Late Agenda of Finance Audit & Risk Sub-committee

HAWKE’S BAY REGIONAL COUNCIL

Finance Audit & Risk Sub-committee

02 March 2022

Subject: Scope for Fund Manager Review

Reason for Report

1. This paper outlines the considerations and presents a draft scope for a review of the fund managers for feedback from the Finance Audit and Risk Sub-committee (FARS).

Background

2. Following a robust procurement process Hawke’s Bay Regional Council (HBRC) chose to place funds equally split between two fund managers, Jarden and Mercer. Initially circa $40 million (Long Term Investment Fund) was placed under management in December 2018 followed by a further $105 million (Port Future Investment Fund) placed under management in June 2019. Funds for the Port Future Investment Fund were derived from the Hawke’s Bay Regional Investment Company Ltd.’s (HBRIC) sale of 45% equity stake in the Port of Napier. It is now appropriate, given the duration of the time since the funds were placed under management with the two fund managers, to consider and put in place, a formal review process of the fund managers performance.

3. HBRC’s funds under the management of fund managers are managed in line with a Statement of Investment Policy and Objectives (SIPO). HBRC’s treasury policy requires that Council formally review and approve the SIPO annually and provide instructions to the fund managers.

4. Currently, PwC as part of the quarterly treasury reporting to Council report on:

4.1. The performance of the individual securities against benchmarks

4.2. Compliance of the funds with the SIPO’s asset allocation targets.

5. The FARS requested staff to draft the scope for a review of the performance of the fund managers to date and formalise a review process going forward. Outlined below are questions to consider when determining the nature and scope of a review along with recommendations from staff. Feedback is sought on the following.

Discussion of Options

How often should the performance of the fund managers be reviewed?

6. The current HBRC SIPO indicates that the fund managers performance will be monitored as follows.

6.1. Investment Managers performance will be monitored quarterly with a view to an annual evaluation of rolling three-year results.

6.2. Returns achieved by the appointed Investment Managers will be assessed by the Council in relation to their stated objectives and the objectives of the Fund. Returns will also be compared with returns earned by a suitable peer group, such as a group of other professional Investment Managers.

6.3. The Investment Manager’s role will be reviewed by Council on an annual basis. Factors taken into account in these reviews will include investment style, resources, organisational strength, investment performance relative to objectives, and any other factors considered relevant to the Investment Managers continuing ability to meet the applicable investment objectives.

Review frequency recommendations

7. Staff recommend that Council monitors the performance and fund manager attributes on quarterly or six-monthly basis using the criteria noted following, including the SIPO requirement to compare performance against other fund managers in the market.

7.1. Although analysing longer track records provides a more accurate indication of a fund's true risk profile and minimises the noise created by short-term volatility of returns, quarterly tracking is important though to enable rapid identification of performance outside of a fund’s normal risk profile or in an event a fund’s performance is significantly different from the peer group/market. Such events would justify requiring an explanation from the fund manager and consideration by the committee for possible divestment.

7.2. A quarterly review of the performance of the fund will highlight any market conditions that will warrant a review or alteration of the SIPO.

7.3. The quarterly review process should include formal meetings with the fund managers, to discuss findings from the review and obtaining feedback.

8. Staff also recommend that FARS:

8.1. Performs a review of the strategic asset allocation (currently 50% Growth and 50% Income) on an annual basis in order to ensure it reflects the risk appetite and earnings expectations of Council where there is flexibility to provide feedback through to the Annual planning process

8.2. Performs a full review of the SIPO every three years to ensure it aligns with expectations of Council’s long term plan and Investment strategy.

What should the criteria be for a review?

9. HBRC’s current SIPO requires that performance of the funds are monitored to:

9.1. Assess the extent to which the Fund's investment objectives are being achieved

9.2. Compare the performance of the Fund's appointed Investment Managers against the agreed performance benchmarks, performance of other relevant professional Managers and market indices

9.3. Understand the existence of any particular weakness in the Investment Managers or the investment product(s) utilised

9.4. Allow the Finance, Audit and Risk Committee to continually assess the ability of both the Council and the Investment Managers to meet the treasury objectives.

Review criteria recommendations

10. It is considered best practice to monitor investment portfolios across three main criteria, as per the following.

Portfolio Governance and Strategy

10.1. Annual strategic asset allocation review to ensure portfolios are still in line with investment strategies and goals

10.2. Full policy review every three years or as required

10.3. Quarterly mandate compliance and drift tracking

Performance and Risk Review

10.4. Quarterly comparison of performance to appropriate market indices and peer groups. (See attachment 1 for an example of a PwC peer group analysis report)

10.5. Quarterly health check that provides a risk, return and contribution analysis across time. (See attachment 2 for an example of a PwC health check report)

Fund Manager Due Diligence (qualitative review)

10.6. Quarterly review of the qualitative fund manager attributes of:

10.6.1. Governance and Controls - Risk management functions at all levels of the organisation (See attachment 3)

10.6.2. People and Organisation - Ownership structure, investment beliefs, corporate culture, historical track record and key individuals’ functions

10.6.3. Investment Process – portfolio construction process, investment style, stock/ manager research capabilities, deal screening criteria and past performance management.

How many fund managers (funds) is appropriate given the size of the investment?

11. Currently HBRC has funds placed with two fund managers (Jarden and Mercer).

Number of fund managers recommendation

12. A prudent portfolio risk management approach is to spread your investment across providers. However, as HBRC’s portfolio risk is already spread across multiple asset classes and jurisdictions the concern is not portfolio diversification but counterparty risk. Most institutions with fiduciary duty invest in at least two diversified managers as HBRC does. Counterparty risk could be decreased further by investing in more fund managers, however the complexity of portfolio monitoring will increase.

13. Regular review of the fund managers’ performance against the performance of the peer group will highlight strengths and weaknesses of the current fund managers, while also highlighting other fund managers that are outperforming the peer group.

Other Considerations

Fees

14. Currently, fund managers deduct fees at source monthly before a net valuation is calculated. This is a standard approach across the industry. It is recommended to review fees on an annual basis, as fund manager fees do and should adjust to market expectation over time. A fee review will include a breakdown of key charges and a comparison to the peer group.

Returns distribution

15. HBRC’s current SIPO requires returns of the funds to be distributed as follows.

15.1. The amount required to meet the Council’s revenue requirements will be informed annually upon adoption of the annual plan

15.2. An amount equal to the New Zealand CPI for the year will be credited to the Inflation Fluctuation Reserve

15.3. Any remaining amount will be credited to the Distribution Reserve.

16. In the event of an insufficient annual return to meet inflation proofing and/or distribution requirements, the amounts required for inflation proofing and/or distribution will be funded from the Distribution Reserve.

17. Staff recommend that Council instructs the fund managers to distribute returns as per above SIPO guidelines twice yearly (In December and June) with appropriate approval from Council.

Who should perform the review?

18. While and independent party can be engaged to provide the reporting requirements of the review process, it is prudent for Council officers and staff to maintain a relationship with the fund managers by having regular formal meetings to discuss the findings of the review and seek feedback. Staff therefore recommend:

18.1. Council engages an independent party to provide reporting, meeting the criteria and timing outlined above

18.2. Council staff hold regular formal meetings with the fund managers to discuss the findings and seek feedback.

Next Steps

19. The next step in this process is for staff to incorporate feedback from the FARS into a formal scoping document with timeframes, objectives and milestones.

Decision Making Process

20. Council and its committees are required to make every decision in accordance with the requirements of the Local Government Act 2002 (the Act). Staff have assessed the requirements in relation to this item and have concluded:

20.1. This agenda item is in accordance with the Finance, Audit and Risk Sub-committee Terms of Reference, specifically “The Finance, Audit and Risk Sub-committee shall have responsibility and authority to (2.4) monitor the performance of Council’s investment portfolio”.

20.2. As this report is for information only, the decision making provisions do not apply.

Recommendations

That the Finance, Audit and Risk Sub-committee:

1. Receives and considers the “Scope for Fund Manager Review” staff report

2. Provides feedback, particularly on the staff recommendations made, sufficient to enable preparation of a formal scoping document that includes timeframes, objectives and milestones.

Authored by:

Kishan Premadasa

Management Accountant

Christopher Comber

Chief Financial Officer

Approved by:

Jessica Ellerm

Group Manager Corporate Services

Attachment/s