Bad Timing

vintage clock radioWe are told in our personal lives that time heals all wounds.  In the investment world, time also has a major impact on the decisions we make.  Pretty well all our investment actions are analysed, measured, and judged within a “time frame”.  A pension fund has a long-term time horizon, and actuaries “value” pension plans, at a minimum, every three years. Accountants for corporate pension funds calculate the liability (balance sheet item) and pension costs (earnings statement item) on a yearly basis, while pension administrators review fund performance from their investment manager on a quarterly basis.  These are the major players who influence the activity within the pension system.

Our culture now has a short-term focus on virtually everything we do.  Today, we live in the “microwave” society.  Studies have shown that over the past five decades the average holding period in U.S. equity mutual funds has shortened from over five years in the 1960s to close to one year today.

We are all losing patience.

I believe this short-termism has a detrimental impact on the overall performance of investment funds – be it a pension fund, an operating and endowment fund, a foundation, or an individual. Such short-term thinking results in increased costs and risk while at the same time returns suffer. In other words, the worst of all worlds.  The diagram below outlines the estimated timelines which I believe apply to the various parties influencing investment decisions. This is based on my 40 plus years of experience as a money manager, plan sponsor, and consultant.

As the diagram shows, the major players do not think within the same time spectrum – and there is very little overlap from one time focus to another.

JJ Chart 3

Pension plans: 40-plus years

The plan is our starting point.  As my previous articles have pointed out, the pension industry has spawned a number of services that might not have been established had it not been for the growth of pension assets. With the assistance actuaries, corporations and other such entities have become plan sponsors. For a defined benefit (DB) plan (where most of the Canadian pension assets reside), the plan sponsor makes certain promises that at the end of a participant’s working career funds will be available to provide pension income to the member and his/her beneficiary for their lifetime. This is the primary advantage of a DB plan: the known quantity and continuation for life, however long.

In the case of the diagram, I have specified a time period of 40-plus years for the pension plan because this used to be the case for two reasons: first, that the plan participant actually worked about 40 years (basically, retiring at the age of 62). Secondly, the plan sponsor would actually be in an industry/sector with a long-term future.

When pension plans were first set up, individuals mainly stayed with one company through their working career (getting the gold watch and the pension at the end), and companies (e.g., mostly manufacturing firms) had staying power. The North American economy has changed significantly over the past five decades as it has moved from a manufacturing base (where workers had higher annual earnings) to a service-based economy (with lower employee wages).

We have moved from building big bridges, big autos, big buildings to building Big Macs.

Pension plans, generally, have a very long time horizon. As a result, when they were first established, the first measurement yardstick was against inflation; typically, CPI plus 3% over 10-year moving time frames – a length of time more closely aligned with a pension plan time horizon.  Although I did not, and do not, agree with CPI being the “primary” benchmark for returns (it is not itself investable), I did agree with the longer-term time horizon.  Since then, industry measurements have evolved through peer group samples to comparing performance against specific market-oriented benchmarks. The time horizon has shortened as a result.

The sponsor investment committee – 3-5 years

Sponsor investment committee members have the fiduciary responsibility to “link” all pension fund activities to the goals and objectives of the pension plan as a whole.  Thus, they are typically, responsible for formulating asset mix policy, setting up appropriate governance procedures, selecting the desired asset classes and asset class segments, designing an effective and efficient investment management structure, determining the desired risk parameters, selecting and evaluating money managers and setting performance standards for ongoing monitoring of the various activities.  Obviously, the investment committee has a critical role to play.  Investment expertise is vital on any investment committee, however, it is not always sufficiently present.  If the chair is not a Chartered Financial Analyst, he or she should have a minimum of 20 years in-depth investment experience.

It is difficult for Investment Committee members, given human nature and lack of ability to predict the future, to look more than three to five down the road, especially in this day and age when geopolitical events, economic factors and the investment environment change so quickly. However, the higher average age of investment committee members might result in setting policy based on their longevity on the committee rather than the focus on the longer term aspects of the pension plan as a whole.  Over my career I have sat in on hundreds of investment committee meetings and I have no doubt that committee members are attempting to operate in the best interests of the plan members. However, as is our human makeup, we get distracted by “little shiny objects” that result in emotional decisions based on recent events. Adjusting the designated longer term asset mix policy in reaction to short-term events might (and usually does) have a detrimental impact on return and risk.

The investment manager – 2-4 years

The time horizon for investment managers should be well defined and set out in the Statement of Investment Policies and Procedures, and the Manager Mandate Statement. The stated time horizon for manager review and evaluation has, typically, been four years. Benchmarks and peer group samples have come and gone and value-added targets and placements have changed over the years, however, this time horizon has remained fairly steady. Very little guesswork is needed at this stage. However, we continue to move away from the longevity of the pension plan.

Even though the time horizon is generally stated as four years, money managers know that in reality it has moved to a shorter period. The consequences of being judged by plan administrators over shorter-term time horizons has resulted in managers changing their own investment time horizon from three to five years a couple of decades ago to more like six to 18 months today. This once again, moves us further away from the long-term nature of the pension fund. As an example, there has never been as clear a focus on short-term corporate earnings results as there is today. Missing earnings results by one penny versus brokerage firm estimates can move a stock up or down by 5% or more.

One factor resulting in the shortening of the managers’ investment time horizon might be the incentives they get for delivering above-average results against a peer group sample or value-added returns above a specific index. A survey a couple of years back by The CFA Institute indicated that close to 79% of managers have less than 50% of their compensation based on longer term measures.

The actuary – 1 year

Once again, the plan does not start without the actuary.  A couple of years back, I went to for some information on occupations. This site ranks the top 200 career positions in the U.S. within five categories:  1) physical demands, 2) work environment, 3) income, 4) stress, and 5) hiring outlook. The number one ranked job was Actuary. Apparently, defining probabilities of people dying has low physical demand, low stress, and you get paid a lot of money for doing it.

In Canada, a plan valuation must be completed, at a minimum, every three years. Some plan sponsors may do it more often depending on their funded status, contribution requirements and benefits offered. The first decade of this century proved extremely difficult for the pension fund industry. We began the decade with the second worst recession since the Great Depression, and finished the decade with the worst recession. Liabilities, increasingly, were forced to a mark-to-market basis at low discount rates, and ballooned as a result. Pension surpluses accumulated in the 1990s quickly became pension deficits.

Although investment policy should be founded on a carefully structured asset-liability risk perspective (as opposed to asset-only), each successive actuarial evaluation should not, in the majority of cases, result in major changes to investment policy or strategy.  Once again, these are short-term snapshots within a long-term evolution.

The accountant – quarterly

The accountant for many years was off on the sidelines. But, finally, they became convinced, not least by the investment profession, that pension liabilities should be put on corporate balance sheets and the variance between the liabilities promised and the actual funded position should be included on the earnings statement. The result is that the “operating” business of the plan sponsor is affected, on an annual basis, by an “asset” that has a very long-term time horizon. Corporations attempt to smooth out the volatility of their bottom line. If the variance from the pension fund increases bottom line volatility, corporations are highly motivated to abandon the DB promise (which DC plans cannot come close to), or to de-risk the pension fund – both to the real detriment of the plan participants.

The accounting requirements have now introduced a critical time frame of one year for plan sponsors reviewing pension fund activity.

The measurement service – monthly

Just when you say to yourself, how much lower can we go, enter the performance measurement purveyors.  These services provide plan sponsors with performance information on a quarterly basis. Now, measurement is a good thing – in spite of what managers say.  You see your doctor on a regular basis to make sure everything is still in the right place – and still working as it should.  Transparency and explanation are owed to plan sponsors and beneficiaries alike.  However, I believe way too much attention is paid to the quarterly numbers, and decisions are made on short-term results that are, typically, detrimental to the longer term performance of a pension fund.  Money managers were fired in the late 1990s for not having enough exposure to the technology industry (i.e., firing “value” managers to hire “growth” managers) and then, a couple of years later, growth managers were fired because they had too much exposure – a bubble that burst spectacularly.

Recent studies in the U.S. show that investment managers who are terminated outperformed, on average, the managers that were hired to replace them over the next two-year period.  It is not easy keeping managers who underperform over the short term.  It is also difficult not to select first quartile managers to replace poor performing managers.  However, mean reversion always exists in the capital markets, although its timing is hard to predict. Managers find they no longer have the luxury of investing with a three-to-five year outlook.

The plan sponsor

Over the past few years I have seen a number of plan sponsors now seeking asset return and liability value information on a monthly basis.  This trend might be the result of hedge fund managers tracking their performance on a month-by-month basis (if hedge fund managers can do it, why not traditional money managers?). It may work for some of them however It does not for the traditional money managers who, ideally, are investing for the long term rather than speculating in the short. Investment managers take cues from the members of the investment committee – sometimes with the members not even realizing that they have influenced the manager’s mindset.  In one situation, as a money manager, I was asked by the investment committee to raise the equity exposure from 55% to 60% within their balanced fund. At the end of the meeting the chair held me back and stated, in private, that he would be upset if I raised the equity limit as he did not agree with the other members of the Committee.  You can see from the manager’s perspective this is a no-win situation.


As shown by the diagram, no one is operating within the same time zone – there is a misalignment. To be prudent going forward and provide the best opportunity to enhance returns and manage risk, we must address this “time warp”. Focusing on the shorter term is costing the pension industry way too much money, time, and effort.  Investment committees should make every effort to develop policy for the long term and vary strategy only when markets have moved to the extremes. Managers should be given mandates with explicit long-term objectives with aligned compensation arrangements. Then they should be given more time to perform within reasonable pre-set boundaries – as long as there hasn’t been an ownership change, key personnel departures or a style change.

Recent performance should be the last reason for terminating a manager relationship where the manager is conducting itself and its process in the manner that was expected.

If a management organization actually believes that it is in a partnership with the plan sponsor (as well as the consultant), the manager may feel more confident investing with a longer-term vision of opportunities and the market. This belief will have three beneficial outcomes. First, the manager is less likely to turn the portfolio over as often, resulting in more monies being kept captive within the fund. Secondly, manager turnover might be reduced, yielding savings of up to 1% of the portfolio segment the manager is responsible for. And thirdly, investment capital will be directed to companies with the best longer term fundamental prospects (rather than the best short-term stock price expectations).

My greatest concern here is the impact the new accounting standards may have on the attitudes of corporate business managers. If Boards, CEOs and Presidents perceive the pension plan activity simply has too great a short-term impact on the bottom line, then those who have stuck with DB plans, thus far, may de-risk their funds and perhaps abandon them altogether. It is no accident that public sector pension plans, facing far less onerous accounting treatment, have, for the most part, continued to offer DB plans while pursuing less draconian risk-sharing solutions.