Investment Policy Statement
27 August 2008
Diocesan Investment Committee
Anglican Diocese of Brisbane
The Diocesan Investment Committee (“DIC”) is established as a Standing Committee of the Diocesan
Services Commission (“DSC”) in accordance with clause 25(g) of the Diocesan Governance Canon.
The DIC will make recommendations to the DSC relating to the management of Diocesan reserves, to
provide the financial resources necessary to support and expand the mission of the church.
The DIC will establish an Investment Fund (“The Fund”) to manage a broadly based portfolio of
investments for this purpose.
2. STATEMENT OF PURPOSE
The purpose of The Fund is to provide income to underpin the Diocesan budget to provide services
on an annual basis.
The aim of the Fund is to provide an income stream in perpetuity – that is, to generate income while
retaining capital that will retain at least its real (i.e. inflation adjusted) value.
For example, assuming a long-term annual average return for the fund to be approximately 8%, with
an inflation rate of 3%, the Fund would not be able to provide a regular income of greater than 5% per
annum in order to avoid decapitalisation over time. The income paid out each year in these
circumstances would be able to be indexed each year in line with inflation.
3. STATEMENT OF RESPONSIBILITIES
The following parties are associated with the operation of the Fund:
3.1 Diocesan Investment Committee (DIC), the Diocesan Services Commission (DSC) and
the Diocesan Council (DC)
? Is responsible for the management of the Fund;
? Is authorised to appoint a professional Investment Consultant(s) to advise on an appropriate
strategy for investing in the Fund;
? Is authorised to appoint a Custodian to the Fund;
? Can approve an Investment Plan;
? Create new Funds as may be deemed appropriate from time to time; ? Is authorised to remove Investment Consultants and or Custodians.
In exercising these powers, the DIC should consult with the DSC. In particular, the DIC should:
? Report quarterly on the Investment Plan and its performance to the DSC.
3.2 Investment Consultant(s)
The Investment Consultant is charged with the responsibility to assist the DIC in:
? Developing ongoing investment policy;
? Assisting in investment selection
? Reviewing investment performance
? Assisting the DIC in conducting investment activities associated with the organisation in
accordance with FPA standards.
The Investment Consultant is to be a third party to the Diocese and must hold an Australian Financial Services Licence (AFSL). All recommended investments must have been researched and approved by the Investment Consultant. All investment decisions must be authorised by the DIC.
The Investment Consultant is to develop an Investment Plan and submit it to the DIC for approval. The Plan is to be consistent with the investment policy outlined in the Preamble and the Investment Guidelines set out in this document.
Once approved, the Investment Consultant is to be responsible for:
? Advising on how to best implement the Plan;
? Managing investment funds in accordance with the instructions issued by the DIC; ? Reviewing subsequent investment performance;
? Providing regular reports on performance (at least quarterly or as required) to the DIC, (special reporting requirements relating to Options and Futures are set out elsewhere in this document).
The Custodian is charged with the responsibility for safekeeping securities, collections and disbursement, and periodic statements.
4.1 General Investment Objectives
? Given the purpose identified in Section 2 above, the DIC recognises the importance of adopting a long term horizon of more than 7 years when formulating investment policies and strategies.
? As a result, short-term fluctuations in value will be considered secondary to long-term investment results, and indeed be apart of a long-term approach to investing which will require exposure to
growth-oriented investments such as shares and property.
? The Diocese is a tax exempt entity and accordingly this should be taken into consideration when developing the investment strategy
? The relationship between risk and return is fundamental to the investment strategy of the DIC. ? Investments will be managed with a view to ensuring that there will be sufficient liquidity to meet expected cashflow requirements.
? Risk exposure is to be managed through prudent investment management and diversification achieved by investing in different asset and sub-asset classes with additional diversification achieved
through the use of different fund managers.
? The DIC would prefer not to invest directly in property.
? Distributions from investments of an income and/or capital nature will be credited to a cash management style trust account for managing cashflow and portfolio rebalancing requirements.
4.2 Specific Investment Objectives
? The Fund has a long-term growth profile and its income objective will be reviewed at least
? The aim of the Fund is to achieve a long-term return of income plus capital growth that exceeds
the Consumer Price Index (CPI) by 5% (?) over rolling 5 year periods (before fees and
management expenses), utilising a risk profile to be determined from time to time by the DIC. It
is understood that the ability to achieve this objective is directly related to the Risk Profile
? The investment time horizon of the Fund is long-term (more than 7 years).
5. PORTFOLIO CONSTRUCTION ISSUES
5.1 Portfolio Construction
In developing the DIC’s views in relation to construction of investment portfolios the DIC need to
consider a number of issues, including:
? Asset Allocation;
? Income taken from the Fund and Income reinvested;
? Managed v Direct Investments
? Passive v Active Management
? Strategic v Tactical Asset Allocation
? Alternative investment strategies (including Absolute Return Funds)
? Income v Capital Growth
In constructing portfolios a number of decisions need to be taken and choices made between
competing approaches. It is important to follow a structured and systematic process in constructing
portfolios which is founded upon the key issues outlined above. The Key steps are outlined in Figure
Identify Identify Asset
Risks Determine Current
Figure 1 – The Investment Strategy Process
Strategic v Tactical Asset Allocation approaches
Strategic Asset Allocation
Strategic Asset Allocation is the process whereby an initial or benchmark asset allocation decision is made in line with the DIC’s view of the world and risk profile.
Once this “benchmark” has been agreed upon, a strategic asset allocation approach often involves
rebalancing the future asset allocation back to the benchmark. This is because different asset classes perform differently during an economic cycle.
A strategic benchmark approach to asset allocation involves establishing a starting point or benchmark. This will vary from portfolio to portfolio and will inevitably be influenced by the prevailing views on each asset class at the time the benchmark is set.
This approach, in theory, effectively involves a process of buying low and selling high, as the outperforming asset class is sold down to top up an underperforming one.
An aspect of this approach however is high transaction costs (as the Fund is tax exempt, another feature of this strategy, namely Capital Gains Tax, does not apply).
One way to ameliorate returns while reducing transactional costs is to allow a range of tolerance around each asset class benchmark. Such a tolerance provides a slight freedom of movement to allow the funds to react to market movements without the need to micromanage the portfolio.
Depending on the asset class, tolerances of between 5% - 15% are appropriate.
There are several ways in which a portfolio can be rebalanced:
? By switching from one fund to another, or
? By utilising surplus cash generated by the investments to add to the underweight funds ? A combination of the two
The second and third approaches reduce the need to sell down an investment that may continue to perform strongly.
Tactical Asset Allocation
A pure tactical asset allocation approach involves making regular and shorter-term changes to asset allocation between sectors, based on short-term views of market direction. This may mean having a small or nil exposure to a particular asset class at any one time. Some portfolio managers apply this approach at the portfolio level or use a tactical overlay (specialty manager) to give effect to short term view of market direction. This approach relies on predicting and exploiting short-term inefficiencies in markets to achieve its results. In cases where there are larger movements in underlying assets this approach can involve additional costs.
Research undertaken by Mercers indicates that almost no tactical asset allocation managers have added any significant value consistently over time. When adjusted for risk and costs, tactical asset allocation can in fact reduce returns on portfolios. This is not too surprising given that pure tactical asset allocation requires the ability of the manager to consistently predict short-term market directions
in order to be successful. There is no evidence anyone has been able to do this consistently over extended periods of time.
The DIC has taken the view that the Strategic Asset Allocation approach and rebalancing the portfolios through cashflow is the best approach for the Fund. Some tolerance is required around each asset class within the Fund, and this is shown in Appendix A.
Cashflow requirements require the Investment Consultant and the DIC to ensure that cash above the required periodic payments of the Fund be used for portfolio rebalancing and investment purposes.
Passive v Active
The returns from financial markets are often broken into two key components:
Beta – this is the market return of a particular asset class. Alpha – this is the additional return above Beta that a manager can provide through the application of
skill and market timing.
Passive management involves obtaining the Beta or market return which can be achieved at low cost.
Active management involves the seeking of outperformance of market return or alpha by a particular investment. This necessarily involves taking more risk than passive managers due to the holding of concentrated portfolios and being over or underweight in some assets. It is the objective of the active manager to “beat the market”.
It is particularly interesting to note the lack of academic literature (and consequently evidence) supporting the perceived skill of active investment management. Rather, the evidence is overwhelmingly in favour of price equilibrium of financial assets in financial markets, which leads the DIC to favour broadly diversified, passively managed, low-cost managed investment funds over direct asset ownership and active investment management.
In practice, it is always possible to identify a particular investment or active investment manager that has delivered performance beyond a benchmark or index. However, this is always identified in hindsight, and often the outperformance does not tend to be consistent from year to year. Accordingly it is extremely difficult for investors to profit from trying to identify the next best manager of money, particular after costs are considered.
The Fund currently holds direct investments in listed shares. Direct investment is a clear example of “active” management as a concentrated position in each asset class is held. This reality needs to be
reviewed in the process of constructing portfolios and balanced with the broader Investment Plan of the Fund.
The approach is therefore to only use active investment management as a complement to a core of passively managed investments and where there are demonstrable, research-proven benefits for so doing on an after fees basis. This approach is known as the Core-Satellite approach.
Managed v Direct Investments
A very important issue in considering the overall approach to portfolio construction is the issue of direct versus managed investments. This is essentially a decision in relation to management and control of investments as well as time and expertise.
There are a number of advantages and disadvantages of each approach, which needs to be considered. A summary of some of the issues is as follows:
? Who controls decision making
? Customising portfolios to meet the needs of the DIC ? Cost efficiencies
? Access to Professional Management
? Access to information
? Administration and reporting
The choice of which approach to use will depend entirely on the requirements of the Diocese. These requirements should be reviewed annually.
Taking into account these issues, managed funds would be an appropriate choice for a substantial portion of the portfolio. Some asset classes (eg global equities) are effectively only available via managed funds.
We recognise that the Fund holds a significant portion of the portfolio in direct investments. A decision on whether or not to continue to hold these investments is appropriate taking into account liquidity and diversification needs.
Before we discuss diversification, it is important to discuss asset classes.
Broadly speaking, there are two types of assets, growth and defensive. Defensive assets are those that do not change significantly in value of themselves, and generally generate income only such as interest. A typical example includes high-interest bank deposits.
Growth assets, on the other hand are those that have the potential to increase (and, on occasion, decrease) in value. Such investments include shares and property. Income is generated through the form of dividends or rent, and often has tax credits associated with it.
More specifically, Defensive assets include such assets as:
? Bank accounts
? Term deposits
? Fixed interest (both Australian and international) ? Debentures
Growth Assets include such assets as:
? Shares – both Australian and International
? Property – both Australian and International
Diversification takes many forms:
? Across asset classes
? Within Asset classes
? Across management styles
Diversification across asset classes is achieved by including an exposure in an investment portfolio to more than one asset class. As described earlier, the process of diversifying financial assets across different asset classes is referred to as the process of Asset Allocation, and specifically, Strategic Asset Allocation is preferred to Tactical Asset Allocation.
Diversification within asset classes is achieved by ensuring a comprehensive spread of individual financial assets in an investment portfolio. Having more than one financial asset in an asset class helps reduce the risk to the portfolio, if an individual financial asset loses value.
Often, the best way to diversify within asset classes is to allocate capital to the known sub-asset classes.
Numerous academic studies of asset allocation reveal that up to 94% of the variability of investment portfolio returns can be attributable to the asset allocation process alone (Brinson eta l 1986,1990). Subsequent studies regarding passively managed, strategically asset allocated investment portfolios suggest that the impact may be even greater than 94% (Ibbotson 2000).
In other words, in general the single biggest decision regarding the likely return on a portfolio is the amount of exposure to growth assets – not the specific assets themselves. As the proportion of
growth assets increases within a portfolio, so too does the potential volatility. The tolerance for this portfolio volatility is measured by a Risk Profile.
In practice, the desired asset allocation is determined by identifying the Risk Profile of the investor. Measurements of risk profile can be simple, or complex – the more rigorous the measurement, the
more accurate the outcome. Matrices developed by Investment Professionals correlate Risk Profile to various asset allocation models. Appendix B shows the effect of return on portfolio constructions of various risk profile.
Note that the risk profile of an investor may necessitate a portfolio that might not have the exposure to growth assets required to achieve the investors goals. In this case, one of two things must occur. Either the goals are revised downwards, with consequently lower expectations of returns, or by a process of education the clients risk profile is increased. Often, a combination of the two may be required.
Often, the best way to diversify within asset classes is to allocate capital to the known sub-asset classes. Academic research has strongly demonstrated the diversification and performance benefits of this practice. For example, there is compelling evidence that including an exposure to Small and Value companies in an equity portfolio is consistently rewarded.
It has been established that investors have little ability to consistently pick the best asset class or sub-asset class in advance. As a result, evidence suggests that a diversified portfolio will reduce risk without necessarily forgoing investment return. The key is lowering the risk of experiencing negative returns over time.
Combining all of the Funds exposures, not more than 25% of the issued capital should be held in any one professional Investment Manager. Recommendations for managed funds are to be sourced from/ made by the Investment Consultant.
5.2 Strategic Asset Allocation
The Investment Consultant has developed a set of strategic asset allocation models for various risk profiles to be chosen by the DIC. Please refer to Appendix A for this table.
The portfolio will be rebalanced within a tolerance of +/- 5% (subject to authorisation) towards benchmark. This will be reviewed annually and take place as appropriate.