5 CIO insights from 5 podcasts

“The reality is I'm an investor. My job really is about looking after the team that's delivering investment advice and investment management to the pension fund. People, investments, long-term strategy, engaging with the client and keeping the show on the road. Making sure that we're a well run business that will keep the FCA happy as well as our members.” - Simon Pilcher

Well here it is. Five great episodes; one more left in this series, and some great guests shaping up for series two. In series one we sat down with Simon Pilcher (CEO, USS Investment Management), Chetan Ghosh (OCIO at Schroders Solutions), Pete Drewienkiewicz (CIO at Gallagher UK), Rob Groves (CIO at Pension Insurance Corporation), and Gerald Chen-Young (CIO of the National Public Pension Funds Association). The podcasts themselves are here: Podcasts | cio investment club.

The origin story for the podcast began when Sean Thompson and I spoke over a post-lunch strong coffee in mid-May last year. The conversation homed in on two topics. First, how much investment media nudges people towards short-term trades. Second, how hard it can be for some of Britain’s most intelligent graduates to find genuinely good finance roles.

We left that chat (after a biscuit or two admittedly) with a goal: have conversations directly with Chief Investment Officers — stewards for vast sums of money, and pull out what you can only learn by speaking to the person in that chair.

What follows are five insights that kept reappearing. I hope it is valuable to aspiring CIOs, people starting the journey of finance and those who partner with investment companies. Before we get started, one thing surprised me: how strongly these CIOs communicated. In a complex world, the ability to describe systems in simple ways is a huge career enhancer. It is certainly true for investment professionals, and I would bet it matters for senior leaders in any industry.

1) Understand who you are serving

CIOs think deeply about the people they serve. Whilst many speak of “asset-liability management” there is a human reality behind it. These are pension payments, due on dates, to real people, for decades.

With that clarity of purpose, aggregating a stream of expected payments into a liability stream becomes more grounded in purpose.

“I serve 577,000 members of the University Superannuation Scheme. Our aim is to secure the financial future for all of our members. And that's mostly by paying those pensions. And for most of those members, those pensions will be paid for at least the next 80 years, I think. So it's quite a solemn task” - Simon Pilcher, CEO of USS Investment Management.

With that clear aim in mind, the job of an investment team, and the CIO ultimately, is to put together a portfolio of investments that can service those payments on time and in full with a margin of safety.

Whilst series one was mostly related to pensions, it also uncovered a useful distinction: when you are paying a defined set of payments (pensions, annuities, insurance), the asset mix is optimised to meet those payments and to minimise shortfall risk. When you are investing for a long runway (endowments, sovereign wealth funds), it’s more about maximising return for a given risk budget.

“Different pools of assets have different term structures of liabilities and you need to be mindful both as an operator, a fiduciary, and a trustee.” - Gerald Chen-Young

These decisions are complicated and multi-dimensional. Liquidity and other portfolio measures are inter-related. It's at this point you need to create frameworks, that help you achieve the overall objectives. But what helps inform those frameworks?

“The future is uncertain. Correlations can change. I think the analysis is thinking about scenarios and risks and not getting kind of false confidence from the past.” - Simon Pilcher

2) Frameworks should drive most decisions (but not all)

The CIOs all saw that judgment is easy when it is well-informed by good analysis within a clear framework. Intuition, whilst important, was reserved for more unusual or exceptional circumstances. So whilst a lot of people think of decisions as the key output of CIOs, it was clear from our discussions that finely-tuned systems were the key concern of CIOs. Decisions were in most cases uncontroversial, given the underpinning analysis.

The frameworks are systems that create repeatable decisions that are consistent and transparent. It helps make decisions auditable, so in hindsight the question "why did we make this decision?" can be easily referenced, but also, and more importantly "how can we make a better decision next time?". CIOs ensure that frameworks, have the outcome in mind, identifies risks to that outcome, have considered the required restraints and incorporate lessons learnt from success and failure.

“Often investment organisations are very fixated with outperforming a benchmark...We’ve moved away from benchmarking to a balanced scorecard because ultimately we need to pay pensions.” - Simon Pilcher

“There are processes because there is a lot of data... and not everything is equally important. The ability to call out whether the process is not right for the decision that you're making is where the best skill is.” - Chetan Ghosh

“We tend to use a mosaic approach. It's unlikely that one model is going to provide all the insights. We have a suite of models: scenario analysis, Monte Carlo, probability analysis, the probability of meeting outcomes” - Pete Drewienkiewicz

CIOs also know when the frameworks do not fully capture all the relevant information for a decision nor have all the appropriate levers to be made. This leads us to 3.

3) Maintain mandate flexibility

Long-horizon investing is mostly a well thought-through plan executed consistently. But, every CIO we spoke to stressed the importance of flexibility and it came in two buckets:

1. Take advantage of new opportunities (a new flavour of credit, a better entry point, a mispriced risk premium) — and be able to act quickly.

2. React to dislocations (tail events, dislocated markets) — without being trapped by governance.

“We always focus on maximum flexibility rather than having a [rigid] strategic asset allocation we have a mini strategic asset allocation decision for each deal” - Rob Groves

A real source of risk for a portfolio is not being able to act due to slow governance: infrequent meetings, rigid approval pathways, and rules written without appreciation that markets can deviate from the norms. This was evident during the recent LDI crisis in the UK. Whilst a lot of work has gone into Investment Policy Statements and Strategic Asset Allocations, these must be treated as things that should be reviewed.

“An Investment Policy Statement is not a catechism, it's not etched in stone. An IPS is a guideline. It's a series of guidelines...During Covid the 10 year treasury fell below 50 basis points we liquidated sat in cash for a while and then redeployed back again to the consistent IPS guidelines.” - Gerald Chen-Young

Flexibility in practice was:

• Delegated authorities and read-to-go contracts with managers in asset classes not currently allocated to.

• Governance that can convene quickly and outside of schedule

• Shared understanding that guidelines exist to stop you doing something damaging - not to stop you doing something sensible.

“We are able to act quite nimbly through delegations, and ad-hoc governance meetings.” - Chetan Ghosh

Flexibility also means, taking bold action. You will rarely de-allocate perfectly at the highs or allocate at the all-time lows.

“When it comes to de-risking a portfolio, better to go early than go late because you lose a lot of optionality if you end up being late.” - Rob Groves

4) Culture does not just emerge, it has to be aimed at

Culture rather than being a touchy-feely topic was considered central to making sure that excellent analysis, problem-solving and strong challenge was happening during the normal course of business.

“Overall...., the role of the CIO is making sure that you've recruited a really strong team, organised in the right way, so you're operating effectively and you've built a culture such that you can do that. And to me, culture's everything. If you've got good people who've got a good culture, then you know the investment performance will follow.” Rob Groves

In my opinion, culture has been a misused phrase, and has often related to perks but not expectations. Consistently CIOs picked out these qualities on top of being hard-working and smart as essential for hires:

• Humility - "Tell me where I am wrong". An innate need for high standards. Operating without the best information is expensive, so having people who are thorough is important. Humility also opens the door for people to speak up.

• Internal Motivation - It is great to have someone around that takes a problem and cannot help themselves but try and solve it. Solving unstructured problems is consistently something which helps individuals stand out in a firm.

  • “I think the thing I would probably over index would be people who are going to solve problems… They might see a problem, it might not be exactly in their core area, but they're going to push on it and help and find a solution to it. Internal motivation, curiosity and self drive.” Rob Groves

• Trustworthiness - Underlying frameworks is an assumption that people genuinely care about the objective of the organisation, which is paying the people it serves. Without trust analysis cannot be relied upon.

  • "Can I trust this person? And, and will they tell me the truth. I think I've probably said goodbye to more people for cultural reasons than for investment in competence." - Simon Pilcher

Hiring great people is not enough though. CIOs want to create a way of a team working together that creates very strong outcomes and does not have the CIO as a bottleneck to lots of decisions.

The CIOs consistently felt that good decision-making culture had the following traits:

• Transparency: People need to be able to explain to laypeople why they have a view, and it should not just be those closest to it who comment on decisions. Sensible non-experts can provide good feedback during a decision-making process to help bring another perspective. Helping each other with new ideas and perspectives is an important cultural muscle.

  • "Making sure everyone's got a chance to speak, making sure you chair these meetings strongly so that no one feels like they can't make a contribution" - Chetan Ghosh

• Accountability: Committees might make decisions on paper, but in reality people do. If people do not feel accountable for things, by seeing benefits if decisions are well-made and responsible if they are not, important decisions can be made without the proper level of diligence.

  • “One of the things that we have very consciously, deliberately sought to inculcate is the idea that I don't take all the decisions. They are going to be the ones who are running much of that decision making responsibility. So you have to devolve power and you have to be delighted when your colleagues are seen to have done an outstanding job and bask in their reflected glory, rather than hog the limelight for yourself.” - Simon Pilcher

• Objectivity: Markets periodically are exuberant or doom-mongering. The noise around is pushing you with the herd. Being able to fall back on analysis you are comfortable with, will allow organisations to make the difficult counter-consensus decisions.

  • “The lesson is... just don't believe the hype. Trust your own judgment, trust the judgment of your team. If you see the things that you are concerned about, just keep pushing, keep digging. Don't let the noise around it put you off what you're doing.”

5) The real risk is missing desired outcomes

Coming back full circle, CIOs measure risk as missing the mark for those they serve. Missing actual investment outcomes. Not volatility, not standard deviation, not VaR, not even mark-to-market.

“People in this industry default to a risk number that is basically a mathematical standard deviation. I would challenge nearly every stakeholder who is responsible for an institutional pot of money to give me a bulletproof logic as to how they set that number.” – Chetan Ghosh.

“An argument can be made that private equity lowers volatility, but people that make that argument are using private equity somewhat as a camouflage for volatility. Just because you don't see the marks day-to-day doesn't mean that there isn't underlying inherent volatility in the asset class.” – Gerald Chen-Young

For a pension fund, risk is not paying pensions on time and in full. For an insurer it is not meeting policyholder promises, inside a capital regime. For an endowment it might be not funding scholarships. Whereas most risk is defined as an input to an asset allocation decision, CIOs seemed to think of risk as the stresses that could stop you fulfilling your outcomes.

Shortfall risk: you don’t meet the return you need for long enough to go off course from your liabilities.

Liquidity and optionality risk: you can’t act when you should act, often when prices are best, because the portfolio is tied up or collateral is gone.

“It could be actually your illiquidity is shot up. Can you deal with that? You lose optionality. Chances are your illiquidity shot up at a time you want to buy liquid markets 'cause they're cheaper, but you're not able to do so.” – Chetan Ghosh

Hidden risks: leverage, concentration, second-order risks that do not appear in a risk report.

Governance risk: the portfolio might be fine, but the system around it can’t move fast enough to make timely choices.

Scenario analysis came up repeatedly, particularly where the stress is sized to a level that intentionally creates challenges. This allows decisions to be made in a way that highlights trade-offs. In particular:

• What does the stress mean in terms of returns afterwards needed to meet the promises?

• What about liquidity, like cash and collateral availability?

  
  

“In the middle of the [2022 UK LDI] crisis for most pension schemes and insurance companies, that meant posting more collateral out. That was something that we were very well prepared for – additional collateral over and above what you think could be the kind of worst case scenario. You always want to be in a position where you are not actually using your buffer.” – Rob Groves

• What would the regulator do in this scenario?

But on top of all the discussion around risk management was a clarifying point: risk-taking is exactly what helps get these promises paid in the first place. A CIO's role is making sure the risks are well-compensated and come together to achieve the desired outcome.

“We need to be careful not to talk about risk in a pejorative sense. Risk isn't bad. What you want is efficient risk, you want to know what your risk budget is, you want to know the risk you are running, and then you want to deploy your risk budget into rewarded risks” – Pete Drewienkiewicz

Bringing it all together, 5 CIO insights

1. Start with those you serve: CIOs begin with the people and promises those assets exist to serve.

2. Frameworks create clarity: Most good decisions are the output of repeatable systems. Transparent enough to explain, and can be improved upon as the institution learns.

3. Good governance incorporates flexibility: the best investors understand that opportunities cannot always be imagined in advance. Delegation and exception routes are necessary to act on opportunity and during market dislocation. Slow decision pathways can be as damaging as a bad trade.

4. Culture requires deliberate action: It is not enough to have smart, hard-working people. You need to have people you trust to solve problems and have high expectations of transparency. A CIO celebrates the success of others.

5. Risk is outcome failure, not a statistic: CIOs care less about volatility and more about what could stop them delivering the promised result. This means that portfolio scenario analysis is more valuable than individual asset metrics. Liquidity has huge value and should not be ignored from analysis. The aim is efficient, rewarded risk.

Next week, I will start a series on "Straight Talking". As always get the blog delivered directly to your inbox on Home | Deciders | for mental fitness | change your mind.