BY KATE CAM, MERCER’S HEAD OF INVESTMENT GOVERNANCE
IN AUSTRALIA AND NEW ZEALAND
APRIL 2014
STRAT
EG
Y
RIS K M A N A G
MER
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GPS
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STRUCTURE
MO
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USING INVESTMENT BELIEFS
AS YOUR GPS
Given the level of market volatility since the Global Financial
Crisis, it is not difficult to imagine a situation where investment
markets abruptly change direction. This means the investment
strategy you have in place may not meet your investment
objectives in the way you envisaged especially over shorter term
time frames. As an investment professional responsible
for meeting the needs of your stakeholders, you need
to decide whether to hold your position, or make changes.
Assessing your next move requires acting on
your investment beliefs. Investment beliefs
describe how you think investment markets
work and therefore how you think you can
create value for your stakeholders. They are
reference points in the investment decision
making process, much like satellites in the
Global Positioning System, that guide you
to where you want to go.
It is Mercer’s view that having an explicit statement of
investment beliefs is an example of industry best practice
that can lead to better investment decision making and even
to better investment outcomes.
WHY HAVE THEM?
Research and anecdotal evidence points to investment
beliefs as providing an “investment advantage” for the
organisations that use them to develop investment
strategy. That is, investment organisations with a
clearly articulated set of Investment Beliefs improve
their investment governance process, and therefore
increase the chance of improving investment
outcomes. We’ll examine the three key aspects of this
statement in turn.
Firstly, the stipulation for gaining this investment
advantage is that investment beliefs are explicit –
they are debated, tested and agreed between key
stakeholders before being clearly articulated in
some form of policy statement. If this is not the case,
investment decisions are likely to be made based on
personal beliefs which are bound to be inconsistent
across the organisation and ultimately inconsistent
with investment purpose.
Secondly, the improvement in investment governance
therefore comes in the form of consistency and
decisiveness when setting investment strategy.
Decision makers are likely to be less reactive when
markets are turbulent thus less susceptible to the risk
of following the herd. Besides keeping the primary
focus on investment purpose, positive impacts may
include less frequent switching from one strategy to
another reducing the associated transaction costs
and tax liabilities.
And thirdly, the potential for improving investment
outcomes stems from the improvement in governance.
Slager and Koedijk (2007) see the impact of investment
beliefs as helping to reduce possible conflicts of interest
and set ”guidelines for best practice” which improves
stakeholder governance. Ambachtsheer (2006)
measured the additional value from improvements in
governance at 1% pa in net investment return where
investment beliefs formed an integral part of the optimal
governance solution.
However, there are practitioners who do not believe
there is a strong link between how investment beliefs
are used and improved investment outcomes. This does
not mean they do not see a benefit of having explicit
investment beliefs. Based on Mercer’s experience, the
process of determining or reviewing investment beliefs
is beneficial in the following ways:
• it aligns interests across the organisation making it
easier for the Board to delegate authority for
investment decision making
• the process provides valuable insights into what other
key stakeholders think about how markets work
• it means key stakeholders are unlikely to be surprised
at how the portfolio behaves in different market
environments.
CONSISTENT
STATEMENT OF
INVESTMENT
BELIEFS
DECISIVE
INVESTMENT
STRATEGY
PRO-ACTIVE
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HOW DO YOU ARRIVE AT
EXPLICIT INVESTMENT BELIEFS?
Investment beliefs can be determined in a variety of ways. An investment beliefs survey can
be administered for all relevant stakeholders to uncover individual beliefs and risk preferences.
Discrepancies can then be debated at a subsequent workshop to ensure all participants
(typically the Board, Investment Committee, CEO and CIO) are aligned. This debate inevitably
draws upon evidence and experience to arrive at shared conclusions.
In addition, Mercer’s view of best practice is to ensure the investment decision makers consider
a variety of market scenarios to test their investment beliefs and subsequent investment strategy.
This builds a sound understanding of the likely behaviour of a portfolio given changes in the market
environment. For example, a strategy built upon a belief in value investing is likely to require a
long-term investment horizon to get results. Testing the Board’s responses to short-term fluctuations
in this particular strategy and the subsequent likely impact on key performance metrics illustrates
the level of understanding and tolerance of the underlying investment belief.
Interestingly, we have found that the survey and workshop process tends to uncover more than
just implicit investment beliefs. Questions over commercial business purpose are often raised
and debated as well as other issues that were previously unknown to the client.
KEEPING THE
INVESTMENT
BELIEFS ALIVE
Once you have a documented Statement of Investment
Beliefs, it is vital to keep it alive if you are serious about
extracting the investment advantage discussed earlier.
This can be done in a number of ways:
• The Board and Investment Committee can refer
their investment decisions back to the relevant
Investment Belief.
• Other Investment Governance documents such
as your Risk Appetite Statement, Risk Management
Statement and Investment Policy Statement
can be directly linked to your Statement of
Investment Beliefs.
• A simple diagram that provides a succinct summary
of your beliefs can be included in internal
and external investor communications.
GOVERNANCE FRAMEWORK AND POLICY SETTING
INVESTMENT PHILOSOPHY AND BELIEFS
RISK APPETITE STATEMENT
AND RISK MANAGEMENT STATEMENT
INVESTMENT POLICY
INVESTMENT
STRATEGY
INVESTMENT
IMPLEMENTATION
INVESTMENT OBJECTIVES
BOTH LONG & SHORT TERM
APPOINT, TERMINATE
INVESTMENT MANAGERS
LONG TERM SAA / HEALTH
CHECK/ SOLVENCY TARGETS
INVESTMENT MANAGER
REPORTING & REVIEWS
ASSET CLASS STRUCTURE
& STRATEGY
REBALANCING & LIQUIDITY
MANAGEMENT
ASSET CONSULTANT /
CUSTODIAN APPOINT /
TERMINATE
CUSTODIAN &
ADMINISTRATION
SUPERIOR INVESTMENT PERFORMANCE
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CONCLUSION
In the event that investment markets abruptly change
direction, Mercer believes it is desirable to be a
stakeholder of the investment organisation that has
been through the process of examining its investment
beliefs as opposed to an organisation that is making
reactive, impulsive investment decisions. Like satellites
in the Global Positioning System, you can refer back
to these thoughtful, pre-determined beliefs to give
you confidence in where you are heading.
References
Ambachtsheer, K. Beyond Portfolio Theory: The Next Frontier Financial Analysts Journal, 2005
Ambachtsheer, K. The Ambachtsheer Letter: How much is good governance worth? April 2006
Raymond, Donald M. Investment Beliefs, Handbook of Finance, John Wiley & Sons, September 2008.
Slager, A and Koedijk K. Investment Beliefs – every asset manager should have them, The Journal of Portfolio Management, Spring 2007.
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MERCER CAN HELP DEVELOP A PROCESS FOR TRUSTEES TO GAIN:
•An appreciation from the board of trustees and other key stakeholders
of what the investment beliefs are;
•An understanding by each individual board member of their role in shaping
and implementing the beliefs; and
•A process and framework for testing new or existing investments against the statements
Please contact Kate Cam to discuss your investment beliefs workshop
[email protected] or call 02 8864 6912
For more information on investment governance go to mercer.com.au/governance
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