Implementation…the Dark Hole

It won’t be our strategy advice that will let you down but your implementation’ Roger L Martin- The Execution Trap

Many of us have had the good fortune to review some very impressive business plans, architectural plans for a new home or home addition or even Sunday’s game plan for your favorite football team. Plans are wonderful, strategies are even better but, as they say, it all comes down to execution…or ‘that’s why they play the game’.

Advising to or overseeing asset pools for beneficiaries — institutional or fiduciary pools of assets- is similar. The asset pool must develop a plan, which in investment lingo means establishing an Investment Policy Statement. The pool must also develop a strategy including best practices, independent and robust research pertaining to things like asset allocation, investment structure and manager due diligence. As importantly, the asset pool has to ‘play the game’ which means it has to implement the game plan.

Let’s remember for a moment that regardless the size of the asset pool; whether $5M or $50B, those involved in managing those assets are held to the same standard and have a responsibility to adhere to prudent fiduciary standards. Failure to adhere to fiduciary standards, even unintentionally, can lead to a lot of bad things…including legal proceedings and financial liability. We don’t mean to be alarmist but overseeing an investment program for the benefit of others is a serious responsibility and implementation is a meaningful component of that responsibility.

Very large asset pools have a distinct implementation advantage. For the most part, large funds (500M+) have the ability to hire both internal staff and/or a Master Trustee bank such as State Street, Northern Trust or BNY/Mellon. The importance of this type of relationship should not be understated particularly with regard to adhering to Fiduciary standards such as best execution; adherence to guidelines set forth in the Investment Policy Statement, effecting portfolio restrictions such as ‘social investing’ and overall risk control. The Master Trustee relationship is essential and you most likely will not find a large, institutional asset pool without such a relationship. The downside is that it is not inexpensive.

Smaller institutional funds ($2M-$200M) do not, normally, have the luxury of hiring such a Master Trustee. Rather, such funds hire a custodian such as Fidelity, Schwab, Pershing or even the local, community bank. While these organizations do a wonderful job at safe guarding fund assets; they do not provide the Fiduciary oversight and risk management characterized by a Master Trustee. That’s a problem.

n our experience, smaller institutional funds can benefit greatly by including an overlay manager in the implementation process. What does the overlay manager bring to the Fiduciary party…plenty:

  • The overlay manager acts as a Fiduciary to the fund and is charged with working in the funds best interest to ensure efficient implementation including best execution.
  • The overlay manager also provides real time risk control for the fund. Each fund has investment guidelines, which can be unintentionally violated. In the absence of a Master Trustee or overlay manager such violations will only be discovered after the fact.
  • The overlay manager also provides the ability to implement specific fund restrictions such as ‘social responsible’ or ‘sin free’ portfolios.

We think of the overlay manager for smaller funds as being, in some ways, comparable to a Master Trustee for larger funds. While the overlay manager does not custody the assets; they do provide similar execution and risk control capabilities.

Applying a fiduciary continuum to an investment program consists of following a well-vetted and documented process that is ‘only as strong as its weakest link’.