By Ashby Monk
This blog is a source of open discussion and engagement on the topic of SWFs. As such, we welcome and indeed seek out all views and opinions on the subject. Today, we offer the eleventh instalment of our segment: “Q&A with a SWF expert, stakeholder or policymaker” (see the Q&A archive). We are pleased to welcome Roger Urwin of Watson Wyatt. While Mr. Urwin’s views are his own, his perspective helps to further debate and facilitate understanding.
Ashby Monk: Thanks for joining us today, Roger. Can you briefly explain what it is Watson Wyatt does, and how you’ve come to be interested in SWFs?
Roger Urwin: Watson Wyatt is the investment adviser to large institutional funds across the world. We have around 500 people in teams located in the major financial centres: London, New York, Chicago, Hong Kong, Shanghai, Sydney and elsewhere. Our work spans asset allocation, manager selection and monitoring services. We are also experts in investment governance and how to structure the investment function. This is essentially about how to deploy a combination of investment committee, directly employed staff and outside firms.
We are advisers to a number of the sovereign funds across the world. They are often the most interesting: sophisticated, have a wide agenda, in the public eye, complex problems to address.
Ashby Monk: What impact is the current financial crisis having on SWFs? Has their behaviour changed over the past few months?
Roger Urwin: As I speak, equity markets this year are down close to 40%, most other asset classes are down in the range 10% to 25%. This has proved a very severe investment bear market and there are no obvious signs yet we are emerging from it. The obvious catalyst is the crisis in confidence in banking and credit, and the spectre of a deep protracted global recession. Of course the SWFs all have very long time horizons so they have been among the calmest voices in the industry. Many of the conversations I’ve had with them have been about ways to exploit new opportunities. But that said they have to keep their stakeholders onside and this climate is difficult to present in a positive light when you expect to perform well at all times.
It’s an interesting point as to how their behaviour has changed. Certainly, they are doing much more thinking on risk and in some cases some re-framing of risk has taken place. I’d say their macro view of what are the key drivers in the investment landscape has changed somewhat. But I have not seen much change in asset mixes beyond a limited degree of rebalancing.
Ashby Monk: As a global leader of the investment consulting business at Watson Wyatt, I’m interested to hear what advice you’ve been giving your SWF clients lately. Can you share this with us?
Roger Urwin: Our clients are getting both barrels from us on this crisis. We see it as a seminal moment for change in both practice and strategy. Most times it’s a combination of these three points.
First of all, the crisis is a financial system failure with several contributory causes and we should become more aware of this inter-connectedness of all things issue. But two things stand out as explanations: that we had developed far too much leverage in the financial system and we have outrun our ability to cope with financial complexity. Much of our advice is about leverage control and managing complexity.
Second, funds need to have a macro view of risk which blends both a quantitative model with a qualitative overlay. No models are powerful enough at present to deal adequately with regime changes so this overlay is critical. Better models and presentations of risk are certainly high up our sovereign funds’ agendas.
Third, while it is inevitable that size of certain risk premia have begun to look interesting, the visibility of most beta returns remains poor. Uncertainty is way up relative to classic risk measures. For most funds this does not yet suggest increasing risk. For most it means that they should stay put with current allocations.
Ashby Monk: Since we both also share a keen interest in pension, I’m curious to see if the current crisis has significantly impacted funding levels? Were pension funds better prepared for this crisis than they were the ‘perfect storm’?
Roger Urwin: Your reference to the perfect storm was the 2000 to 2003 period when global funding levels were hit simultaneously by falling asset prices, falling bond rates and increases to longevity. In three years funding levels fell around 40%. The fall this year is only happening from one of those causes – the falling asset prices given pension fund strategies average 56% in equities. The funding level fall during 2008 is as we speak closer to 30% but it’s a much quicker change. I view it as pretty harmful. Both corporate funds and public funds are not that resilient to deal with these new deficits. Previous answers have generally been to look for additional investment return to fill the gap, but there is a limit to how much this source can produce. I’m quite worried.
Roger Urwin: My work has been on the governance of all types of institutional funds including SWFs. This subject has not attracted much air-time in the past. If you do a Google search on ‘great investment managers’ you get hundreds of hits. If you do the search for ‘great investment committees’ you get one solitary item linked to the research I’ve done with Professor Gordon Clark of Oxford University.
There are a lot of lessons I think. Let’s start with the fact that governance is difficult to change because of agency issues, board members’ agendas and lack of conclusions about good organisational design. But, encouragingly, our best practice models of governance are gaining some traction.
The biggest feature of this best practice model is that good fund boards, and their executive teams, operate with clearly defined areas of responsibility and authority. It pays to be very clear on who does what. Funds are not hugely complex in concept, but all the same it is very easy to have overlaps and problems with roles occurring. Preferably, the executive team has the active role, the Board has oversight and high level influence. This also leads to better accountabilities – the executive is accountable for their performance to the Board, the Boards need to measure their own results and be accountable for these results.
I’d also mention the need for having and following explicit decision-making processes. The quality of decision-making is obviously critical, and good boards work very hard – just like managers – to formalize, streamline, make as efficient as possible their decision-making.
Lastly it’s about alignment of governance budget to investment arrangements. Funds have to work out their competitive advantages and act accordingly. Good funds see governance as an enabler that can be varied significantly over time but few funds think of it this way. It was our research that defined the concept of ‘governance budget’ as a measurable resource based on time, expertise and organisational effectiveness.
Ashby Monk: So what does the future hold for SWFs.
Roger Urwin: We addressed that in our Defining Moments paper early this year. We set out in that paper the complex factors that drive the investment industry and the increasingly influential role played by SWFs. We think these funds are at the nexus of many of the critical aspects of our financial world: globalisation, effective governance, demographics. I think they can do a number of positive things to ease the inter-generational issues that we will encounter. Our 21st century society desperately needs them to be effective.
Ashby Monk: Thanks, Roger, for taking time out of your busy schedule to chat with us today. We really appreciate your insights.