We continue to live in turbulent economic times and the challenging road ahead we predicted for investors in our related article last year continues. Investment professionals at all levels have to make tough decisions in a volatile, uncertain, complex and ambiguous (VUCA) world. There is less clear sight of what could possibly happen, let alone what will happen; and we often deal with questions where there is no single right answer. Yet, despite this, there are some general themes I believe investors should be wary of in 2019 that, if not well-managed, can make the journey ahead even more difficult. Here is our list of five key topics investors should think about in 2019.
1. Value creation as a further dimension to sustainability
Yes, sustainability is back again as a top theme for investors. In a recent Willis Towers Watson paper, sustainable investment is described as an unstoppable train. While to some the train is still slow-moving it has been gathering momentum in recent years with no signs of slowing up. Regulatory pressure, reputational risks and opportunities, and evidence of improved risk-adjusted returns come together with significant public awareness and media mainstreaming to power sustainable investment up many asset owners and asset managers’ agendas.
Over the last year, we introduced a further dimension to sustainability in our work at the Thinking Ahead Institute: the need for organisations to better understand the value they create for stakeholders. There is increasing demand for organisations to provide positive social contributions to maintain their social licence to operate – it is not enough for organisations to narrowly focus on creating financial value without noting the effect of their activity on wider stakeholders (including society and the planet). Understanding what stakeholders value is a critical input into determining an organisation’s vision, strategy and culture, with the aim of improving organisational policies and practices and better monitoring outcomes. In our paper, Mission Critical: understanding value creation, we set out some guidelines for organisation reporting on the value created. We suggest that this is a desirable activity for investment organisations wanting to maintain their social licence to operate – signalling a shift from economic legitimacy to societal legitimacy based on trust.
2. Multi-factor diversity
At a dinner I recently attended, I was struck by the clear message of New York City Comptroller’s office on diversity. As an asset owner responsible for approximately US$200bn, the office has defined a series of explicit policies focussed on increasing women and ethnic minority participation with the aim of creating an even playing field. These policies range from manager selection, board structure, capital allocated to projects and improved access by underrepresented groups to decision makers at the fund. Central to this was the assignment of a chief diversity officer (Wendy Garcia) who reports directly to the Comptroller and board executives and has influence not just on people policies but also on investment policies.
This is significant and is a marker of the dramatic shift in the mind-set of many organisations on the issue of diversity. But as noted in my recent blog, the investment industry as a whole is struggling to catch up. Why? Because for too long both structural and unconscious bias have limited opportunity for individuals that go against the ‘norm’ (non-white, non-male, non-private school educated). Organisations need to be wary of this and employ deeper thinking on diversity, in all of its forms, whilst employing a sustained and systematic commitment to diversity and its inclusion in all aspects of their business models.
Over the last year, we have noticed an uptick of activity by investment organisations to codify culture. We have worked with Willis Towers Watson’s manager research team to develop their culture assessment model of selecting managers for asset owners. This is based on three pillars: (i) how a firm delivers value to its employees, (ii) how a firm delivers value to its clients, and (iii) leadership providing overarching guidance and oversight of culture. More on this framework can be found here. We believe well-managed investment organisations should and will continue to consider this more deeply in the future
4. Total portfolio approach (TPA)
Asset owners are increasingly conscious of the limitations of the strategic asset allocation (SAA) approach. Much interest is being shown by large asset owners on the total portfolio approach (TPA) as a potentially better way of working. Central to this revised approach is the improved ability for governance boards to act quickly and tailor portfolios to achieve specific goals. This method is not yet used widely but has emerged over the last decade and is practiced by a small number of large asset owners, with CPPIB, Future Fund and New Zealand Super Fund as examples.
We define TPA as one in which:
- There is a continuous and dynamic focus on achieving the fund’s investment goals
- Decision rights reside with the CIO / Executive team, whilst ownership of the risk budget or Reference Portfolio resides with the Board
- The portfolio is managed in real-time; all investment opportunities compete for capital at a whole fund level, but only the best ideas actually get into the portfolio.
This is in contrast to the traditional SAA approach which is based on a set meeting schedule loosely connected to the fund’s investment goals. Strategy is updated infrequently as decision rights often reside with the Board, whilst the CIO/Executive team may have some implementation decision delegated to them. Additionally, asset class ‘buckets’ need to be filled, with little room for deviation from pre-agreed weightings.
TPA has a number of advantages over an SAA-based approach, including greater dynamism in the decision making process, better quality of decision framing and better quality of decision-making. We provide further detail on this approach in our soon to be published paper on this topic.
5. Better decision-making
Institutional investing is increasingly a team activity. And collective decision-making is a skill that can be nurtured. Over the last year, the Thinking Ahead Institute has conducted research on institutional decision-making, focusing on how a group can successfully integrate individual thought processes, communication patterns, relationships and other aspects of interactions into effective collective decision-making. Summarised in our paper, Better decision-making: a toolkit, we set out a list of tools that investors can use to make more effective decisions together. These tools range from those that improve the quality and processing of inputs to decision-making, improve group dynamics for decision-making meetings to tools that can help you actually make the decision.
So that’s our list for the new year. Hopefully it will serve you well and we welcome any thoughts on your organisation’s key priorities in 2019. If you are feeling somewhat nostalgic for 2018, here’s a reminder of some of our research, nicely wrapped for you in our Thinking Ahead Institute’s 2018 research index.