Investment Beliefs

Kees Koedijk, University of Tilburg

Alfred Slager, PGGM Investments / RSM Erasmus University
Rotman ICPM / Netspar / Maastricht University
Discussion Forum October 2007

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

Investment Beliefs

Page 2

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

Investment Beliefs

Page 3

Vanguard

''consistently outperforming the financial

markets is extremely difficult''.

Investment Beliefs

Page 4

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)

Investment Beliefs

Page 5

Theory behind investment belief

Investment Belief

Observes behavior in the

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

Theory

Theoretical basis behind the

investment belief.
What is it about that mechanism
Is it a structural, repeatable
phenomenon

Investment Strategy

Describes how the investment

belief can be exploited.

Organization

Organization to successfully exploit the

investment strategy.
Links the exploitation of the investment
beliefs to performance measures.

EXAMPLE
Overreaction

Investment Beliefs

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.

Page 6

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.

Investment Beliefs

Page 7

From beliefs to philosophy

Investment philosophy

Coherent set of beliefs

Investment Belief

Investment Belief

Theory

Investment Strategy

Theory

Investment Strategy

Organization

Organization

Investment Belief

Investment Beliefs

Theory

=
Investment Strategy

Organization

Page 8

Sample: 23 pension funds and 17 asset managers

Europe

North America
Pensionfd

Assetmng

11

Pensionfd

Assetmng

10

New Zealand, Australia

Investment Beliefs

Pensionfd

Assetmng

Page 9

4 groups of investment beliefs

Financial
Financial Markets
Marketsbeliefs
beliefs

Investment
Investmentprocess
process beliefs
beliefs

Risk
Riskpremium
premium

Impact,
Impact, focus
focuson
on management
management

Risk
Riskdiversification
diversification

decisions
decisions
Risk
Risk management
management

(In)efficiencies
(In)efficienciesin
in financial
financialmarkets,
markets,
Asset
Asset pricing
pricing
Horizon
Horizon

Organizational
Organizational beliefs
beliefs

Investment
Investment management
management style
style
Costs
Costs

Sustainability
Sustainabilityand
andGovernance
Governance

Teams,
Teams, role
role of
of investment
investment managers
managers

Sustainability
Sustainabilityand
and Corporate
Corporate

Out
Out vs.
vs. insourcing
insourcing

Governance
Governance in
in asset
assetpricing
pricing
Role
Role in
in investment
investment process
process

Experience
Experience

Investment Beliefs

Page 10

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.

Investment Beliefs

Page 11

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.

Investment Beliefs

Page 12

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.

Investment Beliefs

Page 13

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 outperformance.

Investment Beliefs

Page 14

Some beliefs are more equal

Investment Beliefs

Page 15

Differences in pension funds and asset managers

Pension fund

Asset manager
Risk diversification

Inefficiencies

Risk premiums

Focus

Responsible
Investments

Impact
Risk man.

Active
management
Teams and staff

Goals

Investment Beliefs

Page 16

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

Investment Beliefs

Page 17

Forging a link

Investment Belief

Theory

Investment Strategy

Organization

Performance
Performance
measures
measures

Return-risk ratio
Risk diversification
Asset diversification
Horizon

3, 5, 8 years periods
Alpha

Investment Management Style

Information ratio
Costs

Investment Beliefs

Expense ratio

Page 18

Descriptives
Pension funds create alpha

Investment Beliefs

Are well diversified

Page 19


Pension funds create high return/risk

Investment Beliefs

and report lower costs

Page 20

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 ratios than funds that do not hold such
views.

Investment Beliefs

Page 21

Some caveats
Small sample, yet the broadest so far
Performance measures are relatively crude, managers
might have other performance measures in mind
Weve collected the explicit reported ones, what about
the non-reported implicit ones? Every pension fund
holds them per definition.

Investment Beliefs

Page 22

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.

Investment Beliefs

Page 23

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 ratios than funds that do not hold such views.
Investment beliefs framework helps focus investment strategy, governance and
results

Investment Beliefs

Page 24