embracing an enduring investment approach to thrive in the long term - presentation by philippe...
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For more information contact: [email protected] Philippe Desfossés delivered his presentation titled "Embracing an Enduring Investment Approach to Thrive in the Long Term" at the European Pensions & Investments Summit 2012. Join the 2015 Summit along with leading regional pension investors and global asset managers in an intimate environment for a focused discussion of key new drivers shaping institutional investment strategies today. For more information contact: [email protected]TRANSCRIPT
EPI Summit 2012
1 Sustainable growth / intergenerational fairness / Responsible investment09/05/2012www.rafp.fr
Embracing an enduring investment approach to thrive in the long term
Sustainable growth / intergenerational fairness / Responsible investment
We did not accept to pay the right price for the social security we enjoyed
� Developed countries set up Social Security systems in a very specific and favourable environment
� Continued growth
� Favourable demography
� The environment has changed and is less favourable. Social
2 Sustainable growth / intergenerational fairness / Responsible investment09/05/2012www.rafp.fr
� The environment has changed and is less favourable. Social Security financing is not balanced
� Financing gaps have been « covered » by debt
� The « bill » is transferred to future generations
Something we are sure of : retirement is getting more and more costly
We cannot live longer, keep the same length of working life pay the same contributions, and get the same benefits
���� Something has to give
The way retirement benefits are managed is neutral in regard to demographic constraints:
3 Sustainable growth / intergenerational fairness / Responsible investment09/05/2012www.rafp.fr
� Retirement is always paid out of the National Revenue
�It’ll always be people working and contributing who will pay for those who are retired.
� In 30 years
� For fully funded schemes, their assets will be worth… what economic agents working at that time, will be ready and able to pay to buy them,
� For PAYG schemes, social contributions will be determined by the total amount of the salaries paid to workers.
An inconvenient truth : most of the time retirement schemes are « unfair »
Intergenerational equity and « sustainability »
� The technical yield of a retirement scheme or « how much I get for how much I contributed »
� The notion of « Implicit life expectancy » or how long will it take for my « recouping » my contributions.
4 Sustainable growth / intergenerational fairness / Responsible investment09/05/2012www.rafp.fr
Assuming an observed life expectancy of 25 years (after people have retired at 62), how can we call a retirement scheme, in which, to recoup your contributions, it takes :
� 40 years, or for an opposite situation
� 10 years.
If implicit life expectancy is lower than « observed » life expectancy, what can we conclude?
Why is sustainability so at the core of all the big issues we have to address
For a retirement scheme, « sustainability » means not to distribute benefits that are paid by the « sacrifice » of the young contributors.
"Sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs » . (Bruntland report 1987)
5 Sustainable growth / intergenerational fairness / Responsible investment09/05/2012www.rafp.fr
Being optimist, one can estimate it takes 50 years for an oak to grow
�What % of the forestry can be harvested every year?
�What happens, if one harvests 10% of the forestry every year?
Over optimistic assumptions and enduring investment ?
Liabilities have been “underpriced” Liabilities have been “underpriced” Retirement benefitsRetirement benefits too generoustoo generous
The higher the discount rate the The higher the discount rate the cheaper the cost cheaper the cost
€ 484
€1000
Discount rate :
7%
10 years
6 Sustainable growth / intergenerational fairness / Responsible investment09/05/2012www.rafp.fr
What happens if the actual rate of What happens if the actual rate of return is much lower than the discount return is much lower than the discount raterate
€ 484
Investment return
rate : 3,5% € 684
If the actual return is 3,5% (vs. an expected return of
7%),
���� I am short by 200
Can you be responsible when you overestimate expected returns?
Public Pension Funds (USA and UK)Public Pension Funds (USA and UK)
Market Crash + Irrealistic assumptions = next bail out ?Market Crash + Irrealistic assumptions = next bail out ?
California Public Employees’ Retirement System, California Public Employees’ Retirement System,
•• expected rate of return of expected rate of return of 7.75 percent*7.75 percent* for the past nine years, and for the past nine years, and
8 percent before that, 8 percent before that, * It has just been reduced to ….7,50%* It has just been reduced to ….7,50%
•• annual return during the decade from Dec. 31, 1998, to Dec. 31, annual return during the decade from Dec. 31, 1998, to Dec. 31,
7 Sustainable growth / intergenerational fairness / Responsible investment09/05/2012www.rafp.fr
•• annual return during the decade from Dec. 31, 1998, to Dec. 31, annual return during the decade from Dec. 31, 1998, to Dec. 31,
2008, has been 2008, has been 3.32 percent3.32 percent, and last year, when markets tanked, it , and last year, when markets tanked, it
lost 27 percentlost 27 percent ((http://weblog.signonsandiego.com/weblogs/afb/archives/031711.htmlhttp://weblog.signonsandiego.com/weblogs/afb/archives/031711.html.).)••
Is the solution to add more risk?Is the solution to add more risk?
Discounting liabilities at too high a rateDiscounting liabilities at too high a rate
�� No choice but search for high yield No choice but search for high yield
��High yield means high risksHigh yield means high risks
At the end overoptimistic expected return may lead to lower rates of return.At the end overoptimistic expected return may lead to lower rates of return.
What should not happen anymore?
SENATE THIRD READING
SB 400 (Ortiz)
As Amended July 15, 1999
Majority vote
SENATE VOTE :35-0
PUBLIC EMPLOYEES 7-0 APPROPRIATIONS 15-6
-----------------------------------------------------------------
|Ayes:|Correa, Briggs, Dutra, |Ayes:|Migden, Cedillo, Davis, |
| |Firebaugh, Honda, Knox, | |Hertzberg, Kuehl, |
| |Pescetti | |Maldonado, Papan, Romero, |
| | | |Keeley, Steinberg, |
| | | |Thomson, Wesson, Wiggins, |
| | | |Wright, Aroner |
| | | | |
|-----+--------------------------+-----+--------------------------|
CalPERS, however, believes they will be able to CalPERS, however, believes they will be able to mitigate this cost increase through continued mitigate this cost increase through continued excess returns of the CalPERS fund. excess returns of the CalPERS fund.
8 Sustainable growth / intergenerational fairness / Responsible investment09/05/2012www.rafp.fr
|-----+--------------------------+-----+--------------------------|
| | |Nays:|Brewer, Ackerman, |
| | | |Ashburn, Campbell, |
| | | |Runner, Zettel |
-----------------------------------------------------------------
SUMMARY : Makes various improvements in the benefits provided to
state and school members of the Public Employees' Retirement
System (CalPERS). Specifically, this bill :
Supporters further argue that:
1)The new retirement formulas provided by this bill mark the
first significant improvement in retirement benefits for most
state and school members' in approximately 30 years.
2)The increase in liability for these new benefits can be funded
by the excess retirement assets that have been generated
through investment income and changes in actuarial assumptions
resulting in no immediate increase in costs to the employer.
RAFP made 2 choices
To put intergenerational fairness at the core of its management
� The advantages of the « Point system » (Régime en points)� A « pricing » deliberately prudent
The choice to invest according in the respect of its own SRI Charter
9 Sustainable growth / intergenerational fairness / Responsible investment09/05/2012www.rafp.fr
� Values that coalesce the big issues that determine the passage towards sustainable development
� Why the Best in Class makes sense
From the cotisations to the pensions How are rights acquired?
� The contributions are declared annually by the employer and converted into points.
� The points earned by each beneficiary are based on the acquisition value,which is set every year.
� The total number of points acquired can be consulted on-line (www.rafp.fr).
10 Sustainable growth / intergenerational fairness / Responsible investment09/05/2012www.rafp.fr
A capacity to acquire points growing steadily
+1.30%+1.70% +0.50% +1% +0,50%
€1.03537
2008
€1.03022
2007
€1
2005
€1.04572€1.017Acquisition value
20092006Year 2010
€1.05095
From the cotisations to the pensions How are benefits calculated?
� The amount of the annual pension payment is calculated by multiplying the number of points acquired by the service value, which is also set annually.
� Payments may only start after the age of 60*.
� The entitlement is paid out in annuities, unless the number of points acquired is too low .
200820072005 20092006Year 2010
* The minimum retirement age has been reviewed. The age at which it will be possible to retire –
with a discount – will increase to 62 years by 2018
11 Sustainable growth / intergenerational fairness / Responsible investment09/05/2012www.rafp.fr
An increase of the service value above inflation
A technical yield just above 4% is consistent with an observed life
expectancy of 25 years
€0.04219
2008
€0.04153
2007
€0.04
2005
€0.04261€0.0408Service value
20092006Year
+1.80%+2.00% +1.60% +1%
2010
€0.04283
+0,5%
The founders of the Scheme defined a deliberately prudent pricing
� The “pricing” rate is prudent� 1.34% (management fees included) � 1.04% (ex management fees)
� As the ECB aims at inflation rates of below, but close to 2% over the medium term and taking into account a political « committment » to maintain the purchasing power of the retirement pensions� The pricing rate in nominal terms equals 3,34%
This rate
12 Sustainable growth / intergenerational fairness / Responsible investment09/05/2012www.rafp.fr
� This rate � Has sometimes been criticized for being “too” conservative� Nows it appears just prudent
� Nominal rates in some countries are at historical lows� Greek default questions the very notion of a “riskless” asset
� The return from the ERAFP portfolio has to be significantly higher than the pricing rate, since: To be funded is not enough Some reserves have to be booked (morbidity tables drift, external shock, operational
risk) An extra reserve to fund revalorisation of benefits.
€1,000
€ 635
Why can we say we invest soundly :
• our reserves are « ironclad » reserves have been calculated last year using a discount rate that can be qualified as prudent : 1,7% (3,7% with a core inflation of 2% per year);
• our funding ratio is still high, since it remains close to 110 %, although all the capital losses on the stock portfolio have been taken into account, the impact of the Greek default has been booked;
• our SRI policy is consistent with the way we manage the liabilities side of our balance
ERAFP: a reasonable investor
13 Sustainable growth / intergenerational fairness / Responsible investment09/05/2012www.rafp.fr
• our SRI policy is consistent with the way we manage the liabilities side of our balance sheet. As we invest for the very long term, sustainability is important.
12,5% 26,1%22,6%19,2%15,8%9,2%6,0%2,9%0,01%
0
1 000
2 000
3 000
4 000
5 000
6 000
7 000
1,4% 1,5% 1,6% 1,7% 1,8% 1,9% 2,0% 2,1% 2,2%
1 ,2 0 %
PNT au 31/12/2008PT au 31/12/2008
Provision technique et provision non technique au 31/12/2008 (évaluations)
en m€ Taux de sur-couverture
taux d'actualisation
12,5%
4500
5000
5500
6000
6500
1,2% 1,3% 1,4% 1,5% 1,6% 1,7% 1,8% 1,9% 2,0% 2,1% 2,2% 2,3%
95%
104%
113%
122%
131%
Provision technique (EG)
référence (1,8%)
Taux de couverture (ED)
Sensibilité de la provision au taux d'actualisation (100% pour
taux
en M€
Are we nearing the end of a 30 years long journey and the day of reckoning for some EMU members
Nominal interest of the 10 y French
OATCan we assume that the odds are even
for:
• a 100bp decrease
• a 100 bp increase
14 Sustainable growth / intergenerational fairness / Responsible investment09/05/2012www.rafp.fr
Since its inception, the Euro zone has
benefited from a good environment…..
� This has not encouraged investors
to exert all the required due diligence
For ERAFP, maximizing immediate profit is detrimental to sound and sustainable business
� ERAFP is a long term investor and…. should be a « contrarian »
� Sound asset allocation and SRI best in class investment policy are consistent
15 Sustainable growth / intergenerational fairness / Responsible investment09/05/2012www.rafp.fr
Used to think for the long term, RAFP invests for the long term
Created in 2005, ERAFP is a mandatory, fully funded
pension fund for 4.6 million French civil servants :
� the duration of our liabilities is particularly long
� Based on civil servants’ remunerations, cash flow projections are highly reliable
� There is not hidden put option : members cannot cash in their holdings before retirement.
Net annual Cash Flows (M€)
16 Sustainable growth / intergenerational fairness / Responsible investment09/05/2012www.rafp.fr
We can hold assets for a very long time without
needing to sell :
���� We think long term,
���� We can invest for the long term.
We receive 1.7 Bn € in contributions per year:
� Positive net cash flows remain above 1 Bn € per year for more than 20 years
� ERAFP has particularly low liquidity requirements
*Source
: COR
Provisions du régime (en Md€)*
1,59
76
99
51
27
2005 2010 2020 2030 2040 2050
The financial management of the scheme How is the portfolio allocated?
Curent asset allocation and management
Diversification
assets
25%
Bonds
Real Estate
10%
Limits defined by law
Asset allocation at 31/12/11
Liquidity
4,1%Equities (external
managers)
19,3%
Corporates bonds
(external managers)
9,4%
17 Sustainable growth / intergenerational fairness / Responsible investment09/05/2012www.rafp.fr
Bonds
(min)
65%
€11.4 billion in financiel assets at 31 December 2011
• 65% minimum in bonds
• 90% minimum in euro denominated securities
• 10% maximum in Real Estate
• 5% maximum in FCPR
• 5% maximum in securities issued by a single issuer (except
for Sovereign debt issued by an OECD member and CADES)
sovereign bonds
60,6%local authorities bonds
3,0%
Supranational bonds
3,7%
19,3%
The financial management of the scheme How will asset diversification progress?
2012 target strategic allocation
Target 2012 of asset allocation % of asset
Fixes income bonds 77%
18 Sustainable growth / intergenerational fairness / Responsible investment09/05/2012www.rafp.fr
Increased diversification of credit and international equities
of which convertible bonds 1,5%
International equities 21,0%
Multi asset 1%
Real estate 1%
For the RAFP it was clear from the very beginning that SRI was consistent with its mission
RAFP puts intergenerational equity at the core of its governance.
The same point is used� To buy rights to a future benefit, when you’re working� To pay the benefits to the retirees.
The RAFP wants its investments to contribute to better the future not to increase “our immediate wealth” at the expenses of our children and great children.
19 Sustainable growth / intergenerational fairness / Responsible investment09/05/2012www.rafp.fr
children.
Combination of• very prudent monitoring of the scheme (low discount rate) • the will to have some bearing on the economy in order
• to contribute to a change in the way we produce and • make possible to preserve our common wealth : the Earth
� Decision to adopt a global but not a radical SRI policy
What is at stake? Changing our investment process?
A new world is coming A new world is coming What are the issues that no one should ignore?What are the issues that no one should ignore?•• we are discovering that scarcity will very directly impact our liveswe are discovering that scarcity will very directly impact our lives•• externalities will be more and more internalized.externalities will be more and more internalized.
Can SRI remain?Can SRI remain?•• an overlay an overlay •• something that concerns just a marginal part of your assets or your fundssomething that concerns just a marginal part of your assets or your funds
When an investor says he is doing some investment in SRI When an investor says he is doing some investment in SRI
20 Sustainable growth / intergenerational fairness / Responsible investment09/05/2012www.rafp.fr
When an investor says he is doing some investment in SRI When an investor says he is doing some investment in SRI �� what does it tell about the rest of its investment?what does it tell about the rest of its investment?
Why is it so difficult to change?Why is it so difficult to change? Because most of our decisions do not take into account the long term,Because most of our decisions do not take into account the long term, Because turkeys don’t vote for Chrismas.Because turkeys don’t vote for Chrismas.
«« while the financial services industry performs many economically vital functions, and will continue to play while the financial services industry performs many economically vital functions, and will continue to play a large and important role in London’s economy, some financial activities which proliferated over the last ten years were a large and important role in London’s economy, some financial activities which proliferated over the last ten years were
‘socially useless’, and some parts of the system were swollen beyond their optimal size‘socially useless’, and some parts of the system were swollen beyond their optimal size ».». Lord TurnerLord Turner
«« In recent years, banks have chased shortIn recent years, banks have chased short--term profits by introducing complex products of no real use to term profits by introducing complex products of no real use to
humanity’, and some parts of our industry have become overblownhumanity’, and some parts of our industry have become overblown »» Stephen Green, Chairman of the BBAStephen Green, Chairman of the BBA
A global and integrated SRI policy...
� From inception in 2005, the Board of Trustees decided to implement a comprehensive SRI policy :
� Which covers all asset classes and all assets
� SRI is not just a small pocket in our assets
� SRI is not just an investment strategy amongst others it is our investment strategy
� Which applies a range of ESG criteria transversally
� We believe this is more coherent than the addition of a lot of different theme funds
� Which doesn’t exclude any sectors
21 Sustainable growth / intergenerational fairness / Responsible investment09/05/2012www.rafp.fr
� What is the point of :
� investing in a renewable energy fund if the rest of your equity portfolio is overweight in oil companies ?
� attacking a company for its collaboration with an authoritarian regime, if you buy the bonds of this regime ?
� excluding a polluting industry, if all the other companies you invest in rely on this industry ?
� We apply a best-in-class policy to all asset classes
� We aim to make everyone have a motivation to make progress
Best in class : the best way to be pragmatic and adapt to asset class features ?
What would be the sense of investing just a fraction according to SRI principles ? What would it tell of the rest of the investment ? � Best in Class make sense
What does ERAFP promote?
• a global but also a pragmatic approach - no sector bias (we’ll need oil for a while),
• joining forces by exchanging so we can more
22 Sustainable growth / intergenerational fairness / Responsible investment09/05/2012www.rafp.fr
• joining forces by exchanging so we can more efficiently engage,
• convincing asset managers that they should integrate SRI analysis in their investment process,
• developing indexes so other long term investors can indexes so other long term investors can start investing in best in class SRI. start investing in best in class SRI.
Some asset classes have specific features
• high unitary amount of the investment means interest to pool together (infrastructure or RE),
• investment has to be assessed in its environment (for real estate connection to urban transport)
A transversal approach : engagement
As Robert Urwin stressed investors responsibility: they should act like conscious « universal owners »
For too long a time :For too long a time :
•• institutional investors have been institutional investors have been consenting victimsconsenting victims•• asset owners rights have not been asset owners rights have not been
23 Sustainable growth / intergenerational fairness / Responsible investment09/05/2012www.rafp.fr
•• asset owners rights have not been asset owners rights have not been protected as they should haveprotected as they should have•• fidiciary duty did not extend to fidiciary duty did not extend to shareholders’ rights protectionshareholders’ rights protection
«« Times there are a changingTimes there are a changing » :» :•• institutional investors talk to each institutional investors talk to each otherother•• asset owners want their rights to be asset owners want their rights to be taken care oftaken care of•• fidiciary duty evolvesfidiciary duty evolves•• as a fallout of the crisis authorities as a fallout of the crisis authorities are pushing for a changeare pushing for a change
The UK Stewardship Code produced by the FinancialReporting Council sets out good practice on the engagement of institutional investors with companies�7 principles
http://www.frc.org.uk/corporate/investorgovernance.cfm
This time is different ???
Captain Speaking. Welcome aboardTitanic 2, the first submarine linerin the world.Please relax and enjoy the journey.We won’t find an iceberg in tropicalwaters anyway! Ha, Ha, Ha….
24 Sustainable growth / intergenerational fairness / Responsible investment09/05/2012www.rafp.fr
waters anyway! Ha, Ha, Ha….