Based on MPI’s Annual Trustee Compensation and Governance Practices Survey, we believe that 25% of the sitting mutual fund board directors will retire or step aside due to fund mergers in the next five years. As a result, many Fund Boards will need to recruit new Trustees during this period. These Boards will go through the process of identifying gaps in their skill sets and then seek to add new directors who fill their needs. This bulletin hypothesizes that most of these new board members will have profile which resembles a “T”. In short hand, this means board and wise on top but with a functional skill which accompanied by those of the other Board members provides the capability to meet the challenges of the next 5 to 10 years.
Filling the Needs Gap
The first step is to inventory the current board skills. Probably the best way to do this is to utilize the annual self-assessment process, which all fund Boards are obliged to conduct. It is important to not only assess skills, but also to solicit functional preferences and to gauge the availability of time and commitment.
The second step is to forecast retirements. Usually a Fund board will have adopted a retirement age and the necessary changes will be determined by these. In addition, many Boards have rotation rules. In which case a vacancy may be opening up in any of the Committees or indeed in the Board Chairmanship.
The third step is forecast the challenges which the fund family is likely to face in the next five years. The recruitment of a new Board member is a process of looking through the front windscreen and not in the rear view mirror. It may well be that a fund Board is perfectly constructed for today’s environment but will be unsuited for tomorrows. The challenges are always changing: they may be advent of liquid alternatives, the increasing complicated distribution process, SEC regulatory vigor and reliance on fund directors and compliance officers, the adoption of ETFs or leveraged closed-end funds and the increased use of derivatives.
The fourth step is to determine trustee search criteria and a process which is designed to find the most suitable candidates. Long gone are the days of finding the new director at the country club or adjoining board room. We have found that the ideal new director candidate is likely to have a “T” profile.
The Top of the “T”
Twenty years ago the top of the “T” might have been the only criteria for a new fund director. Wise, sensible, good common sense, polite, well educated, collegiate, collaborative and compatible. Diversity is a consideration: usually this implies diversity of thought which may be evidenced by age, gender, race, geographic location
Above all a fund director must not be conflicted. Independent counsel will closely monitor any affiliations or investments a potential director has. For a fund family with many sub-advisors the exclusion zone can be very extensive not only for the candidate, but also for any member of his or her household. This can be a major consideration when deciding about a new fund director.
Today the availability of time needs to be added. Being a fund director of a mid-sized fund complex requires about 200 hours per year to attend and prepare for meetings. And the time commitment does not automatically come in a neat quarterly basis. Today, many decisions may be needed on an ad-hoc basis, especially if the management company is often adding, closing or merging funds.
Closely allied with the time availability criteria is the absence of conflicting priorities. A fund director needs to be available. Serving too many other boards, whether corporate, fund or not-for–profit may make being available for the fund board problematic. Many of the boards of large fund complexes will not consider a candidate who is serving another fund complex.
Another general criteria for a new fund director is that he or she have empathy for the investor. After all, a fund director’s job is to represent the interests of the fund shareholders. A general understanding of the financial industry is also important especially as the products offered by fund companies are becoming very complicated. A former executive of a different fund company may well be a good candidate, but during the interview process be sure to ascertain if the candidate has “crossed over”. This means, has he or she mentally given up the role of managing and adopted the quote different role of governing.
The Tail of the “T”
The specific skill, expertise or interest of the candidate is represented by the tail of the “T” and will usually reflect the skills gap identified in the criteria setting process.
Over the past 15 years, the skill set most often required in the tail of the “T” has changed. Immediately Sarbanes Oxley with its requirement for a Chief Compliance Officer reporting to the fund Board, expertise in legal, regulatory and compliance issues became dominant. When fund boards were required to have an Audit Committee Financial Expert, knowledge of fund accounting became dominant. In recent years, more and more derivatives are being used in fund portfolios and experience with these types of securities became important.
Today many fund groups are offering “liquid alternative” investments as a way to reduce volatility and experience with these has become important. When the Jones vs. Harris decision placed great emphasis on the board’s understanding of the prospectus, former securities lawyers became desirable for fund boards. The SEC has placed much emphasis on distribution and how fund supermarkets are compensated. This has emphasized the importance of fund marketing skills.
In sum, the concept of a “T” shaped fund director has become an important way to think of the trustee search criteria.