Well, it’s here. After five years of research, over five thousand documents of public pension plan meeting minutes analyzed and culled for data, over 2,500 legal cases examined, hundreds of human hours spent researching, analyzing and modeling, 43 hours of course work, four research analysts working part-time over 2.5 years, one review committee of six experts from governance, finance, law, psychology, economics and philosophy, we did it. We can now measure the governance of asset owners (pensions, endowments, foundations and other dedicated funds). What’s more is not only can we measure governance, but we can relate this to – and even, in part, predict – investment returns, bond yield spreads and funding ratios, specifically as it relates to pensions.
In many ways, our industry is at an inflection point. We will either adapt successfully or become less relevant. As we seek to fulfill our mission of leading the investment profession, we have an opportunity to demonstrate to the broader investment community our understanding of the key issues and help shape the dialogue going forward. – Paul Smith, CEO, CFA Institute
I undertook this dissertation research at Marquette University because, after years of consulting to asset owners on their investments, I had observed the wide range of governance practices, both positive and negative, and how this seemed to have a direct impact on how effective these organizations were, not only in terms of their financial performance, but even in pursuit of their broader missions.
I’m, of course, not the first to take a stab at this issue. There have been others before me. We have the corporate governance (CG) field to thank for that. The CG literature represents a body of work that goes back 30 years. What’s new here is the application of these techniques to an area of the economy that so far has fallen behind the corporate and non-profit sectors when it comes to governance practices.
It begs the question as to why asset owners haven’t implemented these techniques given the widespread move across other sectors. According to the National Association of Corporate Directors (NACD), 92% of public company boards engaged in self-evaluation in 2012, which is essentially everyone. 48% reported doing even more granular director evaluation. According to a BoardSource survey in 2015, a slight majority (51%) of non-profit boards conduct regular self-assessments, no doubt behind public companies, but up from where it was a few years ago.
I suspect the main hurdle has been cultural in nature. The world of investing remains insular and arkane. The very subject itself is confusing and complicated with thousands of organizations offering many more thousands of products to the market from investments to insurance. Occasionally things go wrong on a massive scale, which leaves people more willing to defer to the experts. Our profession, and by that I mean the cadres of investment consultants, actuaries and asset managers, many are not trained in governance matters, and most haven’t been equipped with the proper tools. But they know it’s an issue. I attended the Barron’s Top Institutional Consultant’s Conference last year, and heard governance on the lips of nearly every presenter, so the industry clearly sees the need to move in this direction.
And indeed it does. A report that came out earlier in the year from CFA Institute entitled the “Future State of the Investment Profession”, reported survey results from professionals on changes in the industry. The theme of the report is disruption, and CEO Paul Smith in his cover letter described it as an industry at a crossroads:
In many ways, our industry is at an inflection point. We will either adapt successfully or become less relevant. As we seek to fulfill our mission of leading the investment profession, we have an opportunity to demonstrate to the broader investment community our understanding of the key issues and help shape the dialogue going forward.
One such key issue is asset owner governance, and helping institutional investors to better govern themselves could be one path forward. My vision is that the quarterly meeting schedule will add governance to the agenda of economic and market updates and performance reviews. In my view, one out of every four meetings should be dedicated to this topic.
But why should we care about this? Does it really matter or does talking about governance simply make us feel like we are doing a better job? The data tell us otherwise…
When I approached the public pension sector as the subject for my dissertation research I had one concern that the investment performance would be virtually the same, and there would be nothing really to study. I had figured that state and municipal pensions had similar demographics, similar funding pressures, similar investments, etc., and so their results would look pretty consistent. Boy, I could not have been more wrong. For the 2008-2012 period, the dispersion of annualized returns ranged from 15% on the top end to -4.5% on the low end. How could there be so much variation? Of course it was significant differences in allocation, but as we found in our research the range of governance practices had a direct impact on the choices that boards made in their allocations and investments. Several factors emerged as key drivers, such as the institutional knowledge of the organization. How consistent were the players? How often did they turnover? If it was high, the change in players lead to less organizational stability and adherence to strategies; and this eroded their performance over time.
I look forward to sharing more of our findings, and in the coming weeks will share a glimpse of what we have planned regarding the tools for professionals across the industry, who share our vision of helping asset owners become more effective both in their governance practices and in pursuit of their important organizational missions.
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Christopher K. Merker, PhD, CFA, is a director with Robert W. Baird & Co. Merker holds a PhD in Investment Governance and Fiduciary Effectiveness from Marquette University. He is a past president of the CFA Society Milwaukee and a current board member. An adjunct professor of finance at Marquette University, where he teaches the investment course, Sustainable Finance, he is also executive director of Fund Governance Analytics, LLC, a provider of governance research and diagnostic tools for issuers, asset owners and institutional investors. He publishes the blog, Sustainable Finance, which covers current topics around sustainability in investing (www.sustainablefinanceblog.org)