© Copyright 2006 Rogers Publishing Ltd. The following article first appeared in the June 2005 edition of BENEFITS CANADA magazine.
It’s lonely going it alone. But following the herd can be a risky position for plan sponsors.

We all know Frank Sinatra did it his way. But doing it your way is easier said than done when it comes to managing the retirement savings of thousands of people. For plan sponsors, the risks of following a different investment path than everyone else can be daunting. And while no one really wants to admit they’re stuck in a herd mentality, when it comes to the pension industry, plan sponsors, consultants and money managers are all guilty of approaching plan funding from a pretty generic standpoint.

So thinks Larry Lunn, chairman, Connor, Clark & Lunn Investment Management Ltd. in Vancouver. “Everyone clusters around the conventional wisdom of what everyone else is doing,” he says. The reasoning behind this is simple: being wrong is very risky. As Lunn puts it: “If you move away from the herd and you’re wrong, you’ll be severely criticized. Whereas if you’re wrong along with everyone else, it’s not so bad.”

Just how closely do plan sponsors follow the decisions of their peers? And are there risks to following the rest of the herd when it comes to pension investing? While there are no easy answers, the solutions might lie in the fine line between going with the flow and going it alone.

Gregory Chrispin, principal and director with State Street Global Advisors in Montreal, agrees that watching what everyone else is doing is an integral part of how decisions are made in the pension industry: “Among trustees and boards there is an overall view that they take a lot of comfort in knowing what their peer group is doing,” he points out. “That has always been the case and it is very much ingrained in the way decisions are made.”

When all is said and done, however, it comes down to a single question: “How comfortable are you about being significantly different from the rest of the world?” This is the question Steve Bonnar, principal with Towers Perrin in Toronto, says individual plan sponsors need to consider carefully before moving into new and different territory. In the end, he says the answer is all about risk tolerance: “You need to make sure you’re very certain in your beliefs if you end up with a result that’s very different from the rest of the world.”

But can following the herd add to that certainty? Moving in the same direction as everyone else can help to ease the pain of being wrong, but moving with the rest of the crowd has its own risks—from inertia to a tendency to follow fads.

For example, Bonnar believes plan sponsors need to look before they leap into asset classes or strategies just because other plan sponsors are doing the same thing. Following the herd when it comes to new investment trends can, in his view, lead plan sponsors to take risks without fully understanding the implications.

“At a fundamental level, when you’re thinking about investments, you’re taking on a risk because your assets will move differently from your liabilities,” says Bonnar. “People generally have a one-sided view of risk. It’s only risky when bad things happen—it’s never risky when good things happen.” Ultimately, says Bonnar, “the danger of following the herd is that you don’t know if you’re making the right decision or not.”

Following the herd can also lead to inertia, which can be risky. Damon Williams, vice-president, Aon Consulting in Vancouver, believes one of the biggest risks of the herd mentality in pension investing is opportunity cost. For example, he says plan sponsors have been slow to move into alternative assets even though they’ve been considering them for years. Their reasoning? “A lot of boards are concerned about maverick risk: doing things differently than everyone else,” he says.

On the other side of the coin, Williams notes that plan sponsors who wait to see what others are doing before making a decision do have some justification in their actions, particularly those with smaller or mid-sized plans without an extensive research budget to explore new alternatives and approaches. In such cases, keeping an eye on the herd isn’t such a bad thing, he says.

“A lot of plan sponsors don’t want to be the first to try the waters—they want some company,” he explains. “Larger plans with bigger research budgets are able to independently support their decisions through research; therefore, they tend to be the leaders. Midsized plans will follow suit when they see the large plans doing it.” Williams doesn’t fault such plans for looking at what the big plans are doing to lend credibility to their decisions when they proceed: “it’s quite reasonable for them to have a herd approach,” he notes. Indeed, leadership on the part of big plans has helped the entire industry evolve into new areas.

At the end of the day, Williams says it’s about prudence: “When someone is evaluating from a prudent person standpoint, you need to ask yourself what a prudent person would do in this case. And the only way to do this is to look at what other people have done in the same situation.” Minding what others are doing in such a scenario is not really wrong, he says, “especially for plans that don’t have a big research budget of their own, it’s quite reasonable for them to have a herd approach.”

Bonnar agrees that keeping an eye on your peers is key: “It’s important to know what the rest of the world is doing and it’s important to know when you’re out of step with the rest of the world. But I don’t think it’s important to be the same as the rest of the world,” he says.

So how can plan sponsors keep an eye on the herd while staying true to their own plan’s needs? Lunn says they’re already arming themselves by becoming more educated about new investment approaches and how they fit into individual portfolios. “Plan sponsors are talking to the consulting and investment management communities and gathering intelligence on how to define better ways to achieve their objectives.”

That means looking at non-traditional investments such as hedge funds, portable alpha strategies, emerging markets and real estate. “In addition, some of these asset classes will come to the fore even more with the change in foreign content rules,” he says. “Plan sponsors can look at the bond market more from a global basis rather than a domestic basis.”

Indeed, while some believe that increasingly global options could break up the Canadian herd of pension investors, views are mixed as to whether that will indeed be the case. Recent research by Aon Consulting shows this trend quite clearly: plan sponsors surveyed don’t appear to be making large changes in asset mix as a result of the removal of the cap.

While Aon’s Williams says that this doesn’t necessarily reflect a herd mentality, some plans could be waiting to see what others will do before making the leap. “I suspect it’ll take a couple of years before the effects of the Foreign Property Rule elimination will be fully seen,” he says, noting “we’re not seeing a stampede toward doing asset mix reviews from clients.”

In the end, the herd has both pros and cons among Canadian plan sponsors—and it’s not likely that anyone is going to avoid watching their peers closely in future. Whatever the case, the key in the future for plan sponsors will be treading the fine line between watching what other plans are doing and making sure decisions stay true to what makes sense for their own plan.

Caroline Cakebread is a freelance writer in Toronto. ccakebread@yahoo.ca

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