Good Risk Governance Pays

Good Risk Governance Pays

Investment Best Practices | Risk Management | Valuation

BREXIT and Trust

Posted in Governance, International Investing

Managing risk business challenges uncertainty concept. Elephant with giraffe walking on dangerous rope high in sky symbol balance overcoming fear for goal success. Young entrepreneur corporate world

Like so many, I stayed up late to watch the vote count about whether the United Kingdom should remain part of the European Union (“EU”). With a margin of about 4% or 1.3 million people, “Leave” won the day, despite financial market trades that reflected an expectation to stay. Whatever your preferred outcome, it was certainly exciting to watch “people power” in action and learn more about our neighbors overseas.

No doubt there will be post-mortems by economists, political pundits and pollsters about what led to the British exit from the EU or “BREXIT.” Already, U.S. broadcasters in these early hours of June 24 are drawing inferences about what this historic decision might mean for our upcoming presidential election.

What caught my attention was a Financial Times column by its associate editor Michael Skapinker. In “Two nations but only one trusts business and its allies” (June 22, 2016), he describes opinion poll numbers that reflect a seriously low level of trust in what business executives, economists and those at the International Monetary Fund or the Bank of England have to say. His view is that “None of this is surprising,” due in part to banking and corporate scandals that have eroded Joe Everyman’s confidence in various institutions. What he did find “riveting” was a clear dichotomy between trust levels and how respondents planned to vote on the June 23 referendum. “Remainers” declared a high level of trust. The opposite was true for those in the other camp. Even academics who had little to do with the BREXIT discussion were given short shrift by the “leavers.” His major concern is that doubters don’t engage and are “far harder to win over” when asserting that businesses should not be heavily reined in through regulation.

There is a lot to be said about this concept of broken trust and what commercial and political organizations need to do to assuage fears of those who have been either spurned or were non-believers from the start. This is especially apropos when bad news can travel around the world in seconds, a grumpy customer can influence thousands of people with a single Tweet and a protester needs only a poster board and a magic marker to convey an impactful message. The good news is that there is so much that can be done to showcase leadership and integrity when it exists and there is no time like now to act.

Fiduciary Rule Panel to Discuss Implementation

Posted in ERISA, Investment Management, Regulation, Susan Mangiero

3D illustration of FIDUCIARY title on Legal Documents. Legal concept.

Dr. Susan Mangiero will join a panel of esteemed experts to talk about the U.S. Department of Labor’s Fiduciary Rule on June 21, 2016. Sponsored by the Financial Women’s Association, New Jersey chapter, CPE credit is available (CLE credit is pending). Meeting at the Seton Hall School of Law in Newark, this timely event features the following speakers:

  • Gregory F. Jacob, Esquire – Moderator – Former Solicitor of the U.S. Department of Labor, Partner in the Washington, DC office of O’Melveny & Myers and a member of the Financial Services and Labor and Employment Practices;
  • Susan Mangiero, PhD and Accredited Investment Fiduciary Analyst – Panelist – Forensic economist, investment risk governance expert and author/researcher with a focus on ERISA and non-ERISA fiduciary best practices;
  • Kathleen M. McBride, AIFA – Panelist – Founder of The Committee for the Fiduciary Standard and The Institute for the Fiduciary Standard, a nonprofit, nonpartisan think tank dedicated to providing research, education and advocacy on the fiduciary standard’s impact on investors, the capital markets and society; and
  • Margaret Raymond – Panelist – Vice President of T. Rowe Price Group, Inc. and T. Rowe Price Associates, Inc. and managing counsel with a focus on legal matters relating to retirement savings, including ERISA fiduciary principles and other retirement plan administration topics.

Some of the many topics to be addressed include the following:

  • Features of the Fiduciary Rule and how different market segments are likely to be impacted;
  • Past, present and future characteristics of the IRA marketplace;
  • Use of robo advisors;
  • Product availability and asset allocation, post regulation; and
  • Legal challenges being filed to forestall the implementation of the DOL Fiduciary Rule.

For further information and to register, click here. A special thanks to Dr. Dubravka Tosic and Attorney Gregory Jacob for putting this event together and arranging for continuing education credit.

Note: This event did not occur and will be rescheduled for a date this fall.

Risk Management “What If” Focus

Posted in Risk Management

Cardboard businessman walk straight into the abyss. Business concept

In watching television news this weekend, I am reminded that not everyone understands the proactive nature of risk management. I’ve heard the mantra before. “Why did I buy insurance? A year came and went and nothing happened. I could have saved the premium.”

The problem with this thinking is that no one has a crystal ball. It’s impossible to know with certainty what could happen. The goal of effective risk management is to ask what could go wrong and then assess both the likelihood of occurrence as well as the economic downside should that adverse event occur. What typically follows would be a ranking of worst case “what if” situations and deciding how best to mitigate potential problems.

As I wrote in Risk Management for Pensions, Endowments and Foundations, “… informed and proactive investors have a chance to meet or exceed return targets while minimizing capital exposure, if they do their homework and stay focused on the fact that things can and do change.” Robust risk mitigation helps to stabilize returns. Without it, the value of any or all holdings could free fall or wildly zigzag with little chance of recovery.

Yes, it is true that a risk management process is going to cost something to implement. The central question is whether one can afford not to manage risks.

Victoria’s Secret and Financial Benchmarking

Posted in Disclosure and Transparency, Investment Management, Risk Management

Red Lips_Smaller

Its iconic fashion show won’t occur until this fall but Victoria’s Secret is in the headlines for another reason. Owner L. Brands, Inc. (“LB” ticker) will no longer mail about 300 million catalogs each year. The goal is to save between $125 to $150 million and be more eco-friendly. Shoppers can still purchase online or visit one of 1,164 shops in the United States and Canada (and internationally via retail partnerships). According to Ad Week, earlier experiments in reducing snail mail did not materialize in a drop in sales. Besides, the company’s Twitter profile shows a beefy 9.64 million followers which no doubt helps to contribute to the bottom line.

Catalog news aside, I’m thinking about this $7+ billion sales engine today for another reason. Having just bought one of their sports tops, I was seriously surprised to get it home and realize how small it was for a size that ordinarily fits. Mind you, we’re not talking about a smidge too tiny but something more in the realm of “This item must have been incorrectly tagged.” Kudos to the local store as I had no problem returning it for full credit the next day although I had to take time out of my day to visit a second time. While I am unlikely to buy clothing there again, I do like their scents and they are size-free. As an aside, clothing sizes vary across retailers and over time so I’m not picking on Victoria’s Secret. See “The absurdity of women’s clothing sizes, in one chart” by Christopher Ingraham (The Washington Post, August 11, 2015).

Applied to finance land, the issue of labeling is at the center of more than a few calls for more transparency. On April 15, 2016, the U.S. Securities and Exchange Commission (“SEC”) made public a 341 page concept release, requesting comments as to how best to modify disclosures about items such as core company information, off-balance sheet arrangements, liquidity and capital resources, operating results and risk management. In other words, much of the data that investors would typically review before making a decision to buy, hold or sell a company’s securities is subject to possible change. Part of a Disclosure Effectiveness initiative, this financial regulator seeks feedback about ways that individuals and institutions can be better informed.

Certainly it is a good thing to provide access to reliable data and an accompanying narrative. However, more information is not always the same thing as helpful information. This is particularly true if a metric is misleading or incomplete or both. To illustrate, inputs put forth so far about how to improve current risk management reporting suggests dissatisfaction and a perception that filings are overly broad and should be refined. Comments include requests to present risk factors by entity, materiality and likelihood of occurrence.

With another sixty days before the SEC’s deadline, it’s too soon to know exactly how disclosures will change. Fingers crossed that reforms will address proposals made by knowledgeable persons to ameliorate any deficiencies.

Reputation and the Investment Management Bottom Line

Posted in Customer Service, Disclosure and Transparency, Governance, Investment Consultants, Investment Management, Key Person, Risk Management

Brand loyalty check mark image with hi-res rendered artwork that could be used for any graphic design.

Those in the know understand that both qualitative and quantitative factors must be evaluated when estimating enterprise value. The list of appraisal considerations is too long to address in any one discussion. Suffice it to say that one should understand, measure and benchmark multiple facets of an organization’s business such as production processes, distribution channels, sales infrastructure and customer service. A clarity about the industry in which a business operates is likewise essential. Who are the competitors? What regulations prevail and how is the industry responding to new mandates? Are industry sales sensitive to changes in global or local economic conditions? Is the industry poised for growth or fast reaching its apex?

Turning the microscope to narrowly focus on a single company, it would be remiss to ignore the economics of its brands and reputation. An organization’s customer base can reward shareholders if net sales grow and add to free cash flow. On the other hand, disgruntled buyers can decide to go elsewhere or seek redress in a court of law. Both outcomes are costly and can lower share value. Notably, the damage associated with a lost sale can vary depending on how long it takes to recover, if possible at all. For example, a money manager that loses a large institutional client will be reinvesting a much smaller pool of capital over the ensuing months. Should other long-term consumers like peer pension plans get wind of bad news, they too may exit, causing the asset manager’s portfolio to plummet further.

It’s not remarkable then that new research concludes that “high firm and product awareness – or together, brand awareness – could lead to greater retained assets and new inflows.” Nevertheless, the message is one that bears repeating given the significance. While its 2016 survey affirmed the link between reputation and financial wellbeing, eVestment uncovered some startling trends too. They are summarized below:

  • Institutional consultants review “less than two strategies per asset manager within a quarter.” This low number makes it hard for any particular firm to stand out by virtue of its brand.
  • Institutional consultants in search of “a level of manager diversity” may not be swayed by a multitude of products offered by a larger vendor and instead focus on satisfying other goals.
  • Awareness of larger asset management firms is not always an advantage. Survey results “showed managers with the highest brand awareness averaged outflows 4.5 times larger than inflows.”
  • When a key person departs, the downside outweighs the upside of “the hiring of an equally reputable star portfolio manager.” If this is true beyond the survey sample, asset managers will want to be fully transparent about any events that might be perceived by institutional clients (or their consultants) as negative.

For details, read “Why Asset Manager Reputation Matters” (Chief Investment Officer, May 19, 2016) or download the white paper entitled “Importance of Brand Awareness” from the eVestment website. As Warren Buffett declared, “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.”

Dev Patel and Jeremy Irons Showcase Math Genius in New Film

Posted in Fun, Investment Management

Maths formulas written by white chalk on the blackboard background.

If you get a chance to view “The Man Who Knew Infinity,” go for it. Award-winning actors abound in this tale of math wits at Cambridge University who contributed dozens of important ideas that are still being used in business and science. Dev Patel, stars as the self-taught math genius, Srinivasa Ramanujan, who rose from poverty to team with world-renowned scholars such as Bertrand Russell and John Edensor Littlewood. Based on a book of the same name by Robert Kanigel, this biographical tale of talent writ large examines the unlikely friendship between Mr. Ramanujan and his mentor, Professor G. H. Hardy (played wonderfully by Jeremy Irons), the uncertainties of a war torn England and the dire loneliness of the young man who left his home in India to share his insights about numbers.

Sadly, Mr. Ramanujan died in his thirties, leaving a legacy of path-breaking equations that have since been proven right. According to a 2012 article in Business Insider, his work is used by physicists to compute “the entropy, or level of disorder, of black holes.” Last month, the founder and CEO of Wolfram Research, Stephen Wolfram, reviewed Hollywood’s take on this band of merry mathematicians and pondered how they could have saved countless hours had they had access to his Mathematica product that is used by many Wall Street quants. His admiration for this driven wunderkind is obvious, as is his hope “that many more people will take advantage of the tools we have today to follow Ramanujan’s lead and make great discoveries in experimental mathematics – whether they announce them in unexpected letters or not.”

Popcorn aside, The Man Who Knew Infinity is captivating and well worth a trip to the cinema.

Investment Vendor Due Diligence and the Fiduciary Rule

Posted in Compliance, Credit Risk, Disclosure and Transparency, Fiduciary Liability, Financial Reporting, Liquidity, Susan Mangiero

Always Check For Spelling Errors Concept

When I was a university professor and gave written homework, I frequently found myself in the position of having to remind students that reliance on a spell checker may not always produce good results. “I through the ball” is grammatically incorrect but would not reveal itself as an error. Someone would have to know that “threw” is the appropriate choice. Inevitably, a few individuals would counter that they plan to employ staff to write memos, carry out financial analyses and undertake research. I would then ask how one can adequately evaluate a potential hire, let alone review the quality of that person’s work (if hired) if he or she is lacking sufficient knowledge to recruit and oversee thereafter.

Outside the classroom, selecting and monitoring is no less important, whether it’s an investment security or a service provider. During a recent workshop I was invited to lead about service provider due diligence and the U.S. Department of Labor (“DOL”) Fiduciary Rule, I shared a matrix I created with other investment industry professionals. It showcases some of the many qualitative and quantitative elements that could be used as part of a selection and monitoring endeavor. Big picture categories include, but are not limited to, the following: Client Capabilities, Compliance, Credit Worthiness, Funding Sources and Operational Integrity. See slide 24 of the presentation entitled “Fiduciary Considerations” by Dr. Susan Mangiero.

With its early April 2016 debut, it’s too early to tell how the DOL’s new mandate will influence hiring and subsequent performance reviews. Attorneys emphasize that the bar is set higher than before so it will be important to track how Requests for Proposals (“RFPs”) and vendor interviews proceed. Firms seeking to use a “Hire Me” exemption to avoid being tagged as a fiduciary may not be able to provide sufficiently granular and plan-specific information to ERISA buyers in order for those fiduciaries to carry out their duties. When this question arose during an April compliance conference I attended, several of the presenting attorneys acknowledged that there could be an information gap, adding that buyers and sellers would have to figure out a mutually beneficial path forward. I will defer to the legal professionals to address this issue.

As an aside, the “Fiduciary Considerations” slide deck prepared by Dr. Susan Mangiero includes material produced by others. Efforts were made to attribute the original source. Those seeking to use any or all of this slide deck need to contact the copyright owners of each slide.

Puerto Rico, Pension Deficits and a Need to Know

Posted in Credit Risk, Disclosure and Transparency, Municipal Bonds, Pension

A businessman holding a maginfying glass and following a trail of Dollar symbols to the city.

The news in pension land is sobering to say the least. Sadly, there are too many examples to cover in one blog post but taxpayers, participants, creditors and regulators are trying to understand the nature of the money trail that has, for some plans, led to trouble writ large. Consider what’s going on in Puerto Rico right now.

In addition to a just missed payment of more than $400 million, Governor Padilla told C-Span viewers on May 6 there is no money to pay roughly $800 million due on July 1 2016 to senior bondholders. As he explains, debt service has gone up faster than what he calls revenue inflows. Elsewhere, Nick Brown of Reuters writes at length about gross underfunding of the municipal pension plans in “Puerto Rico’s other crisis: impoverished pensions” (April 7, 2016). Despite multiple reforms introduced in 2013, funding remains perilously low. Keith Brainard, head of research for the National Association of State Retirement Administrators, is quoted as saying: “With about $1.8 billion in assets to pay $45 billion in liabilities, the 96 percent combined shortfall is among the biggest of any U.S. state pension this century, and probably the biggest ever for pensions ‘of this size and scale’.”

Bad economics is more than a numerical exercise. Real people are impacted. Plan participants, taxpayers and investors all have a stake in what happens next. As I wrote on March 19 in “Puerto Rico: Pensioners Versus Bondholders,” many individuals who own debt issued by this U.S. territory are themselves retirees or saving for retirement.

Should contagion occur, the cost of capital for other municipal borrowers will almost surely increase as frightened investors demand higher yields. Worse yet, some lenders may say “no” to certain new debt, leading to possible tax hikes at the local level. There is a trickle down effect when credit risk heads upward. See “Muni Market Shrugs at Puerto Rico Default, but Next Time Could Be Different” by Bernice Napach (Think Advisor, May 2, 2016).

Whatever you think of the Puerto Rico situation and proposed solutions, the clock is ticking for many cities, counties, states and countries that have not adequately funded their pension plans. Capital markets are paying attention. There is a lot at stake.

Investment Benchmarking “Must Do” Tasks

Posted in Disclosure and Transparency, Financial Reporting, Governance, Investment Management, Regulation, Risk Management

Cute young boy with stinky shoe pitching his nose

Whenever the topic of performance measurement comes up in conversation, I think back to a story someone told me about a woman who took the number two spot in a race. Proud of her accomplishment, she telephoned friends and family with the news. Here’s the catch. Only one other runner competed. Technically, her statement was correct but probably a stretch. A typical listener would likely interpret her claims to mean second best out of a large group of athletes.

When it comes to investing, context is likewise critical. A classic fallacy is to describe a security as riskier based on its standard deviation alone and ignore rates of return. If it turns out that the “riskier” security realized large enough gains compared to a second security, the resulting coefficient of variation (“CV”) would flip the ranking. (Ignore for now the notion that relying on a single statistic alone is ill-advised.)

It’s not always easy to construct an appropriate investment benchmark but the exercise is nevertheless vital since performance monitoring drives other decisions. The topic continues to receive focus from practitioners and scholars alike. A deep dive about construction and review is left for another day but the urgency may accelerate sooner than later.

As I listened to a series of compliance Q&A sessions this week about the Fiduciary Rule, I kept pondering how asset allocations are likely to change over the next year. Revised business models, the use of algorithms via robo-advisors and modified sales compensation arrangements will almost surely result in portfolio composition shifts for some investors. Should that occur, it will be incumbent upon a service provider to craft an appropriate benchmark that reflects the new regime and then explain its rationale to each investor. Otherwise, an individual or a plan sponsor may question why the performance of a post-Fiduciary Rule collection of assets is being graded against a stale benchmark.

This issue of dynamic performance evaluation is not new. However, given the regulatory focus on numerous factors that influence asset allocation, one can readily conclude that benchmarks will be part of the Fiduciary Rule implementation agenda in the months to come.

It’s Heeeere – The Fiduciary Rule Has Arrived – Now What?

Posted in Compliance, Disclosure and Transparency, ERISA, Fees, Fiduciary Liability, Governance, Investment Management, Mutual Funds, Regulation

Naughty dog - Lying dog in the middle of mess in the kitchen.

Like most people who work in the financial services arena, I hastily downloaded the long anticipated “Fiduciary Rule” when it was released by the U.S. Department of Labor (“DOL”) on April 6, 2016 and am busy tackling this final version. With more than two hundred pages, it’s going to take longer than a lunch break but is nevertheless vital reading. DOL’s Fact Sheet is a good start. No doubt there will be a flurry of articles and webinars about details and implications. I am attending two events early this week alone.

As with any new regulation, a cadre of professionals will be involved to discuss how best to comply. Ideally, an organization will coalesce its brain trust from Legal, Operations, Sales, Public Relations and Accounting at a minimum. In deference to industry concerns about how long it would take to make necessary changes, implementation will be phased in with a final adherence date of January 1, 2018. Other sought after modifications survived and are expected to make it easier for financial service firms to inform their clients in the aggregate about regulatory mandates.

The elephant in the room is the uncertainty about how post-mandate behavior could veer from the goals of the regulators and who might get hurt as a result. Free market economists refer to the Law of Unintended Consequences when they decry an event that distorts the invisible hand that optimizes demand and supply. Realists will counter that the financial services industry is already regulated and therefore does not operate on the basis of unfettered buy and sell signals. Nevertheless, history has repeated itself many times, demonstrating the acuity of those in search of profitable loopholes.

According to “Beware the Fiduciary Rule’s Unintended Consequences” by Christopher Robbins (Financial Advisor Magazine, April 6, 2016), many industry executives expect smaller firms to wither away “when some of their revenue streams dry up.” A related view is that tiny client accounts will be jettisoned by the remaining service providers and left with few choices other than “computers or robots,” despite the stated purpose of this initiative being to help all retirement investors. Keep in mind that the U.S. Securities and Exchange Commission (“SEC”) seems poised to challenge whether a robo-advisor can serve as a fiduciary. If the answer is “no,” does that preclude these algorithm-based providers from serving retirement customers?

Some attorneys exclaim that this conflicts of interest mandate will open the door wide to added ERISA lawsuits. In “Why Plaintiff Firms Will Love DOL’s New Fiduciary Rules,” Skadden Arps partner Seth Schwartz is quoted as saying that “As night follows the day, there will be more litigation.” In “Fiduciary Rule Less Complex, but Questions Linger,” reporter Sean Forbes (Pension & Benefits Daily, April 7, 2016) interviews a handful of attorneys who express concerns about (a) private rights of action to bring a lawsuit (b) a definition of a fiduciary that “goes way beyond common law” and (c) questions about the enforceability of the Best Interest Contract Exemption (“BICE”).

One big upside of the Fiduciary Rule is that the topic of fiduciary duty is being mainstreamed as never before. Transparency can be a good thing as long as investors pay attention.

Not everyone is convinced that more information will translate into better decisions made at the individual level. During a quick call last week with an in-house benefits attorney, I got his message loud and clear. An employer can only do so much if a participant remains reluctant or unable to engage. Wall Street Journal pundit Jason Zweig echoed this view in his April 8, 2016 column entitled “You Are Responsible For Your Retirement Savings.” His central point is that the DOL Fiduciary Rule is not a panacea that can fully eliminate investment product risk or prevent an individual from working with an ethics-challenged advisor or broker.

Stay tuned for subsequent posts about the DOL Fiduciary Rule.