Post on 18-Oct-2020
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Geo-Political Headwinds are
Risk Management Tailwinds Niagara Institutional Dialogue 2012
Niagara on the Lake, Ontario
Bruce B. Curwood, MBA, CFA, CIMA, Acc.Dir.
Director, Investment Strategy
Don Ezra, M.A, FIA
Co-Chairman Global Consulting
June 11, 2012
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Important Information Nothing in this publication is intended to constitute legal, tax securities or investment advice, nor an opinion regarding the appropriateness of
any investment. This is a publication of Russell Investments Canada Limited and has been prepared solely for information purposes. It is made
available on an “as is” basis. Russell Investments Canada Limited does not make any warranty or representation regarding the information.
This document is not intended as and is not to be taken as an offer or solicitation with respect to the purchase or sale of any security or interest,
nor does it constitute an offer or solicitation in any jurisdiction in Canada, including those in which such an offer or solicitation is not authorized
or to any person to whom it is unlawful to make such a solicitation or offer. Any decision to purchase securities or interests with respect to the
mutual funds described herein (the "Funds") must be based solely upon the information contained in the private placement offering or
prospectus documents for the Funds. The information contained herein is directed exclusively at persons who are accredited investors for
purposes of Canadian securities laws. Series of the Funds to which this communication relates are only available to the persons referred to
above and other persons should not act or rely on the information contained herein. This communication is by Russell Investments Canada
Limited.
Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an
even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return
could, at certain times, unintentionally reduce returns. Diversification does not assure a profit and does not protect against loss in declining
markets.
Russell Investments Canada Limited is a wholly owned subsidiary of Frank Russell Company and was established in 1985. Russell Investments
Canada Limited and its affiliates, including Frank Russell Company, are collectively known as “Russell Investments”.
Frank Russell Company, a Washington USA corporation, operates through subsidiaries worldwide, including Russell Investments Canada
Limited, and is a subsidiary of The Northwestern Mutual Life Insurance Company.
TRADEMARKS The Russell logo, Sovereign, Sovereign Investment Program, LifePoints, MULTI ASSET MULTI STYLE MULTI MANAGER,
and any Russell indices are either trademarks or registered trademarks of Frank Russell Company. The information and any statistical data
contained herein have been obtained from sources which we believe to be reliable but we do not represent they are accurate or complete and
they should not be relied upon as such. All opinions expressed and data provided herein are subject to change without notice.
Copyright© Russell Investments Canada Limited 2012. All rights reserved. The contents of this report are intended for the recipient of the report
only and are not be reproduced, transferred or distributed in any form without prior written permission from Russell Investments Canada
Limited.
Date of first publication: May 2012
INST-2012-05-25-0053 (EXP-12-12)
p.2
THIS CONFERENCE MATERIAL WAS CREATED BY RUSSELL AS AN EDUCATIONAL TOOL
AND IS NOT FOR FURTHER DISTRIBUTION.
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p.3
Overall PIAC* Report Card September 28, 2000
You are on the right track. But there is room for improvement.
A+ A A- B+ B B- C+ C C- D+ D D-
1. Business Like X
2. Governance X
3. Risk X
4. Asset Allocation X
5. Investment Structure X
6. Investment Manager Hiring X
7. Research X
8. Measurement X
9. Documentation X
10. Scale X
OVERALL X
A+ A A- B+ B B- C+ C C- D+ D D-
1. BUSINESS-LIKE X
2. GOVERNANCE X
3. RISK X
4. ASSET ALLOCATION X
5. INVESTMENT
STRUCTURE X
6. INVESTMENT MANAGER
HIRING X
7. RESEARCH X
8. MEASUREMENT X
9. DOCUMENTATION X
10 SCALE X
OVERALL X
*PIAC: The Pension Investment Association of Canada Source: Russell Investments
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Failure to Understand Risk at the Total Fund Level
› Risk – an area that needs greater exploration
› Sponsors tend to look at risk sporadically
› A comprehensive risk-evaluation process should be the
primary factor in managing total fund risk and setting the
pension game plan
› Few sponsors are proactive when it comes to total fund
risk and many use inappropriate tools
p.4
C -
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p.5
Ten Observations on Risk Management
1. Too much dialogue; too little action
2. No one-size-fits-all solution
3. Risk is multi-dimensional (quantitative & qualitative)
4. Investors are not proactive and lack a true understanding of the risks in
their fund
5. Tail events can destroy your fund
6. Financial crises are regular recurring events
7. Satisficing behavior is preferable to optimization of the unknown
8. Agreeing on your primary objective, risk tolerance, risk capacity and
relevant time horizon is critical
9. Risk management is just as much a people issue as an organizational
issue
10. Organizational changes around risk management are difficult and
time-consuming
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Conventional Approaches are Failing Us!
The New Normal.
A new market environment of:
› Austerity,
› Low returns, and
› High volatility, which is
› Often driven by geopolitics.
A period of great uncertainty!
p.6
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Surviving and Thriving in Uncertainty: Creating the Risk Intelligent Enterprise
p.7
Conventional Wisdom
› a random walk
› the Theory
Unconventional Realities
› random, with hops, skips & jumps
› the Reality
factors affecting events will remain
equal factors affecting events will change
events are mildly random events can be wildly random
extreme events are rare and should
be treated as anomalies
extreme events are more common than
we think and should be treated as such
forecasts are accurate and reliable forecasts are inaccurate and unreliable
events are independent of one
another events interact
markets are efficient and rational markets are neither efficient nor rational
Source: Frederick Funston & Stephen Wagner, 2010, Surviving and Thriving in Uncertainty: Creating the risk intelligent enterprise.
John Wiley & Sons Inc, p.34
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p.8
The Problem…
The Problem The inequitable amount of time and
resources that investors spend on
return over risk.
The Solution Building an organization-wide
approach within a risk-management
framework, process and culture!
and the Solution.
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Tailwinds & Headwinds
p.9
1981 – 2007 Tailwinds 2008 – Future Headwinds
Interest rates steadily fall from 1981
peaks
Short-term interest rates are near
all-time lows and are expected to
rise
De-regulation of investment
markets
Global Financial Crisis (GFC), fraud
and various market abuses may
lead to greater regulation
Globalization of trade as Berlin Wall
falls and Cold War ends Possible protectionism and tariffs?
Consumer and government debt
levels reasonable
Consumer and government debt
levels (debt / GDP) elevated
Leverage De-leveraging
Falling inflation
Greater uncertainty as politics may
lead to dichotomous outcomes
(inflation or taxation)
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A Demon of our Own Design
› “The global economy is a complex, tightly coupled,
non-linear system that is turbulent, near impossible to
predict and very difficult to control.”
› Investors face strong headwinds for a prolonged period!
p.10
“The more complex and tightly coupled the system,
the greater the frequency of normal accidents.”
Source: Richard Bookstaber, 2007, A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation.
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Change is Necessary
› The only certainty in investing is that there is no certainty!
› As Trustees, we are generally dealing with incomplete,
ambiguous market information
› Returns often appear to follow a normal pattern and then
they don’t – movements can be random & dramatic
› Markets are complex adaptive systems affected by
human behavior
› Humans suffer from a host of behavioral biases
› So investors can’t generally predict or control return!
p.11
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So What Can We Learn From The Current Crisis?
p.12
RIMS State of ERM Report 2008 found that
organizations seeking better performance need to
broaden their programs to mature in the
competency drivers that support front-line risk
ownership, linkage and governance oversight…to
build a culture of risk-adjusted decision making
throughout an organization.
“
“
RIMS = Risk & Insurance Management Society
ERM = Enterprise Risk Management
Source: RIMS ERM Report 2008
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The Governance Catch-22
p.13
Governance can overcome unconscious
bad behavior
Unconscious bad behavior can
undermine Governance
BUT
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5 Governance Impediments to Risk Management
1. Narrow interpretation of the solution set
(seeking a tool, not a process)
2. Impatience and short cuts
(ignoring behavioral issues)
3. Looking at the normative instead of a broader
perspective (underestimating dynamic markets)
4. Inadequate allocation of time
5. Defining the problem incorrectly
p.14
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Understand Why Change is Necessary: Return, by nature, is largely unpredictable
p.15
In short,
by optimizing the unpredictable (return),
we have been focusing on the wrong variable.
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p.16
On what you
can control
(re)Focus
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What Can Trustees Control?
1. The governance process (to overcome bad behavior)
› Discipline
› Preparedness
› Focus on the primary goal
› Better communication
2. The risk-management process
› Determine the level of acceptable risk relative to your primary goal, risk capacity, risk tolerance and time horizon
› Be cognizant of liquidity, transparency & leverage
› Utilize stress testing & scenario analysis (ask yourself what can go wrong)
p.17
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The More Thoughtful will…
› Realize that risk can’t be summed up in a number, but involves
intangibles such as investor culture, behavior and strategy
› Evaluate whether their horizon is long or short
› Take into account the fact that a meltdown results in temporary
imbalances: can you take that risk?
› Improve your governance structure and risk management
practices (invest for success, but be cognizant of the downside)
› Focus more on common sense in risk management and
develop a comprehensive framework (quantitative &
qualitative)
› Consider new approaches
“There is no education like adversity”, Benjamin Disraeli‡
p.18
‡
Source: Disraeli – A Biography, Stanley Weintraub, October, 1993
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Summary
1. The world is driven more and more by geopolitical
forces, which are overriding investment fundamentals
2. Investor uncertainty is therefore greater than ever
3. To avoid being blindsided, a better understanding of
fund risk(s) and better preparedness is essential
4. Investors need to focus on the two things they can
control: Governance & Risk Management Process
5. It all comes down to building a culture of risk-adjusted
decision-making
p.19
Geo-political headwinds should be
tailwinds for risk management!
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Russell Surveys 2012 Results
› Purpose of the study
› To gather information on measuring attitudes towards risk management as well
as governance.
› Surveyed population - Pensions & Investments Advisor Panel
› Respondents by sector: Corporate, Public, Endowment, educational Institution,
Foundation, Health Service Organization, Union
› Respondents by function: Investment/portfolio management, Pension
management/administration, Employee benefits/Human resources, General
financial administration, Cash management, Insurance/risk management
› Number of Respondents = approx. 233 (Survey#1) and approx. 205 (Survey#2)
› Plan type: DB, DC, E&F
p.20
Source: Pensions & Investments (in conjunction with Russell Investments), 1st Risk Survey February 2012 and 2nd Risk Survey March 2012
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Top Concerns in 2012 Pertaining to Investment Program
p.21
TOP CONCERNS IN 2012 PERTAINING TO INVESTMENT PROGRAM
Rank Corporate Plans % Public Plans % Endowments &
Foundations %
1 Market Volatility 88.6 Market Volatility 82.1 Market Volatility 82.5
2 Risk Management 69.5 Risk Management
Risk 79.9 Risk Management 80.0
3 Regulatory Changes 53.5
Expense Control
Manager
Transparency
41.0 Regulatory Changes 37.5
4 Expense Control 42.9
Regulatory
Changes Need for
Contributions
30.8 Manager
Transparency 35.0
5 Need for
Contributions 40.0
Performance vs.
Peers 25.6
Expense Control
Inflation Control 32.5
Source: Pensions & Investments (in conjunction with Russell Investments) , 1st Risk Survey, February 2012
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p.22
90%
58% 52%
58%
73% 81%
Risk more
important than
5 years ago
Pension plan
presents higher
risk to balance
sheet than 5 years
ago
Pension plan
presents higher
risk to earnings
than 5 years ago
Investment portfolio
presents higher risk
to organizational
mission than 5 years
ago (E&F only)
Increase in scrutiny
from Board &
Investment
Committee vs.
5 years ago
Complexity of
manager selection
has increased from
5 years ago
Comparing Importance of Issues Today versus 5 Years Ago
Source: Pensions & Investments (in conjunction with Russell Investments), 1st Risk Survey February 2012
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Portfolio Changes Due to Risk Measures (Last 12 months)
p.23
Source: Pensions & Investments (in conjunction with Russell Investments), 2nd Risk Survey March 2012
Minor Tweaks 46%
Moderate Changes
28%
Major Overhaul
5%
No Changes 21%
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Risk Management: Perception vs. Action
p.24
Source: Pensions & Investments (in conjunction with Russell Investments), 2nd Risk Survey March 2012
90.0%
79.2%
35.5%
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
90.0%
100.0%
Risk more important than 5 years ago
Made changes to portfolio due to Risk Management (last 12 months)
Need to spend more time on risk management
(i.e. currently spending "too little" time)
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Expect to Take Additional Steps to Increase Risk Management (within12 months)?
p.25
Source: Pensions & Investments (in conjunction with Russell Investments), 2nd Risk Survey, March 2012
18.3 18.8 23.2
32.9 37.5
39.3
48.8 43.8 37.5
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Corporate Public E&F
No (net)
Yes but no plan
Yes & Have a plan
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Top Steps Taken to Improve Governance
p.26
Source: Pensions & Investments (in conjunction with Russell Investments), 2nd Risk Survey, March 2012
Increase monitoring & supervision
69.2%
Hired investment consultant
28.4%
Added staff 19.9%
Purchased/built risk tools 19.9%
Outsourced 10.9%
No changes 17.4%
Other 5.5%
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Institutional investors fall behind USA Inc in conversation with Amanda White top1000funds.com May 9, 2012
› Institutional investors are clearly behind in risk management compared to the innovative techniques implemented in treasury departments of corporate America, chief investment officer of Wurts and Associates, Jeff Scott says.
› Scott, who spent his career managing the balance sheet at Microsoft, Dow Chemical, the Alaska Permanent Fund and now investment consultant Wurts, says institutional investors want to manage returns, which is impossible.
› “Returns are a function of animal spirits. They swing between fear and greed. Do companies really change in long-term valuation over the weekend?” he asks.
› And while he points to investors such as Warren Buffet who “thinks about risk constantly with his capital”, Scott says many institutions are not thinking about risk.
› “There is poor governance, and poor risk management. A lot of losses experienced by funds throughout the financial crisis were a function of missing simple risk-management concepts like custody of collateral and liquidity. You didn’t need fancy mathematical risk models instead of common sense you can get in Omaha.”
› Scott says that institutional investors are behind in their risk-management practices.
› Many asset-management firms and hedge funds have far superior approaches to risk management than institutional investors. There are steps to take and it has to start with governance, and then understanding the risks you are taking.
p.27
Any views or opinions made are solely representations of the cited author (Jeff Scott) and do not necessarily represent those of Russell Investments.
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Russell Hazard Report
Sample Pension, as of December 31, 2011
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Surplus Summary Risk Analysis
Sample Pension, As of December 31, 2011
Sources: The above analysis is based primarily on Russell’s Capital Markets Forecasts and data from Bloomberg and FactSet. Please see Slide 31 ’Supplemental Information’ for
further details on the analysis provided.
This is a sample report provided for illustrative purposes only and is not meant to represent any actual results.
Equity 45%
Canada Equity 20%
Global Equity 25%
Fixed Income 40%
Canadian Agg 40%
Other 15%Canada Real Estate 10%
Global Infrastructure 5%
Physicals 16%
Unhedged Liability 84%
Assets ($450)
Liability ($500)
95% Surplus VaR Forward looking/Non-normal inputs
Less Risk M ore Risk Assets Liabilit ies
Treasury Rates 2.4% 2.2%
Credit Spreads 0.6% 1.5%
Equity Beta 7.0%
Other Assets 5.6%
Currency 0.0%
Active M anagement 0.9%
Diversification 0.0%
Total 6.1% 3.7%
Sponsor ImpactFunded
Status
Surplus/
Def icit
$ millions
As of 12/31/2011 90% (50.0)
R isk Enviro nmentLess Risk M ore Risk
Immed.
Recog.
IAS 19
Recog.
Amort ize
1 year
Amort ize
5 years
Standard VaR 80% (109.7) 1.31 2.45 (19.7) 28.1
Stressed VaR 57% (231.6) (1.13) 2.35 (141.6) 3.7
Scenario s
2011 Debt Crisis 83% (89.6) 1.71 2.47 0.4 32.1
Global Financial Crisis 82% (80.0) 1.90 2.48 10.0 34.0
Tech Bubble 83% (91.9) 1.66 2.47 (1.9) 31.6
100 bp Int Rate Decr 80% (113.0) 1.24 2.45 (23.0) 27.4
10% Equity Decline 86% (70.3) 2.10 2.48 19.8 36.0
Volatility Environment5th, 50th and 95th Percentiles as of April 30, 2012
Equity
Currency
Fixed Income
2.50 40.0
10 Year
Expected Returns
2011
EPS
2011
Free Cash Flow
0 50 100 150 200
50th 95th5th HighLow
-100 -50 0 50 100
p.29
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Asset Only Summary Risk Analysis
Sample Pension, as of December 31, 2011
Sources: The above analysis is based primarily on Russell’s Capital Markets Forecasts and data from Bloomberg and FactSet. Please see Slide 31 ’Supplemental
Information’ for further details on the analysis provided.
This is a sample report provided for illustrative purposes only and is not meant to represent any actual results.
Equity 45%
Canada Equity 20%
Global Equity 25%
Fixed Income 40%
Canadian Agg 40%
Other 15%Canada Real Estate 10%
Global Infrastructure 5%
Physicals 16%
Unhedged Liability 84%
Assets ($450)
Liability ($500)
95% VaR Forward looking/Non-normal inputs
Less Risk M ore Risk
Treasury Rates
Credit Spreads
Equity Beta
Other Assets
Currency
Active M anagement
Diversification 0.0% 0.0%
Total
Sponsor ImpactAs of 12/31/2011
R isk Enviro nmentLess Risk M ore Risk
Immed.
Recog.
IAS 19
Recog.
Amort ize
1 year
Amort ize
5 years
Standard VaR 1.64 2.47 (3.0) 31.4
Stressed VaR (0.79) 2.37 (124.7) 7.1
Scenario s
2011 Debt Crisis 2.29 2.49 29.7 37.9
Global Financial Crisis 0.92 2.44 (38.8) 24.2
Tech Bubble 2.27 2.49 28.4 37.7
100 bp Int Rate Incr 2.26 2.49 28.0 37.6
10% Equity Decline 2.10 2.48 19.8 36.0
Volatility Environment5th, 50th and 95th Percentiles as of April 30, 2012
Equity
Currency
Fixed Income
438.0
429.8
407.0
285.3
439.7
371.2
438.4
2011
EPS
2011
Free Cash Flow
2.50 40.0
Assets
450.0
0.0%
10 Yr Exp. Asset
Returns
2.4%
0.6%
7.0%
5.6%
0.9%
6.1%
-40 -20 0 20 40 60
0 50 100 150 200
50th 95th5th HighLow
p.30
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Supplemental Information
Note: This supplemental information relates to Slide 29 and Slide 30
p.31
●
● Asset values are based on actual market values w here available, and are otherw ise estimated.
● The value of the liability and its behavior in different environments is estimated from the generalized pension plan cash flow s, reported liability values, sensitivity to interest
rates, and information regarding the status of the plan. This data is typically provided by the client or the plan’s actuary, or derived from corporate f inancial statements.
● The alpha and tracking error assumptions used in this analysis are based on published expectations for the Russell funds in the portfolio. For investments outside of Russell
funds, estimates are based on the Russell alpha assumptions for the asset class/strategy or they have been provided by the client.
● Free cash flow s and earnings per share f igures are based on the corporation’s most recent 10K filing as provided by FactSet or Bloomberg w here available.
● Value at Risk (VaR) calculation and decomposition is calculated follow ing industry standards.
● 95% VaR represents the 1 in 20 dow nside Value at Risk on a forw ard-looking, one-year basis.
● 95% VaR calculations are based on return, standard deviations, and correlations w hich are generated from a non-normal asset class return distributions w ith fat tails as
represented by Russell’s capital market forecasts.
● VaR is calculated independently for individual components, w ith a diversif ication component balancing to total VaR.
● The VaR associated w ith the liabilities is captured w ithin the Treasury and Credit Spreads components.
● Active management is defined as the difference betw een the actual allocation and policy w eights, combined w ith alpha and tracking error expectations for active managers.
●
●
●
● The volatility environment is represented as follow s:
● Equities – The average value of the S&P/TSX 60 VIX index over the previous month plotted against its historical range (October 2009 to present).
● Fixed Income – The standard deviation of the yield on the 10-yr Canadian government bonds over the previous month plotted against its historic range (January 1990 to
present).● Currency – The average standard deviation of the JP Morgan G7 Currency Volatility Index over the previous month plotted against its historic range (June 1992 to present).
V2.0.0009
All values are estimates and should not be relied upon for any regulatory or f inancial f iling.
10-Year Expected Return is the expected return for each asset and liability component (Russell’s capital market forecasts).
The Stressed VaR scenario (“2XVol/ ρ~1.0”) assumes standard deviations are 2 times Russell’s current forecast. Correlations betw een asset classes are assumed to be 1.0 ,
except for surplus calculations, w here Treasury returns are assumed to have a correlation of -1.0 w ith other asset classes.
Scenario calculations are based on actual events defined as follow s: Tech Bubble (March 24, 2000 through April 4, 2001), Global Financial Crisis (June 8, 2008 through March
9, 2009), 2011 Debt Crisis (April 11, 2011 through October 3, 2011).
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p.32
Q&A
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p.33
Appendix
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Practical Considerations for Risk Management: A customized approach
1. Practical first steps, define:
› What is the primary objective for your fund?
› How much risk do you need to take on to meet your primary objective?
› What is your organization’s risk tolerance and risk capacity?
› What is your relevant time horizon?
› What are current and projected cash flows?
› What is your comparative advantage in investments and what needs improvement?
› What are your risk-management beliefs (conservative or informed judgment) and are your
current strategies appropriate?
› Are your investment beliefs supported by appropriate research?
› What are the required resources and risk-management tools needed to succeed?
› Is your governance process structured to succeed and are you focusing on the appropriate
issues? Is your valuable fiduciary time appropriately allocated? Do you need to delegate more to
investment professionals?
› Do you understand the possible tail events (not just normal markets)?
› Are you measuring what matters and is your reporting appropriate and focusing your attention
correctly?
p.34
BETA V1
Practical Considerations for Risk Management: A customized approach
2. Look at the impact of your fund on your organizations today vs. 10 or 20 years ago. Ask yourself:
› Is the impact considerably larger or smaller?
› Is the investment fund a significant exposure for your organization?
› How does this compare to peers in your industry?
3. Is an investment solution satisfactory or do you need to de-risk?
› If the latter, can you reduce the liabilities (based on the past or for the future)?
› With whom and how can you start the dialogue and negotiate this process?
4. Evaluate your depth of expertise in risk management and governance:
› Are you capable of handling this complex topic yourselves or do you need third-party assistance?
› Do you need a change agent to assist you or a 3rd party deep dive for governance and risk management?
p.35
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p.36
Fiduciary Asset / Liability Structural Implementation Operational
Governance
1. Legislative/Legal 2. Political 3. Decision-making 4. Imprudent
delegation 5. Publicity 6. Documentation
10. Benefits
18. Maverick 19. Research 20. Initial Due Diligence
28. Procedural Control
48. Resources 49. Systems / Technology
Objective Setting 7. Policy
Asset Allocation 8. SRI 9. Actuarial / Funding
11. Mismatch 12. Assumptions 13. Asset Mix / Class 14. Model 15. Downside 16. Diversification
21. Rebalancing 29. Cash flow
Asset Class Strategy 17. Regret 22. Active / Passive 23. Currency 24. Benchmark
30. Hedging 31. TAA 32. Timing 33. Credit
Manager / Portfolio Structure
25. Style 26. Sector 27. Country
34. Manager 35. Holdings Concentration 36. Tracking Error
Manager Research & Selection
37. Residual 38. Call
50. Liquidity
Custody / Execution 39. Trading 40. Transition
51. Custodial 52. Securities Lending 53. Valuation
Performance / Process Evaluation
41. Tolerance 42. Monitoring 43. Control 44. Contract 45. Audit / Accounting 46. Oversight
47. Ongoing Due Diligence
54. Guideline breach
Decision
Risk
Russell’s General Hierarchy of Governing Fiduciary Concerns
Hig
h I
mp
act
Hig
h R
isk
M
od
era
te R
isk
L
ow
Ris
k
BETA V1
Summary of 3 Steps to Trustee Redemption
1. Acknowledge the problem
Human behavior can be irrational
Markets are not normal
Managing risk is a complex, pervasive problem, which most Trustees have failed to master
2. Understand why change is necessary
Unconscious bad behavior can undermine good governance
By trying to optimize the unpredictable (return), we have been focusing on the wrong variable
3. Take action!
Focus on the things you can control:
i. Good governance
ii. Determine an acceptable level of risk and develop a risk-management culture & process
p.37
Risk Management is the cornerstone of
investing!
BETA V1
Take Action
Organize for success:
› Training – educate & use research to gain
market insight
› Culture – establish a risk-aware culture
through open communication and trust
› Accountability – develop an effective decision-
making structure with appropriate documentation,
reporting and oversight
› Motivation – don’t create incentives which inhibit
the achievement of your long term-goals
p.38
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Remember, the Chair & CIO Play a Vital Role in Fund Governance
p.39
A culture or collaboration through partnership and rigorous self assessment
Governance
Structure
Unambiguous Accountability
Focus on what matters
- Primary Objective
- Risk Management
- Strategy
Delegation to Professionals
Board / Committee
Membership
Tenure / Recruitment / Orientation
Behavior
Expertise
Experience
Training / Development /
Appraisal
Proper Business Plan
Agendas & Documentation
Investment Education
& Innovation
Oversight
Prioritize by importance
Governance
Process
A
Common
Vision
Board
Effectiveness
Tim
ely
Decis
ion
Resea
rch
/
Beliefs
Resources
Source: Based on the
"Proposed Board Effectiveness
Model" of Richard Leblanc, PhD.
BETA V1
Markets Are Anything But Normal
› Irrational human behavior leads to less certainty
› Market bubbles are inevitable and can lead to crisis
› Traditional mean-variance deficient & insufficient
› Over reliance on optimization tools leads to
overconfidence
› Magnitude of investment exposures unknown, resulting in
significant fund losses
› The rate of change and periodic market volatility are not
likely to abate and could escalate
p.40
BETA V1
And There Are Many Ways To Mismanage Risk 1. Relying on historical data
2. Focusing on narrow measures
3. Overlooking knowable risks
4. Overlooking concealed risks
5. Failing to communicate
6. Not managing in real time
p.41
“Solutions from outside the traditional framework will
be required.”
Source: Six ways to mismanage risk, Harvard Business Review, March 2009
BETA V1
Pension Fund Trustee Competence Major findings
› Many trustees have limited problem-solving skills relevant to
investment issues
› Most trustees are unable to deal with probabilities and are
inefficient information processors
› Short cuts (heuristics) dominate trustee decision-making
procedures
› Diversity of trustee competence suggests the possibility of
considerable disagreement or resistance
p.42
Source: University of Oxford 2005 Study
Leadership and structured decision-making are crucial otherwise there will
be low levels of innovation and slow adaptation to changing
circumstances.
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This All Leads to Ineffective Decision-making
› Unclear objectives
› Ambiguous accountability
› Changing investment beliefs
› A failure to delegate to investment experts
› Short evaluation periods for long-term strategies
› Unrealistic performance expectations
› Lack of trust in staff & service providers
› Insufficient time / resources
p.43
BETA V1
Pension Governance: The UK Pensions Regulator 2006 Report
Areas where large funds demonstrated better governance include:
› Professional trustees
› Appropriate internal controls are in place to monitor and mitigate risks
› Degree of appropriate knowledge and learning ascribed to trustees
› Training levels were higher where the responsibilities of trustees are greatest
› Confidence and those with in-house administration
› Formal processes to identify risks
p.44
BETA V1
Organizational Research Denotes Various Behavioral Impediments
1. Overconfidence & irrationality
› Optimism
› Biased opinion (the recency effect)
› Lack of formal investment training
› Illusion of control
› Portfolio segregation
› Hindsight bias (delude ourselves we knew)
› Confirmation bias (trend fallacy)
2. Reference dependence / heuristics (short cuts)
3. Personal agenda
4. Group think (committee composition, polarization, etc)
p.45
BETA V1
Thank You Bruce B. Curwood, MBA, CFA, CIMA, Acc.Dir.
Director, Investment Strategy
Don Ezra, M.A, FIA
Co-Chairman Global Consulting