The most important component of the pension governance cycle is the development of prudent investment policy guidelines. The ultimate objective of this process is to establish an effective investment strategy while implementing control mechanisms that help limit risk to an acceptable level.

But what is an ‘acceptable’ level of risk? How should plan sponsors set the metrics around a specific mandate? And how can they accurately gauge whether a manager is truly adhering to a given strategy and not carrying excessive risk?

By examining detailed information from Canadian pension universes from over the past three years, Canadian pension plans can find the answers to these questions.

For example, the table “Pension plans over $250 million” provides a snapshot of various universe characteristics for Canadian pension plans of this size. The first column shows that as of December 2005, the maximum deviation from the index for modified duration was approximately three years. Based on this information, it would have been quite unusual for a manager to deviate from the index duration by more than three years, meaning any such deviation should precipitate warning bells.

This universe data also makes it possible to assess the performance of a plan’s managers, by comparing their value added with the median and range within their style group. The second column shows the fouryear value added of Canadian equities portfolios with a value bias. Since the median value added was 2.45% per year, it would therefore be reasonable to base one’s valueadded expectations on this achievable result.

The universe data also provides trustees with insight into plans’ foreign equity allocations. The third column in the accompanying table indicates that roughly a quarter of such plans were just about to exceed the former foreign content limit in September 2005. This indicates the foreign property rule was no longer a true guide for large players.

By establishing specific targets or metrics around the manager mandate, governance can be effectively made more transparent and the monitoring process more straightforward. This allows for more frequent monitoring and better plan oversight on the part of the sponsor. The key is to strike the right balance between the latitude managers desire and the point at which this latitude significantly increases the risk assumed by the plan.

The data from these Canadian pension universes can provide plan sponsors with key insights into what’s happening in the markets, what investment decisions their peers deem to be ‘reasonable’ and what risk level they consider unacceptable. Used effectively, these pension universes can serve as the maps and compasses that can help Canadian pension funds safely navigate the sometimes volatile waters of institutional investing.

Christian Lachaussée is with BENCHMARK, the investment analytics arm of RBC Dexia Investor Services in Montreal. Christian.Lachaussé