Strategic tilting has added 1.1 per cent, or NZ$3 billion, to the New Zealand Super Fund’s reference portfolio over the past 10 years, David Iverson, head of asset allocation at the NZ$41 billion fund told delegates at the Fiduciary Investors Symposium at Cambridge University.
In the 10 years to February 2019, the New Zealand reference portfolio returned 12.6 per cent and the tilting program has added a further 1.1 per cent on top of that. This is way above the expected return from the program which was set at around 40 basis points.
The tilting program is the fund’s largest active return strategy, and by design the largest portion of active risk.
It constitutes around 30 instruments and markets including the recently added commodities and critically is a contrarian strategy so relies on strong governance.
“That’s the critical thing,” Iverson said. “About 80 per cent of this program is good governance and 20 per cent the investment management. The ability to be able to say you can hold something that will lose is very difficult. We all want the risk but not the pain that goes with it.”
The tilting program “has all the time varying expected returns in it” compared to the reference portfolio of 80 per cent equities, 20 per cent bonds which is built on a premise of a 30-year return forecast horizon.
“We link all our strategies back to our beliefs and how markets work and the comparative advantages we have, and this is one of those, it’s a contrarian strategy. We are very transparent in the way we build our dynamic asset allocation framework, it’s very systematic. If markets fall we’ll buy and if they fall further we’ll buy some more. Our governance structure is such that there has to be a reason why we don’t buy more, rather than the other way around.”
The program is fully internalised, partly due to cost but mostly because of alignment, particularly around the time horizon.
“We have a much longer horizon in which we expect this to pay off and manager’s time horizons are not set up for that. We wanted to calibrate this on the basis we could suffer a five-year loss. We think we have the ability to hold the loss for a longer period of time,” he said.
Iverson was speaking at the event in a panel conversation on asset allocation with Wylie Tollette, executive vice-president, client portfolio solutions at Franklin Templeton Investments who said that while dynamic asset allocation can add value it is risky.
“If markets are increasingly micro efficient cross sectionally but macro efficient, in that they can stay under or over valued for a long time, there are ways of taking advantage of that and that is dynamic asset allocation. You can add value that way but it is a risky,” he said.
Tollete, who was formerly chief operating investment officer at CalPERS, recently co-authored a paper in the Journal of Portfolio Management with Eugene Podkaminer and Laurence Siegel called “Preparing a multi-asset class portfolio for shocks to economic growth”. In the paper the authors examine the impact of shocks to economic growth and the implication for asset allocation. They advise investors to “take less risk than you think you need to meet your return objectives”.
Speaking at Cambridge, Tollette said that with large allocations to equities, investors were now very tied to economic growth.
“Hitching our wagon to economic growth subjects them to some dramatic shocks,” he said, referencing the paper which looks at how to deal with those shocks.
“The first way to do that which most of the people in this room would have already done, is to broaden your asset spectrum to include forestland, infrastructure, real estate put it in there, and see it consistently drives your efficient frontier up and to the left. You need to be very careful about anything that narrows your investment universe,” he said.
He said that strategic asset allocation is the number one decision and driver of performance between one investor and the next and agreed that in the medium term it is possible to exploit macro inefficiencies if the right governance structure is in place.
“If you the have the right team internally you can leverage tactical asset allocation,” he said.
This is supported by the fact that the “periodic table of annual returns” shows that the asset class with the best one-year return changes every year. In 2018 it was US fixed income, in 2017 emerging market equity, in 2016 infrastructure, in 2015 US real estate and so on.
“There are very few patterns in that, it doesn’t look like an efficient market. An efficient market wouldn’t have that degree of variability. It’s due to the economic shocks, and if an investor can either lean into or away from those assets you can add value to a portfolio.”
Risk management in these programs is critical, and understanding and measuring the performance, and communicating it back to the governance structure is important.
“This allows you to constantly evaluate how your strategic allocation is doing versus the reference portfolio, and how your decision making is adding value,” he said.
