The stress of Covid19 has underscored the need for fiduciary investors to not only manage their directional governance, but to beef up their relational governance as well, particularly as ‘early access’ schemes have damaged personal balance sheets.
“We need to understand there’s a mindset of retiring on the Friday with a pot of gold and converting that to an income stream on the Monday,” Michael Drew (pictured), managing partner at MGD Private, said in an interview with Investment Magazine’s Market Narratives.
“In a world where the outlook is muted, volatility is here and we’re debating printing money again, understanding the nature of the investor problem is critical.”
While Drew concedes most funds have advanced governance processes, the stress of the pandemic combined with shifting prudential standards around liquidity and liquidity cascades mean fiduciary investors are forced to have difficult conversations with clients around how best to stay the course.
“I’m a strong supporter of how we can use behavioural finance to help folks with their mental accounting,” Drew said, adding the defined contribution system means the individual household bears the lion’s share of the investment risk.
“So we really need to make very clear the priority for their pool of funds matches their liabilities, and that the fund’s investment principles and beliefs are aligned and evidenced in their portfolios.”
Drew will be speaking along-side global and local investment and governance experts at Investment Magazine’s upcoming November Fiduciary Investors Symposium.
On top of the difficult market conditions, the Australian government’s ‘early access’ scheme has seen $33 billion to $35 billion worth of superannuation withdrawn as citizens grapple with widespread job losses and economic closure.
“Those numbers will come home to roost,” Drew said. “There needs to be some really clear thinking about repair of personal balance sheets post-Covid.”
Drew said serious questions need to be asked about how those resources are being used, and the opportunity cost of fundedness in retirement.
“As humans we struggle with intertemporal trade-offs,” Drew said. “We’re much more into gratification than to think of our future selves in twenty to thirty years time.”
But while young people face the problem of not getting enough risk into their portfolios, Drew argued it’s those people at the end of their working life who face the most damage.
“The average Australian accumulates half their retirement savings in their last decade of their working life,” he said.
“And it’s that exact generation in the last ten years of their working life that find the highest levels of discrimination in the workforce. That absolutely keeps me up at night.”
Another troubling aspect is, of course, the asset mix required to provide a steady income stream to those looking to retire, with Drew agreeing that the likes of long/short and absolute returns style investing will become more prevalent.
“Non-linear strategies will have a role in portfolios,” he said, adding managers should think about pooling based solutions and systematic withdrawal solutions.
“But we have to face the reality that the key liability hedging asset is marginally above zero, which will lead to some very difficult trade offs and difficult conversations about expectations of standards of living going forward.”
In order to have those tough conversations, Drew said fiduciary investors must understand that governance is a process and needs a budget that is stated and quantified.
“It’s not just doing things right, but asking are we doing the right things,” he said.
During a research project he and co-author Adam Walk undertook called Investment Governance for Fiduciaries, published by the CFA Institute Research Foundation, Drew found committee agendas often failed to reflect the fund’s stated goals.
“Some funds said they believed that asset allocation drives the largest portion of returns, but when we looked at the actual timing of their agenda, 75 per cent of that time was spent discussing manager selection,” he said.
“We need to do something more than monitor and review, we need to superintend the whole process and ensure the system is governed in a holistic way.”
Drew said large asset owners must distinguish between investment expertise and investment governance expertise, while making sure there is mission clarity between those setting the strategy and those doing the operational work.
“These two parties need to work in harmony,” he said. “And they need to have the beneficiary front-of-mind in every decision.”
In order to build a culture where relational governance is given just as much weight as directional governance, Drew said the fund’s leaders must demonstrate their commitment from the top.
“While the Chief Investment Office is often the keeper of the culture, the Chief Executive Officer and the Chief Risk Officer need to have a clear line of sight to how that relational governance is permeating through the organisation,” Drew said.
“That way risk becomes an enabler and not an inhibitor.”
As shown through the Covid19 stress, Drew said a well resourced Risk Officer function can provide an enormous amount of risk assurance to the fiduciary and ultimately to the beneficiaries.