Investment Beliefs

Rotman ICPM / Netspar / Maastricht University

Discussion Forum – October 2007

Investment Beliefs

Kees Koedijk, University of TilburgAlfred Slager, PGGM Investments / RSM Erasmus University

Page 2Investment Beliefs

What makes an investor great?

• Investment management– Investment managers need an investment process in sync with theory

(Damodaran 2007)

– Upward potential for good governed pension funds (Ambachtsheer 2007), best governed pension funds focus on coherence, process and people (Roger and Urwin 2007)

• Strategic management: – Identifying core competences, aligning organization

• Common thread: focused investment beliefs


Focus on investment beliefs

• Why not? – Companies have to articulate their unique selling proposition for

their client(s)– Especially in financial markets where different visions co-exist

• If not– It becomes difficult for trustees to evaluate new developments,

and whether to embed them in their own strategies– More likely to “join the herd”, increasing costs and opportunity

costs along the way


Vanguard

''consistently outperforming the financial markets is extremely difficult''.


Research set up

• Our paper investigates– What investment beliefs are out there– How do investment beliefs of pension funds and asset

managers differ– Can we say something about their link to performance

• Data collection– Web site, (annual) report, presentations collections– Focus on largest asset managers and pension funds– Scope: publicly reported beliefs (the explicit ones)


Theory behind investment belief

•Observes behavior in the financial marketplace;•Frames why the organization deals with this in a sophisticated way.

•Theoretical basis behind the investment belief. •What is it about that mechanism•Is it a structural, repeatable phenomenon

•Describes how the investment belief can be exploited.

•Organization to successfully exploit the investment strategy.•Links the exploitation of the investment beliefs to performance measures.

EXAMPLE

Overreaction Mispricing with information dissemmination

Sell with negative, buy with positive earnings announcement

Trading strategy with short term horizon. Good versus bad news announcements have to be identified.

Investment Belief Theory Investment Strategy Organization


New Zealand Superannuation Fund

“exploit the premium available to investors who do not require liquidity. Our long investment horizon, combined with […] no outflows, means we are extremely well positioned to capture this premium.”


From beliefs to philosophy

Investment philosophy




… =

Coherent set of beliefs


Sample: 23 pension funds and 17 asset managers

North America

Pensionfd Assetmng

7 11

Europe

Pensionfd Assetmng

9 10

New Zealand, Australia

Pensionfd Assetmng

3 0


4 groups of investment beliefs

Financial Markets beliefsFinancial Markets beliefs

•Risk premium

•Risk diversification

•(In)efficiencies in financial markets,

Asset pricing

•Horizon

•Risk premium

•Risk diversification

•(In)efficiencies in financial markets,

Asset pricing

•Horizon

Investment process beliefsInvestment process beliefs

•Impact, focus on management

decisions

•Risk management

•Investment management style

•Costs

•Impact, focus on management

decisions

•Risk management

•Investment management style

•Costs

Sustainability and GovernanceSustainability and Governance

•Sustainability and Corporate

Governance in asset pricing

•Role in investment process

•Sustainability and Corporate

Governance in asset pricing

•Role in investment process

Organizational beliefsOrganizational beliefs

•Teams, role of investment managers

•Out vs. insourcing

•Experience

•Teams, role of investment managers

•Out vs. insourcing

•Experience


PGGM

capitalize on our strength as a long-term investor. […] We can select investments which generate a high return in the long term, even though they may suffer short term losses.”


PensionDanmark

According to PensionDanmark, “the best investment results are most likely to be achieved with a relatively small and focused investment team combined with a high degree of outsourcing to external managers.”


OTPP

“managing investment risk is just as important as generating returns. Maintaining a well-diversified portfolio is the cornerstone of the Fund's risk management program.”


ABN Amro

Expects over the longer term to see ”the majority of value added come from stock selection as this normally represents a more stable and consistent source of out-performance.”


Some beliefs are more equal…Count Column % Count Column %

Risk premium 10 6.4% 2 2.5%

Risk diversification 14 9.0% 2 2.5%

(In)efficiencies in financial markets /asset pricing 9 5.8% 12 15.0% Horizon 10 6.4% 4 5.0%

43 27.6% 20 25.0%

Impact, focus of management decisions 34 21.8% 15 18.8%

Risk management 6 3.8% 6 7.5% Investment management style 25 16.0% 14 17.5%

Costs 2 1.3% 1 1.3%

67 42.9% 36 45.0%

Teams, role of investment managers 9 5.8% 13 16.3% Out vs. insourcing 5 3.2% 0 0.0% Experience 1 0.6% 3 3.8% Other 5 3.2% 3 3.8%

20 12.8% 19 23.8%

Sust. & Corp. Gov. in asset pricing 4 2.6% 0 0.0% Role in investment process 5 3.2% 1 1.3%

9 5.8% 1 1.3%

Pension liabilities 7 4.5% 1 1.3%

Goal 3 1.9% 1 1.3%

Other 7 4.5% 2 2.5%

17 10.9% 4 5.0%

Total Count 156 100.0% 80 100.0%

Investment process beliefs

Organizational beliefs

Sustainability and Corp. Gov.

Other beliefs

Pension fund Asset Manager

Financial markets


Differences in pension funds and asset managers

Pension fund Asset manager

Risk diversification

Risk premiums

Responsible Investments

Goals

Inefficiencies

Active management

Teams and staff

Focus

Impact

Risk man.


Relationships between beliefs

• Weak relationships expected and found: suggests sensible thought-out processes

• Some relationships show up, suggesting

1. Organizations which hold beliefs about where their added value is, tend to apply it in the investment process.

2. The impact of lower costs becomes more visible with a longer time horizon.

3. Beliefs about risk diversification and inefficiencies are in some cases passed on to the external managers that pension funds select.

4. On the other hand, pension funds with beliefs about in- and outsourcing are more focused on the organizations goals and pension liabilities.

5. Some organizations consider risk premia in a broader setting


Forging a link


Risk diversificationReturn-risk ratio

Asset diversification

Horizon 3, 5, 8 years periods

Investment Management StyleAlpha

Information ratio

Costs Expense ratio

Performancemeasures

Performancemeasures


Descriptives…

Pension funds create alpha Are well diversified


…

Pension funds create high return/risk and report lower costs


Links exist

• Between several investment beliefs and structural performance measures.

– Organization with investment beliefs on risk diversification also show better return-risk performance measures, but also lower costs. Focus pays off.

– Funds that hold a clear view on how risk management is organized, usually in combination with a view on the management style, realize higher alpha and return/risk ratio’s than funds that do not hold such views.


Some caveats

• Small sample, yet the broadest so far

• Performance measures are relatively crude, managers might have other performance measures in mind

• We’ve collected the explicit reported ones, what about the non-reported implicit ones? Every pension fund holds them per definition.


Summarizing

Investment beliefs: still relatively unexplored?

– Developing a set of investment beliefs makes sense from a strategic perspective: an organization has to identify where and how it does add value to the investment process.

Structure emerges

– Beliefs about the financial markets, investment process, organization, and sustainability and corporate governance.


Pension funds and asset managers differ

– A pension fund focuses on risk diversification, getting its beta right. – An asset manager stresses the role of risk management and argues for a particular

investment style. Asset managers emphasize the quality of their organization.

Promising link between beliefs and performance

– An organization with investment beliefs on risk diversification shows better return-risk performance, but also lower costs.

– Funds that hold a clear view on how risk management is organized, usually in combination with a view on the management style, realize higher alpha and return/risk ratio’s than funds that do not hold such views.

– Investment beliefs framework helps focus investment strategy, governance and results

Documents

Investment Beliefs