As per the Principles of Regulation 28, funds must conduct reasonable due diligence before making contractual commitments to invest in assets managed by a third party, for both local and foreign assets. They must also understand the changing risk profile of assets over time.
Given these regulatory requirements, the onus is on the trustees to have a process in place to monitor their underlying investment managers’ performance to ensure that the board’s expectations are being met. Further to this, the effective management and monitoring of a pension fund’s underlying investments is critical in ensuring that members receive sufficient benefits upon retirement, in line with the fund’s investment objectives.
Likely examples of ESG factors could include broad based black economic empowerment, executive remuneration, environmental emmisions, exposure to climate risk etc.
The process of monitoring
What does it mean to monitor an investment manager in the context of investment performance and overall fund objectives? There are a number of ways boards can ensure this process is undertaken correctly and rigorously. This includes both qualitative and quantitative methods of monitoring.
As a starting point, the fund should request regular, and where necessary, additional ad-hoc presentations or reports from their investment managers to provide updates on these factors. These may be directly managed by the fund or via another service provider, such as an asset consultant, multimanager or other intermediary to the fund.
- These reviews can include assessments of investment teams such as experience and qualifications; investment process and philosophy; and any changes that may have occurred over the reporting period.
- The reports should also include feedback on investment decisions made over the period, for example, why certain buy or sell decisions were made in the portfolio.
- Current positioning is important to understand at a holdings level (what individual stocks or bonds are being held for example), and also what the asset allocation of the fund is and how it has been tactically managed over the period.
- It is also important to understand how environmental, social and governance (ESG) factors have been integrated over the period and if any of these issues had a material impact on performance.
- Trustees should assess the performance of the investments in the context of their overall objective, i.e. are they on track to meet these objectives? Depending on the nature of the fund, itsobjectives may vary from outperforming an index, outperforming the peer group average, outperforming a composite index, inflation (consumer price index) plus returns, or simply a cash plus return.
- The underlying investment managers should provide reporting on risk-adjusted returns, i.e. how much risk did the asset manager undertake to produce the return? Ideally investors want the highest return for as little risk as possible.
- An attribution analysis would be useful for the trustees to understand what contributed to or detracted from the performance over the period.
- Funds should assess the performance of the investments relative to their specified benchmarks. A benchmark is a reference point against which an investment’s performance can be evaluated. For example, a fixed-income portfolio can be benchmarked against the All Bond Index or an equity manager can be assessed relative to the category average of general equity funds.
Trustees should also continuously monitor the fees charged by the underlying asset managers, as these will impact the total return. This would include both fixed fees as well as performance-based fees. In addition to comparing these fees to that of peer group asset managers, they must also be evaluated against the overall performance relative to the benchmark of the various portfolios.
The importance of benchmarking
Investment portfolios and asset managers come with a wide range of investment benchmarks. It is therefore crucial that trustees work toward having a more simplified and logical investment portfolio offering with regards to the underlying benchmarks. An example of this could be having inflation-plus benchmarked portfolios for the full risk spectrum; for example: inflation + 3% for a cautious investor,
inflation + 4% for a moderate investor and inflation + 5% for a moderate-aggressive investor. This is not to say that alternative benchmark types must not be included, but rather that there should be a spectrum within each benchmark type included.
It is also important to highlight the role benchmarks play in active and passive investing. For active investors, investment managers would seek to outperform the benchmark, however a passive or index investor would seek to track their stated benchmarks.
CFA Institute Available: www.cfainstitute.org
FSCA; Available: www.fsca.co.za