Policy: Investment

Purpose

The purpose of the Investment policy is to articulate the principles that govern the investment strategy of the University for investible funds entrusted to it. This policy also covers key aspects of investment governance, including investment due diligence, distribution, rebalancing and foreign currency management.

Overview

The Investment Policy establishes the guiding principles for managing the University’s investment portfolio and it details:

• The nature of socially responsible investments;
• The framework supporting the University’s investments.
• The strategies adopted by the Council to achieve the set of investment objectives;
• The risk and return objective of the University’s General Cash Float and Long Term Investment Pool;
• Appropriate long term strategic asset allocation and asset allocation ranges;
• Stress testing programs and dynamic asset allocation processes;
• The measuring, monitoring and reporting of performance;
• The process for reviewing investment managers for fiduciary and strategic considerations;
• Objectives for investment distribution and managing foreign currency exposure; and
• Regular portfolio rebalancing to maintain target asset allocations.

The investment objectives, strategies and constraints of the portfolio are stated in quantifiable terms for the purpose of measurement and accountability. The Council (or its delegate) must determine an investment strategy with regards to the circumstances of the portfolio annually.

This policy should be read and used in conjunction with the following:

• Finance Committee Charter and the SRI policy;
• Risk Management Framework;
• Governance Framework;
• Business Plan;

Scope

This Policy applies to all funds held in the University’s investment portfolio.

Definitions

ANU Act means the Australian National University Act 1991.

APRA means Australian Prudential Regulation Authority which is an independent statutory authority accountable to Parliament.

CPI means Consumer Price Index.

DAA means the dynamic asset allocation.

Derivatives are financial instruments whose value and marketability are derived from the value of an underlying asset, liability or index which represents either the direct ownership of an asset or the direct obligation of an issue. Derivatives include financial instruments that trade on an organised exchange or “over-the-counter” (OTC) and which include, but are not limited to, futures, swaps, forwards, warrants and options.

FUM means Funds Under Management

Fund means LTIP plus GCF.

GCF means the General Cash Float.

LTIP means the Long Term Investment Pool.

MER means Management Expense Ratio which is a ratio, expressed as a percentage per annum, used to capture expenses incurred by the underlying investment managers and all associated investment operating costs.

Relevant law means the Australian National University Act 1991, the Corporations Act 2001 (and associated regulations).

PGPA Act means the Public Governance, Performance & Accountability Act 2013.

SAA means strategic asset allocation.

Policy statement

Background

1. The Australian National University is a body corporate established by the Australian National University Act 1991. The University is considered a “corporate Commonwealth entity” under the Public Governance, Performance & Accountability Act 2013.
2. Section 9 of the ANU Act confers upon the Council the power over the University, granting it entire control and management of the University, including the power to ‘invest money and dispose of investments.
3. The Council recognises its fiduciary duty to administer the investment portfolio prudently for the benefit of the University and the unit holders. The Council is supported in this regard through its Finance Committee.
4. The University’s Long Term Investment Pool has a long term investment horizon reflecting its perpetuity. The distribution parameters determine the framework used in the distribution of income generated by the portfolio to unit holders.
5. Unit prices on the LTIP, and hence returns accruing to unit holders, are determined so as to closely reflect the investment returns recorded on the underlying investments. Accordingly, unit holders bear the investment risk in that the investment returns recorded are reflected directly in changes to the monthly unit price of the LTIP.
6. The LTIP Application and Redemption Guideline outlines the process for accepting applications into the LTIP and redemptions from the fund by unit holders.

Setting the investment strategy

7. The Council (or its delegate) determines the investment strategy for the University as a whole and for the underlying Long Term Investment Pool and the General Cash Float. The investment strategy will have regard to the circumstances of the portfolio, including all legislative and regulatory requirements.
8. Setting the investment strategy is a continual process that aims to ensure alignment between agreed investment objectives and the structure of the investment portfolio.
9. In setting objectives, the Council recognises that the objectives are intentions and that they may not be achieved in any particular time frame.
10. The Council recognises the achievement of competitive long-term investment returns will require the portfolio to accept investment risk. In doing so, the Council has identified key factors that critically influence investment performances. These are:

• The setting of investment objectives to reflect the best interest of the University
• The strategic and the dynamic asset allocation
• The University’s liquidity position
• The monitoring and adapting to market changes to meet investment objectives
• The oversight and management of investment activities, ensuring effective internal controls, processes and governance
• The monitoring foreign currency exposure and hedging activities in compliance with policy; and
• The oversight and monitoring of the Custodian to ensure that the Fund’s settlements take place in a timely and efficient manner and that the fair value of assets are established and recorded.

Investment philosophy

11. The Council views the LTIP to be a long term investment vehicle. The GCF is viewed as a short term investment vehicle. The Council professionally manages the assets supporting those portfolios with the aim of assisting stakeholders in achieving their desired investment outcome.
12. The following set of investment beliefs informs the investment strategy setting process of the University:

• Return requires risk but risk does not guarantee return, i.e. achieving a return in excess of the risk free return requires taking on incremental risk of some description.
• Risk and return are related. Capital markets are usually reasonably efficient in pricing financial risk, in the sense that, if the expected return on one asset exceeds the return on an alternate asset, there is normally an additional risk entailed in holding the former asset. However, capital markets are also complex and not always rational. Theories such as the Efficient Markets Hypothesis are frequently violated in practice.
• Diversification reduces risk. Combining assets with various unique risk characteristics may reduce the volatility of portfolio returns.
• Risk is more multifaceted than the short term volatility of returns. At the portfolio level, short term volatility may not be a relevant risk measure when risk is considered to reflect the failure to meet the investment objective. While high levels of volatility may be indicative of high failure risk, the potential for large negative returns may also have a large bearing.
• Risk is related to a failure to meet objectives. The failure to meet the objectives is the ultimate definition of risk for a fiduciary. The relevant dimensions of this risk are the chance that it will occur, the circumstances in which it will occur and the extent of a shortfall faced when it does occur.
• Active management can add value. In some markets, participants do not all have return-maximising objectives and/or some participants are likely to underperform on average. Active professional investment management can, on average, add value in such markets.
• Behavioural issues are important. Behavioural issues apply at the security level, at the asset class level and in constructing total investment portfolios. At all of these levels, these issues can, in some circumstances, exert a more powerful influence on markets than rational economic optimisation.
• Costs and implementation leakage matter. Fees, brokerage, taxes and opportunity costs from being “out of the market” must all be considered both in on going portfolio management and when restructuring portfolios.
• Long term returns are expected to be superior when a genuinely long term perspective is used.
• Corporate social responsibility, ensuring socially responsible investing behaviours are maintained throughout the execution of the investment strategy.

13. Investment strategies consider the following portfolio profile factors: investment time frame, stakeholder’s expectations and factors that influence the University’s risk tolerance so as to achieve the strategic objectives which should be aligned with “SMART” characteristics: Specific; Measurable; Achievable; Realistic; Time-Bound.
14. The strategy objective must clearly state a quantifiable return target that is both attainable and measurable over a specified time period. The following investment objectives are intended to assist in achieving this goal:

• the individual investment strategies seek to earn a return in excess of its policy benchmark over the long term;
• the portfolio’s assets will be managed on a total return basis which takes into consideration both investment income and capital appreciation;
• the importance of the preservation of capital, and adherence to the principle that varying degrees of investment risk are generally rewarded with compensating returns; consistent with long term growth objectives; invest in a manner which provides a degree of downside protection in declining markets and to assess investments on a tax-effective basis where applicable.

Formulating investment strategy

15. Following the adoption of appropriate risk and return objectives, the Investment Office formulates the investment strategy for endorsement by the Finance Committee and approval by the Council. The Investment Office is responsible for:

• The risk and return assumptions for each asset class
• The long term asset allocation that is expected to maximise the probability of achieving the stated return objective, subject to the targeted level of risk and any other constraints, while ensuring adequate diversification of risk premia on a look through basis (using risk factor analysis).
• The development of the asset allocation that maximises diversification on a “a look through basis” using risk factor analysis to ascertain the foundational risks associated with each asset class.
• Stress testing to assess the robustness of the asset allocation and better understand the risks embedded in the portfolio
• Finalising the benchmark portfolio taking all aspects of the analysis into consideration.

Consideration of investment covenants

16. In taking decisions on investment strategy, the Council will have regard to the overall circumstances of the portfolio as well as the particular circumstances pertaining to the University, and will comply with all applicable legislative requirements.
17. The Fund’s investments will be managed with a view to ensuring that the Fund will have sufficient liquidity to meet expected cash flow requirements.

Developing strategic asset allocations for LTIP

18. The long term strategic asset allocation anchors the portfolio’s investment strategy. The portfolio’s SAA decisions dominate the investment outcome. In determining the SAA for the LTIP, the Investment Office relies on modelling undertaken by its asset consultant and aims to balance risk and return to maximise the probability of achieving its stated objectives.
19. Long term return assumptions are primarily used for the purpose of calculating the level of investment risk inherent in the investment strategy expressed as the likely number of negative annual returns over a 20 year period. This calculation uses a risk premia based approach.
20. These assumptions are derived using a risk premia approach. The starting point is the lowest risk asset class (cash) and then adding return premiums for other classes to reflect compensation for the additional risk.
21. These return premiums are based on long term capital market history and research of the fundamental risk and return characteristics of each asset class.
22. Expected long term returns are checked for reasonableness by using a fundamental or economic based approach. A qualitative overlay is also applied to ensure return assumptions are appropriate and are consistent across asset classes.
23. Assumptions for standard deviations are largely based on history. Consideration is also given to rolling volatility charts to check how volatility has varied over time and considering if there are any reasons to expect volatility levels to change going forward.
24. Asset class correlation assumptions are also largely based on history (to the extent history is relevant), with checks for trends similar to what is undertaken for volatility. Note that correlations between risky assets increase during times of market crisis.

Assessing underlying risk factors

25. As part of the investment strategy, the Council considers the degree of diversification embedded in the Long Term Investment Pool using risk factor analysis.
26. Common risk factors tend to drive returns across multiple asset classes. Diversification is often less effective than can appear to be the case when viewing asset allocation analysis in isolation. Understanding this allows the Council, the Investment Office and its adviser to avoid unintended concentration of risk and develop portfolios that are more effectively diversified. The risk factors identified are:

• Equity Risk Premium: the premium expected from investing in developed large cap equities above the risk-free rate.
• Small Cap Premium: the additional return expected from investing in small cap companies compared to developed large cap companies.
• Emerging Markets premium: the additional return expected from investing in emerging markets relative to developed market equity.
• Term premium: the premium expected from investing in government bonds (fixed terms bonds) relative to the risk-free rate.
• Credit Spread Premium: the premium expected from exposure to credit risk (for example, investing in high yield bonds compared to government bonds).
• Inflation expectation: the difference between the long term average expected inflation and short term unexpected inflation.
• Liquidity Factor: the higher rates of return expected to compensate for the disadvantages of holding less liquid assets.
• Non-Corporate GDP Growth: the returns on assets such as property will be partially explained by GDP growth that is not directly linked to the corporate sector.
• Alpha: in addition to the factor-driven returns, the model allows for “alpha” in asset classes that cannot be managed passively to capture stock specific risks and other unique premia. This reflects alpha that is embedded into beta returns, rather than alpha generated through manager skill.

27. As expected, equity risk tends to dominate the growth orientated portfolio. This is required to achieve higher returns and is appropriate given the longer investment horizon of the LTIP.

Stress testing program

28. The Council acknowledges that stress testing is an important aspect of the investment strategy. Understanding how the portfolio may perform through periods of market stress helps unitholders, stakeholders and the Council to prepare for and manage the portfolio and mitigate risks. This analysis is undertaken in two parts: Historical analysis and Simulation analysis.
29. Historical analysis is used to determine the likely impact on portfolio returns from a selection of historical distressed market events. Each historical shock is assessed on a peak to trough basis to identify the potential for extraordinary loss by comparing return outcomes for the portfolio to its objectives. Potential implications for portfolio management are also considered, such as the likelihood of breaching strategic asset allocation ranges and (where relevant) the need to fund losses on the LTIP’s foreign currency hedge overlay.
30. Although the Finance Committee does not expect history to repeat itself, historic stress tests do provide powerful insight that are factored into the investment strategy process. A key benefit of this type of stress test is that it is objective in nature and inherently captures the complex interrelationships between markets and asset classes during periods of market stress.
31. Simulation stress tests provide a forward looking assessment of the potential for extraordinary loss. This analysis ties indirectly into the Investment Office’s SAA modelling. The model produces possible portfolio outcomes in a manner that reflects the multifaceted and dynamic nature of markets.

Implementation

32. The University implements its investment strategy through the appointment of one or more external asset managers that have responsibility for the investment of the Fund’s assets.

Due Diligence

33. The Council recognises its fiduciary duty to administer the Fund prudently for the benefit of all stakeholders. Prudent administration requires the Council not only to diversify its investments but to conduct due diligence on new asset managers, asset consultants, direct investment or other investment professionals engaged by the University.
34. Due diligence shall be conducted on new asst managers as part of the selection process. The Director of the Investment Office will perform or cause to be performed all necessary and reasonable due diligence with respect to the final slate of asset managers being considered for engagement by the LTIP.

Asset Manager

35. Asset Managers must be shown to have adequacy in the following areas:

• Organisational competency
• Experienced investment staff
• Performance track record with similar mandates
• Commercial, operational, legal and taxation matters, including holding necessary licenses
• Information technology systems
• Risk control procedures
• Quality client reporting.

36. Prior to appointing an investment manager:

• The tax structure and implications for a NFP Australian investor will be documented;
• The legal structure of the investment, including the rights, responsibilities, warranties and representations will be assessed; and
• The ability of the custodian and its methodology for valuing the investment will be documented.

Prior to selecting an asset manager, the candidate will complete an in-depth questionnaire concerning investment philosophy, style and process, including operational and compliance risk management. There will be on-site evaluations of short listed candidates where possible.

37. As part of this process the Council also considers whether the investment should be made via a segregated mandate or investment trust. Consideration is given to issues such as transparency, control, cost and other aspects. The Council will have preference for investment via a segregated mandate.
38. Formal approval to proceed with implementation will only occur once the Investment Office is satisfied that the necessary due diligence has been completed and that there is sufficient understanding of how the investment strategy is expected to perform (including under a range of stressed scenarios).

Operational

39. The Investment Office is responsible for conducting reviews of investment managers operations, including middle and back office functions, to distinguish a well-controlled and managed investment operation. Operational due diligence reviews include:

• Investment manager’s use of technology
• Investment implementation and operational controls
• Investment administration and operational controls
• Business continuity and disaster recovery plans
• Compliance and audit

Regular Monitoring

40. Regular due diligence addresses governance and human resources of investment managers as well as over-reaching strategic concerns of the Council and includes the following at the indicated intervals:

41. On-site due diligence evaluations are also conducted with both domestic and international investment managers at their primary place of business when practical. Virtual evaluations are conducted quarterly and may be necessary on a more frequent basis.
42. Quarterly evaluations include:

• Evaluating the investment manager’s staff and how they jointly carry out their fiduciary responsibility to the University;
• Conducting Interview with individuals who directly manage the University’s account;
• Evaluating the significance of personnel shifts or organisational changes that may affect the University’s portfolio;
• Holding in-depth reviews regarding the investment manager’s philosophy, style and approach to investing the University’s assets; and
• Developing a clear understanding of the significance of short-term periods of good or poor performance by the manager.

Reporting

43. The Investment Office reports any defects to the Chief Financial Officer for review. General findings are reported to Finance Committee not less than once a quarter.

Performance and investment monitoring

44. LTIP’s performance objective is to achieve a net return of CPI + 3.5% over a rolling 7 year period. The expected frequency of a negative return is once in a 5 year period. The SAA is tested regularly to ensure that the LTIP is fit for purpose to achieve its return objective.
45. The Council, through its Finance Committee, meets on a regular basis to consider how the Fund is performing relative to the set investment objectives. The monitoring process aims to proactively identify potential issues or areas of concern, investigate these thoroughly and take action where appropriate.
46. The Council, through its Finance Committee, formally reviews each asset class annually or sooner, if required.

• Overall performance and performance of each underlying manager relative to objectives and peers;
• Style characteristics, including whether any unintended risks/biases are present in the portfolio;
• Whether it is possible to construct the portfolio more efficiently; and
• The forward looking level of conviction in incumbent managers relative to their potential managers or products or styles.

47. Performances for individual asset classes are measured against suitable industry standard indices. The Council considers the indices detailed in Appendix A are appropriate for the asset classes in which Fund assets are invested.
48. In monitoring its investments, the Council will receive regular input from a number of sources, including the Custodian and other investment professionals.
49. Each external asset manager is required to monitor and review their mandate regularly, to ensure that it meets the conditions of the outlined investment management agreement. The manager is required to inform the Investment Office if there is a breach. In addition, a monthly mandate compliance review will be undertaken by the Custodian.
50. The Council may choose to review a manager’s mandate upon the occurrence of any the following:

• Material alteration to the structure of the Fund;
• Significant changes in the underlying economic assumptions used in the development of the Fund’s objectives;
• Significant modifications required arising from a revision to the expected optimal long-term asset allocation;
• Deficiencies in the objectives/policies that emerge in their practical operation;
• Operational errors;
• Compliance issues identified by the Custodian; and/or
• Performance.

51. The Investment Office engages in regular dialogue with its Asset Managers on investment matters and may conduct regular, periodic on-site examinations on such matters as the need arises. These matters would include:

• Assistance with administrative issues generally;
• Timely commentary on significant market events;
• Timely notification of investment actions that may draw media, Government or member attention;
• Advice on economic conditions that may affect investment returns and objectives, international political events, changes in real return expectations, and general changes in economic conditions;
• Significant changes in personnel or in the business operations of the manager;
• Returns on individual sectors, including events which have a significantly adverse impact on the return of the portfolio; and
• Year-end review of projected returns for the following 12 months.

Foreign Currency Exposure Management

The University manages its foreign currency exposure of the LTIP as part of the overall management of its investment assets and is consistent with the long term investment objectives of the LTIP. The Finance Committee will set the foreign currency hedge targets and limits based on its assessment of international economic environment.

Currency hedging

52. The University is a long term investor and considers the following when determining its foreign currency exposure:
53. Maintaining a foreign currency exposure on the grounds of reducing overall volatility and risk. Unhedged portfolios are exposed to currency fluctuations, with foreign asset values decreasing if the AUD appreciates and increasing if the AUD depreciates.

• Inflation erodes the purchasing power of a currency. Subsequently, currency movements are influenced by central bank interest rate policies to curbe inflation. Hedging a currency exposure may enable the capture of the interest rate differential between the monetary policies of two countries.

Currency management

54. The Council, through its Finance Committee, approaches currency management in the following manner:

• the foreign currency exposures are considered at the total portfolio level;
• a dynamic approach is applied to managing currency exposure; and
• foreign currency assets are left unhedged where the cost or complexity of hedging is prohibitive, or if there is strong expectations that those currencies will appreciate over the medium to long term (for structural reasons rather than dynamic valuation reasons).

Risk management

55. The Council, through its Finance Committee, has regard for the various risks associated with currency management. The key risks of currency management include:

• market risk: the loss arising from movements in currency market movements;
• counterparty (credit) risk: the loss due to the default by a counterparty to meet its obligations under a currency transaction; and
• reporting risk: the University being unable to accurately ascertain the value of its foreign currency exposures in the LTIP.

Foreign currency exposure management

56. The table displayed below reflects the SAA foreign currency range for the LTIP. These target positions are intended as a guidance for decision-making and do not impose strict hedging requirements.

Dynamic currency management framework

57. The Finance Committee applies a dynamic approach to managing currency exposure with a view to achieving the objectives of currency management. The following factors are considered when determining changes in the levels of foreign currency exposures: economic conditions; valuations; and sentiment.
58. The suggested dynamic range for the foreign currency exposures for the LTIP is 0% - 75%.
59. The Investment Office achieves the desired foreign currency exposure through the following mechanisms, the:

• allocation to asset classes with foreign currency exposure and;
• level of currency hedging within asset classes with foreign currency exposure

Implementation

60. The Investment Office implements currency hedging within the ranges of the SAA (see the SAA table above). When desired, specialist investment managers with expertise in currency management are employed when active currency management in a hedging overlay structure is desired.
61. Currency management are undertaken using the Australian dollar as the base currency.
62. Currency management activities are limited to the establishment of an adjustment of long only positions of the Australian dollar. No net short positions of the Australian dollar are held.
63. Currency management activities have an absolute limit of 100% of the current market value as established by the custodian.
64. It is permissible to have different exposures in relation to individual currencies and the desired level of foreign currency exposure within the portfolio.

• For example, the desired level of foreign currency exposure for the LTIP could be 20%, however the exposure to the Japanese Yen on Japanese domiciled assets within the portfolio may be 100%.

Counterparties

65. Contracts are only established with counterparties with the highest credit rating of A1/P1 or better for short term payment ability. Approved counterparties and limits are established by the Director of the Investment Office with the initial approval of the Finance Committee and reviewed periodically.
66. The Director of the Investment Office notifies the Chief Financial Officer of any changes to either the approved Counterparty List and/or the respective limits within five business days.

Benchmark

67. The performance of currency management is applied against the strategic benchmark of the LTIP on a monthly basis.

Reporting

68. The custodian calculates and reports the month-end LTIP’s foreign exchange exposure and hedge ratio calculations each month on the sixth business day.
69. The Investment Office provides a portfolio valuations and foreign currency exposures, including hedge ratios to the Finance Committee at all meetings where Investments is on the agenda.
70. Foreign currency exposures are within tolerance limits previously approved by the Finance Committee at the time of reporting. Should the foreign currency exposure exceed the tolerance levels, the Investment Office is required to correct these levels within two business days.

Roles and Responsibilities

71. The Investment Office performs an independent check on the custodian’s foreign exchange exposure and hedge ratio calculations within two business days of receiving the custodian report.
72. The Investment Office executes foreign currency hedges under delegation (Number 461), not exceeding 10% of the underlying currency exposure in any one day. Finance Committee approves currency hedges in excess of 10% of the underlying currency exposure.
73. The CFO can also execute foreign currency hedges under delegation (Number 461), not exceeding 10% of the underlying currency exposure in any one day and can set a variance of +/- 10% in the target hedge position established by Finance Committee.
74. The Finance Committee sets target hedge ratios and can approve execution of foreign currency hedges of the underlying currency exposure with no limit.

Dynamic Asset Allocation (DAA)

75. The Council, on advice, may also from time to time adopt a medium term asset allocation tilts within the portfolio.
76. DAA decisions would be based on expected returns and risks from each of the asset classes and undertaken with a view to reduce volatility or with the aim of capital preservation in the portfolio. These decisions will be consistent with the Fund achieving its long term investment objectives.

Socially responsible investment

77. The University directly manages a large investment portfolio. The aim of the portfolio is to deliver a balance of risk and return within parameters determined by the University. Investment returns from the University’s investment portfolio support operational revenues, provide for payments on liabilities and underpin endowment mandates. In making these investment decisions, the University also considers its wider social responsibilities as an investor. To this end, the University has formulated a Socially Responsible Investment Policy.

Strategy review

78. The Council will formally review the investment strategy at least annually to gauge whether the agreed investment objectives and investment strategies remain appropriate.
79. The results of the review will be reported with any recommendations for changes, if considered appropriate. Any decisions to adjust the investment strategy will have regard to the financial condition of the University. A detailed analysis setting out the rationale for the change and the expected impacts will be provided.
80. Short-term fluctuations in the financial markets should generally not require an adjustment in the investment objectives, although changes to the investment strategy may need to be made from time to time. The following criteria may be considered, among other things, to determine the need for a change in the investment strategy:

• Significant changes in the long term social, political or economic environment;
• Emergence of new investment opportunities or a change in expectations regarding the achievement of the investment objectives
• Material change in size, business mix and complexity of the University; risk profile of the Fund, or in the Fund’s underlying assets; liquidity profile of the Fund; or legislative or regulatory requirements.

81. Depending on timing and severity, events relating to the above list of criteria may require an interim review of the investment strategy, the need for which will be determined by the Council on a case by case basis.

Investment Rebalancing

Investment rebalancing is important to maintain the risk-return characteristics consistent with the Strategic Asset Allocation and the Dynamic Asset Allocation. The LTIP is diversified across multiple asset classes to achieve a set of investment objectives over time within a defined risk parameter. The key objectives of rebalancing are:

• Maintain a high level of control over portfolio outcomes by regularly rebalancing the portfolio to the target asset allocation weights to achieve the stated investment objectives.
• Minimise the risk of unintended deviations from the target asset allocation in volatile markets that could result in unrewarded investment risks and unintended tracking error, relative to benchmark performance.
• Monitor portfolio liquidity and exposures to asset classes that have been impacted by significant market movements resulting in deviations from the target asset allocation.
• Consider transaction costs in portfolio rebalancing decisions to preserve the integrity of the SAA and DAA.

82. Rebalancing is an important mechanism to implement the investment strategy effectively and efficiently, achieve the targeted investment objectives, risk management and manage the Fund’s liquidity position. In doing so, the rebalancing strategy adopted takes into account the Council’s risk appetite against expected returns net of rebalancing cost, within the asset allocation rages of the Strategic Asset Allocation.
83. Rebalancing decisions made by the Finance Committee could require:

• additional allocation to the Fund's existing investment managers
• reallocation between existing investment managers in any one asset sector
• appointment and termination of investment managers

84. The Rebalancing Decision Making Process Map to summarise the decision making and implementation processes has been documented in Appendix A.

Implementation of the rebalancing strategy

85. A transition manager may be appointed where the Council deems it to be necessary for the efficient transfer of assets to manage the transition process in a risk controlled and cost efficient method, minimising explicit (commissions and brokerage) and implicit costs (bid-offer spreads and market impact). See Appendix B.
86. The Investment Office monitors the actual asset allocation against the SAA on a monthly basis to identify and monitor asset sectors that are within 1% of the SAA upper or lower ranges. This ensures that significant divergence from the SAA ranges are identified and resolved in a timely manner.
87. Rebalancing bands (or drift) of +/- 5% around each asset sector are set to reduce the frequency of rebalancing and transaction costs. These bands provide the flexibility to avoid frequent rebalancing, provided an asset sector has not deviated by more than 5% from its SAA or DAA weight. The drift range is not a hard limit but is monitored and asset allocation outside the drift range does not constitute a breach if the asset allocation is within the SAA ranges set by the Council.
88. If the actual asset allocation for any of the asset sectors excluding cash falls outside a drift range of +/-5% on a monthly basis, the Investment Office rebalances the asset sectors to the target range. Asset sectors could be rebalanced well before they have hit their 5% range limit. At other times, particularly in volatile markets rebalancing should be avoided unless asset sectors are significantly outside the 5% range limit. The Finance Committee is notified when the asset allocation goes outside the 5% range.
89. The execution of the rebalancing decisions may involve redeeming funds in sectors that are overweight to target allocation and investing the proceeds in asset sectors that are underweight relative to the target allocation. This is achieved by redeeming funds from external managers in sectors that are overweight and investing the cash proceeds with external managers in sectors that are underweight or deploying cash.

Rebalancing Factors

Transaction costs

90. Rebalancing strategy that involves a higher level of trading activities results in higher direct (brokerage) and indirect (market impact) costs. Market impact of the trading activities is dependent on market liquidity and the size of the trades to be implemented and could result in trading at disadvantageous prices during periods of extreme market volatility.

Operational Risk

91. The Fund minimises operational risk by not frequently rebalancing small imbalances that typically do not move the portfolio’s risk-return profile significantly away from optimality. Portfolio drift within the ranges endorsed by the Finance Committee that does not have a significant impact on portfolio efficiency are tolerated.

Illiquid investments

92. The illiquid nature of asset sectors such as private equity, infrastructure and real estate restricts the ability to maintain the risk return profile of the target asset allocation. This means that the risk-return profile increases overall portfolio risk if illiquid assets outperform liquid assets for extended periods of time. The policy is to proportionately share the underweight or overweight to such illiquid assets across all LTIP unit holders.

Investment Distribution

Distributions are made quarterly from investible funds entrusted to the University for their beneficiaries. The key objectives of distributions made from the University’s investments are:

• To balance the goals of asset preservation and budget stability against intergenerational equity, ensuring that the University’s current needs are met without compromising its future monetary needs.
• To ensure the sustainability of endowments to achieve their mission over the full extent of the desired time horizon.
• To achieve an impactful (maintaining utility) distrution for beneficiaries and facilitate a robust budgeting process.
• To maintain the real value of contributions received and to grow the overall size, allowing for increased earning available to beneficiaries.

The distribution parameters determine the distribution to unitholders of LTIP. The University is assisted in this endeavour through a triannual review of the Strategic Asset Allocation (SAA) of the LTIP. The SAA anchors the LTIP investment strategy. The SAA decisions dominate the investment outcome. In determining the SAA for the LTIP, modelling is undertaken by external asset consultants to balance risk and return to maximise the probability of achieving the stated objectives.

93. The triannual review determines if the SAA is capable of supporting the existing distribution rate, while being consistent with the Council’s risk appetite expressed as the target investment return (CPI + 3.5% over a 7-year period) and the target risk (one negative year in five years).
94. In setting the distribution strategy, the Council recognises that a distribution model which consistently distributes less than the real return on the fund will, over time, accumulate significant real market value. The build-up of capital value of the portfolio will significantly increase the benefit to future generations at a cost to the current generation.
95. To minimise the (generational) impact, the annual distribution rate is based on a rolling three-year asset balance of the LTIP at 31 July of each given year.
96. In setting the distribution strategy, the Council recognises that the objectives of unit-holders are intentions and that they may not be achieved in any particular time-frame.
97. In taking decisions on the distribution strategy, the Council will have regard to the overall circumstances of the portfolio as well as the particular circumstances pertaining to the University, and will comply with all applicable legislative requirements.