implementing a long-term investment philosophy - presentation by roger gray - european pensions and...
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For more information contact: [email protected] Roger Gray, the Chief Investment Officer at USS Ltd. shared his presentation entitled "Implementing a Long-Term Investment Philosophy" at the European Pensions and Investment Summit. Join the 2015 Summit along with leading regional pension investors and global asset managers in an intimate environment for a focused discussion of key new drivers shaping institutional investment strategies today. For more information contact: [email protected]TRANSCRIPT
European Pensions and Investment Summit 2012
IMPLEMENTING A LONG-TERM INVESTMENT
PHILOSOPHY
1
Roger Gray
Chief Investment Officer, USS Ltd.
PHILOSOPHY
• USS
• How to be a long-term investor• How to be a long-term investor
• Current conditions
2
USS
• Open DB pension scheme since 1974
– 400 UK universities, higher education and research institutions
– 285,000 members: 50% active, 30% deferred, 20% pensioners
– Assets: £33bn (€40bn)– Assets: £33bn (€40bn)
• Target SAA
Equities 50%
Alternatives 21%
Property 9%
Bonds 20%
• Largely internally managed: investment office of 95
3
Strategic Asset Allocation
• Managing twin objectives– Required contribution rate
– Volatility of required contributions
• SAA has become more balanced • SAA has become more balanced – Reducing risk concentrations
• Potential addition of liability hedging overlay– A liability-matched target state
– Current market yields in long-term perspective
4
Gilt Yields – Nominal & Index-Linked
5
6
7
8
9
10
Bo
nd
Yie
ld %
Latest Yields (as of 14 May 2012)
Nominal 3.2%
Index-Linked -0.1%
5
-1
0
1
2
3
4
5
Bo
nd
Yie
ld %
UK 30-Year Nominal UK 30-Year Inflation-Linked
Diversification: Implementation
• From low-cost model …
– In-house manager: Equities, Govt Bonds, Property
– Passive-like costs, some alpha
• ... to cost-effective customised solution• ... to cost-effective customised solution
– Wider range of activities
– Alternatives team; delegated manager fees
– Dynamic asset allocation and A-L risk management
– Greater operational demands
– Increased regulatory scrutiny
6
Diversification: Governance
• Clarification of Delegations
– Board, Committees, Executive
• Additional Specialist Expertise• Additional Specialist Expertise
• Investment Company Subsidiary
– Professional board: executive and non-executive
– Comprehensive investment management agreement
7
• USS
• How to be a long-term investor• How to be a long-term investor
• Current conditions
8
Characteristic Traits
INVESTORS: Short-Term Long-Term
LIABILITIES Short-term Long-term
CASH-FLOW Negative Positive
TURNOVER High (Trading) Low (Stewardship)
RISK Volatility Sustained loss or shortfall
9
RISK Volatility Sustained loss or shortfall
FORECASTS New, direction, technicals Risk premia, inefficiencies
ILLIQUIDITY Low tolerance High(er) tolerance
MANAGER
TENURE Short Long
ASSESSMENT Performance... Process/People...
INCENTIVES Short-term Long-term
Managers: Internal or External
Internal External
ALIGNMENT Career Relationship vs. Transaction?
INCENTIVES Long-term alpha
Risk-adjusted, after-cost
Collective and individual
Benchmarks: Beta vs. Alpha?
Short vs. Long-term?
Luck vs. Skill?
10
GOAL Return maximisation Profit maximisation
FOCUS Investment Asset gathering vs. capacity?
TRANSPARENCY Visibility, control & risk mgt. Integrated/superior reporting?
COST Scale: basis point per AUM? Profit goal, business expense
CAPABILITIES Incomplete, inferior, robust? Accessing best managers?
TIMELINESS Build investment/operations? Selection and due diligence
RISK BUDGET Concentration? Governance burden
ALLOCATIONS Permanent Occasional
Required Risk, Desired Risk
Risk-Taking Capacity
• Funding Ratio
• Strength of Covenant
• Duration of Liabilities
Risk Tolerance
• Contribution Minimisation
versus
• Acceptable volatility of • Duration of Liabilities
• Maturity of the Scheme
(projected cash flow)
• Risk-Sharing
(benefits + contributions)
• Acceptable volatility of
contribution rate
• Regulator’s Tolerance
– recovery period
– return assumptions
11
Sustainable Investment Policies
• Working within your boundaries
– Tolerable contribution rate and funding ratio?
– Acceptable recovery period?
– Reasonable asset performance assumptions?
– Scope for sharing risks and benefits?– Scope for sharing risks and benefits?
• Covenant, fund rules, actuary, regulator, human factors
... Long-term investment based on acceptable risk
12
DAA and Long-Horizon Investing
• DAA: When to take what and how much risk?
– Absolute and relative value
– Time-varying risk premia– Time-varying risk premia
• Equity
• Credit
• Illiquidity
• Insurance
• Long horizon stabilises required rate of return
... The comfort of long-term confidence cones
13
150
200
250
Fun
din
g R
ati
oConfidence Intervals & Risk Tolerance
Liabilities + 3%
Liabilities + 2%
Liabilities + 1%
Assumes:Sharpe Ratio = 0.25
Initial Funding Level = 85%
0
50
100
Fun
din
g R
ati
o
14
• USS
• How to be a long-term investor• How to be a long-term investor
• Current conditions
15
Taking Risk … if you can
• Systemic capacity shortages for
– Taking Risk
– Providing Liquidity
Bearing Complexity– Bearing Complexity
• Tension between our Twin Objectives
– Investment Returns: keep contributions ‘affordable’
– Limiting Risk: avoid (much) higher contributions
... heightened by low funding ratio
16
Some Post-Crisis Issues for SAA
• Instantaneous vs. long-term risk and return– e.g. Term structure distortion
– Playing ‘safe’ can add risk and make you poorer
• Hedge funds: mix your own
• Commodities: of super-cycles and 1-month futures• Commodities: of super-cycles and 1-month futures
• Risks of pro-cyclical risk models
• What data set?– Example of optimal currency hedging:
• With or without 2008
• Asset-liability context
17
10.9%
11.0%
11.0%
11.0%
An
nu
alis
ed
Mo
nth
ly V
ol
Optimal FX hedging
Full data set: Excluding H2 2008:
10.8%
10.9%
11.0%
An
nu
ali
se
d M
on
thly
Vo
l
18
10.9%
10.9%
0% 20% 40% 60% 80% 100%
FX Hedge RatioA
nn
ua
lis
ed
Mo
nth
ly V
ol
1.0
1.2
1.4
1.6
1.8
2.0
2.2
1999 2000 2002 2004 2006 2008 2010
Do
llar
& E
uro
100
150
200
250
300
Ye
n
Dollar
Euro
Yen
10.7%
10.8%
0% 20% 40% 60% 80% 100%
FX Hedge Ratio
An
nu
ali
se
d M
on
thly
Vo
l
Investment Conclusions
• Assets serve liabilities
• The ERP is dead, long live the ERP
– Expected rewards for bearers of systematic risk
• Too much of a good thing
– Is policy sustainable? What to do if ‘worst case’ scenario?– Is policy sustainable? What to do if ‘worst case’ scenario?
– Diversification of factor risk
• Contrarianism at extremes
– Can you buy/hold in stressed markets?
– Can you defer return-seeking in complacent markets?
– Can you afford not to?
– Regulatory regime, horizon, covenant strength, human factors
19
European Pensions and Investment Summit 2012
IMPLEMENTING A LONG-TERM INVESTMENT PHILOSOPHY
20
Roger Gray
Chief Investment Officer, USS Ltd.