Investment Policies

Investment Policy Test

An investment policy should focus on the big picture, stating such things as asset allocation, types of allowable investments rather than specific investments, and other criteria such as standards of investment quality and rate of return objectives. If this is accomplished, the Trustees can refer to their “business plan” and make adjustments on a quarterly or annual basis. As a “test” a Trustee should be able to read investment policies and answer yes to the following questions.

1. Is the policy carefully designed to meet the real needs and objectives of the retirement plan?
2. Is the policy written so clearly and explicitly that a complete stranger could manage a portfolio and conform to the desired intentions?
3. Would the retirement fund have been able to sustain a commitment to the policies during the capital markets that have been actually experienced over the past ten, twenty, fifty, or even sixty years?
4. Would the investment managers have been able to maintain fidelity to the policy over the same periods?
5. Would the policy, if previously implemented, have achieved the objectives and results desired?

Asset Allocations

One of the basic tenets of an investment policy is asset allocation. Asset allocation is simply a decision to expose certain percentages of total Fund assets to segments of the investment markets. In order to achieve higher returns, generally one must be willing to accept higher volatility. Volatility is one way to measure risk.

Rates of Return

To increase one’s understanding, one can also look at the actual rates of return and volatility for the past 25 years. This places the spectrum of anticipated investment returns and risk in focus. Obviously, Trustees who take positions that are either 100% in bonds of 100% in stocks are at the extreme end. Most fiduciaries prefer to be some place in between. That point that offers the greatest return with the least amount of risk is called the optimum asset allocation. Many Trustees through common sense have determined how their own portfolios should be structured based on the philosophy that one does not put all his or her eggs in one basket.

Risk

By now as a Public Fund Trustee you may have a thought in mind as to how much risk you are willing to incur. The key then is what is the minimum required rate of return that must be achieved? This is often expressed in terms of an actuarial interest assumption, an assumed rate of earnings that the retirement fund will realize over a long period of time. Another factor in a plan’s funding is INFLATION. Because defined benefit plans provide a benefit as a percentage of wages, the variable of inflation and its impact on wages can be substantial. Earnings, when combined with contributions, should allow the Fund to pay promised benefits by a specific date.

Three points to keep in mind

1. What is my minimum required rate of return expressed in terms of percentage growth?
2. How should I mix assets so as reasonably to assure the achievement of those returns without taking undue risk?
3. How do I offset inflation?

Trustee Outline For Developing A Written Investment Policy

The Pension Review Board is providing the following basic outline for a Trustee to consider in developing a written investment policy.

Written Investment Policy Introduction

• • Who is my Fund?
  • Who are my beneficiaries?
  • What are their needs?
  • How is the Fund governed?
  • What are the variety of legal statutes that constrain the Fund operation?
  • Who do people talk to when they want to know more?
  • What are we trying to achieve in this statement?

Investment Objectives (These should be expressed as a percentage)

• What are the actuarial assumptions or other minimum earnings rate that we must make in this plan in order to assure long-term growth?
• What is our overall asset allocation?
• How much will we have in government obligations?
• How much in corporate bonds?
• How much in stock, etc.?

What are the objectives of the total fund as measured in the following ways?

• Absolute rate of return
• Relative rate of return
• Risk adjusted rate of return
• Real rate of return (measured against inflation)
• What time series do we assign for achieving these objectives?

Investment Policy

Describe the Investment Policy as it relates to each of the specific assets in your allocation. For example, if you have stocks do you believe in a growth philosophy or a conservative income philosophy? For bonds, do you believe in long-term, intermediate bonds, or comparing the bonds against a recognized index? Other issues in investment guidelines: What are my concerns and needs for:

• liquidity
• diversification
• preservation of principle
• risk of loss
• restrictions (such as South Africa and other prohibited transactions)
• legislation

Investment Manager Review Procedure

• How often is the manager to be measured?
• Against what indices?
• In the event of extreme circumstances in the investment markets, what should the manager do?
• How will the performance be measured?
• Who will do it?

Contact the Texas Pension Review Board at (512) 463-1736 if you any questions or if you would like a copy of a written investment policy that is on file.