Through their momentum properties, cap-weighted indices favour the emergence of speculative bubbles, according to research by EDHEC-Risk Institute, which concludes cap-weighted stock market indices offer no particular advantage.
With less institutional flows forecast in the next few years, asset managers will need to implement a convincing “fiduciary overlay” to win business from large investors.
The effects of adding TIPS and alternatives to the existing asset mix are being explored in an asset liability analysis conducted for the $53 billion Oregon Public Employees Retirement System by Strategic Investment Solutions.
A presentation from SIS, which looked at five new asset allocation scenarios adding a 5 per cent alternatives allocation, and between a 0.1 per cent and 11.4 per cent allocation to TIPS, showed all except the most conservative mix achieved the actuarial return without accounting for alpha.
Further, reducing the total equities allocation by nearly 10 per cent, achieved through halving public equities and slightly increasing private equities, together with a 5 per cent and 4 per cent allocation to alternatives and TIPS, would yield the same expected return.
A risk/reward analysis was used to point toward an appropriate level of risk/return with the consultant finding generally the Sharpe ratio, or risk/return efficiency was higher for lower return mixes.
With liquidity analysis, and scenario analysis in inflation, deflation, recession and low-return environments, the conclusion was that the ultimate net cost does not suggest taking less risk.
A July presentation to the investment committee will include defining the ALM analyses, refining a potential asset allocation policy (including new asset classes such as the opportunity portfolio, alternatives and TIPS) and adopting a new asset allocation policy.
Asset allocation
| Asset class | target | Mix4-1 | Mix4-2 | Mix4-3 | Mix4-4 | Mix4-5 | current mix |
| Public equity | 46% | 19.8% | 21.9% | 24.2% | 31.4% | 39.2% | 42.9% |
| Private equity | 16% | 18.8% | 20.7% | 22.9% | 24.0% | 25.0% | 19.8% |
| Fixed income | 27% | 36.9% | 36.9% | 31.5% | 28.5% | 20.7% | 25.7% |
| Real estate | 11% | 8.2% | 10.1% | 12.1% | 11.0% | 10.0% | 9.4% |
| TIPS | 0% | 11.4% | 5.5% | 4.3% | 0.1% | 0.1% | 0% |
| Alts Port | 0% | 5.0% | 4.8% | 5.0% | 5.0% | 5.0% | 2.2% |
| Equity | 73% | 51.7% | 57.6% | 64.2% | 71.4% | 79.2% | 74.3% |
| Expected return | 8.61% | 7.75% | 8.08% | 8.42% | 8.76% | 9.09% | 8.61% |
| Std deviation | 12.8% | 10% | 10.9% | 11.9% | 12.9% | 14% | 12.8% |
| Sharpe ratio | 0.44 | 0.47 | 0.47 | 0.46 | 0.45 | 0.44 | 0.44 |
source: Strategic Investment Solutions
The International Centre for Pension Management’s Keith Ambachtsheer believes if pension fund stakeholders “fessed up” about the real state of their funding situation, the business of pension fund management, and its subsequent investments, will have a brighter future. He spoke to Amanda White.
There are not many pension funds around the world that can satisfy the five criteria set out by Keith Ambachtsheer as the dimensions of their success. Some might say he sets a high, but fair, bar, but then perhaps the bar should be high for the custodians of millions of retirees’ savings.
According to Ambachtsheer, who is director of the International Centre for Pension Management (ICPM) and adjunct professor in finance at the Rotman School of Management, University of Toronto, there are five defining characteristics of pension funds that are most likely to do well.
They will have: alignment of interests and be free of conflicts of interest; good governance; realistic investment beliefs and perceptions of risk; sufficient scale; and be able to pay competitive compensation.
“Sadly there are many funds that can’t pass the test,” he says.
So much of his thinking centres on acutely exploring the relationship between retirement savings and the business of pension management, and the role of investments within that. He questions how pension fund organisations are positioned for the long-term as a core component of that, with appropriate asset classes, measures of risk and performance, incentive compensation and outsourced versus in-house management all stemming from that core.
Ambachtsheer, who operates his own advisory firm, KPA Advisory Services and is also a co-founder of CEM Benchmarking which measures the organisational performance of pension funds globally, says there is a growing realisation that turning retirement savings into pension payments should create value – not destroy it.
“With this in mind we have to define what is value and how much does it cost – what is the value proposition?” he says.
Ambachtsheer believes an important starting point is pension fund stakeholders “coming clean” in their investment modeling.
“If you do the modeling properly it is easy to see there will be situations where you end up draining all the money out of the fund. Modeling should be done so that assets and liabilities are in line with the fund’s ability to pay. You can’t capture that unless you do realistic modeling. In the US they haven’t done that,” he says.
One of the defining characteristics of the ICPM is its foundation of peer-group research partners willing to collaborate, not just with co-investment opportunities but with the sharing of ideas and experiences.
To this point he uses the DKK 660 billion ($114 billion) Danish ATP as an example. The fund is required to do its modeling on mark to market basis, with the Dutch regulator dictating there must be a surplus buffer.
“The result is their assets and liabilities are in line with their ability to pay. In the US they haven’t done that, so asset liability management becomes irrelevant because the gap between the known monthly obligations and the money in the fund and contributions is so different,” he says. “Some funds are in that position already, and they have to come clean.”
Ambachtsheer says letting go of the anchor of high returns of the last century, and embracing risk management, will play important roles in framing the future.
“Communication and messaging that to the public is a serious thing, it needs to be a defensible realistic message, conveying expectations that are realistic,” he says.
Investment collaboration has also been widely debated at the ICPM bi-annual forums where about 100 members meet to discuss both the latest academic thinking, often commissioned by the Rotman School, and its practical application.
While Ambachtsheer believes collaboration can work in certain situations, he also says funds have to be very careful about what to collaborate on.
“There are some situations that would beneficial to all, for example we were talking about the fact that not everyone has to go internal with private markets but perhaps rethink how much to pay for external. With 2:20 you can say that’s the offer, then what is our bid. The more funds that do it, the more we’ll move the price.”
By collaborating, he says, funds can collectively see more deals than they might on their own. Sharing information and negotiating capabilities are paramount.
On the point of performance, many funds have begun examining their executive staff incentive schemes, Ambachtsheer says there is more that can be done in aligning interests, of all stakeholders, and costs.
“There is a case to be made of having an override, where no one gets paid until the entire fund has a positive return,” he says. “This would be a demonstration that you are aligning your interests.”
The global application of a code of best practice for institutional investors, developed by the UK Financial Reporting Council, was debated at the International Corporate Governance Network’s annual conference in Toronto. Amanda White reports.
As pension funds around the world shift international equity allocations to emerging markets, they should be increasingly cautious about the benchmarks in use, according to Conrad Saldanha, the New York-based portfolio manager for emerging markets equities at Neuberger Berman.