Maybe it’s time to get back into the water, with a life jacket

Greg BrightInstitutional investors have never been market timers, but in this editorial, publisher of, Greg Bright, argues maybe now is the time for pension plans to take a bet.

Anecdotal evidence suggests most large pension funds have at least decided to move back towards their strategic asset allocations, while many have started to do so.

The GFC, aided by the slowness with which unlisted assets are valued, has pushed the value of broad-market equities down well below strategic ranges for many funds. If the recent rally continues, 2009 will certainly turn out to be “the year for beta”. In such an environment, alpha/beta separation is looking like a thing of the past, at least for a while.

In both the US and Europe, transition managers are reporting a strong first quarter, as mandates are withdrawn and re-issued. Custodians are reporting a significant jump in transactions, as active managers receive more cash flow from pension funds that still have positive cash flow.

The big issue is whether pension funds should be making market-timing decisions right now. Traditionally, their advisers would have said not to market time at all. But this time it really is different.

For a long time, automatic rebalancing has served those institutional investors who practiced it well. This is a good way to reduce the impact of bubbles and busts on portfolios, which are usually weighted towards market-cap indices.

The problem with the current situation is that asset values have fallen so far and the outlook for fundamental market drivers is so bleak that fiduciaries are understandably nervous about going back into the water, just yet.

This is just the time, though, that they and their advisers can really add value for members and/or the plan sponsors.

That is not to say that some things may have changed for a long time, perhaps forever.

There will be a long cloud over fund governance for the foreseeable future. Funds which invested in products and strategies that their staff, let alone trustees, did not fully understand will have lost credibility. Alternatives are not dead but they require more oversight than some investors were willing or able to provide.

Overall risk management, which for so long played second fiddle to investment returns, has taken its rightful place in the institutional investment process. Custom benchmarks will become more commonplace.

Counterparty risk has taken on a new meaning. Blue-blood institutions cannot properly guarantee to honour their debts. Some pension funds are arguably too large to be secure with just one custodian.

Lowly correlated assets do not remain that way in a time of crisis. They go to one. And when you can’t transact because of liquidity constraints, the resultant losses can be catastrophic.

Liquidity is more important than anyone gave it credit, or a premium, for. There’s a reason cash is often referred to as the risk-free rate.

More competition is not always good. Co-operation and co-investing between like-minded fiduciary funds will mushroom over the next few years. Funds will be more circumspect about bidding up the price of assets.

The role of advisers is being questioned by smaller funds, but fiduciaries cannot outsource their fundamental responsibilities. Perhaps another lesson is that if a fund cannot provide sufficient internal resources to adequately govern a fund, the whole thing should be outsourced.

Larger funds will reassess whether their relative success has been due purely to scale, which may have hidden shortcomings in management or oversight.