The US case involving the purchase of shares in an Australian bank by Australian investors on an Australian stock exchange has important implications for US institutional investors and their drive to diversify investments offshore, a paper finds.

A white paper commissioned by the Council of Institutional Investors (CII) to examine the impact on institutional investors of the 2010 case, Morrison v National Australia Bank, was released this week. (Click here to download the report.) The case is detailed below.

The paper, authored by Christian Ward and Campbell Barker, lawyers at Yetter Coleman, argues that Congress should grant US investors the right to sue for securities fraud regardless of where shares are purchased.

The paper says restricting the scope of US antifraud protection, an outcome of the case, significantly alters the risk profile of foreign investments.

“Under Morrison, US investors will have no recourse in US courts for fraud by the numerous foreign companies that list their shares outside the US but raise money in the US through the purchase of those shares by Americans,” the paper says.

Globally, there is a clear trend for institutional investors to invest offshore. According to the Towers Watson Global Pension Assets Study, the weight of domestic equities in the pension equity portfolios of the largest seven pension markets has fallen, on average, from 64.7 per cent to 28.1 per cent since 1998.

Of those largest seven markets the US, however, remains the country with the largest home bias to equities.

Disincentive to invest

According to the argument in this white paper, the lack of antifraud protection for US investors in offshore securities may act as a disincentive to invest offshore, which would further buck the global trend, and have diversification implications.

“The lack of remedy under US law may make American institutional investors more wary of diversifying their portfolios, as the purchase of stock on a foreign exchange will not carry the same legal safeguards as the purchase of stock on a domestic exchange,” the paper says.

In the Morrison case, the plaintiffs, who were Australian purchasers of ordinary shares of National Australia Bank, which is organised under Australian law, argued that statements made by bank officials artificially inflated the share prices.

Where it concerned the US courts was the fact that they alleged those deceptive statements came from misleading accounting used by one of the bank’s subsidiaries – Homeside – located in the US.

From a US perspective, in the Morrison case, the lawsuit involved foreign plaintiffs, against a foreign defendant, concerning securities traded on a foreign exchange – a so-called “foreign cubed” or “f cubed”.

The Southern District of New York and Second Circuit Court of Appeals dismissed the action because it involved only harm to foreign investors, and it found the alleged fraudulent conduct in the US was too far removed from the alleged injury.

Transactional test

The Supreme Court upheld the dismissal of the action, but for a different reason.

It adopted a test that focuses solely on the place where securities are purchased and sold – a transactional test.

If a securities transaction occurs on a US exchange or otherwise occurs in the US, the antifraud provisions of Securities Exchange Act apply. But those provisions do not apply if the transaction does not occur in the US.

This paper argues that the transactional test fails to take account of the reality of financial markets transactions in a globally connected economy. For example, both the US and the EU have laws requiring brokers to adopt a “best execution” policy that ensures orders to buy and sell securities are executed to a client’s best benefit. This may mean the execution takes place on an exchange offshore.

“In today’s globally connected economy, investors may have no idea where a purchase order for securities is carried out. Some securities are listed on two exchanges – one domestic and one foreign – and investors will not know through which exchange their transaction is routed,” the paper says.

Soon after this case in 2010 the Dodd-Frank Wall Street Reform and Consumer Protection Act was passed by US Congress.

In the act, Congress responded to the Morrison case by expanding “the extraterritorial jurisdiction of the antifraud provisions of the federal securities laws”, but only in actions brought by the SEC or the DOJ, and not by private investors.

Transnational fraud

In the CII paper, the Yetter Coleman lawyers argue that US investors should have a private right to sue for transnational securities fraud.

Part of the argument is it puts further fiscal pressures on agencies like the SEC, which already operate on tight budgets; and that a private right of action would ease the burden on government agencies, which may not have the resources to address transnational securities fraud even if that fraud significantly harms domestic investors.

Further, it argues that a private right of action results in recoveries that far exceed recoveries by government agencies.

For example, the SEC recovered $40 million for investors defrauded by Enron, but investors recovered more than $7 billion in private suits.

According to the CII paper, the Morrison case has had wide reaching implications in the past 18 months.

For example, even if investors place their purchase from the US with a US broker, courts have ruled that the transaction is not “domestic” if it settles on a foreign exchange.

Similarly a case involving a US pension fund that purchased the stock of a Swiss company on a foreign exchange was dismissed because the stock was purchased on a foreign exchange, even though the US fund placed its stock orders in the US.

It argues that allowing investors to assert claims to recover losses caused by fraud also ensures investors’ confidence in the truth of financial disclosures, which in turn, promotes the efficiency of capital markets.

Yetter Coleman clients include the New York State Retirement Systems and Ohio Public Employees Retirement System.

In research released this week, EDHEC-Risk Institute, part of EDHEC Business School, examines the risks of ETFs managed within the framework of the Undertakings for Collective Investment in Transferable Securities (UCITS), and calls for regulators to avoid creating artificial distinctions between so-called “synthetic” and “physical” ETFs.

Frédéric Ducoulombier, director of EDHEC-Risk Institute – Asia and co-author of the study, says that between 80 and 90 per cent of investment in ETFs in Europe is by institutional investors.

Concerns about the potential risks associated with ETFs are overstated and have been influenced by “misleading” marketing attempting to promote counterparty risk based distinctions between physical and synthetic replication ETFs, Ducoulombier says.

“We are concerned that this fixation on ETFs is not the best use of regulatory time and may be sending the wrong message to investors,” he says.

“When you discuss the risks of ETFs you don’t think about the risks of other products on the market that may be riskier and you may frighten investors away from the very products that are the most regulated to sections of the industry that do not offer the same protections.”

ETFs from the European Union are managed within UCITS directives, which impose rules of conduct on a wide range of areas, such as managing and preventing conflicts of interest, leverage, diversification, and risk management.

EDHEC-Risk says that this ensures ETFs within the UCITS framework have at least  the same level of security and risk as any other UCITS fund.

In particular, the counterparty risk associated with the use of over-the-counter derivatives transactions is limited in UCITS ETFs as this risk is strictly limited by UCITS to 10 per cent of a fund’s net asset value.

“This is just the legal requirement,” Ducoulombier says. ”If you look more closely you will find that many synthetic ETF providers aim for zero per cent counterparty risk, reset daily.

“The physical replication ETF model is not exempt from counterparty risk because counterparty risk is assumed when a physical replication ETF engages in securities lending, which is common.”

Rather than assume that one type of replication is safer than any other in terms of counterparty risk, EDHEC-Risk recommends that investors pay more attention to counterparty risk mitigation.

These are: the level of collateralisation; the quality of the assets performing the economic role of collateral; and the ability of the fund to enforce its rights against collateral in the case of default by the counterparty.

EDHEC-Risk calls for regulators to categorise funds according to the economic exposure achieved or the payoff generated, and not on the methods or instruments used to engineer this exposure or payoff.

“By disregarding the nature of the payoff generated by the fund to focus on the instrument it holds to generate this payoff, regulation could create a false sense of security vis-a-vis ‘simple’, ‘plain vanilla’ or ‘mainstream’ products, which in fact can include large and, more worryingly, hard-to-predict extreme risks,” the research paper warns.

“This could reduce incentives for investors to perform effective due diligence on the actual risks of the products and exacerbate adverse selection and moral hazard phenomena, whose mitigation should be the major and ongoing preoccupation of the regulator.”

EDHEC-Risk’s entry into the debate on ETFs comes within weeks of the expected publication of new regulations for ETFs issued by the European Securities and Markets Authority.

“What we want is for investors to have information on risk, returns and costs so they can do their due diligence,” Ducoulombier says.

“In the end, if you have a type of regulation that makes investors believe that one sector is safe and you don’t have to do your due diligence, then you have moral hazard and free-rider problems arising.”

As part of this push for more transparency of costs, returns and risk, EDHEC-Risk advocates a new measure allowing investors to better understand what share of the total return generated through risks assumed on their behalf by funds is passed on to them.

The research paper recommends a calculation of this Total Return Ratio (TRR).

“By highlighting the share of returns that does not accrue to an investor, such a ratio would permit an assessment of the true cost of asset management beyond the picture given by the total expense ratio,” the paper says.

EDHEC-Risk also calls for greater disclosure and transparency around index-tracking instruments to give investors more information on the type of index that is tracked and how effectively it is being tracked.

“The regulator should be looking at first-order issues of index definition, index transparency and auditability and investors should question the efficiency and the stability of their indices, and evaluate the tracking efficiency of their indexed investments” Ducoulombier says.

Currently, there is no standardisation or mandatory information on tracking error risk in the European regulations.

A new paper by PIMCO, which among other things examines the performance difference between defined benefit and defined contribution funds in Australia and the US, concludes that “a focus on target setting of overall portfolio performance and risk outcomes through liability-driven investing leads to better performance”.

The paper quotes research from Towers Watson’s DB versus DC Plan Investment Returns report, which shows defined benefit plans outperformed defined contribution plans in the US by about 1.03 per cent per year over 14 years, and have been less volatile year-on-year.

PIMCO also conducted original research in Australia looking at defined contribution fund default options compared to defined benefit funds, which account for about 75 per cent of the market.

It found that on average from 1995 to 2010 defined benefit funds outperformed defined contribution default options by about 0.57 per cent points a year. This equates to a 9.12 per cent greater return from defined benefit funds over the 15 year period.

Sara Higgins, account manager at PIMCO in Australia and author of the paper, says the performance differential alone is impetus to examine how defined benefit investment strategies are managed and could be applied for better member outcomes.

“We are not suggesting defined benefit will be in vogue in Australia, but there could be a way to approach retirement income in a more appropriate way,” she says. “Super funds have traditionally been looking at accumulation, now there is more of a focus on decumulation and helping retirees spend. There could be a way to incorporate a liability-driven approach to include the retiree objective.”

PIMCO suggests that super funds could apply a target-date/lifecycle approach to investment management but add a dynamic asset allocation overlay to account for the precariousness of investment cycles and longevity assumptions.

“Each year the fund should look at the internal rate of return and the target that has been set and say are we close to being fully funded, or should the asset allocation change to reach the target?” Higgins says.

Most Australian funds have calculated similar risk and return objectives, resulting in reasonably uniform asset allocation of about 60 per cent in growth assets and 40 per cent in defensive assets.

While the Australian superannuation industry is the fourth largest in the world, with about $1.3 trillion in assets, due to the mandated nature of the system it is evolving. The system is ageing, which could result in investments shifting out of those growth assets.

PIMCO analysed 258 superannuation funds representing about $790 billion and found the total benefits held for individuals over the age of 50 was about $479 billion, quite a significant portion of the entire sample. Total benefits held for individuals aged over 60 represented about $238 billion.

Global investors learned the hard way in 2011 that the strong long-term growth story for emerging markets does not necessarily result in strong returns in the short-term.

In fact, as investors contemplate the year that was, emerging market equities, for many, was one of the worst performing asset classes. Emerging market equities took a battering as investors shed risk in the second half of the year.

Morningstar lists emerging markets equity as its worst performing asset class in 2011.

Listed companies in Asia – the supposed growth engine of a sluggish world economy – generally fared little better. Asia Pacific (ex Japan) equities and Japanese equities were also in Morningstar’s five worst performing asset classes for 2011.

But for investors focused on long-term returns, many are predicting that emerging markets hold attractive opportunities for those willing to hold their nerve in 2012.

Russell Investments, while warning that investors will have to scrounge for every basis point as the low returns environment continues, are relatively optimistic on the outlook for China and emerging markets.

Peter Gunning, Russell’s global chief investment officer predicts China will have a soft landing, with policy makers starting easing as inflation fears subside.

“China has just started to ease policy settings and it is our expectations that the China wild card will turn positive in 2012,” Gunning says in Russell’s 2012 Global Market Outlook.

“We think that China will engineer a soft landing and contribute to a modest global growth acceleration by the latter half of 2012.”

Goldman Sachs’ chief economist Jan Hatzius is another who thinks Chinese policy makers have a lot of ammunition left when it comes to stimulating growth.

Both Goldman and Russell are predicting a recession in Europe in 2012, but say that the spillover will be felt less dramatically in China.

“The strongest part of the world economy is still going to be China, which will be the strongest major economy,” he says.

“Trend growth is very high and there is a lot of room for policy makers to respond to slower growth and declining inflation by easing policy both on the monetary and fiscal side.”

Goldman holds to the consensus view that China will slow but still achieve a relatively robust 8.5 per cent growth rate in 2012, and this is also a view shared by Russell.

Hatzius notes that the key risk to this forecast is any substantial disruption in global capital flows as a result of the situation in Europe unravelling.

When it comes to Asia-ex-Japan, Russell believes that share market valuations remain attractive across the region.

It is a view shared by HSBC, and both believe the region has strong potential for outperformance if risk appetite was to come back in the second half of the year on the back of a resolution to crisis in Europe and a pick-up in global growth.

Russell says that price-to-earnings ratios for Asia ex-Japan are below 10-year averages and price-to-book value for the region is 1.6 times.

In China, equities look particularly attractive, with Russell saying forward and trailing P/E ratios are now below 10 times, compared to peaks of over 20 times in 2007.

HSBC is also positive for emerging markets beyond Asia, noting in its Outlook for 2012 Looking Past the Abyss that Russian equities marry in with their positive view on oil and other hard commodities.

“Within Eastern Europe we favour Russian equities, valuations remain low at about 4.9 times earnings against a 10-year average of about 8 times,” the report states.

HSBC is also positive about the outlook for Latin American equities, noting policy makers in the region have ample room to cut rates and are in a strong macroeconomic position.

“Latin American countries are in better shape than their developed market peers, supported by higher levels of consumer confidence and solid fiscal accounts,” the report notes.

Russell sees opportunities in emerging markets beyond equities, saying that emerging market credit could also be a potentially attractive opportunity.

The authors of the 2012 outlook paper note that emerging market credit has suffered as investors looked to safe havens but predict it will “materialise as an attractive asset class – both fundamentally and from a valuation perspective – and could challenge battered Western sovereigns for risk free status”.

Russell predicts that emerging market currencies will remain strong.

Emerging market equities revealed the biggest difference year on year, with outflows of $47.7 billion for 2011 contrasting with inflows of $95.6 billion for the previous year.

The emerging markets equity funds tracked by EPFR Global ended 2011 with their seventh consecutive weekly outflow with uncertainty around Europe, China’s prospects this year, and high levels of inflation all cited as drivers.

Developed market equities also had significant outflows of $123 billion for the year.

All bond funds saw inflows of about $110.6 billion, with US bond funds attracting $62.3 billion for the year.

European bond flows saw a record outflow for the year of $29.8 billion, with the previous year recording inflows of $3 billion.

Within sector funds, commodities also attracted significant inflows, with about $12.8 billion for the year, with currency hedging being the significant motivation.

EPFR Global tracks traditional and alternative funds with about $13 trillion in assets.

Meanwhile State Street’s Investor Confidence index reveals a changing risk appetite from 2010 to 2011. At the end of 2011 the index was 99.3 and a year earlier it was around 104.5.

The index, which was developed by Harvard University professor Kenneth Froot and Paul O’Connell of State Street Associates, measures investor confidence, or risk appetite, by analysing the buying and selling patterns of institutional investors.

The index assigns a precise meaning to changes in investor risk appetite: the greater the percentage allocation to equities the higher risk appetite or confidence. A reading of 100 is neutral and represents the level at which investors aren’t increasing or decreasing their allocations to risky assets.

“The entire financial services industry was underweight US Treasuries. We were short duration and underweight sovereign debt. But it turned out it would have been the best decision to be long US debt,” he says.

“It has been a humbling year, we thought we were in a slow recovery, but that completely stalled and for much of the second half of the year we faced the prospect of a double dip.”

Ailman says his team started the year with conviction that inflation would be a key issue for 2011 and had an underweight position in fixed income and a commitment to invest in inflation-sensitive assets.

He says one of the best investment decisions he made this year was to build up the TIPS portfolio, but not because of inflation, because yields were lower.

The decision to be a bit more tactical on asset allocation also paid off for the fund, he says, with a neutral position in global equities from the middle of the year, an example.

CalSTRS’ investment team had a creative year working on a number of new initiatives and long-term projects such as the risk overlay, which it will continue to integrate into its investment process next year.

“Diversification is still the centre piece, still our main risk tool, but we need additional tools,” he says.

The fund also created an innovation group and Ailman says the expansion of the investment universe to include opportunities such as micro finance, commodities and global macro hedge funds, has been very interesting.

Ailman says “austerity” will be the key word for 2012, with countries unable to grow their way out of the crisis.

“Austerity is not good for GDP growth, we will have low GDP this year and next,” he says.

With this in mind the fund is debating its equity position, with Ailman’s preference for a neutral position, and will also look at weighting public markets differently.

Ailman says there will be pockets of opportunity in 2012 and that “next year will lend itself more to active management”.

“We have flexibility around our active/passive ranges but will be tilting our portfolio more towards active.”

The best decision for next year will be trying to buy stable cash flows, in whatever form that appears, he says.

Williams says the broad ranging de-risking that has dominated investment thinking in the second half of 2011 will continue, with investors more concerned about capital preservation than chasing returns.

“The underlying thesis currently prevailing in markets is that investors are chasing the return of their money, not the return on their money,” Williams says.

Hermes has identified five macro themes it believes will shape the economic outlook for next year.

These are:

• The realisation that policy-makers are out of effective tools and that the world is set for next-to-zero policy rates and probably low bond yields.

• More quantitative easing (QE) is on the way, and the question is whether this will backfire leading to cost rather than demand-led inflation. If QE is to work, it will be based on the “heroic” assumption that institutions will give up their treasuries and gilts to invest in risk-assets.

• Whether big economies continue to step closer to “becoming Japan”. Despite concerted government efforts to drive interest rates down, consumer spending is yet to revive.

• Europe will remain a “dark cloud” over the world economy. The question of whether Europe will engage in outright monetisation will depend on the capitulation of a German government, which is yet to fear recession and deflation.

• China to loosen monetary policy and move decisively to support growth as policy makers strive to maintain the status quo ahead of a once-in-10-years leadership change.

In his latest economic outlook for the first quarter of 2012, Williams says that there will be little “growth payback”, and the continued pressure on consumers, banks and governments to repair balance sheets means “downbeat assessments and warnings of a re-run of the 2008 crisis are looking increasingly realistic”.

“One of the big difference between now and anytime since the crisis is that it has become clearer that low bond yields have become one of the few tools left in the box and not as a reflection of economic data.”

Central banks and governments simply won’t tolerate aggressive shifts upwards in bond yields until the economic fog lifts, and it is unlikely this fog will lift in 2012,” he says.

Williams says this makes more QE inevitable to maintain inflation expectations, which suggests that there is still value for investors in selected inflation-linked bonds.

However, Williams questions if these latest rounds of QE will have the desired effect, arguing they may actually hinder growth by hitting already fragile consumer demand.

“QE done in the same way as QE back in 2009 could backfire,” he says.

“We know QE does stoke inflation, but it has been the wrong kind of inflation, it has been cost inflation rather than demand-led inflation. This tends to hit us [consumers] in pockets rather than help us out through increases in energy prices and through asset prices in general, including oil.”

Williams also argues that the regulatory pressure on banks to beef up their balance sheets will also hamper QE’s aim of encouraging investors to invest in risk assets.

Despite uncertainty about the outlook for the world economy, Williams says that there may be some opportunities in risk assets for investors willing to look beyond the current prevailing mindset of capital preservation.

“De-risking will undoubtedly continue and there may be pockets of light. If policy is perceived to be loose for even longer than expected then, of course, cheap cash will need a home,” he says.

“One of the beneficiaries of that could be growth assets, as it was in 2009. So, it is not in itself a gloomy outlook for equities or necessarily for other growth assets, such as commodities. But the driver there is much more cheap money looking for a home rather than a significant pickup in fundamentals.”

Williams argues that due to the effect of the previous bouts of QE, the true QE-adjusted policy rate is, in fact, much lower than the headline figure.

Using US Federal Reserve chairman Ben Bernanke’s own analysis that the $600 billion part of QE2 was equivalent to 75 basis points off the funds target rate, Williams extrapolates what is the “true” QE-adjusted policy rate for the US.

Given that the cumulative value of all QE so far is $2.6 trillion, Williams estimates this has been the equivalent of slicing some 325bp off the funds target rate.

“The US is running an effective nominal policy rate of not 0.25 per cent but -3 per cent, or -5 per cent in real terms.

Williams predicts that when rate-tightening cycles finally do come they will be “abnormally shallow”.

Hermes’ Policy Looseness Analysis suggests a “neutral” US Fed funds target no higher than 3 per cent, versus a 7.5 per cent long-term average. In the UK its analysis points to a policy rate of 2.75 per cent versus a long-term average of 5 per cent.

Williams says that with interest rates likely to stay at very low levels through 2012, it is now apparent that the US and UK have be running ultra-loose policy for the fifth year running.

“The hope is that more QE doesn’t end up throwing out the [growth] baby with the bath water,” he says.

Despite institutional investors predicting that returns for property will fall over the next two years, high-quality, core US real estate remains an attractive investment opportunity, says Greg MacKinnon, the head of research at the Public Real Estate Association.

In its latest fourth-quarter Consensus Forecast, the not-for-profit research organisation says a survey of members reveals investors predict that returns will fall from the strong result this year.

Despite the downward revisions in forecasts, MacKinnon says that this does not indicate a reversal in the market.

Long-term average total returns for the US market have been in the range of 9 per cent a year.

Investors’ average five-year forecasts were in line with this average, and MacKinnon notes that the lower volatility, ongoing yields and returns compared to other asset classes still make a compelling case for property.

The average forecast of returns in 2012 for the National Council of Real Estate Investment Fiduciaries’ (NCREIF) Property Index was 7.0 per cent, which is down from the predicted total return for 2011 of 12.4.

Investors expect much of this fall in total return to come from decreasing rates of capital appreciation, with income predicted to remain stable in 2012.

“The forecast for next year are slightly below average compared to the long-term average; in large part this dip in forecast for returns has been due to the surprisingly strong returns through 2011,” MacKinnon says.

“At the beginning of this year and the end of last year people were looking for a recovery of values in 2012. Having gone through 2011 it seems that the recovery has come earlier than expected. So, in a sense the return that was expected in 2012 has come earlier.”

The NCREIF Property Index covers institutionally-held properties which are predominately high-quality, core real estate.

MacKinnon says that in early 2010 and early 2011 there has been a “flight to safety” in property, with institutional investors showing the greatest interest in high quality assets.

“Most of the research has found that the demand in 2010 and early this year was in the six major US markets comprising of New York, Washington DC, Boston, Chicago, San Francisco and Los Angeles,” he says.

“Through 2010 and spring 2011 there was enormous demand for this high-quality core property.”

While MacKinnon says that prices for top quality assets in these markets are approaching previous boom levels, the broadening out of a recovery in secondary markets in the US has stalled due to concerns about the US economy and the crisis in the Euro zone.

“Investors are putting their hands up and saying, ‘Let’s wait and see what happens in the broader economy before we go slightly up the risk spectrum’,” he says.

The survey of a subset of 22 its members included large investors such as TIAA-CREF, Morgan Stanley Real Estate Investors, Russell Investment Group, BlackRock and Aberdeen Asset Management.

The investors, on average, predicted that income returns for all property types would hover at around 6 per cent. Capital growth was forecast to fall to 1.8 per cent in 2012, from 6.1 per cent in 2011, before recovering to 2.2 per cent in 2013. US property was forecast to achieve average capital growth of 2.9 per cent a year between 2011 and 2015.

The most bullish outlook was for the US apartment market, with investors predicting an average total return of 14.1 per cent in 2011, dropping to 9 per cent in 2012.

In 2013 this was predicted to fall further, to 8.5 per cent, but over the five years to 2015 was predicted to achieve a total annual return (including income) of 9.7 per cent.

“The fundamentals in apartments have been quite strong partially due to the blow-up in the single family residential housing market in the US,” MacKinnon says.

Beyond strong demand for rental properties, support for the apartment market comes from buyers’ greater capacity to attain finance. Unlike the housing market, the apartment market didn’t experience the same over-building in boom times.

“Now we have a lot of demand and the supply is only starting to catch up, so going forward the demographics look good, as do the supply and demand issues look good, and it has a lot of fundamentals that point to this market getting its wind back,” MacKinnon says.

The greatest fall in sentiment for returns was seen in the office and retail segment of the US property market.

The average forecasts for returns in 2011 for office property were 12.6 per cent, and for retail property was 11.7. These were expected to fall to 7.1 per cent and 7.9 per cent, respectively, in 2012.

Asset owners are increasingly putting pressure on their asset managers to abide by the CFA asset manager code of professional conduct, with one CIO stating that managers who do not comply could be penalised in the future.

Chief investment officer of the Policemen’s Annuity and Benefit Fund of Chicago, Sam Kunz, who sits on the CFA’s asset manager code advisory committee, says his fund now asks managers in RFPs, and ongoing reviews, whether they abide by the code.

“In the future it may be that managers outside the code will be penalised in a way – it will be harder for us to hire them,” he says.

Kunz believes that ethics are tightly tied in with a firm’s culture, which ultimately has an impact on performance.

“A firm’s culture is a fairly good predictor of its long-term performance,” he says.

“If you believe ethics is part of culture then it must be addressed seriously. From a return point of view the adoption of the code it is very attractive.”

He says the adoption of the code is also an important tool for the industry to regain trust from the wider community.

“The adoption of a code of ethics also fosters trust. The higher the trust you have in someone looking after your assets for you the better. The code is a very useful tool,” he says.

Michael Trotsky, who is the executive director of the $48 billion Massachusetts Pension Reserves Investment Management Board, says the fund also asks managers if they comply with the code in their RFP process.

He believes the code is important because it sets a minimum standard for the industry.

“Managers who do comply have an advantage,” he says, adding he’s “not ready” to cut out valuable managers who don’t comply.

Kunz believes asset owners play a part in the code’s take-up and at his fund a question is included in the annual review of managers asking whether they have adopted the code, and if they haven’t then why not. He also includes the same question in all RFPs and asks all managers he meets with. The fund employs 55 funds managers.

Both Massachusetts PRI and AustralianSuper are also looking at extending a question regarding code compliance beyond just new RFPs to ask existing managers as well.

CIO of AustralianSuper, Mark Delaney, who also sits on the advisory committee, says the six principles of the code act as a clear risk statement of what the expectations of behaviour should be.

“It raises ethical questions of culture and behaviour and acts as clear guidelines for what you expect of your own organisation and those that deal with you. It engenders more confidence in the industry,” he says. “We would be reluctant to appoint a manager who doesn’t abide by those.”

Silk Invest, a frontier markets asset manager, claims to abide by the code, and chief investment officer, Daniel Broby, says it is such markets where the code can make a difference.

“We are partly about capital market development, and in countries like Nigeria and Kenya where there is no regulatory infrastructure, if we can encourage them domestically to accept codes like this it can make a difference.”

Brody says an ethical code also encourages the industry to behave like a profession.

“As an industry we haven’t been as client centric as we should have been,” he says. “Professionalism goes beyond just treating a client’s money as if it was your own money. It is about objectivity, and having processes in a company beyond just investment processes, like a disaster recovery plan.”

“It is an endorsement of ethical standards by senior management.”

The principles are voluntary and flexible, which is a deliberate strategy, and Brody says there is no point having a code that “only the big boys can adopt”.

A member of the CFA board of governors, Aaron Low, who is also principal of Lumen Advisors, says the code is principles based, because “the reality is that different firms will necessarily have different ways of addressing procedures and processes that assure ethical conduct”.

“But by inviting compliance with a global set of standards, investors have a common framework from which to understand their investment manager’s commitment to ethical conduct. We see this as essential to earning and maintaining investor trust.”

Head of standards of practice and outreach at the CFA Institute, Bob Dannhauser, says one of the strengths of the code is it affords flexibility for firms to comply in the way that is most appropriate for their size, focus, and management style.

“But given the broad scope of risk management processes, we’d like the guidance we provide to be as useful to as many potential adopters as possible,” he says.

In 2012 the CFA will be asking the advisory council, and the wider industry, for feedback to better understand any common impediments to adoption of the code.

“The headlines keep reminding us of the value of investment managers offering proof of their commitment to ethical conduct beyond just saying the right things in finals presentations, and we continue to believe that the code offers firms an excellent opportunity to signal prospects and clients alike that they manage their firms with client interests foremost and are indeed worthy stewards,” he says.

“Restoring trust in the markets is essential to economic recovery, and we think our profession’s embrace of high standards of conduct can play a part in bolstering investor trust and confidence.”

The CFA Asset Manager Code of Professional Conduct states that managers have these responsibilities to their clients:

• To act in a professional and ethical manner at all times
• To act for the benefit of clients
• To act with independence and objectivity
• To act with skill, competence, and diligence
• To communicate with clients in a timely and accurate manner
• To uphold the rules governing capital markets

Institutional investors’ continuing commitment to alternative assets was revealed in two Preqin studies. The first research is a survey of 70 alternative asset investment consultants and the second is a paper looking at investors’ outlook for hedge funds in 2012.

The survey revealed that despite 40 per cent of investors interviewed having experienced hedge fund returns that did not meet their expectations in 2011, more than 38 per cent of investors say they plan to increase their allocation to hedge funds next year.

More than half of investors surveyed say they will leave allocations approximately the same, and 9 per cent will decrease their allocation to hedge funds.

The public pension funds on Preqin’s database make up some 13 per cent of its total investor universe, and have a mean allocation of 6.8 per cent to hedge funds.

These funds also have a mean target allocation to hedge funds of 7.7 per cent, indicating strong flows to hedge funds from public pension funds in 2012, Preqin says.

Private sector pension funds, family offices and foundations on the database all indicated they plan to lift their allocations to hedge funds.

The consultants – who collectively advise on more than $1.5 trillion of alternative assets – say 54 per cent of their clients indicate they want to invest more capital in hedge funds in the next 12 months.

“Undaunted by poor economic conditions, hedge fund investors will continue to push hedge fund assets towards the $2.6 trillion high reached in 2007 prior to the crisis,” researchers say in their report Institutional Investor Outlook for Hedge Funds in 2012.

The vast majority of investors say they will seek to invest with new managers to some extent over the next 12 months, with just 20 per cent saying they will stick exclusively with their existing managers.

The most sought after hedge fund strategy for investors were long/short equity strategies, with 38 per cent of investors saying they plan to invest in the strategy in 2012.

This was followed by global macro (26 per cent), commodities driven strategies (15 per cent) and event driven (13 per cent).

Direct investment was also preferred to funds of hedge funds, with 79 per cent of investors on the database looking to invest in hedge funds in 2012.

In contrast, there has been a significant decline in the proportion of investors planning to invest in co-mingled funds of hedge funds in the next 12 months from 42.5 per cent in the fourth quarter of 2010 to 24 per cent of investors in the fourth quarter of 2011.

The consultants surveyed indicated that their clients were showing strong interest in increasing their allocations to a range of alternative assets.

In private equity almost two-thirds of investors thought that North American and Asian private equity presented the most attractive opportunities in 2012.

Consultants also ranked small- to mid-market buyout, distressed private equity and secondaries funds as the strategies that presented the most attractive invest opportunities.

Consultants also reported strong client interest in private equity, with 60 per cent of those surveyed saying their clients expect to either slightly or significantly increase their exposure to the asset class.

In private real estate, two-thirds of consultants say that North America represents presents good investment opportunities, and half of those surveyed say that Asia is also attractive.

Almost three-quarters of those surveyed say they plan to either slightly or significantly increase their allocation to real estate.

The majority of respondents indicate they will increase their allocation to infrastructure next year and see primary fund investments as the best opportunity followed by secondary market purchases.