The following study, commissioned by the Virginia Joint Legislative Audit & Review Commission (JLARC), reviews the current performance benchmark structure of the Virginia529’s Prepaid529 plan (Prepaid 529). The purpose of the study is a third-party assessment of the appropriateness of the investment benchmarks used to measure fund performance of the Prepaid529 fund, given the investment goals, strategies, and risk tolerance that have been adopted for the fund. The analysis will focus on the benchmarking of investments at three separate levels including the Total Fund Level, Asset Class Composite Level, and the Investment Manager Level. The main findings are:

– Prepaid529 employs a monthly pro-rata roll-up of the individual investment manager benchmarks weighted to each manager’s end-of-period market value. As a result, the current benchmarking methodology attributes all performance variation to the difference between each investment manager and their respective benchmark; this is commonly referred as Investment Manager Level attribution.

Recommendation: Callan believes that all investment portfolios are best analyzed relative to their benchmarks at three different attribution levels; the Total Fund Level, the Asset Class Level, and the Investment Manager Level. To measure performance in this framework, asset class and investment manager benchmark weights must be held static and not adjusted to the capital value of the individual managers.

– Total Fund Level analysis seeks to answer the question of whether or not the overall implementation of the strategic asset allocation has added value relative to the policy benchmark, and to attribute the sources of relative performance to asset allocation, asset class structure, and manager selection decisions. This is valuable to stakeholders because it provides insight as to what is responsible for the growth or decline in a Total Fund’s value.

– At the Total Fund Level, the benchmark should reflect the strategic asset allocation decisions formalized through the asset-liability study process and approved by the investment committee. Accordingly, we recommend fund level attribution relative to the actual policy approved in the 2016 asset-liability study.

Recommendation: Use the portfolio asset classes and their weights modelled in the 2016 asset-liability study to construct the Total Fund Level benchmark.

– At the Total Fund Level, Callan believes that the Investment Policy Statement (IPS) asset class categorization and performance presentation of Equities, Fixed Income, and Alternatives could be enhanced by separating Fixed Income into Core and non-Core categories. Core would generally represent investment grade fixed income and non-Core would represent non-investment grade, convertible bonds, and emerging markets debt.

Recommendation: At the IPS Level of asset class categorization, delineate between Core Fixed Income, which would include cash, stable value, and investment-grade U.S. bonds; and Non-Core Fixed Income, which would include U.S. high yield bonds, convertible bonds, bank loans, and emerging market debt.

– Asset Class Level analysis seeks to answer the question of whether the implementation of the asset class has added value relative to the asset class benchmark, and to decompose the sources of relative performance to 1) structural decisions/style biases and 2) manager performance. This is valuable to stakeholders because it provides insight into how each of the two decisions contributes to asset class performance.

Recommendation: At the Asset Class Level, Callan believes that the investment benchmarks weights should be static to preserve the attribution information resulting from investment manager tilts away from their respective benchmarks.

– At the Investment Manager level, Callan agrees with the vast majority of VA529’s current benchmarks. There are some recommended benchmark changes to better reflect the investment style and universe of specific managers.

Recommendation: At the Investment Manager Level, Callan believes that the investment benchmarks weights should be static to preserve asset allocation effects arising from investment manager rebalancing or the Asset Allocation Effect.

– Callan believes migrating to a three level relative attribution approach provides relevant insight into performance at both the Total Fund and Asset Class levels and that this additional information adds value to the different levels of engagement by PrePaid529’s stakeholders.