governance

In Australia, the government has taken up the recommendation of the Financial Service Inquiry that the objective of superannuation should be enshrined in law and be defined as 'providing an income in retirement'.

Good Governance Starts with Defining Success

Addressing Mission Clarity

Much has been said about the importance of good governance in achieving the best outcomes for pension fund members.

But before a framework for good governance can be implemented, fiduciaries must first decide what it is exactly that they want to achieve, according to Michael Drew, Professor of Finance at Griffith University.

Drew and his colleague Adam Walk, Research Fellow at Griffith University, make the argument in a recently published paper on the importance of governance to retirement systems, titled: ‘Governance: The Sine Qua Non of Retirement Security’.

Do we have the governance framework right to address the issues that mums and dads are trying to deal with in the retirement income phase? What is the frame of success? That is really at the heart of the paper.

“We are entering the retirement income part of the lifecycle and suddenly time is now finite,” Drew says in an interview with [i3] Insights.

“Do we have the governance framework right to address the issues that mums and dads are trying to deal with in the retirement income phase?

“What is the frame of success? That is really at the heart of the paper,” he says.

The increasing number of members who are transitioning to retirement means that funds need to adopt more of a liability-driven framework instead of focusing on portfolio level returns.

“We are trying to bring some mission clarity to the table. I think we all agree it has to be something more than beating peers or league tables,” he says.

In Australia, the government has taken up the recommendation of the Financial Service Inquiry that the objective of superannuation should be enshrined in law and be defined as ‘providing an income in retirement’.

Yet, most funds are squarely focused on quarterly investment returns of their various options.

The objective of a superior short-term investment performance and that of a sustainable income in retirement are two different, and sometimes conflicting, goals, Drew argues.

“I have spoken before about the dangers with league tables, especially in regards to sequencing risk and path dependency, and that a second quartile fund in time-weighted returns might actually give you a better dollar-weighted outcome,” he says.

“What we were hoping to do with this papers is to move the discussion away from a time-weighted return framework, because from a success point of view time-weighted returns are not the best outcome.

“For some people the objective will be a supplemental income. Because of members’ interrupted work patterns, or income levels, it could be that the actual mission is to supplement the public pension and get an ASFA (Association of Superannuation Funds of Australia)-like comfortable outcome at the end of the journey.

“For other funds, with high account balance members, it might be an income replacement.”

“What is the measure of success? We are not saying that time-weighted return measures are not important; they are absolutely important. You need to govern the skill of the manager.

“But we are asking questions around mission clarity …, is the mission being fulfilled? That allows the trustee to think about all the levers available to them.”

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We prefer to see investment committees spend eight minutes out of every 10 on asset allocation questions, rather than on the 13th manager in the line-up.

Drew would like to see more time being spent on those aspects of investing that really matter to the outcome for members.

That means less time dealing with manager selection and more on asset allocation.

“We think the evidence is there that the majority of returns come from that asset allocation piece and we far prefer to see investment committees spend eight minutes out of every 10 on asset allocation questions, rather than on the 13th manager in the line-up.

“We are in a low return world, so how do we make sure that we got all of the levers coordinated?

“We are just asking: ‘Are committees looking at income replacement, projected income replacements and those measures of success, or are they just looking at sharp ratios, information ratios and those sorts of things?'”

Drew says some funds are further in their thinking about this than others.

“There are pockets of excellence and what we are trying to do with the papers is to test whether it is clear what the target is and whether funds have the means to achieve the target?”

The paper ‘Governance: The Sine Qua Non of Retirement Security’ was published in the Summer 2016 edition of The Journal of Retirement.

For a general guide on ESG issues in Australia, please see here.

For [i3] Insight’s guide to retirement, please click here.

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[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.