Is your organisation really smart?

I attended an interesting breakfast seminar at the consultants, Redington, last week about minimising mistakes. The starting point was that ‘stupid people don’t learn from their mistakes; smart people do; really smart people learn from other people’s mistakes’.  Two speakers, from KKR and 24 Asset Management, gave a short description of what they had done to make sure their organisations fell into the last category before a more general discussion.  Some of it is fairly obvious, at least to those of us who have been around for 30+ years: it is largely cultural and has to be led from the top; owning up to mistakes should be encouraged, not penalised, so long as the knowledge gained is shared; senior people should go out of their way to give time to dissenting views and always speak last at meetings; diversity of decision-makers is good; careful analysis both beforehand and afterwards (was the decision a good one?) is helpful. However, it is much easier said than done, particularly for younger organisations and staff.  The hard question came from the audience: if a junior employee makes a mistake which costs the business money, but owns up to it and shares the lessons learned with their colleagues, what do you do with their bonus?  Reduce it on the basis they made a mistake?  Leave it alone, on the basis that they behaved well?  Or increase it as a signal to encourage colleagues to learn from the mistake. One shared conclusion was that the behemoths among us, whether civil service or investment bank, don’t usually fall into the very smart category.​

William Bourne and Mukesh Malhotra attend LAPF strategic investment forum

On 7th February 2019, William and Mukesh were table representatives during the roundtable discussion on  'Asset pooling - are local authority pension funds saving money?'​ at the  LAPF Strategic Investment Forum in London

Pooling guidance

MCHLG has issued an informal consultation around updated guidance on pooling for LGPS funds.  The previous guidance was issued in 2015, prior to the establishment of most of the eight pools, and much has since changed.  The consultation is also welcome, so long as MCHLG is willing to listen to what it hears. Four years on, the case for pooling is not proven, except in the important sense that it has led to significant fee reductions.  It could be argued that this would have happened anyway but there is no doubt that the imminent arrival of the pools concentrated asset managers’ minds.  Aside from this, in our view the main benefit, again not unimportant, has been the increase in resources which can be directed to areas such responsible investment and, through collaboration, infrastructure. On the negative side, there have been significant costs in the setting up of the pools, both in the higher staffing levels and the need for legal and other advice.  How long it takes to recoup this is almost impossible to estimate but it certainly should be measured in decades, not years.  It also puts the Funds which are large enough to achieve economies of scale already in a dilemma: can they agree to transferring assets to the pools while fulfilling their fiduciary duty? The guidance proposes that they should take into account the benefits to members across the pool and indeed the whole LGPS, but we find it difficult to reconcile that with 101 Committee members’ duty to their local members and employers.  In our view, if the pools are indeed beneficial in the long term, they need to demonstrate that.  101 Committees can then make their own decision (we are tempted to add in their own time) on the basis of whether it is good for their own members without invoking parties further afield.  That would be clearly consistent with their fiduciary duty. Read Linchpin’s full response to the consultation here.​

William Bourne participates in responsible investing roundtable at the 15th annual lgps governance conference

17th - 18th January 2019 - 15th Annual LGPS Governance Conference 'Clarity in Confusion' - Bristol - William is participating in a roundtable on responsible investing​

​Linchpin 2019 Inflation Update

William Bourne has since 2012 written an annual update on the long-term outlook for inflation by monitoring shifts in a varied range of inflation indicators.  Last year for the first time the consensus tipped towards inflation: we agreed on the direction of travel but argued significant rises were not yet imminent.  One year on, austerity has clearly been abandoned, and protectionism is on the march: we consider both to be inflationary.  On the other hand, the US Federal Reserve’s determination to cap inflation will in our view lead to an economic slowdown, which is deflationary. A year ago we concluded that deflationary forces had after 25 years finally been outweighed by more inflationary ones.  Behind this lay secular indebtedness, shifts in relative power between capital and labour in the West, and a cyclical upswing in Emerging Markets economies.  We argued that higher inflation is inevitable eventually but placed more emphasis on market indicators suggesting not quite yet. Headline numbers in 2018 have continued to rise gently to around 2% in most of the world.  Japan is an outlier below this number and the US an outlier above. The final abandonment of fiscal austerity by most developed countries is clearly inflationary in the long term.  Not only does it build up government debt level, but by adding to demand it increases pressures in areas such as labour costs.  It confirms our view that western money will ultimately be debased.   Under the traditional model, new demand would be filled first from spare capacity.  Today the output gap is minimal in most countries, and the new demand is often in different industries and areas to where excess supply lies.  We have not changed the indicator for the output gap, but we have for deleveraging - really it is now a case of leveraging. In 2017 commodity prices rose by 8% and we marked them as Inflationary.  In 2018 non-energy prices were not greatly changed but oil prices rose by around 25%, so we have maintained this measure as Inflationary.The growth in trade friction is another factor leaning towards inflation, both prima facie as tariffs are added to goods but also in the longer term as competitive pricing pressures reduce.  We have moved the Costs indicator (re-named from Labour Costs) to Inflationary. Last year it was the market indicators, and primarily bond yields, that made us hesitate about predicting an immediate rise in inflation.  A year later, US bond yields have risen decisively, with 10-year bond yields categorically breaking up through 3% before falling back.  Other sovereign bond yields have not risen by much in 2018 suggesting that, outside the US, inflationary pressures are likely to remain muted.  We have therefore retained bond yields at Neutral. Monetary policy is very tight around the world except for China. The US Federal Reserve is in our view on the verge of making a policy error by over-focusing on inflation concerns.  This is how most recessions are caused, and we now expect at best a slow-down, at worst a recession.   Having said this, the Federal Reserve has softened its tone: while it is still talking further interest rate rises, Fed. Chairman Powell’s latest speech clearly prepares the ground for some backtracking.  Notwithstanding, we have moved this indicator to Deflationary.In summary, government fiscal policy seems inevitably to lead to higher inflation, but it is only coming through in some market and financial indicators.  Our 13 indicators have moved in different directions, with two (cost pressures and deleveraging) indicating more inflation and two (lower growth and monetary policy) signalling lower. Table showing direction of travel for inflation  Current market estimates of inflation The current IMF forecasts for Advanced Economies are little changed, whether in the short term or five years out, at 1.9% (deflator measure, 1.8% twelve months ago) and 2.0% five years out (end period CPI, 1.9% twelve months ago).  Estimates for Emerging Markets over the next five years average out at 4.2% end period CPI at the same time, compared to 3.9% 12 months ago.  US consumer inflation, as measured by the Personal Core Expenditure (ie. ex food and energy) was 2.2% in November 2018 (2.1% a year ago).  It peaked mid-year at 2.9% and has been falling back since. Conclusion In our view the final ditching of fiscal austerity, combined with the levels of debt in the West and an increased level of political dysfunction, bakes in higher inflation in the longer term.  However, in the short term the forces may actually be pulling in the other direction: we believe that the ECB and the Federal Reserve are on the verge of making a policy error by running too tight a monetary policy and economic growth has probably peaked this cycle.  That may be what market indicators, and particularly bond yields, are telling us. If you would like to discuss anything in this article with the author, please contact us.​

William Bourne attends LAPFF Annual Conference

On 6th - 7th December 2018, William attended The LAPFF Annual Conference in Bournemouth.

What elements are needed for good governance over shared services?

All the eight asset pools mandated by the Government are now up and running, which is a tribute to the hard work of many people within and outside the LGPS.  There is an accompanying drive to share other non-investment services in order to gain economies of scale.  It is a sad fact of life that some of these ventures will succeed, while others will run into problems.  This is where good governance structures are essential. Delineation of the different bodies - where interests overlap, where they are aligned and where they are less so - is the first requirement.  The Government is about to launch a consultation over whether to separate funds from administrating councils.  This would be a move in the right direction but there also needs to be recognition that even services with shared interests are not always aligned. For example, the pension fund may wish the emphasis to be on service quality, while the council’s focus is on saving money.  In the case of the pools, which are in most cases separate entities, Board members may have their own agendas which diverge from their customers.  There should always be a service level agreement between the fund and service provider, both to set out expectations and a process for resolving conflicts and problems such as non-performance.  Key Performance Indicators (KPIs) are an important monitoring mechanism but on their own insufficient.  In the private sector sanctions tend to be imposed or the relationship is terminated if the service-provider fails to meet the agreed targets.  With shared services identifying effective ones is more difficult.  Any financial penalty ends up penalising either the pension fund member or the local tax-payer.  Termination is difficult, perhaps impossible, if the shared service has been agreed at council level or, as with the pools, is the result of a Government directive. There are two other vital elements of good governance over these complex relationships.  The first is a body with clear powers to effect change in the event of non-performance, whether that be to terminate the relationship or to replace senior management.  The second is sufficient resources to achieve this in practice. Most of the pools have put the elements described above in place, albeit they are so far untested, and the funds are in many cases short of governance resources.  However, my big question is whether the shared service arrangements which MHCLG is encouraging are doing the same. Find out more about our services here.​

William Bourne attends East Sussex Pension Fund Employer Forum

On 23rd November 2018, William attended the East Sussex Pension Fund Employer Forum.