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Why Governance matters

April 16, 2020

If someone offered you a low-cost investment that could improve your fund’s performance with very little risk, what would you think? Too good to be true?

Governance Matters

A deal too good to be true?

If someone offered you a low-cost investment that could improve your fund’s performance with very little risk, what would you think? Too good to be true? What if you were told that the world’s leading investors had all made the same investment and that capacity for other investors to join in was almost limitless? Interested now? Read on.

A feature that we believe distinguishes the world’s best institutional investors is that they have all paid a lot of attention to their governance. And, as you would with any high-return, low-risk asset, they continue to do so by making small maintenance investments to ensure that their prized asset remains in its best possible shape.

What is governance?

Governance, as a term, is most often focused on board activities, but to be comprehensive it needs to consider all the people and processes an organization puts in place to achieve its mission. When sophisticated investors talk about governance, they do so with this wider context in mind. That means they’re thinking about not only how to make their board (or investment committee) work more effectively but also how the management team (whether internal or outsourced) contributes to mission success and the various frameworks put in place to guide good decision making.

You better believe it

It’s commonplace now for investors to have a developed set of investment beliefs. Among those beliefs, it’s also common to say something about governance. Here’s a small sample:

  1. High-quality governance and decision making are critical to success.
  2. Sound investment governance practices can lead to better investment outcomes.
  3. Effective governance, leadership and a strong culture are essential for a world-class investor.

Despite a professed belief in the value of governance, it is also very common that the topic gets little dedicated time on board agendas.
If you say governance matters to you, how are you demonstrating that?

How governance quality impacts returns

Think of your favorite competitive activity. You might enjoy participating but you know there are competitors out there who are just that much better at it than you. Sometimes they are just more “naturally gifted,” but usually it’s because they are driven to compete and put in long hours of practice. Investing is a highly competitive activity. The lure of higher returns attracts organizations that are prepared to apply considerable effort to find 101 ways to eke out small performance gains. To do that, they can hire well-trained (and well-paid!) specialists, invest in sophisticated systems and adopt exacting regimes for making decisions (i.e., how they play the game).

In this high-stakes game, investors know that they are set up not only to beat their competitors but also to feed off their weaknesses. Their competitors’ losses are their gains. Let’s pause for a moment to consider how we believe the winners win:

  • They engage top-quality decision makers and empower them to reach their full potential.
  • They’re very disciplined about how they make decisions. In particular, they know that as humans we are subject to biases that are detrimental, so they put in place consistent and coherent decision-making processes that counter those biases.
  • They’re constantly learning and striving for better ways to do what they do. They can always improve. They look for new opportunities that come out of this learning process.
  • They have a clear understanding of what they are good at and, just as important, what they’re not.
  • These steps enable them to confidently adopt strategies that require more sophistication and patience, safe in the knowledge that they can stay the course through whatever turmoil markets throw at them.

Conversely, investors that don’t invest in these good governance attributes tend to be inconsistent in their approach. Their goals might keep shifting. They miss key warning signals. Very commonly they look for success in chasing past returns. Often they lose their nerve when times get tough and then fall into playing the “blame game.”
Do you have mechanisms in place to ensure that your organization is creating, not destroying, value?

Sounds simple, so why isn’t everyone doing it?

If the returns from better governance are within reach, why doesn’t everyone grab them? It’s not a cost issue; financial costs to transform governance are relatively small in the context of other decisions that funds routinely make. We feel reasons are diverse: Some funds are constrained by legislatively enshrined poor institutional structures or are burdened by competing multiple objectives; some lack the awareness to recognize that there are better governance models available, and some that are aware simply might not know where to start.

Organizations will also have their own inherent view of the quality of their governance. We believe danger with self-assessment in this area is the human tendency to be overconfident in one’s own abilities. Based on our experience, few funds will be willing to admit that they have below-average governance. Are you the best you can be? The section below is a simplified checklist of factors that distinguish best-practice investors. How many questions can you answer with an unqualified “yes”?

Good takes many shapes

Governance is very context specific: A small fund with a simple portfolio will have considerably less-sophisticated governance arrangements than a large one with complex private market investments. A useful way to think about what is required is by considering your organization’s governance budget. An organization’s governance budget is its capacity to apply governance disciplines, whether at a board or management level. You can look at this in one of two ways: Either your governance capacity drives your investment arrangements or vice versa. If your budget is low, then you need either to keep your strategy simple or to outsource to someone who can offer a deeper governance budget.
Does your governance budget match your strategy?

A 12-factor approach to good governance

The following checklist summarizes characteristics that Willis Towers Watson evaluates when considering the governance quality of an organization. A total of 25 or more unqualified “yes” responses indicates governance in pretty good shape; 15 or fewer suggests that you would likely benefit from some significant work on governance effectiveness.

The checklist

  • Mission clarity:
    Do you have a clear organizational mission? Is it supported by a business plan than aligns activities to the mission? Are key stakeholders aligned behind the mission?
  • Effective use of time:
    Do you have clearly specified delegations? Does the board (investment committee) focus on strategic decisions leaving operational decisions to management?* Do strategic issues (like governance) dominate the agenda?
  • Leadership:
    Are the key leaders in your organization (e.g., board chair, or CEO or CIO*) effective in focusing different skills and styles in the organization? Do they engage well with stakeholders? Do they bring passion and energy to their roles?
  • Beliefs:
    Do you have well-developed investment beliefs? Are the board and management aligned on these? Are beliefs frequently referenced in decision making?
  • Risk management:
    Do you have a clearly laid-out risk appetite statement? Do you have a process for budgeting and monitoring allocations to different risk factors in your portfolio?
  • Manager selection:
    Do you have a clear framework for hiring and firing investment managers? Is this forward looking, focusing more on organizational elements than past performance?
  • Investment team:
    Are you able to attract a highly skilled, appropriately sized investment team?* Do they have clearly defined responsibilities, and are these aligned to your organizational goals?
  • Board competencies:
    Does your board have members with strong finance or investment backgrounds who are able to effectively challenge and guide management thinking? Is there a trusting, constructive relationship between the board and management?
  • Compensation:
    Are you able to offer an employee value proposition that attracts the highest quality people?* Do you have results-based performance compensation? Is it deferred to recognize sustainable performance?
  • Competitive positioning:
    Do you have a clear idea of your organization’s competitive strengths and weaknesses? Is your strategy aligned with these? Can you add value through the quality of your investment team* and investment model?
  • Operating in real time:
    Are you able to make decisions in real time when required? Are you able to make the most of the time horizon afforded to your organization?
  • Learning:
    Do you have an organizational culture of always striving to be better? Do you have processes to learn from past decisions? Do you network with peers to learn how they do things?

*If CIO responsibilities are outsourced, think about the OCIO when answering questions related to management.


The information included in this presentation is intended for general educational purposes only and does not take into consideration individual circumstances. Such information should not be relied upon without further review with your Willis Towers Watson consultant. The views expressed herein are as of the date given. Material developments may occur subsequent to this presentation rendering it incomplete and inaccurate. Willis Towers Watson assumes no obligation to advise you of any such developments or to update the presentation to reflect such developments. The information included in this presentation is not based on the particular investment situation or requirements of any specific trust, plan, fiduciary, plan participant or beneficiary, endowment, or any other fund; any examples or illustrations used in this presentation are hypothetical. As such, this presentation should not be relied upon for investment or other financial decisions, and no such decisions should be taken on the basis of its contents without seeking specific advice. Willis Towers Watson does not intend for anything in this presentation to constitute “investment advice” within the meaning of 29 C.F.R. § 2510.3-21 to any employee benefit plan subject to the Employee Retirement Income Security Act and/or section 4975 of the Internal Revenue Code.

Willis Towers Watson is not a law, accounting or tax firm and this presentation should not be construed as the provision of legal, accounting or tax services or advice. Some of the information included in this presentation might involve the application of law; accordingly, we strongly recommend that audience members consult with their legal counsel and other professional advisors as appropriate to ensure that they are properly advised concerning such matters. In preparing this material we have relied upon data supplied to us by third parties. While reasonable care has been taken to gauge the reliability of this data, we provide no guarantee as to the accuracy or completeness of this data and Willis Towers Watson and its affiliates and their respective directors, officers and employees accept no responsibility and will not be liable for any errors or misrepresentations in the data made by any third party.

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