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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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"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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