A week-long Board Effectiveness Program with peers from around the globe, including those from Canada’s HOOPP and Denmark’s ATP, has given AIMCo board member, Andrea Rosen, a new perspective on best practice.

In a business environment where most people are working harder, multi-skilling, facing lower-than-necessary resourcing, staffing and margins, a week-long course could be viewed as indulgent.

But the value of networking with global peers, discussing and implementing governance best practice, was not lost on AIMCo board member, Andrea Rosen.

Specifically, Rosen says the chance to spend time with board members of funds such as the established and prevailing HOOPP and ATP gave her a chance to expand her viewpoint.

“What was revealed to me is that HOOPP had an incredibly good track record of returns, so it was worth understanding how that happened and what they did to get that,” she says.

“I also sat next to an ATP person who said seven years ago their CEO set a mission of being the best in class in performance and service. In both of these funds it came down to structure, strategy and vision.”

Rosen, who is an experienced board member, serving on the boards of ManuLife Financial, Emera, Hiscox as well as the $70-billion AIMCO since inception five years ago, says the program provided “more data points to think about”.

 

Do things differently

What became evident through the intensive, highly interactive strategic program, Rosen says, is the importance of understanding how the funds got to where they are.

“For example, did they get the results because they spent $80 million on an attribution system to facilitate those sophisticated investments? There were some similarities between them in how they achieved their success. It was a good wake-up call for us and our management – that we have to go beyond the truism of good governance,” she says, which includes paying staff competitively.

“It showed the importance of understanding the nuances like what does the destination look like, how do we get there, and what are the signs to get there. It’s the setting of expectations.”

In addition the fact these funds have achieved their stellar results through out-of-the-box thinking and implementation, such as the use of derivatives, demonstrated that a fund doesn’t have to emulate other funds, and it is possible to do things differently.

“We are a bit myopic in the Canadian market that we talk about CPPIB and OTPP almost exclusively,” she says. “At this event it enabled me to get a better understanding of HOOPP’s success – they don’t get the same type of press as OTPP and CPPIB. As a board member of AIMCo, it intrigued me to look at more obscure cases of pension fund-management success.”

Specifically, she says the program examined the best-in-class attributes, examples of the specifics of success and how funds achieved them.

 

A higher level of responsibility

The program, which is a joint venture between the Rotman School of Management Executive Programs and ICPM and called the Rotman-ICPM Board Effectiveness Program for Pension Funds and Other Long-Horizon Investment Institutions, runs over four and a half days. In past programs it has been attended by board members from 20 funds from 10 countries.

Keith Ambachtsheer, the academic director of the program, says the program focuses less on facts and elementary board discussion, and more on the higher level responsibilities of board members to provide oversight of what is essentially a complex financial institution.

The course, held at the University of Toronto covers a history of organisation governance, rethinking fiduciary duty, a case study on boardroom dynamics, guiding and assessing investment beliefs and organisation design, a case study on OTPP, risk measurement and management, board challenges and solutions.

According to Rosen, the funds that have been successful have shown that if the mission is compelling enough, as in the case of HOOPP and ATP, it will attract the right people.

“It is management’s role to set the strategy and ours to test it,” she says. “We were doing it anyway but this program has provided us with more data points to test it. It is not good governance to put education solely in the hands of management; that is only one view. The board also needs to be responsible for education.”

AIMCo manages about $70 billion for 26 clients.

 

Using a fund of funds enabled the Future Fund to build a large exposure to hedge funds quickly during the global financial crisis, chief investment officer of the Future Fund, David Neal says.

The Future Fund, which uses a combination of fund of funds and direct hedge fund investments, decided it did not have the breadth of skill and research to entirely invest directly.

“Could we realistically, or want to, try to build a team with enough talent and size to cover the industry? It’s not consistent with our notion to keep the investment team small enough to sit around a table and talk about all of the opportunities and strategies to build our portfolio,” Neal says.

“We thought with fund of funds, and the extra edge of someone who’s actually doing it, was worth exploring. As we started, we found other benefits of fund of funds, for example, in the crisis we were able to move quickly. We had one investment-management agreement with one organisation, which has relationships, and we can throw money at them quickly and could build a large exposure quickly. There was an execution service that came from it that would have taken a long time.”

Environment-specific risk

Neal says the Future Fund, which has almost 20 per cent exposure to hedge funds, is looking to expand its exposure and invest in commodities, catastrophe bonds and macro managers.

The fund has generated 4.9 per cent since inception, well below its mandate of consumer-price index plus 4.5 to 5.5 per cent

“We are clearly behind, but we don’t think there is much more we could have done. It is very dangerous to play catch-up. If you load up more risk, you’ll blow it,” Neal says. “You have to take the right amount of risk given the environment.”

Investors must manage the risk profile to the prevailing landscape, Neal says, but he believes there will be opportunity to take more risk in the next decade.

Meritocracy for assets

The Future Fund has a “dynamic” allocation process, but it is not relative to a benchmark. Rather, all investment opportunities are assessed on their merit.

“Long-term characteristics can change quickly, the GFC showed that,” he says. “It is not about active tilting but managing risk/return and adjusting accordingly.”

Because of this dynamic nature, the funds are shifted from one opportunity to another.

“There are managers we are happy with who we take money from because the opportunity changes,” Neal says.

The Future Fund considers every investment opportunity on a hedged basis, so each investment can be compared on a like-for-like basis. The fund then decides how much currency to hold.

At the moment it has 12.5 per cent in emerging-market currencies and 18 per cent in developed-market currencies

“Currency is the risk I worry about the most – or it is the cause and solution of the risk I worry about the most – liquidity.”

Neal sits on the Hedge Fund Standards Board and encourages investors to sign the standards’ investor chapter.

“The more investors that sign, the more that managers are interested.”

In this paper, Steven Kaplan from the University of Chicago Booth School of Business and National Bureau of Economic Research considers the evidence for three common perceptions of US chief executive officer pay and corporate governance.

The first is that chief executive officers are overpaid and their pay keeps increasing; the second is that CEOs are not paid for performance; and, finally, that boards do not penalise CEOs for poor performance.

While average CEO pay increased substantially through the 1990s, it has declined since then, Kaplan finds.

CEO pay levels relative to other highly paid groups today are comparable to their average levels in the early 1990s.

In fact, the relative pay of large company CEOs is similar to its average level since the 1930s, the research indicates.

Kaplan’s work also reveals that the ratio of large-company-CEO pay to firm market value has also remained roughly constant since 1960.

This suggests that similar forces, likely technology and scale, have played a meaningful role in driving CEO pay, along with the pay of other top-income earners.

Kaplan also looks at the rate of CEO turnover and how executive pay is determined by the market.

Consistent with that is the widespread majority-shareholder support companies’ pay policies have received, despite the beefing up of regulations around shareholder rights and executive compensation.

Kaplan notes that top executive pay policies at over 98 per cent of S&P 500 and Russell 3000 companies received majority-shareholder support in the Dodd-Frank-mandated Say-On-Pay votes in 2011.

To read more, click here.

Active quant strategies came in for criticism after the global financial crisis, with a number of models seen as lacking both the appropriate diversification and the dynamism necessary to react to major market events.

While acknowledging the need to rethink quant models, global head of active equities for developed markets at State Street Global Advisor (SSgA), Marc Reinganum, tells top1000funds.com how quant investing has evolved and how the manager has overhauled its own approach.

 

Dynamic models

Reinganum says SSgA took a close look at its quant models in the wake of the financial crisis and what emerged was a consensus that, whatever approach was taken, it needed to be more dynamic and able to quickly rebalance to take into account of changes in market conditions.

“Active quant equity at SSgA in 2012 has evolved substantially from where it was in 2007,” he says.

“We have done an enormous amount of research to make our models more agile and nimble, and able to be appropriate for the prevailing macroeconomic environment and investment conditions.”

Reignanum calls these “dynamic models” as they are designed to change as the effectiveness of the characteristics or factors the models use to forecast future performance also varies at different times of the economic cycle.

“We have extensively studied how to systematically relate conditions we observe in markets today to the intermediate performance of these factors,” he says.

“This is typically over a three-to-six-month investment horizon. Back in 2007, we were very focused on long-run models, which in the long run do work. But it became very clear to us that these models built on long-run performance – that is, how our factors perform on average over time – [and] the context of that approach was important.”

These conventional long-run models perform well when market conditions and economic climates are near long-term historical norms, according to Reignanum, but underperform when markets are more turbulent and abnormal.

It was these conditions that prevailed during the first heyday of quant investing, with quant strategies performing strongly in an economic environment that would later become known as The Great Moderation.

 

Historical data plus…

However, Reignanum says SSgA realised that its quant strategies had to also perform during times of abnormal conditions, when there was greater market volatility.

What emerged was a two-year project to mine historical data from a number of countries.

The 40-person research team looked at how more than 100 factors, such as the momentum and valuation factors of particular stocks, performed over time in an effort to see how that performance could be forecast.

SSgA also expanded the range of factors that it studies.

“Most quantitatively orientated investors, including SSgA, focused primarily only on those factors that worked well on average over time. But as we did our dynamic modeling – and if you think about wanting to understand how models work over intermediate horizons – you need to open up the potential set of factors that you study,” he says.

“This will include factors that may not work well in the long run, but may work quite powerfully over shorter, intermediate time horizons.”

Reignanum says an example of this is financial leverage, where a long-run model would not include financial leverage, despite there being different market episodes where it might be either advantageous to take on leverage or better to avoid it as much as possible.

“In 2012, we allow our models to include these transient or opportunistic factors that were not in long-run models,” he says.

While the historical performance of these factors is an important ingredient in the quant model, it also must be forward-looking and reactive to changes in market conditions.

 

Beyond the conventional

As it did for investors around the world, the global financial crisis sharply brought into focus for SSgA the need to better understand the broader macro environment and the changes within it.

However, SSgA wanted to maintain its systematic and disciplined investment approach, Reignanum says, and this pushed the manager to look beyond conventional macroeconomic forecasting measures such as GDP, employment or inflation.

“We are looking at how investors actually express their views in markets today and that defines the macroeconomic environment and market conditions – very much market-based and very much not subjective but objective,” he says.

To form this “objective” view of markets, SSgA monitors what is happening in fixed-income markets, examining information on term structure, at credit spreads.

The historical performance of the 100 factors SSgA has identified and the monthly analysis of market conditions are then plugged into a range of forecasting equations that are designed to forecast the future performance of each of these factors based on the conditions that are observed at a given point of time.

The forecasting horizon is three to six months, with forecasts updated on a monthly basis.

“We view this process as expressing high conviction, which is perhaps unusual to hear from a quantitative-oriented firm,” he says.

“The term conviction or concentration has been usurped by fundamental analysts. If you talk to a fundamental portfolio manager, he might often say ‘my best ideas are expressed in these 20, 30 or 40 stocks’ – a very concentrated sense of the world in terms of individual stock holdings. From our quantitative perspective, we view concentration in a different way. We see it as focusing our portfolio on themes or characteristics that are likely to pay off over the next three to six months.”

This involves choosing securities that provide an exposure to the most impactful factors at a particular point, whether that is value, momentum, reversal, risk or risk aversion over the short term.

“Our best ideas are created by using securities to form portfolios that have the desired exposures to desired themes or characteristics that we think will be rewarded. We do not explicitly look at concentration as a limited number of securities, rather we try to get those exposures using as many different securities as we can so we don’t have investor portfolios that are sensitive to firm-specific or idiosyncratic risk.”

The longest model that has been running in using this framework has been a US small-cap strategy.

It began in 2011 and has been a top-quartile-performing strategy out of a universe of about 700 offerings, says Reinganum, performing particularly strongly in last year’s choppy market conditions.

He says the model also predicted that despite widespread uncertainty and market volatility during the third quarter of last year, that markets would rebound and risk would be rewarded.

“At the time the human emotion would say ‘I want to run away from this risk’ but by keeping our rudder deep in the water, by the fact that we knew we had done extensive and thorough research, we knew what direction to set sail and we did. That is the advantage of the quantitative process. We can mitigate the impact of emotions,” he says.

Earlier Quant models, pictured above right, limber up for their creator, Mary.

 

As British Columbia Investment Management Corporation (BCIMC) moves towards its target of having 30 per cent of its portfolio exposed to real assets, it is seeking collaborative opportunities with similar large institutional investors.

The investment manager is on the lookout for other like-minded investors and has already made significant co-investments in recent years.

This year BCIMC joined forces with the Public Sector Investment Board (PSIB) to acquire TimberWest Forest Corp, western Canada’s largest timber and land-management company.

The deal, which is believed to have been worth more than $1.03 billion, resulted in the formerly public company moving to a privately held entity with ownership split evenly between both BCIMC and PSIB.

BCIMC has also attracted high profile partners outside Canada. In June this year CalPERS announced that it would become a one-third owner in Bentall Kennedy, one of North America’s largest real-estate-investment advisories.

CalPERS purchased the ownership interest from Ivanhoe Cambridge, the real-estate subsidiary of la Caisse de dépôt et placement du Québec.

CalPERS had been a client of Bentall Kennedy for more than a decade and will now be part of an ownership structure that is split evenly between BCIMC and Bentall Kennedy’s senior management.

BCIMC chief executive and investment officer, Doug Pearce, says that the collaborative initiatives ensure an alignment of interests with like-minded long-term investors, while also ensuring the ongoing deal flow necessary for the fund to reach its real-asset targets.Pearce explains that the fund also sees advantages in scale, that is, co-investment allows the different players to access large deals, the size of which have been a barrier to entry, and reduces competition for scarce quality-yielding assets.

Powering across borders

BCIMC has effectively used this strategy to secure key core infrastructure assets. The investment manager teamed up with two other Canadian investors to purchase Washington State’s biggest electric utility for a reported $3.5 billion.

The purchase of just under half of Puget Sound Energy involved fellow Canadian pension managers, Canada Pension Plan Investment Board (CPPIB) and Alberta Investment Management (AIM).

Puget Sound Energy provides electricity and natural gas services to nearly 2 million people over the US border in Washington state.

In addition to its investments, BCIMC is also active in collaboration on a range of environment, social and corporate governance-related investor networks.

It was an early signatory to the United Nations backed Principles for Responsible Investment (UNPRI).

As part of its work at UNPRI it has worked with other members to promote improved standards of disclosure by companies operating in emerging markets.

BCIMC is also working collaboratively within UNPRI and the Investor Network on Climate Risk to encourage stock exchanges around the world to incorporate environment, social and corporate governance considerations in requirements for listed companies.