Minimizing risk over chasing returns: Insights from consulting veteran Ronald Peyton

When Ronald Peyton joined investment consultant Callan in 1974, Richard Nixon was president, the Vietnam War was winding down and the Dow Jones Industrial Average closed the year at about 616.

It was also the year the federal government passed the Employee Retirement Income Security Act. Over the past 50 years, Peyton, now executive chairman at Callan, has witnessed dramatic changes in the realms of investment consulting and institutional investing.Pensions & Investments interviewed Mr. Peyton, who served as CEO of Callan from 1990 to 2017, in honor of his nearly half-century career at Callan. Questions and answers have been edited for style, clarity and conciseness.

A: I joined one year after the company was formed. We had something like 50 employees at the time. In fact, I was one of their first clients, as I was on the investment team at Marathon Oil Co. They invited me to join Callan, and I moved to Chicago from Ohio. There were no cellphones or PCs, no FedEx or UPS, so we just wrote our correspondence on typewriters, copied them on carbon paper and carried our reports by hand when we met with clients. Now, of course, with the proliferation of high-tech, we have texts, emails and powerful hand-held computers that can communicate with clients instantaneously and access sophisticated data. Technology has brought huge efficiencies to the industry. By the time I left Chicago for San Francisco to become president and chief operating officer in 1981, we had about 150 employees and now we have about 200. We never really tracked assets under advisement at the beginning but now our AUA is at about $4.7 trillion over about 529 separate asset pools. That now includes about 300 separate entities of fund-sponsor clients.

A: It has become extremely complex with the dramatic increase of new investment products, particularly with the expansion of alternative investment products. There are now some 34,000 investment strategies in our database. Thankfully we have the databases and computer power to keep track of all that. This complexity of the investment landscape also means that front-line consultants have to possess a greater deal of broad-based knowledge than ever before. However, conversely, it also means that we have more consultants and analysts with specialized areas of expertise to back them up. It was in the 1980s when we developed specialists to handle increasingly complex topics in performance evaluation, capital markets and manager research. While the industry has become very specialized, we still need the front-line consultants that work with clients to be knowledgeable on a broad base of subjects. Also, when I started at Callan, we had very few competitors, but the industry has mushroomed in size and consultants range from small, niche players to the giants.

A: Clients have always focused on generating maximized returns at an acceptable level of risk. Our job is to keep them focused on a longer-term perspective of achieving the returns they need with the least risk and to avoid focusing on short-term gains. We consistently advise clients that one of the most important elements of investing is minimizing risk in achieving the returns needed to fund their objectives, not always seeking the highest returns. When all you do is chase returns, you expose yourself to almost unlimited risks.

A: I would say the rise in popularity of defined contribution plans, which have largely replaced defined benefit plans in the private sector. I think DB plans are an elegant solution to retirement problems — and because of mortality averaging and professional management they are actually half as costly as funding your own retirement through a DC plan.

A: Due to regulations and accounting practices. ERISA was passed in 1974 — the main reason the consulting industry got started was because everybody that ran a pension fund had to show that they were providing fiduciary oversight. So the performance measurement business got started because that was one proof that you were monitoring your plan. But then the rules, regulations and accounting requirements got more demanding and the private sector moved predominately to DC plans. Corporations understandably didn’t want to be “guarantors” of pensions and, as a result, have their financial results impacted by financial market cycles. Now, DC plans in the private sector are funded by employees (with employer matching) who must select their own investments, and the employees must bear the investment risks. I am happy to say that DC plans have progressed at a faster rate than I would have predicted — especially through the use of target-date funds, automatic enrollment and automatic escalation, all of which are effectively getting employees to actually put the money in their plan. Combined with a reasonable investment strategy, these are the keys to long-term success.

A: I think some of the fee pressures have not been completely beneficial as they will lead to continued consolidation in the industry. This will lead to fewer and fewer investment firms. Already, assets are concentrated in a small group of very large firms. And this tends to benefit players who engage in passive management, which has outperformed active management for a long while. However, these things run in cycles — eventually we may see active outperform passive. In that scenario, there might be a resurgence of smaller firms, and perhaps even larger ones, that are able to provide active alpha in returns but certainly at higher fees.

A: I first noticed an interest among clients in private equity in the late 1970s, but we did not hire a full-time PE and hedge fund specialist until the late 1980s. PE has seen a number of surges in popularity coinciding with market developments. The Nasdaq tech boom from 1996 to 2000 and its subsequent implosion spurred a great interest in PE from institutional investors since buyout funds and private investments tended to fare pretty well in terms of valuations. And then again, between 2005 and 2008 — before the global financial crisis — there was a big resurgence of investments in private equity, which fared fairly well during that downturn. Alternative assets have now become mainstream in the investment community. For a well-diversified portfolio with proper oversight, alts are now very well received. They are no longer a “scary alternative.”

A: A lot of public pensions funds are not getting the funding they need — and that’s the big problem in governance. Most pension funds have control over their investments, they have control over their benefits, but many don’t have real control over the funding. For DC plans, there are many encouragements for proper funding via employer matching and escalation policies, but many employees need to step up their retirement savings.

A: I think more functions at large pension funds will be done in-house due to cost advantages. Blockchain will revolutionize the administrative functions and likely eliminate many back- and middle-office positions. I have no idea what AI is going to do, but it will have some sort of role to play. It promises to be very disruptive, but hopefully will be beneficial. There’ll also be challenges in DC plans with the shift in focus from accumulation to retirement distribution as participants age. I mean, how do you take money out of your DC plan in retirement without exhausting the plan before you pass on? This is the mortality risk that is faced by DC participants.

A: We have a very active ESG team at Callan that meets regularly with hundreds of clients who are, I think, focusing on very intelligent and reasonable approaches to their own ESG efforts in their portfolios. ESG is definitely here to stay, and it’s real. But clients have many different approaches to ESG today, which will probably evolve in the future. I find most ESG measures to be reasonable and helpful as they are put into practice.