(April 11, 2013) — Chief investment officers’ primary goal in convincing their boards that a new risk allocation approach is appropriate is to remind them the risks are already here – there’s just no-one managing them.
Don Pierce, CIO for the San Bernardino County Employees Retirement Association, told this year’s aiCIOCIO Summit in New York it was an easier marketing sell to tell his board that it made sense to clarify the risks they were already taking.
“Instead of letting the market dictate, why don’t we use the information available to us and be informed? We’re already taking risk, so let’s clarify it,” he said.
“Some folks from a finance background got it straight away; others without that background took a little longer. But they all came on board after we kept reiterating that they already had this risk, and no-one was responsible for managing it.”
San Bernardino’s fund undertook a new rebalancing strategy in 2005 after two years of set up time and negotiations. Initially the investment team thought the new strategy would generate additional returns of 0.35% over the course of the plan – the gains are currently riding at 0.87%.
The cost has been minimal – the fund pays 0.04% to Russell Investments as its overlay manager, plus the CIO’s time and the software costs.
Talking to the company’s board about their concerns was key, Pierce said. “What was important to the board at the time was they didn’t want us transacting like day traders – they were concerned about increasing out turnover. “So we built the framework to include a modest amount (of transactions) and were able to achieve a lower turnover ratio and be informed.”
Mike Dieschbourg, senior managing director at Broadmark Asset Management, said the language used to explain to the board about why a change in allocation strategy was important was the only way to implement change.
“You need to make it relevant to the board and what they’re used to – if you take a public fund you need to talk about the goal of helping people meet their retirement expectations,” he said.
“Getting people off the market indices is critical – and you can do that by providing examples that make sense to them. After the problems we had in 2008, it took your average 60% equities, 40% bonds fund 22 months to return to where we were before 2008 – that sort of language where you’re saying it takes years to correct what’s happened changes mindsets.”
Dieschbourg also stressed that many people overestimated the value of obtaining increased returns, and underestimated the value of making a loss.
“The pain we feel from making losses is three to four times greater than the same amount of gain – and you feel that loss for longer,” he added.
Celia Dallas, director of investment strategy research at Cambridge Associates, told the conference she sympathised with CIOs who find themselves facing resistance whenever the bring up the issue of risk management with their boards.
“The best way to get the message through is to focus the mind on where the current strategy isn’t working using a lens they perhaps haven’t used before. You can point out the weaknesses in the existing framework this way,” she said.
However, Pierce admitted he had “got lucky” with his understanding board, and confessed he didn’t know if they would have stuck by his decision to move to the new rebalancing strategy if it hadn’t been as successful as it was for the first 18 months.
“I’d like to think that the board would have given us enough time, but I honestly don’t know,” he said.
“I will say this: we buy call options on interest rates as interest rate increases are a big tail risk for us, but we were early going into it and as a result lost some money. The board backed us and even wanted to expand that position – that’s encouraging that they can look past the initial struggling period.”
The fourth annual aiCIO CIO Summit runs Thursday – Friday at the Harvard Club of New York.
Related content: Interview with Don Pierce in aiCIO‘s Power 100