Pension funds used to be considered long-term investors, but the reactionary behaviour of a recent prudence* of pension funds globally has changed my view of their time-horizons and subsequent role in capital markets.
*Prudence is the newly-crowned collective noun for pension funds as per the competition in our newsroom. Have your say in our poll.
The recent turmoil in Europe has given me cause to reflect on the long-term nature of investing and the shift in asset allocation by pension funds as risk tolerance and liability-matching – or indeed the ability to make benefit payments – become more of a consideration.
Moreover the reaction of pension fund investment teams seems more akin to a fund manager protecting its assets under management (collective noun for fund managers anyone?). They are genuinely worried about daily movements in markets and how to position their funds to protect against risk, and capture opportunities.
As pension funds discover and truly understand their shorter-term liquidity needs, their investment decisions are changing in order to meet them.
Dynamic asset allocation, tactical asset allocation, opportunistic investing – all are in vogue.
Has it really come to this?
For public pension funds, in the US in particular, this is a reality. If interest rates move in a particular quarter, then liabilities will move, which affects the funding position, and ultimately the investment decisions. A short-term focus is demanded.
Naturally this is a generalisation, and there are some funds defined as pension funds that act more like sovereign wealth funds. But those that come to mind which fit this category don’t have to start paying benefits for a number of years.
Of course the nomenclature doesn’t really matter, and neither does the timeframe, really, as long as there is someone on the other side of the trade (and costs are kept down). And that all depends on the risk tolerance.
With this in mind, sovereign wealth funds will become an even more important part of institutional investing. They typically rebalance, and so are regular buyers (or sellers); they have genuine long-term time horizons and sufficiently different risk tolerances. They also have a global outlook.
The benefits of other long-term investors, such as endowments, have also been touted, but perhaps some unexplored territory is the behaviour of wealthy families, with their willingness to trade a chance of becoming considerably richer for a smaller chance of becoming poorer, they can play a part in this increasingly complex and changing environment.
*In my office, other contenders for the collective noun were
A sashay of pension funds
A sloth of pension funds
A laggard of pension funds
An indecision of pension funds
A privilege of pension funds
A lemming of pension funds
A Macbeth of pension funds
A trip of pension funds
Some of my personal (non-related) favourites were
A shuffle of bureaucrats
A sneer of butlers
A subtlety of sergeants at law
An ambush of widows
A worship of writers
Oh, and I made this one up
An ego of Gen Ys
What does it take to actually be a long-term investor?
The best description of what it means to be a long-term investor I have seen is contained in a speech by David Denison (http://www.cppib.ca/files/PDF/speeches/Conference_Board_of_Canada_-_2010_Summit_David_Denison_-_FINAL_(April_13).pdf).
If you have not come across this speech, David suggests the following preconditions to being a long-term investor. The list is not exhaustive.
• an appropriate business model
• a tolerance for volatility
• rigour around portfolio construction
• an enabling governance model
• the design of the investment process
How many funds are capable of meeting these?