Investors to rebalance portfolios

Institutional fund managers face an array of challenges in relation to asset allocation. The Pyramis Pulse European Pension Insights survey, developed in conjunction with and executed by FT Mandate/PWM, was completed by 160 investment officers at insurers, multi-managers and private and public pension schemes, reveals several pressing concerns jostling for attention after two of the most volatile years in investment history. Responses from 10 participating European countries were nuanced in their differences based on country-specific issues. However, overarching key themes emerged. The most widespread concern is risk and solidity ratios, cited by 29 per cent of respondents, but there are plenty of other challenges, such as volatility, cited by 24 per cent, low returns (13 per cent) and the rising nominal yield environment (9 per cent). Funding status remains a major issue for pension funds. As institutions look ahead to 2010, they are confronted by 2009’s difficult circumstances. Many are now substantially out of their target ranges for certain assets, particularly in equities and alternatives, and a dichotomy has developed between those that are still underweight equities (24 per cent), and an almost equal number that have been carried above their target weightings (22 per cent) by the market’s rising tide. In alternatives, a substantial 34 per cent of respondents said their holdings were below target, while just 12 per cent said they were overweight the sector. This partly reflects the differing risk profiles of traditional pension funds and other investors, and the other players more inclined to invest in alternatives such as commodities and hedge funds. The latter group for instance might include those pension funds that are using alternatives for the alpha-generating leg of a liability driven investment strategy. Another asset class that is relatively out of kilter compared with target levels is credit, where 60 per cent of respondents are where they want to be, but 19 per cent are overweight. Nevertheless, 21 per cent intend to increase their exposure to credit in the next few years, as investors begin to see credit as a broad asset class embracing corporate debt as well as sovereign bonds and also contemplate emerging market debt. While most respondents are also more or less where they want to be in real estate (59 per cent), 28 per cent say they are below their target range. Concern about inflation continues to drive investment in property, however, with 37 per cent looking to increase their exposure, at a time in the cycle when prices are depressed, and 30 per cent planning to add explicit inflation hedging strategies such as US Treasury Inflation Protected Securities (Tips) and commodity exposure. This variance from target asset allocations is one reflection of the last few years’ dislocation, and is endemic across the asset management industry. Antony John, chief executive of FundQuest, the $40bn (E27bn) multi-management arm of BNP Investment Partners, says in the last two to three years, there has been an explosion of issues concerning managers broadening their discretion and moving to the limits of their benchmark. The strategic asset allocation changes planned for the next one to two years reflect the respondents’ departure from their target asset allocation. Around a quarter want to boost their equity holdings and a similar number want to reduce their exposure to equities, to rectify the dislocation from their target ranges. The most striking shift will be the 41 per cent who intend to increase their allocations to emerging market equities in their search for higher returns. This is part of a larger trend for greater exposure to overseas markets, and in particular to look at global mandates holistically, rather than splitting allocations between the domestic economy and the rest. Movement around private equity is relatively limited, with 72 per cent planning to make no changes, and 19 per cent, generally representing the largest investors, intending to boost their allocation, despite recent liquidity issues. As investors look at how to get back into equities, 20 per cent intend to increase their allocations to directional long/short strategies, and 20 per cent to equity market neutral to avoid exposure to broad market moves. “Many investors are looking at how to get back into equities and recoup the losses sustained in 2008 and early 2009,” says Young Chin, chief investment officer at Pyramis. “Long-term traditional expectation is that equities can deliver a real rate of return of 6 per cent with a reasonable level of volatility, but recent market action may have shaken that,” he adds. Pyramis is therefore encouraging clients to look at non-directional strategies in a more creative way. Respondents were also asked about the methodology they plan to use to bring asset allocations back into target range, with 41 per cent expecting to rebalance existing assets while 30 per cent have no action planned, and 8 per cent are awaiting advice from their consultants. Dealing with the threat of inflation is a priority, cited by ten respondents, and an attempt to improve diversification is also near the top of the agenda, attracting six mentions. Although assets plummeted in unison during the crunch, as cheap credit fell away, investors have kept faith with the concept of diversified returns across all asset classes, and are looking for a mix of market capitalisations, styles and geography; 45 per cent said they would diversify into alternative asset classes such as property, infrastructure, private equity and hedge funds to better manage volatility. Hedge funds, however, lost credibility during the crisis, as they failed to live up to expectations, gated investors and fund prices fell further than anticipated. While 28 per cent of respondents intend to increase their allocations to hedge funds, only 31 per cent now say that funds of funds and multi-managers are one of their preferred hedge fund strategies, but this was nevertheless more popular than multi-strategy single managers, who score only 12 per cent, equity market neutral (11 per cent) and global macro (15 per cent). Relative value and convertible arbitrage strategies are marginal plays attracting just 4 per cent of the votes. These findings reflect a discernable nascent trend to prefer transparency, even if that means going for a single strategy manager, and the signs that institutional investors may be more inclined to look at the risk management, compliance and reporting resources of managers in more exacting due diligence procedures. “Within the hedge fund space there seems to be a move by buyers to smaller, single strategy funds rather than funds of funds,” says Saker Nusseibeih, head of investments at Hermes Fund Management – a multi-specialist asset manager with £25.7bn (E28.4bn) under management. “Many feel they receive insufficient direct access and information about the underlying managers’ strategies, exacerbated by the ruction in the market which has thrown up a massive dispersal in returns,” he adds. “The evidence post-Madoff is that there is more interest in single managers because investors desire transparency and purity in their positions.” Another gathering trend is for alpha and beta to be more explicitly split and delivered by different managers. Asked whether actively managed equity strategies will deliver alpha in the foreseeable future, 47 per cent agreed and 21 per cent agreed strongly.