Pension Governance Today: Strengths, Weaknesses, and ...

Pension GovernanceToday: Strengths,Weaknesses, andOpportunities forImprovementA Research Report Presented ByKeith Ambachtsheer, Rotman ICPMRonald Capelle, Capelle Associates Inc.Hubert Lum, CEM Benchmarking Inc.October 2006

Why This Study Now?• Spotlight has been on corporategovernance• Now turning toward pension fundgovernance• Little has been published to date onpension fund governance

Prior Published Studies• 1992: O’Barr and Conley• 1998: Ambachtsheer, Capelle, Scheibelhut• 2006: Clark, Caerlewy-Smith, Marshall

Research Design: Funds• Senior executives from 81 pension funds forwhich CEM Benchmarking Inc. hadperformance data• Aggregate assets of these pension fundswas $1.4 trillion dollars at end of 2004

Characteristics of the RespondingPension Funds at December 31, 2004RegionAustralia / New ZealandCanadaEuropeUnited States% (EW) *4%41%11%44%% (DW) **1%13%32%54%Sponsor TypeCorporatePublic SectorOther% (EW) *38%41%21%% (DW) **14%66%20%SizeBillions of $USD* Equal-weighted ** Dollar-weightedMedian$3.7BMean$17.9 B

Research Design: Survey• Part I – 45 statements• Aspects of oversight, management and operations• Ranked on a 6 (most positive) to 1 (least positive) scale• Averaged to create a single ‘CEO’ score• Part II – 2 Open Ended Questions• Question#1 – key oversight challenges (63 responded)• Question#2 – key management challenges (60 responded)• Summarized by question• Results were compared to the 1997 surveycompleted by 80 fund executives (using thesame 45 statements)

Pension Fund Oversight andManagement: What Really Matters?What are the more important oversight issues?Agency / context issuesGovernance effectiveness issuesInvestment beliefs / risk management issuesProportionof Responses44%36%20%What are the more important management issues?Strategic planning / management effectivenessAgency / context issuesInvestment beliefs / risk management issues73%15%12%

Pension Fund Governance andManagement: Specific Challenges• Agency / context issues• Balancing stakeholder interests• Understanding the legal / regulatoryenvironment• Oversight effectiveness issues• Appropriate skill / knowledge set for the Board• Clear delegation to management

Pension Fund Governance andManagement: Specific Challenges (cont’d)• Investment beliefs / risk management issues• Understanding context-based risk and its management• Informed ‘investment beliefs’ and their relevance• Shift to risk budget-based investment process• Strategic planning / management effectivenessissues• Resource planning, organization design, andcompensation• Clear delegation from the Board• Effective IT-based implementation systems

CEO Score Highlights• CEO attention has shifted from operationalto management themes• Board competency, board delegationand compensation levels representpersistent problems• Positive association between performanceand governance clustered around theyears in which CEO Score was measured• Quality of governance varied over time

Relative Frequency of CEO Scores 1997 versus2005. Everyone Above Average All the Time40.0%% Relative Frequency30.0%20.0%10.0%0.0%≤3.5 >3.5≤4.0 >4.0≤4.5 >4.5≤5.0 >5.0≤5.5 >5.5≤6.019 9 7 3.8% 7.5% 20.0% 27.5% 28.8% 12.5%2005 2.5% 9.9% 11.1% 28.4% 25.9% 22.2%CEO Score1997 CEO Scores 2005 CEO Scoresmean 4.8 4.9std deviation 0.6 0.7

Six Highest Scoring Statements in 1997and 2005 Show Shift in FocusRanking19972005Ranking1I can describe our mission.*I can describe our mission.*12Superior investment performancereduces future contributions.I ensure the setting of appropriateand understandable performancestandards for our investmentmanagers.*23Our board of governors does agood job representing theinterests of plan stakeholders.I can describe our values.*34I ensure the setting of appropriateand understandable performancestandards for our investmentmanagers.*I can describe our fund’s strategicpositioning.45Employee sub-par performance isunacceptable in our organization.There is a high level of trust betweenthe board of governors andmanagement.56I ensure the setting of appropriateand understandable values andethics for employees.*Developing our investment policyrequired considerable effort andrepresents our best thinking.6

Six Lowest Scoring Statements in 1997 and2005 Show Persistent ProblemsRanking19972005Ranking40Compensation levels in ourorganization are competitive.Compensation levels in ourorganization are competitive.4041My board of governors does notspend time assessing individualinvestment managers orinvestments.My board of governors does notspend time assessing individualinvestment managers orinvestments.4142My board of governors examine andimprove their effectiveness on aregular basis.My board of governors examine andimprove their effectiveness on aregular basis.4243Our fund has an effective processfor selecting, developing, andterminating members of the boardof governors.I have the authority to retain andterminate investment managers.4344I have the authority to retain andterminate investment managers.Our fund has an effective processfor selecting, developing, andterminating members of the boardof governors.4445Performance-based compensation isan important component of ourorganization design.Performance-based compensation isan important component of ourorganization design.45

Six Statements with the Largest ScoreChangesRanking123456StatementI have clearly-written documents describing our mission,vision, values, strategic positioning, and operations andresource plans.My board of governors examine and improve their owneffectiveness on a regular basis.Superior investment performance reduces futurecontributions.I can describe our operational plan relating to what we aregoing to accomplish in terms of quality, quantity, timeliness,and resource requirements.Employee turnover is low.Compensation levels in our organization are competitive.ScoreChange+ 0.55+ 0.54-0.53+ 0.53+ 0.43+0.42

Positive Association Between Governance andPerformance Near Years CEO Score MeasuredFour-Year NVA Performance vs 1997Pension CEO Scores Co-efficientsFour-Year NVA Performance vs 2005Pension CEO Scores Co-efficientsNVA-CEO Co-efficient+0.8+0.6+0.4+0.2+0.0-0.21997CEOScoresNVA-CEO Co-efficient+0.8+0.6+0.4+0.2+0.0-0.22005CEOScores-0.41997 CEO Score vsNVA Co-efficient95 96 97 98 99 00 01 02 03 04 050.3 0.2 0.4 0.3 0.4 0.1 -0.1 0.1 0.1 0.3T-Values 1.3 0.8 2.0 1.3 1.4 0.4 -0.4 0.2 0.2 1.0Last Year of 4-Year PeriodNANA-0.42005 CEO Score vsNVA Co-efficient95 96 97 98 99 00 01 02 03 04 05-0.5 -0.3 -0.1 0.0 -0.2 0.3 0.4 0.6 0.8 0.4 NAT-Values -1.4 -1.2 -0.7 0.0 -0.4 0.9 1.5 2.8 2.7 1.9Last Year of 4-Year PeriodNA

Quality of Governance Varied overTime• 35% of funds responded to both the 1997and 2005 governance survey• Mean and variance of CEO Scores forrepeat participants was similar to thelarger group in 1997 and 2005• Correlation of 1997 and 2005 CEO Scoresfor the repeat participants was low at 49%

Oversight / Management Costs vs.CEO Scores• Statistically significant positive relationship• At the $10B fund level, high-scoring fundsspent an average $4M per annum moreon oversight / management costs thanlow-scoring funds.

Pension Fund Governance: Strengths• High levels of dedication and trust• Strategic planning being formalized• Increased emphasis on resource planning,organization design, and compensationpolicies

Pension Fund Governance:Weaknesses• Board member selection processes• Board effectiveness evaluation processes• Board micro-management• Undue compensation constraints

Opportunities for Improvement• Remove ‘competing financial interests’problem• Construct ideal board compositiontemplates• Initiate board self-evaluation processes• Clarify board-executive roles• Address HR competitiveness issue

Future Research Activities• Legislative / regulatory roles in improvingpension fund governance?• Standardized risk-adjustment of returns?• Linkages between corporate governanceand pension fund governance?• Case studies?