Increasing investment complexity, cost pressures and regulatory requirements are leading institutional investors to seek new ways of devising and implementing their investment strategies.
At Mercer, we are seeing significant evolution in governance arrangements and how investment programs are being implemented to keep pace with these developments. In this article, we provide a high level outline of the main governance models that have emerged over the last five to 10 years to help institutional investors ascertain which model(s) may best meet their needs both today and in the future.
Goals of Governance
Governance can be defined as the sum of time, resources and expertise deployed for decision making. In the context of investment, a governance process establishes:
- Who is responsible and accountable?
- What should be done to operate and oversee the investments?
- How often should the roles and responsibilities be revisited?
It is widely acknowledged that good governance improves the chances of successful management of investment portfolios. A key goal of the governance framework is to ensure that any risks and costs incurred are no greater than are needed to achieve the institution’s investment objectives.
The basic principles which underpin a good investment framework are grounded in common sense. In particular:
- Every element of the investment structure should be the explicit responsibility of an individual or group of individuals (“nothing should fall between the cracks”).
- Those with responsibility for decision making, management and monitoring should, in aggregate, have sufficient knowledge, competence and timeto perform their duties well. Where such knowledge, competence and/or time does not exist, either corrective action should be taken or the tasks should be delegated to suitably qualified professionals.
- The structure should try as far as possible to avoid unnecessary duplication of roles. It should be based on delegated responsibility and informed oversight.
As a result of the long and growing list of tasks to be undertaken, institutional investors have evolved their governance models in different ways to, firstly, meet their obligations as fiduciaries in overseeing the management of assets, but secondly, to ensure the most impactful decisions receive the most attention to improve the odds of success. Investors may be able to devote more attention to the most critical factors through an evolution of their governance model.
We have broadly seen five governance models develop:
- Expanding the in-house team with greater use of third-party research and tools but full in-house implementation and ongoing evaluation
- Greater use of traditional investment consultants for advice on strategy and research but full in-house implementation
- Use of third-party manager selection platforms for operational implementation but retaining all investment decisions, including manager selection
- Partial outsourcing to provide for operational implementation as well as selective investment decisions such as manager selection, Dynamic Asset Allocation and implementation
- Full outsourcing to provider for all operational implementation as well as investment decisions following strategy and risk budget setting, sometimes called Delegated Management.
We believe that good governance is important in increasing the chances of positive outcomes for institutions, impacting both risk management and investment performance. Institutional investors have adapted to a changing investment environment by adopting different governance models over the past decade. Five broad models have emerged, each with their own benefits. This has resulted in increased choice and flexibility for institutional investors to decide what model (or models) best suits their needs.
Garth Gregory is a Senior Investment Consultant at Mercer Investments. He advises institutional clients on their investment policies, portfolio structures and fund manager selection.
This article does not contain investment advice relating to your particular circumstances. No investment decision should be made based on this information without first obtaining appropriate professional advice and considering your circumstances.