Embracing an Enduring Investment Approach to Thrive in the Long Term - Presentation by Philippe Desfossés at the European Pensions & Investments Summit

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For more information contact: emailus@marcusevans.com …

For more information contact: emailus@marcusevans.com

Philippe Desfossés delivered his presentation titled "Embracing an Enduring Investment Approach to Thrive in the Long Term" at the European Pensions & Investments Summit 2012.

Join the 2015 Summit along with leading regional pension investors and global asset managers in an intimate environment for a focused discussion of key new drivers shaping institutional investment strategies today.

For more information contact: emailus@marcusevans.com


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  • 1. EPI Summit 2012Embracing an enduring investment approach tothrive in the long term Sustainable growth / intergenerational fairness / Responsible investment 09/05/2012 Sustainable growth / intergenerational fairness / Responsible investment www.rafp.fr 1
  • 2. We did not accept to pay the right price for the social security we enjoyedDeveloped countries set up Social Security systems in a veryspecific and favourable environment Continued growth Favourable demographyThe environment has changed and is less favourable. SocialSecurity financing is not balanced Financing gaps have been « covered » by debt The « bill » is transferred to future generations 09/05/2012 Sustainable growth / intergenerational fairness / Responsible investmentwww.rafp.fr 2
  • 3. Something we are sure of : retirement is getting more and more costlyWe cannot live longer, keep the same length of working life pay the same contributions, and get the same benefits Something has to giveThe way retirement benefits are managed is neutral in regard to demographic constraints: Retirement is always paid out of the National Revenue It’ll always be people working and contributing who will pay for those who are retired. In 30 years For fully funded schemes, their assets will be worth… what economic agents working at that time, will be ready and able to pay to buy them, For PAYG schemes, social contributions will be determined by the total amount of the salaries paid to workers. 09/05/2012 Sustainable growth / intergenerational fairness / Responsible investment www.rafp.fr 3
  • 4. An inconvenient truth : most of the time retirement schemes are « unfair »Intergenerational equity and « sustainability » The technical yield of a retirement scheme or « how much I get for how much I contributed » The notion of « Implicit life expectancy » or how long will it take for my « recouping » my contributions.Assuming an observed life expectancy of 25 years (after people have retired at 62), how can we call a retirement scheme, in which, to recoup your contributions, it takes : 40 years, or for an opposite situation 10 years.If implicit life expectancy is lower than « observed » life expectancy, what can we conclude? 09/05/2012 Sustainable growth / intergenerational fairness / Responsible investment www.rafp.fr 4
  • 5. Why is sustainability so at the core of all the big issues we have to addressFor a retirement scheme, « sustainability » means not to distribute benefits that are paid by the « sacrifice » of the young contributors."Sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs » . (Bruntland report 1987) Being optimist, one can estimate it takes 50 years for an oak to grow What % of the forestry can be harvested every year? What happens, if one harvests 10% of the forestry every year? 09/05/2012 Sustainable growth / intergenerational fairness / Responsible investment www.rafp.fr 5
  • 6. Over optimistic assumptions and enduring investment ? 10 yearsLiabilities have been “underpriced” Retirement benefits too generous €1000The higher the discount rate the Discount rate :cheaper the cost 7% € 484What happens if the actual rate ofreturn is much lower than the discountrate Investment return rate : 3,5% € 684 If the actual return is 3,5% (vs. an expected return of 7%), I am short by 200 09/05/2012 Sustainable growth / intergenerational fairness / Responsible investment www.rafp.fr 6
  • 7. Can you be responsible when you overestimate expected returns? Public Pension Funds (USA and UK) Market Crash + Irrealistic assumptions = next bail out ? California Public Employees’ Retirement System, • expected rate of return of 7.75 percent* for the past nine years, and 8 percent before that, * It has just been reduced to ….7,50% • annual return during the decade from Dec. 31, 1998, to Dec. 31, 2008, has been 3.32 percent, and last year, when markets tanked, it percent, lost 27 percent (http://weblog.signonsandiego.com/weblogs/afb/archives/031711.html.) http://weblog.signonsandiego.com/weblogs/afb/archives/031711.html.) • Is the solution to add more risk? Discounting liabilities at too high a rate No choice but search for high yield High yield means high risks At the end overoptimistic expected return may lead to lower rates of return. 09/05/2012 Sustainable growth / intergenerational fairness / Responsible investmentwww.rafp.fr 7
  • 8. What should not happen anymore?SENATE THIRD READINGSB 400 (Ortiz)As Amended July 15, 1999Majority vote SENATE VOTE :35-0 PUBLIC EMPLOYEES 7-0 APPROPRIATIONS 15-6 -----------------------------------------------------------------|Ayes:|Correa, Briggs, Dutra,| |Firebaugh, Honda, Knox, |Ayes:|Migden, Cedillo, Davis, | |Hertzberg, Kuehl, | | CalPERS, however, believes they will be able to|| |Pescetti | | | |Maldonado, Papan, Romero, | |Keeley, Steinberg, | mitigate this cost increase through continued| | | |Thomson, Wesson, Wiggins, | excess returns of the CalPERS fund.| | | |Wright, Aroner || | | | ||-----+--------------------------+-----+--------------------------|| | |Nays:|Brewer, Ackerman, || | | |Ashburn, Campbell, || | | |Runner, Zettel | -----------------------------------------------------------------SUMMARY : Makes various improvements in the benefits provided tostate and school members of the Public Employees RetirementSystem (CalPERS). Specifically, this bill : Supporters further argue that: 1)The new retirement formulas provided by this bill mark the first significant improvement in retirement benefits for most state and school members in approximately 30 years. 2)The increase in liability for these new benefits can be funded by the excess retirement assets that have been generated through investment income and changes in actuarial assumptions resulting in no immediate increase in costs to the employer. 09/05/2012 Sustainable growth / intergenerational fairness / Responsible investment www.rafp.fr 8
  • 9. RAFP made 2 choicesTo put intergenerational fairness at the core of its management The advantages of the « Point system » (Régime en points) A « pricing » deliberately prudentThe choice to invest according in the respect of its own SRI Charter Values that coalesce the big issues that determine the passage towards sustainable development Why the Best in Class makes sense 09/05/2012 Sustainable growth / intergenerational fairness / Responsible investment www.rafp.fr 9
  • 10. From the cotisations to the pensions How are rights acquired? The contributions are declared annually by the employer and converted into points. The points earned by each beneficiary are based on the acquisition value, which is set every year. The total number of points acquired can be consulted on-line (www.rafp.fr). Year 2005 2006 2007 2008 2009 2010Acquisition value €1 €1.017 €1.03022 €1.03537 €1.04572 €1.05095 +1.70% +1.30% +0.50% +1% +0,50% A capacity to acquire points growing steadily 09/05/2012 Sustainable growth / intergenerational fairness / Responsible investment www.rafp.fr 10
  • 11. From the cotisations to the pensions How are benefits calculated? The amount of the annual pension payment is calculated by multiplying the number of points acquired by the service value, which is also set annually. * The minimum retirement age has been reviewed. Payments may only start after the age of 60*. The age at which it will be possible to retire – with a discount – will increase to 62 years by 2018 The entitlement is paid out in annuities, unless the number of points acquired is too low . Year 2005 2006 2007 2008 2009 2010Service value €0.04 €0.0408 €0.04153 €0.04219 €0.04261 €0.04283 +2.00% +1.80% +1.60% +1% +0,5% An increase of the service value above inflation A technical yield just above 4% is consistent with an observed life expectancy of 25 years 09/05/2012 Sustainable growth / intergenerational fairness / Responsible investment www.rafp.fr 11
  • 12. The founders of the Scheme defined a deliberately prudent pricingThe “pricing” rate is prudent 1.34% (management fees included) 1.04% (ex management fees)As the ECB aims at inflation rates of below, but close to 2% over the mediumterm and taking into account a political « committment » to maintain thepurchasing power of the retirement pensions The pricing rate in nominal terms equals 3,34%This rate Has sometimes been criticized for being “too” conservative Nows it appears just prudent Nominal rates in some countries are at historical lows Greek default questions the very notion of a “riskless” asset €1,000The return from the ERAFP portfolio has to be significantly higher than thepricing rate, since:  To be funded is not enough  Some reserves have€to be booked (morbidity tables drift, external shock, operational 635 risk)  An extra reserve to fund revalorisation of benefits. 09/05/2012 Sustainable growth / intergenerational fairness / Responsible investment www.rafp.fr 12
  • 13. ERAFP: a reasonable investorWhy can we say we invest soundly : • our reserves are « ironclad »  reserves have been calculated last year using a discount rate that can be qualified as prudent : 1,7% (3,7% with a core inflation of 2% per year); • our funding ratio is still high, since it remains close to 110 %, although  all the capital losses on the stock portfolio have been taken into account,  the impact of the Greek default has been booked; • our SRI policy is consistent with the way we manage the liabilities side of our balance sheet. As we invest for the very long term, sustainability is important. Provision technique et provision non technique au 31/12/2008 (évaluations) en M€ Sensibilité de la provision au taux dactualisation (100% pour Taux de sur-couverture 6500 en m€ PNT au 31/12/2008 Provision technique (EG) PT au 31/12/2008 1 2 , 0% référence (1,8%) 131% 7 000 0,01% 2,9% 6,0% 9,2% 12,5% 12,5% 15,8% 19,2% 22,6% 26,1% Taux de couverture (ED) 6 000 6000 122% 5 000 5500 4 000 113% 3 000 5000 2 000 104% 1 000 4500 95% 0 1,2% 1,3% 1,4% 1,5% 1,6% 1,7% 1,8% 1,9% 2,0% 2,1% 2,2% 2,3% 1,4% 1,5% 1,6% 1,7% 1,8% 1,9% 2,0% 2,1% 2,2% taux dactualisation taux 09/05/2012 Sustainable growth / intergenerational fairness / Responsible investment www.rafp.fr 13
  • 14. Are we nearing the end of a 30 years long journey and the day of reckoning for some EMU members Nominal interest of the 10 y FrenchCan we assume that the odds are even OATfor:• a 100bp decrease• a 100 bp increase Since its inception, the Euro zone has benefited from a good environment….. This has not encouraged investors to exert all the required due diligence 09/05/2012 Sustainable growth / intergenerational fairness / Responsible investment www.rafp.fr 14
  • 15. For ERAFP, maximizing immediate profit is detrimental to sound and sustainable businessERAFP is a long term investor and…. should be a « contrarian »Sound asset allocation and SRI best in class investment policy areconsistent 09/05/2012 Sustainable growth / intergenerational fairness / Responsible investmentwww.rafp.fr 15
  • 16. Used to think for the long term, RAFP invests for the long term Net annual Cash Flows (M€)Created in 2005, ERAFP is a mandatory, fully funded pension fund for 4.6 million French civil servants : the duration of our liabilities is particularly long Based on civil servants’ remunerations, cash flow projections are highly reliable There is not hidden put option : members cannot cash in their holdings before retirement.We receive 1.7 Bn € in contributions per year: Positive net cash flows remain above 1 Bn € per year for more than 20 years Provisions du régime (en Md€)* ERAFP has particularly low liquidity requirements 99 76We can hold assets for a very long time without 51 needing to sell : *Source : COR 27 We think long term, 9 1,5 We can invest for the long term. 2005 2010 2020 2030 2040 2050 09/05/2012 Sustainable growth / intergenerational fairness / Responsible investment www.rafp.fr 16
  • 17. The financial management of the scheme How is the portfolio allocated? Curent asset allocation and Asset allocation at 31/12/11 management Limits defined by law Real Estate Corporates bonds 10% (external managers) Diversification Liquidity 9,4% assets 4,1% 25% Equities (external managers)Bonds 19,3% (min) 65% Supranational bonds 3,7% sovereign bonds local authorities bonds 60,6% • 65% minimum in bonds • 90% minimum in euro denominated securities 3,0% • 10% maximum in Real Estate • 5% maximum in FCPR • 5% maximum in securities issued by a single issuer (except for Sovereign debt issued by an OECD member and CADES) €11.4 billion in financiel assets at 31 December 2011 09/05/2012 Sustainable growth / intergenerational fairness / Responsible investment www.rafp.fr 17
  • 18. The financial management of the scheme How will asset diversification progress? 2012 target strategic allocation Target 2012 of asset allocation % of asset Fixes income bonds 77% of which convertible bonds 1,5% International equities 21,0% Multi asset 1% Real estate 1% Increased diversification of credit and international equities 09/05/2012 Sustainable growth / intergenerational fairness / Responsible investmentwww.rafp.fr 18
  • 19. For the RAFP it was clear from the very beginning that SRI was consistent with its mission RAFP puts intergenerational equity at the core of its governance. The same point is used To buy rights to a future benefit, when you’re working To pay the benefits to the retirees. The RAFP wants its investments to contribute to better the future not to increase “our immediate wealth” at the expenses of our children and great children.Combination of • very prudent monitoring of the scheme (low discount rate) • the will to have some bearing on the economy in order • to contribute to a change in the way we produce and • make possible to preserve our common wealth : the Earth Decision to adopt a global but not a radical SRI policy 09/05/2012 Sustainable growth / intergenerational fairness / Responsible investment www.rafp.fr 19
  • 20. What is at stake? Changing our investment process?A new world is coming What are the issues that no one should ignore? • we are discovering that scarcity will very directly impact our lives • externalities will be more and more internalized.Can SRI remain? • an overlay • something that concerns just a marginal part of your assets or your fundsWhen an investor says he is doing some investment in SRI what does it tell about the rest of its investment?Why is it so difficult to change? Because most of our decisions do not take into account the long term, Because turkeys don’t vote for Chrismas. « while the financial services industry performs many economically vital functions, and will continue to playa large and important role in London’s economy, some financial activities which proliferated over the last ten years were‘socially useless’, and some parts of the system were swollen beyond their optimal size ». Lord Turner « In recent years, banks have chased short-term profits by introducing complex products of no real use to short-humanity’, and some parts of our industry have become overblown » Stephen Green, Chairman of the BBA 09/05/2012 Sustainable growth / intergenerational fairness / Responsible investment www.rafp.fr 20
  • 21. A global and integrated SRI policy...From inception in 2005, the Board of Trustees decided to implement a comprehensive SRI policy : Which covers all asset classes and all assets SRI is not just a small pocket in our assets SRI is not just an investment strategy amongst others it is our investment strategy Which applies a range of ESG criteria transversally We believe this is more coherent than the addition of a lot of different theme funds Which doesn’t exclude any sectors We apply a best-in-class policy to all asset classes We aim to make everyone have a motivation to make progressWhat is the point of : investing in a renewable energy fund if the rest of your equity portfolio is overweight in oil companies ? attacking a company for its collaboration with an authoritarian regime, if you buy the bonds of this regime ? excluding a polluting industry, if all the other companies you invest in rely on this industry ? 09/05/2012 Sustainable growth / intergenerational fairness / Responsible investment www.rafp.fr 21
  • 22. Best in class : the best way to be pragmatic and adapt to asset class features ? What would be the sense of investing just a fraction according to SRI principles ? What would it tell of the rest of the investment ? Best in Class make senseWhat does ERAFP promote? • a global but also a pragmatic approach - no sector bias (we’ll need oil for a while), • joining forces by exchanging so we can more efficiently engage, • convincing asset managers that they should integrate SRI analysis in their investment process, • developing indexes so other long term investors can start investing in best in class SRI.Some asset classes have specific features • high unitary amount of the investment means interest to pool together (infrastructure or RE), • investment has to be assessed in its environment (for real estate connection to urban transport) 09/05/2012 Sustainable growth / intergenerational fairness / Responsible investment www.rafp.fr 22
  • 23. A transversal approach : engagement As Robert Urwin stressed investors responsibility: they should act like conscious « universal owners »For too long a time : • institutional investors have been consenting victims • asset owners rights have not been protected as they should have • fidiciary duty did not extend to shareholders’ rights protection« Times there are a changing » : • institutional investors talk to each The UK Stewardship Code produced by the Financial other Reporting Council sets out good practice on the engagement • asset owners want their rights to be of institutional investors with companies taken care of 7 principles • fidiciary duty evolves http://www.frc.org.uk/corporate/investorgovernance.cfm • as a fallout of the crisis authorities are pushing for a change 09/05/2012 Sustainable growth / intergenerational fairness / Responsible investment www.rafp.fr 23
  • 24. This time is different ???Captain Speaking. Welcome aboardTitanic 2, the first submarine linerin the world.Please relax and enjoy the journey.We won’t find an iceberg in tropicalwaters anyway! Ha, Ha, Ha…. 09/05/2012 Sustainable growth / intergenerational fairness / Responsible investment www.rafp.fr 24