Achieving Investment Excellence

About the Authors xiii Acknowledgments xv Foreword xvii Introduction 1 Levels of Excellence: Assessing and Improving Your Practice 6 How to Use the Book 8 Chapters of the Book 9 Part One Pension Funds: Understanding the Role, Shaping the Mission Chapter 1 The Role of Pension Funds, and the Role of Boards 19 The Role of Pension Funds 20 The Pension Triangle 22 Duties of Trustees 24 Responsibility as a Fiduciary 26 Delegation and Agency Relationships 27 Responsibilities as a Board Member 30 Responsibilities as a Shareholder 31 Balancing the Three Roles 31 Understanding and Managing Your Stakeholders 32 Government 32 Regulator 32 Financial Markets 33 Non-Governmental Organizations 34 Endnotes 34 Case Study—GEPF 36 Chapter 2 Developing Purpose, Mission, Vision, and Goals 39 The Functions of a Pension Fund 41 Purpose 44 Mission 45 Values 46 Vision 49 Strategic Goals 50 Endnotes 51 Part Two Designing the Process Chapter 3 Grasping the Investment Essentials 55 Investment Goals 56 Understanding Return Concepts 57 Return 57 Expectations 57 Understanding Risk Concepts 59 Risk is not Volatility 60 Risk Premium 61 Getting Risk Measures Right 62 Risk Is about Behavior 63 Steering Your Portfolio 64 Benchmarks 65 Diversification 66 Conventional vs. Alternative Assets 67 Active vs. Passive Investing 68 Better Beta: Styles and Factors 70 Responsible Investing 70 Motives or Mission 71 Instruments 72 Endnotes 72 Case Study—PFZW 74 Chapter 4 Investment Beliefs as Guiding Tools 77 Why Investment Beliefs Matter 78 Basics of an Investment Belief 81 Developing a Set of Investment Beliefs 82 When, If Ever, Is the Time to Change Investment Beliefs? 83 How (Not) to Use Investment Beliefs 87 Endnotes 88 Case Study—New Zealand Superannuation Fund 90 Chapter 5 Designing the Investment Management Process 93 The Investment Process 94 Setting Objectives: Aligning Goals and Risk Appetite 95 Investment Objectives 99 Formulating Expectations 100 Portfolio Construction 101 Implementation and Monitoring 103 Implementation 103 Monitoring 103 The Investment Policy Statement 105 Endnotes 108 Chapter 6 Organizing the Investment Function 109 Inventorizing Investment Models 110 Model 1: Traditional Asset Allocation Model 112 Model 2: Endowment Model 112 Model 3: Factor Allocation Model 114 Model 4: Opportunity Cost or Reference Portfolio Model 116 Model 5: Dual Strategic/Operational Benchmark Model 119 Model 6: Risk Parity Model 120 Developing Your Own Investment Approach 122 Endnotes 123 Case Study – GPFG 124 Part Three Implementing the Investments Chapter 7 Implementing the Investment Strategy 129 Organizing the Implementation 130 The Rationale for Managing Costs 132 Selection of Managers 134 Active vs. Passive Management 136 Internal vs. External Management 138 Relationship with Suppliers 139 Bridging the Implementation Gap 141 Endnotes 142 Case Study—ATP 144 Chapter 8 Building the Investment Portfolio 147 Framework for the Investment Portfolio 148 The Board’s Role in Portfolio Construction 151 What Is a Good Investment Portfolio? 152 Capital Market Assumptions 156 Diversification 157 Rebalancing 160 Endnotes 160 Case Study—OTPP 161 Chapter 9 Monitoring and Evaluation 164 Monitoring 165 What to Monitor? 167 Monitoring as a Multidimensional Process 168 Monitoring the Policy 169 The Position of Monitoring on the Investment Committee’s Agenda 170 What Is the Optimal Frequency for Monitoring? 171 Monitoring Should Be Based on a Sound Approach: It Should Never Be a Mechanical Exercise 171 What to Look for in Monitoring 171 When Does a Board Move from Monitoring to Evaluation? 175 Evaluation 176 Endnotes 178 Part Four Organizing the Board Chapter 10 Becoming an Effective Board 181 Responsibilities of the Board 181 Board Composition 185 What is Expected from Board Members? 187 What is Expected of the Chair? 188 Appointing New Board Members 189 Governance Budget of the Board 191 Board Decision-Making Culture 193 Supporting the Board: Executive Office and Staff 194 Ingredients of an Effective Board 197 People and Board Composition 197 Process 198 Perspective 198 The Right Altitude, Horizon and Distance 198 Power and Delegation 198 Learning 199 Endnotes 199 Case Study—CalPERS 200 Chapter 11 Establishing the Investment Committee 203 Roles and Responsibilities 204 Advise the Board on an Investment Policy Statement 205 Evaluate the Managers’ Performance and Take Appropriate Actions 205 Document the Investment Process and Decisions Made 205 Members of the Investment Committee 207 Forming an Effective Investment Committee 208 The Role of the Chairman of the Investment Committee 210 A Model for an Effective Investment Committee Meeting 210 The Investment Committee Agenda 211 Committee Preparation: Quality, Clarity and Timeliness and Extent of Materials 212 Roles 213 The Results of the Meeting 214 Evaluation and Learning 214 Endnotes 215 Chapter 12 Managing the Investment Management Organization 216 The Roles of the Investment Management Organization 217 Functions and Typical Evolution of the IMO 219 Outsourcing 222 Subsidiaries: Majority or Fully Owned by the Pension Fund 223 Pros and Cons of a Proprietary IMO 225 Issues in Dealing with an Investment Organization 225 The Service Level Agreement 227 Monitoring and Evaluating the Investment Management Organization 228 Endnotes 228 Case Study—Future Fund 229 Part Five Learning, Adapting and Improving Chapter 13 Learning to Decide and to Take Advice 235 Psychology of Decision-Making: Biases, Preferences, and Habits 236 Group Processes on the Right Track 241 Learning to Make Complex Decisions 243 Using Expert Opinions 245 The Investment Consultant 247 Challenges and Dilemmas in Taking Advice 249 Decision-Making under Pressure 251 Endnotes 254 Chapter 14 Achieving Investment Excellence 255 The Five Activities Driving Towards Excellence 256 Activity 1: Setting the Strategy (Chapters 1–2) 257 Activity 2: Designing the Investment Process (Chapters 3–6) 257 Activity 3: Implementing the Investments (Chapters 7–9) 259 Activity 4: Organizing the Board (Chapters 10–12) 259 Activity 5: Learning to Adapt (Chapter 13) 261 The Learning Board and the Characteristics of the Levels of Excellence 261 Leadership 262 Resources 262 Mind-Set and Culture 262 Measures and Scorecards 263 Maintenance and Education 264 Levels of Excellence and the Board Learning Perspective 264 The Board’s Journey towards Achieving Excellence 264 Step 1: Determine Where You Are Now 264 Step 2: Define Your Long-Term Ambition 266 Step 3: Define the Roadmap 266 Step 4: Execute the Roadmap 267 Enduring Investment Excellence 267 Endnotes 269 Self-Reflection Questions 270 Appendix A 282 Appendix B 284 References 293 Index 301