Seeing the Forest Through the TreesImproving risk management in managing investment portfolios

Decisions that matter

Mercer conducted a survey of 124 institutions in

October 2010 that was focused on decision-making

and governance processes. While 79% of committees

indicated that they are comfortable making investment

decisions, the majority of respondents take one to

three months to make decisions and 25% take more

than three months. This can result in delayed execution

of necessary changes and missed market opportunities.

If investment committees are facing these issues, they

should ask themselves a few important questions:

n How many resources should be overseeing the

portfolio, and what should be the primary areas

of focus for these resources?

n Is monthly or quarterly portfolio and manager

oversight enough? What if something happens

in the interim?

n How quickly can staff or a committee react

to an event that might affect the portfolio?

n How often should an investment committee meet?

n How prominent is risk management on the

committee’s agenda?

n What is the risk of indecision? Can missing market

opportunities be quantified?

n What is the cost of neglect? Does the benefit of

hiring the right expertise outweigh the cost?

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It’s 4:25 pm and the investment committee has met for two hours and still has three agenda items to discuss before the meeting

ends in five minutes. The evaluation of manager A has taken nearly 45 minutes. All three items, including a manager search and the evaluation of the current asset allocation, will need to be discussed at the next quarterly meeting. Sound familiar?

What ‘risks’ are we talking about?

Recent market volatility and the velocity of change in the markets have driven many

US institutional investors to take a fresh look at how they define and manage risks.

Financial risks such as general market risk, credit risk, interest rate risk and liquidity risk

have historically received, and generally still receive, the primary focus by investment

staff members and committees. In addition, over the past decade, high-profile fraud

and lax internal controls at some large financial institutions have caused significant

losses for institutional investors, causing a more intense focus on non-financial or

operational risks. These issues, plus the substantial increase in allocations to complex

alternative investment strategies, strain the ability of the investment staff and

committees to understand their portfolio and how all the pieces fit together. Investment

staff members and committees are realizing that what they don’t know can hurt them

and, as a result, are spending more time focusing on how their providers (that is, invest-

ment managers, custodians and consultants) implement their investment strategies.

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Strong governance is critical to effective risk management

It is critical to focus on financial and non-financial risk

management when navigating the increasing complexity

of this market, including complying with expanding

regulatory and fiduciary requirements. But do investment

staff members and committees realize that risks are

also inherent in not having a strong, disciplined

governance structure in place to make proactive

decisions and oversee providers? For example, a

typical not-for-profit investment committee meets

four times a year for two hours apiece. If committee

members spend one hour preparing for each meeting,

then the committee spends roughly 12 hours per year

overseeing the institution’s portfolio. Each committee

should ask itself whether that is enough time and

whether this is the best practice for a fiduciary.

The committee should also consider whether it is

spending time on the right things. Our philosophy is

that the majority of the value of a portfolio is driven

by setting an appropriate strategy – focusing on asset

allocation, setting policy and defining objectives and

risk tolerance. However, many committees spend the

majority of their time on manager selection, termination

and monitoring activities. Implemented consulting

arrangements can balance this equation more effectively,

helping these committees spend their time and resources

where it matters most for their portfolios, thereby

enhancing governance processes and structures.

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0 10 20 30 40 50 60 70 80

Setting objectives

Defining risk tolerances

Line-up structure

Manager selection

Implementation

Monitoring and oversight

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Why spend 80% of your time for 20% of the value?

Time allocation% Value add

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Implemented consulting – Managing ‘governance risk’

At Mercer, many of the plan sponsors we talk to realize

that they could do more to effectively manage all of

the financial and non-financial risks facing their

investment portfolios. And many of these investors

realize that not having a robust governance framework in

place is a risk in itself. One way to help improve overall

governance is to consider delegating some or all

investment decisions and day-to-day oversight to

a third-party fiduciary and focus limited time and

internal resources on setting strategy and managing

policy matters. These “implemented consulting”

arrangements can be beneficial to committees that want

to fulfill their fiduciary duties by focusing on setting

the strategic direction for the portfolio, getting the

asset allocation right and monitoring performance

of the portfolio against overall objectives. Instead of

spending time meeting with managers and taking

several months to come to decisions, these committees

can delegate various tasks and decisions, including

manager selection and replacement, building alternative

investments portfolios, daily operational oversight and

administrative functions to experts who are willing

to take on the commensurate fiduciary responsibility

associated with these tasks. In our October 2010 survey,

27% of the respondents indicated that they have

considered such an arrangement in the recent past and

15% indicated that they would be considering adopting

such a framework within the next 12 months.

What’s left for the committee and staff to do?

One consideration for any institution looking at an

implemented consulting relationship is to understand

the committee’s and staff’s roles in the new governance

structure. These groups don’t become “rubber stamps”

once they start delegating day-to-day activities. Senior

staff continues to have an obligation to oversee the

organization’s assets, liabilities and risks and should

work closely with all providers involved in the process.

In the not-for-profit arena, institutional leaders want

to keep their committees, typically a fertile source

of donations, engaged in the life of the organization.

A custom solution can be crafted that engages the

committee and allows them to fulfill their fiduciary

duty by tasking them to set policy, review results and

stay involved with manager decisions. Their level of

involvement in the portfolio beyond that can be

articulated in the investment policy statement.

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Considerations for outsourcing

Plan sponsors should ask themselves whether they

believe they are adequately covering all the responsi-

bilities on their plate with the resources they have and

whether an implemented consulting arrangement,

tailored to their preferences, might improve their

governance structure and, therefore, be an effective

risk mitigation tool. Committees and staff should

think about where their strengths lie, where they have

internal expertise and the best position to add value

for their investment goals. Delegation may make sense

where internal gaps exist, either in lack of resources

or lack of internal expertise.

When considering the insource versus outsource

dilemma, some institutions have run into staffing

issues such as finding and retaining top investment

talent and handling the potential problem of typically

higher salaries found in an investment office relative

to other staff members. On the other hand, those who

look outside the institution for a solution may face a

cultural roadblock of losing dedicated resources and

full control. They would have to accept the fact that

they would be sharing resources with other institutions.

When costs and the potentially deep pockets of

external providers are taken into consideration,

looking outside for some or all of the investment

duties deserves serious consideration.

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One size does not fit all

How much is delegated and in what way will depend

on each institution’s specific situation, making

customization an important component of an imple-

mented consulting arrangement. As interest in these

solutions grows, investors may get confused about the

multiple models available, which range from discretion

via fully customizable solutions to standardized

off-the-shelf multimanager portfolios. One size

does not fit all situations and the ability to tailor

an implemented consulting arrangement to your

institution’s needs is the key to delivering success.

At Mercer, we can customize a solution and help

improve your governance structure using our intellectual

capital, experienced resources, proven expertise and

longstanding track record of success.

No matter where a client falls on the governance

spectrum above – whether the organization is:

n Looking for research tools such as our proprietary

manager database to supplement what the organi-

zation does internally

n Looking for an adviser to partner with even though

it is comfortable making investment decisions

n Considering an implemented consulting arrangement

We can help.

Tools

Supplementing internal resources

Advice

Helping you make decisions

Solutions

Making decisions on your behalf

n Proprietary database

n Access to specialist

research resources

n Manager notes, ratings and analysis

n Strategic asset allocation

n Asset/liability modeling

n 35 years investment consulting experience

n Manager research and selection

n Timely, proactive decisions

n Real-time monitoring and

implementation

n Scale and leverage for contract and fee negotiation

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Author

Kim Wood is the US Leader for Implemented Consulting,

responsible for the development and delivery of Mercer’s

Implemented Consulting services to institutions such

as defined benefit (DB) and defined contribution (DC)

plan sponsors as well as endowments and foundations.

She is a member of the US Investment Consulting

Leadership Group.

Kim spent 13 years in finance and treasury roles at

Ford Motor Company, notably as Director of Global

Asset Management, overseeing investment of the

company's DB and DC assets worldwide.

Kim received her bachelor’s degree in business

administration from Truman State University

in Kirksville, Missouri, and her MBA from the

University of Illinois, Urbana-Champaign.

For further information, please contact:

Kim Wood

+1 312 917 8991

kimberly.wood@mercer.com

Mercer’s Implemented Consulting

Proven expertise focused on your investment program

n Mercer is a leader in providing strategic investment

advice, with more than 1,000 investment professionals

advising more than 3,000 clients in 40 countries.

n Mercer’s specialist investment management opera-

tions, legal and compliance resources monitor and

manage discretionary portfolios for more than 400

clients globally representing more than $50 billion

in discretionary assets.

A highly customized solution to meet your needs

n Portfolios are implemented using a broad universe

of nonproprietary, unaffiliated investment managers.

Client preferences for high-quality legacy managers

are easily accommodated.

Objective, timely and informed decision making

and implementation

n A global manager research team of more than

110 experts provides real-time manager information

to consultants, allowing for quick reaction to market

opportunities.

n Experts at every level of investment program

management make decisions on your behalf.

Assumption of fiduciary responsibility

n Mercer acts as a fiduciary for the investment

consulting advice we provide and the investment

management duties we fulfill on your behalf.

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This contains confidential and proprietary information of Mercer

and is intended for the exclusive use of the parties to whom it

was provided by Mercer. Its content may not be modified, sold

or otherwise provided, in whole or in part, to any other person

or entity, without Mercer’s written permission.

The findings, ratings and/or opinions expressed herein are the

intellectual property of Mercer and are subject to change

without notice.

This does not contain investment advice relating to your particular

circumstances. No investment decision should be made based on

this information without first obtaining appropriate professional

advice and considering your circumstances.

Information contained herein has been obtained from a range

of third party sources. While the information is believed to be

reliable, Mercer has not sought to verify it. As such, Mercer

makes no representations or warranties as to the accuracy of

the information presented and takes no responsibility or liability

(including for indirect, consequential or incidental damages),

for any error, omission or inaccuracy in the data supplied by

any third party.

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Copyright 2011 Mercer LLC.

All rights reserved.

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