Three of the items below are directly related to pension plans, but each of the elements covered — investment strategy, communication, expected returns, and operating models — applies to all asset owners.
The path of simplicity
Bob Maynard will be retiring next month as the chief investment officer for the Public Employee Retirement System of Idaho. As the announcement of his departure said a year ago, he has been a “steady influence,” with a “simple, transparent, focused, and patient” approach, eschewing many of the trends of the day.
He laid out his philosophy in a 2011 paper, “Back to the Future: Conventional Investing in a Complex World,” the conclusion of which begins:
I believe the endowment model, as generally explained and implemented here, goes too far in the direction of the complex, opaque, and complicated, and has too high a risk of breaking in turbulent times.
In the decade since, most institutional portfolios have gotten even more “complex, opaque, and complicated,” although recent events have caused some asset owners to wonder whether it’s time to backtrack.
(Also of interest is Maynard’s earlier “Behavioral Finance: Pitfalls and Prevention for Plan Sponsors,” but it appears to no longer exist online. Reach out if you would like a copy.)
Communication
Any investment role is a mix of analysis and communication. The analytical part gets all of the attention, but the success of investment professionals is often directly related to their ability to communicate well — and to do so with people that range from deep specialists to those who have had relatively little background in the field.
Buried within an April Institutional Investor portrait of Jon Glidden, CIO of the Delta Air Lines pension fund, were some paragraphs about his ability to bridge gaps. One asset manager noted that Glidden “could talk to us in our lingo and then he could summarize it on a high level for his board.” A former boss said, “The communication skills are really the key in terms of leading a team and being a CIO.”
The investment team, asset managers, and fiduciary decision makers all have different roles, languages, and concerns. Being able to adapt — to find the right style and depth of communication — is a skill that leverages what everyone else brings to the table.
Expected returns
One line of academic research looks at expected returns and what drives them. Here are two papers regarding that kind of forecasting.
The first, “The Return Expectations of Public Pension Funds,” considers a variety of possible drivers for those expectations. The abstract:
The return expectations of public pension funds are positively related to cross-sectional differences in past performance. This positive relation operates through the expected risk premium, rather than the expected risk-free rate or inflation rate. Pension funds act on their beliefs and adjust their portfolio composition accordingly. Persistent investment skills, risk-taking, efforts to reduce costly rebalancing, and fiscal incentives from unfunded liabilities cannot fully explain the reliance of expectations on past performance. The results are consistent with extrapolative expectations, as the dependence on past returns is greater when executives have personally experienced longer performance histories with the fund.
The second, “Pension Underfunding and the Expected Return on Pension Assets: The Impact of the 2008 Financial Crisis,” looks at corporate defined benefit plans as opposed to public ones. In regard to expected returns (ER), the authors assert that:
plan sponsors purposely overstate ER to reduce the pension expense, especially in periods when DB plans experience a significant deterioration in pension funding. To complete the picture, we also test the hypothesis that the pension expense is lower for plans making the transition from a funded to an underfunded status. We indeed find that the revisions in ER are economically significant and generate expense-reducing outcomes.
New models of aggregation
A 2021 brief from bfinance, “Asset Owner Investment Vehicles,” began:
Until recently, the provision of investment vehicles has essentially been the territory of asset managers — except in the case of investors that have opted to carry out asset management activities in-house. Yet in recent years, more investors have sought to improve operational efficiency, reporting and governance by launching investor-dedicated funds: vehicles to house most or all of their externally-managed (and, potentially, internally-managed) portfolios.
The short piece addresses some potential benefits, including economies of scale, cost savings, and better resource allocation. Tax and regulatory issues may favor the use of such vehicles in some jurisdictions, while impeding or prohibiting them in others.
For those asset owners who don’t want to go full OCIO or full in-house, it might be something to look at, but it’s new enough that there is a lot of variability in the nascent offerings. And in cost too, “with the most expensive proposal priced twice as high as the least expensive equivalent offering.”
Published: August 5, 2022
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