Edition: June - August 2015
Goals based investing - how SMART is your investment strategy?
A new phrase doing the rounds in investment circles is goals based investing. While the phrase might be new, however, the concept is not. It has been around for a number of years in the pension world in the form of liability-driven investment or LDI. With LDI the investment goal is defined by the financial liability created by the fund rules of a DB pension scheme and the ability of the assets to cover that liability or member expectations through the funding level.
Over the years, the concept of LDI has also been applied to DC schemes. While DC schemes may not have a financial liability to members, there is an expectation by members about the type of retirement they want to buy. It means that every member in a DC scheme is in essence running their own DB scheme as expressed in their targeted replacement ratio.
Now let's apply goals based investing to a DC pension scheme. As the Board of Trustees, your vision is to keep pensioners from eating cold baked beans one day and therefore one of your goals is to deliver at least a targeted replacement ratio of say 75% for those members who have 40 years of membership in the fund. Your measure of success would be how many members retire with an actual replacement ratio of 75% or more.
At year end you pull the statistics and see that 90% of retiring members had a replacement ratio of 75% or more. Were you successful in achieving your goal based on your vision? Yes. Were you successful in beating your peers' performance numbers? Perhaps not, but does it matter? No two pension schemes are exactly the same. What is more important is that as a Board there is a vision and you have put down tangible goals to measure your progression against as you move towards realising your vision for the scheme.
I would summarise my message to investors who have already implemented or are thinking of implementing a goal-based investment approach in the following three points: