Barnaby Nelson: So it’s great to have everyone back together this week in the second episode of our podcast series, focusing on change and unintended consequences.
So, Christine and Ryan, it’s fantastic to have you both back from Citisoft and RBC; and for us to be joined by Randy McGathey from the Milestone Group today, who has extensive experience in the North American space, especially with asset owners. And you’re the proud author, I would say, Randy, of the asset allocators report from 2020, which I’m sure will come in very handy today.
So, thank you all very much for joining us again.
Randy McGathey: Pleasure to be here.
Ryan Silva: Thanks for having us.
Christine Knott: Nice to be here.
Barnaby Nelson: So last week we talked about kind of today’s operating model—spreadsheets, their role, good and bad, in supporting asset allocators in particular around the world. We talked about thresholds, we talked about the limits of spreadsheets, we talked about governance, and we also talked about the risk of that kind of post-Excel bounceback as a bit of a challenge that we all face.
So now that we’ve described the baseline, today we’re going to talk about the external pressures that are impacting that operating model today, so, what’s driving change at a boardroom level; what are the macro considerations, in particular, regulatory and others; and really, what are the unintended consequences of some of the actions that we’re seeing in the market today.
So to kick us off, just to give a quick, broad view of basically what the regulatory and pressures landscape looks like around the world, not surprisingly, it depends very much on where you are. At one end of the spectrum is Australia and, increasingly, South Africa, where the pressures for change are really very strongly felt, most acutely felt in the world, and those pressures are really driven very strongly by an increasing amount of regulatory enforcement.
At the other end of the scale, North American asset owners who feel significantly less pressure to change—roughly 3.5 out of 5 on our scale—driven mainly by internal considerations around risk optimization and kind of their own efficiencies.
In the middle, you’ve got the Europeans, not only geographically, but also functionally, who are really stuck in the middle of ESG land; very, very, very strongly focused on governance and sustainability as a massive driver, all the way from the grassroots up.
So it does depend on where you are. But I wanted to maybe, just to kick off, Randy, if I may, with your take on that. That’s the kind of—what I’ve run through is the survey findings. Does that reconcile with your take?
Randy McGathey: It does indeed, Barnaby. You’ve characterized it just right. There is significant external pressure, if you will. In Australia, for example, APRA is urging, shall we say, the superannuation funds to transform with a focus on transparency and delivering optimal outcomes to members. And so, in the context of your framing, the regulatory environment is actually having a significant effect there, and we could talk more about the details.
But contrasted with that would be North America, where I would suggest that sort of the maturity and longevity of ERISA has been sort of well ingrained in the pensions and asset owner market; everyone’s familiar with that, compliant with that.
And so the factors that are sort of driving transformation in North America, if we’re going to put an external framing on it, would be market forces, the seeking better returns; everyone is seeking better returns, but by taking on more complex assets, more advanced investment strategies, and all of the infrastructure and process that’s necessary to support that. So, sort of very different drivers of transformation, I’d say, in those two markets.
Barnaby Nelson: Yeah. Absolutely. And, I mean, one of the other factors that we have and I didn’t really showcase was the scale piece in terms of the size of the asset owner or the pension fund.
Ryan, what’s your take in terms of actually how we’re seeing—is there much diversity in terms of what the big ones are focused on versus the smaller ones?
Ryan Silva: Yeah. So I think, because how they look at their clients, the pensioners, changes. You know, over the last, I’d say, 5-plus years, we’ve seen a few of the asset owner pools consolidate, right? And then you also have plans such as the College of Applied Arts and Technology opening up their plan to asset owner pools that aren’t tied to colleges.
And so it’s about sort of diversifying the liabilities. So I think when we talk about pressures, macro pressures, especially in different regions, I think demographics plays a part, and then the size of the asset pool also plays a part because you’re essentially servicing a bigger underlying base of pensioners. That’s what we’re seeing with our clients.
Barnaby Nelson: Yeah. And, Christine, what do you think from a—obviously, you’re sitting, talking to these board members every day. I mean, are these considerations kind of top-of-mind, particularly in North America, in terms of the whole market forces, the diversification, that kind of thing?
Christine Knott: Yeah. I mean, it’s really interesting. And I agree, Randy, the longitude or the length of time that ERISA has been in place has really made a difference in the U.S. market. In the Canadian market, I think it’s really interesting because, to Ryan’s point, you see different plans doing different things because of what’s happening.
There’s a force, particularly in Ontario right now, for plans to consolidate. So whether that’s the university plan, whether that’s IMCO, all of these other plans that are being pushed in that direction with regards to coming together, I think part of that is the government indicating that there needs to be a better place for the pensioners and the information and being able to have a better management set up so that you’re not dealing with smaller firms and allowing for a broader scale to be able to be leveraged.
And we’ve seen that with the various provinces across the country, whether it’s BC or Quebec, there are these very large plans. They’re not plans, they’re investment management shops who manage the money for plans. And they have the infrastructure, and they’ve got the ability to be able to provide that level of transparency. And I think that’s what people are seeking and really need.
And I think as well—this is going to sound a bit crazy—but we’ve also got the pressure of the new millennials coming into these plans, who effectively want that level of transparency. They want that information. They want to understand. So I think there’s not just pressure from a regulatory perspective, but also bottom-up.
And I see Randy nodding his head. So, do you agree with that, Randy? Am I off base?
Randy McGathey: No. I completely agree with you. And I’m nodding because what you just described very much applies in Australia as well, where APRA is in fact precipitating mergers. They’re seeking size. Superannuation funds are merging in order to create efficiencies of scale and to achieve greater levels of transparency, in fact, is a principal objective there, so that members can clearly understand what it is they’re getting. And then just to have the scale and the means by which to seek and achieve best practices—again, I’m using words that you did—to deliver the best outcomes possible for their members or investors.
So, in the case of what you just described in Canada and in Australia, the regulatory pressures are having closely aligned effects, so.
Barnaby Nelson: Maybe to put that together, ultimately, it’s fascinating because it really means you’ve got two kinds of buckets. You’ve got, basically, a consolidation world, and then you’ve kind of got ERISA land, I suppose, if you wanted to kind of call it that. And I think it’s fascinating because, in the survey, there was a stat that stood out, that Australians are twice as likely to be consolidating as Americans are at a pension fund level. So, ultimately, that spectrum really stands out.
But this whole question of consolidation driving scale and all this kind of stuff, noble objectives at the top end, but presumably, it depends a lot on the way it’s being executed in terms of actually how kind of the people who are driven to consolidate are taken in on this.
How does this play out? Because ultimately, for me, the big guys, as you said, they’re investment management shops, they’re not plans. The smaller guys who are trying to eke out an investment management strategy, trying to, basically, trying to deliver, what’s this kind of forced consolidation doing to them from a mindset perspective? Randy?
Randy McGathey: So there’s some of those distinctions that you just described, and I’m thinking in North America, where some pension plans are investment managers driven largely by their size. I would say the mega plans are, in fact, highly sophisticated and developed. And I mean, I don’t want to sound—whatever I say is going to be understated—but they are investment management firms, they have their own investment operations, and they are, in fact, often creating best practices and the state of the art.
But those that aren’t that big are seeking services as a client, not as an investment management firm. And so, it really is like two separate categories.
Interestingly—and that’s not necessarily the topic of this conversation—but the second of those two groups, I think are sorting out whether or not it makes sense for them to try to become their own—to become an investment management firm, and there are plenty of those. But those that aren’t are deciding, should we seek a buyout firm for our liability? Or should we look to an OCIO and allow that OCIO to create that scalability for us?
Ryan Silva: Something we’ve seen is that, in Canada, out west, there were sort of political incentives for smaller plans to merge into the bigger plans, and on the back of some of the bigger plans having some big losses. And so then it created pause for the smaller plans and the trustees of those smaller plans to say, we have a fiduciary obligation to our pensioners that the super-plans may not be this panacea of sort of just like, give it to them and everything will be amazing. So they have to figure out where those lines exist, where they still have their obligation to their pensioners because that’s one thing they cannot outsource. They can outsource their investment managers, but they cannot outsource, essentially, their obligation and their duty to their pensioners.
So I think we’ve seen some of the smaller plans seriously consider that, especially at the board level, at the trustee level, to make sure that the super-plans are giving them what they need in order to be able to govern and control.
And then, from the super-plans’ perspective, they had to ask themselves, okay, now we suddenly have clients or these pools of assets. And are we going to give them the reporting? Or how do we manage to give them the reporting and meet their needs? And are they okay with our asset allocation? And so on, right? And the different types of products.
So I think there’s still conversation. The liabilities still have to be considered. Because at the end of the day, we have to protect the retirement income of these individuals. And it’ll be interesting.
And I think, especially in Canada, the changing demographic, as our population starts to bring in a lot of immigration—Canada has said that there’s a plan to step up immigration—and we bring in folks that are going to come straight into the workforce, and there’s going to be sort of an influx of folks joining these plans. And what does that mean? As they come from different geographies and different expectations of what their retirement income looks like.
So I think there are a lot of complex forces at a macro level that we’ll be dealing with.
Barnaby Nelson: Yeah. But I think what’s really coming through very strongly is this existential question that regulators are driving now, is are you an investment management shop? Or are you a plan? And ultimately, I think for me, that kind of clarity that’s being driven, as you said, by various provinces in Canada, by APRA, and also, I think, increasingly in South Africa as well, it is a detail question that has many strands attached to it in terms of, as you said, are you fit to be an investment management shop with client service responsibilities and et cetera, et cetera.
And presumably, there must be a large number of organizations that are getting caught in the halfway house between the two, that they’re not just a couple-of-people pension plan nor are they basically a 50-billion pension plan; they’re somewhere in the middle.
I mean, from a North American perspective, for those that aren’t kind of—we talked at the beginning about ERISA being a much more kind of stable background, more of a mature market in the U.S. What are we seeing there in terms of when people aren’t preoccupied with consolidation and this existential question? What are the boardroom conversations going on there?
Randy McGathey: I think it’s about operational transformation, sort of coming back to the home base here, and seeking ways to—well, to both mitigate operating risk as a threat to the plan and its funded status, or the operation of a DC plan—different situation; but also, looking to just make it more efficient and responsive to the individuals, to the organization that is running the investments.
So, building on some anecdotal and survey work that we’ve done, we would observe that even the largest in pension plans, asset owners who are running their own shops have relatively fragmented technology infrastructure. And they’re then confronted with ways to try to operationally make sense of it—not make sense of it, but to operate it efficiently and coherently. And they’re looking at, what should we do to make it be better, more integrated, more efficient?
So we, I think in terms of just the necessity of creating a view of the overall portfolio when you may be accounting for or processing different asset classes on different platforms, and then the need to bring that together so that you have a single view for the asset allocator to come to conclusions about if, when, and what should be done to adjust the portfolio from time to time to keep it in compliance with strategy and investment policy, and then to trade it. And that can often involve a significant number of different systems. So if they’re looking for ways to either better integrate those systems, or in fact, is there yet a different technology that may enable an operating model that is in fact just fundamentally more integrated and, therefore, more efficient and responsive to their needs.
Christine Knott: I would agree with you, Randy. I think one of the things we see from a consulting perspective is, we’re often brought in to help organizations to understand and determine how to better operate. So, what does an efficient operating model look like?
I think there’s a lot of pressure on the service providers to have to evolve and be able to answer questions for them. I think there’s also this insource, outsource, how much in, how much out. Obviously, custody is always out, but the rest, what does that look like? What does that mean? And I do think that there’s a significant amount of pressure to try to get the efficiency.
And one of the things that we see particularly in Canada—and I know having worked with some firms in Australia as well, very similar—the types of assets, I should say, that they’re investing in. The fact that they’re investing in—there’s not a building you walk in in Toronto that doesn’t have some pension plan name on it, right? And the reality is that these organizations are really looking for different asset classes, different viewpoints, and they have to have the tools to be able to report on them, just as Ryan said, and as you said as well, to be able to provide their pensioners the information that they need.
And so, there’s a lot of things that have to happen. So to your point, how do they cobble these things together? And historically, they’ve been able to kind of piece it. But as real estate investments, private placements, the diversity of the assets that they’re investing in I think are really driving some of that organizational change that you’re talking about, or operational change. They can’t necessarily change what they do. As Ryan said, you know, as the trustees, they have a responsibility. But they still have to—but how do they pull it all together?
And I think it does put a lot of pressure on service providers. And I think it’s forcing firms to look elsewhere to get both the service providers plus the technology providers to kind of come together and work together, and we’re seeing a lot more consolidation that way. And a lot of that is being driven by the plans themselves, I think. That’s my perspective. I don’t know what you and Ryan think.
Randy McGathey: I agree completely. In fact, I’d say that they are—the asset owners, the institutional investors are looking more broadly for their solutions, both from a service and a technology perspective.
Christine Knott: Yes.
Randy McGathey: And driven by that, the traditional service providers are changing the way that they think and assemble solutions for their clients. So, what you might have called a custodian a decade ago is actually much more than a custodian now, and they’re bringing additional kinds of solutions, including technology solutions that weren’t necessarily homegrown to the market, to the relationship, to the solution.
Christine Knott: Right.
Barnaby Nelson: And so, one thing, we’ve managed to actually go a podcast and a half without mentioning the three letters of E, S and G. And I’m just listening to everything we’re talking about in terms of inputs, and to your point about driving efficiency, rationalization, an existential question of what we’re here for in terms of consolidation. All of that is now set against—particularly in Europe, set against a context of the entire operational stack needs to be seen through a new dimension now. It’s not just about investment performance; it’s about sustainability, governance, and so on and so forth.
I mean, Europe, from the research, Europe is absolutely at the square centre of all of this; 4 out of 5 in terms of the pressure at boardroom level being felt by this. And also, Africa, interestingly enough. But it’s only half as strong in North America and APAC.
And so, in the context of what you guys were just saying, massive change, massive need to rationalize, to pull together, what’s ESG doing to that? Is that kind of adding a fifth dimension to the whole project and blowing them up? Is it running in parallel? How are you feeling that the whole ESG discussion is playing out from a North American context?
Ryan Silva: I’ll jump in. My view is that ESG is in fact an important current or influence in the U.S. market. It’s not being imposed from a regulatory perspective but from a market perspective. So large institutional investors, the huge pension plans are very focused on ESG. They think about it from its sort of social impact perspective. But ultimately, as they must, from the U.S. perspective and ERISA, they have to look at it from what’s the import of ESG on the long-term performance, the ability of the investment structure to deliver the returns and the benefits out to the pensioners that are required.
So, the institutional investors are looking for ESG to have a positive effect on the outcomes that they deliver to the pensioners and, therefore, the providers. So we’ll say the investment managers, the people producing the product, are highly motivated to compete to deliver products that are responsive to what the investors, the asset owners are looking for. So I think it’s active, but not from a regulatory perspective, but from a very typical U.S. perspective, is let the market sort it out.
I would also add just anecdotally from a noninstitutional investor perspective, but from an individual investor, retirement investor perspective, when we raised the notion of millennials in the past, I have some anecdotal access to millennials, and I can tell you it’s at the top of their mind. I get frequently quizzed about what’s happening ESG-wise, and where can the right, “from an ESG perspective”, investment solutions” be found for those millennials’ personal retirement and personal operating investing as well. So, the market will sort this out because the big providers want all of those sources of business.
Barnaby Nelson: So I won’t ask who on this call wants to speak for the millennial community, or if any of us believe ourselves to be millennials, but I think it’s a really great point. Ultimately—if I hear you right, ultimately, regulation trumps market forces, and so, therefore, a certain degree, basically, when you’re being handed by an APRA or somebody like that, you’re going to do what they say first and market forces all kind of always come as the kind of discretionary part of the portfolio, if you like.
But I think it’s also, to your point about the pressure being felt from the outside, one of the quotes in the research was that ESG in Europe is grassroots, bottom-up responsibility that’s deeply felt by every individual. I mean, presumably, we’re seeing that kind of come through. And some of the smaller plans, I’m assuming, are going to be much more sensitive to that than some of the bigger ones, just given their makeup.
Does that resonate, Ryan? I mean, in terms of just the exposure that some firms in North America are carrying to ESG?
Ryan Silva: So I haven’t seen it so much in the smaller firms. I was recently speaking to a new CIO of a large plan, around 40 billion. And his point was that he was going to build out the technologies to understand the carbon footprint of the portfolio, and he was going to do everything he could to report out on it, but he was not going to sacrifice his fiduciary obligation for returns in order to make it a green portfolio. So, I think from a list of priorities—to Randy’s point—the market is driving it, they are considering it, but it’s not at all costs.
And I think the other thing is, over the last few conversations, we’ve talked about how complex the macro environment is, and then how that is sort of leading to transformations within organizations. When you start to consider applying an ESG filter to your portfolio, it adds another degree of complexity and having to consider. So, it’s just one of those things that I think people are taking their time with.
Recently, Tesla getting kicked out of the index; it just highlighted the fact that a company that sort of created a market for sustainability can have violations in other parts of the ESG; that it isn’t as simple as just being green; that there are many different factors to how we assess how honestly and how close we are to sort of a standard.
I mean, it’s evolving. We’re trying to really sort of keep the truck moving, change the tires, and fuel it at the same time. So I think, the Canadian market, what I’m seeing is people are going to take their time so that they take care of the basics first and then apply this. And it will definitely evolve. I mean, Randy’s right, it’s definitely a force and a current. We’ll get there, it just may not be tomorrow.
Barnaby Nelson: Yeah. Absolutely.
And, Christine, just one thing that is always challenging, basically, is people raise the term ESG. And, Ryan, to your point, that kind of loosely translates into carbon footprint, measuring. But obviously, ESG as a theme is so much broader than that. What are the other areas that kind of ESG translates into in terms of, okay, well, these are the areas that we need to be thinking about? Because, obviously, some of the big Canadian funds are leading the world in this stuff in terms of their thinking, so.
Christine Knott: They are, yeah. I would agree. It’s interesting. They definitely are leading the charge in terms of making sure that, from an investment perspective and also the way they operate.
I think one of the biggest challenges is the reporting. And so, those smaller firms, you know, to Ryan’s point, you see some of them doing it, and it’s a big implementation. I spoke with one small plan last year, and it took them two years to get their ESG reporting put together, everything operational, multiple toolsets. It’s a lot of effort. I think the larger plans have the benefit of the infrastructure, as Randy was talking about earlier, that infrastructure to be able to create the reporting.
Just stepping out of the asset owner world, the investment management firms are having the same challenge. So it’s across the board. It doesn’t matter whether it’s an asset owner or it’s an investment manager. And a lot of the smaller firms are using third parties, so those investment managers have to adhere if the plan wants to adhere, right? So there’s a lot of pressure across the board.
And you joked about the millennials. I am not a millennial, but I am the mother of one. And let me tell you, we do not use plastic. She’s changing our world. And we’ve been talking about this. You know, she’s recently into a plan herself. What does that mean? What does that mean from an investment perspective? So, it is fascinating to see, and I think it is going to change.
I think the other thing too is, in the Canadian marketplace, there was always a concept from an investment perspective, we all joke about remember the old days—Randy, you’ll smile at this—people were always worried about the sin stocks. Right?
Randy McGathey: That’s right.
Christine Knott: So, ESG is just taking it that much further. It’s taking that conceptual idea, formalizing it, and making it so important from an investment perspective.
And also, I think providing plans an opportunity to rethink or reestablish how they’re thinking about being able to provide that level of transparency to their pensioners, which I think is critical. And I think as we see consolidation, I think we’re going to see more and more of it coming to play.
And I don’t think from a regulatory perspective we’re going to get hit as quickly as the UK has. I think they’ve been hit very fast; it’s become such a big piece. I think it’s going to take a while for everybody to catch up there, certainly based on my experience.
And I do think that North America’s kind of doing it at its own pace. I think Canada’s adopting it a little bit quicker, probably much more like Australia, very similar marketplaces. Look, we got our constitutions at the same time, we’re Commonwealth countries, and we’re both the same size in terms of population. So it’s a very similar kind of phenomenon that’s happening there as it is here. So I think we’re going to see that become more driven by them as opposed to being driven by the regulator. And I think that that pressure is really what’s going to be—we’re going to see come through.
Barnaby Nelson: That’s a great point. Because ultimately, you’ve kind of got stage one of ESG, which is, as you said, just basically track and manage—or track and see performance, and then two is kind of a far more distant stage in North America, which is actively managing performance based on what you are seeing.
And as you rightly said, the UK and Europe is way, way ahead on that. And it’s going to be interesting, I think, to see a market that operationalizes ESG across the entire investment cycle is going to have some very strong trickle downs, as you said, into Australia, into South Africa, the one—also similar mix, and Canada.
So look, so just to tie it all together, I mean, we’ve covered off a huge range of things. But I think when you pull together the challenges and the disparities between the regulatory enforcement markets and then kind of the more mature stable markets, as we said, around ERISA in the U.S., for example, you’ve got a parallel set of considerations. On the one hand, this existential question about, am I an investment management shop or am I a plan—Christine, to your point.
Alongside that and intermingled with that is this whole question of risk and efficiency as a focus. So whether or not that is the primary driver, as we’re seeing in America, or whether or not that’s a consideration as part of the whole consolidation question depends on where you are. But there doesn’t seem to be any doubt that ESG is just gently warming up, certainly, in North America and outside of Europe. As a consideration, it’s rising through the ranks. And every year that the millennials become more and more entrenched—without using an oppositional word—in the workforce, the more important it’s going to get.
So I hope that’s a reasonable summary of kind of the big considerations that are playing out. The value of this podcast series, obviously, is the next one we get to talk about how the rubber hits the road. So, how are these considerations actually turning into projects? And what does that journey really look like?
Because that’s the meat of this, basically, is, okay, this is what we’ve talked about, is what’s on people’s minds. What we talked about in the last session was what the operating model is that they’re now having to adapt and change. So hopefully, the next conversation, we can really get into the nuts and bolts of it.
So, I hope that’s a decent summary. But thank you so much for your inputs and your suggestions.
If anyone wants to dig into any of the statistics, you can download the key findings and the report at thevalueexchange.co, or reach out to Christine at Citisoft, Ryan at RBC, and Randy at the Milestone Group. I don’t think those are your email addresses, but you can probably divine it. So thank you very much, guys.
Ryan Silva: Thank you. It’s been a pleasure.
Christine Knott: Thank you.
Randy McGathey: Thank you.