Trust Funds

Statement of Investment Objectives and Guidelines - Long Term Funds

1 Introduction

The purpose of this Statement of Investment Objectives and Guidelines (this Statement) is to set forth the key considerations and policies that will govern the investment management of the assets of the Trust Funds Principal-Long Term Fund (the Fund). The Business, Finance, and Audit Committee of the Board of Regents (the Committee) shall be empowered to ensure that the Fund's financial practices are consistent with this Statement. This document will be reviewed regularly and revisions will be made, if warranted.

If at any time an investment manager feels that the objectives cannot be met, notification in writing should be sent to the Assistant Trust Officer. By initial and continuing acceptance of these Objectives and Guidelines, the manager concurs with the provisions of this document.

1.1 Investment Policy

The overall investment policy shall be to manage Fund assets in a prudent, productive manner in accordance with provisions of pertinent Wisconsin statutes governing the investment of these Trust Funds. (Sections 36.29 and 881.01 Wis. Stats. and Regent Resolutions 695, 1590, 1615 and 7406 are attached.) The investment managers shall seek to increase the aggregate value of the assets under management while conscious of the need to preserve asset value. Excessive volatility in fund asset values is to be avoided. Reasonable consistency of return is expected on a year-to-year basis although the Board of Regents recognizes the inherent volatility of securities markets on a short-term basis.

Since consistency of return and protection against loss of capital are of prime importance, the Fund is to be managed to limit downside risk. An important implication of this policy pertains to the use of derivative securities. Since a derivative security offers a wide array of payoffs, there is the potential for extremely undesirable investment outcomes that conflict with the overall investment policy. To mitigate the chance of a policy violation, the use of derivative securities is limited to the specific investment vehicles and strategies authorized by these guidelines.

In an effort to address the issue of risk, certain concerns have been identified, including but not limited to: potential loss of capital, volatility of returns, default or bankruptcy, liquidity, diversification, and leverage. To a varying degree, each of these concerns is addressed implicitly or explicitly in different sections of these guidelines, but for clarity, they are summarized as follows:

  • Capital Loss Preservation of the value of capital (in real terms) is of major concern regardless of whether price action is due to the market, a sector or a particular issue - and whether based on technical or fundamental considerations.

  • Volatility Portfolio exposure to such volatility is expected to be limited as a reflection of the need to preserve capital and achieve consistent returns.

  • Default Only securities of financially sound companies are expected to be used in a portfolio.

  • Liquidity Portfolio positions should be issues that are publicly traded in sufficient volume to facilitate, under most market conditions, prompt sale without severe market price effect.

  • Diversification The portfolio is to be well-diversified such that no single catastrophic outcome in a single security will compromise the capital preservation objective. Concentration in any one issue, issuer, industry or geographic area is to be avoided.

  • Leverage Under no circumstances shall the portfolio employ leverage.

1.2 Investment Objectives

The investment objectives for the total fund are to provide real return/investment return net of endowment spending plan distribution over an extended period of time. For evaluation purposes, the achievement of the Funds' performance objectives will be measured over a four-year time period, a period generally representative of a full investment market cycle. The four-year measurement period shall be computed on a 48 month moving average basis.

The following performance goals are set forth:

  • First quartile relative performance to the NACUBO (National Association of College and University Business Officers) universe.
  • Total investment performance over a four-year period should exceed the percentage change in the GDP Fixed Weight Price Deflator plus the Endowment Spending Plan distribution rate (currently five (5) percent).
  • The equity investment return over a four-year period should exceed the performance of the relevant benchmark plus two (2) percentage points.
  • The fixed income investment return over a four-year period should exceed the performance of the relative benchmark plus 100 basis points.

2 Portfolio Guidelines

2.1 Asset Classes

The following asset classes and approved derivative securities on those asset classes are permitted investment vehicles:

  • Equity-oriented Vehicles
    • Domestic Large Capitalization
      Common Stocks
    • Domestic Small Capitalization Common Stocks
    • International Common Stocks
    • American Depository Receipts (ADRs)
    • Domestic Preferred Stocks
    • Convertible Bonds
  • Fixed Income-oriented Vehicles
    • US Government Notes and Bonds
    • US Agency Bonds
    • Mortgage-backed Securities
    • Asset-backed Securities
    • Corporate Bonds
    • Cash Equivalents

Managers may request (in writing to the Assistant Trust Officer) that the Committee change the list of approved investment vehicles at any time.

2.2 Asset Mix Policy

There will at all times be a Fund asset mix policy expressed in terms of policy weights; these policy weights will be reviewed at least once per year. The investment return on the passively implemented policy asset mix will be calculated as the investment return on an appropriately weighted blend of the following benchmarks, which represent the permitted asset classes described above:

  • Standard & Poors 500 Index
  • Russell 2000 Index
  • MSCI Non-US Equity Index
  • Lehman Aggregate Bond Index
  • Lehman International Aggregate Bond Index
  • The appropriate weighted blend will be based on the asset mix established by the Committee and updated each year.

2.3 Asset Management Decentralization

Management of the Fund will be decentralized through the hiring of specialized investment managers. More than one manager may be retained in each group.

Over the four-year investment horizon, the specialized investment manager's investment return should exceed the investment return of the benchmark plus an appropriate active management premium with risk (as measured by the standard deviation of return) no greater than the benchmark portfolio. The following specialized management styles shall be represented:

Equity - Domestic Large Capitalization Managers holding large capitalization issues will be compared to the S & P 500 Index plus 200 basis points. The risk of the portfolio should not exceed risk of the benchmark portfolio.

Equity - Domestic Small Capitalization Managers holding small capitalization issues will be compared to the Russell 2000 Index plus 200 basis points. The risk of the portfolio should not exceed risk of the benchmark portfolio.

Equity - International - Managers holding international issues will be compared to the MSCI Non-US Equity Index plus 200 basis points. The risk of the portfolio should not exceed risk of the benchmark portfolio.

Fixed Income - Fixed Income managers will be compared to the Lehman Aggregate Bond Index plus 100 basis points. The duration of the portfolio should not differ from the benchmark portfolio by more than one year.

Fixed Income - International Fixed Income managers in the international market will be compared to the Lehman International Aggregate Bond Index plus 100 basis points. The duration of the portfolio should not differ from the benchmark portfolio by more than one year.

Each investment manager shall be responsible for investing fund assets in a manner consistent with the intent and provisions of this Statement. Investment managers shall have full discretion with respect to diversification and issue selection subject to the restrictions contained in this Statement. The Committee may provide additional specific guidelines to individual investment managers.

Committee approved derivative strategies may be employed to limit risk levels and to enhance liquidity provided the overall portfolio risk level will be no greater than the benchmark portfolio. A manager using derivative securities is expected to model the return characteristics of the portfolio to assure compliance with portfolio risk constraints. Option-adjusted duration will be used to define the risk of any derivative security.

3 Portfolio restrictions

The Committee is responsible for ensuring compliance with portfolio constraints by setting proper investment allocations and constraints on the specialized investment managers. Investment managers must satisfy these portfolio restrictions and report the status of their portfolios with respect to these constraints. All constraints are to be applied on a market value basis.

3.1 General restrictions

The following restrictions apply to the Fund as a whole:

  • Common stocks may represent no greater than 85% of the market value of the total Fund.
  • Foreign equities must represent no more than 20% of the equity portion of the Fund.
  • Foreign fixed income investments must represent no more than 20% of the fixed income portion of the Fund.
  • The Fund may contain no more than 5% of the outstanding shares of any company.
  • All security transactions should be executed with the view of obtaining the best net execution with due consideration given to all other relevant factors.
  • Not more than 5% of the Fund may be invested in the securities of any one issuer, unless the issue is U.S. Government guaranteed, or an issue of an agency of the U.S. Government.
  • Not more than 15% of the Fund may be invested in the securities of any one industry.
  • Security transactions that involve a counterparty rated below high quality are prohibited.

Pursuant to the guidelines specified in this statement, investment activity in the following is prohibited:

  • The securities of any issuer which practices or condones through its actions discrimination on the basis of race, religion, color, creed or sex including any issuer employing persons in nations by which their laws discriminate on the basis of race, religion, color, creed or sex.

  • Derivative securities unless the investment class is an approved asset class under these guidelines and the underlying asset is eligible for investment in the portfolio.

  • Any municipal or other federally tax-exempt securities.

  • Short sales.

  • Letter securities.

  • Commodities.

3.2 Equity restrictions

The following restrictions apply to equity oriented managers:

  • Equity managers shall be fully invested.

  • Equity managers specializing in domestic companies may not invest in ADRs or foreign equities.

3.3 Fixed Income restrictions

The following restrictions apply to fixed income-oriented managers:

  • Each security in the portfolio shall have an option-adjusted duration between the minimum and maximum option-adjusted duration securities in the benchmark index.

  • All securities in the portfolio must have a minimum quality rating of investment grade with no less than 75% of the fixed income portion of a manager's portfolio rated upper-medium grade or above.
  • Dollar issues of foreign corporations or governmental entities must not exceed 15% of the total market value of the bond manager's portfolio.

3.4 Cash Equivalents restrictions

To the extent that cash exists awaiting investment, managers are expected to handle their short-term needs using US Government and Agency issues. Alternately, the State of Wisconsin Investment Board Short Term cash fund may be used. Additionally, the custodian Short Term Investment Fund (Common Trust Cash Investment Fund or CTFI) may be used, subject to the guidelines of that fund, attached as appendix A.

3.5 Exceptions

Holdings above the imposed limitation resulting from market appreciation are acceptable provided that the Committee is notified of any such variation at the next regularly scheduled investment review meeting.

  • The Committee approves the investment in the Standish International Fixed Income Fund (SIFI Fund). The investment guidelines of the SIFI Fund have wider latitude in the use of derivative securities relative to these guidelines. The Committee grants this latitude as outlined in the SIFI Fund prospectus for this investment only. All other aspects of this investment must conform to these guidelines. Furthermore, the manager must provide (in electronic form) the composition and percentage share of the SIFI Fund owned by the Fund . The investment in SIFI is limited to 15% of the fixed income portion of the Fund.
4 Reports
  • All reports and disclosures should be submitted to:

University of Wisconsin System Trust Fund Operations

Attn: Asst. Trust Officer

780 Regent Street, Suite 221

Madison, WI 53715

  • On a monthly basis, investment managers will submit a portfolio valuation report that includes a transactions summary. The portfolio valuation reports should clearly exhibit compliance with all portfolio policies and restrictions. All positions must be marked-to-market.

  • Trade confirmations will be sent by facsimile on the trade date.

  • Annual investment meetings (more frequently, as warranted) will be held with the Committee.

  • Immediate telephone advice should be rendered by the investment managers when, in their judgment, the consequences of financial/economic developments will have a material impact on the Fund's asset value.

  • Monitoring portfolios for compliance with the above provisions in this Statement is the initial responsibility of the investment managers subject to final review by the Assistant Trust Officer.

  • Managers employing derivative securities must use the following reporting conventions on a continuous basis:

The manager should provide verification that the portfolio risk continuously remains within risk guidelines if the value of the security underlying the derivative vehicle were to move up or down by 1/2 standard deviation instantaneously.

Should a rapid movement in the value of the underlying security occur, such that the risk guidelines of the portfolio are violated, the manager should restructure as soon as is practical. If the restructuring process exceeds 5 business days, the Assistant Trust Officer should be informed on the 5th business day after the guideline violation occurs.

5 Glossary

derivative security

A contract whose value is contingent on the value of another security and/or the realization of a specific economic event.

equity portion The market value of equities plus cash reserves.

fixed income portion The market value of fixed income investments plus cash reserves .

fully invested A minimum of 95% of the market value of the portfolio must be invested in approved securities at all times. Cash positions for the remainder of the portfolio should not be employed for tactical asset allocation purposes, but only for facilitating transactions from one active position to another.

high quality Rated "AA" or above by Moody’s and/or Standard & Poor’s.

industry The specific branch of manufacture or trade measured using Indata equity industry groupings.

investment grade Rated "BBB" or above by Standard & Poor's and/or "Baa" or above by Moody's.

investment return Annualized time weighted total return; i.e., income plus realized and unrealized capital gains and losses calculated consistent with AIMR (Association for Investment Management and Research) performance presentation standards.

large capitalization Companies with market capitalization similar to the firms which make up the S&P 500.

option-adjusted duration Modified duration is adjusted to incorporate the embedded options.

portfolio The investment selections of each manager.

real return Nominal rate of return less the inflation rate (as measured by the GNP price deflator).

small capitalization Companies with market capitalization similar to the firms which make up the Russell 2000.

upper-medium grade Rated "A" or above by Moody’s and/or Standard & Poor’s.

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