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:

  1. Think like a CEO about your investments. What is your vision for your investments? What do you want your investments to achieve? A DB scheme wants to pay liabilities as and when they fall due. A DC scheme wants to provide the retirement to members they expect. Once you have established what this vision for your investments is, make sure that your service providers also understand and buy into your vision. This will ensure all parties' interests are aligned.
  2. Make sure your investment goals are SMART, meaning Specific, Measurable Attainable, Relevant and Time-bound. Too often an investor is fuzzy about their goals and this lead to confusion and expectation gaps are created when investment strategies get built, implemented and monitored. A client once defined their investment goals by saying that they want the return on their capital to exceed the cost of their capital by at least 2% with a 75% probability over a one-year period. Now that is a powerful statement.
  3. You can't manage what you can't measure. To manage your progress in realising your vision you need to measure, on an on-going basis, whether you are achieving the goals you set. Think of it as keeping an eye on your satnav: you don't want to find out too late that you should have turned left instead of right, it wastes valuable time and opportunity and you could quickly end up in a dodgy part of town. Measuring your investment performance is obviously important, but don't forget to also check on how you are measuring up to the goals you set.

For more information contact Petri Greef on pgreef@riscura.com or call +27 (0)21-673-6999

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