Troubled Markets Cast Doubt on Re-risk Timing

(March 28, 2012) — Record outflows from government bond funds last week showed investors were ready to take on more risk, but further unsettlement and disappointing economic figures this week could indicate they have moved too soon.

At $1.01 billion, outflows from United States long term government bond funds were the biggest on record last week, according to market monitor EPFR, and investors pulled over $13 billion from US Money Market Funds, the company said.

Elsewhere in fixed-income, investors were turning against low yielding assets, EPFR said, citing commitments to bond funds as the smallest since the first week of the year.

EPFR said: “The search for undervalued stocks did see retail investors commit money to Europe Equity Funds for the first time since mid-2Q11 while dividend equity funds posted inflows for the 62nd time in the 64 weeks since the beginning of 2011.”

Never miss a story — sign up for CIO newsletters to stay up-to-date on the latest institutional investment industry news. 

However, investors may have moved too soon.

This morning the Office of National Statistics in the United Kingdom revised down its estimate for the country’s growth for the last three months of last year, from a negative 0.2% to a negative 0.3%, with most of the downward revision being made to household and government expenditure, while the contribution from inventories was increased.

Azad Zangana, European Economist at Schroders, said the figures for the first quarter of the year were also revised down by 0.2%, with the second three months revised down by 0.1%, which means the economy contracted in the second quarter of last year where it had previously thought to have been flat.

Zangana said: “The latest GDP data is significantly worse than expected and shows weaker momentum heading into 2012. Growth for 2011 as a whole is now 0.7% rather than the previous estimate of 0.9%. Our view is that the weakness highlighted in this release in combination with the poor production and retail sales data so far for, it is more likely than not that the economy also contracted in the first three months of this year, which would put the UK in a technical recession.”

Elsewhere, European markets were abuzz with rumours of a potential Spanish bailout as the country continued to struggle with its debt and poor growth projection.

Spanish Prime Minister Mariano Rajoy told reporters in South Korea that Spanish ministries will be required to cut their budgets by 14-15% as part of the new set of austerity measures that are to be set out at the end of the week.

Further north, politicians in the Netherlands, which had been one of the stronger economies in the Eurozone, admitted this week that it was struggling to agree how to slash its national deficit. The country received an unfortunate double-whammy as analysts at investment bank Citi said it should no longer be classed as a ‘core’ nation to the beleaguered Eurozone.

How a CIO Built an Alts Portfolio From Scratch

The Profile: Jeremy Wolfson, Chief Investment Officer who currently manages the $8 billion dollar Los Angeles Water and Power Employees' Retirement Plan, speaks about how he has been able to grow the fund's alternatives allocation with the support of his consultant and the eventual approval of his board.

(March 28, 2012) — When Jeremy Wolfson, Chief Investment Officer at the Los Angeles Department of Water and Power, came to the fund about five years ago, the scheme lacked a structured investment staff and a sizable allocation to alternative investments.

“When I came to the organization, I grew the organization’s staff around what I thought were best practices in the industry,” says Wolfson, who came to the public fund from the private sector. He notes that just a few years before his tenure at the fund, 100% of the fund’s assets were actively managed internally by the board, investment staff, and advisors, without external fund managers.

An implication of 100% internal management for the scheme was an inability to pursue more complex, long-term investments, such as alternatives, largely due to lack of resources. It was also a blessing in disguise, because when the financial crisis hit in 2008, the Los Angeles Department of Water and Power did not suffer the same fate of many of its peers that suffered liquidity issues.

How did Wolfson and the board go from nearly 0% in alternatives to a long-term total target of 16%? “We did it one deal and one opportunity at a time. The consultant runs models and brings opportunities to the board, so when it’s time to source a good fund manager — it’s paced appropriately.”

Never miss a story — sign up for CIO newsletters to stay up-to-date on the latest institutional investment industry news. 

In terms of roadblocks Wolfson encountered while building an alternatives allocation, Wolfson notes that funds that already have a lot of partnerships with fund managers for alternatives are more challenged to find opportunities compared to funds that are starting from about nil in gaining exposure to the asset class. “When you have no allocation, like our fund did, it’s less of a challenge to locate potential partnerships because you can go in any direction,” he says.

In 2007, the fund had been more heavily invested in public markets. “In 2008 we had a small amount of partnerships. Coming into a portfolio where I wasn’t inheriting a lot of partnerships allowed us to sit back and think on what strategies made sense,” Wolfson says. “The fund was conservative to begin with before the financial crisis and continues to be conservative, but because we were not hugely into asset classes with long lock-up periods, we did not have liquidity issues.”

Today, for the most part, the fund looks more like its peers, with 40 to 50 managers across all asset classes. Since farming the fund’s asset management out to investment managers and hiring consultants — Pension Consultant Alliance as the fund’s general consultant and Cortland Partners as the real estate consultant — the fund’s exposure to alternatives has increased substantially within the board’s allocation.

The pension has gained that exposure by starting with a secondary fund-of-funds to get initial exposure to alternatives, working with the board and consultants to pursue fund-of-funds in the primary market. From there, the fund transitioned to forming direct partnerships with private equity managers.

The fund’s current long-term asset allocation: 51% in public equity (US, international, and emerging markets), and 33% in fixed-income. Alternatives consist of private equity at 1.5% of the portfolio with a 5% target, real estate at 2.4% with a 5% target, and real returns at a 6% total — its purpose being to help hedge inflation. The fund is also pursuing commodities with the board’s recent approval of timber, Wolfson says.

Looking ahead, Wolfson says alternatives will continue to be a growing part of the fund’s portfolio — an idea echoed by a recent survey by Casey Quirk and eVestment Alliance that showed alternatives are to be the most sought after by institutional investors in the United States this year. In total, these alternatives are to make up 20% of all fund manager searches, according to consulting firms responsible for advising investors with over $9.7 trillion in assets.