Your investment committee meeting is going to adjourn in a matter of minutes, and at least one and possibly two of three thorny items is likely to remain on the agenda unresolved — a manager evaluation, a manager search and an asset allocation evaluation. A strategy discussion wasn't even scheduled. It looks like something important will have to wait until the next quarterly meeting, but can the organization really afford another delay? The committee's decisions can't be taken lightly or rushed, but it takes the right resources to make the right calls, and many investment committees might not realize the true cost of inaction and indecision.
I say this because of a survey on decision-making and governance processes Mercer conducted in 2010. Of the 124 institutions that responded, 79% indicated they were comfortable making investment decisions, but with the majority of them taking one to three months to make them and 25% taking more than three months, one has to wonder how many market opportunities are being missed, and how many necessary changes are going unmade?
Those questions are easy enough to pose, but investment committees need to ask themselves several more — especially now, when the volatility of global markets is forcing a fresh focus on defining and managing investment risk.
General market and credit risk, interest rate and liquidity risk have always been a primary focus of committees, which are typically structured to deal effectively with them.
But the significant losses suffered by institutional investors amid the past decade's high-profile frauds — along with evidence of lax internal controls at some financial institutions — have raised the profile of non-financial and operational risks as well. Add to that the increase in allocations to complex alternative investment strategies and it's obvious that investment staff members are strained to grasp all these dimensions of risk, and need to focus more and more on how their investment managers, custodians and consultants are stewarding their investment strategies.
Thus, the questions pile on.
- How many resources should be overseeing the investment portfolio, and what should be their primary areas of focus?
- Is monthly or quarterly portfolio manager oversight enough, given what can happen day to day?
- How quickly can staff react to a portfolio-influencing event?
- What is the risk and cost of indecision?
- Is it possible to quantify missed market opportunities?
- Indeed, given all of this, is risk management itself high enough on the committee's agenda?
Committees must understand that not having a strong governance structure in place to make proactive choices and oversee providers is a risk in and of itself. To sketch the basic problem, let's figure that a typical investment committee meets four times a year for two hours each time. And let's say each committee member spends an hour preparing for each meeting; this translates, roughly, into 12 hours per year overseeing an institutional portfolio.
Now, it's up to each committee to decide whether this is enough time and whether their focus is right, but in my experience there tends to be a time/value disconnect in too many investment committees situations. I believe that many committees spend 80% of their time on manager selection, termination and monitoring activities, which arguably add but 20% of value. Instead, committees should strive for achieving the far greater value derived from strategic action by spending time on setting policy, defining objectives, and balancing asset allocation and risk tolerance. These call for resources, whether from within or outside the committee, and a governance framework that can ensure proper management.
The cost/benefit issue comes into play here, as committees decide whether they can ensure a focus on strategic value with existing resources, or whether they should delegate some (or all) investment decisions and day-to-day oversight to a third-party fiduciary. In the survey of 124 institutions I mentioned earlier, 42% said they either have considered or plan to consider such delegation. Clearly, it's a decision that institutions are wrestling with, and it's never a one-size-fits-all solution. Indeed, how much of the committee's actions are delegated — and in what way — depends on the unique factors at play in each institution. Customization is key, and there are multiple models. Depending on where the institution falls on the governance spectrum, the committee may only be looking for research tools and databases to supplement its internal efforts, or it may seek expert advisors while it continues to make its own investment decisions, or it may choose to hand off the investment decisions altogether.
But making these choices depends on having a strong governance structure in place to guide policy and practice, as well as knowing where the gaps are. It's smart for committees to assess their position along the governance spectrum and how they are managing the risks at hand. And it's important to prioritize all the issues, analyzing such variables as exactly what resources should be overseeing the investment portfolio, how frequently is oversight required, how quickly can a response be made to market events, and how to quantify the risk of indecision and missed market opportunities? We'll keep trying to answer these and other questions, as we explore the global parameters of investment risk.
Kim Wood is Mercer's U.S. leader for implemented consulting, responsible for the development and delivery of Mercer's implemented consulting services to institutions such as defined benefit and defined contribution plan sponsors as well as endowments and foundations. She is a member of the U.S. investment consulting leadership group.