(This is post 3 of 7 on the 2016 Thinking Ahead Institute global roundtable, held in London on 2 and 3 November. The theme of the event was “Fuller measurement, broader integration, better decisions”)
The Thinking Ahead Institute initially launched the research stream on the value chain with a topical day held in London on 24 June. Since then, the subject has been further developed through a webinar, an asset owner dinner in London and discussions at the New York roundtable. Despite a view that most agents in the chain are doing their best to serve the end investor, there is general consensus that the value chain could work better. The current chain is heavily intermediated, with most participants differentiating themselves on the basis of specific skills. However, it is far from clear that a proliferation of skill throughout the chain is in the end investors’ best interests.
Tim Hodgson introduced this discussion by questioning what constitutes skill in the investment chain. How might skill best be deployed in the investment process, and once its proper place has been identified, can the rest of the chain be simplified with associated cost reductions? Asset owners in particular face a trade-off between skill and cost, in an attempt to optimise the value proposition for the individual investors they represent.
Tim introduced a list of actions to improve the value chain by addressing the issues of skill, cost and value, and invited attendees to vote on the likely impact and practicality of each. The approaches suggested were:
- Consolidate assets / harvest economies of scale
- Introduce a governance audit for asset owners
- Develop a culture audit for asset managers
- Increase stewardship resources
- Move from ad valorem fee bases
- Reframe mandates in ‘better beta’ terms
- Collapse the cost chain, by simplifying and consolidating intermediate agencies
- Promote radical transparency
- Improve industry ethics
Attendees showed a marked preference for the first of these, in terms of both impact and practicality, although opinion was divided on how best to achieve this. Options discussed ranged from bulking assets (and pricing power) under a fiduciary manager, legislated consolidation of smaller asset pools (eg the Local Government Pension Scheme (LGPS) in the UK) and using an overlay provider for more effective stewardship and engagement. Combining assets via a single asset manager was also proposed, although this has consequences for the potential to earn alpha. Creating a low-cost, passive consolidator was suggested, although some attendees questioned the incentive for a passive provider to engage effectively with investee companies.
With this discussion serving as background, attendees were then asked to consider, in breakout groups, a case study/scenario where assets from previously separate pools are combined (the example used was the London collective investment vehicle in the LGPS). Each of the groups was given a base-case portfolio based on a “typical” regional investment model. Specifically, the groups were identified as:
- Norway-lite: predominantly passive and smart beta/factor-based public investments
- Australia-lite: high alpha conviction in public markets, outsourced to third party managers
- Canada-lite: significant in-sourcing of asset management skills, with a dominant orientation towards private market alpha sources
The breakout groups were presented with starting conditions corresponding to their scenario, and allowed some flexibility to adjust their orientation. They were tasked with estimating the cost of moving to the target position (including resourcing and systems costs) and the benefits, expressed as an uplift to annual risk-adjusted return, once there. The exercise proved illustrative in a number of areas – in all cases there was a significant up-front transition cost, but also an expectation of an improved annual return. The groups therefore confronted a j-curve with long-run positive expected benefits. This highlighted the need of “selling” the proposals to all stakeholders, to obtain buy-in for meeting the initial cost in order to get to the ultimate desired state. It also illustrated that there are several options for “optimising” an asset owner’s approach to engaging with the value chain, and that wide acceptance of a particular approach (culture, local norms) generally made it easier to obtain stakeholders’ sign-off.