Paper: Opportunities Scarce for Active Managers, Risk Recovery on the Horizon

Last year was disappointing for active equity managers and as an overall climate of risk aversion persists, many of the early indicators of a risk recovery are emerging, Wellington concludes.

(April 30, 2012) — Opportunities for active equity managers to make outstanding returns for their clients were scarce in 2011, according to a recent whitepaper by Wellington Management.

Macro-driven risks associated with political and fiscal uncertainty, which caused unprecedented high correlations, were the greatest culprits, Wellington said. The firm also said that because of the scarce opportunities for active managers, they should focus on securities in which they have a truly different opinion. “Trying to time 10% movements in stocks, industries, or countries won’t move the needle much overall,” Wellington said.

Consequently, according to the firm, the focus on safety among investors was nearly as extreme in 2011 as it was in 2008, when the market was down almost 40%. “We found that while 2011 and 2008 ended with very different market returns, they shared many traits, including massive risk aversion and an extremely narrow opportunity set of market-beating stocks, which severely limited the ability of active managers to add value,” Wellington asserted. “The good news is that historically these flight-to-safety periods have tended to be fairly short-lived, and if that trend holds, we would appear to be on the cusp of an excellent period for risk assets.”

While few of the typical warning signs of a return to safety within portfolios were triggered in 2011, many of the early indicators of a risk recovery are emerging, Wellington concluded, outlining the following factors:

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1) High-yield spreads are contracting.

2) Volatility is moderating, and the volatility curve is no longer inverted (short-term volatility is now lower than long-term volatility).

3) Housing and housing stocks are turning in some surprisingly good results.

4) China has been one of the better-performing non-US markets recently, and several of the country’s leading indicators have turned positive.

Wellington’s conclusions regarding active equity managers contrasts with another report by the firm released earlier this year, which asserted that equities will have long-term return benefits for most investors despite the asset class underperforming bonds over the past 15 years.

Ultimately, the authors of the report on equities over the long-term concluded that they believed investors should base strategic asset allocation decisions on fundamentals and valuations, rather than on recent returns. While allocations to other areas of fixed-income or to alternative asset classes may be appropriate, there are often limits to their use, such as liquidity constraints and the skill required to select and monitor complex strategies. Thus, the paper asserted: “We believe that current market conditions and historical capital market behavior suggest that now is a good time for investors to examine their fixed income and equity allocations to determine if they have the appropriate exposure to equities to meet their long-term objectives.”

OMERS, Japanese Partners Eye $20 Billion Infrastructure Fund

The pension plan representing municipal workers in Ontario has teamed up with two Japanese partners to launch a global investment fund.

April 27, 2012) — One of Canada’s largest pensions is joining forces with Japan’s pension schemes to launch a $20 billion infrastructure fund to invest in assets including railways, ports and gas pipelines located primarily in North America and Europe. 

The Ontario Municipal Employees Retirement System (OMERS) has revealed that it has committed $7.5 billion to the new infrastructure fund with Japan’s Pension Fund Association and a consortium led by Mitsubishi Corp., Japan’s largest trading house. Of the $7.5 billion, OMERS committed $5 billion to the fund, Japan’s Pension Fund Association has committed $1.25 billion, and Mitsubishi’s consortium has committed $1.25 billion. The fundraising goal of the newly dubbed Global Strategic Investment Alliance (GSIA) is $20 billion.

“We’re very pleased to be partnering with these sophisticated investors in pursuit of high-quality, large infrastructure investments that we can own over the long term,” said Jacques Demers, President and CEO of OMERS Strategic Investments. “Based upon the feedback in the market, we anticipate welcoming a number of other forward-thinking pension plans and other long-term institutional investors from around the world into the GSIA over the next 12 to 18 months thereby bringing significant additional (ie. billion dollar plus) commitments to the program.”

The initiative represents the immense influence among institutional investors in helping to meet the needs of a growing and aging population, translating to increasing demand for infrastructure investment worldwide. 

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The popularity of infrastructure among institutional investors was highlighted in an August 2011 study by Keefe, Bruyette & Woods, which found that the hype over alternatives among institutional investors in the US is not expected to subside. The study by KBW followed another poll in early August 2011 by SEI — completed by 106 pension executives overseeing assets ranging in size from $25 million to over $1 billion — that revealed an increasing number of pension funds are using alternatives as funded status volatility continues to be a primary concern.

Last September, following President Barack Obama’s national infrastructure push detailed in his speech before Congress, the largest public pension fund in the US expressed its commitment to the asset class. The California Public Employees’ Retirement System (CalPERS) Board of Administration earmarked up to $800 million for investments in California infrastructure over the next three years. The scheme’s plan called for investments in both public and private infrastructure, including transportation, energy, natural resources, utilities, water, communications, and other social support services. “We remain committed to California’s future and the investment opportunities that run deep between our coastline, mountains and valleys,” said Rob Feckner, President of the CalPERS Board of Administration. “We are prepared to increase our investments in infrastructure with our first and foremost goal being on investment returns, and a secondary goal of supporting essential community services that are crucial to continued economic development, a safe environment, and healthy schools and communities.”  

Related article: Infrastructure for ­liability-driven ­investment.

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