Agenda Item #4.7b REPORT TO THE BOARD OF GOVERNORS SUBJECT AMENDMENTS TO THE CURRENCY HEDGING POLICY IN THE UBC ENDOWMENT AND STAFF PENSION PLAN INVESTMENT POLICIES MEETING DATE JUNE 2, 2014 Forwarded to the Board of Governors on the Recommendation of the President APPROVED FOR SUBMISSION Presented By Pierre Ouillet, Vice-President Finance, Resources & Operations Peter Smailes, Treasurer Jai Parihar, President and CEO, UBC Investment Management Trust Report Date May 14, 2014 DECISION REQUESTED IT IS HEREBY REQUESTED that the UBC Board of Governors approve the following amendments to the Currency Hedging Policy for the UBC Endowment and Staff Pension Plan Investment Policies, as recommended by UBC Investment Management Trust: 1. 0% currency hedging policy for foreign public equities and private equities and 100% currency hedging for other foreign assets; and, 2. Limit the maximum foreign currency exposure of the fund to the maximum weighting permitted for investment in foreign public and private equities. EXECUTIVE SUMMARY UBC Investment Management Trust (IMANT) is seeking approval for an amended Hedging Policy in the UBC Endowment and Staff Pension Plan Investment Policies. The Current Policy requires 50% currency hedging policy for Developed Markets currencies exposures, with a range of 40 to 60%. Attached: Section 5 of the UBC Endowment Fund Statement of Investment Policies and Procedures - Objectives, Return and Risk Expectations, Asset Allocation Policy (Redline and Proposed Revision) Template revised: 4/8/2014 6:25 AM
SECTION 5 OBJECTIVES, RETURN AND RISK EXPECTATIONS, ASSET ALLOCATION POLICY Fund Objectives 5.1 The primary objective of the Fund is to maximize the rate of return at an appropriate level of risk in order to: (a) honour the wishes of the donors of endowed funds, (b) provide cash flows and capital appreciation that are sufficient to support the Endowment s current spending objectives plus inflation and expenses, and (c) preserve the capital and purchasing power of each endowment in order to provide the same level of support to future generations i.e. maintain intergenerational equity. Return and Risk Expectation 5.2 The Fund is expected to achieve over moving four-year periods a return, before all fees and expenses, at least equal to a composite benchmark made up of passive investments in appropriate market indices (target Investment Policy Portfolio, (IPP) and is defined below in Section 5.5) according to the Strategic Asset Allocation Policy weighting. 5.3 The risk inherent in the investment strategy over the intermediate term (a five to ten year period) is three fold. There is a risk that long-term market returns will not be in line with expectations. To the degree that an active management style is employed, there is a risk that the added return expected of active management over passive management will not be realized, or will be negative. There is also the risk of annual volatility in returns which means that in any one year the actual return may be very different from the expected long-term return (such return may also be negative). The initial measure of risk is the 4-year rolling rate of return compared with the current spending policy. The portfolio optimization modeling suggests that there is roughly a 60% probability of achieving the return target over a 10 year period.
Risk expectation can be measured in several ways. The initial measures are: (a) Standard Deviation The Strategic Asset Allocation Policy is expected to achieve a target standard deviation of 10% or less in nominal terms over ten year periods. (b) Intergenerational Equity The test of intergenerational equity is the retrospective examination of the Endowment regarding: i. Maintenance of the inflation-adjusted value of the Fund, balanced by ii. an equitable distribution of the Endowment s real rate of return across all generations of Beneficiaries. Asset Allocation 5.4 In identifying the long term Strategic Asset Allocation Policy that would best meet the above Fund objectives, consideration has been given to: (a) the factors outlined in Fund Overview (Section 3), (b) capital preservation and the need to maintain inter-generational equity, (c) the long-term return expectations and the risks associated with key asset classes, as well as the relationships of their returns with each other, inflation and interest rates, (d) diversification benefits obtained by the inclusion of several asset classes, and (e) practical considerations.
5.5 Over complete market cycles, the allocation is expected to stay within the following ranges and approximate the Strategic Asset Allocation Policy: Component Asset Classes Percentage of Fund at Market Value Range Minimum Maximum Index Name Investment Policy Portfolio Benchmark (IPP)* Policy Allocation Cash & Cash Equivalents 0.0% 4.0% DEX 91 Day T-Bill Index 2.0% Cdn Mortgages 3.0% 7.0% DEX Short Term Bond Index + 1.0% 5.0% Bonds 10.0% 16.0% DEX Universe Bond Index 13.0% Total Fixed Income 15.0% 25.0% 20.0% Cdn Equities ** 10.0% 20.0% S&P/TSX Composite Index 15.0% 20.0% Foreign Global Equities** 15.0% 25.0% MSCI World Net Index (CAD) MSCI Emerging Mkts Net 10.0% Emerging Mkts** 7.5% 12.5% Index (CAD) Total Public Equities 40.0% 50.0% 45.0% Private Equity** 7.5% 12.5% MSCI World Net Index (CAD) +2% (lagged 3 months) 10.0% Real Estate** 10.0% 15.0% CPI + 4.0% 12.5% CPI + 4.5% 12.5% Infrastructure** 10.0% 15.0% Hedge Funds** 0.0% 0.0 HFRI Fund of Funds: Conservative Index (Cdn) 0.0 Total Alternatives 30.0% 40.0% 35.0% * The IPP Benchmark includes a 50% hedge of Developed Market foreign currency exposures into Canadian dollars. ** The Table reflects the long term Policy Benchmark. For the transition period actual weights will be above or below these targets.
5.6 Recognizing that buying and selling securities does incur a cost and that there is a trade off between transaction costs and benefits, for public market securities, the Fund will be rebalanced on a monthly basis: (a) If an asset class is above or below an asset class range (varies by plus or minus 2% to 5%, dependent on asset class), management must rebalance to the range. Management has discretion to rebalance to the mid-point or to the range. Any deviations from the asset class mid-point must be reported to the Board. It is anticipated that management will generally rebalance to the asset class mid-point when an allocation is 3% above or 2% below the target weight. (b) In periods of extreme market volatility, the above rebalancing policy may be suspended upon confirmation and approval by the Chair of the Board and notification to the Board. For the transition period, the alterative asset classes will be outside their long term target ranges and the ability to directly rebalance is not within IMANT s control. 5.7 In the event the Board or Investment Committee suspends further allocations or redemptions to or from an asset class as a result of unfavorable market conditions, the investment policy asset class weights will be adjusted accordingly until such suspension is removed or the policy amended. 5.8 The Investment Policy Portfolio benchmark includes 0% currency hedging for foreign public and private equities and 100% currency hedging for other foreign assets. 5.75.9 The maximum foreign currency exposure of the fund is limited to the maximum weighting permitted for investment in foreign public and private equities. As part of risk management of foreign currency exposure the Fund shall target a 50% currency hedge ratio for Developed Markets currencies. The actual currency hedge ratio may deviate between 40% and 60% of total foreign currency
exposure. Any Developed Market currency exposure less than 2% of the value of the Fund can be left unhedged. 5.8 Emerging Markets currency exposures are to be unhedged to recognize expected higher growth and currency appreciation and high transaction costs. 5.95.10The Investment Policy Portfolio Benchmark (IPP) based on the Strategic Asset Allocation Policy is outlined in Section 5.5 effective June 30, 2013. See Appendix A for a historical record of the IPP benchmarks. 5.10 The IPP benchmark includes a 50% hedge of Developed Markets foreign exposures into Canadian dollars. Hedging is done to reduce short term volatility from currency fluctuations.
SECTION 5 OBJECTIVES, RETURN AND RISK EXPECTATIONS, ASSET ALLOCATION POLICY Fund Objectives 5.1 The primary objective of the Fund is to maximize the rate of return at an appropriate level of risk in order to: (a) honour the wishes of the donors of endowed funds, (b) provide cash flows and capital appreciation that are sufficient to support the Endowment s current spending objectives plus inflation and expenses, and (c) preserve the capital and purchasing power of each endowment in order to provide the same level of support to future generations i.e. maintain intergenerational equity. Return and Risk Expectation 5.2 The Fund is expected to achieve over moving four-year periods a return, before all fees and expenses, at least equal to a composite benchmark made up of passive investments in appropriate market indices (target Investment Policy Portfolio, (IPP) and is defined below in Section 5.5) according to the Strategic Asset Allocation Policy weighting. 5.3 The risk inherent in the investment strategy over the intermediate term (a five to ten year period) is three fold. There is a risk that long-term market returns will not be in line with expectations. To the degree that an active management style is employed, there is a risk that the added return expected of active management over passive management will not be realized, or will be negative. There is also the risk of annual volatility in returns which means that in any one year the actual return may be very different from the expected long-term return (such return may also be negative). The initial measure of risk is the 4-year rolling rate of return compared with the current spending policy. The portfolio optimization modeling suggests that there is roughly a 60% probability of achieving the return target over a 10 year period.
Risk expectation can be measured in several ways. The initial measures are: (a) Standard Deviation The Strategic Asset Allocation Policy is expected to achieve a target standard deviation of 10% or less in nominal terms over ten year periods. (b) Intergenerational Equity The test of intergenerational equity is the retrospective examination of the Endowment regarding: i. Maintenance of the inflation-adjusted value of the Fund, balanced by ii. an equitable distribution of the Endowment s real rate of return across all generations of Beneficiaries. Asset Allocation 5.4 In identifying the long term Strategic Asset Allocation Policy that would best meet the above Fund objectives, consideration has been given to: (a) the factors outlined in Fund Overview (Section 3), (b) capital preservation and the need to maintain inter-generational equity, (c) the long-term return expectations and the risks associated with key asset classes, as well as the relationships of their returns with each other, inflation and interest rates, (d) diversification benefits obtained by the inclusion of several asset classes, and (e) practical considerations.
5.5 Over complete market cycles, the allocation is expected to stay within the following ranges and approximate the Strategic Asset Allocation Policy: Component Asset Classes Percentage of Fund at Market Value Range Minimum Maximum Index Name Investment Policy Portfolio Benchmark (IPP) Policy Allocation Cash & Cash Equivalents 0.0% 4.0% DEX 91 Day T-Bill Index 2.0% Cdn Mortgages 3.0% 7.0% DEX Short Term Bond Index + 1.0% 5.0% Bonds 10.0% 16.0% DEX Universe Bond Index 13.0% Total Fixed Income 15.0% 25.0% 20.0% Cdn Equities * 10.0% 20.0% S&P/TSX Composite Index 15.0% 20.0% Global Equities* 15.0% 25.0% MSCI World Net Index (CAD) MSCI Emerging Mkts Net 10.0% Emerging Mkts* 7.5% 12.5% Index (CAD) Total Public Equities 40.0% 50.0% 45.0% Private Equity* 7.5% 12.5% MSCI World Net Index (CAD) +2% (lagged 3 months) 10.0% Real Estate* 10.0% 15.0% CPI + 4.0% 12.5% CPI + 4.5% 12.5% Infrastructure* 10.0% 15.0% Hedge Funds* 0.0% 0.0 HFRI Fund of Funds: Conservative Index (Cdn) 0.0 Total Alternatives 30.0% 40.0% 35.0% * The Table reflects the long term Policy Benchmark. For the transition period actual weights will be above or below these targets.
5.6 Recognizing that buying and selling securities does incur a cost and that there is a trade off between transaction costs and benefits, for public market securities, the Fund will be rebalanced on a monthly basis: (a) If an asset class is above or below an asset class range (varies by plus or minus 2% to 5%, dependent on asset class), management must rebalance to the range. Management has discretion to rebalance to the mid-point or to the range. Any deviations from the asset class mid-point must be reported to the Board. It is anticipated that management will generally rebalance to the asset class mid-point when an allocation is 3% above or 2% below the target weight. (b) In periods of extreme market volatility, the above rebalancing policy may be suspended upon confirmation and approval by the Chair of the Board and notification to the Board. For the transition period, the alterative asset classes will be outside their long term target ranges and the ability to directly rebalance is not within IMANT s control. 5.7 In the event the Board or Investment Committee suspends further allocations or redemptions to or from an asset class as a result of unfavorable market conditions, the investment policy asset class weights will be adjusted accordingly until such suspension is removed or the policy amended. 5.8 The Investment Policy Portfolio benchmark includes 0% currency hedging for foreign public and private equities and 100% currency hedging for other foreign assets. 5.9 The maximum foreign currency exposure of the fund is limited to the maximum weighting permitted for investment in foreign public and private equities. 5.10 The Investment Policy Portfolio Benchmark (IPP) based on the Strategic Asset Allocation Policy is outlined in Section 5.5 effective June 30, 2013. See Appendix A for a historical record of the IPP benchmarks.