Niagara Institutional Dialogue 2012

Recent developments in Europe have illustrated that now, more than ever, the destiny of pension funds and foundations lies with developments outside of the scope of traditional financial analysis. As a result, a holistic approach to investment decision-making is required – one that looks beyond security-selection and integrates geopolitical and macro-economic analysis.

This view was shared by many attendees at the third annual meeting of the Niagara Institutional Dialogue in Niagara-on-the-Lake, Ontario June 11-13, 2012. Topics ranged from Middle Eastern politics, to the role of multi-lateral institutions in the Eurozone crisis, to the federal government’s pension fund policies, to exploiting the “volatility anomaly”, to the operational risks associated with investing in emerging economies and finally to the burgeoning role of ETFs in modern investing and how a manager exploited them to create and an alpha-based strategy.

Globalization has been a hallmark of economic development over the past 3 decades. However, Virginie Maisonneuve, head of global equities for fund manager Schroders warned the attendees that increased trade disputes and financial firewalls are resulting in the “fragmentation” of the much touted “global village.” David Asher, Senior Fellow at the Centre for New American Security provided ample evidence that this fragmentation was also occurring along geopolitical fault lines. Asher, a former advisor to the US Special Operations Command for Counter-Threat Finance, has pursued the finances of several global organizations with terrorist-links. His lengthy list of geopolitical “flashpoints” reinforced our inability to adequately forecast future events.

Underpinning these conflicts is a fundamental shift in social structure not seen since the demise of the feudal system over 500 years ago. This, according to author and financial commentator Dr. Richard Bookstaber. In an interview by Josephine Marks, the Managing Director of Pension Assets at Scotiabank, Bookstaber argued that a shift to a post-industrial society will yield new opportunities for institutional investors with a long-term investing horizon.

While traditional economic models seem to be failing, economic forecasts may be possible through a careful reading of history. Pulitzer Prize winning author Liaquat Ahamed suggested that the current crisis has many parallels to the European banking crisis of the 1920’s. He warned the audience that the inter-war period contained a number of false economic recoveries and numerous policy missteps by regulators. It was generally agreed that we must draw on history where financial models break-down, but some wondered aloud whether a war was the necessary outcome of such economic calamities.

Fresh off a plane from the coal-face of the Eurozone crisis, Dr. William De Vijlder, CIO of Strategy & Partners at BNP Paribas reflected on various possible outcomes. His review of the multitude of multi-lateral organizations was of particular interest to participants overwhelmed by the complexity of inter-relationships between, and shared history of, Europe’s multi-lateral financial institutions.

One possible outcome openly discussed in the meeting was the total destruction of the euro. Noted economic commentator Dr. Philippa Malmgren suggested that the euro-zone would need to be destroyed before a more stable economic system could be developed. According to Malmgren, the foundations upon which the euro was built (e.g. divergent retirement policies) are fundamentally flawed.

Pension Management
Aware of the dangers of un-sustainable retirement policies, Canada’s Minister of State (Finance). The Honourable Ted Menzies addressed the gathering by arguing for prudence in Canada’s approach to retirement planning. He provided the rationale for the Canadian government’s Pooled Retirement Pension Plan (PRPP) and the fielded questions concerning Canada’s retirement age.

Despite dire warnings from a number of speakers concerning geopolitical and macroeconomic risks, Don Ezra, Co-Chairman of Global Consulting at Russell Investments argued that pension risk management needed to be enterprise-wide. Bruce Curwood of Russell Investments (Canada) proposed a risk management framework that encompassed not just investment risk, but fiduciary, strategy and operational risk.

Many of Canada’s largest pension funds have commanded a global following. The consultant advising one such plan, the Ontario Teachers’ Pension Plan (OTPP), was recognized by the Niagara Institutional Dialogue as this year’s “NID Honouree.” Malcolm Hamilton, a partner at Mercer in Toronto has been advising OTPP for many years and shared his experiences in a wide-ranging interview conducted by John Ilkiw, former Vice-President, Research and Risk Management at the Canadian Pension Plan Investment Board.

Investment Strategy
As event moderator Christopher Holt emphasized during the meeting, big-picture issues such as geopolitics, economics and pension management should inform investment decision making in order to be useful.

To that end, noted financial practitioner and researcher Dr. Harindra de Silva was joined by Robert Jackson of HighStreet Asset Management and Adrian Hussey of University of Toronto Asset Management (UTAM) in a discussion of the “low volatility anomaly”. Markets, the trio agreed, were not as efficient as the CAPM suggests. The result is that many high-volatility asset classes don’t provide returns commensurate with their risk. In other words, markets often seem to reward patience, not risk-taking.

Robert Cultraro, the CIO of Hydro One’s pension plan explored the relative merits of three such asset classes – global equities, global fixed income and global unlisted real estate – with Dr. Russell Chaplin, CIO of Property at Aberdeen Asset Management, Benjamin Legge, CIO of Highstreet Asset Management and David Joy Chief Market Strategist at Ameriprise Financial. Jeffrey Tarrant, co-founder of Protégé Partners later provided a perspective on hedge funds. Tarrant is perhaps best known as the hedge fund of funds manager who made a 10 year bet with Warren Buffett that hedge funds would outperform the S&P500.

Buffett’s bet with Protégé provided a framework for further discussion and debate over the relative merits of active and passive management. Closely-followed hedge fund manager Barry Allan argued that active management was critical in today’s environment while two member of the ETF community argued that ETFs allowed investors to focus on macroeconomic issues without the distraction of security selection - Dr. Carlos Asilis of Glovista Management and Alfred Lee, Investment Analyst of BMO Asset Management.

The annual NID debate also focused on the trade-off between bottom-up and top-down investing. Virginie Maisonneuve of Schroders represented the arguments in favour of bottom-up security-selection while Philippa Malmgren laid out the arguments in favour of a focus mainly on top-down macroeconomic developments instead. The light-hearted debate was astutely moderated by NID Advisory Board member Hugh Innes.

Regardless of the balance of active and passive management, recent geopolitical and economic developments also impact back-office operations. This point was underscored by Brad Taylor of RBC Dexia who added that recent regulatory changes resulting from the Euro-zone crisis may actually provide new opportunities for institutional investors. Tying together the issues of operational risk and the Euro-zone crisis, Patrick Ludden of BNY Mellon highlighted the specific operational risks and implications of a Euro break-up.


Geo-political Headwinds are Risk Management Tailwinds


Bruce B. Curwood, MBA, CFA, CIMA, Acc.Dir. Director, Investment Strategy
Russell Investments
Don Ezra, M.A., FIA Co-Chairman Global Consulting
Russell Investments

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View research paper

I have been involved with risk management, in one way, shape or form, throughout my working career (spanning more than 30 years) - as a former Treasurer/plan sponsor and current Pension Trustee/consultant. In 2000, just before the “Tech Wreck”, at the request of Pension Investment Association of Canada (PIAC) I graded their collective performance in 10 areas: from governance, through asset allocation, to performance. Except for the advanced mega plans, the majority of the funds were attributed a failing grade in two specific areas, Research and Risk Management.

The new normal - an environment of austerity, low returns and high volatility, often driven by geopolitics – is necessitating unconventional approaches to investment management. To best achieve your primary objective in an environment riddle with just too many non-controllable variables, satisficing behavior is probably preferable compared to finding the best option available. Evaluating your risk tolerance, the organization’s risk capacity and determining the relevant time horizon is critical. At this juncture, effective risk management would be achieved through an intelligent combination of expertise and good governance.

Risk Management is a newly evolving field, still in its infancy. Nonetheless, the rewards for effective risk management may be greater than ever. The time is opportune for investors to acknowledge the problem and take action. A step in the right direction would require an overhaul of their approach to risk management and building an organization-wide risk management framework, process and culture or ERM (enterprise risk management). Most importantly, the risk management approach adopted should be practical and relevant to the investors, but also embedded in their governance process.

Today, the global economy is a complex, tightly coupled non-linear system that is turbulent, near impossible to predict and not quite controllable. Pensions and Investment (in conjunction with Russell Investments) recently conducted a series of studies to gather information on measuring attitudes towards risk management as well as governance. The studies revealed that 9 out of 10 respondents considered risk more important today than five years ago, with more than half saying it is much more important. Governance structures as they stand are, in many cases, inadequate. Nearly three-quarters of the respondents indicated an increase in the time their investment committees and boards of directors are spending on oversight, compared to five years ago.

Against this backdrop, Russell’s Risk Analysis Model aims to inform institutional investors of the location of and exposure to downside economic risk. In this respect, the model is forward-looking, evaluates risk in terms of corporate financial measures or relevant nonprofit measures, and illustrates the risks the plan poses to the larger organization.

Plan sponsors need to look inside their own plan and make sure their risk is focused on the new normal.
In short,

  • Dialogue on risk management has evolved but there is still far too little action.
  • Risk is multi-dimensional, and its management requires various objective tools (triangulation) coupled with good subjective analysis.
    The equation for success is Q2:
    Quantitative (strong research coupled with multiple tools) x Qualitative (good judgment)
  • Investors need to focus on the two things they can control: Good governance and their Risk Management process.
  • To avoid being blindsided by market events, better understanding of fund risk and preparation is imperative.

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.

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”.

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-2012-05-25-0054 (EXP-12-12)

Operational Risk Investing in Emerging Markets & Today’s Euro

Patrick Ludden, Managing Director, Cash/Foreign Exchange Product Manager
BNY Mellon Asset Servicing Global Product Management
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Effective risk management is a continuous process of identifying, analyzing and managing risks.

Once a manager has decided to invest in a market with approved levels of credit and market risk, operational risk must also be managed daily, especially now with the potential Greek exit from the Euro. From a global custodian perspective, Patrick shared the critical drivers, potential outcomes, and best practice tools to manage and ultimately mitigate operational risk.

Patrick’s discussion touched on the importance of client documentation and the accuracy of processing prior to a client investing. This helps to prepare operationally for close monitoring for better reaction time if any necessary changes are to be made; not following market regulations or requirements could lead to penalties that can be costly.

Patrick discussed how institutions around the globe have had detailed scenario-driven contingency plans in place for months in anticipation of a potential country exit from the Euro. Operational readiness is critical in the event there is an exit, as institutions potentially need to de-convert assets back to an established local market convention. Patrick gave examples of how Bank of New York Mellon has teams of people dedicated to various scenario-testing to ensure they are prepared for a possible country exit, emphasizing that in this event of a country exit, the essentials of client communication and reporting throughout the de-conversion process.

The Eurozone Crisis: The Role of Institutions, Credibility and Governance

Dr. William De Vijlder, CIO of Strategy & Partners, member of management committee
BNP Paribas Investment Partners
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The Eurozone economic climate is deteriorating, unemployment (especially youth unemployment) is at a 40-year high, and sovereign bond spreads against German Bunds are rising in the periphery. After analyzing the three faces of this crisis, Dr. De Vijlder discusses the three key concepts at the heart of these problems --- credibility, commitment and governance --- and examines the trade-offs among them and the actions taken by the various institutions and authorities to try to deal with them. He then describes the roles and responsibilities of the Eurozone’s institutions, as well as the specific role of Germany, in order to develop a framework for understanding the possible outcomes in Europe.

Fragmentation in the Global Village

Virginie Maisonneuve, Head of Global Equities,
Schroders Investment Management
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Globalisation is a complex concept that is commonly used and one of the most debated. In our view, globalisation has economic, technological, social and cultural elements that have led to the blurring of boundaries and the shrinking of distance giving rise of the ‘global village’. Despite the increasing interconnectedness of the global landscape we are also witnessing growing fragmentation. The four most striking fragmentations are macro-economic, social, community-linked and attention fragmentation resulting from our hyper-connected lifestyles. We believe the presence of these emerging or shifting fragmentations will create a challenge for investors, corporations and citizens of the global village as they might result in unexpected changes and increasing volatility. This has implications for global institutional investors and the fragmentations discussed in the attached presentation may materialize in conflicts, drive economic divergence or, at the very least, add complexity and confusion to decision making processes.

In today’s highly volatile market environment we feel it is more important than ever to look through short-term fluctuations and choose companies and management teams that are focusing on long-term trends. Combining in-depth local knowledge with a global perspective will help navigate an evolving risk framework. As short-term noise increases, the value derived from analyzing long-term earnings potential is all the more crucial. This combined with an understanding of the key long-term trends shaping the increasingly volatile investment environment, gives framework for high conviction portfolios.

Exploiting the Volatility Factor in Financial Markets

Dr. Harindra de Silva, President & Portfolio Manager
Analytic Investors, LLC
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Global Real Estate Presentation to to NID Investment Committee

Dr. Russell Chaplin – CIO Property
Aberdeen Asset Management
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View Research Paper: Global Property Strategy
View Research Paper: Aberdeen Global Property Market Outlook

Dr. Russell Chaplin, CIO-Property at Aberdeen Asset Management made the case for an allocation to Global Real Estate during Robert Cultraro's mock pitch to the "NID Investment Committee". Although an investment in Global Real Estate can be made for the purposes of enhancing total returns through a higher-leveraged, value-added or opportunistic strategy, Russell focused on the benefits of diversifying pension investments through a Global, core, low-leverage strategy.

Global Real Estate has offered the highest level of income return over the last seven years as compared with income returns from government bonds and equities. In addition, it can offer higher risk-adjusted returns by providing multi-asset portfolio risk reduction in addition to diversification of a domestic-only real estate portfolio; particularly when the portfolio is constructed with a strategic tilt towards markets with low correlations with Canada and away from those with relatively high fees and tax leakage. Over the long term, Global Real Estate has also been very effective in preserving purchasing power. Capital growth net of Canadian inflation for several countries, including the UK, US and Australia, has been generally higher than Canada over rolling 10-year periods and since 1994.

Russell also discussed ways of accessing Global Real Estate and the trade offs that investors will face as a result. He reported that the expected nominal total return, after fees, for a core, low-leverage global property portfolio is approximately 7% per annum (4.5 to 5% in real terms) over the next 10 years with an observed volatility of approximately 8%.

Middle East and Asian Flashpoints, Fissures and Fractures: Things that go Boom in the Night

David Asher, Non-Resident Senior Fellow
Centre for a New American Security
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Big is Not Always Better; A case for Small Hedge Funds

Jeffrey Tarrant, Co-Founder
Protégé Partners
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Investing using Exchange Traded Funds

Alfred Lee - VP Investment Strategist
BMO Exchange Traded Funds
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Alfred Lee provided a summary of the global ETF landscape and some of the key drivers behind its rapid growth to a US$1.5 Trillion (AUM) industry. Alfred also spoke about the mechanics behind ETFs, while also addressing how liquidity is best assessed for these instruments. As institutional usage of ETFs have grown, they are now being used in ways beyond cash equitization and transition management. Advanced strategies using ETFs were also provided to address how institutions can use these products to better improve portfolio efficiency in an institutional investor's portfolio construction or cash management process. Attendees looking to learn more about ETFs and how they can be used in their plans are encouraged to contact BMO ETFs to set up educational discussions.

Alfred Lee, VP & Investment Strategist (416) 359-5352, This e-mail address is being protected from spambots. You need JavaScript enabled to view it
Sam Ditella, VP National Accounts (416) 416.350.3126, This e-mail address is being protected from spambots. You need JavaScript enabled to view it

Investing using Exchange Traded Funds

Dr. Carlos Asilis, Co-founder and Chief Investment Officer
Glovista Asset Management
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Providing Alpha

Barry Allan – Founding Partner
Marret Asset Management
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Barry Allan presented us with his current investment view, in which the enfolding global sovereign debt crisis is destabilizing the financial system, leading to both heightened volatility and high correlations across asset classes. The crisis is most advanced in Europe, but will also play out in the US and Japan. This will be followed by a long period of deleveraging accompanied by weak growth and continued low inflation. Getting to a sustainable path to lower debt/GDP will be more difficult due to a relatively weak economic environment. Reflation as a policy response won’t work, neither will increased buying of Treasuries by the Fed, as this would require they abandon their inflation mandate.
Therefore we can expect continued high volatility and correlations until we see a lower debt/GDP path. In the meantime safe havens will be bullion, which provides protection against a US Treasury sell off, AAA corporate bonds hedged against US Treasuries, high quality dividend stock hedged against indices, and short positions to protect capital and reduce volatility. In the aftermath high yield will provide both attractive yields and spreads; high grade bonds also have interesting high spreads. Interest rate risk can be hedged out. Other yield plays will be dividend stocks and REITS. Technology, in cases where growth can be identified, will also perform well. In the short term, controlling volatility and protecting capital will be critical. Doing so will put investors in a good position to succeed in the crisis’ aftermath.
indicated an increase in the time their investment committees and boards of directors are spending on oversight, compared to five years ago.


Global Equities - Finalist Presentation to the NID Investment Committee on Global Investing

Benjamin Legge - President and CIO
Highstreet Asset Management Inc
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In Benjamin Legge’s ‘Finalist’ presentation to the NID Investment Committee, he presented the case for equities as the most advantageous global asset class in terms of reward vs.. risk over the coming decade. While there exists a strong tendency to focus on and extrapolate the recent past, which has been an admittedly challenging period for equities, Mr. Legge provided the Committee with a longer-term perspective to remind us that we have indeed seen such periods before and that this too shall pass. In discussing both the low yields/returns available to investors in fixed income, as well as the irrationally cheap valuations available in profitable, high-quality global companies, Ben presented a convincing argument that equities present the most attractive risk/reward profile amongst the available alternatives over the coming decade.


[1] Source: Pensions & Investments – 1st Risk Survey, February 2012; 2nd Risk Survey, March 2012