During my 30+ year career working first as an actuarial consultant then as a director in asset management, I have worked with pension schemes in many countries, including for the last decade those in several countries in Africa.[i]
While each country brings its own peculiarities, not least regarding regulatory restrictions on asset allocation, there are common features. Two documents are always present: the Trust Deed & Rules and the Investment Policy Statement.
The Trust Deed & Rules, or whatever name the governing documentation goes by, is the most important scheme document. It sets out the powers of the trustees, what they can and cannot do, and defines the benefits to beneficiaries.
I would argue the Investment Policy Statement (IPS), sometimes called the Statement of Investment Policy, is the second most important document of a pension scheme. What is interesting is how its length varies from country to country. I have seen them as short as a couple of pages or as long as 30 pages, with corresponding levels of detail.
In fact, I think the IPS is in practice the most important document the trustees can hold in their hands. This is because the governing documentation is external to the trustee body, it is a principal to which trustees are agents. By its nature the governing documentation is non-trivial to modify and is more static than dynamic over time.
By contrast the IPS is directly owned by the trustees. It is their working document for how the assets of the pension scheme should be invested and monitored, and hence determine the success or failure of the pension scheme[ii]. That the IPS is a working document must not be understated. An IPS is not a document that gathers dust on the shelf. The trustees must own their IPS. It must be reviewed and revised often, as the investment landscape is never constant. The ultimate benchmark for a pension scheme is nature of assets versus nature of liabilities, and over a longer timeframe the nature of liabilities will change as the constitution of the scheme membership changes. This change in liability nature will necessitate a change in investments regardless of, and in addition to, the investment-only considerations.
An IPS codifies the investment decisions and how they are implemented. Not all investment decisions are equal, there is a hierarchy. At the top of the hierarchy is the Strategic Asset Allocation (SAA) and trustees need to own this decision, it must not be delegated. At the other end is stock selection, and this should be delegated to specialist asset managers. [iii]
A classic study[iv] of US pension schemes has shown that the SAA explains over 90% of the variability of investment return, and hence whether the pension scheme succeeds or fails. This is why SAA sits at the top of the investment hierarchy. This is why the trustees must not delegate it.
What the trustees must do is spend their time analysing what SAA is correct for them. SAA must be determined relative to the pension scheme liabilities, and an Asset Liability Model (ALM) is the correct tool to use for this purpose. ALM is a powerful and quantitative-rich tool which not only encapsulates the liabilities but also the trustee risk appetite, and any regulatory restrictions. As such it is usually performed by suitably qualified expert advisers. An ALM study delivers not only a SAA, it delivers the rationale for the SAA which trustee can first understand themselves and second communicate to members. Or put another way, a determine a SAA which both maximises pension scheme success and lets the trustees sleep well at night.
The SAA is documented in the IPS, together with how it is implemented. A well-constructed SAA is naturally implemented with specialist mandates to appropriate asset managers. The asset managers are monitored against market benchmarks that are aligned to the specialist benchmark. The absolute worst benchmark is a peer benchmark as it creates the wrong incentives, decreases the benefits to members and increases the likelihood of scheme failure.
Pension scheme trustees must embrace and own their Investment Policy Statement. Investment decisions, and in particular the Strategic Asset Allocation, are the most important decision made by the trustee body. They are decisions which have an inherent lifetime which is longer than the term of any trustee. As such the Investment Policy Statement is a key part of the institutional memory of the pension scheme.
Andrew Slater FIA CFA
CIO Star Capital
26 February 2024
For more information on how Star Capital can give multi-asset international exposure, boost return and reduce portfolio risk please contact me at andrew.slater@starcapmgt.com or CEO Darshan Ruparelia at darshan.ruparelia@starcapmgt.com
[i] I have worked with pension schemes as an actuarial and/or investment advisor in UK, US, Canada, the Netherlands, Germany and Hong Kong. In Africa I have worked with pension schemes in Kenya, Nigeria, South Africa, Namibia and Côte d’Ivoire. I have also advised on pension policy in Georgia.
[ii] For a Defined Benefit scheme failure is assets less than the value of liabilities. For a Defined Benefit scheme the same test applies with comparison against member expectations of pension relative to their contributions.
[iii] The exception is if you are a very large pension scheme with in-house asset management capability.
[iv] Gary P. Brinson, L. Randolph Hood, and Gilbert L. Beebower, “Determinants of Portfolio Performance”, The Financial Analysts Journal, July/August 1986; Gary P. Brinson, Brian D. Singer, and Gilbert L. Beebower, Determinants of Portfolio Performance II: An Update, The Financial Analysts Journal, 47, 3 (1991).
