Step 4: Strategy formulation and selection builds specificity and substance to the investment principles created in step 3.

It is a highly iterative set of three sub-steps:

4.1 Ambitions and criteria

  • Set specific ambitions, and define the criteria for evaluating whether they have been met.

4.2 Scenarios

  • Create scenarios describing potential strategies, by combining options of where to focus (e.g. which asset classes, industries, geographies) and of how to succeed (e.g. sourcing options, active vs. passive management).

4.3 Selection

  • Evaluate strategy scenarios against the ambition criteria, rank them, and when satisfied select an investment strategy. In many cases none of the initial scenarios will meet all criteria. This will lead to repetition and re-examination of earlier steps until a recommended investment strategy emerges.

4.1 Setting the ambitions and criteria

Ambitions are derived from and underpin the principles (and in turn therefore, the mission). They provide the level of specificity required to set criteria against which potential strategy scenarios can be evaluated and ranked.

They will include terms that are financial (such as achieving a particular funding ratio or growth target) and, potentially, terms that lie beyond immediate financial considerations (such as providing wide beneficiary well-being satisfying long term societal as well as financial aspirations, or aligning the investment portfolio with the low-carbon future to ensure sustainability for beneficiaries).

Criteria should preferably be measurable, including those that relate to ESG considerations, and should have enough obtainable information to allow meaningful differentiation across scenarios. Where criteria reference a financial benchmark, the right benchmark will be needed for steering performance and reporting to stakeholders at a later stage.

Ambitions and their criteria may go beyond the direct outcome of the investments to include elements such as operational metrics and organisational capabilities (e.g. attractiveness of the strategy to talented professionals).

Examples

AMBITIONCRITERIA

Target funding ratio

X

Outperform benchmark

X% above Index Y

Achieve growth target

X% per year

Increase economic development in our country/region

X%

Support younger generations

Top X for people under Y

Reduce carbon footprint

X%

Topics to consider

  • What risk and return are you targeting? Absolute or relative to a particular benchmark?
  • Do you want to outperform your peers? By what amount?
  • What is your preferred investment horizon?
  • What is the cost required to execute (e.g. is active management prohibitively expensive)?
  • What is your ability to execute (e.g. fit with the skills/competencies of your organisation)?
  • Is positive impact on people and/or the planet a primary or secondary objective?
  • In which mainstream domains and which ESG or impact areas do you want to excel?
  • What quantifiable benefits will you create for your beneficiaries/customers other than financial returns (e.g. regional development, CO2 emission reduction)?
  • Are you trying to align with any specific views from beneficiaries/customers (e.g. a healthcare pension screening out tobacco investments)?
  • What level of investment in specific impact themes do you want to have?
  • What is your timeframe for impact?
  • Do you want to be a meaningful active owner?

  • What stakeholder needs are you looking to address (e.g. being an attractive organisation for talented professionals)?

  • How well aligned is the scenario your mission statement?
  • How well aligned is the scenario with future compliance considerations?
  • Other…

4.2 Creating strategy scenarios

To create investment strategy scenarios to evaluate, you will select combinations of where you want to focus and how you plan to succeed, along with relevant metrics.

To illustrate the scale and complexity of creating scenarios, consider that the universe of options for where to focus is the full range of investment allocations across: asset classes, sectors, geographies, type of funds, fund strategies, time horizon, size of investment, size of stake relative to others and more. Your investment strategy considerations thus far should guide your thinking on what will be a manageable number of scenarios to consider.

Many scenarios will be immediately unsuitable due to your investment principles, and others will be rejected when further tested against your ambitions (e.g. an ambition to avoid carbon-intensive investments will most likely disqualify choices that has a significant asset allocation in the oil and gas sector; an ambition to avoid large volatility will disqualify any choice with significant VC-investment).

The remaining scenarios will be then be ranked. Ideally, each possible scenario will be run through an evaluation that will include a financial model, risk model, and, possibly, a real-world impact model. The depth and complexity of these models is an additional, important choice.

The result will be a final investment strategy that can be approved.

Topics to consider

WHERE TO FOCUSHOW TO SUCCEED

Below we’ve listed a suggested range of options to consider. Your criteria may restrict the choices under consideration, leading to some of the possibilities being immediately unsuitable.

  • What is the range of investment opportunities to consider, and which options are favoured?
    • Asset classes (e.g. debt, equity, ETFs, currencies, alternatives like real-estate, infrastructure, commodities, private debt/loans)
    • Sectors (e.g. consumer goods, financial services, healthcare, energy, utilities, basic materials, industrials, tech, telecom) and sub-sector – which to overweigh, which to blacklist?
    • Geographies (region, country)
    • PE & VC funds (e.g. growth, early-stage, real-estate, mezzanine, LBOs, distressed)
    • Hedge funds and fund strategies (e.g. quant, arbitrage, event driven, global macro, directional)
    • Type of investment (e.g. fund of funds, multi-asset funds, targeted funds, individual equities, individual debt offerings, co-investment, strategic, direct ownership)
    • Time horizon (<5 years, 5-10 years, 10-20 years, >20 years)
    • Individual investment size ($M, % of portfolio)
    • Ownership stake (<1%, 1-5%, 5-20%, 20-50%, 50-100%)
  • Which choices will contribute most to achieving your targets?
  • What are the right attributes/characteristics (return, types of risks, etc.) for each investment opportunity?
  • What are favoured options in the overall portfolio of various investment opportunities to be considered, and why?
  • Which choices will contribute most to achieving your ambition? How are portfolio characteristics being valued (e.g. risk diversification)?
  • Where are the largest capital needs, from an economic point of view and an impact point of view?
  • Are there new vehicles that could be explored to expand the range of options (ESG-related examples: green bonds, equity linked to success on an impact theme)?
  • Other…

Each scenario will include a combination of several asset allocations. The level of granularity required will vary, but should be sufficient for you to evaluate and compare the scenarios. 

The appropriate operating model is critical and the organisation’s internal capabilities (reviewed back in Step 1: Context) will guide your decisions here. 

  • To what extent will you out-source investment management or manage investments in-house, now and in the future?
  • Active or passive management (for selecting investments)?
  • Active or passive ownership (i.e. engagement with investee companies)? What level of engagement?
  • What partnerships could be created to maximise returns?
  • What is your approach to scale and cost?
  • What are your objectives on transparency and/or reporting?
  • How much innovation do you want to finance? How patient is your capital?
  • What partnerships could be created to maximise the positive impact of an investment (e.g. other asset owners/investors, public/private groups)?
  • What types of engagement are most suitable for you? In which situation will engagement be used to improve financial returns or to improve positive impact?
  • Will the future asset owner professional combine both financial analysis and ESG analysis or are these separate skills?
  • Other…
Example of a How to succeed consideration: comparing management options
  IN-HOUSEOUTSOURCED
Active
  • In the long run, active management outperforms passive management returns.
  • I have the volume, expertise and capabilities to manage the required investments at a better cost than through a third party, for a comparable return.
  • In the long run, active management outperforms passive management returns.
  • An experienced third party will provide me with the right performance at a better cost.
Passive
  • In the long run, passive investment outperforms active management returns.
  • I have the volume, expertise and capabilities to manage the required investments at a better cost than through a third party, for a comparable return.
  • In the long run, passive investment outperforms active management returns.
  • An experienced third party will provide me with the right performance at a better cost.

4.3 Selecting an investment strategy

Finally you will evaluate the scenarios against everything the organisation has learn about itself in the process. This is an intensive period where hypotheses are set and multiple analyses are done as the hypotheses are run through models to test the viability of outcomes.

Board-level involvement

The process is now moving towards implementation and execution mode, and the executive is likely to take an increasing role with the board’s active participation pared back to oversight and governance. The board may retain a significant role, for example via specific sub-committees.

Often one or more criteria will not be met by a scenario put forward and it may be necessary to move back a step, either creating a new set of scenarios to evaluate, or adjusting your ambitions or criteria. Each constructed scenario will be run through a financial model, a risk model and possibly an ESG impact model. You will need to decide the appropriate features, depth and complexity of the models based on your ambition and criteria.

The scenarios will be ranked and those coming out on top may be further evaluated using more advanced tests, including stress tests covering deviations from expectations in the market, general economy, internal factors (e.g. capabilities for internal active ownership) and ESG trends, (e.g. climate scenario analysis as recommended by the Financial Stability Board’s Task Force on Climate-related Financial Disclosures).

If this leads to an unacceptable outcome, another round of iteration may be required, until an investment strategy is established that fits your vision, mission and investment principles, qualified by your ambitions and criteria.

Actions and roles

  1. Project sponsor to hold one or more workshops with the investment committee, CIO, and project lead to set ambitions and criteria from the approved investment principles.

  2. Project lead to present the recommended ambitions and criteria for board approval.

  3. After sign-off, the working group will prepare and evaluate scenarios.

  4. Project sponsor and project lead present recommended scenario for board discussion.

  5. At the next board meeting, board approves/signs off (or sends back to working group for further analysis).

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