloom of abject growth lifts, the fog of uncertainty is likely to remain.

 

Part of the mandate given to US regulators by the Dodd Frank Act is to measure and monitor systemic risk, but more than one risk measure is needed to capture the complex and adaptive nature of the financial system.

The Office of Financial Research, part of the US Department of Treasury, has put together a survey of 31 quantitative measures of systemic risk, examining the existing scholarly literature, in an attempt to capture systemic risk from diverse perspectives.

 

To access the paper, and the diverse and evolving approaches to systemic risk, click here

 

A survey of Systemic Risk Analytics

 

Some of the world’s largest investors have outlined their expectations of how companies should respond to climate change. (more…)