Delegating or Outsourcing Asset Duties? Watch Governance Anyway

It is not unusual to delegate or even outsource functions investment committees commonly perform. But taking that step doesn’t mean washing the hands of all involvement with governance. A recent blog post makes suggestions regarding what can be done to continue to monitor and exercise active involvement in how plan funds are managed.

In “Governance Checklist for Today’s Fiduciaries,” Michael Thomas and Peter Carippo of Russell Investments outline what duties still must be fulfilled and offer suggestions for exercising oversight.

Unchanged

Even if functions are outsourced or delegated, there are duties that do not change, Thomas and Carippo argue. “First, the investment committee should retain responsibility for documenting the objectives, constraints and risk tolerance on behalf of the sponsoring organization,” they write.

Objectives. Examples of such objectives, they say, include:

• Fully funding a pension plan within seven years, with 95% confidence that required contributions will not exceed $100 million in any calendar year.

• Support a 4% annual spending policy, while preserving the funds’ absolute value after accounting for inflation.

Constraints. Thomas and Carippo suggest that a fee budget, eligible asset classes/strategies and bands for rebalancing or tactical tilting all can serve to constrain an investment committee and its designees from certain actions that will affect the plan.

Risk Tolerance. This is often a component of objectives and constraints, say Thomas and Carippo; they add that it typically is expressed through a strategic asset allocation approved by the investment committee.

Define Success. Thomas and Carippo also suggest that an investment committee define how the investment strategy will be measured to determine whether it is a success and monitor the results against the standards it sets.

Changes

Shift in the design and implementation of investment strategy is the biggest change in an investment committee’s responsibilities when outsourcing or delegation occurs, say Thomas and Carippo. “We think that best practice is to push decision-making to the level where the expertise resides,” they write. “A practical application of this principle is that the investment staff or OCIO partner decides on which sub-advisor to hire,” they further suggest.

But if it does so, how can the investment committee meet its fiduciary duties? Thomas and Carippo suggest that the general answer is for the investment committee to make sure that “a proper due diligence process” has been followed” rather than exercising direct due diligence. They suggest that the committee can do this by making sure that standards are met in these areas:

1. investment policy
2. investment thesis
3. risk
4. trust
5. process

Among their suggestions regarding oversight also is that it include making sure that:

• any proposed investments are consistent with the investment policy statement;

• the underlying investment thesis is sound;

• the risk entailed in the investment is reasonably well understood and consistent with stakeholders’ risk tolerance;

• the counterparties to the transaction are trustworthy;

• the OCIO partner has a clear understanding of objectives, constraints and risk tolerance, and follows appropriate processes;

• the investment staff followed an appropriate process; and

• sufficient time was spent evaluating the investment opportunity.

And that there is consideration of:

• the role that the investment plays in the overall portfolio and its consistency with stated investment beliefs and the investing time horizon;

• the underlying investment proposition;

• the source of a positive expected return;

• any information advantage used to outperform the passive alternative;

• any unique situation relative to another opportunity;

• the distribution of possible outcomes looks like;

• environments in which the investment may struggle;

• what could go wrong and what could mitigate those factors;

• how the OCIO partner demonstrates progress toward objectives; and

• whether the OCIO partner is proactive in helping the investment committee meet its objectives.

“The investment committee is rarely in the best position to evaluate specific investment opportunities,” write Thomas and Carippo, who argue that the investment staff or OCIO partner should perform that function. Nonetheless, they argue, an investment committee does “play a vital role in ensuring that the objectives, constraints and risk tolerance are well defined; the investment strategy was arrived at following a sound process; and the results are monitored relative to clearly defined measures of success.”