Without revealing or claiming an ideology, I will admit I get most of my news from watching and reading sources that are largely contrary to my leanings. Whether it’s the hypocrisy of one side blaming the other for all of the country’s ills or the 24-hour sound-bite society we all live in, the result is usually frustration and disappointment. If I kept this conflict to myself the story would be over but this self-imposed, semi-tortured state often leads me to vent to my family at the dinner table. The predictable question that usually comes back is “why do you watch/read it if it makes you upset?” While I cannot argue with the question’s basic logic, I would contend it’s always a healthy exercise to view things from a different angle in order to gain a stronger overall understanding of how things work. I would also posit taking in information that only supports your current worldview results in a rather rigid mindset and existence. Get ready to experience a shift in perspective by considering the following theoretical scenario…
An investment committee makes the decision to hire an active large cap core equity manager for a competitive 0.55% (55 basis points in industry-speak) annual fee. In the first year of engagement, the manager is able to generate a gross of fee return of 11.0% versus an S&P 500 Index return of 10.0%. On an absolute basis, the resulting 45 basis points of net outperformance logically makes the committee feel good about the hiring decision and the manager. Let’s dig a little deeper…
Now what if I told the committee that the first 10% of their manager’s performance was actually “free” (almost)? This reality exists since an average investor can quickly and easily gain 100% exposure to the performance of the S&P 500 index for 5 basis points (or less). Breaking down the math, since roughly 91% (10.0% / 11.0%) of the portfolio’s total return of 11.0% for the period has a cost of 5 basis points, the committee essentially paid 50 basis points (0.55% – 0.05%) for the additional 1.0% (the portion of the 11.0% return attributable to the manager’s skill) return the active manager was able to earn above the index’s return of 10.0%. As a result, without changing any of the scenario’s parameters (just viewing the results from a different angle), the manager’s reasonable 55 basis point fee just turned into a 50% performance charge on the portfolio’s 1.0% gross outperformance. To compound the uneasiness that you may be feeling, we all know even truly skilled managers do not always outperform their benchmark index. Unfortunately, when this is the case the math tilts exponentially against the investor since the committee is paying a 55 basis point “skill-based” fee regardless of the manager’s result. Let’s keep digging…
Before the committee in our hypothetical scenario gathers the torches and pitchforks to lead the charge against active management, it is important to remember that the portfolio did generate outperformance (a valuable skill worth paying for), which the committee likely could not have achieved on their own. Outside of this scenario, skill is not just about outperformance, an active manager may offer downside protection and/or reduce volatility relative to a passive benchmark. In either case, it’s simply a math problem: what is “active manager skill” worth? Additionally, how can investors level the playing field so that inevitable periods of underperformance have a lower impact on the portfolio, encourage committee patience, and prevent poor decision making? For committees willing to commit the time and effort, the answer may be implementing a performance-based fee structure for their active managers where appropriate. Operational challenges aside, in a skill-based and measurable profession, the only managers not comfortable being evaluated and compensated for their net positive contribution are logically those not convinced they are truly adding value.
Before closing, let me make one thing perfectly clear: while there are ebbs and flows in investor preferences and the saliency of arguments for active and passive management, it is not (and should not be) an either/or tradeoff in the minds of investors. Active and passive investment strategies can, and should, effortlessly coexist in the capital markets and investor portfolios. Further, large cap core active management makes an easy target for this scenario since this particular segment of the market is arguably the most efficient when compared to others. Ironically, much of this market efficiency is driven by the critical price discovery of competing active managers. Other market segments and asset classes do not necessarily share this efficiency nor are they advisable to access on a passive basis from our perspective. See, we can all get along.
This blog is provided for informational purposes only and should not be regarded as investment advice or as a recommendation regarding any particular course of action.
Many see compliance as a necessary evil to appease regulators and meet standards set forth by the law. It is no doubt an annoyance to those whose sole focus is to do their job quickly instead of carefully. Compliance takes time, and time is money. It is also not a direct revenue generator, so many CEOs are hesitant to go all-in on what looks and feels like a negative force for their business.
While this thought process is understandable, it is also shortsighted. Sure, having a compliance officer run through your business like a fine-toothed comb is sure to decrease flexibility and customization to some degree; however, what is gained from an investment in compliance is more than worth that sacrifice.
As this blog post will explain, proper compliance provides checks and balances and a sense of security for both employees and clients that is necessary for any business to move forward with confidence. When those who depend on your business know that you are doing everything to stay at the forefront of regulations, laws, and best practices, businesses often see their commitments pay off in higher morale and a retention of clients who would otherwise leave if legal issues struck.
Hiring a compliance officer is not enough to effectively protect your company. Compliance is only as effective as its implementation. Like any relationship, trust is paramount–namely, the trust between management and compliance. That trust is forged with the realization that compliance is employed to help, not hinder business.
Everyone on the team must be held accountable for employing and respecting the compliance process. There cannot be exceptions, even for the CEO. This displays, from the top-down, that this process matters. The entire team is responsible for remaining transparent and allowing the compliance officer to do his or her job and feel welcome to join meetings and make inquiries whenever he or she feels it is necessary to do so. Whenever leadership embraces compliance, the organization feels empowered to follow suit.
Frankly stated, businesses that lack compliance in the investment consulting industry put their clients and employees at greater risk. This could increase the probability of employee turnover, client terminations and business failure. As fiduciaries, our business hinges on our clients’ trust. The moment this trust comes into question is the moment that it is broken–often irreparably so. A strong commitment to compliance creates a culture within a firm of trust and confidence which is then passed along to client relationships. This forms the foundation of lasting partnerships both internally and externally.
Inadequate compliance can lead to business and service shortcuts which erode trust and confidence that ultimately lead to lawsuits, which can quickly cause clients and future clients to think twice before trusting you with their assets. This distrust has a trickle-down effect, causing decreased business, plummeting morale within the company and an eventual implosion due to distrust both inside and outside the firm. If a fiduciary is forced to defend its standards in the court of public opinion, the damage is often already done.
Understanding the powerful assurance that properly implemented compliance can provide, AndCo Consulting has committed to making compliance a priority by hiring Matt DeConcini as chief compliance officer. Matt has over 20 years of legal and compliance experience working with and on behalf of institutional clients and their participants and beneficiaries.
With $72 billion in retirement fund assets, we take our fiduciary responsibilities extremely seriously. In our quest to be a transformational leader in the investment consulting industry, we found that proper compliance should no longer be seen as anything but mandatory. We are setting the standard today, by allowing Matt to own his position with the full support of the entire AndCo team.
Peace of mind cannot be bought, but our clients and team can rest easy knowing that we are monitoring business practices, policies and procedures through a comprehensive and integrated compliance program. As we know from experience, a cross-organizational approach to compliance also allows us to deliver organization-wide consistency, sustainability and transparency.
But this is just the beginning for AndCo. We are listening to our team, our clients and the industry as a whole to find opportunities for innovation every single day. Our dedication is not only to making our own firm successful, but shaping the industry for years to come.