Towards More Effective Investment ManagementDocument Transcript
A Discussion Paper
Towards More Effective Investment Management
Prepared by the
General Synod Financial Advisory Group
1. Introduction 2
2. Major asset classes, their returns and associated risk 3
3. The principles of asset allocation 7
- Objectives and time horizons
- Risk tolerance
- Current and future needs
- Investment constraints
- Consolidation of investment funds
- Decision making and oversight
4. Constructing an investment portfolio 10
5. Evaluating and reviewing investment managers 12
6. Fees and charges 14
7. Possible investment portfolios 15
The Terms of Reference of the General Synod Financial Advisory Group (the
Advisory Group) include:
“ (vii) To provide recommendations to the Dioceses which will assist them in
the management of their finances and assets, including when necessary on
appropriate organisational and decision-making structures;”
The Advisory Group has received several approaches from Dioceses over the past
couple of years concerning the adequacy of investment returns. While the assets and
investments of Dioceses vary greatly, the effective management of those assets and
investments will be important to all Dioceses. And the general principles upon which
their effective management should be based are likely to apply regardless of size.
At a time when many Dioceses are being challenged by declining congregations and
income, this can make a critical difference to the ability of a Diocese to provide
adequate resources to achieve the goals it sets for its Christian mission.
An earlier discussion paper issued by the Advisory Group emphasized the need to
prepare accurate and comprehensive financial accounts to facilitate the effective use of
limited Diocesan resources (Financial Reporting by Dioceses & The Application of
Australian Accounting Standards, August 2001); early this year a framework for the
preparation of a ‘benchmark’ set of accounts was recommended to Dioceses. A
further discussion paper (Diocesan Key Performance Indicators, November 2002)
outlines ways in which information can be organized to enhance the ongoing
management of Diocesan finances.
This discussion paper sets out the general issues and principles involved in effective
investment management, and recommends how Dioceses can move towards this goal.
However, the Advisory Group is not a financial advisor and recommends that
Dioceses seek professional financial advice in this regard. The Advisory Group is
able to discuss the principles of asset allocation and investment oversight outlined in
the discussion paper, and is willing to use its best endeavours to facilitate approaches
to advisors or fund managers by individual Dioceses.
As with previous discussion papers, the Advisory Group welcomes comments from
Dioceses on this paper and the issues raised within it. Comments should be sent to:
General Synod Financial Advisory Group,
PO Box Q190,
QVB Post Office, Sydney,
2. Major asset classes, their returns and associated risk
The major asset classes considered by investors and their financial characteristics are:
Cash not only includes current bank balances but also securities that generally provide
a (relatively) stable capital value and current interest income. They are typically short-
term investments, with a low risk of loss of invested capital.
Corporations, governments and semi-government authorities issue fixed interest
securities generally referred to as bonds. They typically offer higher returns (or yields)
than cash, but when other interest rates rise, bond prices (or the capital value of a
bond) will generally fall in order to maintain comparable yields in the market, and
In addition to direct property investment such as office buildings, the property asset
class includes securities or units issued by companies, property trusts or property
syndicates. They in turn invest directly in physical properties. Some of these
securities are listed on the stockmarket and are called listed property trusts. Unlike
physical property, which can be difficult to sell quickly, listed property securities can
be readily traded on the stockmarket.
Shares (or equities)
Shares give an investor part ownership in a company (capital) as a well as a right to
receive dividends (income). Shares tend to be riskier, or more volatile, than other
types of investments. However, over time, shares have also provided higher returns
than fixed interest securities and cash. Within this asset class both Australian and
international shares are usually included when building a diversified portfolio.
Asset Classes Investment Perceived Risk Type of Return Examples
Cash Short term - usually Low Income; No Growth Cash management
up to 1 year in Capital trusts, bank deposits
and short term bank
Fixed Interest Short to medium Low to Medium Income; Some Treasury notes,
term - usually 3 to 5 Growth in Capital debentures, fixed
years interest trusts and
Property Long term - usually Medium to High Income and Growth Commercial, office,
5 years or more in Capital industrial, hotel and
retail listed property
Shares Long term - usually High Growth in Capital; Shares listed on the
5 years or more Some Income Australian and
In the context of more effective investment management, the key focus of attention
should be on the expected returns and the associated risks for each asset class.
Table 1 compares annual investment returns of each major asset class since 1984, and
with several types of diversified portfolios. Historically, shares and diversified
portfolios have provided higher long-term returns than exclusively income-generating
assets such as bonds and cash. When compounding is taken into account (as a result
of reinvesting at least some of each year’s earnings), these differences can create even
more substantial variations in total returns over time.
The period from 1984 to 1999 was particularly favourable for all asset classes, largely
because economies generally expanded and inflation and interest rates declined (both
in Australia and in most other countries). However, past returns may not be indicative
of future returns, although the pattern of returns is likely to continue in the future with
growth assets such as shares expected to have higher long-term returns, despite being
more volatile, than cash.
Because most investors wish to enhance the total return from their assets but limit the
risks from investing, and since no individual investor (or investment manager) can
accurately predict how each asset class will perform in the future, diversification of an
investment portfolio across all asset classes is usually recommended. The nature of
this decision, and subsequent changes to it, will largely determine the long-term
returns and volatility of any investment portfolio.
It is therefore important that any investor understands the broad nature of investment
risks and the trade-off between the risk and returns from different assets, even if it is
only to recognize the likely consequences of a ‘passive’ decision not to diversify.
In order to pursue higher returns, an investor must be willing to assume additional
risk. While shares and property securities tend to provide higher long-term returns
than cash, for example, they can also expose an investor to higher levels of risk,
particularly in the short run.
But time has a moderating influence on market risk – that is, the longer an investment
is held, the more likely that it will earn a positive return. Chart 1 compares the risk
associated with the major asset classes by displaying their range of returns for 1, 5 and
10 year periods over the last eighteen years. As can be seen, the range, or volatility, of
returns reduces over time for all asset classes, but particularly for growth-oriented
assets such as Australian and international shares.
Volatility of Major Asset Sectors - Range of Returns
Over 1,5 and 10 Year Periods (1 January 1985 - 30 September 2002)
% p.a. International
Cash Fixed Interest
1 5 10 1 5 10 1 5 10
1 5 10
1 5 10 1 5 10
Source: Vanguard Investments
Holding diversified investments across each of the asset classes can therefore
moderate the overall market risk of a portfolio. Unfortunately, no matter how well
diversified an investment portfolio, it is impossible to eliminate all risks. Some
important investment risks are:
• Inflation Risk - rising prices due to inflation can erode the real value, or
purchasing power, of invested funds. If an investment earns 6%, but inflation is
4%, the real return is only 2%. This risk is particularly relevant for cash
investments where the possibility of low, or even negative, real returns can be quite
high. Over long periods in the past, the higher returns from shares have outstripped
inflation by larger margins than either fixed interest securities or cash (Table 1).
• Market Risk - the risk that equity or fixed interest markets will decline in value.
The stockmarket is influenced by investors’ changing expectations of the economic
outlook as well as that for individual companies; and the fixed interest market is
influenced by expectations about official interest rates and inflation. For example,
during October 1987 the Australian All Ordinaries Index of share prices dropped by
42.1%; and, in the first half of 1994, the Australian fixed interest market dropped
by 6.4%, although in the following years both recovered strongly (Table 1).
• Specific Risk - investing in only a single security can increase the risk of loss.
Investors who own shares in just one or two companies are unable to offset the
risks of unexpected poor performance by those companies that a broadly
diversified portfolio would enable. Similarly, investors who believe that there is no
risk associated with government or government-guaranteed bonds can often be
disappointed if interest rates rise and the capital value of those bonds is reduced as
• Currency Risk - a change in the value of the Australian dollar will impact the
return on international investments, whether in shares or fixed interest securities. If
the Australian dollar appreciates as sharply as it has recently, then the total return
on the investment could even be negative for a time, despite a rise in the underlying
value of the asset. (This risk can be offset by currency hedging but at a cost).
These risks can best be managed over time by an investor through the clear
identification of investment objectives and time horizons, as well as effective
oversight of investment decisions.
There are many other risks that may not be foreseen but can undermine the
confidence of investors and disrupt markets, resulting in lower returns; the collapse
of major businesses (which can include financial institutions and therefore involve
the possibility of default risk for investors who may have apparently ‘safe’ deposits
with them), terrorism, war and disease are just some examples from past and recent
experience. In periods of extreme stress or crisis, all asset returns can suffer and
even the historical pattern of relative returns can be distorted.
3. The principles of asset allocation
Effective asset allocation comes from an understanding of the different asset classes
and the risks associated with investing in each. The most appropriate asset allocation
is unique to each individual investor, and based on a range of factors including
• Objectives and time horizons,
• Risk tolerance, and
• Financial situation.
Investment objectives and time horizons
In broad terms, investment objectives typically seek to maximize returns over some
period while controlling risks. Since there is no universal definition of risk,
investment objectives should seek particularly to identify and address those risks
specific to a Diocese.
In order to be effective, investment objectives must be communicated to and
understood by all interested parties. Within a Diocese this would include not only
those involved directly in the process of deciding and overseeing investments but also
those who bear the ultimate risk of their decisions. Effective communication requires
investment objectives to be:
• Measurable (quantified),
• Achievable (realistic),
• Clearly communicated (defined),
• Relevant (appropriate time horizons), and
It is also important that these objectives be reviewed as circumstances change. In the
case of a Diocese, for example, this might occur as a result of an unexpected reduction
in income as a result of changed economic circumstances that means the existing
balance between investing for growth or income will also need to change.
Understanding risk tolerance
There is no simple answer to how an investor’s risk tolerance will affect asset
allocation. It takes time - and some experience with investing - to understand and
accept risk, in particular the willingness to ride out short-term market fluctuations in
pursuit of long-term gains.
Investors with similar goals and time horizons could choose different asset mixes
depending on both their financial situations and views on risk.
Determining current and future needs
A Diocese’s current and future financial situation should always be considered when
deciding on an investment portfolio.
It is usually important to have access to some part of any investment portfolio for
“emergencies” or unexpected short-term expenses.
Where should short-term funds be invested? Bank deposits or short-term bank bills
can easily be converted to cash to cover emergency needs. While shares and longer
term fixed interest funds can usually be easily accessed, the greater volatility in their
market prices means that a capital loss may be incurred if circumstances require an
urgent sale of these assets.
Investors who do not have a suitable investment option to meet short-term cash
requirements often find it difficult to stick to their long-term investment objectives.
Having decided on the relevant investment horizon and made plans for emergencies, it
is necessary to consider the needs for capital growth and income over the longer term.
This would obviously be done within the framework of the goals and priorities for
Christian mission within a Diocese.
The appropriate time horizon will vary from Diocese to Diocese but, as for all
investors, the longer the time horizon the more short-term market fluctuations can be
accepted. Also, the longer the time horizon, the greater the market risk that can be
assumed as a trade-off for higher returns (see Chart 1 and Table 1). However, only an
investor who continues to monitor the progress of a portfolio over time will be able to
accurately assess the need for changes to its strategy when circumstances change.
The experience of the past year or so provides a very timely reminder in this respect.
While all investors suffered from the extreme volatility in markets, and the increased
uncertainty about the economic and political outlook, equities were particularly hard
hit. Investors in domestic and overseas shares experienced substantial losses in the
capital values of their shares, some of which have substantially recovered as a result of
recent strong rises in equity markets. Only those investors with well-developed short
and long-term objectives were likely to have made informed decisions about whether
or not to change their portfolios over this period.
All investors have some constraints that will affect their overall investment objectives.
In the case of most families, for example, it is ownership of their home, which despite
being their principal long-term asset, is often seen as a goal in itself and quite separate
from their “investments”.
For Dioceses, such constraints can include historic buildings, endowments and trusts
(especially those with specific conditions attached to their use), and ethical charters
that preclude investment in certain businesses or areas of economic activity.
Such constraints should be identified and monitored as part of the investment
oversight within a Diocese. In the case of ethical charters, they would be explicitly
incorporated into its investment objectives but in other cases, such as historic
buildings, they are often best managed separately from other investments.
The consolidation of investment funds
In most cases, however, it is preferable to consolidate all available funds into one
portfolio, which can then be invested in accordance with the Diocese’s objectives and
on the time horizons decided. Attempts to manage investments separately can often
lead to confusion in investment goals, particularly when a variety of small amounts are
involved, substantial inefficiencies in oversight and management, as well as an
unnecessary increase in fees and charges if managed by independent advisors.
Decision-making and oversight
There should be a clear process of oversight and reporting of the investments of a
Diocese, even those that may be regarded as ‘passive’ in nature. A particular example
of the latter is buildings and other church property, which, if they are to contribute
effectively to the mission of the church, need to be regularly reviewed not only in
terms of their physical condition and maintenance needs but also their appropriateness
to support specific mission goals.
An appropriately constituted Investment (or Asset Allocation) Committee might be the
most straightforward way to achieve such oversight. This process should include
senior Diocesan officials but can often benefit from the participation of outside
advisers who are able to add not only experience but specific expertise to the process.
A properly constituted Diocesan Audit Committee could also be an important
component of oversight within the Diocese (see the model Charter for Diocesan Audit
Committees that was endorsed by Standing Committee of General Synod at its
meeting on 9-11 November, 2002, and circulated to Dioceses later that month).
4. Constructing an investment portfolio
There are many factors which impact on optimal asset allocation, including:
Past investment performance is no guarantee of future results. In the 1990s, both
Australian and international shares recorded strong returns (Table 1). But many
commentators now argue that market price to earnings ratios are historically high,
meaning that shares appear overvalued. This would suggest that for the foreseeable
future, there could well be lower returns from shares. This paper does not attempt to
predict the future direction or strength of shares or other assets, but does recommend
that Dioceses should set realistic expectations for future returns and risks when
managing their investments.
When it comes time to invest, many investors hesitate because of fears of market
fluctuations. The risk associated with having a precise ‘market timing’ strategy
(picking the right time to invest) is high. Hoping to take advantage of fluctuations in
market values might sound ideal but, in reality, very few investors, if any, can
accurately foresee the short-term direction of markets. Investing over time on the
basis of sound objectives, and then ‘staying the course’, is usually a better long-term
investment strategy than attempting to second guess market timing.
Hints on Implementation
Creating an investment mix that suits specific needs will take careful consideration
and planning. Once a Diocese has identified an asset allocation (with or without
professional advice) that suits its long-term objectives, the next step is to choose the
investments within each asset class. Many Dioceses will find outside professional
advice the most effective way to build a diversified portfolio. That advice is often
included in the general advice offered by managed funds.
If a range of investments already exists, the assets should be listed at their current
values (and returns) and compared to the proposed asset allocation of the new
portfolio. Decisions can then be made about how to best adjust the mix of existing
investments by selling assets that are over-represented and/or buying those assets
needed to obtain the ‘target’ allocation.
Consideration should be given to using managed investment funds to build an
investment portfolio, particularly if investing for the first time. Managed funds are
based on a simple idea - investors put their money into a pooled fund, which invests
on their behalf in various securities according to the fund's stated objectives.
Benefits of managed funds include:
• Diversification - A managed fund may invest in a broad range of securities,
providing easy access to a diversified portfolio.
• Management - Professional managers monitor the funds on a daily basis, saving
time and money. Economies of scale often provide lower brokerage costs.
• Convenience - Managers provide regular statements and reports on all
transactions and investment returns.
• Liquidity - Investments in a managed fund may be readily sold.
5. Evaluating and reviewing investment managers
Generally, fund managers are assessed on the following criteria:
• Investment Philosophy
An investment manager’s investment philosophy represents the firm’s core set of
investment beliefs. Having a logical and defensible investment philosophy is a
prerequisite to being a successful investment manager. If an investment manager
cannot clearly explain its investment philosophy, it probably doesn’t have one.
• Organisational Issues
An examination of the quality and stability of the manager’s employees, how well
they work together, the stability of its ownership structure and the structure of
performance incentives for its investment professionals is essential, as is a review of
its total funds under management. However, depending on the manager’s investment
style, bigger is not always better (some management styles lose some of their
effectiveness once funds under management exceed a certain level).
• Investment Process
A review of the manager’s day-to-day investment process, including how it makes
investment decisions, manages currency (in the case of international investments), and
how individual stock decisions are made should also be undertaken.
Combining Investment Manager Styles
An investment manager’s style is the process the manager uses to make investment
decisions, and can be broadly characterized as passive or active (see the diagram on
the following page).
Different investment styles tend to excel at different times under different economic
and market conditions, and all investment styles may underperform at some time.
By combining a number of complementary investment styles in the one portfolio, the
overall return of a portfolio can be less volatile. Ideally, when one manager is going
through a period of underperformance, another manager who is performing well will
Reviewing an investment manager’s performance
Assume a managed fund sends out annual statements to its unit holders reporting an
8.5% a year return for the past five years. It is difficult, from this number alone, to
judge whether this is a satisfactory performance.
One way might be to compare the return with other managed funds. However, such
comparisons do not necessarily indicate now well a particular investment manager has
actually performed. Their returns might be higher, although largely as a result of luck
rather than the quality of their investment decisions (increasing the likelihood of
relatively poor returns in the future).
It is the comparison between the actual return from a managed fund (or portfolio) and
the return that could have been generated from the assets it has invested in that
indicates whether any fund has performed well, or not.
For this purpose investors and fund managers set benchmarks as reference points
against which to check their progress. A benchmark is useful provided the correct
benchmark is adopted.
Whatever benchmark is adopted, three questions need to be answered to assess
whether or not an investment return is “good”:
a) Where is the fund invested?
b) What are the benchmarks for each asset class?
c) Did the investment manager outperform or underperform those benchmarks?
6. Fees and charges
Professional investment management is not free. Hence, when considering managed
funds it is important to be aware of all the fees that are charged, as over time, they can
diminish total returns.
There are different types of charges an investment manager may charge.
Some managed funds have an upfront charge. Up to 5% of the amount invested is
provided for in most prospectuses for retail funds, largely to pay sales commissions to
the financial advisor. Alternatively, there may be an exit fee of up to 5% if
withdrawals are made within a prescribed penalty time, usually within three years.
For a wholesale investor, however, this fee can be substantially lower and of the order
of around 0.7%. While the size of investments to justify treatment as a wholesale
investor will vary between managed funds, Dioceses that have a portfolio of around
$500,000 will usually qualify as a wholesale investor.
Every fund charges ongoing annual expenses to cover both the investment manager's
costs and the costs of operating the fund - custody and accounting charges, legal fees,
GST etc. The Management Expense Ratio (MER) is the annual fees and costs
expressed as a percentage of assets.
To illustrate, the average annual MER for different managed funds is:
• Australian Share Funds - 1.78%
• International Share Funds - 1.95%
• Diversified Funds - 1.72%
• Cash Management Trusts - 1.04%
• Australian Fixed Interest Funds - 1.38%
(Source IFSA, August 2001)
7. Possible investment portfolios
The investment portfolio’s detailed below are examples only. They are provided as
general information about investments. Dioceses should seek professional advice
before making informed investment decisions.
Cash Capital Stable Balanced
Typical • Capital Guarantee • Beat Inflation • Beat Inflation
Investment • Beat inflation • Exceed average return of • Exceed average return of
Objective • Return matching Bank competitor funds competitor funds
Sources of • Yield on cash and short • Mainly income yield • Income from equities and
return term debt securities from fixed interest debt securities. Potential
securities. Small scope for capital gain or loss
for capital gain or loss
Typical Short Short – Medium Medium to Long Term
Investment Less than 1 year 2 - 5 yrs 5 – 15 yrs
Defensive 0:100% 30:70% 50:50%
Aust Equities Cash
10% Aust Equities
Intl FI Intl FI
Intl Equities 20%
Aust FI 7%
Cash Aust FI
Growth High Growth
Typical • Beat Inflation • Beat Inflation
Investment • Exceed average of • Exceed average of
Objective competitor funds competitor funds
Sources of • Income from equities • Some Income from
return (dividends) and fixed equities. Large potential
interest securities. for capital gain or loss
for capital gain or loss
Typical Long Term Long Term
Investment 10 – 25 yrs 10 – 25 yrs
Defensive 70:30% 100:0%
Intl FI 5%