What’s on a trustee’s mind?

If you’re trustee of a medium or small sized pension fund (for argument’s sake, below 1 billion euro assets under management), are you in a position to effectively to manage your balance sheet and asset managers, and what tools do you need? That was the main topic of last Thursday’s seminar, organized by pension institute Netspar, together with the Business School of Maastricht University. Kees’ presentation focused on the necessity of developing beliefs, if only to be aware of what asset managers and financial markets can and cannot deliver. This helps improve investment governance while managing the total workload of boards.

The subsequent discussion highlighted the following issues :
1. Tackle the basic questions
Trustees receive their information from investment consultants, their asset manager or insurer. While they’re doing a great job processing the information, some of them indicated that they feel that they’re overseeing the terrain but find it difficult to pinpoint where they are on the map. What are the main discussions out there? What is researched and what not? On which subject is some form of consensus?
Trustees warmed to the idea to start out with a basic set of beliefs based on the current research out there, and tweak it based on the vision of the fund. Most asset managers propagate active management, investment consultants do not shy away from it also, and trustees have to cope with peer group risk in bull markets if they’re not invested in active strategies (this argument reverses in bear markets).

2. Don’t shy away from the obvious beliefs
Diversification as a free lunch is a deep rooted belief for many pension funds. We’ve now learned that diversification doesn’t amount to simply adding more strategies. Moreover, the need for diversification depends on the market outlook: when markets go up, diversification is not something that we really need, only when markets go down. So the obvious question now changes to: diversification is a free lunch, provided that the right combination of strategies is pursued in the portfolio. Moreover, benefits of diversification should especially materialize in downturn markets.

3. Scale your ambitions up or down regarding your size and resources
A small pension fund might share the same beliefs about sustainability as a large pension fund. However, market participants and stakeholders demand a lot more from a large pension fund, due to its potential impact in the financial market and large participant base. The trick is to let the large funds do the first mover steps, whether in sustainability, new strategies or business models. A smaller fund has the luxury to assess if turns out to be a first mover advantage that might be successfully adapted copied, or something to be shunned. When adapting, the strategy has to be downsized accordingly and communicated as such. It simply doesn’t make sense for a 100 million fund to visit AGM’s and take the same active shareholder stance like Calpers or ABP.

4. Be clear about the consequences of your beliefs
Focus on lower costs matter a lot for funds with assets below 1 billion euro’s. Pension advisor Keith Ambachtsheer, and consultancy firm CEM have down a lot of convincing research on this subject. For every ten-fold increase in size, net returns increased by 17 basis points. All other things being equal, a one billion fund tends to generate 17 basis points higher return than a 100 million funds. What does this imply in practice, if your board adapts this as a leading belief? A suggestion was that in the selection process, lower costs should be a decisive factor instead of a best-in-class focus. After all, costs are certain, returns are not, and once managers tend to be selected, their (out)performance tends to be, on average, disappointing for most funds. It might seem that you settle for the second best option, but it might well turn out to be the winner in the long run due to costs.

About Alfred Slager

Alfred Slager is professor of pension fund management at TiasNimbas Business School, and director of CentER Appplied Research at the Tilburg School of Economics and Management. His expertise includes international financial services, with a particular interest in investment management and pension funds. He regularly teaches courses to investment managers and pension fund trustees. Prior to this he worked as Chief Investment Officer at Stork Pension Fund, as investment strategist and policy advisor at PGGM Investments, and as manager research and investment manager at Fortis Investments. Slager regularly publishes on pension and investment management subjects and teaches executive courses for pension fund trustees.
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