Sharing the investment challenge

We have seen a blizzard of new investment techniques as the fund management industry has launched increasingly creative products that plug – or would claim to plug – shortcomings in traditional investment techniques.

This wealth of innovation has been positive for trustees, giving them highly effective new tools, but it has also burdened them with additional knowledge demands. The ongoing monitoring of new investment products will not be easy – after all, trustees have struggled for years to establish a robust methodology for monitoring comparatively straightforward, mainstream investments like equities and bonds. Now they are confronted with more opaque, esoteric offerings, which might not even have a clear or regular market price or a physical form to be verified and audited.

Here it is not simply a matter of monitoring performance (arguably a dangerous practice anyway), it is about evaluating all elements of the investment process with a particular emphasis on identifying prevailing areas of risk (for risk, read: “something that could result in the investment product delivering an outcome you didn’t expect or want”). The problem with monitoring risk is, of course, the biggest are those you aren’t aware of and therefore aren’t monitoring. That is a central problem with new techniques – you may not think of the risk until it is too late, and then you’ll be learning about it through bitter experience!

The modern trustee therefore needs to think evermore widely in determining potential risks. For example, areas from LDI to hedge funds to private equity to diversified growth to better bonds could bring with them a host of “new” risks, such as counterparty, gearing, correlation and “ability to deliver LIBOR” risk. Trustees should ask questions like “How do I evaluate the ongoing ability of my counterparties to pay what they owe when it’s due?” and “How have the (supposedly) differently correlated asset classes I am invested in been behaving? Have expected correlations been maintained? If not, what are the implications for my strategy? Am I getting what I bought and if not why not?”

Trustees will require more extensive investment (and other) consulting advice, as structural and contractual positions become more complex – they need to know who is responsible for what in any investment structure, which is not always clear. Advisers therefore need to be up to the task, so trustees need to be probing: finding out whether their advisers are ahead of the curve, leading the innovation or behind it, and thus lacking essential technical insight.

And even with cutting edge advice, risks don’t go away. What if fundamental weaknesses in a new investment approach have yet to be discovered? Pensions history is littered with products that gained traction based on a compelling story of upside advantages, only to be discredited when hitherto hidden downside risks detonated.

Trustees can’t abdicate their responsibilities, so they themselves need to be probing and questioning when considering new investment solutions. Of course, most trustee boards operate as a self-contained unit with no connection to other trustees facing the same questions. If only there was a method for trustees nationwide to share their knowledge and experience, time would be saved, issues and problems would be flagged up earlier and good practice could evolve more quickly. That is why Trusteeweb has been launched.

Trusteeweb is an online community created by the Pensions Management Institute and Anthony Hodges Consulting to open up trusteeship in the UK. It is a peer-to-peer community enabling trustees to meet (in “e-space”) in a confidential environment – rather like Facebook or Friends Reunited for trustees! It can be accessed via www.trusteeweb.co.uk.
Over the next few months, the aforementioned trustee challenges associated with modern investment techniques will be among the areas we will be addressing on Trusteeweb. The results will be interesting so watch this space…

Steve Delo is president of the Pensions Management Institute