I wish someone had told me how to be a better trustee

“I wish someone had told me” is a series of posts that feed into our inquisitive nature at CN&CO. Each week we hear from someone in our network about something interesting or surprising that’s recently happened or occurred to them – or lessons they learnt. These blogs are a way to pay it forward and form part of CN&CO’s belief that the world can be a better place – and we all have a responsibility to make it so. This week’s post is by Carel’s colleague at EasyRetire, Deresh Lawangee – retirement fund specialist, actuary, classical music lover, petrolhead and all all round good guy who is passionate about helping people retire well. Says Carel:

“When I was a trustee on the Hollard retirement funds (decades ago now!) I realised what a responsibility trustees have to their fellow employees in helping their retirement funding to grow as much as possible in as short a time as possible – responsibly, ethically and with ongoing, transparent communication. And now, in my role as the executive driving much of our retirement funding activities at EasyEquities (where we are fast approaching R20 billion in assets under management in our EasyRetire business alone), this responsibility is one I feel even more. Working with Deresh and team is a privilege and I hope you enjoy his article – even if at first blush you may find it heavy reading. It really is a guide to trustees, ordinary people, in companies who must choose asset managers – the clever people who decide where retirement money gets invested:

Mastering the Art of Fund Manager Selection and Monitoring: A Strategic Guide by Deresh Lawangee

Introduction

In the intricate landscape of pension fund management, the quality of fund managers holds the key to the success of investment strategies. Selecting and monitoring the right fund managers is a paramount decision that requires a meticulous evaluation of critical factors. This article serves as a comprehensive guide, shedding light on the essential steps and best practices to achieve optimal investment performance.

Laying the Foundation: Crafting an Informed Investment Strategy

A fundamental precursor to effective fund manager selection is the establishment of a robust investment strategy. Here’s how it’s done:

Precision in Portfolio Construction:

Diversification with Stochastic Optimization: The journey commences with a methodical diversification approach, powered by an optimisation (stochastic) model. This model factors in the risk tolerance of fund members, thereby amplifying the potential for maximizing retirement outcomes.

Unveiling Active-Passive Allocations: For each asset class, a thoughtful analysis determines the ideal balance between active and passive investments. This equilibrium is influenced by the asset class universe’s size, information efficiency, market cycles, return spread, and volatility distribution.

Harmony in Investment Styles: A nuanced understanding of different investment styles sets the stage for their harmonious blending, enhancing portfolio performance and resilience.

Harnessing Alternative Asset Classes: Forward-thinking strategies involve the strategic integration of alternative asset classes, such as private equity, to achieve both quantitative and qualitative outcomes, such as addressing complex societal challenges.

Commitment to ESG Principles: Ethical considerations and Environmental, Social, and Governance (ESG) principles are embedded in the investment process, ensuring alignment with responsible investing practices.

Navigating the Maze of Manager Selection

Selecting fund managers is an intricate process that requires astute judgment and comprehensive evaluation.

How hire Managers: Unearthing Managerial Excellence:

Information asymmetry is a major issue in the arcane world of investment management. Investment managers have more information than you. It is difficult to verify or refute the information provided. Research is the key and a trusted and competent advisor will level the playing field.

Every manager you meet will “be the best manager, with the best investment team and the best process”. Again a trusted and competent advisor can separate the cream from the crop.

Beyond the Superficial: The allure of fashionable appearances and eloquent presentations is cast aside, replaced by a rigorous assessment of the manager’s investment philosophy, process, and anticipated aggregate outcomes. Don’t be impressed by the fancy suits, fancy offices, and slick presentations. You need to delve deeper to understand how investment returns are generated.

Investment returns must be a causality of the investment philosophy and processes, otherwise, investment returns are produced by luck which is not sustainable.

Understand what economic market cycles favor your investment manager and what cycles will cause your investment manager to struggle. Ideally, you should weight your managers accordingly during different cycles.

Capitalizing on Competitive Advantages: Discerning managers with unique skills and competitive advantages becomes a cornerstone of the selection process, propelling the fund towards alpha generation. Unique investment processes and styles diversify the sources of investment return.

Delving into Replicability: An in-depth analysis of the replicability of outcomes ensures the longevity of performance through various market cycles.

Safeguarding Against Dependencies: Key person dependency is managed with prudence, ensuring the resilience of the fund’s investment strategy. Most investment firms have some form of key person dependencies, the investment hotshot with all the ideas and answers. Some of these individuals are investment savants and can generate significant wealth over long periods of time, understanding that investment outcomes are linked to this individual is important in managing key person dependency. Ideally investment processes and outcomes that are more organizationally dependent are preferred.

Unmasking Decision-Making: Transparency in decision-making processes and clear accountability enhance confidence in the chosen fund managers. Beware of key person dominance in an investment team, it hinders robust debate and alternative views which are important in money management. Active investment management is more of an art than an exact science however dominant individuals can create blind spots in investment decision making creating a risk to investment outcomes.

How to fire managers: When and How to Part Ways:

Beyond Performance Metrics: Termination decisions go beyond raw performance metrics, considering an array of factors that influence investment outcomes. Poor investment returns in isolation is not enough to fire a manager. Given the market/economic cycle how was the manager expected to perform?

Performance Amidst Market Cycles: Evaluating a manager’s performance within the context of market cycles provides a holistic view of their effectiveness.

Reasons to fire a manager: Persistent underperformance, deviations from the fund’s philosophy and strategy, lapses in governance, high staff turnover and/or loss of key staff are indicators to reevaluate a manager in your portfolio.

Another reason to replace a manager is if you found a manager with a superior investment process or strategy.

Beware of spin doctors tasked to explain away poor performance. As mentioned above, information asymmetry is a reality in the arcane world of investment management so you need a trusted advisor to act as your BS filter.

The Role of Trustees: Empowering Informed Decision-Making

Trustees play a critical role in shaping investment decisions, leveraging their expertise to steer fund strategies.

Empowering Trustee Expertise:

Capitalizing on Trustee Strengths: Trustees evaluate their technical investment competency, enabling the determination of their level of involvement in asset management decisions.

Trustees should have an honest assessment of their technical abilities to make informed investment decisions and appoint competent advisors where appropriate.

Can trustees make strategic and tactical decisions between asset classes? If yes -appoint specialist managers per asset class. If no- then appoint multi-asset class managers.

Can trustees perform thorough due diligence and appoint asset managers? If yes- use single asset managers. If not- appoint a multi-manager.

Conclusion

In the intricate dance of pension fund management, the selection and monitoring of fund managers emerge as a strategic art, shaped by meticulous analysis and insightful decision-making. The caliber of fund managers chosen significantly influences the trajectory of investment strategies and, consequently, fund performance. By adhering to the principles and best practices outlined in this guide, pension fund trustees can chart a course towards optimal investment outcomes.