Prudent Person Principle
Investment & Solvency II
© 2015 Towers Watson. All rights reserved.
Agenda
1. Definition
2. Regulation
3. Issues arising
4. Things to consider
5. Asset governance
2
towerswatson.com
© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Prudent Person Principle
A definition….
“A legal rule requiring investment advisers to only make
investments for their clients' that a "prudent person" would
make…..It does not require that the investment adviser
always make correct decisions; it merely requires him/her to
make decisions that will be generally accepted as sound for
someone of average intelligence……stating that trustees
must manage the affairs of others as if they were managing
"their own affairs."
3
towerswatson.com
© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Regulation
Solvency
II Directive
Delegated
Regulation
Guidelines
4
towerswatson.com
© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Regulation
Article 132 of Solvency II Directive
“…properly identify, measure, monitor, manage, control and report….”
“…ensure security, quality, liquidity and profitability…..availability”
“…linked…close matching”
“…best interest of policyholders” [Conflict of interest]
“derivatives…reduction of risk…efficient portfolio management”
“…not admitted to trading on regulated markets kept to prudent levels…”
“…properly diversified….”
“…excessive concentration….”
“Member States can restrict….”
5
towerswatson.com
© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Regulation
EIOPA Guidelines on System of
Governance 25-30
Investment risk management
Assessment of non routine
investment activities
Unit linked and index linked
contracts
Not admitted for trading on regulated
financial market
Derivatives and Securitised
Investments
6
towerswatson.com
© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Assessment of Investment Risk Management
“well structured,
disciplined and
transparent”
“duty to protect
policyholders and
beneficiaries interest”
7
towerswatson.com
© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Assessment of Non Routine Investment Activities
Ability to perform/manage
Risks specifically related
Consistency with
policyholders/beneficiaries
interests and liabilities
Impact on quality, security,
liquidity, profitability
Inform AMSB
New ORSA
8
towerswatson.com
© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Security, Quality, Liquidity, Profitability of Portfolio
Overall basis
Liability constraints
Consistency with risk appetite
Characteristics of the asset
Events that could change characteristic
Issues relating to localisation and availability of
assets
9
towerswatson.com
© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Unit linked and index linked contracts
Best interest of policyholders and
beneficiaries and disclosed objectives
Liquidity
Interests of remaining unitholders
10
towerswatson.com
© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Assets not admitted for trading/Derivatives
Implement,
manage, monitor,
control
procedures in
relation to
investments not
admitted to
trading or
complex products
Mark to market =
Risk Function
sign off on model
Back up models
Should show how
derivatives
enhance portfolio
not create
additional risks
Where used in
unit linked funds,
additional
enhancements in
place to protect
policyholders
11
towerswatson.com
© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Issues Arising
•
•
•
•
•
•
•
•
•
•
•
Principles rather than rules
Raising the bar
Complex products
Structured products
Independent expertise
“Look through”
Portfolio Bonds
Mandates
New asset classes
Legal risks
Derivatives
If you don’t understand it…..
….don’t invest in it!
12
towerswatson.com
© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
To consider
•
•
•
•
•
•
•
•
•
Independent investment expertise
Review processes, procedures, controls
Clear policyholder literature
Communication (type/frequency)
Solvency I rules
UCITS rules
Diversification
Documentation
PRIIPS
Talk to Joe
13
towerswatson.com
© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
14
towerswatson.com
© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Plato’s account of the trial of Socrates
(Translated by Benjamin Jowett.)
πρὸς ἐμαυτὸν δ᾽ οὖν ἀπιὼν ἐλογιζόμην ὅτι τούτου μὲν τοῦ
ἀνθρώπου ἐγὼ σοφώτερός εἰμι· κινδυνεύει μὲν γὰρ ἡμῶν
οὐδέτερος οὐδὲν καλὸν κἀγαθὸν εἰδέναι, ἀλλ᾽ οὗτος μὲν
οἴεταί τι εἰδέναι οὐκ εἰδώς, ἐγὼ δέ, ὥσπερ οὖν οὐκ οἶδα,
οὐδὲ οἴομαι· ἔοικα γοῦν τούτου γε σμικρῷ τινι αὐτῷ τούτῳ
σοφώτερος εἶναι, ὅτι ἃ μὴ οἶδα οὐδὲ οἴομαι εἰδέναι.
I am wiser than this man, for neither of us appears to
know anything great and good; but he fancies he knows
something, although he knows nothing; whereas I, as I
do not know anything, so I do not fancy I do. In this
trifling particular, then, I appear to be wiser than he,
because I do not fancy I know what I do not know.
Wisest is he who knows he knows nothing
15
towerswatson.com
© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
How TW provides consulting to insurers
TW Global Investment
TW EMEA Risk Consulting & Software
Investment strategy
150 professionals
P/C insurance
350 professionals
Insurance and
Investment team
for
insurers
Investment research
230 professionals
Client Consulting
400 professionals
Life insurance
350 professionals
Insurance Mgmt consulting
25 professionals
RCS software
75 professionals
850 people worldwide
490 in Europe
Insurance
capabilities
Inv. model
solutions
FIA
Risk team
CRO
Board
Investment
strategy
CEO
Investment
governance
CFO
Capital mgmt
Implement
efficiently
CIO
Inv function
16
towerswatson.com
© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Governance & Organisational design
Strategic Principles
Mission and goals
Beliefs
Enablers
Organisational
Design
Culture
Talent
and
and
leadership reward
Value chain
Investment Policy
Frameworks
Portfolio optimisation:
strategy, asset
allocation, risk
Manager
line-up
Execution
17
towerswatson.com
© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
A selection of recent investment projects
Maximising
risk-adjusted returns
Portfolio
construction
Modelling
solution
Model
validation /
calibration
Full asset
allocation review
STAR model
Model validation
Partial or ‘flash’
asset allocation
review (eg fixed
income only)
SAA tool
Smart Beta /
hedge fund
portfolio
construction
Consulting
support linked
to model
Dynamic asset
allocation
Risk Agility EC
and C-ALM
(MoSes)
Model / quantify
market / credit
risk
Implementing portfolio
solutions
Bonds and
derivatives
Returnseeking (&
alternative)
assets
Monitoring
Bond manager
selection advice
Manager selection
- hedge funds
Manager monitor /
access to Dream
(TW’s manager
research
database)
Smart Beta
manager selection
Manager selection
- Smart Beta
Independent
opinion of
derivative
strategies
Manager selection
– equity
Implementation of
Interest rate/
inflation/credit/
extreme risk
hedging
Manager selection
–private markets
Improving inv. risk
management and
governance
Risk
Management
Governance
Stochastic ALM to
articulate
the risk budget
Review capability of
Internal asset manager
Economic scenario /
extreme risk analysis
Investment
beliefs/objective
workshop
Investment Health
Check
Review investment
decision making
structure
Liquidity management
process and scenarios
Board and Executive
training
Operational Due
Diligence
ALM governance and
processes
Asset manager
fee review
18
towerswatson.com
© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Narrowing the universe
The issue with screening for past performance
Number of managers
3000
2500
2000
1500
1000
500
0
Skilled
Mediocre
Good performers
Bad
Not good performers
Source: Penfold, Robin. “Do not hire managers for past performance” Towers Watson Limited, 2011
19
towerswatson.com
© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Sustainability of..
..competitive advantage
Towers Watson manager research framework…
Investment professionals
• What is the calibre of key people?
• Do they exhibit the traits of great investors?
• Are resource levels sufficient?
Approach/insight generation
• Is there evidence of competitive advantage in the way a team generates
investment ideas?
• Is the philosophy compelling and consistent with the resources and skill set
available?
Portfolio management
• How effectively does the manager convert ideas into portfolios?
• Does the manager think enough about risk and overall portfolio construction?
Firm and team stability
• What are historical levels of personnel turnover and corporate activity?
• Looking forward, what is the culture and what mechanisms do they have in
place to help retain people?
Opportunity set
• Is the opportunity set large enough for the manager to exploit effectively given
their particular process?
• How might this change over time?
• How does the manager think about capacity?
Alignment
• Is there evidence that both the firm’s and the key investment professionals’
interests are aligned with those of clients via well structured performance fees
and co-investment?
• Is the product’s fee too high?
20
towerswatson.com
© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
‘Skill thesis’’ is a detailed (19
pages for this EM equity
manager) written document
explaining in full the rationale
for a manager rating.
21
towerswatson.com
© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Skill summary
ABCFund Managers
Skill
1
Emerging market equities ‒ Emerging Market Equity
Expected deviation
Absolute return
Soft risk
Average
Executive summary
We have a positive view on ABCFund Managers' (ABC) Global Emerging Markets (GEM) team and product. Key strengths are the team's deep belief in its investment philosophy and process, as well
as the team's willingness to look further than many peers for ideas. We are, however, conscious of the broader team's limited experience relative to some peers and the relatively short time it has been
running this strategy for (since 2008). Also, whilst we believe there are some issues from ABC being a publicly listed firm, there is material alignment of interests through employee ownership
(approximately 30% of the business), co-investment and performance related fees.
Success factors
Strengths
Weaknesses or issues
Investment
professionals
The strategy's Portfolio Manager XX YY and Co-Portfolio Manager WW
ZZ appear to be insightful and pragmatic investors
The analyst team is less experienced than that of some peers in this space, though this is
somewhat mitigated by its access to broader firm resources, including the new global equity team
The investment team appears to have a strong investment culture and be
motivated to succeed
Potential for lack of challenge to XX
There is an apparent deep belief in and adherence to the investment
philosophy and process
Assessment of environmental, social and corporate governance (ESG) risks appears to lack
rigour
Approach/insight
generation
As the product gains traction with investors, there may be increased distractions for marketing
purposes for XX and ZZ, although the firm is partly addressing this by increasing its client
servicing resources
The GEM team will be leveraging the house research base for inputs into
its analysis (for example, for views on commodities prices)
South African base may give local insight
Portfolio
management
Firm and team
stability
Strong thinking on portfolio management and risk control from XX
Structural style bias and benchmark agnostic portfolio (50-60 stocks with small-/mid-cap bias) will
provide, at times, volatile returns relative to a market index
Ability and willingness to invest up to 25% of the portfolio in developed
market-listed companies with significant exposure to emerging markets
Some evidence of shareholder engagement, but largely limited to voting proxy shares
Long-term focus on asset management business
Unclear plans for accepting senior investors into the managing partnership
Profitability and diversity of local business
The business has a concentration in South African equity products
The firm's development of a global equity product has the potential to create a distraction for the
team
Opportunity set
Ability and willingness to look further for ideas than many peers
The team's investment philosophy leads to significant numbers of stocks being discarded at the
start of the process and opportunities are potentially missed
The strategy's capacity target seems somewhat high, and discipline in management of capacity
has been questionable in South African strategies. However we believe capacity issues are not a
major concern at the current level of assets under management
Alignment
Strong processes in place to improve alignment of interests, including
employee share ownership and co-investment in ABC’s internal funds
Being a publicly listed firm may bring some external pressures to the business, although the
management team is focused on minimising this and the firm's employees are the largest (around
30%) shareholder group
Significant percentage of asset base on performance-based fees
Willingness to invest materially in new product launches, ahead of having
asset growth
Equity ownership offers limited direct alignment to the success of the Emerging Markets product,
given the strategy's small size relative to the firm's South African business
Co-investment in the GEM strategy is limited due to local tax regulations
Key:
towerswatson.com
Significant strength
Strength
Neutral
Weakness
22
© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Snapshot as at 31 March 2015
UVWX
Emerging Markets Equity
Investment professionals
1
2
3
Primary professional
experience
Portfolio manager
experience
Analysts experience
Firm and team stability
26 years industry experience
13 Firm asset growth
19% growth rate over the last year
26 years industry experience
14 Product asset growth
9% growth rate over the last two years
18 years industry experience
15 Portfolio manager
turnover
16 Analysts turnover
0 known gains, 0 known losses over the last three
years
18% gains, 0% losses over the last three years
4
Primary professional
20 years on the product
tenure
5 Portfolio manager
21 years at the firm
tenure
Approach/insight generation
Opportunity set
6
Three year returns
1.5%pa net relative return, 0.25 net information ratio
7
Five year returns
6.2%pa net relative return, 0.83 net information ratio
8
Seven year returns
3.8%pa net relative return, 0.42 net information ratio
Portfolio management
9
Downside protection
17 Manager asset class
capacity
18 Product capacity
49,832 million USD in active equities
(Percentile: 91 in a universe of 721 managers)
411 million USD per stock
(Percentile: 99 in a universe of 134 products)
Alignment
19 Significance of
product to firm
20 Ownership
61.9% of firm assets in product
10 Risk level
0.13 Calmar Ratio over last seven years
(Percentile: 92.9 in a universe of 183 products)
7.5%pa tracking error over last five years
11 Portfolio turnover
28.9%pa
21 Manager alpha share
38% of alpha assuming a 95.0 bp fee
12 Active share
83% versus MSCI EM-ND
0.0% employee ownership
First quartile versus equity universe*
5th percentile
Lower quartile
Median
Upper quartile
95th percentile
Notes: The performance used in factors 6 to 10 and 21 is for the Emerging Markets Equity ‒ SA vehicle. Returns are in USD. Benchmark is FTSE All-World All Emerging.
* The universe displayed is the Towers Watson Snapshot analysis for all active long-only equity products with at least 10 factors calculated as at 31 March 2015 (5,022 products).
First quartile = Below lower quartile, Second quartile = Lower quartile to median, Third quartile = Median to upper quartile, Fourth quartile = Above upper quartile
Source: eVestment
towerswatson.com
Key:
Strength
Neutral
Weakness
Not rated
Product score
23
© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Operational Due Diligence
24
towerswatson.com
© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Internal & external fund governance
25
towerswatson.com
© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Joseph O’Dea
Senior Investment Consultant
joseph.o’[email protected]
Colin Murray
Senior Consulting Actuary
[email protected]