Institutions become comfortable with programs offering customized solutions and expertise for increasingly complex and challenging markets.
The institutional investing world continues to grow more complex as new and sometimes disparate challenges arise — turbulent markets, regulatory and legislative changes and the need for more sophisticated analysis. Often, fiduciaries must try to address these additional burdens with resources that are already strained.
Total investment program management has emerged as a viable option for addressing today’s challenges, offering internal investment professionals access to customized investment strategies and top-tier expertise. The comprehensive nature of total investment program management allows internal staff to concentrate on big-picture strategy and other core competencies.
“There is a lot more interest among investment fiduciaries than there was four or five years ago,” says Steven A. Miller, practice leader for investment program solutions at Northern Trust. “Institutional investors often do not have the staff to devote to the sole task of program management.”
When the challenges outweigh available resources, performance in one or more areas can suffer, particularly in terms of investment results. Consider the performance variance among endowment funds. The National Association of College and University Business Officers found the average nominal return for endowments between $50 million and $100 million was 5.8% during the 10-year period ended June 30, 2008. Endowments between $100 million and $500 million had a 6.4% average nominal return, while endowments with more than $1 billion returned 9.5% during the same period. This data might suggest that larger foundations — with potentially larger staffs — were better equipped to address all aspects of program management, including investment in alternative asset classes.
Total investment program management is designed to give internal investment staff new insight into their portfolios by bringing additional resources and comprehensive analysis to the investment management process. “One group within the investment program management team might focus solely on researching investment managers,” Miller explains. In this way, he says, decisions including investment manager hires and terminations are made in a more informed way. “You don’t just go out and find a good manager,” Miller adds. “In addition to identifying the best managers, you combine them in a way that potentially produces the most efficient risk-adjusted returns.”
The same approach is applied to other institutional investment portfolios, such as pension funds. “In crafting an investment management strategy the team might start with an asset/liability study, then conduct an analysis of various portfolio compositions in meeting stated risk and return objectives,” Miller says.
Services also can be customized to meet the needs of the investor, he adds. One organization might want quarterly meetings for detailed discussions of the overall process, while another might prefer quarterly reports and annual meetings.
“You don’t just go out and find a good manager. In addition to identifying the best managers, you combine them in a way that potentially produces the most efficient risk-adjusted returns.”
— Steven A. Miller
Practice Leader for Investment Program Solutions, Northern Trust
Total investment program management also enables internal staff to pursue strategies and solutions that were previously outside their areas of expertise or beyond the limits of their resources. These solutions range from investment strategies to plan administration.
Investment Strategy: With the enactment of the U.S. Pension Protection Act of 2006, pension plans have a more immediate need to hedge their exposure to liabilities using solutions such as liability driven investing (LDI). “Implementing an LDI program requires comprehensive analysis of a plan’s liabilities,” Miller notes, “and often includes the development of a liability benchmark.”
There are several aspects to the investment side of an LDI strategy that a total investment management program can address, says Jennifer Tretheway, managing director for manager of managers services at Northern Trust. “For example, the portfolio manager must examine the duration of the fixed-income portfolio and determine whether to use derivatives, such as interest rate swaps, or physical securities, such as Treasury STRIPS, to tailor the duration of the portfolio to meet each client’s needs,” Tretheway says. In cases such as this, the total investment program management team typically includes experts in implementing an LDI strategy.
Plan Administration: Total investment program management is often a good strategic fit when plan sponsors are considering combining the management of defined benefit (DB) and defined contribution (DC) plans. Today, DC plan assets are receiving the same level of scrutiny as DB plan assets, Tretheway notes. For this reason, pension plan sponsors are increasingly looking to parlay DB plan due diligence and expertise into their DC plans.
“Plan sponsor investment committees can eliminate redundancies in monitoring, and their DC plans will usually benefit from the higher level of monitoring enjoyed by DB plans,” she says.
A main driver for this trend is the increasing popularity of target-date retirement funds, Tretheway observes. “DC plans are starting to look more like DB plans because plan sponsors are able to provide advice,” Tretheway says.
As DC plans continue to draw more attention from government regulators, more pension plan sponsors are expected to seek fiduciaries who can oversee both their DB and DC plans, Tretheway adds.
“Companies are searching for new ways to drive down costs, and plan sponsors are attracted to fee reductions resulting from economies of scale.”
— Jennifer Tretheway
Managing Director for Manager of managers Services, Northern Trust
“Companies are searching for new ways to drive down costs, and plan sponsors are attracted to fee reductions resulting from economies of scale,” she says. “By combining DB and DC plan management, DC plans generally benefit from lower management fees through the plan’s access to lower fee tiers of managers and a better choice of investment management options for plan participants. This also helps plan sponsors better fulfill their fiduciary obligations.”
Total investment program management solutions also can help investment professionals manage pension assets on a global basis. “Due to recent technology developments and clarity received on several tax and regulatory points, U.S.-based multinational corporations can commingle U.S. pension plan assets with pension assets outside the U.S. in a tax-transparent manner that does not have the negative tax consequences that have led to the separate investment of assets for each country in which a corporation has retirement plans,” notes Rick Campbell, investment program strategist at Northern Trust.
Complete reliance on local decision-making for each of a corporation’s defined benefit plans across many countries creates a number of challenges.
Perhaps the most significant benefits of total investment program management are stronger governance and risk management. Teams of professionals are dedicated to specific aspects of institutional investing.
Complete reliance on local decision-making for each of a corporation’s defined benefit plans across many countries creates a number of challenges. “These include varying asset classes across plans, inconsistent implementation of asset allocations, more managers than a corporation may be able to monitor closely, higher investment management expenses and varying tax issues and treatment across plans,” Campbell says. This can lead to unwanted surprises when a manager used by one plan experiences an unusually large loss that increases funding costs for the whole corporation.
“The program manager can consolidate reporting across all subsidiaries. Standardizing the reporting process provides internal investment staff with ‘apples to apples’ data and performance comparisons across countries,” Miller says. “This can be a powerful risk management tool for that company.”
“Having a core group of managers used across a corporation’s multinational plans improves the coordination of investment strategy across plans.”
— Rick Campbell
Investment Program Strategist, Northern Trust
Total investment program management also gives multinationals greater control. For example, subsidiaries could share a roster of managers. “Headquarters leverages the best internal and external investment expertise, and the pool leverages the best managers globally,” Tretheway says. “Thus, pooling provides headquarters with better governance over plans’ investment manager hiring and firing decisions.”
“Having a core group of managers used across a corporation’s multinational plans improves the coordination of investment strategy across plans,” Campbell says. “This reduces the risk associated with a manager employed by one subsidiary that is not be used by other subsidiaries and, as a result, might not receive as much attention and monitoring.”
Global pooling also provides potential cost reductions in the form of Value-Added Tax avoidance, lower investment management fees and reduced expenses for manager searches and performance reporting.
Perhaps the most significant benefits of total investment program management are stronger governance and risk management. Teams of seasoned professionals are dedicated to specific aspects of the institutional investing process, constantly monitoring the market, the portfolio and individual manager performance.
“Their experience and expertise enable them to offer insights and advice that a fiduciary might not otherwise enjoy,” Miller says.