Achieving Investment Excellence

Crucial methods, tactics and tools for successful pension fund management

Achieving Investment Excellence offers trustees and asset managers a comprehensive handbook for improving the quality of their investments. With a stated goal of substantially and sustainably improving annual returns, this book clarifies and demystifies important concepts surrounding trustee duties and responsibilities, investment strategies, analysis, evaluation and much more.

Low interest rates are making the high cost of future pension payouts fraught with tension, even as the time and knowledge required to manage these funds appropriately increases — it is no wonder that pensions are increasingly seen as a financial liability. Now more than ever, it is critical that trustees understand exactly what contributes to investment success — and what detracts from it. This book details the roles, the tools and the strategies that make pension funds pay off.

• Understand the role of pension funds and the fiduciary duty of trustees
• Learn the tools and kills you need to build profound and lasting investment excellence
• Analyse, diagnose and improve investment quality of funds using concrete tools and instruments

• Study illustrative examples that demonstrate critical implementation and execution advice

Packed with expert insight, crucial tools and real-life examples, this book is an important resource for those tasked with governing these. Achieving Investment Excellence provides the expert insight, clear guidance and key wisdom you need to manage these funds successfully.

About the Authors xiii

Acknowledgments xv

Foreword xvii

Introduction 1

Levels of Excellence: Assessing and Improving Your Practice 6

How to Use the Book 8

Chapters of the Book 9

Part One Pension Funds: Understanding the Role, Shaping the Mission

Chapter 1 The Role of Pension Funds, and the Role of Boards 19

The Role of Pension Funds 20

The Pension Triangle 22

Duties of Trustees 24

Responsibility as a Fiduciary 26

Delegation and Agency Relationships 27

Responsibilities as a Board Member 30

Responsibilities as a Shareholder 31

Balancing the Three Roles 31

Understanding and Managing Your Stakeholders 32

Government 32

Regulator 32

Financial Markets 33

Non-Governmental Organizations 34

Endnotes 34

Case Study—GEPF 36

Chapter 2 Developing Purpose, Mission, Vision, and Goals 39

The Functions of a Pension Fund 41

Purpose 44

Mission 45

Values 46

Vision 49

Strategic Goals 50

Endnotes 51

Part Two Designing the Process

Chapter 3 Grasping the Investment Essentials 55

Investment Goals 56

Understanding Return Concepts 57

Return 57

Expectations 57

Understanding Risk Concepts 59

Risk is not Volatility 60

Risk Premium 61

Getting Risk Measures Right 62

Risk Is about Behavior 63

Steering Your Portfolio 64

Benchmarks 65

Diversification 66

Conventional vs. Alternative Assets 67

Active vs. Passive Investing 68

Better Beta: Styles and Factors 70

Responsible Investing 70

Motives or Mission 71

Instruments 72

Endnotes 72

Case Study—PFZW 74

Chapter 4 Investment Beliefs as Guiding Tools 77

Why Investment Beliefs Matter 78

Basics of an Investment Belief 81

Developing a Set of Investment Beliefs 82

When, If Ever, Is the Time to Change Investment Beliefs? 83

How (Not) to Use Investment Beliefs 87

Endnotes 88

Case Study—New Zealand Superannuation Fund 90

Chapter 5 Designing the Investment Management Process 93

The Investment Process 94

Setting Objectives: Aligning Goals and Risk Appetite 95

Investment Objectives 99

Formulating Expectations 100

Portfolio Construction 101

Implementation and Monitoring 103

Implementation 103

Monitoring 103

The Investment Policy Statement 105

Endnotes 108

Chapter 6 Organizing the Investment Function 109

Inventorizing Investment Models 110

Model 1: Traditional Asset Allocation Model 112

Model 2: Endowment Model 112

Model 3: Factor Allocation Model 114

Model 4: Opportunity Cost or Reference Portfolio Model 116

Model 5: Dual Strategic/Operational Benchmark Model 119

Model 6: Risk Parity Model 120

Developing Your Own Investment Approach 122

Endnotes 123

Case Study – GPFG 124

Part Three Implementing the Investments

Chapter 7 Implementing the Investment Strategy 129

Organizing the Implementation 130

The Rationale for Managing Costs 132

Selection of Managers 134

Active vs. Passive Management 136

Internal vs. External Management 138

Relationship with Suppliers 139

Bridging the Implementation Gap 141

Endnotes 142

Case Study—ATP 144

Chapter 8 Building the Investment Portfolio 147

Framework for the Investment Portfolio 148

The Board’s Role in Portfolio Construction 151

What Is a Good Investment Portfolio? 152

Capital Market Assumptions 156

Diversification 157

Rebalancing 160

Endnotes 160

Case Study—OTPP 161

Chapter 9 Monitoring and Evaluation 164

Monitoring 165

What to Monitor? 167

Monitoring as a Multidimensional Process 168

Monitoring the Policy 169

The Position of Monitoring on the Investment Committee’s Agenda 170

What Is the Optimal Frequency for Monitoring? 171

Monitoring Should Be Based on a Sound Approach: It Should Never

Be a Mechanical Exercise 171

What to Look for in Monitoring 171

When Does a Board Move from Monitoring to Evaluation? 175

Evaluation 176

Endnotes 178

Part Four Organizing the Board

Chapter 10 Becoming an Effective Board 181

Responsibilities of the Board 181

Board Composition 185

What is Expected from Board Members? 187

What is Expected of the Chair? 188

Appointing New Board Members 189

Governance Budget of the Board 191

Board Decision-Making Culture 193

Supporting the Board: Executive Office and Staff 194

Ingredients of an Effective Board 197

People and Board Composition 197

Process 198

Perspective 198

The Right Altitude, Horizon and Distance 198

Power and Delegation 198

Learning 199

Endnotes 199

Case Study—CalPERS 200

Chapter 11 Establishing the Investment Committee 203

Roles and Responsibilities 204

Advise the Board on an Investment Policy Statement 205

Evaluate the Managers’ Performance and Take Appropriate Actions 205

Document the Investment Process and Decisions Made 205

Members of the Investment Committee 207

Forming an Effective Investment Committee 208

The Role of the Chairman of the Investment Committee 210

A Model for an Effective Investment Committee Meeting 210

The Investment Committee Agenda 211

Committee Preparation: Quality, Clarity and Timeliness and Extent of Materials 212

Roles 213

The Results of the Meeting 214

Evaluation and Learning 214

Endnotes 215

Chapter 12 Managing the Investment Management Organization 216

The Roles of the Investment Management Organization 217

Functions and Typical Evolution of the IMO 219

Outsourcing 222

Subsidiaries: Majority or Fully Owned by the Pension Fund 223

Pros and Cons of a Proprietary IMO 225

Issues in Dealing with an Investment Organization 225

The Service Level Agreement 227

Monitoring and Evaluating the Investment Management Organization 228

Endnotes 228

Case Study—Future Fund 229

Part Five Learning, Adapting and Improving

Chapter 13 Learning to Decide and to Take Advice 235

Psychology of Decision-Making: Biases, Preferences, and Habits 236

Group Processes on the Right Track 241

Learning to Make Complex Decisions 243

Using Expert Opinions 245

The Investment Consultant 247

Challenges and Dilemmas in Taking Advice 249

Decision-Making under Pressure 251

Endnotes 254

Chapter 14 Achieving Investment Excellence 255

The Five Activities Driving Towards Excellence 256

Activity 1: Setting the Strategy (Chapters 1–2) 257

Activity 2: Designing the Investment Process (Chapters 3–6) 257

Activity 3: Implementing the Investments (Chapters 7–9) 259

Activity 4: Organizing the Board (Chapters 10–12) 259

Activity 5: Learning to Adapt (Chapter 13) 261

The Learning Board and the Characteristics of the Levels of Excellence 261

Leadership 262

Resources 262

Mind-Set and Culture 262

Measures and Scorecards 263

Maintenance and Education 264

Levels of Excellence and the Board Learning Perspective 264

The Board’s Journey towards Achieving Excellence 264

Step 1: Determine Where You Are Now 264

Step 2: Define Your Long-Term Ambition 266

Step 3: Define the Roadmap 266

Step 4: Execute the Roadmap 267

Enduring Investment Excellence 267

Endnotes 269

Self-Reflection Questions 270

Appendix A 282

Appendix B 284

References 293

Index 301

KEES KOEDIJK is dean and director of TIAS Business School and a professor of finance at Tilburg University, the Netherlands. He is managing editor for the Journal of International Money and Finance, and his work has been published in numerous peer-reviewed journals. Kees Koedijk has served on many investment committees and advisory boards.

ALFRED SLAGER is professor of pension fund management at TIAS Business School, and a trustee for the Dutch Pension Fund for General Practitioners. His extensive practical experience makes him a frequently invited advisor to pension funds and speaker at international events on pensions and asset management.

JAAP VAN DAM is principal director of investment strategy at PGGM, where he is responsible for the strategic change agenda for the pension fund. He chairs the European Chapter of the 300 Club and serves as member on numerous advisory boards, including the Research Committee of the International Centre for Pension Management.

IMPROVE FUND PERFORMANCE THROUGH ENHANCED UNDERSTANDING AND EFFECTIVE GOVERNANCE

Trustees play an essential role in the success of pension funds and other long-term asset organizations. The performance of such funds depends on the trustee's level of knowledge and expertise. Whether you are a new or experienced trustee, Achieving Investment Excellence will help you safeguard fund performance while remaining faithful to the fund's mission and long-term strategic goals.

Inside, you'll learn how to effectively and confidently steer your fund's portfolio with a thorough understanding of risk concepts, return expectations and key investment tools and benchmarks. With an ability to thoroughly assess the quality of your investment set-up, you will be ready to engage in strategic changes that can yield real, measurable gains for your fund.

The board is key in achieving long-term investment success. Achieving Investment Excellence is peppered with discussion questions, case studies and practical tools you can implement to immediately begin improving board effectiveness and fund performance. Regardless of fund size, you can realize greater returns, simply by improving your understanding of how the board designs, guides and monitors investment. Embrace the opportunity inherent in the trustee role and begin focusing the investment agenda on what really matters.

PRAISE FOR

ACHIEVING INVESTMENT EXCELLENCE

"It is a well-written journey through all key aspects of investment governance. Not only trustees would benefit from this well of knowledge, but also professionals working within the institutions and stakeholders on the outside."
—Knut Nordheim Kjaer, Chairman and Partner, FSN Capital, Norway

"Thus far, there has not been a high-level source for systematically educating board members on the challenges of their duties. Most of the investment literature is either too superficial or too specialized. Achieving Investment Excellence spans the relevant fields."
—Theresa Whitmarsh, Executive Director, Washington State Investment Board, United States

"This book is a great addition to financial literature. The scope of the material and the mini-cases make it very accessible for a wider public than only board members and trustees."
—Eduard van Gelderen, Chief Investment Officer, PSP Investments, Canada

"This book will be invaluable. I find each page to contain extremely helpful guidance to pension fund trustees."
—Frank J. Fabozzi, Editor, Journal of Portfolio Management, United States

"Raising the investment governance budget is crucial for pension fund trustees. This book achieves exactly that. A 10-hour crash course on the key elements of investment excellence for pension funds."
—Jaco van der Walt, Head - Investment Management Office, FirstRand, South Africa

"I have found it to be thorough, well-organized, well-written and it will be, I am sure, of great help to any pension fund trustees starting out on the job, as well as those wanting to refresh their perspective."
—Steve Lydenberg, Partner - Strategic Vision, Domini Impact Investments, United States

"Achieving Investment Excellence is a book that was waiting to be written and the three authors are uniquely qualified to make it happen! Written in clear, simple language, the book covers all the essentials that trustees and others involved in the governance of pension investing need to know without compromising on accuracy or rigour."
—Sung Cheng Chih, CEO, Avanda Investment Management; Board Member, MIT Endowment, Singapore

"This book is outstanding. It successfully provides trustees with actionable learnings and insights that will improve decision making in pursuit of best practice in governance and sustainable investment excellence. It should be required reading for all investment committee members."
—Todd Ruppert, Board member and Endowment Chair, Furman University and INSEAD business school; Venture Partner, Greenspring Associates; Retired CEO and President, T. Rowe Price GIS

"Boards of trustees are key in creating and supporting the conditions for long-term investment success on behalf of their beneficiaries. Achieving Investment Excellence will be of great help for board members aiming at playing their role more efficiently in the rapidly evolving field of pension investing."
—Lionel Martellini, Director, EDHEC-Risk Institute; Professor of Finance, EDHEC Business School