IPE at 20: Insights from 100 conversations
“I agree with you, but how do we get from here to there?”
Anonymous, from a book tour conversation
Very few people have the opportunity to write a book on the future of pension management and then travel the world to discuss and debate it. Being such a lucky person, I feel obliged to share what I have learned from those conversations.
The story starts with the publication of my book, The Future of Pension Management: Integrating Design, Governance, and Investing, a year ago. Its first launch was at the University of Toronto in April 2016. That was followed by many over 2016, taking me to the US, Europe, Asia and Australia. Each event generated intense conversations and multiple perspectives on the topic.
Below, I set out the book’s three key messages, summarise the responses to them, and assess what those mean for the future of pension management. In short, the book asserts that we know how to:
• Design sustainable 21st century workplace pension plans;
• Build effective 21st century pension organisations;
• Transform retirement savings into wealth-producing capital.
The challenge now is to turn that knowledge into constructive action.
Sustainable 21st century workplace pension plans
Designing sustainable workplace pension plans starts with setting a sensible target that supplements a country’s first-pillar old age pension. Establishing such a target deserves more attention than it gets. Once established, careful attention must be devoted to calculating a target-consistent contribution rate. Such calculations raise a series of mission-critical questions: how long will employees be in the workforce? What will be their earnings profile? How long will they live after retirement? What will be the return on retirement savings?
“It was gratifying that most appreciated the need to go back to basics, starting with the question of what we want workplace pension plans to accomplish”
These lead naturally to questions about riskbearing and participant choice:
• How are the investment and longevity risks embedded in workplace pension plans best borne?
• How can we test the effectiveness, fairness, and sustainability of any specific risk-bearing arrangement?
• Should the plan design offer participants a default option?
• Should there be opt-out choices regarding participation, contribution rates or investments, for instance?
• On a public policy level, should employers be required to offer employees a workplace plan which meets a minimum national standard?
Conversations about design
How did launch attendees respond to design thinking? A minority simply could not get out of the dysfunctional 20th century ‘defined benefit versus defined contribution’ framing of the question. It was gratifying that most appreciated the need to go back to basics, starting with the question of what we want workplace pension plans to accomplish, and then answering the logical design questions that follow from it. At one end of the spectrum, Australians are in a good place; they only need to bolt income-for-life back-ends on to their DC plans. At the other end, the Dutch are in a tough place; they need to unscramble their messy collective DB omelette before they can move to a better place.
The single most important point that the management philosopher Peter Drucker made in his 1976 pensions book The Unseen Revolution was that pension organisations are not exempt from the three universal rules of organisational effectiveness: mission clarity; good governance; and unfettered access to the resources required for mission achievement. Drucker’s logic is supported by the 25-year track record of the world’s first Drucker pension organisation – the Ontario Teachers’ Pension Plan (OTTP).
Steadfast adherence to the three Drucker effectiveness rules has placed OTPP first in long-term value-for-money rankings in the delivery of both investment management and benefit administration services. A key success factor was an early decision to insource most investment management, including on the private markets side. This proven ‘maple leaf’ success driver was emulated first by other Canadian pension organisations, and more recently by thought-leading pension organisations around the world.
Among attendees there were three ‘yes, but’ responses to the Drucker’s organisational effectiveness message:
• We have governance problems because our board of trustee selection process is dysfunctional;
• We are forced to outsource because we cannot pay private markets people inside our organisation sufficiently to be competitive; and
• We are forced to outsource because we do not have sufficient scale to insource.
These are indeed serious organisational effectiveness impediments. On the brighter side, fixing problems requires first understanding what they are. There are good strategies for making dysfunctional board selection processes functional. There is good information to assess the multi-billion dollar pension delivery costs of artificial compensation constraints, and of the absence of scale economies. What is often lacking is the requisite courage to be the missing change agent.
The intellectual foundations for wealth-producing investing were laid out in the 1930s. Benjamin Graham and David Dodd published Security Analysis in 1932 and John Maynard Keynes’ The General Theory of Employment, Interest, and Money, including the famous chapter 12, appeared in 1936. Together, these provided both a normative theory of investing for the long term, and a colourful description of the institutional challenges involved in applying the theory. Unsurprisingly, early adopters have outperformed, and continue to outperform market indexes by material amounts. For example, my book documents the extraordinary track records of long-term investor Keynes himself, of Warren Buffett, and of Yale’s David Swenson. In contrast, conventional active management is inherently dysfunctional, with institutional investors trading for short-term gains with each other in what is a zero-sum game. The costs of playing borne by clients.
However, an important institutional shift towards long-termism has commenced. The pioneering role of OTPP has already been mentioned. The 2008-09 global financial crisis was a catalyst. Today, organisations such as Principles for Responsible Investing (PRI), Focusing Capital on the Long-Term (FCLT), the CFA Institute, and the International Centre for Pension Management (ICPM) are impacting institutional investment behaviour. At the same time, organisations such as the Financial Stability Board (FSB), the International Integrated Reporting Council (IIRC), the Sustainable Accounting Standards Board (SASB), and CEM Benchmarking, are rewriting the book on corporate and investing performance reporting.
Once again, most of the investment conversations were about a move from saying to doing. It is one thing to ‘get’ the long-termism message; it is another to change short-term investment conventions that may have been in place for decades. The cultures and skill sets of investors who think like business owners, and those that try and outwit the competition in an ongoing series of one-year trading cycles are very different. Also, organisational change requires that boards of trustees understand this difference, and its implications for investment policies, mandates, and people. I have noted above that this is easier said than done.
In conclusion, the typical opener in 100 book tour conversations was some version of ‘I agree with you, but how do we get from here to there?’. The book does not offer easy answers, but it asserts it is the right question. In the end, addressing it is a question of leadership. Let’s get on with it.
Keith Ambachtsheer is director emeritus of the International Centre for Pension Management at the Rotman School of Management, University of Toronto and the president of KPA Advisory Services