Greater Investment Skill Needed to Tackle Deficits, Investors Told

(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.”

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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