Success in alternative investments requires focus on governance, Watson Wyatt says

Moving to new and advanced investment strategies has the potential to backfire on pension plans without strong governance models, according to experts at Watson Wyatt Worldwide, a leading global consulting firm. To take advantage of alternative investment opportunities, companies need to devote considerable resources to managing and monitoring their investments.

ìThe quick growth of alternative investments, such as hedge funds, private equity and infrastructure, might lead some to conclude that everyone can benefit from such tools, but that is not the case,î said Carl Hess, director of Watson Wyattís investment consulting in North America. ìAlternative investments will pay off consistently only for well-governed organizations. To delve into these investments before putting the needed governance in place is putting the cart before the horse.î

Driven by the need to better align their investment strategies with long-term pension liabilities, many plan sponsors are revisiting their fundís risk profile, restructuring their investment policies and looking for new ways to produce higher returns. Actively overseeing the investment process is critical to a successful outcome, Hess said.

Organizationsí investment strategies generally fall within one of three camps, and dictate what level of governance will be necessary:

ï Cost minimizing ñ Managing down all costs to limit fees and other leakage from easily available investment returns. This typically focuses on equity and bond investing, and should appeal to companies with the lowest governance resources.

ï Diversity seeking ñ Focused primarily on diversifying investments ó perhaps by adding some alternative investments ó and finding competitively priced, packaged market exposures with specific risks removed. This should appeal to organizations with sufficient governance resources to pursue some value-creation opportunities.

ï Diversity and skill exploiting ñ Looking for significant investment diversity, including the nontraditional areas of private equity, hedge funds, infrastructure or real estate, and willing to accept a high proportion of risk based on the managers of those funds. This should appeal to companies willing to put in place the highest levels of governance.

High levels of governance generally involve higher budgets and a greater devotion of time and expertise to monitoring investments. In addition, organizations that achieve high levels of governance tend to build teams with complementary skills and clear lines of accountability, making for more effective oversight.

ìSeveral years ago, pension plan sponsors had fairly simple decisions to make ó decide the equity-bond split and then select asset managers to implement that asset allocation,î Hess said. ìBut regulatory issues, product proliferation and competition have complicated these decisions. Sponsors have to deliberate and develop strategies that either take risk to create value or focus on minimizing risk.î

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