This paper proposes a unique dynamic portfolio construction framework that improves portfolio performance by adjusting asset allocation in accordance with a forecast market risk.
It finds that modifying asset allocation to the market risk barometer offers investors the “promising opportunity” to meaningfully enhance portfolio performance across market environments.
To access the paper click below
Risk-based dynamic asset allocation with extreme tails and correlations
A strong financial services sector is an integral part of solving the world’s “real challenges” of unemployment, poverty and global imbalances Josef Ackermann, chief executive of Deutsche Bank and chair of the financial services governor’s group at the World Economic Forum, says.
Speaking at the 2102 annual meeting in Davos last week, Ackermann, says “we need to stop the blame game and start looking forward”.
Pointing to Spain’s 42 per cent youth unemployment, he says a strong financial services sector is needed to support the type of recovery that is needed and to contribute to prosperity in order to grow the real economy on a global scale.
In a separate session at the annual meeting, chief executive of Citi, Vigram Pandit, pointed out that 400 million jobs need to be created between now and the end of the decade.
The financial services governor’s group, chaired by Ackermann, discussed the economic outlook, regulatory framework and sustainability within the financial sector, as well as look at risk management and the lessons from other industries including aviation and food.
“It is seldom that so few have done so much to so many,” he says. “When you boil it down only a few banks failed the test, the bulk of banks managed the crisis very well and increased profitability and market share.”
So, he says, one of the lessons from the crisis is to single out those that have made major mistakes; the group also thought a more differentiated analysis of the crisis revealed that while banks made mistakes there were also political mistakes and market inefficiencies which helped cause the crisis.
“We now need to pull forces together to make the system more stable without jeopardising the efficiency of markets and the financial of the real economy.”
He said the governor’s group supported reforms in liquidity management, improving market infrastructure, and a system to exit failed banks, but there was also a need for consistent, global rules.
But in his view it is not wise to come up with new proposals or taxes as it would add to instability.
Ackermann says: “on the psychological and political side we are proactive in helping put in place insurance funds on a national or European level, to do something on the compensation level. This is a very emotional issue and we are working in the industry on a proposal.”
A pay-for-performance measure of chief investment officers in the US has revealed paying more for an executive does not translate to better performance.
Developed by executive recruitment firm, Charles Skorina & Company, the index is calculated by assessing an institution’s investment returns over the past five years, and measuring it against the salary of the CIO.
A basis points earned per $100,000 of compensation is derived and then the CIO’s are ranked by this measure of “performance for pay”.
By this calculation, John Hull, chief investment officer of the Andrew W. Mellon Foundation was the highest performing CIO, with 105 basis points per $100,000 of salary.
Hull manages $5.1 billion and earns $620,000, ranking him 46 out of 50 on Skorina’s list of highest paid CIOs in the US.
The highest paid CIO on this top 50 list is Harvard endowment’s Jane Mendillo earning around $4.7 million in total compensation, followed by Yale’s David Swensen with around $3.7 million.
Endowments dominate the list, with Texas Teachers’ CIO, Britt Harris the only pension fund chief investment officer featuring on the list, earning just over $1 million according to the Skorina data.
Applying the performance for pay calculation reveals Harris generated 29 basis points per $100,000 of salary; Swensen 16, and Mendillo 10.
Skorina says institutional investment boards have been asking him for years to develop a measure of performance for pay and so his aim was to develop a basic, objective and consistent measure.
“Chief investment officers and asset managers measure their service providers every day, but have excuses for why it doesn’t apply to them,” he says. “We wanted to create a simple measure, to create an MER for CIOs. If they think a measure such as basis points per dollar of their salary shouldn’t be used then earnings per share shouldn’t be used, and the S&P and Dow Jones would be defunct.
“You can say that each fund has different benchmarks and measures, but what it gets down to is how much money was made for the institution. An institution will forget about all the other things if you have a negative return.”
The remuneration of pension fund investment executives is a sticking point in the industry.
To compete with the open market, attract and retain a certain calibre of executive, and compensate them for the peculiarities of being a fiduciary, there is a certain minimum required. At the same time this has to be balanced with communication to beneficiaries, governments and other stakeholders about what is fair, often within tight budget constraints.
Communicating what is value for money, and developing appropriate pay structures as part of this measurement is a challenge.
The ranking of performance per pay of a CIO as measured by Skorina (see the article Do you get what you pay for?) seems crude. It doesn’t consider the working environment, benchmarks, constraints and governance, or responsibilities such as reporting, staff training and motivation, technology oversight and strategic thinking.
Charles Skorina argues none of that matters; that institutions are paying their CIOs to generate a return, and so they can be measured against that return.
To some extent that is true, but life isn’t that simple. At least Skorina is bring the idea of accountability for salary to the fore, and perhaps it is a starting point.
One of the issues the industry is grappling with is an appropriate pay structure.
The 2011 Mercer Financial Services Executive Remuneration Survey in the UK shows across that sector that pay continues to move away from short-term incentives.
Mercer reveals that from 2008 to 2010, base pay for senior positions in this sector rose from 25 to 34 per cent, at the same time, the proportion of long-term incentives at the chief executive level increased from 36 to 46 per cent, with annual bonuses dropping from 39 to 23 per cent.
In the pension industry there is no formula for success, however a number of funds have spent, and are spending an increasing amount of time on this issue and developing their own ideas of performance benchmarking and appropriate compensation.
CalPERS has a performance and compensation committee, and has an elaborate measurement system for its executive pay structure.
The chief investment officer is measured against a variety of short and long-term, investment and organisational, issues. (CalPERS CIO pay structure)
Similarly the Canadian Pension Plan Investment Board has identified executive pay as a key organisational issue – this in the context it employs more than 800 people and manages all assets in house – and has developed a pay-for-performance formula within a risk framework
Keith Ambachtsheer’s paper – How should pension funds pay their own people – provides a case study of CPPIB.
More widely Ambachtsheer identifies executive remuneration as one of five critical pieces of the puzzle if a pension fund is to satisfy its tasks of investing productively, administering efficiently and advising wisely.
To do these well, he says, requires aligned interests with stakeholders, good governance, sensible investment beliefs, effective use of scale, and competitive compensation.
A practical guide to good governance for pension board trustees was one of the results of the Rotman ICPM Board Effectiveness Program which included participants from 21 funds from nine countries.
The program, the first of its kind to be aimed specifically at board members of pension funds and other long-horizon investment institutions, looked at the functionality of boards, examining when they get stuck and why, as well as the right way for a board to approach strategy, planning and execution.
The impetus for the program came from the desire of the program’s academic director, Keith Ambachtsheer, to provide help to pension fund boards to overcome areas where they may be dysfunctional, which he believes arise from a desire to implement rather than oversee.
The program asked participants to submit in advance the top challenges facing their boards. This revealed good governance and sensible investment beliefs as the two of the key challenges.
As a result of the program, which is collaboration between Rotman Executive Programs and the Rotman International Centre for Pension Management, a plan was developed for trustees to use as a guide.
The good governance advisory team decided on three key steps to implementing a governance improvement program:
Similarly participants developed a step-by-step guide with regard to sensible investment beliefs and organisation design that included:
The other challenges nominated by the board included robust risk management, effective stakeholder communications, and financial sustainability.
The program will be held again next month, and is already sold out, but to register for future offerings visit www.rotman.utoronto.ca/icpm
A majority of investors believe “stability bonds” could provide a partial solution to the euro zone sovereign debt crisis, but are concerned that these bonds carry a high moral-hazard risk, a CFA institute poll reveals.
The poll found 55 per cent of European investment professionals believe that the common issuance of stability bonds can help alleviate the debt crisis, but only as part of a package of structural reforms, fiscal integration, and a strong common governance framework.
The risk of moral hazard, where some member states may follow poor budgetary discipline with limited implications for their financing costs, is a key concern of CFA Institute members.
More than half of investors also believe the bonds will reinforce financial stability in the euro area and 56 per cent agree that it will facilitate the transmission of euro-area monetary policy.
“Stability bonds” are seen as an instrument to address liquidity constraints and ultimately reinforce financial stability in the euro area.
The poll of 798 investment professionals comes in the context of the European Commission’s consultation on the issuance of “stability bonds”.
The bonds are seen as creating a new way for governments to finance their debt, the European Commission says.
In a Green Paper outlining various potential models for a stability bond, the Commission says that the bonds will potentially offer a “safe and liquid” investment opportunity for savers and financial institutions.
The Commission claims that such a stability bond would be the catalyst for a euro-area-wide integrated bond market to rival the liquidity and size of its $US counterpart.
While a majority of respondents agree that resolution of the euro-area sovereign debt crisis should require common issuance of sovereign bonds, 40 per cent disagree with this strategy.
A common view from respondents is that the stability bonds could bring temporary relief in the short run, but will only postpone the problem and be detrimental in the long term, possibly fuelling the next crisis.
Some respondents believe the long-term negatives would outweigh the short-term benefits, as stability bonds would create further systemic risk, resulting in national sovereign debt crises being replaced with a Europe-wide debt crisis.
There is also a clear consensus among investors, however, on how the bonds should be issued.
Joint and several guarantees would be the most effective approach for the common issuance of stability bonds among member states of the euro area, according to 64 per cent of CFA members polled.
A partial substitution of stability bond issuance for national issuance – in which a portion of government financing needs would be covered by stability bonds, with the rest covered by national sovereign bonds – is supported by 64 per cent of CFA members.
Investors strongly advocate three key preconditions that countries wanting to access stability bonds would have to agree to. These are:
Agnès Le Thiec, CFA Institute’s capital markets policy director, says the new financial instruments, while helping to solve the euro zone debt crisis, cannot cure structural problems of imbalances in trade and competitiveness, or public debt, in many member states.
“Stability bonds also carry a high risk of moral hazard, and would therefore have to be associated with much more extensive structural reforms, fiscal integration and a strong common governance network,” Le Thiec says.
