Risk Management at the Wellcome Trust

by Simreet Gill
J.P. Morgan Investment Analytics & Consulting
simreet.k.gill@jpmorgan.com

The Wellcome Trust is one of the most diverse biomedical research charities in the world. Wellcome Trust spends over £600 million every year, both in the UK and internationally, achieving their mission of supporting and promoting research to improve the health of humans and animals.

The net value of the Trust’s investment asset base was £13.1 billion ($23.3 billion) as of 30 September 2008. Wellcome Trust has an extremely diversified portfolio with over 50% invested in alternative assets and property. The Trust is one of Europe’s largest institutional investors in hedge funds. The overall investment target is to generate 6% of real return over the long term, within an appropriate risk framework. The Trust is a client of Investment Analytics & Consulting’s risk measurement services.

Exhibit 1: Total portfolio cumulative returns since 1986 (sterling) annualized
Source: Wellcome Trust web site.

An Interview with Sarah Fromson, Head of Investment Risk and Performance

Sarah joined Wellcome Trust in January 2008, taking on the newly created role of Head of Investment Risk and Performance, with an aim of strengthening the risk and control function within the Trust. Sarah reports directly to the CFO and the Director and works closely with the CIO and Investment Division.

J.P. Morgan was pleased to interview Sarah to learn more about Wellcome Trust’s investment and risk management processes.

J.P. Morgan: What is Wellcome Trust’s investment strategy?

Sarah Fromson: Wellcome holds a diversified portfolio spanning cash (a plain vanilla approach, with an aim of carefully controlled counterparty risk), bonds, long only equities, carefully selected hedge funds, private equity, venture capital and property.

The aim of the investment strategy is to avoid the three ways that endowments “blow up”, namely through:
 

1. Insufficient liquidity to account for planned needs;
2. Erosion by inflation as suffered by many German charities in the 1920s; and
3. Insufficient diversification often associated with reliance on stock provided by a single donor.

Exhibit 2: Asset allocation - September 2008
Source: Wellcome Trust web site.

J.P. Morgan: What type of relationship exists between the portfolio management and risk management functions at Wellcome Trust?

Sarah Fromson: Danny Truell, the Chief Investment Officer (CIO) of the Trust, is a visionary investor who delivered excellent fund performance since his arrival at the Trust in 2005. I work with the CIO and his team to provide risk measurement, performance management, risk monitoring and recommendations for managing risk. The governance structure of this Trust ensures full transparency of portfolio management and risk management decisions.

The CIO assumes full responsibility for the performance of the portfolio as well as the management of risk. My role is to support the CIO’s work whilst also ensuring that risk is measured and monitored, with resulting issues highlighted and fully discussed.

With regards to major investment decisions, the CIO sources what-ifs and analysis from the Risk Management team. The Risk Management team also performs investment due diligence on potential new hedge fund and long only managers.

I maintain a position of independence and am thus able to escalate any issues directly to the CFO, Director and the Board.

J.P. Morgan: How does Senior Management get involved in the risk management process at Wellcome?

Sarah Fromson: The Trust is very focused on both the qualitative and quantitative risks it takes on in its investments.

An investment committee meeting is held on a quarterly or more frequent basis to provide support and challenge to the investment executives. This committee consists of experienced external investment professionals and internal senior management.

The Board of Governors acts to fulfil its overall responsibility to maintain an oversight of Wellcome’s investments.

J.P. Morgan: : Is the risk management process driven by regulatory requirements and if so, can you please briefly explain these requirements to us?

Sarah Fromson: Wellcome is regulated by the Charity Commission and not the Financial Services Authority (UK regulator) and their requirements are subtly different. The Charities Commission prescribes that, instead of a detailed analysis of the processes and results, they require an overview of the risk identification process, an indication that the major risks identified have been reviewed or assessed and confirmation that control systems have been established to manage those risks.

Wellcome Trust is also regulated by its own constitution. The constitution gives Wellcome Trust the ability to invest in a wide range of instruments in any part of the world. The constitution details that the Trust may enter into an investment that may cause unlimited financial obligation or liability only if it enters into a matching investment which limits the financial obligation or liability or if it does so in order to manage risk.

J.P. Morgan: Could you please give us an overview of the Risk Management processes employed at Wellcome?

Sarah Fromson: The aim of risk management at the Trust is to focus on the key risk parameters of the portfolio, cash/liquidity and VaR dynamics. Traditional VaR analysis is most useful for publicly quoted securities, but we have extended our risk models to incorporate infrequently valued assets classes, including private funds and property. We recognise the inherent imprecision of the exercise, but note that it is more important to be approximately right, than precisely wrong.

Wellcome Trust also places emphasis on analysing and reviewing all of its external funds, mandates and direct investments in asset class. Operational assessments of external managers and funds have assumed greater importance over recent years, as has an emphasis on counterparty risk analysis.

J.P. Morgan: What are the key risk indicators which you believe are important in your day to day assessment of the portfolio risk?

Sarah Fromson: Wellcome Trust takes a pragmatic approach to managing risk and is able to take a long-term view. It has a range of risk measures which are monitored and actively reviewed and is able to shift the emphasis on a dynamic basis, given their view of market and economic conditions. In recent months, Wellcome Trust has moved away from a primary focus on a VaR limit of 15%. The Trust now places a greater emphasis on liquidity levels, absolute levels of cash and coverage (including charity commitments, as well as costs and bond liability), as well as VaR and currency exposure. The Trust deliberately ensures that the portfolio is invested across a wider range of asset classes.

For example, over the past year, Wellcome Trust has observed the positive correlation between sterling and world equity markets (sterling and equities have declined at the same instances). Prior to that, the correlation between sterling and equities has not typically behaved in this fashion. As a result, Wellcome Trust acted to provide a “hedge” to the portfolio using non-sterling investments, given sterling’s behaviour as a "risky asset". As of September 2008, the Trust had approximately half of the investments in non-sterling denominated assets and instruments, net of a passive currency hedging overlay.

J.P. Morgan: What have been the key challenges faced by Wellcome Trust over the past year and how has your investment strategy and risk management changed?

Sarah Fromson: Over the past year, declining markets have led to a number of key challenges specifically around increased market volatility, increased correlation and decrease in liquidity.

Wellcome Trust has always monitored the impact of changes in the currency markets on their portfolio, but foreign exchange volatility and sterling weakness have meant increased focus in this area. Greater attention to cash flow forecasting within the Trust has meant that three-monthly and long term cash forecasts are now reviewed on a weekly basis, by the Investment executive.

The Trust has analysed and aggregated its underlying private holdings to a fuller extent than was previously feasible, enabling improved understanding of the sectoral, regional and market capitalisation positioning across the full gamut of public and private equities held.

Operational risk assessments across external funds and mandates have assumed greater importance in a post-Madoff world. The Trust is pleased, but not smug, that it effectively avoided implication in the well-publicised prime brokerage and hedge fund implosions, although the second order effects of these collapses have changed the investment landscape for all.

J.P. Morgan: In your opinion, how do you see your role and that of the risk management team evolving in the future?

Sarah Fromson: I see my role as providing effective support and challenge for the CIO and Investment Executive, in ensuring that the Trust retains its purchasing power to support current and future generations of scientists and researchers. The Trust is increasing its involvement in directly held equities and other securities, which will require further developments in the risk measurement and management areas.