Issue: March/May 2008

We conclude our series on formulation of the Investment Policy Statement and the FSB’s good governance requirements for retirement funds with a look at benchmarks, reviews, communication and training. Our guest columnist is Scott Harvey, head of STANLIB’s Institutional Client Service Department.*

The essence of good governance

Good discipline, good communication and good processes help ensure a good deal for fund members. All three are emphasised in the watershed Financial Services Board (FSB) document Good Governance of Retirement Funds. Two vital components of a robust process are benchmarks and reviews.

FSB circular PF 130 states that an Investment Policy Statement (IPS) should be reviewed at least annually to enable the IPS to stay abreast of changes in the economic climate or in fund obligations.

These big strategic issues go to the top of the agenda. But other elements should also be reviewed, including investment performance.

As indicated in previous TT editions, a well-structured IPS covers subjects such as the category of investments, risk profiles, diversification strategy and the expected rate of return across asset classes.

These issues should be reflected in a mandate for the investment manager. (Mandates tell the managers what is expected of them.)

The FSB recommends that boards of trustees insert into these mandates a requirement that the asset manager aligns its governance practices with those of the retirement fund.

Among other things, the FSB says asset managers should also be required to provide trustees with:

  • Details of the manager’s corporate governance policy and how it is applied when making investments;
  • The voting guidelines followed by the managers when exercising their rights as shareholders and how these align with the board’s policies;
  • Information on companies in which a fund’s assets have been invested;
  • Explanations of important actions and decisions by the managers;
  • Details of how the managers monitor their investments and the companies concerned.

It is also customary for funds to set key benchmarks against which portfolio managers can be measured.

Benchmarks are influenced by risk profiles and reasonable return expectations, as discussed previously. When defining benchmarks, it is common practice for boards of trustees to seek assistance from professionals unconnected with the asset managers.

Reviews obviously measure performance against the benchmark.

Sometimes an apparent mismatch occurs when short-term dynamics skew expectations.

For example, the benchmark may simply be to remain inflation-positive over any one-year period – perhaps two percent above the consumer price index. However, equity markets may surge by over 25 percent in a year while the manager delivers only 11 percent year-on-year growth. This might be because the portfolio has been diversified over various assets classes to reduce risk while still striving to beat the benchmark.

The manager has beaten the benchmark, but may have disappointed some members of the fund.

Any review, however, should be conducted in the context of the mandate and risk profile. Knee-jerk revisions after the results of a single quarter or even a year are rarely appropriate.

Though annual IPS and mandate reviews are recommended, performance (or business) reviews of the asset managers are typically conducted over rolling three-year periods or longer.

Strategic review implies that a strategic timeframe applies. Three years or longer is more suitable when long-term performance is measured in an environment where the time to retirement might be five years, but could be 40.

It is in the interest of all parties that proper records be kept of all changes to mandates and benchmarks. Good record-keeping goes hand in hand with good communication.

The FSB notes in its circular: "The IPS should be reviewed regularly to ensure it continues to meet the objectives of the fund. Any deviations or changes should be explained to beneficiaries.

"Effective and regular communication between the board, beneficiaries and asset managers is essential, not only for . . . transparency and disclosure, but also to establish proper and regular monitoring of fund performance, adherence to the terms of the mandate and the IPS."

The FSB says the IPS should be disclosed to beneficiaries, investment managers and, where necessary, regulatory bodies.

It adds: "There should be regular reporting to the beneficiaries, preferably quarterly, in a (way that) is easily understood, on relevant performance, risk/return and fund matters, especially relating to any changes."

The FSB emphasises member communication, but constant communication with asset managers is important, too. Tell the manager about shifts in member sentiment or other factors unique to each fund that might help the manager do a better job.

In all communication, a common vocabulary fosters understanding. It might be lacking when individual members come from dissimilar backgrounds.

This is one reason trustee training has become so important. Benefits are legion, but a key advantage is that trustees become familiar with investment terminology. Simultaneously, feedback to training sponsors like STANLIB helps investment professionals understand the key concerns of trustees and members.

The FSB’s guidelines are so comprehensive that in recent months a training course dedicated specifically to circular PF 130 has been developed by the Principal Officers Association.

The circular certainly covers a lot of ground, though this series has had a bias toward investment. However, there is no substitute for a thorough reading of the entire circular and its annexures. It may take time, but you will find it an illuminating read and the document an extremely useful tool for trustees.

  • Institutional Client Service is a division of STANLIB, a leading institutional asset manager and South Africa’s largest unit trust company.