Posts Tagged 'Governance'

Penny Wise. Pound Poor.

Published November 10, 2011 Uncategorized 1 Comment
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Ashby Monk

This week the Boston Globe published an article shaming MassPRIM for paying a total of $267,000 in performance based bonuses. In other words, the 25 person team at MassPRIM was made to feel bad for accepting a little over 10 grand per person in annual performance compensation after the pension had its second best year ever. Seriously? In all honesty, I think articles like this one may actually do damage to our pension system’s long-term sustainability. Here you have a major newspaper calling on a $50 billion pension fund to pay its staff significantly below market levels. For some flavor, see this quote lifted from the article:

“For these highly paid individuals to have a payment scheme that gives them huge bonuses for their performance is totally outrageous. Obviously, they haven’t gone by Occupy Boston to see how people are feeling about how the rich are getting richer and the working families are struggling.’’

The author’s point is to say that Massachusetts’ pension fund employees make more money than other government employees, and paying them a bonus (despite the fund’s banner year) is totally unfair. What the author doesn’t mention is how much less the MassPRIM employees make than their peers in the private sector — i.e., how much they are actually giving up in terms of potential compensation to work for a mission-driven organization like MassPRIM. So, just for fun, I thought I’d actually follow through on this article’s logic and think about what would happen if MassPRIM started paying its employees even less than it already does (which is already a pittance compared to other pension funds in the US and Canada).

So let’s assume that all performance based compensation is cut and investment staff are paid well below $100,000 per year. Right away, it becomes extremely challenging for MassPRIM to hire talented investment professionals. Even the most mission-oriented individual would be hard pressed to work at MassPRIM when they could be making three or four times that much at another pension fund and possibly ten times that much in the private sector. So MassPRIM would quickly lose some of its most talented employees. As a result, the fund would not have the capability or even credibility to manage its assets in house (as many of its peers are doing to cut down on exorbitant fees paid to the private sector). Because of this, MassPRIM would be forced to rely on private sector asset managers almost entirely. So the question then is how much MassPRIM would end up paying these private sector asset managers in terms of annual bonuses. I can promise you that it’s more than $10k per person. In fact, in the private equity space, I’m sure some of the bonuses are 100 times that large. Is this preferable to paying in-house staff a competitive wage? No. No it’s not.

Anyway, I’m sorry for the rant. The author of this Boston Globe article undoubtedly has good intentions, but his argument will ultimately exacerbate the problems we see in finance today! (Rich getting richer etc.) As I see it, one of the big benefits of moving assets in-house is reducing costs and fees. But this really isn’t possible without a highly sophisticated in-house team of finance professionals. How are you going to hire these people without paying competitive salaries?

To Preserve and Appreciate

Published September 27, 2011 Uncategorized Leave a Comment
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Ashby Monk

Here’s something odd: I’ve come across some funds lately with mission statements that call for both capital preservation and capital appreciation.

Don’t the boards that write these statements realize that these two concepts are diametrically opposed to one another? Don’t they realize that the portfolio that will achieve the former won’t achieve the latter? Apparently not.

As I see it, the only way to achieve both of these objectives from an investment strategy / risk budget approach is to split the fund up into two separate units with their own strategies and profiles.

However, even then, that would probably require two separate mission statements to guide the behavior of staff. After all, one of the touchstones of good governance is clarity of mission — without this it’s really hard to align the interests of the staff with the organization as a whole.

Anyway, Board members, to preserve and appreciate is akin to eating cake and having cake. You can’t do both. Rewrite your missions accordingly.

The Benevolent Dictator Governance Model

Published August 31, 2011 Uncategorized Leave a Comment
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Ashby Monk

Having spent more than a decade looking at the design and governance of institutional investors, I think there’s something really quite appealing about giving a single, highly skilled professional — who is also completely apolitical and highly ethical — absolute authority over a given public pension or sovereign fund. Why? We in the governance game spend a lot of time (too much) thinking about appointment procedures that balance the representative interests of the fund’s stakeholders with the demands of a modern financial institution in terms of skills and talent. And, I assure you, the level of difficulty of staffing an entire Board with sophisticated and depoliticized individuals is, to put it simply, high. (Think triple lindy levels of difficulty.) So, this ‘benevolent dictator style governance model’ has a certain appeal; it would permit real time decision-making and avoid a plethora of extra-financial interests that too often creep into board meetings and decisions. I mean think of it: a sort of Warren Buffet type character that you can trust to run the entire show. It would be awesome!

Snap out of it, Ashby! Pull your head out of your ivory tower! Seriously. As theoretically appealing as this governance model may sound, it’s a recipe for trouble. (As we know all too well, theories of finance don’t always translate into sound finance practice.) And for real world evidence, you need look no further than the New York State Common Retirement Fund.

At the CRF, the New York State Comptroller has absolute authority over the fund. And what happens when you give one man authority over 140 billion dollars? Let’s just say it hasn’t been pretty, as Columbia’s Andrew Ang details in a new case study:

“Edward Regan, who served as comptroller from 1979–1993, was investigated in 1989 by the New York Commission on Government Integrity for directing state business to investment banks and lawyers who had donated to his campaign. The commission also found that an adviser to the comptroller’s office had used office letterhead to produce a campaign agenda which apparently tied the awarding of government contracts with campaign contributions.

H. Carl McCall served as comptroller from 1993–2002. He was criticized for writing to companies in which the CRF had invested on state letterhead asking them to consider the resumes of a number of friends and family members. McCall was also accused of directing CRF business toward campaign contributors. In a class action suit led by the CRF, McCall selected two law firms which had donated approximately $100,000 to his election campaign. The selection of these firms was contested by the other plaintiffs in the case, but the district court ruled that there was inadequate proof of a “pay-to-play” scenario. The third circuit court upheld this finding.

McCall was succeeded by Alan Hevesi…In 2007, then Attorney General Andrew Cuomo launched an investigation into “systemic conflicts of interest” in the comptroller’s office during Hevesi’s tenure. Hevesi was accused, and eventually pleaded guilty, of accepting $1 million in gifts and travel from Elliot Broidy, the founder of Markstone Capital Group, in exchange for granting Markstone a $250 million investment mandate. Hevesi’s political advisor, Henry Morris, pled guilty to taking placement fees on the CRF’s alternative investment portfolio and to providing access to the fund in exchange for campaign contributions. David Loglisci, former chief investment officer of the fund, also pled guilty in connection with the scandal. In total, eight people pled guilty and $170 million was recovered on behalf of the fund.”

I think it was William Pitt who said that power is apt to corrupt the minds of those who possess it. No doubt that’s as true today as it was back in the 1700s.

Governance Conundrum: 1% Resources + 10% Time = 90% Impact?

Published August 15, 2011 Uncategorized Leave a Comment
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Ashby Monk

As readers of this blog know, I spend a great deal of time waxing on about institutional governance, organizational design, risk management, investment decision-making, and zzzzzzzzzzz. Yes, I’m well aware that these issues are far less sexy than the business of actually making bets or taking risks. However, I’m convinced…to the core of my being…that if a fund can get the boring stuff right, the sexy stuff will fall into place. So, despite receiving many pleas from dinner guests, airplane passengers and random passersby, I will continue to talk about (and research) these mundane aspects of institutional investment.

Anyway, I bring all this up (again) because I was recently with the CIO of a sovereign fund, and this individual actually agreed with me on this point (…stop the presses…). In fact, this person’s single greatest challenge was to keep the fund’s Board focused on “what matters” rather than on “what’s fun”. In this individual’s estimation, upon arrival at the fund, the Board was spending 1% of available resources and 10% of available time on the things that generated 90% of value for the fund: governance, asset allocation and risk tolerance. Instead, they were spending all of their time on the sexy stuff; investments and mandates. Not good.

Because most Boards are comprised of representatives rather than pure finance experts (i.e., bureaucrats, politicians, unions, teachers, firemen, policemen, what-have-you), they often don’t have the background to credibly assess the merits of a given investment or mandate. So why spend all this time doing so? On the other hand, these Boards could focus and have a real impact on improving policies, refining process, selecting allocations, choosing risk tolerance, etc. etc.

All this is to say that while Boards may enjoy spending their time on vetting sexy investments,  they should really be focusing on what matters. At the very least, we need to dramatically change the 1, 10, 90 ratio to something more like 30, 60, 90.

It’s Expensive To Save Money

Published August 1, 2011 Uncategorized 3 Comments
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Ashby Monk

Over the weekend, I saw an interesting article by Pauline Skypala in the Financial Times on managing costs within a pension fund. Here’s a quick blurb to pique your interest:

“The fund management industry is mostly run for profit – for the owners rather than the investors. The owners of fund groups are virtually guaranteed a profit; the investors with them enjoy no such guarantee.

The article is entitled “How to cut costs in running pensions.” And so, you must be wondering, how exactly does she suggest pensions should cut costs?

The answer: bringing assets in-house. (Yes I know; I’ve written on this topic ad-naseum. But let’s just go with this for a second.) To make her case, she draws on an interview she conducted with Chief Executive of OMERS Michael Nobrega:

“Omers, the Canadian pension fund that looks after municipal workers in Ontario, calculates that for every $1 it spends on internal investment management it makes $25; if it employed external managers that figure would drop to $10…All but 15 per cent of the fund’s C$53bn ($55bn) of net assets are run in-house. External managers are employed to access markets where the fund does not have personnel on the ground, such as some in Asia…”

And Pauline Skypala concludes:

“Large scale plans run on a not-for-profit basis with in-house management are undoubtedly the cheapest way to look after people’s retirement savings. Governments keen to help their citizens build their own pension pots should take note.”

Agree to agree, Ms. Skypala, about the benefits of running assets in-house. There are lots of potential cost savings. And the data from OMERS is quite compelling in this regard.

But (!) the decision to bring assets in house is totally dependent upon the fund’s internal governance. If the fund can’t actually muster a sophisticated asset management program in house, then it really shouldn’t be trying. So, the first step of “saving money through in-sourcing” should be “spending money on operational and governance upgrades.”  And, actually, the prequel to that step one should be “securing buy in from the sponsoring authority to spend a lot of money on internal operations.” In my experience, it’s the prequel that poses the biggest problem and puts people off to the whole shebang (…just like Star Wars…). For example, I know plenty of funds that have a lot of internal flexibility when it comes to investing but very little flexibility when it comes to hiring talent.

So, generally speaking, when thinking through the necessary governance components for a move in house, I focus on the People, Process and Politics.

  1. People: Direct investors must be able to attract, motivate, and retain talented individuals with the necessary skills and competencies for managing a modern financial institution. Talent or human capital is paramount for success in financial markets and arguably in modern economies. However, doing this tends to be quite challenging. Since sovereigns and public pensions are governmental, these organizations have to find ways to fill public sector jobs with individuals that can compete in and with the private sector. This requires innovative compensation policies and structures.
  2. Process: Direct investors also require highly developed decision-making frameworks and risk mitigation capabilities in order to manage the complexities of investing. Success is a function of how decision-making is framed, routinized, and implemented. Scholars have recognized the importance of governance for institutional performance for many years. Research has also unequivocally demonstrated a correlation between ‘good’ investment governance and positive financial returns. Innovation in governance is particularly important in overcoming inherited institutional and organizational features, which helps to ensure functional performance.
  3. Politics: Direct investors have to be able to manage the impact that politics can have in the investment decision-making process. To suggest that public funds can be entirely apolitical is, in my view, naïve. Every public fund is the product of a political decision. And yet, close ties with policymakers can be damaging to returns if these relationships distort the investment decision-making of skilled professionals. Indeed, research in a rather different domain shows that political influence can lower the financial returns of government pension funds. Also, the political angle extends to the “buy in” that these funds have to receive from their masters for a sophisticated investment program. Consider this: a successful infrastructure investor might need to conduct due diligence on 100 deals for every 10 investments; can a government stomach spending tens of millions on the 90 opportunities that lead “nowhere”?

All this is to say: Yes, institutional investors can save money by bringing assets in house. But they can lose a lot of money as well if they don’t first invest in the people and process while managing the political intrusions and securing political buy in!


Some Rare Uncertainty For The Future Fund

Published March 23, 2011 Uncategorized 1 Comment
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Ashby Monk

Six months after Paul Costello announced his intention to leave his post as general manager at the Future Fund, the Australian SWF still hasn’t named a replacement. And now, three months after he apparently told the government that he did not want to continue on as Chairman beyond his five-year term, David Murray has just been re-appointed as Chairman (albeit for a shortened term of only twelve months instead of the normal five years). For a SWF that has been an example of good governance, all this uncertainty is more than a little bit surprising. What’s going on?

Since I’m sitting an ocean away, I’m reduced to scouring the webs for some answers. And, as you might imagine, the Australian press is buzzing with rumors and speculation about all of this. For a taste of the things said, here’s one interpretation of events:

“Today’s announcements of appointments and reappointments to the fund’s board came amidst the backdrop of bitter wrangling within the board and, some say, some disagreement between the Treasurer, Wayne Swan and the finance minister, Penny Wong, over Murray’s fate. Swan is said to have been opposed to his reappointment. In the end a face-saving compromise has been found, with the ministers saying Murray had informed them some time ago that for personal reasons he didn’t wish to serve another full five-year term. So he’s been given an extension of 12 months, although there are suggestions that he might depart well inside the 12 months. It would have been awkward not to reappoint Murray given that the fund is currently without a permanent general manager. The inaugural general manager, Paul Costello, left the fund at the end of last year, reportedly after some differences of opinion with Murray.”

Elizabeth Knight also has a rather provocative take on the situation:

“The big board split over at the $71 billion Future Fund is not the result of a disagreement over the running of the organisation, it is not about investment decisions nor is it about performance – it is about personal ambition.”

It’s hard for me to know what to believe (as there are many interpretations to choose from). So I think it’s only fair to give Murray the last word in all of this:

“I indicated last year that if the fund was in good shape at the end of my five years, I would prefer to move on…I didn’t want to bat on for a long period…But there were some transitional issues. We had four common retirement dates (on the board). And we are going to have to settle in a new general manager.”

That sounds sensible enough to me. Replacing Costello and Murray within a matter of months would create quite a serious deficit in terms of institutional knowledge. Given the fund’s success since its inception in 2006, that would be a shame. And finding someone of Costello’s caliber (who would also be willing to work for a public investor) was always going to be a challenge. So, in a way, Murray is staying on to ensure continuity and certainty, even if his short-term re-appointment appears to outsiders as just the opposite.

Australia’s Future Fund: The Self Aware SWF

Published October 31, 2010 Uncategorized 1 Comment
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Ashby Monk

A serious case of jet lag woke me up this morning at an uncivilized hour. (I’m in Kuala Lumpur for a conference). So, since it was still dark out, I decided to try to be productive by making my way through the Australian Future Fund’s latest annual report. And, I have to say, it’s impressive. Not only does it offer stunning detail on the operations of this fund, but it also has a few surprises, such as a GAPP implementation report on page 119.

However, I was particularly struck by the Future Fund’s ongoing commitment to improving its organization. So, despite the fact that the fund was set up according to “best practice” principles of governance in 2006, it has decided to use the lessons from the recent financial crisis to further refine its operations:

“The Board has initiated a review of governance practices and arrangements within the organisation, including a comparison of key governance elements to those of other leading global funds. This reflects the obligation on the Board to have regard to international best practice for institutional investment and the Board’s own view that good governance protects and creates investment value. The outcome of this review will help the Board ensure the organisation’s time, resources and skills are optimally applied to the achievement of the Investment Mandate. Ultimately this will contribute to the achievement of performance goals and other key targets over the medium term.”

That’s music to my ears…

Very Different Countries, Same Constraint

Published July 21, 2010 Uncategorized Leave a Comment
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Ashby Monk

I’ve been covering the internal debates in Nigeria and India over whether to set up a new SWF for some time (for Nigeria, see here, here, here, here, and here and for India, see here, here, here, and here). If you aren’t aware, each country comes to the ’SWF debate’ with very different circumstances and, it should also be noted, motivations for why a  SWF is needed:

  • India wants a SWF so that it can invest some of its foreign exchange reserves in strategic resources around the world. Think of this as a sort of ‘strategic commodity acquisition fund’.
  • Nigeria’s wants a SWF for more traditional purposes, such as stabilization, diversification and inter-generational equity.

In any case, over the past few months both countries have actually made considerable headway on their proposed SWFs. While India’s Finance Ministry has said that the decision on whether to establish such a fund has not been made, many think it a fait accompli. And while Nigeria’s Governors have yet to give their blessing to using the Excess Crude account for funding the new SWF, it is generally expected that the new SWF will soon become a reality.

Indeed, two well-crafted editorials were published today on the merits of SWFs in each country; one by the Editors of The Economic Times of India and the other by the Editors of the Daily Independent of Nigeria. Both seem to conclude that SWFs are a good idea and worth doing but with constraints:

India: “…there is merit in the proposal, provided we can devise an institutional mechanism that can deploy the funds with integrity and flexibility…Can we have a fund like Temasek or the Abu Dhabi Investment Authority, professionally managed, picking winners, tolerating some losses? To answer in the negative is far too cynical, and ignores innovations like the new pension system, where retirement savings are being managed by competent professionals in a competitive framework.”

Nigeria: “The possibility that the Fund could be mismanaged is real, especially given Nigeria’s ugly experience with the Excess Crude Account (ECA)… We therefore challenge the committee set up to work out the operational modalities of the proposed SWF to do a thorough job. First, it must ensure that its structures and funding sources are well defined. Moreover, it must have well-designed funding and withdrawal rules that are consistent with the stated objectives. Furthermore, as the nation’s common wealth for the present and future generations, its operation must be governed by strict standards of prudence, transparency and accountability. Nigerians need to be reassured that the administration of the SWF will be entrusted to seasoned professionals, knowledgeable in modern economic management systems. Furthermore, its governing board must have adequate representation from all sections of the country and sectors of the economy. Only then will the idea of setting up a Sovereign Wealth Fund for the country be likely to receive wide support.”

In sum, these different countries who want SWFs for very different reasons seem to agree on one thing: it’s not worth doing unless it’s done well. And I couldn’t agree more; if the governance and design of these funds are sub-standard, the new SWFs could fail to achieve a Pareto improvement, which means that the countries shouldn’t have done it to begin with.

SSTF: A New American SWF?

Published June 25, 2009 Sovereign Wealth Funds 4 Comments
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Ashby Monk

Elizabeth Stauderman and Jonathan Weisberg of Qn, a publication of the Yale School of Management, recently interviewed Larry Summers on the topic of SWFs. It’s a great interview, as Summers talks candidly about a variety of topics. Of particular interest to me was his discussion of pension reserve funds. Summers defined this type of SWF as:

“…funds that are accumulated in the context of pension arrangements of one kind or other, where countries quite reasonably seek the benefits of international diversification.”

While he acknowledges that other countries “quite reasonably” have set up these types of SWFs to invest retirement assets, Summers also lists the reasons why such a fund was deemed inappropriate in the United States:

“We’ve made a decision in the United States that the Social Security trust fund should not invest in equities, even through index funds…we’ve made that decision very substantially out of a judgment and concern about the politicization of the marketplace and the politicization of corporate decision-making.”

Summers is referring to the late 1990s when the Clinton Administration considered investing the U.S. Social Security Trust Fund in equities. The proposal was torpedoed due to fears that politicians would have influence over the investments, intrude on the Trust Fund’s operations, and engage in ‘stock picking’ so as to use Trust assets for personal or political gain.

To be sure, the specter of politicians interfering in huge public investment funds is unappealing. However, some evidence from outside of the United States suggests headway has been made on the political issue. Since the 1990s, numerous OECD countries, such as Australia, Canada, France, Japan, Ireland, Korea, New Zealand, Norway, and Sweden, have all decided to pre-fund and invest their SS assets in equities (most of them actively). In this process, all of these countries designed and implemented new governance practices that explicitly sought to immunize their reserve funds from political influence.

Take Canada as a case study: many Canadians raised similar political concerns during the 1997 debates that created the Canada Pension Plan and its corresponding Investment Board. In response, the politicians that designed Canada’s system did their best to make the CPP a largely autonomous entity with investment decisions placed well beyond the reach of any politician or interest group. In fact, the 1997 legislation explicitly rejected all political or social investing objectives and defined the welfare of plan participants as the singular focus of the CPPIB. In addition, the founding legislation requires changes to the CPP program – including changes to the set-up of the CPPIB and its investment mandate, or to CPP benefits and contribution rates – be approved by the federal government and two-thirds of the provinces representing two-thirds of the population. This is a level of exigency greater than that required to change the Canadian constitution.

In sum, Summers’ comments about the Trust Fund reminded me of two things: 1) The idea of diversifying SS Trust Fund assets was taken quite seriously in the 1990s until political concerns thwarted the effort; and 2) there exists today governance practices designed explicitly to deal with these same political concerns, which means the main roadblock that stopped the policy in the 1990s isn’t necessarily a road block today.

This then leads to an interesting thought experiment: could the US borrow and modify the the new governance practices developed by other countries to transform the Social Security Trust Fund into a pension reserve fund? Probably not. The possibility of such a policy being taken seriously (especially after the financial crisis) in Washington today is beyond remote. But I think the idea is worth revisiting. If other countries are pre-funding and diversifying their SS assets so as to manage population aging all the while limiting the influence of politics, why can’t the US?

To be sure, there are still other debates to consider when thinking about investing SSTF assets actively, such as risk adjusting (this is a biggie). But I expect such debates also took place in Australia, Canada, France, Japan, Ireland, Korea, New Zealand, Norway, and Sweden…

Misunderstood: Future Fund’s Governance

Published June 23, 2009 Uncategorized Leave a Comment
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Ashby Monk

Alex Dunnin flagged up an interesting Future Fund governance story in the Financial Standard. He suggests that the rumor that former treasurer Peter Costello would be offered a position working for the Labor Government at the helm of the $60 billion Future Fund illustrates a deep misunderstanding of the Future Fund itself. Dunnin notes:

“For example, the board already has a chairman in former CommBank chief executive David Murray and six guardians. Any role for Costello would have only been to join the board as an additional guardian or to replace one of the incumbents, noting that guardian John Paterson whose term expires this year is yet to be formally renewed.”

In short, Dunnin views the Costello appointment rumor as evidence that Australian politicians are unfamiliar with the Future Fund’s governance. This seems a bit of a stretch, but, given the Fund’s youth, it is possible that the politicians who were pushing for Costello to take over the Future Fund were forced to familiarize themselves with the Fund’s appointment procedures; the very procedures that were set up to keep politicians like them from meddling in the Fund’s internal activities.

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This website is a project of Professor Gordon L. Clark and Dr. Ashby Monk of the School of Geography and the Environment at the University of Oxford. Their research on sovereign wealth funds is funded by the Leverhulme Trust and The Rotman International Centre for Pension Management.

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