CPD: The overlooked art of good governance

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Identifying who does what and where the responsibility and accountability lies is a vitally important task of the governing fiduciary.

Does your Outsourced CIO fit within your governance structure and offer the governance you need? It is a vitally important, yet often overlooked element in the development and maintenance of an enduring and resilient investment program.

But what is good governance? And does it really make a difference? The strength of the global capital markets of the last decade or more has meant that most financial organisations have done fairly well, regardless of any structures, processes and strategies employed. In short, almost everything has gone up and most have ‘done well’. But as the COVID-19 market meltdown of 2020 reminded us, markets go down as well as up, so many financial advice businesses need to have in place robust structures, policies and procedures that help guide their investment programmes.

What is investment governance?

Investment governance is not investment management. Investment management is the process of implementing investment portfolios through selecting fund managers or buying and selling securities directly. In contrast, investment governance describes how investors and their investment programmes are developed and then overseen through the adoption of structures, policies, processes and procedures. Investment governance can foster effective stewardship of assets being an important consideration for all financial advice businesses and their clients.

To be most effective, governance structures and processes need to be well defined so that those involved know who is responsible for what decision and when it takes place within the investment management process. For example, descriptions of the:

  1. Roles and responsibilities, i.e. what the Board of Directors, Investment Committee, advisers, fund managers and/or staff are responsible for.
  2. Investment and decision-making process, i.e. what decisions are made and how they are made.
  3. Items that are delegated, i.e. what stages of the investment process are delegated and to whom.
  4. Reporting and review process, i.e. how risk, compliance, performance and outcomes are regularly tracked and assessed.

All of the above should be in the best interests of the client.

Case study 1

Gary and Clive merge practices and put a governance framework in place

Gary and Clive merged their two financial planning practices 18 months ago to achieve the benefits of scale across the major aspects of their business. Now combined, they have close to $800m in funds under advice and a team of seven staff across their businesses.

Gary and Clive recently had a planning session and as part of this planning agreed the following:

  1. Roles and responsibilities – As business partners Clive has an interest in investments whereas Gary has a strong interest in process and is keen to ensure roles and responsibilities are clarified.  In addition to this Clive and Gary are keen to put in place an overall advisory board to provide insight and challenge to their business strategy along with an investment committee which also includes externally appointed individuals offering their expertise in strategic asset allocation and portfolio construction.
  2. Investment decision making process – The advisory board of Gary and Clive’s practice has delegated authority on investment decisions to the investment committee who have delegated authority from the advisory board to develop the Investment Policy Statement for the practice in line with the licensee guidelines as well as the asset selection and oversight processes of their model portfolios.  The Investment Committee includes Gary and Clive, one of their paraplanners in their practice who is a certified financial analyst (CFA) and a paid external asset consultant, all three members of the practice are voting members on the investment committee whilst the external asset consultant consults to the committee but does not vote on investment decisions.
  3. Defining roles and responsibilities  –  As part of the investment committee charter there are a number of items in the investment management process that are delegated to Gary and Clive’s team, an effective way to document and clarify roles and responsibilities by sitting with the team and determining by task or work activity who is responsible for that task, who is accountable for ensuring the task is completed, who needs to be communicated to about the task and finally who needs to be informed that the task is completed.  The benefit of completing this exercise within a team ensures there is clarity on roles and accountability within each team.
  4. Reporting and governance – One of the key elements to managing the performance and risks within a practice and business is regular visibility and reporting at an advisory board level. Standard templates for reporting and risk monitoring will enable the advisory board and business owners to track financial and non-financial performance over time.

Common structures at investment organisations

In most financial advice businesses, it is relatively easy to identify three different types of roles:

  • the governing fiduciary
  • the managing fiduciary
  • the operating fiduciary.

These three roles can be undertaken by separate parties, while in other cases they overlap of responsibility and execution. Whatever the situation, the delineation of responsibilities should be clearly articulated and documented so that those involved are clear as to who is responsible for what.

In most practices it is the governing fiduciaries that set the mission, develop strategy and review progress. Governing fiduciaries are usually boards of directors, investment committees or trustees. These groups typically set the objective, identify core belief sets and determine the risk appetite that will guide all involved and eventually be reflected in the broad investment strategy and approach.

The managing fiduciaries make the relevant investment decisions that reflect both the asset allocation policy and the underlying beliefs as articulated by the governing fiduciaries.

The operating fiduciaries, which is a role that can also be undertaken by the managing fiduciary, makes the investment and execution decisions. These decisions, such as buying or selling securities, require day-to-day attention and are invariably made by investment professionals such as investment managers.

How decisions are made – the decision-making process

A general principle in the investment decision-making process is that decisions should be made by those most equipped to make them. For instance, the decision to buy shares in one listed company over another should be left to experienced and suitably qualified professional portfolio managers and analysts for whom buying shares is part of the daily function, rather than to a committee who meet once a quarter. Engage the services of others that do have the experience and skillsets. This might mean the hiring of an outsourced CIO for oversight of key investment policy decisions.

For effective investment decision making, governing fiduciaries should retain responsibility for issues they are best positioned to address and delegate everything else. Governing fiduciaries should, for example, decide on risk appetite which will inform the long-term strategic asset allocation, the most important determinant of long-term performance. This is because they, more than anyone else, should understand the objectives and constraints.

Assigning responsibilities: a clear understanding of where the ‘buck stops’

Identifying who does what and where the responsibility and accountability lies is a vitally important task of the governing fiduciary. Responsibility can then be assigned to the various groups in the governance structure, with the authority noted.

For instance, the governing fiduciary might be responsible for ‘deciding’ the objectives and risk appetite. The groups fulfilling the managing fiduciary role, such as an investment committee or an outsourced CIO, might ‘advise’ on those key strategic decisions while ‘deciding’ on asset class and investment strategy and fund manager selection. In addition to these roles, they would be responsible for ‘overseeing’ the operating fiduciaries who are responsible for ‘deciding’ the buying and selling of securities.

The role of the Outsourced CIO

Partnering with an Outsourced CIO does not remove the oversight and governance responsibilities from financial organisations, investment committees or staff, but it can offer significant efficiencies (both cost and operational) and capability enhancements to a wide range of investors. Having a single entity with total portfolio oversight on a day-to-day basis is also an attractive element of this approach. A good Outsourced CIO can:

  1. Help governing fiduciaries where applicable, formulate investment objectives, develop policies, i.e. Responsible Investment, and design a strategy to increase the odds of achieving those objectives.
  2. Execute the investment strategy, including managing cashflows and rebalancing and the monitoring and management of underlying overlay and asset managers, i.e. the hiring and firing of managers.
  3. Control and monitor the risk and performance profile of the total portfolio and its constituents.
  4. Develop an appropriate total portfolio reporting package to assist the governing fiduciaries in the discharge of their duties, e.g. tracking progress towards goals and monitoring current and prospective risks.

Many of the functions performed by Outsourced CIOs are similar to those executed by internal CIOs. However, due to economies of scale, Outsourced CIOs can provide a broader range of services and bring scale benefits.

The governance checklist

Every financial organisation is unique. Those with governance responsibilities should consider structures, policies and procedures that make sense for their particular circumstances and resources. However, below are some key questions that all governing fiduciaries could ask:

  1. Have we clearly stated the purpose of the fund, its objectives and risk appetite?
  2. Do we, the governing fiduciaries, focus on the big picture by taking responsibility for the most important strategic decisions and policy development, while delegating everything else?
  3. Is the structure that we have in place appropriate given our scale and resources? Are the roles and responsibilities, including decision rights, clearly articulated? i.e. do we define who does what, when?
  4. Do we have sufficiently experienced, skilled and resourced parties in the various governance layers? Are ‘real time’ functions delegated or outsourced appropriately? (i.e. are ‘governing’. ‘managing’ and ‘operating’ fiduciaries roles and responsibilities defined?)
  5. Have we detailed objectives, policies and procedures clearly in accessible governance documents?
  6. Have we aligned our risk management framework with the structure of the fund or investment programme, its objectives and the risk appetite?
  7. Is our regular reporting package helping us fulfil our governance responsibilities by succinctly providing high level performance, risk and asset allocation details of the portfolio(s) while drawing attention to items that require further attention?
  8. Are we reviewing ourselves regularly and ensuring we are appropriately structured given our objectives, constraints and the prevailing market realities?

Conclusion – What separates the best from the rest?

Below are some of the markers of the more successful governance structures and investment programmes to consider:

  • The governing fiduciaries clearly and consistently communicate the fund’s purpose (i.e. the overarching investment objective or the fund and/or organisation) and risk appetite.
  • Roles and responsibilities are clearly articulated with authority appropriately delegated to staff, advisers and/or outsourced providers. Governing fiduciaries focus on ‘governance’ rather than ‘management’. Those making the decisions have the necessary skills, experiences and resources.
  • There is organisational continuity with stability among the various governance layers (e.g. investment committee membership, outsourced providers and advisers).
  • The governing fiduciaries adopt forward-looking perspectives focusing on the most important strategic decisions including the development and oversight of an appropriate risk management framework.
  • There is a holistic approach to risk management, with emphasis on developing robust policies, procedures and reporting.
  • There is an emphasis on building meaningful strategic partnerships with fewer external providers, than might be typical.
  • Guided by strong governance documents and policies, all levels of fiduciaries at successful funds tend to work together towards common goals and objectives.
  • Recognising that markets change, and opportunities and risks evolve over time, the best funds can adapt as conditions warrant.
  • There is a focus on long-term objectives and risk rather than short-term and peer-relative performance. Successful investors recognise that markets are complex and volatile and that outcomes.

Seeking a partnership with an outsourced CIO may provide the enhancement to your governance structure and processes that your practice needs. As highlighted good governance with robust structures, policies and procedures in place can help guide investment programmes towards achieving the investment goals your organisation desires.

 

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