Greater Investment Skill Needed to Tackle Deficits, Investors Told

Russell Investments’ Sorca Kelly-Scholte said simple de-risking has become too expensive and the time for a more tactical, strategic approach is now.

(October 18, 2013) — De-risking has been made expensive through quantitative easing and volatile markets, so pension funds’ best solution is to move into tactical asset management, according to Russell Investments.

Managing Director of consulting and advisory service Sorca Kelly-Scholte told delegates at the National Association of Pension Funds conference in Manchester that the impact of de-risking during times of loose fiscal policy had made shifts into fixed income assets almost prohibitively expensive.

“As a rough rule of thumb, for each 10% moved from equities into bonds, another 0.5% of liability is added in terms of annual contributions: the cost of de-risking is cash,” she said.

“This means that many pension funds have now reached their de-risking limit. The big stick we’ve been waving to manage pensions has lost its power… the lever can’t be pulled any further.”

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Plan sponsors are also increasingly hesitant to add extra contributions given they have already put a large amount of cash in. Figures from consultancy LCP showed that FTSE 100 employers in the UK paid £21.4 billion in additional contributions in 2011 and £21.9 billion in 2012.

“If that has reached its limit too, we need to look at how else we can get traction on returns in our funds,” Kelly-Scholte continued.

“There are other levers to pull that don’t introduce volatility. They are tactical asset allocation, stock selection, looking for new opportunities, and strategies—including those in alternative and illiquid assets. Ultimately, it’s about introducing more active management.”

Kelly-Scholte added that the financial services industry was inherently creative, and that the recent economic crisis had provided a fertile ground for new strategies.

However, she conceded that to follow this path would take up a lot of resource and effort, which some investors may struggle with.

“You might wonder whether it’s worth all of that work to gain an extra 0.3% per year in returns, but that’s equivalent to raising your equities portfolio by 10%, which not many funds want to do,” Kelly-Scholte said.

“It’s hard to find diversity in capital markets, but finding true diversity comes through more skill-based strategies today.”

Kelly-Scholte finished her presentation by advocating a greater allocation to illiquid assets, and expressed her dismay at the lack of interest by UK pension funds in this space.

“The objective to get to settlement for a buy-in has caused trustees to see illiquid assets as an obstacle, but they’re setting up their own obstacle for constraint by doing that,” she said.

“There is a capacity limit to the buy-in and buyout markets…and with that in mind they should be looking at getting the illiquidity premium available.”

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(October 18, 2013) — Investors’ optimism about a global economic recovery is faltering but European equities and emerging markets are finding renewed favour, according to a survey.

Only 54% of investors responding to a monthly Bank of America Merrill Lynch survey believed the global recovery will strengthen, a 15% drop from last month. Almost three-quarters projected economic growth to stay “below trend” in the coming year, an increase of 10% from September.

The survey of more than 200 global managers with $643 billion of assets under management found the negative sentiment stemmed from the tail risk of the US economy.

“Events in Washington clearly caused investors to shift back towards their benchmarks, but asset price gains can still be driven by high cash levels,” Michael Hartnett, chief investment strategist at BofA Merrill Lynch, said.

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Managers expected similar results for corporate profits, the survey found. Only 28% of those surveyed said they expected global corporate profits to improve over the next 12 months.

Investors’ equity holdings have dropped—in correlation to the general negative outlook—with a growing shift back to fixed income.

Only half of those surveyed were overweight equities, a 20% drop from last month, according to the survey. US equities took the biggest hit, with no asset allocators being overweight in the sector.

European equities allocations, on the contrary, reached a six-year high of 46% of overweight investors. European corporate profits are also experiencing great optimism with 10% of those surveyed choosing the Eurozone as the “most favorable outlook.”

“Strong flows into Europe would call for a touch of near-term caution, but solid macro momentum in the region suggests that any dips in EU equity markets would be enthusiastically bought,” John Bilton, a European investment strategist at the bank, said.

BoA Merrill Lynch found favor for Japanese equities also resisting the negative global trend, recording a second successive month of improvement.

The report concluded emerging markets saw a relative upturn as well. Investors have largely increased allocations into the region—only 10% was underweight in October and 26% have been overweight.

However, only 5% of managers expected the Chinese economy to strengthen in the next year, pointing to the industry’s discrepancy in emerging markets outlook.