Session 1: The Challenge of Long-Term Management  Richard M. Burridge Center for Securities Analysis and Valuation Annual ...
The   Challenge of Long-Term Fund Management <ul><li>We Believe: </li></ul><ul><li>A disciplined, consistently applied app...
Investment Policy Overview <ul><li>Investment policy is a combination of philosophy and long-range planning </li></ul><ul>...
Investment Policy Components <ul><li>Key aspects of investment policy include: </li></ul><ul><ul><li>Fund’s mission </li><...
<ul><ul><li>Funding Policy – Cash flow into the Fund  </li></ul></ul><ul><ul><ul><li>How and when contributions are made t...
Investment Policy  Fund’s Mission <ul><li>One sentence statement of what the fund is to accomplish  </li></ul><ul><ul><li>...
Investment Policy Risk Tolerance <ul><li>From an investment policy perspective, risk can be viewed as the likelihood of fa...
Risk and Risk Tolerance   Sources of Risk <ul><li>Capital market risk (beta/systematic) </li></ul><ul><ul><li>Incurred to ...
Investment Policy  Fund Objectives <ul><li>Investment objectives  identify the set of management results that would signal...
<ul><li>Techniques for Selecting a Policy Asset Mix  </li></ul><ul><ul><li>Investor Consensus </li></ul></ul><ul><ul><li>E...
Asset Category Targets <ul><li>An asset category target is a diversified collection of securities within a broad asset cat...
Asset Mix/Manager Rebalancing <ul><li>Asset Mix/Manager rebalancing refers to periodically adjusting actual allocations to...
<ul><li>Passive management  refers to investment strategies designed to match (before expenses) the performance of a speci...
Investment Manager Strategy Manager Selection and Retention Manager Selection/Retention Criteria Criteria Importance Peopl...
Performance Evaluation Methodology Plan Sponsor Report Card
 
 
Governance <ul><li>Roles and Responsibilities </li></ul><ul><ul><li>Identify individuals and organizations involved in the...
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"Posey - Conference Slides"

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  • 4 Our firm was founded in 1984 by Dave Tierney and myself. We have offices in Chicago and New York. We are wholly owned by the six Principals of the firm. Our only business is providing investment services to the institutional investment community. Although we are quantitatively oriented, we pride ourselves in effectively communicating with our clients and developing practical solutions to complex investment problems. Our people have worked as fund sponsors and are familiar with the importance communication and education.
  • There are a variety of ways to approach the policy asset allocation decision. We list eight (8) methods on this chart. The first, the Investor Consensus method, is based on the policy asset allocation of similar funds and not doing anything materially different. The Experiential method pertains to recommendations of experienced institutional investors. For example, institutions such as JP Morgan, BGI, Brinson Partners, and Morgan Stanley routinely publish their asset allocation recommendations. The Market Capitalization method is based on an investable world wealth portfolio. The Optimization method is a mathematical algorithm that utilizes the expected return and risk characteristics and correlations of asset classes. Although this method is a favorite among investment consultants it suffers serious flaws because of the instability of the inputs. The Asset Simulation method begins with the current investment policy then examines a variety of investment scenarios that are more and less aggressive. A range of probable outcomes is determined for each asset mix. The Minimum Target Return method seeks to find a combination of asset classes that will minimize the probability of experiencing an investment return less than some minimum target. The Asset/Liability method simulates a variety of investment outcomes pertaining to the fund value that depend on assets flowing into and out of the fund as well as the investment performance of the fund. Although I have not mentioned the royalties that flow into the PSF, they are a critical input in this allocation method. In fact, they should be an important consideration in any asset allocation anaylsis.
  • "Posey - Conference Slides"

    1. 1. Session 1: The Challenge of Long-Term Management Richard M. Burridge Center for Securities Analysis and Valuation Annual Conference November 7, 2008 Ann Posey Managing Director Nuveen Investment Solutions 312- 461-1100 [email_address]
    2. 2. The Challenge of Long-Term Fund Management <ul><li>We Believe: </li></ul><ul><li>A disciplined, consistently applied approach to investment management </li></ul><ul><li>is critical to success </li></ul><ul><li>A well-documented investment policy detailing investment processes, </li></ul><ul><li>procedures and governance is an integral part of such an approach </li></ul><ul><li>An understanding of the investment risks, expected returns, and the capability </li></ul><ul><li>to budget and manager these risks along with an appreciation of the </li></ul><ul><li>risk tolerance of the investment trustees constitute the foundation of a </li></ul><ul><li>comprehensive investment management and control facility </li></ul>
    3. 3. Investment Policy Overview <ul><li>Investment policy is a combination of philosophy and long-range planning </li></ul><ul><ul><li>Philosophical Statements </li></ul></ul><ul><ul><ul><li>How do we define success? </li></ul></ul></ul><ul><ul><ul><li>How do we define failure? </li></ul></ul></ul><ul><ul><ul><li>How do we define risk? </li></ul></ul></ul><ul><ul><ul><li>How much risk should be assumed? </li></ul></ul></ul><ul><ul><li>Long-range Planning </li></ul></ul><ul><ul><ul><li>Establishes the guidelines and procedures that direct the long-term management of the fund’s assets </li></ul></ul></ul><ul><ul><ul><li>Based on long-term consensus estimates of capital market opportunities and the fund’s obligations </li></ul></ul></ul><ul><ul><ul><li>Allows decision-makers to pre-experience the future; prevent surprises, avoid panics </li></ul></ul></ul><ul><li>Investment policy succeeds not because of unique insights, but because of a focus on long-term goals and a continuity of applied strategies </li></ul><ul><li>There is no one correct answer </li></ul><ul><ul><li>Different financial circumstances of sponsoring organizations </li></ul></ul><ul><ul><li>Different investment objectives of sponsoring organizations </li></ul></ul><ul><ul><li>Different temperaments of decision-makers </li></ul></ul>
    4. 4. Investment Policy Components <ul><li>Key aspects of investment policy include: </li></ul><ul><ul><li>Fund’s mission </li></ul></ul><ul><ul><li>Risk tolerance </li></ul></ul><ul><ul><li>Investment objectives </li></ul></ul><ul><ul><li>Policy asset mix </li></ul></ul><ul><ul><ul><li>Capital Market Risk </li></ul></ul></ul><ul><ul><ul><li>Asset category target selection </li></ul></ul></ul><ul><ul><li>Implementation and Risk Management </li></ul></ul><ul><ul><ul><li>Manager structure and implementation </li></ul></ul></ul><ul><ul><ul><li>Manager selection and retention </li></ul></ul></ul><ul><ul><ul><li>Allocation of risk to active management </li></ul></ul></ul><ul><ul><ul><li>Asset mix/manager rebalancing strategies </li></ul></ul></ul><ul><ul><ul><li>Liquidity management </li></ul></ul></ul><ul><ul><li>Governance Policy </li></ul></ul><ul><ul><ul><li>Responsibility, Authority and Accountability </li></ul></ul></ul><ul><ul><ul><li>Documentation </li></ul></ul></ul><ul><ul><li>Monitoring and Control </li></ul></ul><ul><ul><ul><li>Performance Evaluation Methodology </li></ul></ul></ul><ul><ul><ul><li>Benchmark portfolios </li></ul></ul></ul><ul><ul><ul><li>Performance attribution and risk analysis </li></ul></ul></ul>
    5. 5. <ul><ul><li>Funding Policy – Cash flow into the Fund </li></ul></ul><ul><ul><ul><li>How and when contributions are made to the fund </li></ul></ul></ul><ul><ul><ul><li>Amount and timing of contributions </li></ul></ul></ul><ul><ul><li>Benefit Policy – Cash flow out of the Fund </li></ul></ul><ul><ul><ul><li>Specification of payments </li></ul></ul></ul><ul><ul><ul><li>Specification of eligibility requirements </li></ul></ul></ul><ul><ul><li>Investment Policy – Level and type of investment risk </li></ul></ul><ul><ul><ul><li>Financial status of the plan </li></ul></ul></ul><ul><ul><ul><li>Financial strength of the plan sponsor </li></ul></ul></ul><ul><ul><ul><li>Risk tolerance/preferences of the plan fiduciaries </li></ul></ul></ul>Policies That Determine The Financial Health of an Investment Program
    6. 6. Investment Policy Fund’s Mission <ul><li>One sentence statement of what the fund is to accomplish </li></ul><ul><ul><li>Sources and uses of funds </li></ul></ul><ul><ul><ul><li>Magnitude </li></ul></ul></ul><ul><ul><ul><li>Volatility </li></ul></ul></ul><ul><ul><ul><li>Risk factors </li></ul></ul></ul><ul><ul><ul><li>Future </li></ul></ul></ul><ul><ul><li>Other Factors </li></ul></ul><ul><ul><ul><li>Past success </li></ul></ul></ul><ul><ul><ul><li>Past disappointment </li></ul></ul></ul><ul><ul><ul><li>Investment constraints </li></ul></ul></ul><ul><li>Example for Retirement Investment Programs </li></ul><ul><ul><li>Primary Mission: To secure the benefits promised to plan participants </li></ul></ul><ul><ul><li>Secondary Missions: </li></ul></ul><ul><ul><ul><li>Reduce funding costs as a percent of payroll </li></ul></ul></ul><ul><ul><ul><li>Control funded ratio (assets/liabilities) </li></ul></ul></ul><ul><ul><ul><li>Control short-term return volatility </li></ul></ul></ul><ul><ul><ul><li>Maintain adequate liquidity for benefit payments </li></ul></ul></ul><ul><ul><ul><li>Avoid investments in socially “undesirable” companies </li></ul></ul></ul>
    7. 7. Investment Policy Risk Tolerance <ul><li>From an investment policy perspective, risk can be viewed as the likelihood of failing to achieve the fund’s missions </li></ul><ul><ul><li>Informed look at the past; successes, disappointments, reasons </li></ul></ul><ul><ul><li>What is success? </li></ul></ul><ul><ul><li>What is failure? </li></ul></ul><ul><li>Risk tolerance indicates the trade-off that plan sponsor will accept between </li></ul><ul><ul><li>the probability of failing to achieve the fund’s missions </li></ul></ul><ul><ul><li>versus </li></ul></ul><ul><ul><li>the reward derived from achieving those missions in excess of expectations </li></ul></ul><ul><li>What may be a highly risky strategy for one investment program may be a low risk strategy for another </li></ul>
    8. 8. Risk and Risk Tolerance Sources of Risk <ul><li>Capital market risk (beta/systematic) </li></ul><ul><ul><li>Incurred to achieve a return in excess of inflation (real return); low cost (passive management) </li></ul></ul><ul><ul><li>Implemented via asset allocation policy based on acceptable asset classes and acceptable level of investment uncertainty </li></ul></ul><ul><li>Active management risk </li></ul><ul><ul><li>Incurred to achieve a return in excess of that provided by the capital markets </li></ul></ul><ul><ul><li>Uncorrelated with capital market risk; controlled via diversification among multiple managers; transferable; difficult to obtain, more expensive than capital market risk </li></ul></ul><ul><ul><li>Two types of active management risk: Skill (a compensated risk) and Style (an uncompensated risk) </li></ul></ul><ul><li>Interest rate risk </li></ul><ul><ul><li>Exposure of the plan’s surplus to changes in interest rates (an uncompensated risk) </li></ul></ul><ul><ul><li>Minimization of interest rate risk reduces funded ratio volatility </li></ul></ul>
    9. 9. Investment Policy Fund Objectives <ul><li>Investment objectives identify the set of management results that would signal a successful investment program </li></ul><ul><ul><li>Appropriate investment objectives may significantly differ among institutional funds </li></ul></ul><ul><li>Investment objectives should be: </li></ul><ul><ul><li>Unambiguous, measurable, investable and appropriate </li></ul></ul><ul><ul><li>Consistent with the fund’s mission </li></ul></ul><ul><ul><li>Reflect the fund sponsor’s risk tolerance </li></ul></ul><ul><li>Example Objective Statements </li></ul><ul><ul><li>Generate a 3.5% real rate of return </li></ul></ul><ul><ul><li>The current long term actuarial annual investment rate </li></ul></ul><ul><ul><li>Match the return and volatility on a composite of market indices weighted in proportion to the fund’s allocation to various asset classes </li></ul></ul>
    10. 10. <ul><li>Techniques for Selecting a Policy Asset Mix </li></ul><ul><ul><li>Investor Consensus </li></ul></ul><ul><ul><li>Experiential </li></ul></ul><ul><ul><li>Market Capitalization </li></ul></ul><ul><ul><li>Optimization </li></ul></ul><ul><ul><li>Asset Simulation </li></ul></ul><ul><ul><li>Minimum Target Return </li></ul></ul><ul><ul><li>Asset/Liability Analysis </li></ul></ul><ul><ul><li>Strategic Planning </li></ul></ul>Investment Policy Asset Allocation Mix
    11. 11. Asset Category Targets <ul><li>An asset category target is a diversified collection of securities within a broad asset category </li></ul><ul><ul><li>It represents the set of feasible investment opportunities that the plan sponsor believes best achieves the purposes for which the asset category was included in the policy asset mix </li></ul></ul><ul><ul><li>It can be viewed as the ideal index fund </li></ul></ul><ul><li>A viable asset category target should satisfy three conditions: </li></ul><ul><ul><li>Consistent with the fund’s risk tolerance </li></ul></ul><ul><ul><li>Its expected long-run risk-adjusted returns are preferred to those of all other alternative targets </li></ul></ul><ul><ul><li>Offers the plan sponsor an investable alternative </li></ul></ul>
    12. 12. Asset Mix/Manager Rebalancing <ul><li>Asset Mix/Manager rebalancing refers to periodically adjusting actual allocations to asset categories and managers back to policy allocations </li></ul><ul><li>Procedures to address this “drift” include: </li></ul><ul><ul><li>1. Do Nothing </li></ul></ul><ul><ul><li>2. Specify bands in which actual allocations may move. Outside of theses bands, allocations must be rebalanced to policy weights </li></ul></ul><ul><ul><li>3. Tactically manage the actual allocations within prescribed ranges </li></ul></ul>
    13. 13. <ul><li>Passive management refers to investment strategies designed to match (before expenses) the performance of a specified market target index </li></ul><ul><li>Active management is any investment strategy designed to outperform (after expenses) an appropriate benchmark on a relatively consistent basis over time </li></ul><ul><ul><li>Necessary Belief Statements to employ active management </li></ul></ul><ul><ul><ul><li>Do superior active managers exist </li></ul></ul></ul><ul><ul><ul><li>How many are there and can they be identified </li></ul></ul></ul><ul><ul><ul><li>Level and consistency of their skill </li></ul></ul></ul><ul><ul><ul><li>Risk tolerance (Patience) </li></ul></ul></ul><ul><li>On average, active and passive managers can be expected to underperform (after fees) a market index. </li></ul><ul><ul><li>Impact of fees and transaction costs </li></ul></ul>Investment Policy Investment Management Strategy
    14. 14. Investment Manager Strategy Manager Selection and Retention Manager Selection/Retention Criteria Criteria Importance People 25% Organization,Investment professionals, compensation Process 25% Philosophy, style, decision-making, risk control Procedures 25% Benchmarks, trading, quality control Performance 20% Return and risk relative to an appropriate benchmark Price 5% Investment management fees
    15. 15. Performance Evaluation Methodology Plan Sponsor Report Card
    16. 18. Governance <ul><li>Roles and Responsibilities </li></ul><ul><ul><li>Identify individuals and organizations involved in the management of the Fund </li></ul></ul><ul><ul><li>Assign accountability, responsibility and authority to each </li></ul></ul><ul><ul><ul><li>Trustees </li></ul></ul></ul><ul><ul><ul><li>Investment Committee </li></ul></ul></ul><ul><ul><ul><li>Investment Staff </li></ul></ul></ul><ul><ul><ul><li>Custodian </li></ul></ul></ul><ul><ul><ul><li>Consultants </li></ul></ul></ul><ul><ul><ul><li>Actuary </li></ul></ul></ul><ul><ul><ul><li>Investment Managers </li></ul></ul></ul><ul><li>Documentation </li></ul><ul><ul><li>Create a written Investment Policy Document </li></ul></ul><ul><ul><li>Review on a regular basis </li></ul></ul>

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