Asset owners worldwide are being confronted by multiple stakeholders to take on greater responsibility and be noticeably influential in the investment chain than ever before. No more so than in the area of sustainability and climate change. This has added significant complexity to decision making and raises hard questions about resourcing and whether their governance arrangements are still fit for purpose.
In trying to answer these questions we believe it is helpful to think about organisational maturity as a concept, which is influenced somewhat by fund size, but mainly by sophistication and ambition to deal with this increasing complexity.
To help, we have developed an asset owner maturity model which can be viewed as a set of structured levels that describe how well the behaviours, practices and processes of the organisation can reliably and sustainably produce required outcomes. There are three distinct levels within it: type A (basic), type B (well-resourced) and type C (advanced) which are differentiated by the specialisation and depth of governance and the sophistication and breadth of the investment model.
In the past, most asset owners have kept their capabilities to the type A level in which the board has ownership of the investment policy via the strategic asset allocation (SAA) and implements it using outside investment managers. But with deepened purpose and more complex goals coming from sustainability (like net zero) and headwinds from a difficult macro-economic environment with a new normal of lower-for-longer interest rates, this approach looks somewhat outdated. Indeed there appears to be an imperative for many to step up to a more sophisticated model that will allow them to deliver enhanced outcomes under these circumstances.
This maturity profile, increasingly adopted by asset owners, is a type B (well-resourced) level in which the board shares the investment policy ownership with an internal team (or the outsourced CIO is an equivalent model) which also owns the investment implementation.
The next maturity development is type C (advanced) where the internal team or outsourced CIO takes responsibility for the investment policy and implementation while the board owns the risk appetite strategy in a total portfolio approach (TPA) arrangement. The so-called Canada model of asset owners (such as CPPIB, CDPQ, OTPP) is relevant example here where an increased in-house resource configuration has led to agency value chain improvement through cost reductions; better management of external agents and increased investment sophistication though co-investing in private market mandates and stronger correlation with liabilities through LDI.
Clearly each asset owners’ circumstances are different, and many cannot contemplate moving up the levels, but it is our contention that those aspiring to have real-world impact through their sustainability programmes will find it extremely hard to manage without attaining type C maturity.
Notwithstanding, we observe that funds continue to actively review their governance and investment models and explore how these can be enabled by cultural and technological innovation. They are also placing greater value on methods that capture higher investment sophistication with lower complexity, such as OCIO, co-investment models, index strategies and TPA.
Last year we published a global study into the current and future asset allocation practices of leading asset owners, with a particular interest in understanding TPA – a joined-up investment philosophy that results in a more streamlined approach to portfolio construction. The concept of TPA is both a behavioural construct (i.e. relating to mind-set) and a technical construct (i.e. relating to process and governance). When fully present in organisational mind-set, process and governance, a TPA is well-equipped to deliver outcomes that are consistent with the fund’s mission and goals, with likelihoods of success significantly higher than are possible when using customary SAA-based approaches. We estimate that for a TPA process that is done well, these advantages – in return terms – could be worth in the region of 50-100 basis points per annum.
A number of funds in this study (ATP, CPPIB, Future Fund, GIC, NZ Super, QSuper and TCorp), identified themselves with this governance approach citing advantages in dynamism, decision framing and decision-making. We believe that a TPA should produce a portfolio that fares better on risk measures and advanced sustainability practices and we continue to see slow but steady adoption of this approach as organisations try to better connect the total portfolio with the fund goals.
More recently, we have worked with a number of asset owners to examine transformational change in the following areas as they consider their maturity profile:
- Business model: To address multi-stakeholder purpose with a focus on clients, workers, society, planet and owner/sponsor, as well as a model that explicitly commits to manage portfolios and operations in line with net-zero ambitions.
- People model: Develop best practice in employee experience including diversity, equity and inclusion (DE&I); build out learning and development programmes and promote superteams.
- Investment model: Build total portfolio thinking where investment processes are more aligned to goals and enabled by collaboration and one-team culture; 3D investing (risk, return and real-world impact goals); and concepts of universal ownership to build better beta through more joined-up management of externalities and systemic engagement.
It is clear that asset owners are being challenged to transform themselves in order to be fit for a broader purpose and, while change remains slow, sustainability considerations are accelerating this shift. Furthermore, there is a growing understanding that maturing bring with it distinct advantages, through increased scope for investment sophistication and specialisation, while also better addressing challenges such as disjointed governance and fiduciary constraints.
Acknowledging that all models are wrong, but some are useful, we believe this framework will be particularly helpful for those asset owners aspiring to lead this change. And they are likely to be collaborative, self-aware organisations that subscribe to systems thinking. You know who you are.