An equities-biased strategy for the Nottinghamshire Local Government Pension Scheme is against the trend for funds in the UK, but the local government scheme has no plans to de-risk as it tries to make up its funding level.

 

The strategy of the £3.5 billion ($5.7 billion) Nottinghamshire Local Government Pension Scheme, one of the United Kingdom’s many individual public sector pension funds, will remain biased towards equities with the fund holding steady with a 72 per cent allocation to the asset class and no plans to de-risk.

“We are a traditional Local Authority Fund with a high allocation to equities,” says Simon Cunnington in the Pensions and Treasury Management division at the fund which draws its membership from over 100 local employers in the East Midlands and with over 100,000 individual members.

“Our members like us to invest in real assets that generate economic growth and all our investments are long-term. We tend not to worry about quarterly numbers too much and we know equities are volatile, but believe they will continue to outperform other asset classes over 10-15 years.”

In a strategy Cunnington characterises as proudly independent and without any recourse to investment consultants, Nottinghamshire returned 14 per cent last year against its benchmark of 12.5 per cent, boosting assets under management by $653 million.

The equity allocation produced the best returns at 17.7 per cent followed by bonds returning 12 per cent with the fund’s UK property allocation trailing with returns of 1.8 per cent.

Around two-thirds of the equity portfolio is passively managed, mostly in-house by a team of six, but with a portion also invested via Legal and General tracker funds. The remaining third is actively managed by Schroders.

Nottinghamshire uses active management both for diversification and to improve returns, says Cunnington, proven by the in-house passively managed equity portfolio returning 10.4 per cent on a 5 year annualised basis ending September 2013 versus returns in the actively managed portfolio coming in at 12.2 per cent.

Nevertheless, it is not ignoring passive strategies and is currently stress testing all its portfolios in a benchmarking process that looks at the returns possible in passive index strategies versus the active strategies it has chosen to pursue.

“We wanted to measure the impact of our decision to invest differently,” says Cunnington. “It has kicked off a process that may see a few changes.”

One change, he says, will see a reduction in its allocation to UK gilts in favour of sterling denominated corporate bonds that will include European and US companies.

“Our bond portfolio is traditional and low risk with the majority in UK gilts. We plan to reduce our exposure to gilts because we don’t believe performance is going to be as strong going forward,” he says.

Nottinghamshire’s private equity allocation accounts for 2 per cent, around $261 million, of the total equity allocation. In an allocation begun in 2001 most investments are via fund of funds and secondary funds.

Despite the costs incurred in this strategy, Cunnington insists it is essential given Nottinghamshire’s lack of in-house expertise with the asset class. In coming months he hopes to increase the allocation to infrastructure currently made through private equity fund managers Partners Group.

Nottinghamshire is also unusual for its large property allocation accounting for 12 per cent of assets. $473 million of the property portfolio is directly held in domestic property investments managed by Aberdeen Asset Management.

“We like property over bonds because it gives a similar income, but has a better prospect of capital growth. Our UK investments did particularly well up until 2007 and although they have suffered since, we are just beginning to see a turnaround,” says Cunnington, noting that secondary property in particular has struggled.

“There is only a limited supply of prime property so values have held up here but secondary stock has fallen. The key is to keep the rents coming in.”

The remainder of the property portfolio is invested in pooled property funds in the UK and Europe.

Asset allocation at the fund is shaped according to set ranges. The equity allocation ranges from between 55-75 per cent, the property allocation can stretch from 5-25 per cent, the bond allocation between 10-25 per cent and cash holdings between 0-10 per cent.

The large equity allocation is also part of the fund’s deficit recovery program. Nottinghamshire is only 84 per cent funded but because of its buoyant cash flow, with an annual investment income of around $147 million, it can “ride out the volatility.”

Costs are kept low at the fund by a combination of in house management and a limited number of external managers.

The fund had investment management costs of 0.18 per cent net of assets in 2012-2013 and it is driven by the belief that simpler investment strategies lead to lower management fees because of less trading and transition costs.

 

 

 

There may be ‘green shoots’, but 2014 will see no rush for the exit from abnormally loose monetary policies says Neil Williams, Chief Economist for Hermes’ Global Government & Inflation Bonds, in his Quarterly Economic Outlook. Despite volatility over ‘taper-gate’ and concerns that central banks will start withdrawing stimulus, policy rates and bond yields may have to stay low for even longer.

Read full paper here

This research by academics at Duke and Columbia Universities looks at whether it still makes sense to separate equities allocations into developed and emerging market buckets.

 

Given the dramatic globalization over the past twenty years, does it make sense to segregate global equities into “developed” and “emerging” market buckets? This paper argues that the answer is still yes.

While correlations between developed and emerging markets have increased, the process of integration of these markets into world markets is incomplete.

To some degree, this accounts for the disparity between emerging equity market capitalisation in investable world equity market benchmarks versus emerging market economies in the world economy.

Currently, emerging markets account for more than 30 per cent of world GDP.

However, they only account for 12.6 per cent of world equity capitalisation. Interestingly, this incomplete integration along with the relatively small equity market capitalisation creates potentially attractive investment opportunities.

The academics argue this research has important policy implications for institutional funds management.

 

The paper can be accessed here: Emerging Equity Markets in a Globalizing World

The Dutch Philips pension fund has traditionally had a low risk profile, managing a separate liability-matching porfolio and a return-seeking portfolio. A new agreement with its members means it will rethink its  investment strategy, with inflation-sensitivity one of the priorities.

 

The €15 billion ($20 billion) Philips Dutch pension fund is set to go “back to the drawing board” on its investment strategy after reaching a fundamental new pension agreement with its members.

The Dutch electronics giant is no stranger to invention, having produced both the first DVD and compact cassette. A series of changes linked to the introduction of a new national pension agreement in the Netherlands are now set to get its pension fund in innovative mode.

Rob Schreur, chief investment officer of Philips Pensioenfonds, explains that the fund’s trustees have determined to aim for a real rather than nominal benefit ambition in the future.

“Our members also feel a real pension matters, and as a result we’ll need to go back to drawing board to see if our investment strategy matches this objective,” Schreur says.

In addition, an agreement between Philips and the unions was reached regarding the introduction of a collective defined contribution pension agreement, Schreur explains.

Discussions are due to be held at the end of 2013 on questions such as if and how to build inflation sensitivity and protection into a new-look investment mix. Any major investment changes will need to be approved by regulators at the Dutch Central Bank.

Questions about implementation “with the best way being not in a hurry” would then need to be addressed, says Schreur.

As “there are a lot of things going on in financial markets and a lot of things that could happen, we need to be careful implementing any new strategy,” he adds.

As it stands

Currently, the largest chunk of the fund is invested in a €10.5 billion ($14.2 billion) liability-matching portfolio. This is mostly invested against a benchmark of core European government bonds. A 13 per-cent inflation-linked component within the matching portfolio mostly consisting of inflation-linked swap exposure.

The fund adopted a liability-matching concept back in 2005.

Schreur concedes that while the approach has many strengths there are also weaknesses. He outlines these as getting a precise picture of liabilities, setting an effective discount rate and finding instruments to match the risk assumed in the discount curve.

He reflects “there has been and probably will continue to be a lot of discussion regarding the regulatory curve used to discount liabilities, which in itself is a case in point regarding the various, prudent, curves which might be considered.”

Even from a market valuation perspective, it is hard to say whether a swap curve (and Libor obligations) are better than using a government curve for a market valuation of liabilities, reckons Schreuer.

“However, you have to admit over the last couple of years that government bonds across the world have a lot more risk than was expected 10 years ago,” he says.

Schreur is confident that the Philips fund’s liability-matching portfolio has continued to deliver decent returns despite low government bond yields.

“In the run up to the low yields the matching portfolio had a particularly good return, and our 6.5 per cent average total returns over the last five years are higher than most Dutch funds,” he says.

The low-yield environment and the Euro crisis in particular have inevitably led to some changes.

“What we did over the last couple of years was try to get a good view of what might happen in Europe and adapt the risk profile of the matching portfolio to balance the risk of continuing turmoil in the Euro area or even a break-up,” says Schreur.

Greater international diversification has proved a suitable answer to the dilemma. Interestingly though, despite lowering its exposure, the Philips fund showed determination to cling on to Italian and Spanish government debt by lowering its minimum credit requirements.

“We felt it was worth keeping some Italian exposure rather than getting negative real yields from Germany,” Schreur says, but of course this was a risk-balancing act, he adds.

Mortgage investments are held by the Philips fund to aid the diversification of the liability-matching portfolio.

“The spread on mortgage investments is attractive at a couple of per cent over government yields in the Netherlands,” he says.

Schreur takes pride in the fact all these changes were managed while the fund maintained its low-risk credentials.

“Using a cost-effectiveness analysis and comparing to other funds we are at the lower end of the risk profile, with asset risk slightly over 3 per cent compared to a median of 8 per cent,” adds Schreur. “All that is history though, and we have to look forward.”

 

Rich returns

The fund’s €4.5 billion ($6 billion) return portfolio is dominated by equities, which has a 55 per cent strategic weighting. Real estate takes 15 per cent strategically, with 10 per cent in both emerging market and high yield bonds, and another 5 per cent earmarked to both commodities and cash.

The return portfolio aims to cover the fund’s longevity risk. This has been quite a challenge, reflects Schreur “as longevity risk is a difficult beast” with unexpected increases liable to occur.

Schreur comments that the fund has received some valuable help from the Dutch government with its increase of the national retirement age to 67, and the tying of future increases to longevity.

Commodities are set to be reviewed to see if they have a place in the new investment mix, reveals Schreur.

Emerging market bonds have had a difficult time in 2013 “but this kind of volatility was more or less to be expected,” he says. Hard currency bonds look most attractive from a tactical perspective though, he adds.

Returns have been “flat” for the first three quarters of 2013 across the whole fund at 0.6 per cent – caused by a 0.7 per cent loss on the liability-matching portfolio. This is a disappointment that has been compensated for by a clear improvement in the vitally important funding ratio up to 109 per cent – made primarily by an increase in interest rates.

That development might not be nearly as thrilling as anything you can listen to on an old cassette or watch on a DVD. It is nonetheless a product of some very different work at Philips’ Eindhoven base that should nevertheless end up pleasing a lot of Dutch savers.

 

The $46 billion Norwegian DNB Livforskiring has a conservative strategy but it should not be confused with a static approach. The fund revises the investment strategy of its defined benefit offering on an annual basis.

 

Norwegian pension investor DNB Livforsikring is set to stick to a conservative investment strategy due to continued regulatory pressures, according to Tom Rathke, DNB’s head of wealth management.

The NOK 285 billion ($46-billion) fund, the largest in Norway’s private system, faces a tough funding requirement. It has to set aside returns of around 3.4 per cent every year to meet guarantees on its defined-benefit offering, with parent company DNB’s shareholders picking up the bill for any negative returns.

“There is no symmetry and no claw back in Norway, as if we return above our 3.4 per cent target the extra goes straight to our policyholders. That’s why we have a very, very conservative strategy, which has become more conservative over the past few years,” adds Rathke.

Events away from the idyllic fjords and forests of Norway seem also to be conspiring to keep the strategy’s cautious bent in place.

Despite being one of a handful of countries to have resisted the allure of joining the European Union, Norway is still subject to Europe’s new Solvency II insurance regulations.

Solvency II should further reinforce the strategy status quo at DNB Livforsikring after its likely introduction in 2016, says Rathke.

“Low interest rates and volatility in equity markets also brings us to being conservative,” Rathke points out.

Some 9 per cent of the defined-benefit fund is currently invested into equities, 16 per cent in ‘current’ bonds, 18 per cent in money markets, 41 per cent in hold-to-maturity bonds and 14 per cent in real estate.

It is the hold-to-maturity bond bucket, which currently grants a yield of 4.9 per cent, which is the key to matching liabilities, explains Rathke. This consists mostly of Norwegian Krone-denominated credit bonds rated A- or better, typically issued by insurance companies.

The fund’s 9 per cent equity weighting, while low from an international viewpoint, is typical by Norwegian standards.

“A few years ago all the Norwegian insurance-style investors were at the upper end of the 20s for equity exposure, and now we’re all between 5 and 10 per cent,” Rathke explains.

 

Conservative but nimble

DNB Livforskiring’s conservative strategy should not be confused with a static approach.

Far from it, as it revises the investment strategy of its defined benefit offering on an annual basis, something which will be useful for the fund’s efforts to navigate through the changing regulatory environment, Rathke says.

The increasing burden of longevity, coupled with the need to meet guarantees every year have also necessitated an annual strategy review. “Building up a cushion for longevity risk is one of our main focuses,” stresses Rathke.

Derivatives and overlays are frequently deployed to take positions on asset classes. “The use of derivatives is very important for us as we don’t want to have the risk management on top,” says Rathke.

 

Low-interest challenge

Low interest rates have naturally also been a challenge for the fund.

But some shelter has been provided by the fund largely avoiding government paper.

Unlike many institutions with conservative strategies, DNB Livforsikring has only a “very limited” exposure to low-yielding government bonds – mostly from Norway, Sweden, Germany, Belgium and the European Investment Bank.

Norwegian government bonds have been seen as a safe haven in markets over the past few years, making Rathke more enthusiastic about short duration Oslo debt.

Duration in itself is a hot topic for the fund, with the likely impact of Solvency II is making DNB Livforsikring assess duration across its credit investments.

DNB Livforsikring aims for 20 per cent domestic exposure within its equity investments, and as much as 66 per cent of bond investments are made within Norway. Any overseas credit investments are converted into Norwegian Krone to avoid any foreign exchange exposure.

As the defined-benefit fund’s strategy has moved into ever-more conservative territory, the real estate allocation has been lowered from 17 per cent in 2011 to 14.3 per cent today.

“Solvency II also makes it better to hold government bonds rather than real estate,” Rathke points out.

DNB Livforsikring keeps its direct real estate investments close to home, holding them purely in Norway and Sweden, it has also accessed international funds indirectly.

The conservative stance has notably also kept DNB Livforskiring’s defined-benefit offering away from any big moves into alternative assets. It does have a small (2 per cent) private equity bucket, but Rathke confesses “infrastructure will not be a direct part of the future of the investment strategy due to the harsh capital charges on it under Solvency II”. There could be some space to get involved in infrastructure loans though, he adds.

Rathke would “definitely say” that the conservative approach is working in meeting the tough liability requirements. He is able to point of “healthy returns” in 2013 of 3.6 per cent up to end of the third quarter of 2013 (above the 3.4 per cent target).

While the defined-benefit offering is ticking along nicely on-target, a new NOK 33 billion ($5.4 billion) defined-contribution portfolio is giving DNB Livforsikring an unusual chance to make some risk ploys. Equity allocations have been set up to 30 per cent, 50 per cent and 80 per cent across different defined-contribution portfolios. Returns have been as high as 16.5 per cent in the first three quarters of 2013.

With the defined benefit offering closed “the focus going forward is only on defined contribution,” says Rathke. Keeping the defined benefit offering returning so dependably within its limited wiggle room will also no doubt require more good work though.

New research has found that if you have a PhD and work for a money manager your flows will be larger and your performance will be better.

This research in the US shows that the gross performance of domestic equity investment products managed by individuals with a Ph.D. (Ph.D. products) is superior to the performance of non-Ph.D. products matched by objective, size, and past performance for one-year returns, Sharpe Ratios, alphas, information ratios, and the manipulation-proof measure MPPM. Fees for Ph.D. products are lower than those for non-Ph.D. products.

Investment flows to Ph.D. products substantially exceed the flows to the matched non-Ph.D. products. Ph.D.s’ publications in leading economics and finance journals further enhance the performance gap.

 

To access the paper click here