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Investment Commitees

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beleggings commissiesAlfred is a strategic advisory member of several investment committees of pension funds. But what is an effective investment committee? In this project sponsored by PGGM, the investment committees of Dutch pension funds were analyzed. What roles do they have, what can be observed about board room dynamics, how have they evolved and what challenges lie ahead? In depth case studies and interviews were held with pension funds.

Alfred Slager, Belegginscommissies.
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Could sensible changes hurt the pension funds’ license to operate?

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At a recent seminar of the Dutch Central Bank, organized for pension fund trustees, one workshop that I presented (in Dutch) dealt with the question of organisational changes in risk and investment management. There was a rather simple question to begin with: are the changes in domestic and international regulation random, or are there structural developments behind these changes? If the answer is random, then it makes sense for trustees to hold off major changes (pensions are long term decisions and not something to be trifled with in the short term), if they are structural, it makes sense to adapt, and implement those changes which are likely to last for a long time. My argument was that there are structural changes going on, which might not come as a surprise, but the end results might well be.
What are these changes? In a nutshell: the centerpiece of the argument hinges on pension funds increasingly being viewed as financial intermediaries. Pooling assets, performing asset transformation, acting as a delegated monitor. A clearer focus on the asset transformation then introduces risk management, which will be far more explicit in the years to come. After all, a pension fund knowlingly generates risks, and expects to be rewarded for it, but this implies that the design of risk management, its link to the goals, and the allocation of results due to generating these risks (to the sponsor, participants, pension fund) is somewhat of a higher priority than investment management. Which leads to the delegated monitoring function. Pension funds who have a clearer focus on what they want, and what the risks are, should be able to manage their investment managers more strictly, shifting the balance from the suppliers to the buyers (which is a good thing).

The devil is in the detail though. If a pension fund goes through all these motions, the end result might well be that it looks like, acts like and talks like a financial organization. Paradoxically, participants increasingly lose faith in the financial sector, as surveys indicate. This poses a dilemma, which is not unsolvable though. Trustees could acknowledge that their organisation should be run as a financial organisation, but definitely is not one, and make this visible in the way the investment are run, requiring trustees to speak out, and say what they do or do not like, with the preferences of the participants in mind. Think about debates like active and passive management, costs, long term investing, these are the kind of debates that ultimately determine whether a pension fund will be confused with an asset manager, or invests on behalf of its participants.

 

Challenging Investment Beliefs

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At the EPFIF (International Pension Fund Investment Forum) on September 4th, the theme of the seminar was challenging investment beliefs; critically questioning the conventional or self-evident truths.

My presentation focused on the challenging part. Investment beliefs are a tool to help you challenge conventional truths, thought out badly, or ignored, they become a challenge to the investment organization. Investment Beliefs is part of a broader approach to investigate and improve how we manage institutional investments. Is has to do with a simple question: what makes a fund a good investor? One of the things we observe when analyzing investment processes and how they are organized, is that no matter how large or complex the organization is, the major decisions are closely linked to a limited set of fundamental choices, where the organisation articulates how it views debates like active vs. passive management, risks, costs, or for example the role of diversification.

Writing down the major choices you have made in designing, and implementing the investment policy and processes that in your view is the best way to achieve the participants’ goals, are a sensible thing to do, and help discipling the decision making process. However, many organisations fail to do so. The presentation argues that trustees miss out on a valuable tool to manage the principal-agent relationship, because asset manager tend to have their own investment beliefs, which in the implementation of the investment policy might not always help the pension fund achieve its goals.
Unfortunately, there is no free lunch to be had. The presentation also draws attention to the decision making and implementation process. Investment beliefs can also challenge the design and performance of the organisation in a bad way. An organisation runs into trouble if beliefs and its investment process are based on one or more of the following reasons, such as adopting a beliefs system which are copied from leaders, without a real grasp why these beliefs matter. Finally, the presentation concludes with a number of observations on how funds have applied investment beliefs in a sustainable manner.

Exploring Executive Offices of Pension Funds – and why it matters

At the Benelux Pension Fund Roundtable, I discussed the role of executive offices at pension funds. Trustees steadily expand the staff and resources for these executive offices. However, we find that these offices (the Dutch term is “pensioenbureau”) come in different shapes and sizes. For example, do trustees need them to handle the increased complexity of coordination? This requires different knowledge than setting it up with the intention to provide counterweight to asset managers. Finally, some of the larger pension funds tend to concentrate all policy making activities within the executive office.

In the presentation, I do not favor one model, but raise concerns that when trustees are not quite clear about the model that they prefer, executive offices might grow without any restrictions, possibly even becoming counterproductive at some point. For example, how do you make sure that the incentives (or investment beliefs for that matter) of a large executive office is aligned with the trustees, instead of nudging towards the investment manager?
 

Working with investment beliefs

We regularly work with pension funds to clarify the investment philosophy, usually by debating the (existing) investment beliefs. This could be an interesting philosophical investment debate with no strings attached; but the relevancy to trigger such a debate is translating these into consequences for the investment organization and roles and responsibilities. The idea behind this is simple – well managed pension funds are better placed to achieve the best results for their participants (unfortunately, it is not a guarantee). This blog rounds up some of the observations we’ve made so far; the following blog will summarizes some workable guidelines.

Scenarios as a tool for investment strategy development (part 1)

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An investor with some (remaining) exposure to Greece, Spain or Italy would agree that we live in uncertain times. Predicting the future is a rather futile exercise, in response pension funds and investment managers are shifting towards the use of scenarios. Van Notten[1] wrote a very instructive chapter in an OECD Study on the use of scenarios. The word scenario has four different uses:

  • Sensitivity analysis, whether in cash flow management, risk assessment, or project management.
  • Contingency plan defining who is to do what during a particular event as used in military or civil emergency planning.
  • Contingency plan but applied to decision-making in corporate or public policy.
  • Scenarios as a more exploratory tool so that a scenario is less a strategy and more a coherently structured speculation, of interest for education.

On one point there is consensus: it is not a prediction or forecast. Pierre Wack[2], an executive at Royal Dutch who pioneered scenario planning, finds that “Forecasts are not always wrong; more often than not, they can be reasonably accurate. And that makes them so dangerous, They are usually constructed on the assumption that tomorrow’s world will be much like today’s […] forecasts will fail when they are needed most: in anticipating major shifts in the business environment that make whole strategies obsolete. […] The better approach, I believe, is to accept uncertainty, try to understand it, and make it part of our reasoning.”

Trichet’s high conviction speech

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Brilliant blog by Izabella Kaminski in ft.com/alphaville, finding strong similarities between Jean Claude Trichet’s swan song at the ECB defending the bank’s record, and Jack Nicholson as Colonel Nathan Jessup, delivering his speech in the courtroom to defend his decisions at Guantanomo Bay in “A Few Good Men. Another example where financial markets love decision makers and actors with high conviction. The speech also highlights the power of compelling story telling.

10 Tips for Crisis Management

Pension funds experienced an uncomfortable déjà-vu when financial markets appeared to be heading towards a new abyss last week. Somehow, markets rebounded but experts fear that there might be worse to come. Business leaders and investors increasingly voice their concerns that politicians are mishandling crisis management. Are investors themselves able to effectively deal with financial crises? A number of pension funds seem to be better prepared in recent weeks, some of them seemed at a loss to act. 10 Tips for crisis management, some borrowed from other disciplines, some new.

Mauboussin – the short version

An MBA student fortunate enough to follow Michael Maboussin’s lectures jotted down the key messages in this blog by Frederica Zaldua. To give a flavour: “Investment outcomes combine skill and luck. Acknowledge the substantial role of luck. We’re all aware of it, but we still underestimate its significance.” In my view, Michael Mauboussin should be required reading for institutional investors, especially “More Than You Know: Finding Financial Wisdom in Unconventional Places”. Importance of design and implementation of the investment process over outcome is still a novel concept in the investment industry, and rarely taught in classrooms and post graduate investment analyis courses

Top investment strategies – Being in tune with today’s investment needs

With the US donning a double-digit unemployment rate and the federal debt level spiraling out of control, more and more people are getting bored of their corporate cubicles. With jobs slashing down and wages going through massive cuts, people are finding it extremely difficult to make ends meet with their restrained finances. During such times, investment can make you breathe a sigh of relief as it gives you a worthy source of income that can be used to seek debt relief in the US. But, are you well aware of the investment strategies that can guarantee best returns? If you’re a novice in the field of investment, you can read on to know about some promising tips that you must consider before taking the plunge.

Best Practice Termination of Investment Mandates

Whenever Charles Ellis writes, I take notice. His classic book “Investment Policy: How to Win the Loser’s Game“ was for me the definitive eye opener. Starting out in the investment industry, managing mandates while working through several investment courses, the central ideas hinged on portfolio optimization, efficient frontiers and new innovative instruments. The implicit paradigm: let investment managers do their work, it’s after all a very technical business and client satisfaction eventually follows. Charles Ellis was – and still is – one of the authors who redresses the roles. He writes from the viewpoint of the client, who owns the responsibility for formulating and assuring implementation of investment policy. Truly understanding his own objectives, the characteristics of the financial markets, and work out this knowledge in investment objectives that should be pursued in a disciplined manner. Sounds elementary, but failing to do so haunted pension funds considerably over the past years.

Prospect Theory and Pension Funds

Interesting interviews with Daniel Kahneman were recently posted, about prospect theory and other key developments in behavioral finance.

According to Thayer Watkins, Daniel Kahneman and Amos Tversky coined the phrase “Prospect Theory” for their studies of how people manage risk and uncertainty,  “for no other reason than that it is a catchy, attention-getting name”. Kahneman and Tversky demonstrate that people’s attitudes toward risks concerning gains may be quite different from their attitudes toward risks concerning losses. When choosing between profit opportunities, risk aversion prevails. On the other hand, when confronted with loss making alternatives, people often choose the risky alternative. Although prospect theory is a few decades old, there is still plenty of ground to be covered for pension fund and institutional investors. Just some hypotheses based on prospect theory that need to be explored:

  • An active manager with positive alpha will become risk averse, locking in his profits, while the opposite is true with negative alpha. If this this is the case, then prospect theory is a more intuitive explanation of the disappointing results for active managers. In the selection and monitoring of active management this should be a key element.
  • Pension fund trustees, when confronted with underfunding, will increase their risk instead of downscaling it. It would therefore make sense to make the risk budget for a pension fund board rules based, with an inverse relationship between cover ratio and risk budget. This is however still the exception, rather than mainstream.

If you have more suggestions on how to fruitful explore prospect theory for pension funds, please let us know!

Emerging beliefs

One of the key messages of the book Investment Beliefs that Kees Koedijk and I wrote, was the importance to articulate your views on how financial markets work. However much we’d like it to be, investing is not a hard science, and academics bicker over the most fundamental tenets of portfolio management. This shifts the burden to investment managers and trustees who simply have to make choices and formulate their beliefs on how the markets work. In our book, we covered beliefs such as risk premia, investment horizon, sustainability, costs, risk management. This is not a complete list. Markets develop, innovate and shed old ideas. Once you start thinking about beliefs that dominate the investment debate, the list tends to grow.

Training for the stress test

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Stress testing with scenarios is in vogue. The Financial Times reported that European banking regulators plan to introduce a tougher stress test process as part of a new mechanism to force recapitalizations of banks[1]. How useful is the tool for pension funds?

Deciding whether to manage your fund active or passive

This week, the LDI (Liability Driven Investments) Congress 2011 was hosted in Amsterdam, were I was invited to hold a small talk on the enduring active vs. passive management debate. The presentation covers familiar grounds. Several attendees were interested in the final sheets, where I attempt to arrive at a practical checklist. Definitely something to expand in a future blog.


How long, and how consistent should you hold on to a conviction?

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That’s the million-dollar question in any industry, but definitely a billion-dollar question in the investment industry. Jeremy Grantham of GMO makes an excellent case in point. He has a conviction, and stood by it. Jeremy helped co-found Grantham Mayo Van Otterloo (GMO), a Boston-based asset management firm, one of the largest managers of such funds in the world, with more than US $104 billion under management. Grantham’s investment philosophy can be summarized by “reversion to the mean.”

Benefits of developing investment beliefs

by Kees Koedijk 0 Comments

Which company makes it its mission to inspire moments of optimism and happiness, to create value and make a difference? Unfortunately, not a pension fund. This is the mission statement from Coca-Cola. However, the largest pension funds are aspiring do something similar – writing up their investment beliefs and strategy and communicating them. More pension funds should follow their lead to improve investment governance and long-term performance.

Jelle Mensonides on risk management

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The assets of pension funds have plummeted during the crisis. With a huge drop in both share prices and interest rates, liabilities of the pension funds went up dramatically as well. Many funds got into serious trouble, and needed to come up with emergency measures. Jelle Mensonides, financial advisor and former CIO of investments at ABP pension fund, explains what led up to these problems and moreover what lessons pension funds should learn from this. Many failed to properly asses all risks, as they mainly approached the problem from the investment side.