Performance Management for Public Investment Funds - Part 1
Corporate PerformanceManagement for Public Investment Funds Sustaining Profitability and Growth in a Volatile World Part 1: Requirements
Executive Summary• The rapidly changing global market presents both new opportunitiesas well as challenges to the Investment Fund Manager• New economic realities give rise to fresh value creation driversdetermining the risk/ reward balance of Investment Portfolios• To survive and prosper in this new age, Investment Fund Managersneed to adopt innovative disciplines in Fund Management practices• Corporate Performance Methodologies augmented bycomputerized Corporate Performance Systems provide systematicplanning and control frameworks for Investment Fund Management toface the new Economy.
Corporate PerformanceManagement Requirements For Investment Funds In The New Global Economy
Market Dynamics Those Generals who are utterly dependent on fortune will come to grief when their future changes, but those who strategize and plan according to the times will prosper. Prosperity is ephemeral, if time and circumstances change, he will be ruined who does not adapt his strategies. - Sun Tzu, The Art of War
Public Investment Fund• A Public Investment Fund manages investment funds on behalf of the public• The investment fund may be owned by the Government• The investment fund may be owned by government owned companies• The investment fund may also be owned by the general public in the form of unit trusts, pension or social security funds
Investment Objectives• Investment Funds manage savings and reserves with an aim of maximizing returns.• Returns may be in the form of capital appreciation as well as income streams.
Social Objectives• Public Investment Funds are sometimes also entrusted with social obligations such as to fund strategic national infrastructures• When evaluating the performance of Public Investment Funds, it is important not to overlook their achievements in meeting these social obligations
Investment Risks• Investment Funds face risks in the form of erosion in capital and business losses.• Investment funds also face risks in the form of the opportunity cost of not investing in better opportunities or not executing investment decisions at better timings.
New Economic FundamentalsThe Capital Appreciation and Income Streams soughtafter by Investment Funds are affected by new EconomicRealities behind Value CreationPast Value Drivers New Value Drivers• How much land and building • Our knowledge and do we own? understanding of the• What is the amount of marketplace inventory we are carrying? • The intelligence that we have• What is the book value of our gathered about our plants and machineries? competition• How many vehicles, vessels • The accumulated operational and aircrafts do we have in know-how of our the fleet? management, personnel and partners • The effective pool of coordinated information shared along our supply and value chain
Balancing Risks/ Rewards Formulating Executing Controlling Balancing Investment Parallel Investment Risks/Rewards Strategies Strategies Portfolios• Public Investment Funds need to balance their Investment Risks against the achievement of their Investment and Social Goals.• Investment Strategies are formulated to balance Investment Risks against desired Investment and Social Gains• Since it is not possible to know the future outcome of any Investment Strategy in particular, a Public Investment Fund may pursue several feasible Investment Strategies in parallel.• These Parallel Investment Strategies may be organized into separate Investment Portfolios for monitoring and control purposes.
Investment Strategy Formulation Implementation Monitoring/ Control• Formulating and controlling the implementation of Investment Strategies are key activities in managing the performance of Public Investment Funds “Great warriors take their stand on ground where they cannot lose. Therefore a victorious army first wins then seeks battle; a defeated army first battles then seeks victory.” - Sun Tzu in The Art of War
Strategy Formulation• Review of Vision, Mission and Driving Principles• Defining desired future value to various stakeholders• Charting directions, milestones and tactical objectives
Execution • Implementation Program • Organization and Coordination • Progress Monitoring • Control/Re-alignment
Controlling and Monitoring Making Conclusions • Developing a clear and thorough understanding of the basis of enterprise value from both external and internal perspectives • Pinpointing critical issues requiring strategic attention
Covering All Angles Market Research/ Human Business Resources Development Product/ Finance Portfolio Risk/ Investor Compliance Relations• All aspects of the Investment Fund need continuous attentive management
The Fund Manager• The management of investment strategies is entrusted to a Fund Manager• The Fund Manager is accountable to the public on the performance of the Investment Fund
The Investment Team Fund Manager Investment Traders Finance Others AnalystsThe Fund Manager is supported by a well-organized Investment Team, comprising• Analysts, who analyze and monitor factors that can affect investment outcomes and help to formulate/ revise investment strategies• Traders, who execute investment strategies• Finance, who manage the financing of the Investment Fund and keep the accounting records of the trading activities• Others, such as Human Resources and Administration
BenchmarkingThe Investment Team’s performance isoften objectively benchmarked against•Pre-determined performance targets such as Investment Plans and Budgets•Performance of other Investment Funds•Industry benchmarks such as market indices
Corporate Performance Management• Corporate Performance Management is a framework for managing performance in an organization• The framework consists of Methodologies Systems Practices
Methodology Investment Methodologies provide methods to formulate and implement Investment Strategies, and to evaluate performance in Public Investment Funds. Examples of Investment Methodologies include The Capital Asset Technical analysis is In the field of Value Investing is aCapital Asset Pricing Technical Analysis Models Model Value Investing Model Economic Value Model Pricing Model a financial markets corporate methodology (CAPM) is used in technique that finance, Economic popularized by finance to claims the ability to Value Added is a Warren Buffet which determine a forecast the future way to determine generally involves theoretically direction of security the value buying securities appropriate prices through the created, above the whose shares required rate of study of past market required return, for appear return (and thus the data, primarily price the shareholders of underpriced by price if expected and volume. a company. More… some forms of cash flows can be More… fundamental estimated) of an analysis. More… asset . More…
Systems• Corporate Performance Management may be implemented manually, but manual methods are usually not feasible in large and complex organizations. • Computerized Performance Management Systems are implemented in complex organizations to ensure timeliness, accuracy and security of information.
Practices• Practices refer to how the Fund Manager actually manages the performance of his Investment Team, including the following factors • Standard Operating Procedures applied at the Investment Fund • The Management Culture at practised by the Investment Team • How members of the Investment Team are rewarded/ penalized for good/ poor performance • The Management Style of the individual who is the Fund Manager • The level of competency of the Investment Team • Etc
Success Factors/IndicatorsThe Corporate Performance Management of an InvestmentFund is concerned with managing success factors drivinginvestment outcomes and reporting performance indicatorsreflecting investment results Currency and national Market robustness Regional and conditions and global sentiments robustness The type of Competition in investment other markets instrument The profitability of the Risk/ Financial Return underlying Obligations investees Investment Outcome
Risk/Return Profile• The Risk/Return characteristic of an Investment Fund depends on the mixture of exposure to various Success Factors experienced by its Investment Portfolios• Each Investment Fund may have a different Risk/Return characteristic compared to other Investment Funds• The level of exposure experienced by each portfolio is influenced by the underlying Investment Philosophy and Strategy embraced by the portfolio• The Fund Manager need to monitor all factors affecting his Investment Fund’s risk/return levels diligently, and respond to changes in these levels with the right timing
Financial Obligations• An investment fund may obtain loans or issue its own debt instruments to raise finance• Such instruments may include loan papers, call options (warrants) etc• These obligations may be secured by assets owned by the investment fund• The investment fund may buy back its own instruments when opportunities arise, for example to take advantage of lower costs of refinancing• The Fund Manager need to consider the state and direction of his investments vis-à-vis his Financial Obligations in order to ensure that his Investment Fund continues to be financially sound and viable
Planning and Budgeting• The Fund Manager will also need to consider information generated by his strategy formulation and investment planning activities, including budgeted figures and the results of investment simulations under various operating scenarios.• Additionally, the Fund Manager need to ensure that his investment plans are updated to reflect the current state and possible future directions of the Market.• He may do this by • Maintaining progressive budget versions to track revisions and reviews • Running rolling budgets and forecasts reflect the latest positions • Conducting financial simulations under new scenarios to test his investment strategies against changes in the economic environment
Non-Financial Success Factors• Public Investment Funds are sometimes evaluated on its achievement of non-financial social goals as well, such as • Provision of employment to locals • Support of government initiatives for the people, for example in the provision of public utilities at affordable prices • Powering domestic business activities during slack periods • Support of government policies to develop strategic sectors• The Investment Manager needs to monitor performance in these areas as well.
Financial Consolidation• An investment fund, and especially a government-linked one, typically is also responsible to set up special purpose vehicles to fund strategic assets of the country, for example to finance significant investments in telecommunication infrastructures.• The Investment Fund typically shares ownership of these associate and subsidiary companies with joint venture partners such as technology providers or subject matter experts. The impact of the financial performance of these associate companies and subsidiaries must take into account the composition of minority interests (such as joint venture partners for technological or financial purposes) in their shareholding structure.• As such, the investment fund may hold in its stable a dynamic and constantly changing set of associate companies and subsidiaries formed as special purpose vehicles to pursue specific objectives.• These associate companies and subsidiaries may hold shares in one another and the shareholding structure may frequently change as part of value creation plans.• Typically, the associate and subsidiary companies conduct significant amount of trade with on another.• These conditions give rise to a need for a tool to handle and automate the process of producing consolidated financial reports across groups of companies with complex and rapidly changing shareholding structures.• Other considerations that may create added complexity and create greater need for the tool include having multiple currencies of transactions, calculating goodwill created along every step of acquisition (in a staggered acquisition scheme), and the need to produce consolidated reporting on financial performance across alternative consolidation paths, for example by common Lines-of-Business or geographical location of operations. In such cases, it is not appropriate to determine overall profitability by simply aggregating the profits of these associate and subsidiary companies, since it is necessary to apply accounting consolidation rules in determining accurately the investment funds share of the profit. A Financial Consolidation Module performs this operation in the overall Corporate performance Management System.
Investment Choices• Fund Managers face a myriad of investment choices every day. They need tools to help them make the best investment decisions consistently.• For example, Investment Portfolios place investments in the form of investment instruments• Each type of investment instrument has a unique set of characteristics and conditions attached to it• These conditions impacts the risk/return characteristic of the investment
Information TypesThe information needed by the investmentfund manager for vigilant monitoring include Market/ Transaction •Investment prices, bids and offers, transaction volumes, derived Statistics measures including Price-Earning Ratios, Dividend Yields, etc Financial News and •Financial and non-financial reports on the performances of investee companies such as company news and Reports announcements, periodic financial reports •Market indicators that reflect investor sentiments Economic and •National, regional, and global economic indicators such as interest Market Indicators rates, currency rates, inflation rates, employment statistics, consumer spending reports, property reports, etc •Statistics on the health of the investee industry such as production Industry Statistics outputs, size of stockpiles and inventories, outstanding book orders •Internally generated information on the size and book value of his Accounting and trading positions, trades done, his realized and unrealized Other Records profitability and the availability of additional funds at his disposal •Investment plans, budgets and financial simulations
Visibility and Information• In order to be effective, the Fund Manager must constantly assess and evaluate the state of all his critical success factors.• Since these success factors can change rapidly, even a moments lapse of attention can bring significant loss to a large investment fund.• The Fund Manager need to be supported by a Corporate Performance System that keeps him updated with the latest information
Information Integration• Due to the inter-relationship and cross-dependency of these factors, the fund manager needs to have access to a consolidated view of the total situation.• He may critically be blind-sided if, for example, he is only looking at the activities and positions held by his trading team without having simultaneous access to current market information.• Similarly, whenever he is reading on economic news and announcements, he needs to have access to market indicators to know how the market is reacting to these news and how, how much and when he should react to them.
Business Continuity• Due to close inter-dependencies between global markets, the Fund Manager needs • Ready access to market information 24 hours a day, 365 days a year • The information need to be summarized and presented in easily understandable forms • The summarized information need to be supported by detailed information that is instantly accessible from the summaries • The integrity, accuracy and consistency of information in all its forms and degrees of detail must be assured at all times• To meet these requirements, the Fund Manager needs an Alert and Instant Messaging System that is integrated into his Performance Management System
Information FormattingThe information needed by the investment manager comesin textual and unstructured formats as well as numerical andstructured formats Textual/ Numerical/ Unstructured Structured • News Articles • Financial Reports • Corporate • Economic Announcements Indicators • Analysts’ • Market Prices/ Consensus Indices
Information Delivery• As market factors can swing the profitability of investment positions within a split second, the timeliness of information delivered to the investment manager is critical.• Also, since other investment managers around the country are accessing the same information, the ability of the investment manager to act on an opportunity against other competing investment managers depends on how fast pertinent information is relayed to him.• As the investment manager may often be away from his trading desk, he need to be reachable and should be able to be alerted on important events via mobile modes of communication such as PDA alerts and SMS messages.• Many of these alerts need to be raised automatically by the system without requiring manual intervention.
Information Sources - ExternalExternally generated information used by the FundManager originates from a myriad of sources such as News Agencies Investee Market Feeds and Aggregators Companies • Market Indices • Interest Rates • Management • Trading Results • Currency Accounts • Bids and Offers Exchange Rates • Operations • Company Statistics Announcements • Planning Figures • Published and Budgets FinancialsThe Fund Manager need a Performance Management Systemthat is capable of collating information from multiple sourcesautomatically and with minimum manual intervention.
Information Source - InternalInvestment Funds typically rely on a number of criticalinternal systems for their operations. These systems include •To manage the investment funds internal finances ERP and cash clearings •To provide record of fund profitability and liquidity Trading & •To manage trading activities and positions Portfolio •To account for revenue streams from investment assets Management Debt •To manage debts and repayments management •To manage debt servicing System Financial •To collect unpublished financial and operational performance reports from investee companies at Reporting System periodic intervals such as monthly management (usually manual) accounts
Standardization of Information• Also of great importance to the information integration process, is the need to standardize information content across the myriad of information sources.• For example, shares on the stockmarket may be categorized into a particular set of industries which is not conducive for the formulation of the investing funds sector-wise investing strategy (e.g. the industry groupings may not lump business with similar risk/reward characteristics together).• The stockmarket may, for example, group various types of industries together under one sector called manufacturing, but the investment fund manager needs to know his exposure into sub- industries such as petro-chemicals, building materials, food, etc since each of the sub-industries may be exposed to a different risk profile.• In such instances, the information presented to the investment manager need to be represented both in the way the stockmarket categorizes it as well as in the way that is in accordance with the investment strategy pursued. This calls for the adoption of a common Information Standards within the Investment Fund.
Information Security• The Performance Management System of a Public Investment Fund contains sensitive information that can be misused by unauthorized persons.• For example, the system may store data pertaining to the stocking up of a particular share counter. The information may be used by a competitive party to outguess the impending liquidation date of the build up position and benefit from declining prices over the period of sale.• Thus, the Fund Manager needs a system that is secure and will only allow authorized users to access the information that they are authorized to view. For example, if the Fund Manager has assigned separate teams to manage portfolios in different companies, each team should only be able to access information pertaining to their investee companies.• Furthermore, the Investment Fund may already have other security systems in place. The Performance Management System should be able to integrate with existing security systems, for example by using LDAP to enable a single sign-on process for each user, to enable centralization of security administration work and avoid duplication administrative efforts.