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Über dieses Buch

More than 80% of the financial assets in the United States fall under the purview of a trustee. That's a big responsibility for an estimated 1% (around 1.5 million people) of the U.S. working population charged with overseeing investments for millions and millions of beneficiaries, public sector, and non-profit organizations. In a world proliferated by investment products, increasingly dominated by indexes, faced—particularly in the pension world—with increasing liabilities, more regulation, and a growing number of social and sustainability objectives, what's a trustee to do?

The Trustee Governance Guide is here to help guide today’s board trustee through the brave new world of 21st century investing. The book focuses on the critical aspects of the Five Imperatives: Governance, Knowledge, Diversification, Discipline, and Impact.

Based on more than a decade of research, practice, and discussions with many key decision makers and influencers across the industry, this book addresses the many topics related to better governance, greater mission-driven financial performance, and impact. The questions the book addresses include:

· What is good governance, how do we know it when we see it, and why does it matter?

· How much knowledge is necessary to be a competent board member?

· How big should my endowment be?

· What are the key elements of a diversified portfolio?

· How much does cost matter?

· What's the difference between socially responsible and ESG investing?

· Can I focus on sustainability and still be a good fiduciary?

This book provides a way for boards to improve and benchmark their own governance performance alongside their peers, and uniquely covers related investment topics in each chapter.

Inhaltsverzeichnis

Frontmatter

1. Introduction

Abstract
A fiduciary is anyone who is placed in a position of trust by another. Fiduciary duty is what has held civilization together since the beginning of human history. Our lives are better off for it, and we see examples of it everywhere we go: of the duty of parent to child, spouse to spouse, and often later in life, child to parent; doctor to patient, policymaker to constituent, manager to stockholder; and the list goes on. Trustees on an investment board also have a fiduciary duty to beneficiaries or donors. Like other types of fiduciaries, they are entrusted to act in others’ interests, and not their own. Fiduciary duty is at the heart of this book.
The goal of this book is to put our work and findings in the hands of the practitioner. In making this guidebook a practical guide, we have structured this book to address the five most critical areas facing every organization with an investment mandate. Each area has several sub-topics related to it, including more technical sections for investment professionals (practitioner focus). By the end of the book, we want this to be something that each trustee can take back to their boards and begin incorporating into regular practice and use to ultimately more effectively fulfill their fiduciary duty.
Christopher K. Merker, Sarah W. Peck

The First Imperative: Be Well-Governed

Frontmatter

2. Crisis

Abstract
Our initial study focused on the five years around the global financial crisis (GFC) period: the lead up, the crisis itself, the aftermath, and recovery. The year 2008 was the second worst year in the markets over the past century, with only 1932 being worse, when the world was in the grip of the Great Depression. We hypothesized that stronger forms of governance would win the day, and those organizations would weather the storm better than those with weaker forms of governance. Our findings support that governance is highly relevant in driving financial outcomes. Some organizations do exceptionally well, but most, about 60%, do at or below the average. For our study period, the top end of the scale was 15% annualized returns and the bottom, −4.5%. In dollar terms there was a vast difference: approximately $1.6 billion per year on average.
Besides such financial impacts, governance also keeps the organization in line and conforming to norms, that is, no criminal acts, no self-dealing, no pay-to-play, and so on. We analyzed 2500 litigation cases over the five-year period to come up with a legal index of performance, and the first complete taxonomy of litigation case types in the public pension world, ranging from minor denial of benefits cases to Securities and Exchange Commission Cease and Desist orders.
Christopher K. Merker, Sarah W. Peck

3. Fiduciary Duty

Abstract
The discharged duty of the fiduciary may be considered the overarching exhortation that demands good governance. The concept of fiduciary duty finds its sources in Roman law. The word “fiduciary” comes from the Latin fiducia, which refers to the transfer of a right to a person, who receives it, subject to an obligation to transfer it again at a future time or upon the fulfillment of a certain condition. This evokes the modern-day idea of a trust or of an asset held in escrow. Fiduciary duty represents a “cluster of obligations” owed by one person, the “trustee” or “fiduciary” toward another, the “cestui” or “beneficiary”, regarding an identified subject matter, which is referred to as the “res” or “subject of the trust”.
We have come a long way from the days of the legal interpretation of the Prudent Man Rule. The development of modern portfolio theory pushed the legal definition further. Codified in Employee Retirement Income Security Act (ERISA) for corporate pensions, and in the Uniform Prudent Management of Institutional Funds Act for endowments and foundations, institutional investors now have full latitude over their investments.
Christopher K. Merker, Sarah W. Peck

4. Good Governance

Abstract
Group effectiveness is a topic of ongoing interest in the management field. How effective organizations operate, ranging from small teams to large corporations, is a field of inquiry that is virtually endless in its theories and case examinations. Within this broad field of research, we have homed in on the boards responsible for the management of large pools of financial assets. The record of effectiveness of these groups is mixed. What is it about these groups, and the individuals that comprise them, that can drive such wide-ranging results? The answer lies in how these groups organize (governance structure), the people that reside on the boards and committees of these organizations (human factors), and how they interact with each other and the consultants, other service providers, and the money managers with whom they work (group processes).
For governance improvement, there are a number of instruments in the market to perform board self-assessments. Once a board goes through a baseline evaluation a board can then engage in a deeper self-assessment with board members and senior staff that reviews additional topics, which, using other board self-assessment tools, can include further analysis of board structure, board and organizational culture, board responsibilities, and board process. Making board governance assessment a standing item for annual review helps the organization identify areas for training and development and track improvements over time, and allows the setting of new goals for the coming year.
Christopher K. Merker, Sarah W. Peck

The Second Imperative: Be Knowledgeable and Beware of Common Errors

Frontmatter

5. Human Error and Behavioral Finance

Abstract
What is human error? Human error means that something has been done that was “not intended by the actor; not desired by a set of rules or an external observer; or that led the task or system outside its acceptable limits”. In short, it is a deviation from intention, expectation, or desirability. Logically, human actions can fail to achieve their goal in two different ways: the actions can go as planned, but the plan can be inadequate, leading to mistakes; or the plan can be satisfactory, but the performance can be deficient, leading to slips and lapses. However, a mere failure is not an error if there had been no plan to accomplish anything in particular.
Behavioral finance has changed the way we fundamentally view the investor. It has effectively challenged the rational expectations model of neoclassical economics. The theory asserts that people are not walking calculators, seeking optimality at every given point, but rather they are emotional decision-makers that are often lazy, rushed, or pressured, and therefore seemed doomed to repeat the same errors over and over. Behavioral finance holds that investors tend to fall into predictable patterns of destructive behavior. In other words, they make the same mistakes repeatedly. Specifically, many investors damage their portfolios by under-diversifying; trading frequently; following the herd; favoring the familiar (domestic stocks, company stock, and glamour stocks); selling winning positions and holding on to losing positions (disposition effect); and succumbing to optimism, short-term thinking, and overconfidence (self-attribution bias).
Christopher K. Merker, Sarah W. Peck

6. Knowledge Not Just for Knowledge’s Sake

Abstract
Board knowledge is a key component to successful investing. The extent of mandated trustee training on investments varies across public plans, endowments, and trusts. In our pension plan study, we found that the most effective organizations had high participation rates among both the audit and investment committees. To be effective, those organizations needed members who demonstrated both engagement and an adequate base of financial literacy.
However, the general lack of education to promote financial literacy is a significant and widespread problem and not just in the public pension plan world. In the “Retirement Income Literacy Survey” conducted for The American College of Financial Services in 2014, 80% of the respondents received scores of 60 or lower on financial questions about retirement. Just 20% received what amounted to a passing grade (https://​retirement.​theamericancolle​ge.​edu/​research/​ricp-retirement-income-literacy-survey). The results are just as dismal when it comes to general financial knowledge. Asked five multiple-choice questions about topics like interest calculations, mortgage payments and investments, just 39% of the 25,509 adults surveyed answered at least four correctly, according to a 2012 survey from the FINRA Investor Education Foundation (http://​www.​usfinancialcapab​ility.​org). That was down from 42% in 2009. Many boards, as has been studied and documented, are held back by insufficient knowledge of its members.
Christopher K. Merker, Sarah W. Peck

7. Origins of Financial Illiteracy

Abstract
Is financial literacy important to competent board decision-making? The short answer is, of course, yes. There are many and frequent trustee educational conferences to help trustees make informed decisions. In attending these conferences, many attendees often feel overwhelmed and embarrassed by their lack of investment knowledge. They should not be. Financial illiteracy is widespread and seen everywhere in the US. Whether it is the low savings rates among aggregate American households, chronically underfunded state and municipal pension systems, or even the federal government’s ongoing tolerance for large budget deficits even in good times, when tax receipts are higher, and public funding needs are less (i.e., for unemployment insurance). Beyond effective board governance, the implications are severe for a society whose citizenry cannot function effectively when making decisions about credit, consumption, saving, and investing. So, why isn’t the US population financially literate? Financial literacy has strong implications for effective board governance. For the 1.6% of the population that make up the fiduciaries and trustees responsible for 80% of the investments made in the US across the many pensions, endowments, and foundations, these people must have the sufficient skills and diligence to at a minimum find and retain the expertise around them to be most effective.
Christopher K. Merker, Sarah W. Peck

The Third Imperative: Be Diversified

Frontmatter

8. 30,000 Products

Abstract
Diversification, as a principle of risk reduction, is an old concept. To attach a date to it, we would have to go back several hundred years in history. For today’s modern board, however, it is a must. The challenge in today’s world is not whether to diversify but rather where to stop with it. Options for portfolio selection are almost limitless, and certainly not all options are of equal value or merit.
There are approximately 100,000 publicly traded stocks globally, and a similar number of corporate bonds. In the sovereign and municipal fixed-income universe, there are over one million unique issues trading in the market. And, of course, the mutual funds, exchange-traded funds, and hedge funds that slice and dice, and re-slice and re-dice this group of stocks and bonds, are in excess of 30,000 products. And just like restaurants in New York City, there are dozens opening and closing every day. Understanding the historical development and role that diversification plays in today’s modern financial markets is important for executing a trustee’s fiduciary duty effectively.
Christopher K. Merker, Sarah W. Peck

9. Theory Time

Abstract
The big boon to modern diversification was not just structural in nature with the introduction of the open-end mutual fund; it was also theoretical. In 1952, a young Ph.D. student at the University of Chicago, Harry Markowitz, published a groundbreaking paper, “Portfolio Selection” (Markowitz, Harry, “Portfolio Selection”, Journal of Finance, Volume 7, Issue 1, March 1952, pp. 77–91). Markowitz had chosen to apply mathematics to the analysis of the stock market as the topic for his dissertation. So, Markowitz took a simple concept—“don’t put all your eggs in one basket”—and demonstrated how even the addition of a high beta asset (a more volatile, higher-risk stock) could bring down overall portfolio risk through lower correlation across the asset mix. In retrospect, this was no easy task: How could higher-risk assets reduce overall portfolio risk? In itself, the concept is counterintuitive. The trick was balance within the overall portfolio.
The practical application of theory, combined with goal setting, is an important function of the board. How much do we need and when? The simple approach discussed in this chapter for asset allocation allows the organization to set reasonable goals, ensure enough cash flow, and balance risk with return. It should be revisited regularly, however, as capital market assumptions will change, as will the internal needs of the organization.
Christopher K. Merker, Sarah W. Peck

10. Over-Diversification

Abstract
The old saying, “too much of a good thing…” So, it is with diversification. The question is how much is too much? Peter Lynch, in his book One Up on Wall Street, coined the term “diworsification” to describe a company-specific problem: companies investing in areas that were noncore businesses “to diversify” the risk of those businesses. As he, and many others successfully argued, this approach of the 1970s and 1980s conglomerate just made for inefficient companies. They questioned why companies should diversify their investments, when shareholders and investors can do it themselves by diversifying their own portfolios.
The logic holds, but a problem emerges when the portfolio is chopped up, so much so, that it too has become “diworsified”. That is a good place for us to begin, with the question, why don’t investors simply hold the market portfolio, and by market, we mean virtually a piece of every asset in the entire world. The first reason you do not is because you have now become the owner of the best and worst performing assets in equal measure. This is a sure-fire way toward mediocre returns in the portfolio.
Christopher K. Merker, Sarah W. Peck

The Fourth Imperative: Be Disciplined and Control Costs

Frontmatter

11. The Active Versus Passive Debate

Abstract
In 2018, Vanguard group passed the $5 trillion mark in assets under management, closing in on BlackRock, the largest with $6 trillion. It was also the fastest growing manager. Question: How does the largest index fund manager get this big and add $368 billion in a single year? (Flood, Chris, “Vanguard retains title as world’s fastest-growing asset manager”, Financial Times, Jan. 4, 2018) Answer: Investors’ insatiable desire for cheap, index investing.
The Active versus Passive debate has been raging since the 1970s, and lately the Passive side has been winning, and winning big, with now nearly half of all US equities in some form of index fund (Merker, Christopher, “Investing: Past, Present and Future”, CFA Enterprising Investor, April 25, 2018). A market that has done nothing but gone straight up since the global financial crisis in 2008 has helped. The argument for passive investing is admittedly compelling in the sense that the fees for active managers can automatically detract from the performance of the fund, and therefore the “alpha” or outperformance of the fund must not only exceed a given benchmark, but a benchmark net of the fee. From there they simply point to the performance track record of managers, showing that many fail to beat the market, or at least beat it consistently. From where did this argument emerge? What are the theoretical underpinnings to it? Since when did beating the market become the mantra?
Christopher K. Merker, Sarah W. Peck

12. Active Versus Passive: The Evidence

Abstract
The Efficient Markets Hypothesis predicts that in markets where information is readily available and widely known there are less likely to be profitable opportunities for stock pickers or active managers. In these markets, it makes more sense to use passive investments and forgo the higher fees of active managers. Correspondingly in markets where there is both less quantity and quality of information there will be profitable opportunities for talented stock pickers to buy and sell mis-priced stocks. In these markets, active managers can be well worth their fees.
We examine the Active versus Passive debate himself with an empirical study. We approach this research with the belief that certain segments of the market are highly efficient, especially for large corporate stocks, and should be indexed as cheaply as possible, while others are highly inefficient, such as the municipal bond market. A hybrid approach is recommended utilizing both active and passive investments.
Christopher K. Merker, Sarah W. Peck

13. Cost Savings and What Really Matters

Abstract
In the department of “not seeing the forest for the trees”, something very odd happened a number of years ago to our investment culture despite good research on the topic. In 1986, Gary P. Brinson, L. Randolph Hood, and Gilbert L. Beebower (BHB) published a paper in the Financial Analyst Journal entitled “Determinants of Portfolio Performance”. They sought to explain the effect of asset allocation policy on pension plan returns, a topic that had largely been unexplored up to that point. BHB asserted that asset allocation is the primary determinant of a portfolio’s return variability, with security selection and market timing (together, active management) playing minor roles. According to their findings, asset allocation explained the variation in a portfolio’s quarterly returns more than 90% of the time.
So, why is this important? Follow us through this string of logic. If we tell you that one course of action will drive more than 90% of the result, and two other courses of action combined will drive less than 10% of the result, where would you spend most of your time? The answer should be obvious. The question then is, why do boards spend so much time on manager selection and so little time on asset allocation?
Christopher K. Merker, Sarah W. Peck

The Fifth Imperative: Be Impactful

Frontmatter

14. Farewell to Uncle Milt

Abstract
Though socially responsible investing (SRI) has been around for as long as portfolio diversification, if not longer, its widespread and transformative effect on investing culture did not begin to take hold until the better part of the last decade. Philanthropy was certainly not known for being a profitable area of activity, and the great monetarist and libertarian, Milton Friedman, provided a widely accepted basis that the costs for corporations, who spent time worried about anything beyond earning a return to their stockholders, would exceed the benefits.
The main reason why Friedman’s earlier view has been successfully challenged is because environmental, social, and governance (ESG) factors in investing is not about philanthropy but about risk management. Investors seeking to manage risks and profitability in the long run also should be concerned about ESG factors. So, why is the integration of ESG into investment analysis important for the reduction of risk? First, we need to only look back at the corporate governance failures of the late 1990s and later 2000s in the financial sector to understand how crucial good corporate governance is to avoiding financial disaster. The Enrons, WorldComs, AIGs, and Lehman Bros. of the world stand out as embodiments of what can go wrong on a massive scale as a direct result of corporate governance failures. Research has found links between corporate governance, social responsibility, environmental and financial performance.
Christopher K. Merker, Sarah W. Peck

15. ESG Challenges

Abstract
When we began teaching sustainable finance at Marquette University more than a decade ago, environmental, social, and governance (ESG) investing and socially responsible investing were still backwaters. A lot, as we talked about in the last chapter, has changed even over the recent years. However, the increasing adoption and application of these types of investing criteria conceal some underlying challenges. Despite the rapid growth of ESG funds across several measures, we still see four main obstacles to ESG investing’s continuing emergence. In this chapter we outline these challenges and chart the progress toward potential solutions.
Christopher K. Merker, Sarah W. Peck

16. OK, We’ve Bought In…Now What?

Abstract
So, let us say for a moment the board has bought in to the fifth imperative, “Be Impactful”, and the board now wants to retool your organization’s portfolio to start heading down this path. What do you do and what resources are available? First, the board will need to decide whether you are about sustainability or you have more stringent requirements. Are there certain values, beliefs, or principles held by your organization that need to be expressed in the portfolio?
This process, once established, requires ongoing quarterly review and reporting. It also requires a rewrite to the investment policy statement. There may be additional consideration given to how the portfolio and mission of the organization are supporting the United Nations’ Sustainable Development Goals. More information on these goals, organizations, and principles is provided in the chapter.
Christopher K. Merker, Sarah W. Peck

Backmatter

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