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Strategic Asset Allocation. The experience of Fundo de Estabilização Financeira da Segurança Social Portugal ISSA Conference, Merida, Mexico Henrique Cruz. Portugal. Area: 91,951 Km 2 Population: 10,6 m Age Struct.: <15 (17%); 15-64 (66%); 64> (17%) GDP: $ 188.7 bn

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strategic asset allocation

Strategic Asset Allocation

The experience of

Fundo de Estabilização Financeira da Segurança Social

Portugal

ISSA Conference, Merida, Mexico

Henrique Cruz

Instituto de Gestão de Fundos - Portugal

portugal
Portugal

Area: 91,951 Km2

Population: 10,6 m

Age Struct.: <15 (17%); 15-64 (66%); 64> (17%)

GDP: $ 188.7 bn

Govnmt: Parliamentary democracy

Instituto de Gestão de Fundos - Portugal

strategic asset allocation fefss
Strategic Asset Allocation - FEFSS
  • Fundo de Estabilização Financeira da Segurança Social (FEFSS)
    • Social Security Reserve Fund
    • Target amount: 200% annual expenditure with pensions
    • As at 31.08.2005: 6 bn € / 80% of annual expenditure with pensions / 4.4% Portuguese GDP
    • 3.99% real rate of return since Dec.’02

Instituto de Gestão de Fundos - Portugal

strategic asset allocation fefss1
Strategic Asset Allocation - FEFSS
  • Inflows:
    • Between 2/11ths and 4/11ths of the employees contributions;
      • unless the Portuguese economy is in an adverse macroeconomic condition
    • Annual superavits
    • Proceeds from the sale of property
    • Reinvestments

Instituto de Gestão de Fundos - Portugal

strategic asset allocation fefss2
Strategic Asset Allocation - FEFSS
  • Investment requirements:
      • OECD issuers, currencies and markets;
      • At least 50% in Portuguese Gvnmt Debt;
      • Max. 40% in investment grade Debt;
      • Max. 25% in equities;
      • Max. 15% in unhedged currency exposure;
      • Max. 10% in real estate;
      • Max. 5% in a strategic reserve.

Instituto de Gestão de Fundos - Portugal

strategic asset allocation fefss3
Strategic Asset Allocation - FEFSS
  • Investment Policy:
      • in the long run, FEFSS returns must be in excess of the cost of the Portuguese public debt portfolio with similar volatility;
      • Use of impairment in hold to maturity bonds;
      • Positive average real rate return in maximum 3 years rolling period;
      • Beat the annual benchmark.

Instituto de Gestão de Fundos - Portugal

strategic asset allocation fefss4
Strategic Asset Allocation - FEFSS
  • Asset Allocation Study inputs:
    • Max. volatility 4%;
    • Use of impairment in 25% of the portfolio;
    • Max. 10% in real estate;
    • Investment in Euro denominated assets vs investment in OECD currency den. assets;
    • Long term risk and return matrix;
    • Correlation matrix.

Instituto de Gestão de Fundos - Portugal

strategic asset allocation fefss5
Strategic Asset Allocation - FEFSS
  • Asset Allocation Study results (Euro):
  • Asset Allocation Study results (OECD):

[1]The estimated  maximum number of years (with a 95% confidence level) required to achieve average annual positive real returns is computed as follows:

[risk x INV.NORMAL(95%; 0;1) / return ] ^2

Instituto de Gestão de Fundos - Portugal

strategic asset allocation fefss6
Strategic Asset Allocation - FEFSS
  • Governance model:
      • Indexed vs active management
      • External management
      • New asset classes
      • SAA Revision

Instituto de Gestão de Fundos - Portugal

strategic asset allocation fefss7

Index

Index

+1%

+1%

+2%

+2%

+4%

+4%

US Aggregate

Bonds

89

94

European Government

Bonds

European Corporate

Bonds

UK Aggregate

Bonds

91

79

86

89

91

94

US Equities

71

77

83

UK Equities

68

77

83

Efficient

Global Equities

69

75

81

Inefficient

Emerging Mkt Debt

59

67

74

84

European Equity

55

64

72

84

EM Equity

54

63

70

82

Semi-Efficient

US Small Cap

42

51

57

67

Japanese Equity

39

51

61

75

Strategic Asset Allocation - FEFSS
  • Indexed vs active management

“Inverse relationship between the efficiency in asset pricing and the appropriate degree of active management” David Swensen – Pioneering Portfolio Management”

History shows that some benchmarks are much harder to beat than others.

Source: Micropal, Lipper, Schroders; Percentile ranking of widely used indices on a rolling 3-year basis up to 30 June 2005. 100 best 1 worst. Mutual fund returns are measured after all fees.

Instituto de Gestão de Fundos - Portugal

strategic asset allocation fefss8
Strategic Asset Allocation - FEFSS
  • External management
    • Indexed management outsourced on an ‘all-in’ cost basis
        • including the cost of trading, settlement, safekeeping, income collection, tax recovery, securities lending, etc.
    • Balanced portfolios submitted to decision benchmarking
        • internally against the benchmarks and externally by subcontracting managers to benchmark the excess return achieved by the in-house team
    • Real Estate: buy expertise
        • best managers at fair prices

Instituto de Gestão de Fundos - Portugal

strategic asset allocation fefss9
Strategic Asset Allocation - FEFSS
  • New Asset Classes
    • Portfolio’s diversified VaR is concentrated on equities and currencies;
    • We need to keep portfolio’s volatility under 4%.
    • Explore benefits of low correlation between equities and hedge funds and between equities and commodities

Instituto de Gestão de Fundos - Portugal

strategic asset allocation fefss10
Strategic Asset Allocation - FEFSS
  • New Asset Classes
    • The hedge fund industry
      • trust
      • systems
      • credit risk.
    • Commodities
      • high volatility
      • low correlation with equities
      • reduction in the diversified value at risk of a portfolio.

Instituto de Gestão de Fundos - Portugal

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Strategic Asset Allocation - FEFSS
  • SAA revision
    • Monitor:
      • inflows and outflows of the FEFSS
      • pattern of return, risk and correlation of asset classes.

Instituto de Gestão de Fundos - Portugal

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Strategic Asset Allocation - FEFSS
  • Final Remarks
    • Indexed management is dominant in FEFSS investments;
    • FEFSS is invested in classical asset classes subject to a 4% volatility ceiling;
    • Diversification is always under consideration;
    • The current strategic benchmark is expected to produce an annual real rate of return of 3.88%.

Instituto de Gestão de Fundos - Portugal