Keith Ambachtsheer provides strategic advice to a global list of major pension funds, including many large Australian funds (among them are the Future Fund, Australian Super, QSuper, Queensland Investment Corporation and Sunsuper). He publishes the well-known monthly, The Ambachtsheer Letter, and is Editor of the Rotman International Journal of Pension Management. He was recently voted by Asset International Magazine as one of the Top 10 most influential academics in the institutional investing world.
He especially focusses on whose interest pension assets should be managed for, and how do we design pension arrangements that are sustainable. He runs a week-long, international education programme for pension fund trustees which many Australians have attended. "Trustees are usually appointed because they represent a group — a union or an employer for example. The challenge is figuring out how to get higher level oversight skills into pension fund boardrooms without giving up on the legitimacy that representativeness brings," Ambachtsheer says.
I met with Keith Ambachtsheer at the Research Affiliates’ Advisory Panel meeting in San Diego on 28 April 2013.
Graham Hand: Keith, how does your advisory service work?
KA: I write four pages a month in The Ambachtsheer Letter. It’s a simple retainer system, I’ve got a bunch of clients in Australia, they have a call option to speak to me. And I work on specific projects for various clients.
GH: They call you to chat about issues they’re working on?
KA: I might get involved in a board meeting, strategic planning, a second opinion. I cut it off a half a day a year per client, but then something bigger comes up. The Future Fund asked me to do an assessment of compensation practices of major pension funds around the world, and I thought, that’s a big piece of business. Turned out to be very interesting. In another assignment, Finland asked me and Nick Barr from the London School of Economics for an assessment of the Finnish pension system. Nick did the macro design side, I did more the institutional structure side, and we did a formal launch of the study in Helsinki. It was a major media result.
GH: I was interested in your comments on the fiduciary responsibilities of trustees of pensions funds, and I’ve never heard said before if a trustee believes a certain form of managing money is not the best or most efficient, they have a responsibility not to use it. Such as if they have a view on active versus passive management.
KA: Right. Well, the other thing I do is I’m the academic director for a board of ethics programme at the Rotman School of Management where we take trustees, bring them into the programme on a Monday morning and send them out transformed by Friday afternoon. We discuss the evolution of fiduciary duty going back to Harvard College v Amory in 1860. Fiduciaries have a legal obligation to be up to date, and to know the best thinking, and this has significant consequences for how you should select trustees of pension funds. Not everyone is capable.
GH: This must be an issue for some of your clients in Australia, they often appoint trustees who have no finance or wealth industry background.
KA: We’ve run a Board Effectiveness Programme three times now, we’ve had half the Sunsuper Board go through the programme, and half the QSuper Board, and some of the APRA regulators. It’s an ongoing debate. We have leading scholars who basically say here’s what I think if I were giving expert testimony in a court case tomorrow, this is what I would say. And a lot of that is how to spend your beneficiaries' money on investments; you have a fiduciary duty. Not to do it directly, you don’t want boards micro managing, you want them to bring in a skilled executive group who can implement a strategic plan, but you have to be capable of looking at the strategic plan.
GH: Given what we do know about active management, as Burt Malkiel has said, that it adds costs to the system and the average active manager does not outperform, does the fiduciary duty create issues if you feel strongly about that?
KA: Here’s the Ontario Teacher’s story. We set the whole thing up according to Drucker’s five principles, and the Board hired a really good executive team, highly experienced CEO and CIO, and they had a view about what investing meant, and it was quite different from what Keynes called ‘beauty contest investing’, where managers are just trading against each other. That’s a loser’s game, and we don’t play a loser’s game. Right away, that was never part of the equation, that traditional view of active management because frankly it’s dumb. So what do you do instead? Well, for much lower cost than outsourcing, you have to hire people who are capable of understanding and creating deals. But then you have expensive people on your staff, and the way a lot of funds are structured, they are not allowed to do that. But it’s like tying an arm behind your back.
Active management in the public space means taking major positions in corporations and being proactive in how well they are being managed. One classic Ontario Teacher’s story is they bought Maple Leaf Sports Enterprises in 1998 for $150 million, and sold it earlier this year for $1.2 billion. And so they were involved in adding value as owners, not as managers.
In 1995, they were heavily invested in non-marketable government debentures, but they decided they had to be in real estate. Again, they didn’t want to go into third-party funds paying fees, so they ended up taking the largest publicly-traded real estate company on the exchange private.
GH: They just bought it?
KA: See, it’s a completely different way of thinking about creating value.
GH: You also encourage trustees, where they own publicly-listed companies, to be active in an owner’s right to influence management.
KA: That’s what active management means. It means being concerned and engaged owners that do what it takes, either on their own or collectively with other funds.
GH: Including meeting personally with the CEO and expressing disquiet about the way a company is run?
KA: It definitely means that. Another important dimension of running a balance sheet is risk, so they reviewed the notion of tracking error, and decided it was useless. What matters is your asset exposure in relation to your liabilities, it’s entirely possible to have an asset portfolio with significant tracking error against some index, but against your liabilities, there is less risk.
GH: And not much comfort that you have a low tracking error when the market is down 20%?
KA: It’s doing smart things by understanding the business you are running. The way to get people’s attention is to bring a law suit against people who do things to protect their own agency risk. You need to wake people up to their responsibilities.
GH: How are regulators affecting global pension funds at the moment?
KA: In Europe especially, the notion of a standard approach to balance sheet management of financial intermediaries is rising. How do you create a set of rules so that the balance sheets support their liabilities, what do we need to do with the capital adequacy rules to ensure we don’t have another financial crisis? But there’s a big push back because most pension funds don’t have surpluses. Pension funds can do some guaranteeing of specific products, but guaranteeing all their liabilities means they must have adequate assets to make the payments, which they don’t. And based on demographics, many will have to stop doing guarantees. In Australia, you’re coming at it the other way, where most of the super funds don’t have guarantees, but there should be an ability to buy longevity risk products.
GH: But whose balance sheet will that be on?
KA: The reality is anyone with a DB arrangement is taking that risk, so it’s not like it doesn’t exist. There needs to be a sensible discussion about should we leave investors on their own or should we create some type of organised accumulation facility which offers longevity protection. People need it. That’s where the leading super funds will go, they will create this facility.
GH: How do you feel about lifecycle funds and alternative financial planning models?
KA: A lifecycle is reality, people have three phases in their financial lives: pre work, work and post work. Part of your work phase is to accumulate enough savings to finance your post work, and designing the system on an age-related basis helps people on that journey. People want a return-seeking and income-seeking (or payment-certainty) component, and they need both.
GH: But what do you do if there is a switch to bonds when they are yielding less than 1%, people don’t have the income they need?
KA: Right, it’s a very high cost to pay for payment certainty. For me, this is one of the value adds of a well-designed super fund. You have a standard default model which in normal times, whatever they are, you have this defined flight path, but then the organisation, given what it sees in its investment options, has to find better returns. There are assets with current yields over 4% instead of 2%, such as Johnson & Johnson, Proctor & Gamble, AT&T. The fund has not only the opportunity but the obligation to adjust the flight path to say, “These are not normal times, we’re not doing our people any favours buying annuities at 2% when we think somewhere down the road it’s going to be 4%.” Now you’re into judgements, which you need to document very carefully, since there’s the exposure risk that you deviated from your flight path and your expectations may not work out.
GH: You’re headed into Tactical Asset Allocation, because you’ve said these returns are not acceptable and we have to find something that is. You might have not wanted to do it.
KA: If tactical means trying to pick off things week to week, I’m not there. Going back to around 2000, government bonds offered real returns of 4% and the stock market was at 1%, but now, the balance is so much in favour of the series of equity cash flows. So there are times when you need to adjust the process, but these are more decade to decade.
GH: And the dilemma for a trustee is you’re putting a 60-year-old into more equities and you prefer not to.
KA: Well, people need to be able to buy the basics and you’re faced with a situation where people still need income to keep body and soul together. So that’s why we have social security as well. The question is, on top of that, how much more do you want to be really sure, and how much are you willing to take some flexibility that may not be for sure but the odds favour a return-seeking option.
You still need income when you’re 85. The idea of buying an annuity at 2% for 25 years is a problem, that’s the arithmetic. To what extent can you put yourself into the position of deciding what your clients would do, because you’re deciding that each one of your 50,000 clients has exposure to this return-seeking model. It’s better to have an organisation looking after an 85-year-old than having people look after themselves.