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.
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.
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.
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.
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.
Geo-political Headwinds are Risk Management Tailwinds
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.
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.
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.
The Eurozone Crisis: The Role of Institutions, Credibility and Governance
Fragmentation in the Global Village
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.
Exploiting the Volatility Factor in Financial Markets
Global Real Estate Presentation to to NID Investment Committee
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.
Middle East and Asian Flashpoints, Fissures and Fractures: Things that go Boom in the Night
Big is Not Always Better; A case for Small Hedge Funds
Investing using Exchange Traded Funds
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.
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.
Global Equities - Finalist Presentation to the NID Investment Committee on Global Investing
| Source: Pensions & Investments – 1st Risk Survey, February 2012; 2nd Risk Survey, March 2012|