New research by Watson Wyatt Worldwide has shown up three main areas which should concern super funds and points to several “necessary” changes in the industry to maximise long-term investment returns.

The research – called ‘Defining Moment: Navigating the Challenging Investment Landscape’ – is to be published in detailed form next month, following a series of one-on-one interviews, an expert opinion survey and Watson Wyatt proprietary research. Roger Urwin, global head of Watson Wyatt investment consulting, presented some of the results in Australia last week. The main areas of concern are: . Risk is not under control: risk is “under-managed” and there may be a prolonged subprime crisis. . Costs are high: total investment costs are up 50 per cent in five years, with funds having very little internal spend, paying “unfair” fees and with non alignment of incentives with managers. . Time horizons are short: funds have long-term goals but short-term performance measurement. There is little genuine long-term investment. Watson Wyatt says that the industry needs some changes. The main proposed changes are: . Increased long-termism . Stronger governance . More independence in advice . A rise in ethical standards . Separate the going rates for alpha and beta. Urwin, who is due to step down from his role in July to take up a new research-focussed position with the firm, said in an interview that pension funds and other institutional investors had to act as stronger fiduciaries to represent the interests of the owners of the funds. This was particularly the case in negotiations over fees and charges. “In most cases they (funds) believe that when they are paying a lot of money they are getting a lot of talent,” Urwin said. “This is not necessarily the case.” He said that the industry could even become the centre for social unrest when people saw the “obscene packages” that some managers were paid. “However, I think we will see the emergence of more low-cost providers,” he said. An example was the providers of “fundamental indexing” services, which offered better than market-cap index returns for only 10bps in costs. The research showed that funds need more betas and beta primes (systematic beta tilts), better cost budgeting and cost containment tactics and they needed to work together to bring down costs. Watson Wyatt suggests funds could shave off 10 per cent from the estimated 45bps in transaction costs and 55bps in investment management costs but double the 5-10bps currently spent on in-house investment oversight. For long-term horizons funds need a renaissance in long-term mandates and managers and to deal with absolute return versus relative return mandates as well as to allow for sustainability of the manager business model and product performance. Funds need a strategy based on a far-sighted belief structure and a “CIO-ship” structure to deliver this.

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