Achieving Investment Excellence

About the Authors xiii
Acknowledgments xvForeword xvii
Introduction 1Levels 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 170What 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