How does your governance committee go about setting strategy for your investment portfolio? How are asset allocation decisions made? How often is strategy considered — is it continually part of your committee's discussions, or do you “set it and forget it” for a year? And are you accounting for the complexities of implementation, or is that something to be dealt with later in the process?
These are the sort of questions that should arise naturally from a careful look at the decision-making and governance processes we wrote about in our last article (“Investment Risk: Resources, governance and getting it right,” Nov. 8, P&I Online). It noted that of 124 institutions surveyed by Mercer last year, the majority of them said they took one to three months to make investment decisions, with 25% of them taking more than three months. Clearly, the challenge for investment committees is to refocus time and resources, ensuring enough time and expertise to set the right investment strategy.
Otherwise, the tendency is to drift along in a familiar “80/20” pattern, by which many of the committees we've observed spend 80% of their time overseeing the routines of manager selection and monitoring, which arguably add only about 20% of value. At this time of intense volatility in global markets, how can committees justify missing market opportunities by failing to focus enough on an appropriate asset allocation strategy and a keenly engaged management of investment risk?
Indeed, too many committees may be caught up in an old model of strategic action — or inaction. The old way to manage investment risk was to do a thorough asset allocation study once every three to five years, and consider rebalancing to targets only when markets go awry or when portfolios are judged to be really out of whack given the flow of market shifts and opportunities — a typical pattern that worked well enough in the pre-recession years of the 21st century.
At best, many committees will revisit their asset allocation once a year, although we've observed that not many committees spend enough time even on this, and when they do, they rarely feel it necessary to run a whole new study; instead, they tend to look at the old data and “gut check” as to whether or not it appears right.
But there's a new way of thinking, in which continuous strategic focus is key. And that's crucial, because more plan sponsors are setting strategies that focus on ultimate goals — for example, a lower-risk steady state, or plan termination in the case of many frozen defined benefit plans. Regardless of goals or strategies, the set-it-and-forget-it model just doesn't work anymore.
Given the dynamic nature of roadmap strategies in today's environment, the strategy should be reviewed at least annually, with more complex and expert-driven analysis of asset allocation than the old gut-check committee approach. Ideally, this means more frequent asset-allocation checks throughout the year, to stay on course.
But that's not all. Committees need to think more about the implementation of the changes that will be required by any strategic roadmap — that is, they should view implementation as a key part of their strategy-setting process. That's because, in the old way of doing things, implementation considerations tended to be thought through only after the studies were done.
Instead, and especially for dynamic strategies that are subject to changes in market conditions, implementation should be an input, not an outcome of the strategy-setting process. Many key questions often need to be addressed :
- Should the strategy include temporary tactical opportunities if these will only place a burden on committee resources in order to implement quickly?
- What level of internal and external delegation should be considered in order to accommodate the necessary speed of execution?
- What level of oversight will be required for the management of overlay/derivative strategies?
- As required resources and technology increase, will they require regular (e.g. daily) monitoring as allocation shifts occur — and should the committee meet when specific triggers are hit to decide what to do, or should it automate and/or delegate the execution process?
Obviously, the importance of thinking through implementation during the strategy-setting process adds layers of complexity that many investment committees may be ill-equipped to deal with. They must know — or learn — precisely what components of their strategy they can implement using existing resources; where the resource gaps exist; and whether a new solution, such as an outsourcing arrangement, is necessary to get to the new strategy and/or monitor and oversee it going forward. Not easy questions, but the right answers will light the way.