Your July 22 editorial is a useful contribution to the topic of outsourcing investment management, a technique which is relatively new in the U.S. but which has been employed more widely in Europe. This technique is sometimes referred to as “outsourced CIO” or “implemented consulting,” but referring to it as “fiduciary management” or “fiduciary delegation” reminds us that we are dealing with two fundamental fiduciary responsibilities: the management of assets, on the one hand, and oversight of that management on the other.
Emergence of fiduciary delegation in the U.S. came in response to “fiduciary fatigue,” the state of mind experienced by many investment committees following the 2008 capital markets meltdown, when asset classes became closely correlated and past performance as an indicator of future returns was finally recognized as impotent. Faced with novel strategies and complex products, the investment committee decision process lagged, inducing a state of flight or fright. Entering the breach came the committee's pension consultants with the timely idea that, by giving the consultants investment discretion over matters on which they previously advised, the investment process would be more nimble and fiduciary fatigue would be cured.
Your editorial addresses many of the challenges of fiduciary delegation, but there are some others which, from a fiduciary perspective, need airing.
First, the engagement of any service provider requires the investment committee to make a prudent selection. To be prudent, the selection decision must be informed and reasoned. As noted in your editorial, there is not a wealth of available benchmark data to allow comparison of different providers, so great care must be taken when making a selection. This suggests that an investment committee should undertake a fiduciary assessment or RFP process to determine which providers can best match the committee's needs. Depending on the extent of delegation, the fiduciary manager may look like a fund-of-funds' manager and should undergo examination with that in mind. Simply allowing the existing consultant to swap hats, which occurs in some cases, is not an appropriate exercise of discretion and may result in fiduciary breach.
Secondly, it will come as no surprise that fiduciary delegation will involve a higher fee than a consulting fee. The committee must decide what is reasonable and in the absence of published data will have to rely on the RFP process for an indication.
Some fiduciary management services involve the use of proprietary funds. Such arrangements are fraught with conflicts of interest and an investment committee must demand full disclosure of management fees and other sources of the fiduciary manager's compensation, before they can make an informed and reasoned decision about the fiduciary manager's selection.
Finally, when all is said and done, the investment committee retains fiduciary responsibility for oversight. As your editorial so aptly points out, the investment challenges which prompt the investment committee to delegate their management responsibility don't change as a result of delegation. Thus, the committee is still responsible for ensuring that the fiduciary manager's response to those challenges is prudent. One must, therefore, ask what has changed. If before the appointment of the fiduciary manager, the committee required the help of a consultant to advise on portfolio construction, asset manager selection and monitoring and other aspects of the investment process, what new competence has the committee acquired that allows it to discharge the oversight responsibility unaided? Some committees may bristle at this suggestion but, from a fiduciary perspective, this is a question that members need to test.
In summary, if properly supervised, fiduciary delegation is a useful technique for institutions to meet the complex investment challenges they face. A fiduciary panacea, it is not.
ROGER L. LEVY
Cambridge Fiduciary Services, LLC