Mercer has revamped the asset allocation of its largest group of funds and in the process refined the way it classifies types of investments into ‘growth’ and ‘defensive’. The multi-manager has also signaled an evolution towards a ‘risk premia-based’ approach to asset allocation in the future. Greg Bright reports.
The Mercer group has completed a strategic investment review of its funds in Australia, which account for about half its multi-manager assets globally.
The $14.7 billion (about A$16 billion) institutional funds, mostly in superannuation trusts, were subjected over the last year to a reassessment of long-term assumptions given the post-global financial crisis environment.
According to Russell Clarke, the chief investment officer, the sectors have been refined to be more ‘true to label’, at the same time as giving the portfolio greater diversification.
Mercer has introduced an “interim” asset allocation, with a view to moving to a “final” set of positions when markets are priced appropriately.
Clarke says that the multi-manager also looked at the three main types of approaches for asset allocation and decided to retain a traditional approach for the time being.
He believes that a risk-premia approach may be beneficial over time, but this could represent too great a shift in thinking for some clients in the short-term. Under this approach, asset classes are assessed according to their quantitative return drivers and qualitative risk factors, with each afforded a ‘high’, ‘moderate’ or ‘low’ risk premium.
Examples of quantitative drivers are: equity risk premium, small-cap premium and credit risk premium. Examples of qualitative risk factors are leverage and regulatory or political risks.
The other approach to asset allocation which Mercer looked at, which seems to be growing in popularity, particularly among big US public sector funds, is a risk-parity-based asset allocation.
Clarke says that this approach achieves better diversification than traditional asset allocation, through leveraging and de-levering asset classes, but it has practical issues and risks which would concern most investors.
He says that there were no ‘new’ lessons to come out of the global financial crisis, however, it served as an important reminder of the things that matter with investments, such as simplicity and understanding the risks.
One of the surprises, for some, was the way most asset classes went to a high correlation with each other, so that traditional diversification between, say, fixed-interest and equities did not seem to work, at least for a certain amount of time.
This is exacerbated with a simple classification of fixed interest into ‘defensive’ and equities into ‘growth’. Mercer’s review included a reclassification of asset classes such that each is given a growth proportion and a defensive proportion.
At the extremes, listed equities are 100 per cent ‘growth’ and sovereign bonds 100 per cent ‘defensive’. However, some other asset classes or sub-classes are a mix of both. Global credit, for instance, is one-third ‘growth’ and two-thirds ‘defensive’. Similarly, unlisted property and unlisted infrastructure are about 63 per cent ‘growth’ and 37 per cent ‘defensive’.
Clarke says the new approach also has the added advantage of being flexible enough to be adjusted according to market valuations. For example, credit may become more ‘defensive’ at certain price levels and the weightings can be adjusted accordingly.
The Mercer funds favour sovereign bonds over credit in defensive allocations for multi-asset portfolios in the long term but sovereign bonds are currently expensive and credit is still relatively cheap, so it would make sense to reverse the preference for now.
Mercer introduced a “real asset” sector and increased its exposure to unlisted assets, added specific allocations to both listed and unlisted infrastructure, added a specific allocation to natural resources and merged Australian and global listed property into one. As a result, the allocation to ‘alternatives’ has been reduced, but this is largely because some investments have been given their own separate classifications.
Clarke says the funds will focus on more genuinely different risk premia in alternatives structures going forward.
The final portfolio will have an increased allocation to emerging market equities and a greater element of inflation protection, although the firm is not expecting a major breakout in inflation in major markets.
The result in the major asset sectors is: equities reduced from 60 per cent to 50 per cent; real assets lifted from 10 per cent to 20 per cent; alternatives reduced from 10 per cent to 6 per cent; and ‘debt’ increased from 20 per cent to 24 per cent.