Good governance can improve pension returns

Governance remains one of the most important factors necessary for successful pension fund management, industry executives said during Pensions & Investments' Global Future of Retirement conference in Washington from June 13 – 14.

“The board selection process needs to be at the top of the list,” stressed governance guru Keith P. Ambachtsheer, director emeritus, Rotman International Centre for Pension Management, University of Toronto, and president of KPA Advisory Services.

In a plan governance change to “tighten the nuts” that began four years ago, the £22 billion ($34 billion) Railways Pension Trustee Co., London, established a new investment committee structure that included members with more experience, CEO Chris Hitchen said during a GFOR panel discussion titled “A Dynamic Model for Board Governance,” which Mr. Ambachtsheer moderated.

At that time, the lower-return environment presented “a smoldering platform for us,” Mr. Hitchen said, because the pension fund's asset allocation was very diversified, expensive and designed for a high-return environment.

The committee's mission shifted focus toward implementing a risk/return framework and to analysis ofreturn drivers, and that goal has to be constantly reinforced, Mr. Hitchen said, adding that “communication is really a very, very important part of what we do.”

The $154 billion New York City Retirement Systems is in the process of moving to “becoming one of the finest systems rather than not-ready-for-prime time and not optimal,” through a series of reforms, said Scott C. Evans, deputy comptroller-asset management and chief investment officer.

One of the biggest changes was establishing a common investment committee for all five of the city's public pension funds that meets a minimum of six times per year. Previously, the city's bureau of asset management had to arrange 54 separate investment committee meetings for each of the city's pension systems, which have a total of 58 elected trustees.

One of the most helpful next steps for the pension funds might include formal investment education for board trustees, Mr. Evans stressed, adding that “open-mindedness and strategic thinking” from trustees pushes his staff to “think differently” about investments.

“Curiosity and skepticism” are the two most important traits of a good pension-fund trustee, said Ari Jacobs, senior partner and global retirement solutions leader at Aon Hewitt Investment Consulting.

“You want someone who is engaged and challenging on the board,” Mr. Jacobs emphasized.

Japan's ¥139.8 trillion ($1.3 trillion) Government Pension Investment Fund, Tokyo, is in the process of reforming its governance structure to achieve the autonomy from government influences on managing the fund, said Sadayuki Horie, senior researcher, Nomura Research Institute.

The Japanese parliament must approve the proposed changes, Mr. Horie said, adding that reforms already made to operations at GPIF “have made a difference.”

As hard as it may be to stick to long-term investment tenets in the current low-return environment, stalwart institutional investors are holding firm.

Maintaining a long-term focus “can be difficult,” admitted Hisae Sato, chief investment officer-finance department, Nissan Motor Co. Ltd., Tokyo, during the GFOR panel discussion “The Call to Long-Term Investing.”

Ms. Sato oversees investment of ¥1.2 trillion ($11.2 billion) for Nissan's pension plans worldwide with the goal of hitting a 4% real rate of return, which she said is much harder of late, given negative interest rates in Japan and corporate issues.

“It's important not to be too conservative or too aggressive” while investing under difficult conditions, said Ms. Sato.

Investment staff who manage the $22 billion benefit plans of The World Bank Group, New York, are able to maintain their long-term focus thanks in part to the support of the “well-defined, robust governance structure” of the oversight committee, said John F. Gandolfo, director and CIO–pensions and endowments, department of treasury.

The bank's investment policy requires Mr. Gandolfo and the oversight board to take a long-term view — between 15 and 20 years — regarding the plans' ability to meet the 3.5% real rate of return goal. That works well because the diversified asset allocation for the plans “requires a long-term investment period,” Mr. Gandolfo said.

“Significant outreach to constituents” that explains the impact of short-term returns in the long-term investment context also shores up support for focusing on the long term, Mr. Gandolfo said.

Institutional investors' long-term horizons can improve the performance of some of the companies in which they invest, said Conor Kehoe, a London-based senior partner and director of McKinsey & Co.

“Short-termism impacts returns,” Mr. Kehoe said, noting corporations under pressure from investors with shorter time horizons tend to lose their own long-term focus.

That said, a “longer-term investment view can be detrimental to plan participants if you stick with companies that may be hurt by market conditions,” said Peter Newell, managing director and senior portfolio manager at Vontobel Asset Management Inc., New York.

In response to a question from the audience about how best to maintain a long-term investment view if a mature pension plan is cash-flow negative because of benefit payments, Mr. Gandolfo said that “impairment may not be a huge problem if the pension plan can achieve its assumed rate (of return).”

He added that it is likely pension funds will underperform in coming years and their boards likely will accept underperformance for one year. “But if it continues for two or three years, it will test the long-termism of boards.”

Embracing ESG — environmental, social and governance metrics — also requires a long-term mindset on the part of boards of trustees, according to asset owners and money managers who participated in the GFOR discussion “From Divestiture to Engagement to Active ESG Ownership.”

Panelists as a group came down strongly on the side of engagement with companies they are invested in as a more effective means than divestiture in pursuing ESG objectives.

For pension funds managing money on behalf of beneficiaries who could be retiring in 40 or 50 years, ESG considerations are key in pursuing the “sustainable returns” needed to meet those beneficiaries' needs. That makes “getting maximum returns for this year, or next year or three years” less of a focus, said Philippe Desfosses, CEO of Paris-based ERAFP, the e25 billion ($28.1 billion) pension scheme for French public servants.

“We're running a marathon,” he stressed, and in that context, “engagement is very important,” noting that efforts by his and other pension funds to engage with French petroleum company Total SA have been productive.

“To the extent we can engage with those companies, and encourage (them) to use their resources more efficiently,” it becomes a win-win situation — good for those businesses, which become more efficient, and good for the pension funds that invest in them, agreed Carol Boykin, representative of the secretary-general for the investment of the $50 billion New York-based United Nations Joint Staff Pension Fund.

“The best way to make yourself felt and make good things happen, without being the least bit inconsistent with your fiduciary obligations to your beneficiaries, is through engagement,” said Ashbel C. Williams Jr., executive director and chief investment officer of the $179.5 billion Florida State Board of Administration, Tallahassee.

“It all comes down to fiduciary duty,” Mr. Williams said, stressing that “duty is just that — it's duty, it's not an option.”

Strong focus on and dedication to fiduciary duty means that pension trustees and investment staff can't allow themselves to be “confused by the noise relating to popular movements, short-term politics, crises of one kind or another, political outcries. You've got to be able to stand up and hold your course,” Mr. Williams said.

But “there's a trick to that. There's an art. That sounds simple, but it's not,” he said, noting that “it's completely foolish to simply say, `No, you're wrong, and we're right' because what will happen? You'll be marginalized, you'll be run over, cast aside, and someone (else) will take your place.”

Douglas Appell contributed to this story.