By Christian Gaya, Business Times 05 April 2013
An
investment policy that is directed solely to the interests of fund members will
have few, if any, prohibitions on investments. The interests of fund members
will be enhanced by sound diversification of risks. In general, rules that
limit or prohibit investments, including investments in foreign securities,
reduce the capacity of the fund to diversify and to serve the interests of fund
members. The two exceptions to this general rule are loans to relate parties
either the government or scheme members and investments in risky derivatives
The
investment policy statement should identify the potential for the fund to be or
to become a dominant force in the domestic market and should specify how the
fund would resolve such a situation. The investment policy should be explicit
about how the pension fund would exercise its voting rights as a shareholder.
The exercise of voice is important but, to avoid a situation in which the
government de facto directs private business, it is usually better to delegate
this power to the fund managers. One way to minimize the conflicts of interest
that may arise from such situations is for the fund to publish, with a lag
time, a summary of the way in which it voted in its various shareholder
capacities. Fearing the potential for pressure on the public fund to influence
corporate governance for purposes other than those in the interests of the fund
itself, some countries have imposed concentration limits or delegated voting
rights to fund managers; others, such as Sweden, have put a cap on the effective
voting power of the fund. In all cases, however, a policy for shareholder voice
should be explicit and documented
Public
pension fund managers have the responsibility to select an investment strategy
that balances risks and returns appropriately. The investment policy comprises
of three main components: setting long-term performance targets, defining an
acceptable level of risk tolerance, and setting parameters for short-term asset
allocation. These need to be set out clearly in an investment policy statement.
The primary focus of investment policies for investment funds is to balance
market risks and returns
Three
types of risks that are needed to be managed are such as the risk of loss due
to counterparty default, the risk of loss due to movements in market prices,
and the risk of loss due to operational failure. In addition to these risks,
public pension investment funds need to be concerned about their role in the
domestic capital market and their exposure to government debt. In the private
sector, the market risk dimension of investment strategies is increasingly
expressed as a comprehensive measure of risk, such as value at risk. This
comprehensive measure of risk automatically signals inadequate
diversification. Therefore, funds can be managed effectively in the
absence of strict sectoral limitations or target ratios. However, this approach
has yet to reach far into the public sector, where investments often are
handicapped by limited mandates and restrictions that militate against modern
risk management practices. Nevertheless, some principles emerge from
international practice to ensure prudent management and improve the efficiency
of public funds.
The
investment policy should identify all relevant risks and the board's approach
to measuring, monitoring, and managing each risk. A
particular problem arises from investments in non-marketable
assets. These investments reduce the liquidity of the fund and are more prone
to malpractice at the time of acquisition, valuation, or sale. Assets can be
purchased above market prices or sold below market prices to benefit fund
managers. Even in the absence of corrupt practices, valuation problems can make
it difficult to assess whether the asset is generating gains or losses. In
general, the investment policy should seek to minimize investment in illiquid
assets. However, in many countries this may not be practicable, especially
where funds are prohibited from investing in foreign assets. One way to contain
the risks involved with investments in illiquid assets is to limit the amount
to a benchmark maximum, set by the board, according to a realistic assessment
of the spectrum of investments available
Where
such investments are permitted, the board should establish a clear policy for
their purchase, disposition, and valuation. The policy could include either
mandatory independent assessment of each purchase and sale of illiquid assets
or supervision by the audit committee of the board before the transaction
occurs. This assessment should evaluate the price set for the transaction, the
independence of the parties involved, and the appropriateness of the
transaction for the fund, with respect to the targeted rate of return. To
reduce the scope for corrupt practices, the prices and details of all
transactions in illiquid assets should be disclosed to fund members and the
public. Investment policies should respect exposure limits, too. To diversify
risk, funds should not invest more than 5 percent of their reserves in a single
asset and should not own more than 5 percent of the liabilities of a given
company. Respecting these rules reduces the influence that funds might have on
corporate governance and thus reduces the possibility of conflicts of interest
Board
of directors or trustees are required to have in depth knowledge of pension
schemes they direct in order to be effective since the investment policy is set
by the board of directors or trustees. It must be fully documented and
available in summary form and simple language to members and their families
including other beneficiaries of the scheme. Clearly, for competitive reasons
that have been introduced by the current regulatory, the publicly disclosed
elements of the investment policy should focus only on general strategies and
attitudes toward risk. Board of trustees should ensure that strategy is aligned
with the objectives of the fund and be able to shield from political influence.
The investment policy should state that the purpose of accumulating and
investing pension reserves is solely for the benefit of members of the pension
scheme and not otherwise Ends
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