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The Prudent Fiduciary Digest

November 20, 2017


To make it easier for readers to connect with me, I have set up times for free phone consultations.  It's a breeze to arrange.  Just go to this site and pick out an available time.

I have had recent discussions with asset owners about evaluating outsourced chief investment officers (OCIOs), improving decision making and governance, and evolving due diligence and manager selection practices.  If you have questions about those topics or others, let's have a chat.

If you're interested, I can fill you in on my recent workshop on due diligence and manager selection.

Enough promotion; on to the readings.
 

A revised primer


This newsletter owes its existence to an invaluable book, A Primer for Investment Trustees, the second edition of which has just been released by the CFA Institute Research Foundation.  (Upon its initial publication, I wrote a blog posting about how it was tailor made "for the prudent fiduciary.")  The new version adds the subtitle, "Understanding Investment Committee Responsibilities."

Back are the "takeaways" and "questions Molly should ask" that so effectively summarize the important aspects of each section.  (Yes, that's why I always include questions to ask in each of these digests.)

One notable change between the two editions:  The first had nary a mention of OCIOs, while the pages on governance structure in the new one are full of references, reflecting the huge shift toward those services during the intervening years.

The Primer deserves to be the basic guide for fiduciaries, whether they are new to the job or need a refresher.
 

Capital market assumptions


Horizon Actuarial Services has published a survey of capital market assumptions, which summarizes the forecasts of 35 well-known consulting and asset management firms.  Given the importance of those assumptions for asset allocation and spending/benefit plans – and the general belief that we are in an era of lower expected returns – it's a good time to ask some questions about them.

Where do assumptions come from?  Do you get them from a consultant or other outside source, or do you have the staff to do the work yourselves?  Do you understand how they were prepared and where they are out of the norm (and why)?

The last two exhibits in the appendix of Horizon's summary show the wide range of expectations that exist for most asset classes.  Notably, David Swensen of Yale recently said that the base expectation for forward returns on a portfolio should be five percent nominal!  That doesn't fit the expectations of the day.

A couple of other reports are helpful when reviewing capital market assumptions.  "The Role of Assets" is a summary by Pension Consulting Alliance of the attributes of each asset class.  And, if you use active management for implementation, Callan's quarterly, "Historical Active Management Premiums by Asset Class and Style," provides some helpful perspective.  (Speaking of which, you should always check to see whether the asset class returns assumed by others include projected active alpha.  Many providers add it in without making that clear.)
 

ETFs


Exchange-traded funds (ETFs) have exploded in popularity over the last decade.  They are probably used in a variety of ways in your portfolio, so here are some resources and issues to consider.

A monograph by the CFA Institute Research Foundation provides a detailed overview of the mechanics and adoption of the vehicles.  As indicated by a report from Greenwich Associates, the use of ETFs by institutional investors (directly and through asset managers) has grown significantly.

But we are early enough in the use of ETFs that there isn't a lot of detailed research on how they whether they are used successfully as portfolio vehicles.  Does the ease of trading lead to better choices or worse ones?

If the primary use is replacing underperforming active managers, you'd think that the impact would be positive.  But we've seen the emergence of "ETF strategists," and, in general, active management is moving from individual securities to asset classes and subclasses.  Will that activity actually add value?

Whether ETFs are used directly by an institution (Harvard drew some attention earlier this year with its very large purchase of a high-yield bond ETF) or via asset managers (we're just starting to see research about the effects of the use of ETFs in actively-managed portfolios), the recent trends are unlikely to abate soon.


Private credit


In the wake of the financial crisis, "private credit" came into its own as an asset class, as banks scaled back their participation in a number of areas of the credit markets.

Increasingly, investors are carving out a specific target for private credit strategies.  New managers have taken advantage of the opportunities that presented themselves, building sizable assets under management.  With short-term interest rates rising, some of the trades created by the financial crisis running out of gas, and many managers not having been tested by a downturn, it's time to make sure that you know what the risks are in private credit.

Cambridge Associates has published a clear and concise introduction to private credit strategies that's worth your while.  If you want more detailed data (and a promotional take on the role of private credit in the economy), you can check out a paper from Alternative Credit Council, an industry trade group.
 

Questions


Here are some questions you might ask at your next meeting:

~ What materials do we use to train members of our committee/board?  How do we measure up to the best practices outlined in the Primer?

~ Do our capital market assumptions reflect the economic possibilities of the future or are they rooted in the results of the past?  Are they realistic?

~ How are ETFs being used in our portfolio?  Do we have a sense of what the potential problems with them might be?

~ Does our use of private credit make sense given where we are in the economic cycle and the changes in that part of the market?
 

Other links of interest


~ "The Worst Investment Conference Imaginable," Kip McDaniel, Institutional Investor.

~ "The Good, the Ugly and the Great: 30 actions that define a Board Chair," Redington.

~ "Global Macro," Meketa.

~ "The Role of Asset Owners in the Market for Investment Research: Where Are the Fiduciary Capitalists?" Capco.

~ "What is MiFID II? And why should you care?" Rocaton.

~ "4 Elements That Retain Talent At Public Pensions," Trusted Insight.

And, one from me:

How much do we really understand about what's happening behind the numbers with our asset managers?  What factors are holding those teams together and what ones are at risk of tearing them apart?

Many happy total returns,

Tom Brakke, CFA
tjb research
tom@tjbllc.com

 
Copyright © 2017 tjb research, All rights reserved.


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