“You need to build a machine that delivers something that’s consistent with what you promised the customers you would do.” – Ken Fisher
I had the pleasure of attending the IMN Global Indexing and ETFs Conference this week in beautiful Scottsdale, AZ. The main focus of this conference was on the tremendous growth in ETFs and how the increase in more low-cost investment options was changing the way advisors and institutions construct their portfolios.
Looking for efficient, low-cost streams of beta or risk factors, which many ETFs now provide, is at odds with the way that many institutions run their investment operations. Institutional investors are often more focused on alpha and outperformance.
I moderated a panel full of some heavy hitters in the state pension world. Pensions have increasingly come under fire in recent years because of the high fees many of them are paying to outside alternative money managers. This has led to poor performance from many of these plans, but it’s also troubling because many don’t have the checks and balances in place to even track the fees they’re paying or understand what they’re investing in.
One of the biggest reasons for this is because many of these large pools of capital don’t have the correct governance in place. It really starts at the top in terms of implementing the correct processes and guidelines. The big picture is dictated by the organization and how it’s structured.
I asked my panelists about this often elusive search for alpha by institutional investors. The best answer to my question came from Paul Matson, an Executive Director with the Arizona State Retirement System. Matson said that most investors look at the quest for alpha entirely the wrong way. He said that the pursuit of alpha through a money manager, or any investment strategy for that matter, was irrelevant if you don’t first build your organizational structure properly.
Very few take the time to consider whether or not they have the capabilities or overall system in place to be able to pull off the type of investment strategy they would like to pursue. Whatever your investment philosophy is, it won’t matter much if you don’t set reasonable expectations at the outset to ensure your investors can understand your process. On the institutional side of the business this means having buy-in from your trustees and investment committee. For financial advisors this means getting buy-in from your clients. Successful investing has to be a team effort when dealing with multiple parties in this manner.
The three pension executives on my panel collectively managed north of $150 billion. They all have large teams in place with various experts in different asset classes and investment structures. Interestingly enough, even with such large assets under management, each one of these pensions found it very difficult to find cost-effective outside money managers. So the majority of their assets were managed in-house by their own employees who were hired for their specific area of expertise.
Each talked about the importance of communicating an overarching process with their investment committees before trying to manage money in this fashion. It’s not only setting expectations, but implementing a process that’s important for an investment organization. In a recent Masters in Business podcast with Barry Ritholtz, Ken Fisher of Fisher Investments talked about the importance of quality control on a business and the investment process:
Control is about quality control. […] In a service business integrity ends up being crucial to your outcome. The greatest investors in the world have bad years. And bad years are just normal. But that’s not what I’m talking about. I’m talking about having control of the process while you’re having the bad year. So that you actually are delivering what you say you’re delivering in that there’s no lack of control that goes haywire. Because once that happens…
The reality in this business is you need control so that you deliver consistently with what you promised you would deliver, which is not a return number, it’s a ‘here’s what we do, here’s how we do it, here’s what we’re going to be trying to do for you, here’s where our bets are gonna be.’
The process over outcomes mindset is a difficult way of looking at the world because the time frames in which investors judge themselves and clients judge their money managers continues to shrink. The best investors realize that a sustainable process comes not only from an intelligent investment strategy, but also from an intelligently designed organization.
Organizational culture is something that is highly underestimated in the investment industry.
For more on the IMN Conference, check out this great wrap-up from Josh Brown:
Scenes from the future of wealth management (TRB)
And listen to the entire Ken Fisher interview here:
Masters in Business: Ken Fisher (TBP)