Cambridge Associates to Investors: Stray Away From Long-Only Equities to Mitigate Risk of Another Perfect Storm

According to Cambridge Associates, investors may want to move away from the traditional approach of allocating primarily to long-only equities, with just a modest allocation to other strategies like real estate and private equity.

(August 3, 2011) — Pension funds must focus on asset-liability risk to mitigate the likelihood of another perfect storm, a report by Cambridge Associates asserts.

“The last perfect storms were 2001-2003 and 2007-2009,” report author David Druley, a Managing Director at Cambridge Associates, told aiCIO. During those periods, interest rates decreased causing liabilities to spike, coinciding with drops in equities.

Consequently, pensions are increasing their allocations to fixed-income to hedge against declining interest rates. “The hedging portfolio is the primary area of focus for many pension funds that implement liability-driven investment strategies,” said Druley. “This approach actually only allows for a portion of the total risk reduction that could be achieved by using a total-portfolio risk-budgeting framework. For one thing, ‘de-risking’ by primarily increasing the allocation to the hedging portfolio unnecessarily reduces long-term expected returns,” he said.

The report asserts that investors should focus more on asset classes that aren’t fully exposed to equity markets.  For instance, an institution could create a long-short equity program that has only 30% exposure to the equity markets but still has attractive return potential if the managers are adding significant value through active management.

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“To implement this strategy, you need to use active management, and the most talented active managers are in the hedge fund space,” Druley told aiCIO, adding that while he believes there are some areas where it’s harder to add value through active management, there are robust opportunities to add value to plans and reduce risk through the use of active management. “With regards to active versus passive, investors must be selective,” he said.

Among the issues for pension funds that the report explores:

  • What a “smarter” growth portfolio might do.
  • What might comprise a “smarter” growth portfolio. Strategies for diversifying the growth portfolio across various betas and active exposures can include passive and active long-only equity strategies; long/short equity hedge funds; arbitrage-related hedge funds; excess return-oriented credit strategies; public and private real estate; natural resources investments; and private equity.
  • How to manage risk inherent in a “smarter” growth portfolio. A strategy that allocates a significant amount of risk to active exposures must extensively diversify sources of active risk


To contact the <em>aiCIO</em> editor of this story: Paula Vasan at <a href='mailto:pvasan@assetinternational.com'>pvasan@assetinternational.com</a>; 646-308-2742

MassPRIM Ups HFs, Emerging Markets, Slashes Equities

The $50.3 billion Massachusetts Pension Reserves Investment Management (MassPRIM) board is shifting its investments toward hedge funds and emerging market debt at the expense of equities.

(August 3, 2011) — As part of a new asset allocation mix, the $50.3 billion Massachusetts Pension Reserves Investment Management (MassPRIM) board will shift $1 billion each to hedge funds and emerging markets debt.

Meanwhile, the fund expects to cut $3 billion from equities, slashing its global equities allocation to 43% from 49%. While international equities will drop to 17% from 21%, domestic large-cap equities will dip to 15% from 17%.

The departure from equities and embrace of alternatives coincides with research this week from Eager, Davis & Holmes, a Louisville-based consultant to investment managers. According to the firm, institutional hires in alternative investments and real estate increased at the expense of domestic equity and fixed-income in the first two quarters of 2011.

“We’ve known for a while now that institutional investments in equity were out of favor, while interest in alternatives — particularly private equity — have increased,” Holmes told aiCIO. With such a high level of volatility in equity, the drive among investors to reduce their risk has driven investors to pursue other asset classes. “Pension funds are seriously underfunded — they’re looking to increase returns. Equities have traditionally been a hedge against inflation — but they’re not the only answer now.”

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The trend away from equities toward alternative investments has also been revealed by consulting firm Towers Watson. The firm’s Global Pension Asset Study — which collected responses from 271 asset managers — showed that North America continues to account for the largest amount of pension fund assets in alternatives, followed by Europe and Asia. The share of alternative investments in global pension fund portfolios ballooned to an average of 19% in 2010 from 7% in 2000.

Earlier this year, the fund announced its plans to embark on an asset allocation review, deciding to shift from a fully fund-of-funds investment strategy to incorporating more direct hedge funds.

“Tim Cahill, our previous treasurer, felt that having a fund-of-funds approach would achieve better diversification,” MassPRIM spokesman Barry Nolan told aiCIO in February. “But there’s also the argument that with a fund-of-funds strategy, you can reach a point of diversifying too broadly, leading to diminishing returns,” he said, noting the while Cahill, who suffered a tarnished reputation over accusations of political influence, achieved solid returns as treasurer, concern centered on the middle layer of management that his fund-to-funds approach created.



To contact the <em>aiCIO</em> editor of this story: Paula Vasan at <a href='mailto:pvasan@assetinternational.com'>pvasan@assetinternational.com</a>; 646-308-2742

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