1. Victorian Funds Management Corporation Restrictions on Pension Investing: An Australian Perspective 2008 06 04 ICPM Leo de Bever Chief Investment Officer Victorian Funds Management Corporation

2. 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 2

3. Australia Pension Savings: Global Context 3

4. High Growth Rate of Pension Assets 4

5. 5 Only Top 25% of Funds Have Index Returns An extra 1% above index for 10 years would have been stellar

6. Investment Costs Fall With Asset Size 6 Better Australian Retail Funds Australian Super Victorian Funds Management Corp Alberta Inv Mgt OTPP

7. Funds Merging, More Individual Accounts 7 Source: Australian Prudential Regulatory Authority (APRA)

8. 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 8

9. 9 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

10. 10 Better Mix of Internal – External Management Ontario 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 Total Investment cost bps~22bps~42bps Value added/Assets last 5 yrs ~4%none Assets Under MgtAUD$110BAUD$40

11. 11 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

12. 12 Only Long Term Focus Justifies Short-Term Risk VFMC Risk Profile at $40 Billion Most Shareholders and Boards want good long term results As long as it does not interfere with making money in the short run Expected long-term payoff from taking risk 2.5% / year

13. 13 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

14. 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 14

15. 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 15