Published by Scott Eason on
A useful framework that enables this analysis is the ABC’s of investments – Aims, Beliefs and Constraints
Time spent agreeing and documenting ABCs is one of the most valuable things a board can do.
Aims need to be easily measurable; a statement along the lines of ‘maximising return subject to the firm’s risk appetite’ is probably a fair description but it isn’t measurable and can lead to different stakeholders having different views of the same performance.
We believe an aim statement needs to be clear in what the fund is trying to achieve. This could be an absolute return, a return fixed to a benchmark or a return compared to peer performance. The time horizon needs also to be clear.
Most companies will have an aim statement. However, the most valuable statement is probably the beliefs statement. Most stakeholders (or board members) will have differing investment beliefs, eg the existence of equity risk premium, the value of active stock selection, the ability to add value through market timing, the attractiveness of illiquid assets. What is important is that a combined set of beliefs is established and set out so that all decisions can be made with these in mind.
Constraints are usually numerous but often the easiest to define, eg avoiding a loss of a certain size, policyholder expectations, regulatory requirements (eg matching adjustment rules), capital levels, governance budget.
Time spent agreeing and documenting ABCs is one of the most valuable things a board can do. Once these are agreed, other investment decisions automatically follow – the assets to be included and assumptions to be used in asset allocation exercises, the choice of managers who manage in line with your beliefs and constraints, and the design of MI to enable you to see if your aims are being achieved within your constraints.