How to Help Your Trustees Fulfill their Investment Responsibilities

Transcription

1 How to Help Your Trustees Fulfill their Investment Responsibilities October 16, 2017 Alton Cogert, CFA, CPA, CAIA, President & CEO

2 How to Help Your Trustees Fulfill their Investment Responsibilties l Trustee Responsibilities l Your Investment Process l Investment Professional as a Fiduciary or Not? l Hidden Costs and Opportunity Costs l Risk Management of Investments l Battling Low Rates for Longer l Putting It All Together 2

3 TRUSTEE RESPONSIBILITIES 3

4 Trustee Responsibilities* - Duties l To act with reasonable skill and care o Depends upon trustee s personal knowledge l To take advice where appropriate o If not competent with investments, you should get proper advice unless the cost of advice is prohibitive relative to size of the pool. o Suitable level of risk and diversification. l To keep the investments under review o Investments should be reviewed on a regular basis by trustees in conjunction with appointed advisors, as applicable. *SAA is not a law firm. Always contact a professional for legal advice. 4

5 Trustee Responsibilities* Decision Making Process l Suitability o Take into account the needs of the policyholders (beneficiaries), the purpose of the trust and type of existing investments. o Determine whether it would be more appropriate to invest in other categories of investment. l Diversification o Maintain a spread of investments with a view to reducing the overall risk profile of the pool. l Delegation, not abdication, of investment management functions o May appoint a discretionary manager, but they must provide a written investment policy statement, including periodically reviewing that statement. *SAA is not a law firm. Always contact a professional for legal advice. 5

6 YOUR INVESTMENT PROCESS 6

7 Your Pool s Investment Process l Over the long run, process determines results. Thus, process becomes more important than results. Positive Result Negative Result Good Quality Process Expected Bad Luck Bad Quality Process Good Luck Expected 7

8 Your Pool s Investment Process Performance Measurement & Analysis Portfolio Monitoring Strategic Asset Allocation Investment Process Value Chain Investment Manager Evaluation & Selection Investment Policy & Guidelines Peer Group Analysis l Strong investment results require a strong investment process. This goes beyond choosing the right investment manager. l A strong investment process is a consistent, proven approach to adding value that can be documented for Trustees and senior management. 8

9 Strategic Asset Allocation Pool Goals & Objectives Recommendation ns s need need to to be be feasible feasible Business Risk vs. Investment Risk Lines of business Balance model output vs. common sense Risk tolerance l 90%-95% of prospective returns will be determined by the allocation decision. 9

10 Investment Policy & Guidelines l A Periodic Best Practices Review is Critical o o Provide peace of mind that the policy is relevant to today s capital markets and the unique requirements of your pool. Protect your pool from investment managers taking actions that have been a problem in other cases. l Key components of Best Practices Investment Policy: o o o o o o Preamble Who? What? Roles and Responsibilities Investment Return and Management Objectives Asset Allocation and Risk Management Guidelines Identification of Appropriate Benchmarks Investment Performance Evaluation and Reporting Investment Policy and Guidelines Evaluation 10

11 Peer Group Analysis l How have peers structured their investment portfolios and how does it compare to what we have done? l Are they using strategies, tactics or ideas we should consider? l How does their investment structure mesh with their business can this help us from a competitive perspective? 11

12 Fixed Income Portfolio Book Yield & Duration Duration (Yrs) Book Yield (%) Max Min Median Average

13 Risk Asset Allocation & Fixed Income Portfolio Duration Duration (Yrs) RA % of Surplus Max % Median % Average % 13

14 Fixed Income Allocation By Sector ST/MMF (%) UST & US Agency (%) Agency MBS (%) ABS/CMBS (%) Corporate & Taxable Muni (%) Max 54.7% 100.0% 45.3% 22.8% 59.4% Median 1.6% 18.3% 20.3% 11.6% 38.8% Average 6.3% 29.3% 18.7% 12.4% 33.3% Sorted by largest exposures to corporate and structured securities. 14

15 Fixed Income Allocation By Credit Rating AAA-AA (%) A (%) BBB (%) Max 100.0% 29.5% 31.8% Median 63.7% 18.1% 14.7% Average 65.4% 16.5% 12.5% Sorted by largest exposures to corporate and structured securities. 15

16 Fixed Income Investment Management Fees Annual Fees (%) Max 0.46% Min 0.09% Median 0.15% Average 0.16% 16

17 Investment Manager Search & Selection l Investment manager evaluation requires balancing the four P s and requires both quantitative and qualitative analysis People Philosophy Process Performance Corporate structure Organization Insurance expertise Tenure, experience and stability of team Compensation Succession Client service structure Key investment beliefs How manager adds value Bottom up/top down Competitive advantage/value Proposition Understandable Intuitive Repeatable Unique Methodical Risk controlled Adjusted for risk Adjusted for fees & taxes if applicable Consistency Rankings vs. peers Upside/downside Consistent with philosophy & process Attribution l We utilize Manager Select, a database of over 60 investment managers with knowledge of working with insurers, including government risk pools. o Knowledge of the market enables selection of the manager with the best fit and best value proposition 17

18 Portfolio Monitoring l Portfolio Monitoring consists of several important components o Compliance monitoring o Investment practices review o Analytical reporting review o Stress & sensitivity testing o Analysis of changing regulatory environment o Turnover analysis o Communication process Ø Routine vs. material event notification Ø Troubled credits how does your manager s position compare to others? 18

19 Performance Measurement & Analysis Where do you fall on this objective continuum and why? Book yield Constrained total return Total return l If book income is the goal, this should be factored into the analysis of performance. l Performance should be adjusted for risk, fees and taxes if applicable. l Performance should be analyzed to determine why the portfolio performed as it did (attribution analysis). l Trends over short and long term periods are important is the manager and overall portfolio performing as expected? l Comparisons with peers is important especially in the context of the overall business. 19

20 Fixed Income Performance 5 Years Ending 6/30/2016 Net of fees 20

21 Total Portfolio Performance - 5 Years Ending 6/30/2016 Net of fees 21

22 INVESTMENT PROFESSIONAL: FIDUCIARY OR NOT? 22

23 Investment Professional as a Fiduciary or Not? l If registered as an investment advisor with the SEC YES l If a broker/dealer, responsible for determining suitability of investments NO l Internal investment professional PROBABLY NO held to standards of employment l If you are unsure, ASK and get assurances in writing. 23

24 HIDDEN COSTS AND OPPORTUNITY COSTS 24

25 Hidden Costs and Opportunity Costs l Hidden Costs just a few o Bonds have no trading commissions, while stocks do. o Cost of bond trading is greater than trading stocks Ø Stock trading commissions were deregulated in the 1970s and have since come down severely with the advent of electronic exchanges Ø Bond trading incurs bid/ask differences and is subject to a generally inefficient market (less so with US Treasuries) Ø Some broker/dealers will buy a bond for their inventory and then sell the same bond to your pool, potentially benefiting on the trade twice. 25

26 Hidden Costs and Opportunity Costs l Opportunity Costs What you could have earned, this is never shown on your financial statements. Here are just a few o Not considering all possible asset classes or investments within that asset class can result in lower investment income o Not considering the possibility and the potential impact from a more diversified portfolio can result in lower portfolio investment returns, adjusted for risk. o Not reviewing your pool s investment process periodically can result in poorer investment results. o Not reviewing investment management fees can result in lower investment income and returns. 26

27 RISK MANAGEMENT OF INVESTMENTS 27

28 Risk Management of Investments l One dimension: Risk Assets l Other dimensions include o Stress testing What is the downside risk? o Diversification o Fixed Income Duration versus Duration of Reserves (Liabilities) o Credit Risk of Fixed Income Portfolio 28

29 Risk Asset Allocation - % of Total Portfolio Risk Assets % Max 41.2% Median 16.5% Average 15.6% 29

30 Risk Asset Allocation - % of Surplus / Net Position RA % of Surplus Max 59.5% Median 24.7% Average 26.3% 30

31 Risk Asset Allocation Sorted by Largest Risk Asset Allocation U.S. Equity % Intl. Equity % HY % Other % Max 100.0% 22.1% 39.0% 24.9% Median 81.8% 8.1% 8.5% 0.0% Average 78.7% 7.9% 11.0% 2.3% 31

32 BATTLING LOW RATES FOR LONGER 32

33 Battling Low Rates for Longer A few ideas l Re-review duration of reserves (liabilities) o Can we be rewarded by increasing investment portfolio duration? Is that worth the risk? l Review risk asset allocation o Percentage of asset limitations are OK for investment policy purposes, but can be misleading o Determine downside risk of a given risk asset allocation. How does this compare with your pool s overall risk appetite? 33

34 Battling Low Rates for Longer A few ideas l Review investment benchmarks, especially fixed income benchmarks o Are they incenting the investment manager not to act in the best interests of your pool? How do they fit within a strategy of battling low rates for longer 34

35 PUTTING IT ALL TOGETHER 35

36 Putting It All Together Some very initial questions l Do your pool s trustees feel comfortable with the depth of their investment responsibilities? Do they still feel comfortable knowing they can delegate, but not abdicate those responsibilities? l Have your pool s trustees considered all parts of the Investment Process in their deliberations about investments? l Are your pool s trustees aware of both hidden costs and opportunity costs within the investment process? Those costs could be seriously degrading the interests of pool members. 36

37 Putting It All Together Some very initial questions l Are your pool s trustees comfortable with the overall level of risk within the investment portfolio? Are they familiar with and comfortable with the ongoing efforts to monitor and manage those risks? l Are your pool s trustees comfortable with the current level of portfolio monitoring, including performance measurement and comparisons to other pools? 37

38 THANK YOU 38