Several factors have been leading institutional investors to explore total investment program management. Chief among these are complex alternative asset classes, more sophisticated investment products, increasingly burdensome regulations and a lack of internal resources and expertise.

Total investment program management includes activities such as portfolio analysis, manager research, performance reporting, risk budgeting and asset allocation. In essence, a total investment program partner serves as an extension of internal staff. Take, for example, an educational institution with a growing endowment fund. As assets increase, those funds become more complicated to manage and staff may be asked to evaluate nontraditional asset classes — hedge funds, real estate, commodities or private equity — while simultaneously attending to their other responsibilities. In addition, because the investment committee typically meets only quarterly to authorize decisions, months may pass before the staff can make changes.

Or consider a corporation with a defined benefit plan. In the United States, the Pension Protection Act of 2006 (PPA) made sweeping changes in how retirement plan sponsors prepare their financial statements and fund their plans. In addition to the PPA, other looming regulatory changes in the U.S. and abroad will make it increasingly difficult for corporate treasurers and internal investment professionals to keep abreast of new rules in order to strategically manage their pension plans.

Evolving Needs

Partnering with a firm that offers total investment program management presents a cost-effective solution for plan sponsors and foundations/endowments facing these challenges. Strategic partnering is nothing new; organizations have entrusted noncore functions, including information technology, accounting and human resources, to strategic partners for years. “Investment program management is an extension of this trend toward strategic partnerships in other business areas,” notes Steven A. Miller, senior program manager with Northern Trust, who manages investment programs for a variety of institutions.

“Organizations want to focus on their core competencies and many do not have investment expertise internally,” continues Miller. “Total investment program management allows organizations to focus on what they do best. A program manager can focus on cash flows and long-term risk, manager selection and reporting while the organization can focus on running their business.” “More and more institutions are looking for a strategic investment partner that can help them deal with the complex investment environment,” adds Jennifer Tretheway, director for manager of managers services at Northern Trust. “They look to their program manager to really guide them and to share best practices.” According to Tretheway, there are many reasons why this path makes sense for an organization, including taking advantage of cost savings through economies of scale, navigating the complexities of liability driven investing (LDI) and supplementing a shortage of internal resources.

Savings and Guidance Through Partnership

Cost savings through an investment program manager can be dramatic for funds. “Industry wide, the greatest interest in total program management has come from smaller endowments, foundations and pension plans,” says David Dykstra, practice leader of investment program solutions at Northern Trust. However, even organizations with more than $1 billion in assets can lower costs, Dykstra adds, noting that Northern Trust is working with institutions that have several billion dollars in plan or foundation/endowment assets. “The trend is moving up-market as larger firms find advantages in investment management partnerships.”

“An investment program manager will pool the assets of multiple clients together, allowing them to negotiate better fees with the underlying money managers and then pass those cost savings on to the client,” Miller notes. In addition to seeking cost savings, institutions are increasingly transitioning to more complex investment strategies. Regulatory changes and market conditions have shifted the focus of defined benefit plan sponsors. They have moved from simply meeting a certain investment return through traditional means to strategies such as LDI, which seeks to meet the plan’s future liabilities. Often, LDI strategies will incorporate derivatives to extend an instrument’s duration to reflect the average life of the liabilities.

“There definitely is a greater focus today on meeting liabilities as opposed to achieving a specific asset return,” explains Tretheway. “Derivatives — typically interest rate swaps — are one of the few instruments that can be structured to provide durations of 20 years or more. Few organizations, however, have the expertise to evaluate, implement and monitor derivative investment strategies. For many organizations, it makes sense to look to a partner to provide that expertise.”

Locating investment professionals with the appropriate skill-sets often proves to be a large hurdle when an organization builds its internal staff. “It’s a challenge to find — and keep — talented investment officers and other key investment staff,” explains Miller. “Staff may retire or leave during a spinoff or merger. Since competitive salaries may be out of the reach of most small- to mid-sized corporations, nonprofits and higher education institutions, key staff may leave for more lucrative positions at Wall Street firms and large investment managers.”

Even highly compensated, talented investment professionals are usually required to wear many hats, notes Dykstra. “A corporate treasurer may be in charge of investment management in addition to other financial responsibilities, and does not have the time to put together and monitor a professionally diversified program.”

Examine All the Angles

Selecting a total investment program manager requires serious due diligence that goes beyond simply looking at performance. There are many factors to consider, and taking a holistic view of the management firm is recommended before making a decision on a total investment program manager.

The expertise of the investment program manager is critical. Do they have experience in putting together entire programs? Do they have experience in setting investment objectives and then executing a strategy to meet those objectives? Do they have the resources to perform in-depth manager research? Are they adept at monitoring programs? Do they have a sound investment process that can be repeated over time?

Total investment program management does not relieve an organization of all of its fiduciary responsibilities. “Typically the organization is able to share certain types of risks, such as custodial risks, with its partner,” explains Miller, noting that a program manager must have processes that will help an organization meet its distinct fiduciary responsibilities. As pension funds and endowments continue to diversify their investments, it’s increasingly important to select a partner that can handle multiple asset classes beyond the more traditional equity and fixed-income mandates. Risk management is paramount, according to Dykstra. Total investment program managers should make solid investments into analytical tools — the quantitative tools used to successfully evaluate money managers.

Ongoing oversight is challenging for all organizations, says Tretheway. “Monitoring investment firms or changing asset allocations on a day-by-day or week-by-week basis is a big responsibility,” she says.

“Can you call your investment program manager with a question or concern as easily as walking down the hall to speak with your chief investment officer?” asks Dykstra. He explains that a total investment program manager should become an extension of the plan sponsor’s or endowment’s organization, not simply a vendor.

As pension funds and endowments continue to diversify their investments, it’s increasingly important to select a partner that can handle multiple asset classes beyond the more traditional equity and fixed-income mandates.

The Bottom Line

Although there are many decisions that go into partnering with an investment program manager, the core of this evaluation process must come down to relationships, believes Dykstra.

“These programs offer a viable way to meet investment objectives at the lowest possible cost,” he says. “But the bottom-line key to success in total investment program management is working closely with your partner to make sure they are able to put together the right investment program that has the appropriate risk/return tradeoff to meet your strategic investment objectives and liabilities.”

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