Presentation by Kees Koedijk. Professor of Financial Management and Dean of the Tilburg School of Economics and Management, held on June 8 at an ICPM conference in Toronto. Also visit the website www.investmentbeliefs.org

1. Investment Beliefs That Matter
Kees Koedijk
June 8, 2010

2. Investment Beliefs
• Questions…
> Is the equity premium dead or alive?
> How long should long term horizon be
> Does active management pay off
> …
• … pension funds and investment managers deal with
day in day out
• Answers…
> Are difficult to give. Investing is not a hard science
despite the econometric advances
> depend on what you believe and matters for you

3. Investment Beliefs
• But…
> If investment results influence the success or failure of pension
funds
> And investment choices are (partly) based on beliefs
> Then thinking about, embedding and evaluating the
consequences of investment beliefs are important to pension
fund governance
• Seminal work
> Ambachtsheer (2007): “We need a new lens. Its components
are a set of investment beliefs grounded in good theory and
confirmed by real-world experiences, … an integrative
investment model ….[and] a decision making protocol ”
> Raymond (2008): “Without this shared understanding [of
investment beliefs], the daily decisions made by investment
professionals throughout and organization likely imply a
incoherent set of investment beliefs”
> Urwin and Clark (2008) Best practice funds share “strong
investment beliefs commanding fund-wide support that align
with goals and informs all investment decision-making”

4. Nice to know which one to adhere to

5. Outline for today’s presentation
• Investment Beliefs: a recap
• Earlier research
• Research set up & findings
• Discussion

6. Beliefs = Governance Tool Kit
• Investment management
> Investment managers need an investment process in sync
with theory (Damodaran)
> Upward potential for good governed pension funds
(Ambachtsheer), best governed pension funds focus on
coherence, process and people (Roger and Urwin)
• Strategic Management Similarities
> Companies have to articulate their vision and strategy
(“USPs; proposition) for their client(s)
> Especially in markets where different visions co-exist
• If not
> It becomes difficult for trustees to evaluate new
developments, and whether to embed them in their own
strategies
> More likely to “join the herd”, increasing costs and
opportunity costs along the way
Investment Beliefs:
A Recap
Earlier
Research
Research Set Up &
Findings
Discussion

7. Set up
Investment Belief Theory Investment Strategy Organization
Investment Beliefs:
A Recap
Earlier
Research
Research Set Up &
Findings
Discussion

8. Grouped investment beliefs
Financial Markets beliefsFinancial Markets beliefs
•Risk premium
•Risk diversification
•(In)efficiencies in financial markets,
asset pricing
•Horizon
•Risk premium
•Risk diversification
•(In)efficiencies in financial markets,
asset pricing
•Horizon
Investment process beliefsInvestment process beliefs
•Impact, focus on management decisions
•Risk management
•Investment management style
•Costs
•Impact, focus on management decisions
•Risk management
•Investment management style
•Costs
Sustainability and GovernanceSustainability and Governance
•Sustainability and Corporate
•Governance in asset pricing
•Role in investment process
•Sustainability and Corporate
•Governance in asset pricing
•Role in investment process
Organizational beliefsOrganizational beliefs
•Teams, role of investment managers
•Out vs. insourcing
•Experience
•Teams, role of investment managers
•Out vs. insourcing
•Experience
Investment Beliefs:
A Recap
Earlier
Research
Research Set Up &
Findings
Discussion

9. Multiple beliefs & investment governance
Investment Beliefs:
A Recap
Earlier
Research
Research Set Up &
Findings
Discussion

10. Research Questions
• Steps so far
> 2007: Explicit beliefs &
small sample
> 2010: Implicit beliefs &
large sample; ICPM
sponsored Research
• Relationship between investment beliefs (structure) and
performance
• More insight into best practices
Investment Beliefs:
A Recap
Earlier
Research
Research Set Up &
Findings
Discussion

11. 2007: Explicit & Small
• Survey for explicit, published beliefs
• Small group identified (ICPM members!)
• Clustering beliefs, correlation measures with performance
• 2000-2006
• Results
> Pension funds and asset managers differ
• A pension fund focuses on risk diversification, getting its beta right.
• An asset manager stresses the role of risk management and argues for a
particular investment style. Asset managers emphasize the quality of
their organization.
> Beliefs influence performance
• An organization with investment beliefs on risk diversification shows
better return-risk performance, but also lower costs.
• Funds that hold a clear view on how risk management is organized,
usually in combination with a view on the management style, realize
higher alpha and return/risk ratio’s than funds that do not hold such
views.
Investment Beliefs:
A Recap
Earlier
Research
Research Set Up &
Findings
Discussion

12. 2010: Implicit, large sample
• ICPM Sponsored Research to follow up
> Can earlier findings be replicated in a broader setting?
> Interrelationships between investment beliefs and
performance measures; integral approach
• CEM Database
> Unique dataset in the pension fund industry: in scope,
depth and longitude
> Nr funds over 600; period extends to 1992-2006
Investment Beliefs:
A Recap
Earlier
Research
Research Set Up &
Findings
Discussion

13. Research Approach
1. Distill investment beliefs
> Ideal situation: survey trustees about investment beliefs
> Alternative approach: Deduce investment beliefs from
realized actions
1. Find variables that match investment beliefs
2. Analyze relationship between investment beliefs variables and
performance measures (Fama & French)
3. Analyze relationship between investment beliefs variables and
performance measures (Panel data)
Investment Beliefs:
A Recap
Earlier
Research
Research Set Up &
Findings
Discussion

14. Deduce Investment beliefs
• Literature review & data analysis suggest that following debates
can be incorporated into the research
Investment Beliefs:
A Recap
Earlier
Research
Research Set Up &
Findings
Discussion
Debate Stylized Investment Belief Example
1. Long term
investing
Long holding periods allow investment in assets with
higher risk premiums.
2. Diversification Diversification is the only ‘free lunch’ in investment
management. Larger funds can realize additional
diversification advantages.
3. Active
Management
With the right skills, resources and process, an
investor should be able to create excess returns with
active strategies.
4. Costs Costs are certain and a drawn down on net returns.
Future returns are uncertain.
5. Organization Access the right skills by combining internal and
external management, lowering principal-agent
costs.
6. Innovation Exploit the early adapter advantage, moving into new
markets or strategies that other investors cannot,

15. Results (1): ranked portfolios
• Lower costs related to higher excess returns & return/risk
• Some variables increase excess returns, as well as return/risk:
> the share of equities,
> the share of illiquid investments
> the share of internal investments.
• More portfolio diversification is associated with a higher return-
risk ratio.
• The share of active management increases five-year excess
returns, but it does not improve the return-risk ratio.
Investment Beliefs:
A Recap
Earlier
Research
Research Set Up &
Findings
Discussion

16. Results (2): panel data
• More diversified portfolios tend to report higher excess
returns.
• Costs do not play a significant role, which is surprising
given previous results.
• Strategies with higher costs do not affect net returns,
although they do increase risk
Investment Beliefs:
A Recap
Earlier
Research
Research Set Up &
Findings
Discussion

17. Combined analyses suggest
Investment Beliefs:
A Recap
Earlier
Research
Research Set Up &
Findings
Discussion
Debate Stylized Belief Research Results
1. Long term
investing
Long holding periods allow
investment in assets with
higher risk premiums.
Share of illiquid and alternative
assets has explanatory power for
returns, no effect on a risk-
adjusted basis.
2. Diversification Larger funds can realize
additional diversification
advantages.
Increased portfolio diversification
is associated with higher return-
risk ratios.
3. Active
Management
Funds should be able to
create excess returns with
active strategies.
Overall, funds tend to earn
positive excess returns, but not on
a risk-adjusted basis.
4. Costs Costs are certain; future
returns are uncertain.
Costs play an important part in
explaining total returns and risk-
adjusted returns.
5. Organization Combining internal and
external management lowers
principal-agent costs.
Internally managed portfolios have
a positive impact on returns and
return-risk.
6. Innovation Exploit the early adapter
advantage, moving into new
markets or strategies
We find indeterminate results of
first-mover advantages into new
assets.

18. Investment Beliefs and Size
• Potential to exploit for example illiquidity, costs and
diversification is also related to size
• The optimal size of a pension fund is a heated debate in
many countries
• General trend: further consolidation
• Size therefore taken into account in analyses.
Investment Beliefs:
A Recap
Earlier
Research
Research Set Up &
Findings
Discussion

19. Size creates economies
• Size–performance relationship generally accepted for pension
funds
• Framed in our research: investment Beliefs integral part of good
pension fund governance (Ambachtsheer; Raymond; Clark &
Urwin)
• Good pension fund governance leads to better performance
(Ambachtsheer)
• Size lowers costs, frees up resources for better pension fund
governance
• Positive relationships between size, investment beliefs (as part
of) investment governance, and performance.
+
+
=>
Investment Beliefs:
A Recap
Earlier
Research
Research Set Up &
Findings
Discussion

20. Results suggest potentially diseconomies as well
Investment Beliefs:
A Recap
Earlier
Research
Research Set Up &
Findings
Discussion

21. Investment beliefs then make sense on either end of
the scale
• Pension funds at the lower end of the size scale
> Higher margin of error in their strategic choices. A pension
fund must make clear choices or risk overstretching its
resources, thereby creating monitoring risks.
• Large pension funds
> Size can generate incentives that may diverge from the
pension fund’s objectives. Size also requires a clear vision
on where to add value if the size of the fund leads to a
market impact
Investment Beliefs:
A Recap
Earlier
Research
Research Set Up &
Findings
Discussion

22. IBs essential part of governance
kit
• Summarizing
1. Investment beliefs address strategic choices in the
investment philosophy and process that affect the future
performance of the fund.
2. CEM data from over 600 funds between 1992 and 2006
show that the debates in the pension fund industry address
the relevant issues: active management, alternatives and
new, innovative strategies.
3. The addition of these activities does not necessarily improve
the overall performance of a fund, and it may eventually
offset the fund’s cost and net returns advantage due to its
size.
4. Beliefs to which a fund adheres affect its success; the
thorough consideration of the relationships between beliefs
is equally important.
Investment Beliefs:
A Recap
Earlier
Research
Research Set Up &
Findings
Discussion

23. Follow up research
• Potential (dis)economies: Larger pension funds are well
positioned but do not always seem to be able to exploit
beliefs
• Case studies planned for the governance process,
choices made by large funds
• More research in the role of external advisors, role
investment committees

24. The End