© Copyright 2006 Rogers Publishing Ltd. The following article first appeared in the June 2006 edition of BENEFITS CANADA magazine.
The Last 25 Years: A New Frontier
Investment managers have changed the way they look at investment strategies and portfolios over the past 25 years.
By Don Bisch
Wendy Brodkin, Practice Leader, Investment Consulting, Central Region, Watson Wyatt Worldwide

BC: Describe the money management industry 25 years ago and compare it to the present.
WB: Twenty-five years ago, the industry was homogeneous and primarily domestic. Most of the assets under management were in balanced funds invested by banks, life insurance and trust companies. Non-North American investment mandates did not appear on the scene until 1982. Today, there are more managers with more products and a greater use of leverage and financial engineering to “depackage”
and “repackage” in interesting ways. Everything is now global—if not the manager’s domicile, then at least the way they analyze investments.

The other significant change has been the transition to defined contribution(DC)plans with the proliferation of investment options and standardization of governance practices.

BC: What will be the most significant drivers of change for pension asset management?
WB: The single most important driver for change is the growing recognition that conventional wisdom relating to risk and return is wrong. Specifically, the traditional “balanced investment portfolio,”whether in a DB or DC framework, is neither “balanced” in terms of its risk nor in terms of alpha and beta, but dominated by equity market beta risk. Furthermore, equity market returns are neither normally distributed nor stable over time. Return “shocks” are possible and regime changes(e.g. changing relationships between stocks and bonds)are normal.

The typical “60% equities/40% bonds” will be replaced by a combination of asset classes and strategies that may be leveraged up and deleveraged down to achieve the appropriate targeted risk and return for each pension fund.

BC: What’s the most important thing you’ve learned about this industry over the past 25 years?
WB: There is always more to learn.

BC: What can be improved?
WB: There are three elements of governance that can be improved. The first is compensation. In many areas, compensation is not properly aligned to get desired results. The focus is on hard costs rather than the opportunity costs of less-than-optimal decisions. It is also evident in manager searches and asset mix reviews. The opportunity forfeited could be millions, even hundreds of millions of dollars, if the work is not properly researched and executed. In contrast, the cost controls are imposed at the level of a few thousand dollars. This coincides at a time when research directed to new and ever more complex ideas and products has increased exponentially.

Second, the priority is on process as opposed to outcome. The test of prudence may very well be in the process, but the payment of pensions will depend on outcomes. There is a certain amount of dodging accountability when processes are followed with limited consideration for the outcome.

The third issue is decision-making. Committee decision-making is generally accepted as “good governance.” The model breaks down when: the committees don’t meet with the necessary frequency; the committees can’t be fully committed because of other responsibilities or turnover; the members don’t all have the requisite knowledge and; generally, there is a mismatch of the responsibility with the structure. The decision-making structure worked well 25 years ago but it is an impediment for adaptation to new investment regimes and the new realities for pension investments, design and funding.