Full market-cycle pacts illustrate how giant fund is serious about future
Hiromichi Mizuno, chief investment officer of Japan's ¥162.8 trillion ($1.5 trillion) Government Pension Investment Fund, has made hiring external managers for a full market cycle a cornerstone of GPIF's efforts to craft fee arrangements better aimed at promoting long-term approaches to investing.
Mr. Mizuno, speaking on a panel May 15 at the CFA annual conference in Hong Kong, painted GPIF's decision to make multiyear commitments to managers — while taking "short-term performance ... totally out of the evaluation methodology" — as his response to managers' criticism that asset owners themselves contribute to short-term behavior by awarding mandates at market peaks and then pulling out their money at the bottom.
Industry veterans welcomed the initiative.
Sarah Keohane Williamson, CEO of Focusing Capital on the Long Term Global, a Boston-based non-profit launched in 2016 to promote long-term approaches to investing, called herself a "huge supporter of any experiment" by GPIF or other sophisticated asset owners to "elongate the time frame" for investment decision-making.
GPIF's initiative could prove to be a milestone for rewarding managers for a long term focus on delivering alpha, said Delwyn Hart, Auckland-based head of external investments and partnerships with the NZ$38.5 billion ($26.7 billion) New Zealand Super Fund — one of FCLT Global's 42 member organizations.
Pulling that experiment off will require getting the details right, some observers say.
Aligning the contracts awarded to specific managers with their respective asset class market cycles will be one important hurdle, Ms. Hart said.
"A lot of people subscribe to the idea of giving managers a suitably long period to prove their credentials" but doing so in practice "can be more challenging," agreed Richard Dell, London-based global head of Mercer LLC's equity boutique.
The head of one global money manager's Asia-Pacific business, who declined to be named, said every active manager has its own alpha-generating cycle, pegging that of his own firm's hefty equity business at between five and seven years.
"But no client is going to give you seven or eight years," he said. Three or four years is far more common, and "you'll be lucky if you get five," he added.
Jonathan Tiu, Singapore-based senior managing director, Asia, with MFS Investment Management, in a May 22 briefing for reporters, said a client survey MFS commissioned in 2016 revealed a similar gap.
The survey of more than 100 MFS clients globally showed them, on average, pegging the length of a market cycle at more than six years. But when asked how long they would tolerate underperformance before firing a manager, the answers were concentrated in the one- to three-year range, Mr. Tiu said.
Citing recent research that showed market cycles stretching to seven or eight years over the past 40 years, Mr. Tiu said "as an active manager, we need the market cycle to be able to add value" — a contention MFS executives have sought increasingly to discuss with client boards and investment committees over the past year or two.
Naori Honda, a Tokyo-based GPIF spokeswoman, said all of GPIF's more than 50 active equity and fixed-income managers will partake in the fund's new performance-based fee structure — a base fee in line with fees paid for a similarly sized passive mandate, combined with performance fees giving managers a healthy share of any alpha produced, but clawbacks for those that ultimately miss their alpha targets.
Extension of multiyear contracts, by contrast, will be more selective, at least at this initial stage for the new fee arrangements, she said.
Managers GPIF has confidence it can achieve a long-term alignment of interests with will be given five-year contracts, in line with those managers' more or less consensus view that five years is "their appropriate investment cycle," said Ms. Honda. That one-size-fits-all approach to contract periods could give way to a more flexible approach going forward, she said.
Managers that GPIF doesn't have sufficient confidence in at present won't be given multiyear contracts. Ms. Honda said those managers won't be terminated — instead they'll have "chances to get multiyear contracts if they gain our confidence," she added.
Executives with active money management firms say having more such arrangements could prove especially beneficial now, as a relentless rally by global equity markets continues to foment demand for passive investment vehicles even as, those executives contend, clients should be focusing more on the downside protection active managers can offer.
When the market is running, it's easy for clients to conclude that passive is the way to go, and a lot of asset owners are feeling that way now, said MFS' Mr. Tiu. But the end of a long bull run is also exactly the point where they should be employing active managers — before, rather than after, a potential crash, he said.
Active managers positioning themselves for rough times ahead, meanwhile, will risk underperforming as a long bull run enters its closing stages, since it's never possible to perfectly time the market, and that could prompt some clients to cut them loose at exactly the wrong time, said the global money management firm's Asia-Pacific head.
FCLT Global's Ms. Williamson, a former senior executive with Wellington Management Co., said sophisticated asset owners are conducting a number of experiments now to address that "time horizon mismatch" short-circuiting ties between asset owners and asset managers due often to misplaced "incentives, habits and behavioral mistakes."
One idea being explored to foster longer-term ties is "longevity discounts," where a manager that, for example, starts out garnering fees of 50 basis points could see them drop to 45 basis points or 40 basis points in subsequent years — effectively a "speed bump" for a client that might be considering dropping a manager experiencing a rough patch, she said.
Another fee experiment
NZ Super's Ms. Hart, meanwhile, cited a May 11 speech by Raphael Arndt, chief investment officer of Australia's A$141 billion ($106.4 billion) Future Fund, in which he said his team is seeking to tie performance fees paid to hedge fund firms retained for more than one strategy to net performance, rather than the performance of each strategy employed, as another interesting experiment in the realm of fees.
For now, however, Ms. Hart said while she finds much to like in the GPIF's efforts to forge fee arrangements that promote long-term alpha, their implications when it comes to managers' ability to cope with the resulting volatility of their revenue streams bears watching.
"We are certainly in favor of incentivizing managers to produce alpha over the long term, but have not yet landed on a strategy for achieving this," she said.
"I suspect GPIF's announcement is the start of a trend that will see fees for active managers become increasingly dependent on performance and will be watching this space closely," Ms. Hart said.