In part two of his series on fund governance, Melville Jessup Weaver principal, Mark Weaver, explains why trustees need to institute a strong decision-making process to manage investments… and how to utilise input from their advisers
Trustees might have the impression that they are required to make specific decisions on each investment held by their fund. But no matter what their level of expertise, all trustees will inevitably have to delegate some degree of investment decision-making to others. Indeed, a large part of trustee business will be deciding how much control over fund investments is ceded to third-parties, and evaluating the performance of external providers.
It would be useful at this point to go through the steps trustees should take to manage their investments appropriately:
Set the strategy: As I detailed in last week’s article, setting the investment strategy should be first item on the agenda. Essentially, this boils down to deciding on the split between the growth (eg shares and property) and income (bonds and cash) assets.
We need to expand this to how much to invest in NZ and how much globally and once assets are offshore how to manage the currency exposure. We then have to decide how much diversification is needed – how many different types of assets we want in the portfolio.
Now we have an agreed trust investment strategy.
Implementation: But we need to move from strategy to reality. What’s the best way to implement the plan?
Will we as trustees decide on each security we hold, having received due advice on this? Or will we give away the management of the portfolio to a manager having agreed the mandate for each asset class?
The answer to these questions are going to depend in part on the trustees skill set. Those with limited knowledge on investments will have to lean heavily on advice from others. Once trustees identify their limitations, they will need to find other experts who can fill the gaps in their knowledge.
Trustees will have to decide which professionals to select and then to set up a basis to monitor them.
Those trustees who have some investment knowledge must think very carefully about how much of the direct decisions they will take on themselves. Hands-on trustees are going to be getting advice on individual securities, which they will need to assess. In some cases the trustees may receive contrary advice from different sources. How do they decide which advice to accept?
Delegation: But even before evaluating external advice, trustees must clearly identify who is making the investment decisions. Is it the third-party investment professional who is making a series of recommendations or is it actually themselves?
If trustees are picking which recommendations to implement they are in effect making the decisions themselves, which makes it difficult to form a proper view on the professional they have employed.
We would argue that this is one of the most important aspects of their role that trustees have to get right. If they do not have the necessary skills they have to delegate the decisions to their adviser.
Performance evaluation: So this discussion takes us to the issue of properly evaluating the investment performance of the trust. Getting a positive return is fine and satisfying but not enough on its own.
How have other trusts done? We need to evaluate the performance against expectations, which requires us to have quantifiable objectives and time periods over which to assess it.
The evaluation criteria should be set once the strategy is determined.
Overall fund performance is the most important metric. However, trustees also have to consider the investment performance of the underlying fund components.
We would argue that the best way to assess the total trust performance is to compare with other funds which have similar risk profiles.
For example, KiwiSaver schemes surveys commonly split the funds into their different risk profiles, balanced, growth, moderate, conservative etc. So cross-fund comparison is easy to achieve.
Similarly, trustees can review manager performance data in investment surveys across different asset sectors.
If funds are taking tactical asset allocation decisions – one of the most important calls trustees can make – these can be monitored against the benchmark position.
It is important to remember, however, benchmarks are just objectives.
Ongoing monitoring: Most trusts do not properly monitor their performance.
But performance monitoring is not about earning boasting rights if the fund happens to be top in one quarter: it is simply a matter of prudence.
Trustees have to regularly monitor results to make informed decisions on their investments.
There are probably too many instances where trustees get congratulated for achieving positive results when in fact the fund might have lost value compared to the market.
To sum up, trustees have to list the key investment decisions and identify who is immediately responsible for each of those calls.