How to Get the Most from Active Management (And Lower the Active Risks)

(November 15, 2013) — Concentrated active investment strategies can create equity alpha, but it’s imperative to implement them in the right way to avoid excess risk, according to Hewitt EnnisKnupp.

Several consultants have extolled the virtues of high conviction or concentrated equity strategies, which sees managers invest in fewer stocks but employ greater levels of manager skill to create alpha.

Hewitt EnnisKnupp carried out research in 2012, and found the number of highly skilled active managers who did managed to produce solid alpha returns has fallen from 20% in the 1990s to around 2%-3% today.

If you’ve managed to seek out one of this 2% to 3%, the challenge then becomes how best to implement their strategy, since concentrated alpha equity often result in higher levels of risk.

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Hewitt EnnisKnupp partner Matt Clink said there were three steps investors should follow: firstly, to spend time selecting the potential individual active managers; secondly, to combine those managers in a complementary way; and thirdly, to apply passive management if desired.

“Employing global equity mandates is the most practical approach for small to mid-sized institutional investors seeking to build a multi-manager portfolio with high active share, as it requires fewer managers than approaches with different mandates for regional and capitalization-focused subsets of the market,” said Clink.

“For larger investors, utilizing regionally or capitalization-focused strategies is also feasible. Each manager should have a high active share relative to its benchmark, i.e., an active share greater than 75% (or no more than a 25% overlap with the benchmark).”

Combining the managers doesn’t mean picking ones with the same investment strategies, Clink continued. But it was important to analyse the reduction in active share as each manager is added to the portfolio to avoid closet indexing.

The third and final step is to determine how much passive management to add to the portfolio. Passive management is used to lower cost, reduce tracking error, add a strategic regional or capitalization beta tilt, and to improve liquidity, Clink explained, although in some cases it might be abandoned completely if the investor wants to maximize their potential alpha and is comfortable with the fees.

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Hewitt EnnisKnupp wasn’t the only consultant to find value in high conviction portfolios. Data analysis carried out by Inalytics in April 2013 found diversified equity portfolios underperformed highly concentrated ones by almost 400 basis points.

(November 15, 2013) — MassMutual, one of the buyers for two-thirds of Rothesay Life, has unveiled a sizeable bulk annuity deal for a US manufacturer.

The North Carolina-based SPX’s pension fund has agreed a deal where its pensioners will be insured by MassMutual. In addition, former SPX employees who are entitled to a future pension benefit will be offered a voluntary lump sum payment, reducing SPX’s defined benefit liabilities by as much as 75%, or $800 million.

Jeremy Smeltser, chief financial officer of SPX, said: “From a company perspective, the $250 million voluntary pension contribution we made to the plan in the first quarter of this year, and the current economic environment, have put us in position to take these actions, which are not expected to require any additional funding.

“These actions are both consistent with our strategy to reduce volatility in pension costs and funding requirements and are expected to strengthen our balance sheet and improve our financial flexibility.”

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MassMutual has been expanding its buyout presence on both sides of the Atlantic since the start of the year. In February, it bought £100 million ($157 million) of Rothesay Life’s perpetual subordinated debt.

Rothesay Life then sold 6% of its company shares to MassMutual in September, as part of a tri-partite deal which also saw private equity house Blackstone and sovereign wealth fund GIC buy up two-thirds of the Goldman Sachs-owned entity.

It’s not all good news for MassMutual however. A class-action lawsuit has been filed against the pension risk transfer specialist by its own employees, claiming it charged excessive fees on its 401(k) and engaged in self-dealing by limiting investment options almost exclusively to its own products.

In addition, the suit alleges the firm’s CEO, Roger Crandall, who controls the group annuity contract that offers the Fixed Interest Account, has invested it all—$500 million—in a general account fund.

Thomas Clark, director of fiduciary oversight for Fiduciary Risk Assessment and FRA PlanTools, told benefitspro.com that putting fixed income funds into a general account was “a relic” of an idea as most use synthetic products that spread the risk while guaranteeing a rate of return.

MassMutual has vowed to fight the lawsuit, saying in a statement: “We believe the comprehensive retirement benefits we offer our participants help them save toward a secure financial future, and we will defend vigorously against these baseless allegations.”