Prudent Person Principle - Willis Towers Watson · PDF filePrudent Person Principle ... Assessment of non routine ... conscious of the broader team's limited experience relative to

Prudent Person Principle

Investment & Solvency II

© 2015 Towers Watson. All rights reserved.

Agenda

1. Definition

2. Regulation

3. Issues arising

4. Things to consider

5. Asset governance

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2

Prudent Person Principle

A definition….

“A legal rule requiring investment advisers to only make investments for their clients' that a "prudent person" would make…..It does not require that the investment adviser always make correct decisions; it merely requires him/her to make decisions that will be generally accepted as sound for someone of average intelligence……stating that trustees must manage the affairs of others as if they were managing "their own affairs."


3

Regulation

Solvency II Directive

Delegated Regulation

Guidelines


4

Regulation

Article 132 of Solvency II Directive

“…properly identify, measure, monitor, manage, control and report….”

“…ensure security, quality, liquidity and profitability…..availability”

“…linked…close matching”

“…best interest of policyholders” [Conflict of interest]

“derivatives…reduction of risk…efficient portfolio management”

“…not admitted to trading on regulated markets kept to prudent levels…”

“…properly diversified….”

“…excessive concentration….”

“Member States can restrict….”


5

Regulation

EIOPA Guidelines on System of Governance 25-30

Investment risk management

Assessment of non routine investment activities

Unit linked and index linked contracts

Not admitted for trading on regulated financial market

Derivatives and Securitised Investments


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Assessment of Investment Risk Management


7

“well structured,

disciplined and

transparent”

“duty to protect

policyholders and

beneficiaries interest”

Assessment of Non Routine Investment Activities

Ability to perform/manage Risks specifically related Consistency with

policyholders/beneficiaries interests and liabilities

Impact on quality, security, liquidity, profitability

Inform AMSB New ORSA


8

Security, Quality, Liquidity, Profitability of Portfolio

Overall basis

Liability constraints

Consistency with risk appetite

Characteristics of the asset

Events that could change characteristic

Issues relating to localisation and availability of assets


9

Unit linked and index linked contracts

Best interest of policyholders and beneficiaries and disclosed objectives

Liquidity

Interests of remaining unitholders


10

Assets not admitted for trading/Derivatives

Implement, manage, monitor,

control procedures in

relation to investments not

admitted to trading or

complex products

Mark to market = Risk Function

sign off on modelBack up models

Should show how derivatives

enhance portfolio not create

additional risks

Where used in unit linked funds,

additional enhancements in place to protect policyholders


11

Issues Arising

• Principles rather than rules

• Raising the bar

• Complex products

• Structured products

• Independent expertise

• “Look through”

• Portfolio Bonds

• Mandates

• New asset classes

• Legal risks

• Derivatives


12

If you don’t understand it…..

….don’t invest in it!

To consider

• Independent investment expertise

• Review processes, procedures, controls

• Clear policyholder literature

• Communication (type/frequency)

• Solvency I rules

• UCITS rules

• Diversification

• Documentation

• PRIIPS


13

Talk to Joe


14

Plato’s account of the trial of Socrates (Translated by Benjamin Jowett.)

© 2015 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.

15

towerswatson.com

πρὸς ἐμαυτὸν δ᾽ οὖν ἀπιὼν ἐλογιζόμην ὅτι τούτου μὲν τοῦ

ἀνθρώπου ἐγὼ σοφώτερός εἰμι· κινδυνεύει μὲν γὰρ ἡμῶν

οὐδέτερος οὐδὲν καλὸν κἀγαθὸν εἰδέναι, ἀλλ᾽ οὗτος μὲν

οἴεταί τι εἰδέναι οὐκ εἰδώς, ἐγὼ δέ, ὥσπερ οὖν οὐκ οἶδα,

οὐδὲ οἴομαι· ἔοικα γοῦν τούτου γε σμικρῷ τινι αὐτῷ τούτῳ

σοφώτερος εἶναι, ὅτι ἃ μὴ οἶδα οὐδὲ οἴομαι εἰδέναι.

I am wiser than this man, for neither of us appears to

know anything great and good; but he fancies he knows

something, although he knows nothing; whereas I, as I

do not know anything, so I do not fancy I do. In this

trifling particular, then, I appear to be wiser than he,

because I do not fancy I know what I do not know.

Wisest is he who knows he knows nothing

How TW provides consulting to insurers

towerswatson.com

16


P/C insurance 350 professionals

RCS software75 professionals

Life insurance350 professionals

Insurance Mgmt consulting25 professionals

TW EMEA Risk Consulting & SoftwareTW Global Investment

Investment research230 professionals

Client Consulting400 professionals

850 people worldwide490 in Europe

Investment strategy150 professionals

Insurance and

Investment team

for

insurers

Risk team Capital mgmt Inv functionBoard

Inv. model

solutions

Investment

strategy

Insurance

capabilities

Investment

governance

Implement

efficiently

CRO CEO CFO CIOFIA

Governance & Organisational design


17

towerswatson.com

Mission and goals

Beliefs

Organisational

Design

Value chain

Culture

and

leadership

Talent and

reward

Frameworks

Manager

line-up

Portfolio optimisation:

strategy, asset

allocation, risk

Execution

Strategic Principles Enablers Investment Policy

Bonds and

derivatives

Return-

seeking (&

alternative)

assets

Monitoring

Bond manager

selection advice

Manager selection

- hedge funds

Manager monitor /

access to Dream

(TW’s manager

research

database)

Smart Beta

manager selection

Manager selection

- Smart Beta

Asset manager

fee review

Independent

opinion of

derivative

strategies

Manager selection

– equity

Implementation of

Interest rate/

inflation/credit/

extreme risk

hedging

Manager selection

–private markets

Portfolio

construction

Modelling

solution

Model

validation /

calibration

Full asset

allocation review

STAR model Model validation

Partial or ‘flash’

asset allocation

review (eg fixed

income only)

SAA tool Model / quantify

market / credit

risk

Smart Beta /

hedge fund

portfolio

construction

Consulting

support linked

to model

Dynamic asset

allocation

Risk Agility EC

and C-ALM

(MoSes)

Implementing portfolio

solutions

Improving inv. risk

management and

governance

Maximising

risk-adjusted returns

Risk

Management

Governance

Stochastic ALM to

articulate

the risk budget

Review capability of

Internal asset manager

Economic scenario /

extreme risk analysis

Investment

beliefs/objective

workshop

Investment Health

Check

Review investment

decision making

structure

Liquidity management

process and scenarios

Board and Executive

training

Operational Due

Diligence

ALM governance and

processes

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18

A selection of recent investment projects

The issue with screening for past performance

0

500

1000

1500

2000

2500

3000

Skilled Mediocre Bad

Number of managers

Good performers Not good performers

Source: Penfold, Robin. “Do not hire managers for past performance” Towers Watson Limited, 2011

Narrowing the universe


19

..c

om

pe

titi

ve

ad

va

nta

ge

Towers Watson manager research framework…S

us

tain

ab

ilit

y o

f..

Investment professionals

Approach/insight generation

Portfolio management

Firm and team stability

Opportunity set

Alignment

• Is the opportunity set large enough for the manager to exploit effectively given

their particular process?

• How might this change over time?

• How does the manager think about capacity?

• Is there evidence of competitive advantage in the way a team generates

investment ideas?

• Is the philosophy compelling and consistent with the resources and skill set

available?

• Is there evidence that both the firm’s and the key investment professionals’

interests are aligned with those of clients via well structured performance fees

and co-investment?

• Is the product’s fee too high?

• What are historical levels of personnel turnover and corporate activity?

• Looking forward, what is the culture and what mechanisms do they have in

place to help retain people?

• How effectively does the manager convert ideas into portfolios?

• Does the manager think enough about risk and overall portfolio construction?

• What is the calibre of key people?

• Do they exhibit the traits of great investors?

• Are resource levels sufficient?


20

‘Skill thesis’’ is a detailed (19

pages for this EM equity

manager) written document

explaining in full the rationale

for a manager rating.


21

ABCFund ManagersEmerging market equities ‒ Emerging Market Equity


22

Skill summary

Executive summary

We have a positive view on ABCFund Managers' (ABC) Global Emerging Markets (GEM) team and product. Key strengths are the team's deep belief in its investment philosophy and process, as well

as the team's willingness to look further than many peers for ideas. We are, however, conscious of the broader team's limited experience relative to some peers and the relatively short time it has been

running this strategy for (since 2008). Also, whilst we believe there are some issues from ABC being a publicly listed firm, there is material alignment of interests through employee ownership

(approximately 30% of the business), co-investment and performance related fees.

Success factors Strengths Weaknesses or issues

Investment

professionals

The strategy's Portfolio Manager XX YY and Co-Portfolio Manager WW

ZZ appear to be insightful and pragmatic investors

The investment team appears to have a strong investment culture and be

motivated to succeed

The analyst team is less experienced than that of some peers in this space, though this is

somewhat mitigated by its access to broader firm resources, including the new global equity team

Potential for lack of challenge to XX

As the product gains traction with investors, there may be increased distractions for marketing

purposes for XX and ZZ, although the firm is partly addressing this by increasing its client

servicing resources

Approach/insight

generation

There is an apparent deep belief in and adherence to the investment

philosophy and process

The GEM team will be leveraging the house research base for inputs into

its analysis (for example, for views on commodities prices)

South African base may give local insight

Assessment of environmental, social and corporate governance (ESG) risks appears to lack

rigour

Portfolio

management

Strong thinking on portfolio management and risk control from XX

Ability and willingness to invest up to 25% of the portfolio in developed

market-listed companies with significant exposure to emerging markets

Structural style bias and benchmark agnostic portfolio (50-60 stocks with small-/mid-cap bias) will

provide, at times, volatile returns relative to a market index

Some evidence of shareholder engagement, but largely limited to voting proxy shares

Firm and team

stability

Long-term focus on asset management business

Profitability and diversity of local business

Unclear plans for accepting senior investors into the managing partnership

The business has a concentration in South African equity products

The firm's development of a global equity product has the potential to create a distraction for the

team

Opportunity set Ability and willingness to look further for ideas than many peers The team's investment philosophy leads to significant numbers of stocks being discarded at the

start of the process and opportunities are potentially missed

The strategy's capacity target seems somewhat high, and discipline in management of capacity

has been questionable in South African strategies. However we believe capacity issues are not a

major concern at the current level of assets under management

Alignment Strong processes in place to improve alignment of interests, including

employee share ownership and co-investment in ABC’s internal funds

Significant percentage of asset base on performance-based fees

Willingness to invest materially in new product launches, ahead of having

asset growth

Being a publicly listed firm may bring some external pressures to the business, although the

management team is focused on minimising this and the firm's employees are the largest (around

30%) shareholder group

Equity ownership offers limited direct alignment to the success of the Emerging Markets product,

given the strategy's small size relative to the firm's South African business

Co-investment in the GEM strategy is limited due to local tax regulations

Skill 1

Expected deviation Absolute return

Soft risk Average

Key: Significant strength Strength Neutral Weakness

UVWXEmerging Markets Equity

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23

Investment professionals

1 Primary professional

experience

26 years industry experience

2 Portfolio manager

experience

26 years industry experience

3 Analysts experience 18 years industry experience

4 Primary professional

tenure

20 years on the product

5 Portfolio manager

tenure

21 years at the firm

Approach/insight generation

6 Three year returns 1.5%pa net relative return, 0.25 net information ratio

7 Five year returns 6.2%pa net relative return, 0.83 net information ratio

8 Seven year returns 3.8%pa net relative return, 0.42 net information ratio

Portfolio management

9 Downside protection 0.13 Calmar Ratio over last seven years

(Percentile: 92.9 in a universe of 183 products)

10 Risk level 7.5%pa tracking error over last five years

11 Portfolio turnover 28.9%pa

12 Active share 83% versus MSCI EM-ND

Source: eVestment

Firm and team stability

13 Firm asset growth 19% growth rate over the last year

14 Product asset growth 9% growth rate over the last two years

15 Portfolio manager

turnover

0 known gains, 0 known losses over the last three

years

16 Analysts turnover 18% gains, 0% losses over the last three years

Opportunity set

17 Manager asset class

capacity

49,832 million USD in active equities

(Percentile: 91 in a universe of 721 managers)

18 Product capacity 411 million USD per stock

(Percentile: 99 in a universe of 134 products)

Alignment

19 Significance of

product to firm

61.9% of firm assets in product

20 Ownership 0.0% employee ownership

21 Manager alpha share 38% of alpha assuming a 95.0 bp fee

Notes: The performance used in factors 6 to 10 and 21 is for the Emerging Markets Equity ‒ SA vehicle. Returns are in USD. Benchmark is FTSE All-World All Emerging.

* The universe displayed is the Towers Watson Snapshot analysis for all active long-only equity products with at least 10 factors calculated as at 31 March 2015 (5,022 products).First quartile = Below lower quartile, Second quartile = Lower quartile to median, Third quartile = Median to upper quartile, Fourth quartile = Above upper quartile

5th percentile Lower quartile Median Upper quartile 95th percentile

Key: Strength Neutral Weakness Not rated Product score

Snapshot as at 31 March 2015

First quartile versus equity universe*

Operational Due Diligence


24

Internal & external fund governance


25

Joseph O’Dea

Senior Investment Consultant

joseph.o’[email protected]

Colin Murray

Senior Consulting Actuary

[email protected]

Documents

Prudent Person Principle - Willis Towers Watson · PDF filePrudent Person Principle ... Assessment of non routine ... conscious of the broader team's limited experience relative to