Commentary: A new era for manager due diligence

The global financial crisis that occurred in 2007-2008 had a lasting impact on public and private pension funds, as the collapse of Lehman Brothers and massive fraud committed by Bernie Madoff placed greater emphasis on fiduciary obligations and manager due diligence.

During the decade that followed, plan sponsors continued to hone their manager research and screening processes until a new wave of disruption sent ripples across the institutional investment landscape.

This time, the black swan event took the shape of a global health pandemic fraught with lockdown orders that forced asset owners and asset managers to work remotely from the confines of their home offices. As the transition to work from home took hold, site visits, a longtime staple in manager due diligence, were replaced with Zoom meetings and investment managers and plan sponsors were forced to adapt to a brave new virtual world.

Initially, plan sponsors and asset owners were reluctant to conduct new searches virtually, and many elected to postpone new manager engagements, hoping the storm would be short-lived. Others decided to invest only in the managers they were currently engaged with. However, as we enter the tenth month of the pandemic with new cases in the U.S. spiking to their highest levels on record and a second wave of lockdowns rolling out across Europe, it is increasingly apparent that a return to normalcy and in-person site visits could take much longer than anticipated. Favoring the incumbent or existing manager that they are using elsewhere in the portfolio is clearly not a sustainable approach for meeting fiduciary responsibilities.

Assessing the operational effectiveness of an investment manager without the ability to lay eyes on a firm's infrastructure, trading floor or physical footprint can also prove to be challenging, particularly if managers are reluctant to share hard or soft copies of key documents for confidentiality reasons.

For the foreseeable future, videoconferencing will remain core to the process by which organizations evaluate the investment and operational strengths, weaknesses, characteristics and biases of managers. And while the purpose of this process remains unchanged, the virtual means by which plan sponsors assess an investment manager's culture, acumen, operational effectiveness and corporate policies will continue to create new challenges and opportunities.

Providing the opportunity to have real-time, face-to-face conversations with colleagues and professionals from across the globe, video conferencing has proven to be an invaluable tool during these unprecedented times. But the technology is not without some limitations.

For plan sponsors conducting manager due diligence entirely via virtual means, a common challenge is trying to assess the team dynamics and cultural fit of an asset manager through a computer screen.

Despite the best efforts of all parties, virtual meetings don't have the same level of spontaneity as in-person meetings for a host of reasons, and as a result, soft sensory perception is reduced along with the interpretation of non-verbal cues that can be invaluable to shaping in-person meetings and assessing team dynamics and culture. Reduced spontaneity can also hinder an organization's understanding of the thought process of an investment team and firm, as some follow-up questions go unasked and discussions become harder to steer.

Fortunately, with time, investment managers are growing more willing to share this proprietary data and information as the use of non-disclosure agreements expands.

The sudden and unexpected transition to virtual meetings from on-site visits forced organizations to re-examine nearly every stage of their manager selection process — a development that's led to enhancements designed to foster better decision-making and results.

First and foremost, both investment managers and plan sponsors are spending more time on planning and preparing for upcoming due diligence meetings. Not surprisingly, the elimination of travel has created more time for better information gathering. Increasingly, organizations are conducting their own qualitative and quantitative analysis of data and information provided prior to the meeting — a higher level of analysis that's unquestionably generated better questions and meeting agendas.

Before the pandemic, a plan sponsor might only be in town for a single day and it was standard practice to schedule one long in-person meeting. With the added flexibility of virtual meetings, these marathon sessions can be broken up into a series of shorter, smaller sessions scheduled across several days. This format has proven to enhance engagement, facilitate more discussions between the organization and the investment manager, and allow professionals from different offices the opportunity to participate in targeted discussions.

Virtual meetings also provide plan sponsors and investment managers the ability to message their own teams in parallel in real time as a meeting is taking place. Often, this communication helps to guide discussions toward what matters most for all parties.

Finally, the unprecedented events created by COVID-19 provide plan sponsors with a rare opportunity to compare how managers are responding to a common challenge, particularly as it relates to the effectiveness of their business-continuity plans. The pandemic has created similar challenges for every asset management firm. Evaluating how firms have responded can offer valuable new insights into their governance, leadership, culture, research capabilities, and ultimately, investment processes.

While the recent trajectory of COVID-19 cases in the U.S. and Europe suggest plan sponsors will be required to conduct manager due diligence virtually well into 2021, the amazing journey traveled during the past 10 months will undoubtedly leave a lasting mark on how manager research and screening is conducted for years to come. Given the pace at which new challenges have been overcome and tactics and techniques have been developed to navigate the current environment, due diligence in a post-pandemic working environment will likely look like a hybrid of past and present approaches.

Fred DeSerio is head of sales and country head of Nikko Asset Management Americas, based in New York. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines but is not a product of P&I's editorial team.