Alternative investments—hedge funds, real estate, infrastructure and private equity—offer the best prospect of higher rewards. But those higher rewards come with higher risks: an investment can blow up. And for pension plan sponsors, the question that hangs over a failed investment is whether the investment committee did adequate due diligence. This was one of the points discussed during a panel session on the legal challenges and pitfalls of investing in alternatives, a discussion that was lead and moderated by Terri Troy, CEO, HRM Pension Plan.
“Do the right thing; when investing plan assets you are a fiduciary,” says Mark Firman, an associate with McCarthy Tétrault, who points to one of the golden rules of pension plan administration. “There’s currently no statute that says stay out of derivatives.” Statutes or no, “what the law judges is the process you undertook to get into that investment.”
That process can be onerous.
“These are investments that you’re going to be stuck in for 10 years or more so you’ve really got to make sure that they work,” urges Jonathan McCullough, founding partner, McCullough O’Connor Irwin LLP. “You’re going to get an inch thick of paper dumped in front of you and you really have to read it. You can’t just rely on your lawyers to read it.”
Those documents may not quite suit a pension plan’s liquidity or even its tax needs, since Canadian pension plans are exempt from Canadian taxes. “The devil is in the details,” he adds.
The solution is to negotiate side letters that tailor an investment to meet a pension plan’s specific situation. “How hard did you press to get preferential terms in a side letter or a side agreement that could have prevented the outcome?” asks Firman. “Whether or not you got them, did you try?”
That means taking a lot of the process in-house and being more proactive, for example using standardized documents that a pension plan can present at the beginning of the investment negotiation, says Barbara Miazga, treasurer and director of University of Ottawa’s pension fund. “When we’re doing the legal review process, we try to carve it out between things like the business-related issues and the more technical issues. We will follow up on the business-related issues ourselves. That’s the sort of thing that is cost-manageable and lets you control the process.”
That does mean making an upfront investment in staff, rather than letting the lawyers’ meters tick. But there are plenty of learning opportunities such as joining the member-driven Institutional Limited Partners Association.
In the end, with the internal staff costs and the external lawyers’ costs, she says, “it can really take only one situation where you need to rely on those protections where it’s worth it.”