Total Fund Management Part 6: TFM Capability
This is now week eight of introducing the Integrated Total Fund Management ("TFM") executive series. This week, we conclude our journey into the practical implementation of TFM following the 11 case studies from Episode 5 over the last three weeks. These case studies were based on the framework and the process we discussed in the earlier episodes and provided many practical uses for TFM to solve common total fund decision challenges many institutional investors face.
However, having a framework and a process is yet not having a capability.
Episode 6 will specifically discuss a wealth of seemingly at first unrelated topics. The (official) title of the episode is "TFM: From a Framework & Process … to a Capability". The unofficial title references to the least served person in the organization, data swamps, the art of leapfrogging, Steve Jobs and the iPhone, and other unrelated subjects."Even if you have your framework and process, you are not even close …because this does not give you a Capability (period intended). This episode is about past mistakes, learning new things, and how to leapfrog this (often) insurmountable) hurdle."
Episode 6 today concludes the topic of TFM implementation. It is the last episode before the grand finale of the series next week, Episode 7, where we will discuss the role of TFM as part of the next stage of development of the Canadian pension model.
What is "capability," after all?
In the last couple of weeks (see here and here), we spent significant amount of time talking about the framework and the process, and we had all these case studies to illustrate the benefits of TFM further. However, a capability is so much more than a framework or a process.
Capability requires a methodology that supports the framework. It also requires proper technology to enable both the framework, the methodology, and the investment process. And it does not stop with technology, however, because you need a platform to be able to have a timely and dynamic process, the ability to look at different perspectives (asset class, country, sector and theme), visualize, slice and dice, experiment and interact with data, ideas, conclusions, and people. Finally, nothing could be done without talent and proper organizational structure. Only when one gets all these pieces of the puzzle right, then the real implementation and management begin. This seems a pretty daunting task.
JFK said it almost 60 years ago in the "Moonshot" speech, and we used it as a motto for our series: TFM - Not Because It Is Easy, But Because it is Hard. It may be challenging, but it is not impossible (unless, of course, one believes that we did not land on the moon!), and the benefits that would accrue to those who dare and succeed are numerous. This episode is for those who dare and want to succeed.
What CIOs want
TFM capability addresses what every CIO or investment committee needs, a properly structured decision-making process. In simple words, it is about making informed and consistent rather than ad-hoc decisions.
Do not get me wrong; ad-hoc and swift decisions are at times needed. Sometimes these are the only ones we have, especially in a crisis where it is about the return of capital and the organization's survival, not the return on capital.
In more general terms, what is required is a clear and consistent framework, which reduces the inherent complexity to an as simple as possible, but not simpler, and intuitive process. Such a process needs to be based on a dedicated function and clear accountability, follow-up, and focus on enabling continuous management and implementation.
Finally, what is needed is a proper technology and a platform to allow the CIO to steer the organization using proper, modern, and timely navigation instruments and radars in lieu of using angular measurements between celestial bodies and the visible horizon to locate one's position at sea. The presentation further specifies a detailed list of requirements for the TFM capability to achieve what CIOs want.
What CIOs actually get
We discussed what CIOs want, but it is also essential to discuss what CIOs actually get. Behind the façade of a shiny steel and glass building, this perception of a tangled patchwork of processes and technologies may eventually negatively impact decisions.
Unfortunately, more often than not, decision-making falls hostage to several organizational challenges. Some of these challenges relate to the lack of continuity, permanent, temporary patches and fixes while waiting (again) for Godot's next Big Bang system initiative, budget constraints and prioritizations where some are more equal than others. Being lost in translation in the endless patchwork of interfaces to translate data from incompatible systems and applications, the lack of straight-through processing opens up the door for lurking mistakes which could easily question the compliance with the fiduciary responsibility to safeguard clients' assets.
And then comes the topology terminology – you have probably already heard about the data pools, data lakes, and what they often become (data swamps).
It is challenging to make consistent and coherent decisions with inconsistent and incoherent data and information. Or using a month's or sometimes, even a quarter-old data for timely decisions. And wait if a crisis hits – all these headaches turn into an acute migraine. Where is my "war room"? Which data to believe? Who will compile it quickly? What am I reporting to stakeholders? Is my process institutionally robust and not just excel heroics?
It is also astounding to sometimes see the struggle within – the undertow of resistance to systems and automation in fear of losing relevance or the job and all that comes with it – salary, benefits, pension. This is the tacit culture that sometimes permeates the organizations.
Faced with these challenges, in many parts of the organization, people "tactically withdraw" under the banner of "think global, act local" and resort to having their local data and systems until better days. This situation, unfortunately, leaves the CIO as the least served client in the organization. It is lonely up there at the top, and it could also be quite foggy looking downhill.
The Request – A Greek tragedy in five parts
"Thinking global and acting local" often creates the challenge of getting total fund aggregate information for the CIO or investment committee decision-making. People might have found their own way to get the information they need, but the real challenge and panic come when the CIO or CEO request information now. I have seen it happen too many times, and I decided to capture its frantic dynamic in a short cinematic Greek tragedy (it is Leo's blog, after all!). It is called "The Request" and describes the events unfolding following an urgent request by the CIO on a beautiful Thursday end of the day, just a day before the weekend. I do not want to spoil the experience, so you have to watch it to believe it.
According to the dictionary (in ancient Greek theatre), it is a play in which the protagonist, usually a person of importance and outstanding personal qualities, falls to disaster through the combination of a personal failing and circumstances with which he or she cannot deal." Quite appropriate.
After reading several papers by Ken Akoundi, founder and chief knowledge officer at Cordatius LLC (a derivative of "wisdom" in Latin, https://cordatiusllc.com/), I first came across this story. In his own words, Cordatius is about the belief in the power of technology to transform the investment offices and that investors have fallen too far behind the technology curve. They are at crossroads and need a spark to modernize and evolve the investment office.
Ken certainly knows his stuff, given his extensive experience as a Ph.D., a quant and a programmer at J.P. Morgan, head of pension strategies at Deutsche Bank, and a chief knowledge officer at RiskMetrics, to name a few.
When I read the papers, many things resonated deeply with me as I have experienced such situations many times myself. He articulated some of the notions so eloquently, and I have to admit, I even chuckled for a bit and had to include some of his brilliant insights as these insights feed right in the topic today. If you are struggling with some issues in the nexus of technology needs and solutions for the investment office, reach out to Ken. This is not a promotion of any form. I never met or spoke to Ken before (but I will, and so should you).
Asset-rich, but technology-poor: Why organizations often fail at TFM?
"Asset-rich, but technology-poor" is yet another of Ken's powerful phrases. But why does this happen?
I had to link all my experiences, observations and past failure to answer why all this happens. Most importantly, this would answer the question, what to do to succeed? Here is a (not so short) list of suspects. I am sure you have your own (extended) list:
If you are now experiencing this emotional roller coaster of excitement for the possibility of TFM and the challenges to implementing it, let me bring you up. Any challenge has its solution. All the next sections are about how to succeed or the fine art of leapfrogging.
The fine art of leapfrogging: What I learned from past mistakes
How can we achieve the TFM capability? Can we leapfrog? The answer is yes, but one needs to be strategic about it.
There is a perfect reason why we have Steve Jobs in the picture below. This is because the iPhone's concept, as a product and technology, illustrates one of the biggest mistakes investment offices venturing into improving their technology, data, and decision-making processes make. They are not focusing on the wrong thing to do.
Apple did not manufacture the iPhone parts. These parts already existed. What Apple had was the design framework of what the iPhone should do (texts, photos, e-mail, and internet browsing). And by the way, the customers did not yet know this either, so it was not driven by demand. Apple created the demand itself. The second thing Apple had was the operating system, iOS. The operating system allows you to make all the various parts from other providers work.
So, you should by now see the analogy. The biggest mistake is to try and produce all the "iPhone parts" internally, no matter if the organization thinks it has budgets, talent and resources. Even "asset-rich," the organization may be "technology-poor" because other influential organizational factors are at play. There was a reason we spent considerable time at the beginning of the organizational challenges. It would help if you had a different, entrepreneurial environment, at the forefront of technology, methodologies, and data, and "at arm's length" from the organization. There was a good reason why many Canadian pension funds were also structured as at arm's length from the government and politicians.
"Internalization" does not mean to do everything internally. The organization needs to internally develop its "operating system" – the framework, process and methodology, and then to find a strategic partner and seed capital to acquire the platform and technology, which should include as well efficient data management. Focus on what having one "iPhone" will help you do across many functions (after all, TFM is about improving efficiency). Focus on methodology, strategy, decisions, and portfolio construction, implementation and having it actionable sooner.
The TFM capability game plan: Rethink your systems
Most of the systems you have are risk systems (Barra, Axioma, Aladdin, etc.) and are typically used mostly for reporting, compliance, or reactive to specific situations or requests. Risk systems are not decision systems, although they are an essential contributor. What you need is decision systems to evaluate RETURN expectations. But not return expectations in isolation but as part of a coherent and consistent macro and market valuation, cycle, liquidity and sentiment, and thematic framework. The TFM Framework is a blueprint for this.
Some of the established risk system names have woken up to the need for decision systems. Are they too big to be able to address this need? The older technology and architecture would be difficult to adapt; many are "cash cows" for their shareholders. One needs to be careful with "stretched promises," which are often used to tame requests. That said, they have money, a market share, and can make acquisitions.
The TFM capability game plan: A start-up mentality and offsetting costs
Although one may have a budget, building in-house is very expensive, considering all aspects – it could quickly go to $60-100 million. And then, you have all the aspects of expertise, people, developers, to name a few. A solution may be to have a strategic partner, seed capital, build a custom-made system, and then enhance it with your experience and commercialize it to offset the cost. Your name will help marketing too.
Consider acquisitions (more about it next), and build it in a modular fashion so that it could serve multiple client bases and purposes (pension funds, asset managers, SWF, family offices, insurance companies, advisors, consultants, outsourced CIO, as well as a basis for portfolio product offerings).
This requires a start-up risk mentality. The fintech/invest-tech/wealth-tech market is highly fragmented with a high potential for consolidation and a "winner takes it all" structure. There are many small entrepreneurs, of 1-2 brilliant brains and ideas, which is the excellent news… The bad news is that they would probably never succeed unless integrated and bought out to larger platforms. Such firms can only survive if they can have a financially stable back upper with the potential to further commercialize the business directly via partnerships and acquisitions, or indirectly, via product development and industry presence. Which one would disappear, survive or be bought out next month?
The TFM capability game plan: Open versus locked platforms
With technology, methodologies, and tools evolving exponentially, you need an open Software-as-a-Service ("SaaS") platform where users generate their investment insights. It needs to be "opened" to 3rd party vendor content (e.g., data, thematic research, broker views, economic forecasts) and the capability to integrate the client's own firm's internal views and intelligence insights, user's own data to build signals and strategies.
Pre-built tools and frameworks need to be open to customization of inputs and preferences by the user. Similarly, the methodology and inputs for all tools, model frameworks, and systematic strategies to be 100% open and transparent to all users (white box, as opposed to a "black box")
The TFM capability game plan: Aggregation versus integration
Any platform, old or new, can aggregate things. One can add them, and "beautify" them (Ken's expression again!), create a nice front end to consume the data. Aggregation means adding things and making it easy to access them. Even if a system is an open one, it does not mean that it is an integrated one. Aggregation is handy but is easily replicable and an inferior TFM proposition. One needs integration, which means all services and your core TFM capability are interlinked.
For example, if your core TFM capability allows you to link macro and markets to public asset classes, and your outside service, which you just acquired, links private assets to public assets, you can now link these two. As such, now you make conclusions on the behavior of the private assets given the changes in the market and macro environment (the public assets now play the role of a translation mechanism).
Now imagine you add another service, stress testing, which creates conclusions about the public asset classes. Because you already have the link to the private asset classes, you can now make conclusions on the impact of stressed market conditions on the private asset classes. This is now powerful because it could cross-link services.
The TFM capability game plan: The platform approach
In private assets, platform investments are a great way to have a foot on the ground (like a foreign office), specialized expertise, access to talent, reputation, and a way to source transactions, even further expanding the platform (M&As, and other forms). You could do the same with your TFM platform.
This way, you could have direct access to the forefront of technology, new data, methodologies. Access to specialized expertise and a talent hub. Pursue accretive acquisitions or other forms of aggregation and integration. Also, to an extent, insulate the TFM framework from internal plights (change in leadership, budget variations [remember, it is self-sufficient and commercialized], internal politics and "hostile takeovers").
The TFM capability game plan: Start-up risk management
If pursuing the TFM capability via a start-up, it is important to close any technological and IT security gaps, regulatory requirements, including full code documentation (necessary if your start-up fails and you acquire the code to use it further internally) and have the initial gaps and closed gaps audited/vetted.
Also, have an audited/vetted investment process related to the various signals and insights generations and data quality and maintenance. This is not money thrown out, as first, it is required so that you can de-risk your investment, there are regulations which you don't want to breach (reputation), but also, other investors will come, and they will be more comfortable to have all these steps already done. This is accretive to the value of the start-up. This is all key to your risk management and initial value creation,
A Strategic partnership with ClearMacro: A unique transaction at BCI
There is a reason why I was able to talk about TFM in detail, both from an academic but also from a practitioner's point of view. This is because this is a road I have travelled. It led to a unique TFM-related transaction that I spearheaded at BCI as a Vice President and Head of Total Fund Management to enable the development of TFM. This is the proper place to thank my colleagues Steven Henderson and Anand Rakesh, for the enormous help on this transaction and all its elements. It took us more than a year to finalize.
I cannot talk about it more for the obvious reasons, but this is an example of a strategic transaction for creating value in the organization's investment management in collaboration and synergy with the Private Equity team. I also have to thank Jim Pittman, the Head of Private Equity at BCI and Kevin Sarafilovic, Senior Portfolio Manager, who worked tirelessly on the deal structure.
I am proud to have enabled BCI for future growth and put the organization among these distinguished investors below, based on the DiligenceVault 2019-2020 reports.
Finally, ClearMacro is an example of a platform that could enable building your own TFM framework and process. It is an example of the benefit of a strategic partnership with like-minded investors and professionals pursuing innovation and better investor decision-making.
Overall Episode 6 Takeaways:
- TFM addresses many of the critical needs of CIOs and investment committees for informed decision-making…
- ...but faces many challenges in today's "asset-rich, technology- and process-poor" organizations…
- …. which are fraught with a patchwork of processes and technologies may eventually impact decisions • Organizations need to rethink existing approaches and practices and venture to become "asset-, technology- and decision-rich" fiduciaries of their client assets
- Most asset owners already have some of these capabilities and have been applying these principles when investing with partners across businesses and geographies
- It is now time to loop back and apply these same principles to address any investment decision-making challenges internally. Many examples of such proactive and innovative strategies already exist
This concludes the complete Episode 6.
Next Thursday, we will conclude our series with the final Episode 7, where the functional role of TFM transforms into a structural role that comes to serve a bigger and better purpose: A vision for the Canadian Model 2.0.
I want to first thank Mihail for another great comment where he covers TFM capability.
I will try to keep my comments brief but pertinent.
As Mihail states at the top, TFM capability requires a methodology that supports the framework. It also requires proper technology to enable both the framework, the methodology, and the investment process.
You can have the best investment minds, a great framework but if you lack methodology and don't have the proper technology to enable both the framework, the methodology, and the investment process, then you're not only inefficient, you're not exercising your fiduciary duty as a pension fund manager.
I haven't worked as long as Mihail in the pension world but worked long enough to see firsthand a few "Greek tragedies" because either the framework was wrong, the governance was wrong or the technology was shoddy rendering the entire investment process obsolete.
If you've worked anywhere long enough in the investment management industry, not just pensions, you have your share of "technology scars" and other scars too.
Typically pensions like to build things internally because they think it costs less and they have more control.
That's theory, what happens in practice is it ends up costing a lot more when you fix all the glitches and it can cost a lot more when your technology impacts your organizational nimbleness to act swiftly and decisively.
Often, buying things off the shelf makes sense but that too is costly and requires a lot of work to integrate and customize.
Mihail talks about a third solution, partnering up with a startup and providing it with the seed capital to grow and nurturing it as you develop the TFM system.
He rightly notes that he enabled BCI for future growth and put the organization among distinguished investors based on the DiligenceVault 2019-2020 reports and he worked hard finding, vetting and nurturing ClearMacro, a platform that enables building your own TFM framework and process.
As he states, "it is an example of the benefit of a strategic partnership with like-minded investors and professionals pursuing innovation and better investor decision-making." (see my comment on ClearMacro here).
What else? Mihail rightly notes there are great risk systems (Barra, Axioma, Aladdin, etc.) that are used mostly for reporting, compliance, or reactive to specific situations or requests but "these systems are not decision systems, although they are an essential contributor. What you need is decision systems to evaluate RETURN expectations."
And here, I'd like to add something, even if you have a great 'decision system', you always need to complement it with outstanding quantitative and qualitative work.
When I was working right next to Mihail at PSP, my job was to write reports where I mostly qualitatively analyzed things and pretty much questioned everything. Why do we want Private Equity, Infrastructure or commodities?
It was my job to write reports, go the Board with my findings and defend them. Mihail helped me a lot with quantitative (and qualitative) analysis and we often just reflected and discussed things with ourselves, our boss and our colleagues.
What I'm getting at is a TFM framework, methodology and decision system sounds great but it's only as good as what you put in it and if it's garbage in, it's garbage out.
There are some things that are easy to program, other things that are much tougher.
For example, right now, we might be in the midst of a profound secular shift in real estate.
We might be, I honestly don't know and to be truthful, neither does Bruce Flatt, Bill Gates or the heads of Real Estate at all Canadian pensions.
These type of structural changes are typically insidious but their effects long-lasting, which is why people are nervous right now on real estate.
Large pensions will tell you "over the long run" but what if this is a secular shift and you're underestimating it? It can cost your pension and your members dearly over the long run.
Again, I'm not saying there is a profound secular shift going on, but there's definitely something going on and you need to have the right senior analysts to internally question these large shifts no matter where they're occurring.
That brings me to another topic Mihail touches upon, career risk. Typically at large pensions, people are managing career risk, and that comes first, not what's in the best interests of their members and stakeholders.
In order to improve TFM capability, you need to set the right culture where employees aren't managing career risk but are actually encouraged to think outside the box and act in the best interest of members.
And that culture is set by the CEO and is carried out by everyone else beneath him or her.
I cannot emphasize how important it is to get the culture right to improve TFM capability.
Lastly, I too would like to plug Ken Akoundi of Cordatius, I invite all my readers to read the papers posted on their site and to subscribe to Investor DNA to get a great daily email with links to important stories in finance and other areas. It truly is a welath of information.
Alright, let me wrap it up, I can talk a lot more on this topic but I want you to listen to Mihail.
Below, Episode 6 of the seven-episode series "Introduction to Integrated Total Fund Management" presented to you by Mihail Garchev, former VP and Head of Total Fund Management of BCI.
Great stuff, please take the time to listen to it, take a lot of notes, there are tremendous insights here.
Update: Please take the time to read the final part of this series here. Mihail saved the best for last!