Embracing an Enduring Investment Approach to Thrive in the Long Term - Presentation by Philippe...

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


� 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:


� 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.


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)


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


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,


•• 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.


|-----+--------------------------+-----+--------------------------|

| | |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


� 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).


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


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


� 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


• 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


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


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€)


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%


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%


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.


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


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


� 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


• 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


•• 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….


waters anyway! Ha, Ha, Ha….

Embracing an Enduring Investment Approach to Thrive in the Long Term - Presentation by Philippe...

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