CIO Profile: Hedge Fund Hopes and Governance Goals

(January 27, 2014) — Just as the UK postal service has had to adapt to the surge in electronic communication, so the team investing its workers’ retirement assets has likewise transformed.

“We have been very busy,” says Royal Mail Pension CIO Ian McKnight. “We have overhauled our governance structure and our asset allocation—it all looks very different to a year ago, even down to moving to a new office.”

In April 2013, aiCIO revealed that the Royal Mail pension’s long-standing CEO Gerry Degaute was leaving to be replaced by the Head of Funding, and Forty Under Forty member, Chris Hogg. McKnight, then the senior investment strategy manager, was made CIO.

A year earlier, more than £28 billion in pension assets and liabilities had been hived off to the UK Treasury to be either sold or managed to maturity. The massive pension fund had been something of a stumbling block to privatising (at least part of) the Royal Mail. The company was successfully floated on the London Stock Exchange in October last year -with pension assets now of around £4 billion.

This smaller, more nimble pension fund has jumped on the opportunity for a total makeover.

“We have created a lower risk strategy that is not as dominated by equities as before,” he says, “and we now have a bespoke liability-driven investment approach. We have a diversified growth assets portfolio, with a higher weighting to direct property in the UK and fewer equities. The exposure we have in stocks is via global and emerging markets managers.”

The fund also has some private equity holdings, but what fires McKnight’s passion is the hedge fund portfolio that he and former British Airways pensions’ alternatives head Bev Durston have put together.

“We are, what I would call, the ‘second wave’ of hedge fund investors,” says McKnight. “The trustees had rejected the idea of them initially, as they had only really considered funds-of-hedge funds. When we addressed the matter again last year, we realised that most of the money was leaving these vehicles, which suited us as we wanted a more thematic, concentrated approach.”

After appointing Albourne as adviser, McKnight brought in Durston looked at some very distinct investment themes: reinsurance and Asian private debt, for example.

“Albourne does the operational due diligence; we lead the investment due diligence,” he says. “It’s a good template for this ‘second wave’ and it is the most efficient way for us. We are able to select the managers we want-and avoid those we don’t. In fact we are signing the contract for a new investment today and cancelling one that hasn’t been performing.”

Royal Mail currently uses six managers and was able to access some closed funds due to Durston’s connections “and the Royal Mail brand” but rejected the idea of managed accounts.

“We didn’t think they were necessary—transparency and liquidity are vastly improved these days—and we concluded you just end up paying for it in performance,” McKnight advises.

So how did such a rapid turnaround happen when McKnight has a team of just three to help manage these assets?

“Creative tension,” he says, twirling a post-box-shaped cufflink. “We have a multi-adviser model so they all pitch in their best ideas.”

He lists most of the major players in European investment consulting as advisers, adding that his team is in essence “an open architecture fiduciary management team”.

“We have sought to create an optimal governance structure,” he says. “We decided what good governance was and said that was where we had to be-and we got there.”

Hogg and McKnight joined with several UK pension funds to explore what constituted good governance—Russell Investments sponsored their project, which set out to define a benchmark for best-practice. “Hopefully this year, with the results from last year, we can provide more answers than questions,” the CIO says.

“Chris manages an efficient team, and we have conducted personality profiles using a clock-face system; fascinatingly, we have someone representing every number—a real spread of talents—and we push ourselves to continually improve.”

This structure helps the investment team to be dynamic and opportunistic, which is necessary, he says.

“I understand that we have the second largest net cash flows of any pension in the UK—after the PPF—we have to be able to allocate around £500 million in new money a year. Imagine we are holding a fire hose towards a series of holes-where do we squirt the water when the holes are full up? We need to have the right access, options and the ability to execute quickly in order to remain flexible and opportunistic.”

McKnight has other plans, but is keeping his powder dry for now.

“We have some really interesting developments around private equity, but I can’t tell you about it yet,” he says. “We are challenging how we and the industry have traditionally done things—we want to be first class.”

Related content: Forty Under Forty – Chris Hogg & Ian McKnight