A way to smooth out future shock
The National Pensions Reserve Fund was set up two years ago, to meet some of Ireland’s future public pension liabilities. Pension costs – as elsewhere – are expected to rise significantly as the population ages, and assets of the fund will be drawn down by future ministers for finance starting in 2025.
The government invests 1% of GNP annually in the fund, and may make extra contributions as well. The fund is meant to smooth the burden faced by the exchequer, avoiding sudden rises over short periods, and capping the pensions burden at a much lower level than it would otherwise be.
Owned by the ministry for finance, the fund is controlled and managed by an independent commission. Commissioners have substantial senior management experience and the fund is structured in this way so it can match returns achieved in the private sector.
The National Treasury Management Agency has been appointed manager of the fund for 10 years, initially. A dedicated unit within the agency manages the fund, headed by a director who reports directly to the chief executive, and, in turn, the heads of three subunits – risk, investment manager relations and research – report to the director.
There is a senior manager reporting to the director who is responsible for external communications, liaison
with stakeholders and other policy and implementation issues. Financial reporting and IT services are supplied
by NTMA staff reporting to the director of finance. The fund’s management structure reflects the fact that all investment management is outsourced.
Staffing at the NPRF unit is lean, and concentrates on high calibre people. Including the management already mentioned, total staffing in the unit is 11 people – three in risk, four in investment manager relations, one in research, the director, director’s personal assistant
and the senior manager. Two extra staff will be recruited shortly. As well as these staff at the unit, three staff
in the NTMA’s finance unit work full-time on NPRF matters.
The commission used several advisers in starting up the fund, though none of them was appointed on a retainer basis. Mercer was appointed for portfolio strategy and construction, The Frank Russell Company for investment manager selection, Watson Wyatt for transition manager selection and Bacon & Woodrow for custodian selection.
Even though there are no members of the fund per se, most Irish residents can be regarded as stakeholders. The Commission produces an annual report on the fund and holds a press conference on its publication. It is now putting the finishing touches to a communications strategy to inform people about the fund.
Asset liability modelling
Because the fund’s aim is to meet as much of the cost of public pensions as possible from 2025 to 2055 – within prudent risk parameters – its investment policy aims to maximise the wealth of the fund over this timescale. The fund will be assessed, periodically, in relation to the public pensions liabilities during this period, to determine its funding.
For the fund to meet its goal, and to choose the best equity/bond split based on the most attractive risk/ return profile, the implications of different strategic asset allocations were modelled along the efficient frontier using scenario and stochastic analysis, and assuming a 3% equity premium. This took account of the high cash flow in relation to the fund’s asset base – a result of the annual injection from the government and the dampening effect of this on equity volatility.
Based on these factors, the fund’s initial strategic asset allocation was 80% equities and 20% bonds.
Having decided on the long-term strategic asset allocation, the commission used efficient frontier analysis to construct the benchmark portfolio. The result was a regional asset allocation strategy with a 50/50 Eurozone/non-Euro-zone split. About half of the equities are passively managed; only Euro-zone bonds are bought, and half of foreign currency assets are hedged.
The commission took a specialist, regional manager approach in its investment manager structure – to give the best chance of choosing good active managers. Initially, 16 managers were chosen – a number that gives the best balance between diversification and the higher fees of multiple managers. In awarding
active mandates, the Commission made sure complementary active management styles were used within mandates.
The NTMA checks on tracking error on each sub-portfolio to make sure it does not go beyond targets, and also performs daily controls to make sure managers comply with their contracts. These controls would pick up instances where a manager’s investment in any one security was more than allowed, for example. At the total fund level, daily controls make sure asset and regional weightings are within acceptable ranges.
Highlights and achievements
The National Pensions Reserve Fund is proud of the results of its proactive investment decision-making process. When it entered the market, the commission opted for an averaging-in strategy given that the fund was starting from a 100% cash base. This decision has meant the fund outperformed its long-term strategic benchmark by a cumulative 1,000 basis points since the start of 2002.
The fund’s performance measurement and review system is innovative, and focuses on three main areas – the manager’s investment team, the investment process and performance results. The National Treasury Management Agency monitors each manager daily, conducts review meetings every six months and makes site visits every 18 months.
When performance is assessed, the origin of a manager’s outperformance or underperformance is identified, then stock and sector selection is appraised on the
basis of the NTMA’s own research information.
The fund has used IT efficiently. When the fund started, the NTMA managed nearly 600 applications for the 16 mandates, and it created a special electronic tendering web site for the process. And the risk and performance management systems which the fund has developed use an inhouse database, which is updated every day and produces a full range of reports with a flexible drill-down facility.