As a recent survey by US management consultant Casey Quirk showed, for investment management, 2009 is all about beta. Director of research, Ben Phillips, spoke to Kristen Paech about mandates that pension funds are investigating, and the role alpha may play.
With global financial markets in turmoil, many pension funds are reviewing their investment strategy and the return they are receiving for a given level of risk. Lower expected returns and changes in funds’ risk tolerance are shaping the way they view alpha and beta, and the types of mandates that will be awarded to fund managers in future.
Ben Phillips, partner – director of research at Casey Quirk, a US-based management consultancy for funds management, says US pension plans are continuing to globalise equity portfolios, which have traditionally been concentrated in the domestic market.
“North America is finally moving away from its home bias and globalising equity portfolios,” he says.
“Many US institutional investors have steered clear of regional mandates. The big beneficiaries have been global equity portfolios benchmarked to the MSCI World.”
When it comes to fixed income, both consultants and funds are placing greater importance on credit research when reviewing fixed income managers, due to dispersion in returns over the last 12 to 18 months and the likely rise in
default rates going forward.
“The crisis exposed that credit ratings are meaningless,” Phillips says. “Strong credit analysis skills to navigate current debt markets became key.”
A recent survey by Casey Quirk of more than 60 consultants advising a total of $11 trillion confirmed that 2009 would be all about beta, as pension funds rebalance back towards their strategic asset allocations.
Institutional investors in North America are expected to award more than $200 billion in mandates this year – an increase of 15 per cent over 2008Â – as traditional long-only equities and bonds regain favour, the survey found.
“Predicted interest in core and core-plus fixed income assignments, an asset class which has seen little search activity in recent years, particularly surged,” the report on the survey results says.
“Nearly three-quarters of US consultants say they will focus on such mandates in 2009, a dramatic five-fold increase over levels recorded last year.”
But despite this increased focus on traditional asset classes, Phillips says alternatives “did not fall as much as everybody thought they would” on the back of poor performance by many multi-strategy hedge funds and liquidity constraints facing the majority of institutional investors globally.
He says the global financial crisis has exposed the hedge fund business model as flawed, but also validated that hedge funds are the future of active funds management.
While Japanese institutions and some retail investors may bail out of the asset class permanently, in the next two years, most of the inflows into hedge funds are likely to come from North America, with around $8 billion in net inflows expected from the Australian market.
In addition, Phillips says pension funds globally are beginning to lump hedge funds, private equity and real estate together when it comes to mandate searches.
“They are looking at hedge funds in a broader portfolio context,” he says.
“The ‘classic’ hedge fund strategies are likely to have more stable demand.”
During 2008, Phillips says hedge funds drowned under their high water marks. Going forward, the pack mentality is likely to fade as the recent period of over-proliferation comes to an end.
This offers pension funds value for money for the uncorrelated alpha that hedge funds represent, albeit they showed strong correlation with equity markets throughout the financial crisis.
During the equity market crash in 2008, hedge funds were 90 per cent correlated to the MSCI World Index, while after the crash the correlation reduced to 40 per cent.
“Pension plans worldwide need a dose of alpha to return to any semblance of fully funded,” Phillips says.
“Uncorrelated alpha supposedly assures this in volatile markets (and amplifies performance in bull markets), for which institutional investors appear willing to pay. Simple market returns increasingly are available for less from passive providers.”
With pension plans, too, under pressure from the financial crisis, especially defined benefit (DB) plans, the prospect of plan mergers has been suggested as a way to secure members’ assets.
However, according to Phillips, these are likely to occur only in countries which have big open-architecture schemes, such as The Netherlands and Australia.
In the US, where the Department of Labor prohibits the buyout of pension plans, only the Taft-Hartley schemes in heavily unionised industries are likely to be merger candidates. The schemes in trouble, such as the big motor company DB schemes which could benefit from the positive cash flows which some other schemes are still maintaining, are probably off limits.
It is possible, he says, that some of the public pension plans could aggregate their investment management teams for greater efficiency.
On the funds management side, private equity firms are still actively in the market for financial services companies. The multi-affiliates and aggregators of funds management firms have a total of “dry powder” for acquisitions estimated at $140 billion, Phillips says.
However, most funds management firms are not looking to expand geographically by acquisition at the moment.