Of Dentistry, Investment, and Perspective

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Over the span of this year, I will have spent more than the equivalent of one working day in the dentist’s chair. It is a family history of terrible teeth rather than an aversion to brushing, but the fact remains: I spend far too much time and money on something I can’t control—or can I?

Upon recounting my dental woes to a friend, I mentioned how pleased my dentist was that he had managed to save the latest molar that had come to grief. “Of course he is—it’s in his interest to do so, even if it’s not in yours,” he said. I quizzed him further, and he responded: “Surely it is in your dentist’s interest to try and hang onto a set of teeth that will going to take continued filling and mending—why wouldn’t he?” Then I remembered hearing about his new house and growing brood of children…

To come back to why I’m recounting this story, I had never considered it that way—and this is the basis for much of this second aiCIO European edition: Looking from another perspective, taking it all in with fresh eyes, and questioning everything that has been forever taken at face value. Our cover story delves into the vague ideology of investment outsourcing and, instead of just recounting its remarkable growth, we push for a concrete proof of value-add—and examine how it has to evolve to be of real benefit to current and future users. Our guest columnist, who has spent more than 20 years watching investors, challenges you to turn your point of view around; this is our aim too.

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The newly award-winning Charlie Thomas visits Germany to find out how its pension funds are fighting back against life-threatening regulatory proposals, and we probe credit markets to uncover new ways of extracting useful value through innovation. The next part, the execution, is all down to you.

Finally, the new CIO of the UK’s Pension Protection Fund grants aiCIO his first interview and explains how he is using his previous career in investment banking to bring new insights to the lifeboat for bankrupt companies’ pension funds.

Often it is not comfortable to make such dramatic changes, but in order to keep a fresh outlook—and investment conscience—it is essential. We hope you will find this edition challenging and that it helps you change your perspective … at least for 24 pages.

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It is potentially a useful exercise—it is probably a good exercise—but whether they can get to the bottom of this issue and form consensus is another matter. We await the outcome with interest (and a hot chocolate).

The Netherlands has a liquidity problem. Unfortunately, the financial regulator, the Dutch National Bank (DNB), is not quite sure what it is.

This may sound like an unfair dig, but it isn’t. The DNB has launched an investigative consultation exercise to delve into a raft of aspects around liquidity, and has called on the army of pension fund professionals in the country for help. The Netherlands is home to some of the world’s largest and most sophisticated investors, so if anyone is able to give an accurate description of what liquidity actually is—where it comes from, how it should be measured, and crucially, how useful it really is—it is them.

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The European Pension Fund Investment Forum’s Netherlands branch has set up a working group that will meet before Christmas to discuss what the regulator needs to know, and what they should provide to trustee boards and investors.

Even outside the Netherlands, this is a useful exercise. Earlier this year, aiCIO looked into how investors managed to price the illiquidity in their portfolios—if they attempted to at all. As it turns out, although the premium has been routinely touted as one of the most useful and valuable to institutional investors, very few of them could put a figure to just how much it was worth to them. One suggested that the value shifted depending on market cycles and demand. Another said he counted the first 100 basis points as an additional premium to high-yield fixed-income assets that he was earning for the lack of liquidity inherent in the security.

There are no doubt formulas and models to find an exact number, but as we have all realised, models work very well—until they don’t. The Sage of Omaha’s line about selling his assets in order to value them is also applicable to the discussion on liquidity.

So this is what the Dutch regulator is looking into, and it fits well alongside its post-crisis mindset. Since the plummet of Lehman Brothers and the subsequent quasi-collapse of the Eurozone, Dutch pensions have fallen off their pedestal somewhat. Once lauded as leaders of the pack, these investors have had to lick their wounds and come up with plans to repair their solvency ratios to the required 105% minimum.

The DNB has demanded that trustees understand exactly what is in pension fund portfolios to the point they can explain it to a third party (which has spelled termination for a range of alternative asset managers), and risk management has come under a very bright spotlight. This is where liquidity comes in.

Even the term itself is woolly. Liquids can be clear and free-flowing or thick and viscous—so to which type does the term refer? And to which should it be applied? It’s obvious that pension funds need a certain amount of cash available at any time—they cannot pay pension benefits in stock certificates—but how much is enough? And how much is too much?

Just as a gooey hot chocolate is comforting on a winter’s day, having an allocation to infrastructure, well-rented real estate, or a poorly traded bond can give an investor peace of mind. But do we really understand how the illiquidity premium we get from this fits on the portfolio? And how it should sit in a risk budget?