Monitoring external equity mandates : the design of a tool to create exposure graphs for a pension fund

At the end of 2008 the equity department of the Grafische Bedrijfsfondsen (GBF) was going to replace the Altis tool that was used to keep track of the way investments were done. Therefore the department was in need of a suitable substitute. This decision of replacement was the starting point of this project. The decision itself is therefore not part of the final assignment which was as follows: Develop a quantitative tool that enables GBF to compare the relevant characteristics of its portfolios with those of their benchmark. Relevant is defined as being both acknowledged by GBF as important and accepted in literature as explanatory. The report is structured around five research questions. The findings will be summarized here together with the corresponding question. In which environment and in what way will the tool be used? The new tool, which will be named RIMOR, will be used solely by the equity department of GBF. Its purpose will be the monitoring of the investments of the portfolio managers. What functionalities should the tool have? The new RIMOR tool needs to be flexible, up-to-date and should produce graphs that compare the characteristics of the portfolio holdings with those of the benchmark holdings. What are the relevant characteristics? Relevant characteristics enable GBF to see whether the investments are in compliance with its guidelines. These guidelines state that the stock portfolio’s characteristics have to match the characteristics of their benchmark as closely as possible and that stock selection should be the primary source of alpha. Carhart’s Four Factor Model is combined with the factors sector and country. The characteristics that are able to depict these factors are Beta, Market Capitalization, country, sector, industry group, Price/Earnings ratio using the Bloomberg next year’s estimated earnings per share and 1 Year total return in percentages To be able to see whether a manager actively manages his portfolio, a module for Active Share is added. What is an efficient way to build the tool? Visual Basic for Excel is chosen as the programming language since it is cheap, easy to maintain and compatible with other applications that are being worked with at the equity department. Because evolutionary prototyping is used as the design method, the users are closely involved in the process. Two kinds of tests are used, chauffeured tests and full user tests. Testing resulted in the addition of a dividend yield and a long term growth indicator. How to familiarize future users with the new tool? To provide new users, now and in the future, with the opportunity to get to know the RIMOR tool a manual is written. This document consists of two main parts. One part explains how to use the tool in daily business and the other explains how it can be altered when requirements change in the future. One person will be in charge of maintaining the tool in the future. A workshop was organized for him where the whole tool and the manual were discussed extensively. The final result is the RIMOR tool. It enables GBF to keep track of the under- and overweights of its investments with respect to preselected indicators that represent important return drivers. The indicators that RIMOR uses can be altered to meet changing needs. By grouping the graphs on one sheet per region or portfolio, a good impression of possible style drifts can be obtained. The addition of the Active Share option completes the spectrum of checks. Together the graphs and the Active Share table enable GBF to monitor the external managers on both angles of the guidelines. ~ 4 ~ In combination with the rest of the available software GBF has access to full range of information on its investments To improve the RIMOR tool even further the following recommendations are made;  To keep the indicators up-to-date, the development of new strategies should be closely monitored.  Creating an option to select or disable some regions or indicators would improve the tool’s speed.  Being able to get historical information would be a major improvement Although there is still room for further improvements it can be concluded that the RIMOR tool is a product that meets all requirements. It has been implemented to the satisfaction of everybody at GBF and it is being used in the daily business processes.