The Decision to Insource Asset Management
There are real advantages to having someone else do the investing for you if you are not an expert on the subject. Pity the poor 401(k) investor who has to struggle with the right asset allocation. He typically does not have the constitution to control his emotions in investing; fear and greed overcome many institutional investors. What can the poor guy do?
- He could get some advice, and then, “set it and forget it,” with occasional rebalancing.
- He could learn about investing and try to lean against the wind.
- He could flounder — that’s the default option.
- Even just investing in a balanced fund is better… one fund does it all.
- Even a money market fund might beat the guy who naively tries to time the market.
But what of a local municipality? I’m sure some municipal Treasurers look at Florida and ask, “What if that happened here? What would I do? Should I try to manage the money internally?”
That’s a tough decision, and one that should be approached slowly, having discussions with all interested parties. One main idea that I would put forth here is that it is not an on/off decision. Let me explain.
In general, the best mergers are little ones, where a larger company acquires a smaller one that gives them:
- Access to a new market for existing products
- Access to a new technology that makes existing products cheaper or better
- A new complementary product
- A new geographic region to sell in.
- Etc.
The same is true of deciding to insource investment management. It does not have to be done all at once. Start with something simple and near to you, like cash management. It might require the hiring of one new person with expertise, or hiring one new firm that would do it in the place of the existing relationship. That initial move can enable later moves in other asset classes. The idea here is to be incremental, build up expertise slowly, and analyze competitive advantage. It may that:
- The existing investment pool is on net better than an external manager, or what could be done internally.
- We are large enough to hire an internal professional to manage it, earning better returns after expenses.
- The external manager has resources that the existing pooled arrangement can’t touch, and is better than an internal arrangement can do.
The answer will differ by municipality, but the question should be asked. Now, there are spillover benefits from having investment professionals on staff; they can be internal consultants on other investing questions. “Should we enter into this swap agreement, together with the municipal bond we are floating?” “What do you think the best borrowing option is for us at present?” “What do you think about the managers of our defined benefit plan?” And there are more questions like that. You would not think to ask them unless you had someone on staff that you thought could answer it impartially, and competently.
As for my own experience, I have been that internal consultant at many of the firms at which I have worked. And it helped the businesses, because they trusted someone that they knew. With that, I simply close by saying look at your existing investment relationships, and test them against a different third party relationship, and managing internally.
