VictorianFunds ManagementCorporation

Restrictions on Pension Investing:An Australian Perspective

2008 06 04 ICPM

Leo de BeverChief Investment Officer Victorian Funds Management Corporation

Australian Pension System

No Public Plan (e.g. Canada Pension Plan)

Required pension savings 9% of salary Contributions taxed at 15% instead of marginal tax rate Fund income taxed @ 15%, capital gains @10%,

dividend tax credit is deductible from taxes Tax Free withdrawals on reaching age 60

Incremental growth largely in DC “super funds” Small size generally means high management costs

“Do it yourself” accounts (e.g. Canadian RSPs) have >1% overhead for balance <A$200,000

Audit fees can be $2000 or more

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Australia Pension Savings: Global Context

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High Growth Rate of Pension Assets

4

5

Only Top 25% of Funds Have Index Returns

100%

120%

140%

160%

180%

200%

220%

240%

260%

280%

Jun-97 Jun-98 Jun-99 Jun-00 Jun-01 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07

VFMC Passive Benchmark +1%

VFMC Passive Benchmark

VFMC Actual net of 6% effective tax and fees

Intech upper quartile

Intech median growth fund

An extra 1% above index for 10 years would have been stellar

Investment Costs Fall With Asset Size

6

Better Australian Retail Funds

Australian Super

Victorian Funds Management Corp Alberta Inv Mgt

OTPP

Funds Merging, More Individual Accounts

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Source: Australian Prudential Regulatory Authority (APRA)

Larger Funds Have Greater Return Potential

Tend to have better systems that can assist with better implementation

Risk management Cash management Implementation error detection

Larger funds make better investment partners Better internal staff Access to better alternatives on better terms

Cooperation with other funds can be substitute Requires strong alignment, similar decision process

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What It Takes to Be Exceptional

Independent Board Must be willing to help push boundaries of comfort

Empowered internal investment team Quality and pay must be commercially competitive Pragmatic internal - external management balance

Focus on maximising return/risk We are risk managers more than asset managers

Long term investment horizon Willingness to invest in unusual opportunities

Doing the basic better Strong risk and back office systems

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Better Mix of Internal – External ManagementOntario

Teachers’2006

Victorian Funds Management Co

2006

Investment staff Salaries ~2 bps ~1 bps

STI and LTI in bps of assets ~10 bps ~1 bps

External Fees (includes embedded fees) ~3 bps ~35 bps

Total Investment Costs ~15 bps ~37 bps

% managed externally ~10-15% ~100%

IT ~3 bps ~0.5 bps

Rent, Legal, Financial, Compliance, Custody, etc

~4 bps ~4bps

Total Investment cost bps ~22bps ~42bps

Value added/Assets last 5 yrs ~4% none

Assets Under Mgt AUD$110B AUD$40

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Asset Allocation Issues

Home country bias still strong Dividend tax credits used as justification

“Endowment envy” encourages uncritical imitation of what worked in the nineties

Taking big risks in inefficient markets had a payoff

Tendency to fill alternative asset class buckets Not enough focus on managing return/risk

May need to create new alternatives Also should not disregard traditional assets

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Only Long Term Focus Justifies Short-Term Risk

1 in 6 Worst Outcome 1 in 100 Worst OutcomeAnnual 4000 10.0% 12000 30.0%Monthly 1155 2.9% 3464 8.7%Weekly 553 1.4% 1658 4.1%Daily 250 0.6% 750 1.9%Hourly 88 0.2% 265 0.7%

VFMC Risk Profile at $40 Billion

Most Shareholders and Boards want good long term resultsAs long as it does not interfere with making money in the short run

Expected long-term payoff from taking risk 2.5% / year

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Governance Challenges

Independence of Boards not always clear Public sector: shareholders control strategy, regulation DC Funds: Consultants support “blame avoidance”

regime

Boards often act like management Few funds have strong internal investment team VFMC is one of handful of exceptions Funds lack the scale for internal management possible “Manager of Manager” model costly

Freedom to switch funds creates peer pressure,encourages short-term management horizon

Practical significance of clients moving is questionable A good management team would stay the course

Other Systemic Issues

Pension adequacy Low average savings balance for larger % of

population Saving 9% of salary is not enough

DC lack of Longevity insurance implicit in DB Funds are discussing collective insurance Not clear clients would be willing to pay

Lump sum distributions out of DB plans At 54 years and 11 months

Fear of legislative change E.g. tax free withdrawals at age 60

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Direction of Change

Fund Consolidation Best thing trustees can do in many cases is vote

themselves out of a job

Fewer, stronger and more independent Boards Need more degrees of separation

Stronger internal teams empowered to act Better delegation from the Board

More cooperation among funds on alternatives Industry fund efforts have not been totally effective

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