A FRAMEWORK FOR
PUBLIC PENSION FUND MANAGEMENT
Public Pension Fund Management Conference
The World Bank
Discussion Materials
Keith P. Ambachtsheer
KPA Advisory Services Ltd.
Washington DC
September 24, 2001
Key Keynsian Message:
“S = I is only half the story”
(perhaps much less than half the story!)
Evolving Perspectives on Savings and Investments
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Socialism vs. capitalism
Principals vs. agents
‘inside’ capitalism vs. ‘outside’ capitalism
Ownership vs. control
Integration vs. segmentation
Rationality vs. irrationality
Individual risks vs. pooled risks
Retirement Income System Design:
the World Bank Model
Pillar #1:
Minimum Income Support
(unfunded, means-tested)
Pillar #2:
Mandatory Universal Pension Scheme
(funded, employment-based)
Pillar #3:
Voluntary Pension/Savings Schemes
(funded, tax-deferred, DB, DC)
Key Peter Drucker Messages:
(from “The Unseen Revolution: How Pension Fund Socialism Came to America”, 1976)
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RIS design will become an increasingly important
element of modern capitalism.
This will be a positive development only if
pension schemes are endowed with “legitimacy”.
Ambachtsheer’s Pension Scheme “legitimacy” test:
(from “The Ambachtsheer Letter” #186/187 July-August 2001)
1.
2.
3.
Adequate target income replacement rates to be
maintained in real terms.
Early vesting and portability.
Clarity on the part of all stakeholders as to what the
‘pension deal’ actually is, and who bears what risks.
Ambachtsheer’s Pension Scheme “legitimacy” test:
(from “The Ambachtsheer Letter” #186/187 July-August 2001)
4.
Symmetry between risk bearing and reward allocation.
5.
Reasonable opportunities for risk pooling.
6.
Transparency through the regular reporting of assets,
liabilities, and contribution rates using generally agreedupon pension finance and economics principles.
Ambachtsheer’s Pension Scheme “legitimacy” test:
(from “The Ambachtsheer Letter” #186/187 July-August 2001)
7.
8.
Sufficient organizational autonomy in how the ‘pension
deal’ is implemented so that its governance,
management, and operations layers can be clearly
defined.
Sufficient scale to deliver the necessary investment and
administration services at reasonable unit costs.
Figure I: Seven Critical Pension Business Questions
ASSETS
LIABILITIES
1. What is the DB pension deal?
5. What is the risk-free asset mix that
would ‘immunize’ the pension debt
outstanding?
6. Should the plan undertake asset mix
policy risk?
7. Should the plan undertake active
management risk?
2. How much pension debt is outstanding?
SURPLUS
3. What is the target asset/liability ratio?
4. How are balance sheet gains and losses
allocated between plan stakeholders?
Who owns the surplus on termination?
Source: Pension Fund Excellence, page 7.
PENSION FUND PERFORMANCE DRIVERS
1.
SIZE
2.
PROPORTION PASSIVE
3.
ORGANIZATION DESIGN QUALITY
Source: “Improving Pension Fund Performance”, By Ambachtsheer, Capelle, Scheibelhut, Financial Analysts
Journal, Nov-Dec 1998
PREVIOUS EXCELLENCE RESEARCH (1)
“After reading our book, you’ll feel a little bit
like the airline passenger who peeks into the
cockpit at 30,000 feet and discovers there is
no-one there.”
O’Barr and Conley
“Fortune and Folly:
The Power and Wealth
Of Institutional Investing”, 1992
PREVIOUS EXCELLENCE RESEARCH (2)
Median Estimate of Excellence Shortfall:
66 basis points per annum
50 Senior Pension Fund Executives
Symposium on “Excellence in
Pension Fund Management”
New York, 1994
BARRIERS TO EXCELLENCE
Rank
1
2
3
4
4
6
7
7
9
9
Barrier
Cited
Poor process (including structure, communication and inertia)
Inadequate resources
Lack of focus or of clear mission
Conservatism
Insufficient skills
Inadequate technology
Conflicting beliefs
Difficult markets
Lack of innovation
Suppliers
98%
48%
43%
35%
35%
13%
8%
8%
5%
5%
THE 11 DRIVERS OF ORGANIZATION PERFORMANCE
Question No.
QUESTION
Governance
2
My governing fiduciaries have good mechanisms to understand and
communicate with plan stakeholders
7
My governing fiduciaries do a good job of balancing overcontrol and
9
Our fund has an effective process for selecting, developing and terminating its
governing fiduciaries
13
My governing fiduciaries and related committees use their time efficiently
(focused and do not waste time.)
14
There is a high level of trust between my governing fiduciaries and the pension
investment team.
15
There is a clear allocation of responsibilities and accountabilities for fund
decisions between the governing fiduciaries and the pension investment team.
THE 11 DRIVERS OF ORGANIZATION PERFORMANCE
Question
No.
QUESTION
Planning and Management
19
I can describe our vision of where we should be in the future.
22
I can describe our fund’s strategic positioning (how we provide better value to
stakeholders than alternatives).
24
I can describe our resource plan (obtaining and optimally utilizing the required
human, financial and information technology resources).
28
Developing our asset mix required considerable effort on the part of myself and
the governing fiduciaries and it reflects our best thinking.
Operations
37
My organization uses its time efficiently (well focused and does not waste time).
AN ORGANIZATIONAL FRAMEWORK FOR DB RETIREMENT
SYSTEMS BASED ON PENSION FUND EXCELLENCE:
CREATING VALUE FOR STAKEHOLDERS
(a) THE PLAN SPONSOR(S)
Define/negotiate ‘the pension’ deal (including benefit formula, who bears which
risks, how surpluses and deficits are to be dealt with, funding policy, etc.)
Appoint/elect the plan trustees/directors
(b) THE GOVERNING FIDUCIARIES
Decide the plan’s risk policy (e.g. how much balance sheet risk is acceptable,
and what ‘payback’ is targeted)
Hire/fire the organization’s CEO and establish executive compensation policy
Approve management’s business plans for the asset management and benefit
administration ‘businesses’
Monitor outcomes vs. targets
AN ORGANIZATIONAL FRAMEWORK FOR DB RETIREMENT
SYSTEMS BASED ON PENSION FUND EXCELLENCE:
CREATING VALUE FOR STAKEHOLDERS
(c) THE MANAGING FIDUCIARIES
Develop, with governing fiduciaries input, an organization vision
Develop and implement consistent HR and IT strategies
Advise the governing fiduciaries on the balance sheet risk policy
Propose and carry out approved business plans for the asset management and
plan administration ’businesses’ consistent with the organization vision
Analyse and report outcomes vs. targets to the governing fiduciaries.
(d) THE OPERATING FIDUCIARIES
(operating either internally as employees or as third parties on an outsourced basis)
Asset Management
Manage pre-defined investment portfolios within pre-defined risk and cost
constraints to achieve pre-defined results
Benefit Administration
Deliver benefit administration services to clients at pre-defined service and cost
effectiveness levels
Key Financial Governance Decisions in Pension Schemes:
=+1.5%
MRPR
RF
= (eg.,TIPS with 15 yr. dur.)
performance
target
Max Risk
= 10%
BUILDING THE STRATEGIC PLAN (I)
RISK FREE STRATEGY
RISKY STRATEGIES
Match CF requirements with
default risk-free nominal and/or
inflation-protected bonds
How do we characterize the
choices?
“It is long term investors who most promote the public
interest. Yet it is they, wherever investment funds are
managed by committees or boards, who will in practice
come in for the most criticism. For the behavior of long
term investors will seem eccentric, unconventional,
and rash in the eyes of average opinion. Worldly
wisdom teaches that it is better for reputation to fail
conventionally than to succeed unconventionally”.
John Maynard Keynes, 1936
“[Active management] is like a game of Snap, of Old
Maid, of Musical Chairs. He is the victor who says ‘snap’
neither too soon nor too late, who passes the Old Maid
to his neighbour before the game is over, who secures a
chair for himself when the music stops. These games
can be played with zest and enjoyment, though all
players know that it is the Old Maid which is circulating,
or that when the music stops some of the players will
find themselves unseated.
John Maynard Keynes, 1936
BUILDING THE STRATEGIC PLAN (II)
Risky Strategies
LONG HORIZON
PRIVATE
Markets
OR
PUBLIC
Markets
=
CF Projection/Valuation Strategies
• Core public equities
• Merchant banking
• Venture capital
• Other?
SHORT HORIZON
PUBLIC
Markets
=
Active Management
=
Absolute Return Strategies
• Event-driven
• Value-driven
• Other?
BUILDING THE STRATEGIC PLAN (III)
Risky Strategies
LONG HORIZON
PUBLIC MARKETS
CORE PUBLIC EQUITIES
‘Build Your Own’
Index Funds
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Trust market participants to do
CF projections/valuations
Don’t trust market participants to
do CF projections/valuations
 Build or acquire your own
processes
 Decide on your own MRPR
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BUILDING THE STRATEGIC PLAN (IV)
CORE PUBLIC EQUITIES
Index Funds
hold market weight in Cisco
regardless of price
 the rule holds whether Cisco is at
$60 or $18

‘Build Your Own’
hold Cisco if it passes the MRPR test
 if MRPR = 0, hold Cisco at $60 or less
 if MRPR = 3%, hold Cisco at $18 or
less
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Which is the better way to build a core public equities portfolio?
BUILDING THE STRATEGIC PLAN (V)
‘Asset Allocation’
Risk-Free
Strategy
Long Horizon
Risky Strategies
Short Horizon
Risky Strategies
A
B
C
D
E
Expected Excess Return
0%
0%
3%
0%
3% 10%
Excess Return Volatility
0%
20%
20%
2%
20% 5%
WHAT ARE THE ‘OPTIMAL’ WEIGHTINGS?
CONCLUSIONS
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Current fund management paradigm needs to be challenged
Any new paradigm should be grounded in common sense and
good OD principles
This presentation introduces a ‘new paradigm’ candidate
involving a re definition of OD roles, and a redefinition of
‘asset classes’ and ‘asset allocations;
It promises more focused and integrated risk management,
and improved fund reward/risk ratios in a zero/low equity risk
premium environment
Do you agree?