1. The Universal Owner
Did you go to many investment conferences in 2018? You probably don’t need me to tell you that ESG (Environmental, Social and Governance) considerations have been brought front and centre this year.
I think this theme can be interpreted at a higher level in terms of how asset owners weigh externalities when making financial investment decisions, and the specific cultural / social compact that sets the context for them to do that.
Roger Urwin writing for the Thinking Ahead Institute defines Universal Owners as:
investors who own the externalities associated with their portfolio companies, their response being to manage the value and utility of members’ wealth by addressing financial and non-financial considerations with both “within-the-system and change-the-system” actions.
This theme is clearly here to stay, underpinned by regulation, and it will be fascinating to see how asset owners (and their advisers) get on tackling the difficult trade offs that are inherent in implementing these preferences. The industry is building and exercising new “muscles” here in many ways so this is bound to feel difficult and hard.
One thing is for sure – after years of what you could call “social loafing” (where particular individuals or groups in the industry could say “it’s not our job”) there’s now a clear requirement to address these considerations: not every investor can or wants to be a Universal Owner but it’s imperative for example for investment consultants to have the right expertise to help clients define their beliefs, and exercise their obligations and preferences, and asset managers need to be able to clearly demonstrate their stance and how this feeds in to their investment process.
2. The DB Superfund
Consolidation isn’t a new idea in DB it’s been mooted for years and a quick glance at the stats showing c6,000 different DB schemes in existence shows that superficially it ought to make sense – but how to actually deliver it, regulate it and ensure members are getting better outcomes from it?
This year has seen apparently massive progress in actually paving the way for this to become a reality, starting with the DB pensions whitepaper in February 2018 which clearly set out the government’s stall on consolidation (mentioning the word 56 times, in comparison to buy-out which was mentioned 18 times and self-sufficiency not at all). Commercial propositions (Clara Pensions and The Pensions Superfund) began unveiling themselves toward the middle of the year, and thanks to the likes of KPMG, Hymans, LCP and Redington there is now plenty of thinking out there illustrating how these funds operate and how they might deliver security for members.
Finally, in December the DWP released the hotly-anticipated consultation on a regulatory regime for consolidation which gives a clear indication of how government expects these vehicles to function. This was accompanied by guidance from the Pensions Regulator and consultation from PPF on how the levy might work for these funds. The flurry of activity would suggest that government and regulators are acting in a co-ordinated way which adds to the likelihood of real change taking place.
One interesting development is that the consultation and debate over the parameters to which consolidators should be run has moved forward the more general discussion about what a self-sufficient run-off investment approach looks like for a DB scheme and what is a reasonable risk to members’ benefits.
A lot has changed pretty quickly and I expect we aren’t far away from the first deal being announced. More options for trustees ought to be a good thing for members. As we reflect on this development I think two questions continue to be on everyone’s mind;
1. How and in what circumstances can trustees get fully comfortable that these propositions will be better for their members?
2. Is 99% the right number (in the context of the likelihood of meeting all benefits that the funds will need to demonstrate in the new regulatory regime).
More on these questions later. I was pleased to see the Probability of Paying Pensions (POPP) gaining currency as part of the language of measuring member outcomes in the consultation, this is a good step forward.
3. The Behavioral Investor
Every single one of us has a brain that is wired to systematically encounter mental pitfalls that lead us to make bad financial investing decisions – all of us. We overestimate our own skills, fail to recognise the role of luck and shield ourselves from information that conflicts with our views. We fear losses and anchor to the status quo. We are suckers for a good story and we allow what is salient today to unduly influence us, among all sorts of other ills.
Groups of decision makers can perform worse than individuals in complex and ambiguous domains via “groupthink”.
Problem: institutional investing frequently combines both of these issues
Ok, I acknowledge I could be accused of being well behind-the-times here as people like Greg Davies, James Montier and others have been putting out good stuff on this for years, and many of the core behavioral insights go back to the by-now well known work of Kahneman and Tversky in the 1970’s, which became linked to the world of economics and finance when Kaheneman was awarded the Nobel prize for economics way back in 2002.
However to me it feels like we’re now approaching a tipping point here where the core biases are becoming more and more well-known and there’s a lot more recognition and acceptance that these things are real and really do affect all of us (individual and professional alike). But simply knowing what’s wrong really is only half the problem (it isn’t as simple as telling ourselves to “not do” this stuff) – what we have more of now are real actionable approaches being proposed to try and counter them. My personal favorite book on this is Daniel Crosby’s The Behavioral Investor. In it he makes the point that in finance 101 you learn all about the two main types of risk, market risk and idiosyncratic risk – but there is a third, potentially crucial risk that is ignored: behavior.
It’s certainly the case that as an advisor or asset manager going into 2019 you need to understand and be honest about how behavioral biases affect you and your clients and what can be done about it. You need to be clear how you are helping your clients avoid the main behavioral pitfalls – as this might contribute more to outcomes than your best manager picks or asset allocation calls. Trying to get to less-biased decisioning by design ought to be one of the objectives of the governance systems of institutional investors (read more here).
Check out my short summary of the key takeaways of the excellent book The Behavioral Investor here.
We must better acknowledge the mistakes our biases lead us to make, lest we remain doomed to repeat Jeremy Grantham’s reported reply when asked “do you think we will learn anything from this turmoil?” which was:
“We will learn an enormous amount in the very short term, quite a bit in the medium term, and absolutely nothing in the long term, that would be the historical precedent” *
*Quote from The Little Book of Behavioral Investing by James Montier