The CHf4 billion ($4.02 billion) pension fund for CERN, Switzerland’s prestigious nuclear research centre, balances a dynamic, tactical strategy alongside long-term investment. CIO Elena Manola-Bonthond runs a careful strategy tailored to fit the fund’s risk appetite.
This strategy takes into account both the market environment and the fund’s liabilities and projected funded status over the short and long term. Only when the pension fund’s governing board has decided the level of risk does the objective turn to maximising returns and determining the asset allocation benchmark, although Manola-Bonthond notes the fund is never 100 per cent aligned to that strategic benchmark.
“By choosing our risk budget, we determine the return we are able to achieve. Yet returns also need to be such that we can close the funded gap over the long term,” says Manola-Bonthond, who trained as a particle physicist but was always drawn to finance. After completing an MBA, she decided to move across to CERN’s pension fund in 2011. She was promoted to CIO in 2015.
“A scientific background is universally relevant in many other kinds of discipline,” she says. “It is the background that trains you to look critically at the data and assumptions.”
She will need all those skills to plug CERN’s yawning funded gap. It sits at just 41 per cent funded, according to international accounting standards, as of December 2017. According to CERN’s alternative methodology, however, it is a healthier 75 per cent, which the fund aims to make 100 per cent by 2041. Doing so will require the equivalent of a 3 per cent average geometric return over the long term.
“This doesn’t mean the annual objective is 3 per cent,” Manola-Bonthond clarifies. “If you fix the return objective in the short term in response to a long-term average, you risk not arriving there. At an equivalent level of market risk, some years 3 per cent is easy to achieve but other years it will be much more difficult.”
In 2017, CERN returned 6.93 per cent, net of external management fees.
CERN’s portfolio comprises liquid allocations to government securities, credit and listed equity, with an alternative portfolio of real estate, private equity, hedge funds and a small dose of timber and farmland.
Because the risk level changes, the liquid asset allocation is rarely static. “The same asset allocation at the beginning, middle and end of the year can have a completely different level of risk. Because we focus on the risk, our approach must be dynamic,” Manola-Bonthond says.
The fund uses conditional value at risk (CVaR) to measure and monitor its market risk, which is set at a 5 per cent CVaR risk limit of -8 per cent over a one-year horizon.
“[This means] in 5 per cent of the worst-case scenarios, the average loss would be 8 per cent,” Manola-Bonthond explains. The liquid book is adjusted and tweaked according to the risk, so that more or less space goes to fixed income and listed equity allocations as the risk changes. Moves are guided by a holistic risk budget, rather than individual risk budgets for each asset class.
“Opportunities in the bond market will determine our risk appetite in equity. Alternatively, a reduction in the credit allocation on the fixed income side will give more space to equity,” she explains. “The different parts of the portfolio have to be synchronised. We have to deliver the performance together within the risk parameters.”
In this dynamic and tactical element of the portfolio, Manola-Bonthond’s focus is on a one-year horizon, rather than the strategic long term. Current strategies include remaining overweight government bonds versus credit and private debt.
“Credit is the most vulnerable in the late phase of the cycle,” she says. The reduction in the credit allocation has increased the weighting to European bonds; she is also thinking of increasing the allocation to emerging market local currency debt. To date, CERN’s emerging market debt allocation has been in hard currency, favouring exposure to Eastern Europe, rather than higher-yielding geographies.
“We will have to see how and to which extent we will hedge the local currency exposure,” she says. The pension fund has about 25 per cent of its allocation in fixed income, including private debt.
A dynamic and tactical strategy also plays out in the 15 per cent listed equity allocation, which has been steadily pared back from 20 per cent in recent years. Over the last six months, Manola-Bonthond has reduced the bias to US tech stocks to neutral; she is now doing the same to US small caps. The only passive element in the equity portfolio is US large caps, where CERN invests in exchange-traded funds to obtain sector exposure. This, however, is balanced by actively allocating between the different ETF sectors.
“Active management in this environment can bring real value,” she says.
Her investment team of 10 meets every week to discuss how the different portfolios are evolving; any important decisions are taken collegially by the team in keeping with the global risk budget, she explains.
In the alternative allocation, the mantra is alpha production.
“Private markets are less efficient; the more inefficient, the more opportunity there is to access alpha,” she says; however, she notes that diversifying and preventing correlation are challenges in alternatives. “In our experience, the correlation between an average private equity fund and listed equity is very strong. Nor is it accurate to say that global real estate isn’t correlated with equity – there is a strong correlation.”
She says the only truly diversified component of the alternative portfolio is the 7 per cent hedge fund allocation, made up of absolute return and CTA diversifying strategies, favouring low equity and credit beta.
“We measure the beta of this strategy all day long,” she says. “We are not willing to pay fees for market beta.”
She also keeps an eagle eye out for style drift in hedge funds to ensure that the strategy in place is the one intended. The process requires a level of due diligence that surpasses that for all other portfolios.
“The due diligence in hedge funds really does take time, particularly when we include a new hedge fund in the portfolio,” Manola-Bonthond says. “It is a very important and long process.”
All CERN’s due diligence in private equity and hedge funds is carried out internally. It involves analysing a strategy’s risk in different market environments and understanding the track record in detail.
“Was it skill or luck? What is the market where the strategy will not deliver?” she asks. “The objective is to avoid any surprises. If a hedge fund suffers losses in a given market environment, we want to have expected it through our due diligence process. If the hedge fund performs in a way we don’t expect, we don’t like it.”
In private equity, due diligence involves extensive analysis of past returns to gauge whether they are the result of alpha or something else. Here, Manola-Bonthond is working with an external provider that has developed a methodology for benchmarking and measuring performance.
“The widely used performance measure in private equity – internal rate of return – assumes you re-invest all proceeds at the same rate of return. By you can’t reinvest a distribution at the same level as you receive it as cash. This methodology cleans this part of the process,” she explains.
In fact, the importance and rigour she applies to internal due diligence makes increasing some allocations in private markets difficult. For example, CERN has a small allocation to farmland that Manola-Bonthond likes but isn’t planning to increase because of the need for a reinforced internal team to cover the due diligence of the managers.
CERN’s 7 per cent allocation to private equity, built up today from an original focus on venture capital, targets the best managers, in a bottom-up approach.
“Our view is that it is the skill of the GP – rather than illiquidity premium – that drives the performance in private equity,” Manola-Bonthond says.
The strategy draws on an external adviser to help gain entry and prioritises nurturing and building general partner relationships.
“During a GP’s next [fund raising], we need to ensure we are invited to invest,” she says. “Our strategy is to keep in contact and show interest via a continuous dialogue.”
Manola-Bonthond has no plans to increase the allocation to private equity. For now, strategy is focused on replacing some managers as funds come to the end of their cycles and better opportunities arise, and also on increasing capacity with managers identified as outstanding.