When I worked in manager research, I kept two logs. The first log, which I no longer actively maintain, was comprised of the old business cards of people moving from one investment manager to another; I thought they could be handy in the event that an industry roast might benefit with some employment history (note that I still have this log).
The second log, which I still maintain, is used to keep track of investment managers that have sold their businesses. In most cases, smaller investment firms were sold to larger firms. In a way, this is a pet project of mine to preserve the history of the investment management business and a record of how today’s investment managers came to be in terms of their people, process, philosophy and performance (a traditional ‘4P’ analysis used for investment manager monitoring and manager searches).
This log also serves an important consulting function in that it provides a decent sample size to determine, among other things, if an investment manager’s performance is negatively impacted after it is acquired (adjusting for factors such as the manager’s investment style being out of favour). This is not an exact science, but it does produce an interesting observation that investment managers have more times than not suffered poor performance after being purchased.
The announcement recently that large public sector pension plans might become ‘Super Funds’ , managing the assets of other plans for a fee, places this issue in the spotlight. Could pension plans suffer and drop off one-by-one by succumbing to the omnibus Super Fund’s investment strategy? While the cost benefits of piggybacking on the scale and scope of Super Funds are clear and difficult to argue against, the actual benefits of a Super Fund’s massiveness in relation to the diminished duty of care it owes its beneficiaries is not clear. It is also not clear how a Super Fund can invest better on a global scale on a ‘before fee’ basis.
As outlined in my firm’s recent Advisory, a Super Fund is still technically a pension plan that is required by law to act in the best interests of its beneficiaries. Once a Super Fund embarks on providing services to other plans for a fee, has it not compromised this singular purpose? After it gets a taste of additional revenue will the Super Fund ask itself how it can earn more revenue? Human nature seems to lean this way, and virtually every business in the world has leaned this way in the pursuit of growth – some successfully and some not so successfully. The recent meltdown of many global financial institutions, and the sheer magnitude of its resulting negative impact, demands that we use caution when considering concentrating the retirement wealth of so many in relatively few hands.
An important lesson to be learned from the plight of global financial institutions is that not all risks can be shifted somewhere else. What will happen if a Super Fund blows up? Will the members of the underlying plans be in a position to sue the Super Fund for negligence? What voice will the underlying plans have in terms of manager selection, asset allocation and rebalancing?
Another consideration is whether any additional or stricter regulations will be placed on Super Funds. If applied to pension plans in general, the additional human and financial capital, and associated governance may be unaffordable by ‘regular’ funds. This problem already exists in terms of the public versus private plan debate; public plan designs and benefits are viewed as largely unaffordable by the private sector. The advance of Super Funds may exacerbate this inequity and stir some heated debate.
The above points are not intended to strike any sort of epiphany. All of these points will no doubt be covered through a reasonable due diligence process and frankly, it is encouraging to see some honest debate. Our industry faces change and challenges all the time and it is good to see this translate into some of the industry rules eventually changing to evolve with the times.
The debate on Super Funds is worthy of more effort than just acceptance of the cost benefits. Will the public have a say in this? Ultimately, it is the taxpayers that shoulder the responsibilities for operating a complex system such as a Super Fund and the ultimate accountability for its results. While it can be argued that this is no different than any fund failing and being absorbed by the public through the applicable government guarantee, the magnitude of a Super Fund failing is rather daunting. Given the magnitude of dollars at stake, perhaps a referendum should be taken such that citizens can democratically vote?
If I seem critical of the Super Fund approach, it’s because a proven approach for selecting investment managers has been put into question in favour of an approach that seems to have a lot of unknowns. Before retaining an investment manager, a due diligence process should be undertaken that includes a traditional ‘4P’ analysis with a ‘3P’ overlay. A Super Fund will no doubt score well on the ‘4P’ analysis but how will it do on the following ‘3P’ overlay?
1. Partnership – an investment manager should partner with its clients to help achieve their goals.
2. Prudence – an investment manager should have a strategy to ensure that its asset growth does not come at the expense of its clients’ risk-return objectives.
3. Principles – ethics and integrity are paramount in a culture of compliance at the investment manager.
While probably a bit more bureaucratic than a typical fund, a Super Fund should be able to meet Partnership and Principles criteria. In terms of Prudence, the only way a Super Fund can meet this criterion is if it can provide asset allocation services that are ‘all things to all people’, as the performance of any one asset class in a Super Fund would most likely be index-like over long time periods.
This brings me to the topic of market-timing, but that’s another story.
Peter Arnold leads the Canadian Investment Consulting Practice for Buck Consultants, an ACS Company. He is responsible for the development and delivery of all investment and defined contribution consulting services in Canada.
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