INVESTMENT POLICY: …the key to successful pension fund management
Investment Policy relates the needs of the sponsors of the plan to the management of the plan assets through a comprehensive and consistently applied investment policy document. The investment policy needs to be well thought out and diligently implemented. Most sponsors adopt an adhoc management due to a lack of understanding of the importance of the investment policy.
The investment policy offers plan sponsors a way of identifying and prioritizing the issues that are of direct importance to the success of pension funds. Investment policy gives sponsors attitudes towards issues such as:
- What is the purpose of the Pension Fund?
- How do we define success?
- How exposed should the fund be to the possibility of failure?
- How do we evaluate investment performance?
The answer to these questions will differ depending on financial circumstances of sponsoring organizations and the temperaments of the Pension Fund decision makers.
Investment policy is a form of long-term strategic planning. It outlines the specific goals that the plan sponsors expect the pension fund to accomplish. The policy describes how the sponsors expect these goals to be achieved. Investment policy documents place little emphasis on transitory market movements and accept as given; the long-term investment opportunities afforded by capital markets. For an investment policy to be successful, it must be consistently applied and concentrate on the fund’s main goals.
Investment policy is any relatively fixed set of procedures that guides the management of a plan’s assets. It deals with:
- The Fund’s Mission;
- Investment Objectives;
- Risk Tolerance;
- Policy Asset Mix;
- Investment Manager Structure; and
- Performance Evaluation
This deals with what the fund expects to accomplish. A fundamental goal is to secure the benefits promised to plan’s participants. It also deals with how the plan sponsors define the plan’s obligations. Will benefits be calculated exactly as stated in employment contract or will benefits be adjusted for inflation. Fund mission also deals with the margin by which assets of the plan exceed the liabilities. The fund’s mission establishes the framework around which the rest of the investment policy is designed.
Naturally, the act of investing entails risk. An investor defers current consumption in anticipation of increased, but uncertain, future consumption. For the purpose of setting investment policy, risk can be thought off as the probability of failing to achieve he fund’s mission. This will vary depending on the mission of the scheme. A scheme that wants to minimize fluctuations in plan contributions will view a large allocation to equity as very risky and will allocate a large portion of assets to interest-bearing assets. Conversely, a plan sponsor whose mission requires adjustment in benefits to maintain living standards will find the high equity exposure policy to be of relatively low risk and consider a high allocation to interest-bearing assets as risky. Risk tolerance expresses the willingness to bear adverse outcomes in pursuit of the fund’s mission.
This defines the set of portfolio management results the plan sponsor believes will signal a successful investment program. It consists of a list of specific and quantiable investment results expected to be achieved over a specific time interval.
The Investment Objectives should be:
- Unambiguous and measurable;
- In accordance with the fund’s mission; and
- Reflect the plan sponsor’s risk tolerance
Policy Asset Mix:
The fund’s policy asset mix is the most important decision. How successfully the fund fulfills its mission rest largely on the choice of, and adherence to, an appropriate asset mix.
Some sponsors use the average asset mix of similar schemes or takes the recommendations of professional investment strategists. This, however, fails to account for the fund’s particular mission, investment objective and the sponsor’s risk tolerance.
The choice of an appropriate policy asset mix goes hand in hand with the choice of asset class targets. Broad market indices tend to be the most appropriate asset class targets. Asset class targets are the set of feasible investment opportunities for which the asset class is included in the policy asset mix.
Investment Manager Structure:
Plan sponsors tend to assume responsibility for asset mix decision and allocate their funds within asset classes among a number of managers, each with a distinct investment style or area of expertise. The investment management structure depends on the plan sponsors views on the merits of active management. Allocation to active managers hinges on two considerations:
- Are managers skillful enough to add value?; and
- How should different managers be combined to be consistent with the asset class target?
This is the process of measuring and interpreting the performance of plan sponsor’s investment program. It relates investment results to the fund’s objectives. Performance evaluation provides sponsors with information about the strengths and weaknesses and areas where the program can be enhanced.
Performance measurement is a component of performance evaluation. Performance evaluation deals with questions such as “What did the policy allocation to asset classes and investment managers contribute to investment results?” How effective were the investment managers’ active investment judgments? How did any deviations from the investment policy allocation affect results? Performance evaluation operates as a feedback and control mechanism. It keeps the investment program on track toward achieving the plan’s mission.
Successful pension fund management depends on the development of an appropriate investment policy that incorporates the fund’s mission, risk tolerance, investment objectives, asset mix, manager structure and performance evaluation. Developing an investment policy document that covers these areas and consistently adhered to it should lead to achieving the pension fund’s goals.
ABOUT OMEGA CAPITAL
Omega Capital Limited is an Investment management, private equity and investment advisory firm. The Company is authorized and regulated by the Securities and Exchange Commission of Ghana.
Nana Kumapremereh Nketiah (JP)
Sophia Obeng- Aboagye
Omega Capital Research
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