Northwood Family Office on Asset-Liability Management

FOR IMMEDIATE RELEASE

Despite the painful lessons of history, many investors are still too focused simply on maximizing returns and not enough on identifying and managing the liabilities they are exposed to, highlights Tom McCullough, President & Chief Executive Officer, Northwood Family Office. He considers Asset-Liability Management (ALM) key to mitigating risks and achieving desired outcomes.

The Chairman at the upcoming marcus evans Canadian Institutional Investment Summit 2011, in Gatineau-Ottawa, Canada, October 17-19, McCullough discusses why Canadian family offices and foundations, as well as institutional investors, should embrace ALM, and why it is essential to identify the objectives of the end client.

Why should Canadian institutional investors put Asset-Liability Matching into practice?

Tom McCullough: ALM is about taking a holistic view of the fund and of the end clients’ needs. It does not focus solely on the asset side of the balance sheet (i.e. how investments perform), but also on liabilities and what the fund requires.

While ALM has been gaining a footing in the institutional world, the idea of ALM in the private wealth and foundation arenas is fairly new, and is a very positive development. It is important for investors to focus not on the amount of wealth they have or on quarterly returns, but on identifying their objectives and increasing the probability of meeting those objectives with the lowest possible risks.

The good news is that there is increasing recognition that there are real liabilities at the other end of the pipe - wealthy families with spending and legacy requirements, charitable organizations counting on foundation funding and retirees who depend on their pension income.

What are the challenges involved in using this approach?

Tom McCullough: Plan sponsors and private clients can be schizophrenic in their attitude toward an ALM approach. When the return environment has been poor and funding deficiencies loom, they want to de-risk their portfolios and ensure outcomes. But when things begin to improve, they are loath to fall too far behind the benchmarks and can reject ALM’s ‘governor’ role on the portfolio’s risk structure.

Also, liabilities can be difficult to forecast. On the pension side, increased longevity is a challenge. People are living much longer than they used to, so liabilities are increasing at a faster rate than initially expected. From the private client perspective, families (and their spending needs) typically grow exponentially, whereas investment returns grow on a linear basis. This can create a funding gap in the private wealth portfolios.

Having said that, despite the difficulties in forecasting liabilities, I believe they are actually easier to forecast than asset returns, which is still the basis of most pension fund, foundation and private client portfolio management. As GMO’s James Montier, says “investors are hopeless at forecasting (asset returns), yet it remains at the heart of the investment process”.

What can large institutional investors learn from your family office experiences?

Tom McCullough: Well, the good news is that we can all learn things from our colleagues in various disciplines within the investment management industry. Private wealth managers tend to be very close to the end clients. It helps us remember that there are real people behind all the work we do; people who are counting on the money we manage for them. Also, many of the behavioral finance lessons learned in the private wealth field (i.e. how normal people react in good and bad markets) are very applicable to pension fund managers, as they deal with real people too (such as plan sponsors and investment committees).

On the other hand, the private wealth industry has better understood the concept of liabilities and requirement to ensure they are ‘fully funded’ from the pension fund managers. This is particularly important for private wealth holders since funding deficits cannot normally be made up by increased funding since they have no plan sponsor!

If you were to give one piece of advice, what would that be?

Tom McCullough: Understand and determine how much investment return is ‘enough’ to meet your clients’ (or beneficiary’s) needs.

Our society is oriented towards ‘more’ rather than ‘enough’. People quickly forget about risks associated with striving for ‘more’. ‘Once in a lifetime’ occurrences are not happening once in a lifetime anymore, but once every 20 years. The impact of loss can be significant and can dramatically affect the life and lifestyle of the end client. And we know that wealth holders have an asymmetric view of risk. They feel worse about losses than they feel good about gains.

So, not surprisingly, I am a big believer in finding ways to lower risks but also to manage the expectations of the wealth owners or beneficiaries, so that the target returns will be within reasonable risk parameters. That may be difficult in this competitive industry, but if we are really looking after our end clients it is vital and, in fact, it is our fiduciary duty.

Contact: Sarin Kouyoumdjian-Gurunlian, Press Manager, marcus evans, Summits Division

Tel: + 357 22 849 313
Email: press@marcusevanscy.com

Canadian Institutional Investment Summit 2011

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