Pension Herding Has ‘Broken Up,’ Says Russell

Large US corporate pension plans have largely broken out of herd mentality over the last 10 years, according Russell Investments’ Chief Research Strategist Bob Collie.

Investment strategies among Russell’s $20 Billion Club—the 20 corporations with the largest pension liabilities—have significantly diversified since 2006, Collie wrote in his latest blog post.

“These plans’ investment decisions are clearly being driven by factors other than a desire to track to broader peer group behavior, and that has to be a good thing,” he continued.

From a study of annual regulatory filings, he found wide-ranging approaches to hedge funds, private equity, real estate, and liability hedging.

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For example, UPS invested more than 12% of its total pension assets in hedge funds, whereas five members of the $20 Billion Club skipped the vehicles entirely.

Verizon had a 19% private equity allocation, compared to Federal Express’ 1%.

Collie also found Dow, Northrop Grumman, and Verizon all had around 10% of their pension assets in real estate, despite ExxonMobile having none.

Furthermore, Ford’s US plans invested 77% in fixed income and 7% in listed equities, pointing to a liability-hedging strategy. Johnson & Johnson’s pension portfolio, however, sought returns with 79% in stocks, and just 21% in fixed income.

But some herding behavior still exists, Collie added—and “frequently with good reason.”

After AT&T shifted to a full yield curve for determining discount rates and service and interest costs in 2015, at least eight other members of the $20 Billion Club followed suit and made the change.

“So the herd is alive and well in some regards,” Collie concluded, “but when it comes to investment strategy, the pension-plan herd has broken up.”

Combining low volatility and value factors can produce better risk-adjusted returns when applied to fixed income strategies, according to research by S&P Dow Jones Indices (S&P DJI).

The combined factors outperformed both broad US fixed income benchmarks and a sample of actively managed funds in tests run by Aye Soe and Hong Xie, directors in S&P DJI’s global research and design team.

“Our analysis indeed confirms that over the backtested investment horizon, both value and low-volatility factor portfolios have higher Sharpe ratios than the broad market,” Soe and Xie wrote. “When evaluated in a two-factor framework, the two-factor portfolio exhibits similar risk-efficient characteristics, even after accounting for hypothetical transaction costs.”

The “majority” of risk in active fixed income portfolios was down to systematic factors, the authors argued. They found that volatility-aware strategies could act as a “risk control mechanism,” similar to the factor’s role in equity products.

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The “two-factor portfolio” Soe and Xie constructed had a higher Sharpe ratio than the average active US fixed income fund when rebalanced either quarterly or monthly, when backtested from July 2006 to August 2015. The monthly rebalanced strategy had a higher information ratio than the average active fund, implying that it would produce more alpha per unit of risk.

Soe and Xie cited recent research by Ronald Kahn and Michael Lemmon—managing directors within BlackRock’s “scientifically driven active equity” group—which found that investors may be overpaying for their exposure to this asset class due to the prevalence of factors driving active fixed income returns.

“Backtested results show that a multi-factor index could maintain a target risk profile (ratings and duration) in line with the broad-based benchmark, while having the potential to provide higher risk-adjusted return,” Soe and Xie wrote.

However, portfolio turnover remains a problem to be addressed in factor-driven strategies, the authors added. The monthly rebalanced two-factor strategy had a turnover rate in excess of 400%, pushing up expected costs. The quarterly rebalanced portfolio had a turnover rate of 239%, which Soe and Xie said was “comparable to that of actively managed bond funds.”

Read the report in full: “Factor-Based Investing in Fixed Income: A Case Study of the US Investment-Grade Corporate Bond Market.”