Canada As The New Frontier
By: J-F Courville
The willingness to be on the frontier for the application of new financial concepts will serve Canadian pension plans and money managers well as the global investment world ushers in a new, more sophisticated age, says J-F Courville, of State Street Canada. Courville’s thoughts serve as the preface for Benefits and Pensions Monitor’s Annual Report on Global Custody. The directory, which starts on page 43, includes key contact information and a listing of services these custodians provide to their clients in Canada.
With its large, highly concentrated, and growing asset pools, Canada is one of the most fascinating capital markets in the world. Constraints on investing outside of the country have increased the level of sophistication needed to extract adequate returns from registered pension funds.
Moreover, the Canadian institutional investment marketplace is characterized by its high degree of sophistication, making this fertile ground for idea generation and for the application of new financial concepts. Even though the bulk of such innovations emanate from the larger U.S. and European markets, Canadian pension funds and asset managers are true trendsetters, always willing, for a host of reasons, to explore and adopt these new structures, processes, and concepts.
More Sophisticated Age This willingness to be on the frontier will serve Canadian pension plans and money managers well as the global investment world ushers in a new, more sophisticated age. This new era is defined by the pressures that created it. On the one hand, a lingering low return environment in traditional markets hangs over the global investment stage, jeopardizing the health of pension infrastructure globally. On the other, corporate accounting scandals and other financial misdoings, as well as the advent of more complex investment vehicles, have raised the level of regulatory scrutiny worldwide and have ratcheted fiduciary standards upwards.
To meet these higher standards, while increasing return potential, institutional investors have adopted a more structured, quantitative, and articulate approach to portfolio construction. Aided by the evolution in financial technology and investment philosophy, global investors can now achieve a better understanding of complex portfolio dynamics and construct superior asset allocation models.
Superior tools themselves do not lead to superior returns. Rather, asset managers and plan sponsors can develop a deep understanding of investment portfolios by using these enhanced tools. This is especially useful as investment professionals turn more and more to structured investment vehicles, using derivatives and alternative investments, such as hedge funds, which follow largely different return distributions.
In navigating these sometimes uncharted waters, institutional investors must be able to look to a small class of global integrated service providers – in particular those with a wealth of investment servicing experience – who are intimately familiar with a plan’s unique requirements and constraints and able to bring experience and knowledge of evolving tools and financial applications to the task.
The use of alternative vehicles is becoming more mainstream as a growing percentage of plans are including these as an increasingly larger share of their asset mix. Hedge funds alone have experienced such exponential growth that a recent study suggests they are moving out of the ‘alternative’ category of investments and will soon be considered a more mainstream asset class. The ramifications of this trend, in Canada and elsewhere, have spilled over to the custodian and across the entire investment process spectrum, and have put new demands on service providers, from the asset manager to the custodian. One result is that custodial services, for example, can no longer be viewed as stand-alone, but instead as one module of an integrated service provider’s offerings.
By offering an integrated menu of capabilities and expertise from which customers can select the service modules necessary to execute their fiduciary duties, providers can help plan sponsors better account for today’s more complicated portfolio structures. Sponsors increasingly demand such comprehensive services that span the investment process and embrace the newest technologies available. Yet, a close knit menu of complementary servicing capabilities is as rare as it is essential in today’s global marketplace.
That’s because these services are often pieced together with the seams showing and stitches missing. Rather, a truly integrated service provider will offer one face to the customer and shoulder responsibility for the integration work. This avoids a situation where parallel product delivery lines run from the service provider to the customer, never crossing unless the customer invests the resources necessary to make them intersect.
A true integration of services at the provider end leads to greater efficiencies and, more importantly, superior valueadded services for the customer. In today’s more sophisticated investment world, such a relationship ensures the customer’s needs are not only met, but anticipated throughout all stages of the investment process.
Regulatory Changes Complicate Picture
Not only is the custodian best positioned to understand a customer’s investment strategies, constraints, and liability expectations, but also the evolving risk and regulatory environment they face. This is particularly important in Canada today, where the regulatory system remains fragmented. The challenge posed by this regulatory patchwork and developments in Canada’s securities laws and requirements, as well as a drive toward improved transparency in the investment process, are regular topics of debate. The compliance requirements they will create in future – including disclosure of proxy voting for mutual funds – remain unknown but will certainly increase the reporting burden of asset managers.
As this new level of transparency arrives in the Canadian markets, custodians must be at the forefront of assisting institutional investors in meeting new requirements.
On the plan sponsor’s part, there is something to be gained by developing a collaborative relationship with a single integrated investment service provider with global expertise, ensuring a greater span of common intelligence and discretion.
In this changing environment, it makes sense for institutional investors to carefully select investment service providers based not only on cost and level of service, but also on a broad offering of capabilities and the industry expertise to surmount challenges and anticipate new opportunities.
Adding Value Versus Containing Costs
In such a complex world, it all comes down to making the right choice of financial costs. On the custodian’s part, it is essential to build increased service offerings into a sustainable business model that takes into account a declining fee environment. On the investor’s, there is balancing the value of additional services with the potential of increased costs.
Fund managers and plan sponsors also face higher demands due to increasingly sophisticated end customers and investment strategy processes. Combined with the need to process a startlingly immense amount of information in a competitive environment, this adds another layer of responsibility for those entrusted with fiduciary duties, from portfolio managers to pension plan board members.
Customers are exercising their right to expect more from their business partners and not just in terms of cost reductions, but from optimizing service delivery and valuable expertise that translates into real, quantifiable benefits to their end customers – the plan beneficiaries. With a better understanding of these inherent heightened fiduciary risks and expectations, the industry is sure to find a proper level where efficient and valued added service delivery is balanced against the most competitive cost structure.
Towards A Collaborative Relationship
The biggest change in today’s equation is the greater sophistication required to assimilate all the features that are available in structuring portfolios to achieve optimal performance and liability defeasement. This has set off a chain reaction that has affected the way institutional investors perform their roles and how financial service providers position their offerings. In this new environment, service providers must focus on providing an integrated family of product offerings that span the stages of the investment process – extending past traditional custodial tasks and tactical trading and rebalancing to strategic portfolio allocation and analysis.
This is leading to a very beneficial result for all – the development of a collaborative relationship model. By forming such a relationship with a global integrated player, pension plans and asset managers can position themselves to take advantage of a range of services and technologies without exposing their competitive edge. This will afford them discretion and the ability to rely on their partner’s knowledge base and scale as future challenges and opportunities unfold.
J-F Courville is chief executive officer of State Street Canada.
- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -