Improving governance offers institutional investors win-win – or at least not-lose-win – odds of boosting performance potentially outdoing even the most optimistic post-fees alpha earned from active management, according to a new Willis Towers Watson (WTW) paper.
The ‘Investment case for better asset owner governance’ study, authored by former New Zealand Superannuation Fund head of strategic projects, Tim Mitchell, found lifting governance standards could see funds reap long-term returns of 140-times the estimated upfront investment of two to four basis points (bps).
Mitchell joined the WTW London office last December as senior investment consultant after departing NZ Super in June of that year.
Just a 10 bps uplift to performance by improving governance would add $190.2 million over 20 years to a $25 billion fund with zero growth, the report shows. If the same fund grew 5 per cent over 20 years, a 70 bps return from higher governance standards would add over $3.5 billion to the bottom line.
“Faced with this outcome – there is some (small) probability that the fund will not get its money back, but an upside potential in the range of 20-140 times its money back – most investors would jump at the chance,” the study says.
The report says the governance return could even exceed an “extremely impressive” long-term active management performance of 100 bps above benchmark (or 60 bps net after assumed fees of 40 bps).
“While there is potential for significant upside under active management, it is matched by potential for downside – unlike governance where the downside potential is likely limited to the cost of its implementation,” the study says.
According to the WTW report, there is compelling evidence for funds to focus on improving governance standards “through any environment”.
“At a time when investors are faced with historically low expected returns, the case seems overwhelming,” the study says.
However, despite the well-documented benefits many funds fail to implement governance improvements due to structural inertia or psychological resistance to change from the board and management.
The WTW report says funds typically focus on governance only after trigger events such as senior board and executive personnel changes or “an extended period of poor performance”.
“It’s not an easy process though,” the study says. “… Boards and executives have to commit to a structured, continuous programme of improvement. This will bring in new, challenging ways of doing things. It’s not as exciting as investing and it may require significant culture change in how decisions are made.”