GOVERNANCE OF A PENSION FUND IS DETERMINED BY those at the top who are entrusted with its oversight, such as the board or the investment committee of the board. This is obviously an important job. The board determines who is responsible for each function and should look after the ‘big-picture’: making decisions concerning asset allocation and risk tolerance while the investment staff and/or external managers concern themselves with the implementation of policy and alpha generation. Micro-management should be avoided at all costs.

The board has a big impact on the culture of the organization, especially in an investment organization. And such an organization needs to be nimble. There have been a number of studies about the amount of information required to make an effective decision or forecast. They have shown that when decision-makers or forecasters are given a large volume of information, they gain confidence in their decision-making or forecasting ability, but the actual accuracy of their ability to do so does not improve. In the investment world, taking lots of time to gain conviction will result in opportunities passing you by. Therefore, an effective board needs to have the flexibility to make decisions quickly.

The composition of the board is also crucial. A board that contains a majority of professional members—those with a solid investment background— will have a greater chance of success than a board consisting mainly of lay-people. A lay-board will need to spend extra time educating itself and will not be able to partake in the more sophisticated investment strategies. These strategies, which may appear to be complicated, convoluted and confusing to lay-people, are often the ones with the most ability to add value over the benchmarks. The common, easy-to-implement, strategies that everybody understands are more likely to bring mediocre results.

SMALLER IS BETTER
Similarly, the size of the board can be important. Ideally, a board should have enough voices to create informed and stimulating dialogue. However, a large board, especially one that insists on forming a consensus, will take a long time to make watered-down decisions. The appropriate size for a pension fund board or investment committee is about four to six members.

Along these lines, a board must be wary of its tendencies to become too political. Board members with agendas need to be silenced, whether they are overt(“I don’t want to invest in company X, because the CEO is a staunch Republican”) or less overt(“I think Hondas are great cars, so Honda must be a great stock to buy”). It’s very simple: all decisions must be made in the best economical interests of the beneficiaries.

GAUGING VALUE
Finally, a board needs to understand compensation. Paying $500,000 a year to an investment staff member who can add $25 million a year in added value over the benchmark is a bargain. Or to twist this another way, a $20 billion fund with a total investment staff payroll of $50 million per year that has consistently outperformed its benchmark by 1% per year makes a lot more economic sense than a professional hockey team with a $50 million payroll that consistently loses money for its owners.

An effective pension fund board is one that helps, not hinders, investment performance. To do so, a board needs to: clearly define what it is and isn’t responsible for, be flexible enough to make quick decisions when necessary, have a majority of professional members and mitigate internal bureaucracy and politics. Those boards that ‘get it’ will set the tone for the investment side of the organization and greatly improve their chances of meeting their obligations.

Dave Finstad is the director, external fund management at Alberta Investment Management in Edmonton. David.Finstad@gov.ab.ca

For a PDF version of this article, click here.