Europeans Cozy Up to Risk Parity | Chief Investment Officer

(December 14, 2012) — Institutional investors in Europe are growing more familiar with risk parity strategies, and those who learn about it would consider allocating to it, an asset management survey has found.

A third of European investors responding to a recent survey by alternatives manager Aquila Capital said they were increasingly familiar with the strategy and of this group 50% said they would consider allocating to it.

The investment manager surveyed 225 institutional investors in the United Kingdom, the Netherlands, Scandinavia, Germany, and other large European countries. The results concur with aiCIO’s annual risk parity survey, which showed 22% of non-US investors were considering the strategy.

The two surveys also agreed on the level committed to the strategy, showing most investors allocated less than 5% of their overall portfolio to risk parity.

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The Aquila survey determined that 80% of investors would maintain their allocation with the remainder increasing their holding. However, the investment managers found only 22% of the third of respondents who were aware of the strategy had actually allocated to the strategy.

Last week, attendees at aiCIO’s inaugural Influential Investors Forum at the Harvard Club discussed the pros and cons of a risk parity approach.

“Our concern about risk parity is that there are not that many risks you need to get paid for taking,” one opponent to the strategy said, adding: “Risk parity seems to absolve the investor from looking at original valuations.”

Another said: “If you lower the risk to reduce the ugly drawdowns, don’t expect great returns.” However, an advocate for the strategy countered: “If there’s more than one asset class that has a risk premium, there should be a balance.”

One of the CIOs on aiCIO’s Power 100 said that once the fund’s trustee board had heard explanations of the strategy by a provider, the board wondered why the investment team were making such a small allocation. This reflects the response to both surveys on the level of allocation.

To read the full aiCIO Risk Parity Survey 2012, click here.

(December 14, 2012) — European pension funds have been scaling back their allocation to illiquid investment in favour of more easily tradable assets, a report from the region’s supervisory authority has shown.

The European Insurance and Occupational Pensions Authority (EIOPA) published its report on the second half of the year today, revealing the results of its local members’ observations on behavioural changes in the past 12 months in the 17 states with major institutional investors.

Of the 17 states, nine members agreed with the statement that “undertakings increase the relative share of liquid investments while reducing the relative share of illiquid investments”. Only three members “somewhat” disagreed and none agreed entirely. The remainder had no opinion.

The question whether pension funds were reducing exposure to sovereigns with higher credit spreads was the only statement better supported. This received agreement from 10 members and disagreement from four.

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The member panel was split on whether investors had been moving out of equities to relatively less risky fixed income securities.

The results may be a blow to some politicians who had been banking on institutional investors to help fund large infrastructure projects across the continent, as public and bank funding has dried up since the onset of the financial crisis.

In the UK, the government had earmarked several billion pounds’ worth of projects that could be underwritten by pension funds in the country.

The National Association of Pension Funds and the Pension Protection Fund in the UK have also launched a platform to unite large investors who want to invest in infrastructure projects.

Paul Kemmer, head of asset solutions at consulting firm P-Solve, said turbulence in financial markets could lead to investors shedding illiquid assets to become more nimble, but it could also mean they would search for assets that are not linked with corporate success, as is the case with equities and bonds.

Kemmer said pension fund portfolios were a natural home for illiquid securities, such as real estate and infrastructure, but investors should demand a premium for taking on such projects and deal with each opportunity on a case-by-case basis.

The EIOPA report is backward looking and investors may have since changed their mind. Last month almost half of a group of European institutional investors responding to a survey by consulting firm Towers Watson said one of the top priorities on their to-do list for 2013 was to explore how to exploit liquidity premia.

One of the UK’s largest pension funds, the Universities Superannuation Scheme, has built an in-house infrastructure team. Several large European asset managers have made similar moves citing requests from the market.

Conversely, the EIOPA report showed insurance companies were seen to be moving into more illiquid assets and shifting further into fixed income.

For the full EIOPA report, click here.