“There is very little pure alpha” said Henrik Jepsen, chief investment officer of ATP, at the Fiduciary Investors Symposium in Amsterdam when reflecting on the giant Danish fund’s experiences with the return class.

The DKK 624-billion ($114-billion) ATP decided to merge the alpha and beta platforms of its investment portfolio earlier this year. This wound back a 2005 decision to create a designated separate alpha unit – in effect a hedge fund subsidiary.

Jepsen explains how ATP’s views on the alpha/beta divide shifted during its great efforts to generate alpha. He thinks any alpha generated after the 2005 split was always a form of smart beta. “We probably reduce alpha now, but by accident,” he says. “I’m not ruling out the existence of alpha but it’s very difficult to extract, particularly on a large scale.”

According to Jepsen, the alpha portfolio was a definite success in constantly generating positive returns with little correlation to the beta part of its $66-billion investment portfolio. “The problem was that the returns were simply too low on an absolute amount”, he says, compared to ATP’s total portfolio. Nonetheless, he reckons that ATP has “retained a hedge fund platform of international quality”, while lowering costs by now reuniting the alpha and beta platforms in a single investment portfolio unit.

“Back in 2005, we saw the world consisting of two types of returns: beta as a sort of reward for carrying market risk over time, and alpha that could give you returns by outsmarting the market,” Jepsen says. ATP’s thinking these days is that “alpha is much smaller than what we thought and what is considered to be alpha is very often a kind of beta – in being a form of exposure against a systematic risk factor”.

ATP’s non-benchmarked return-seeking investment portfolio will continue to be divided into five risk classes: rates at 20 per cent of risk budget, credit at 10 per cent, equities at 35 per cent, inflation at 25 per cent and commodities at 10 per cent. The risk allocations are designed to ensure “all classes are meaningful but there is not any one dominating completely”. The portfolio is vital is generating cash flow to meet benefit commitments and Jepsen says it is designed to perform “more or less all the time” due to capital considerations. Some 85 per cent of the portfolio is invested in house.

Outside of the investment portfolio, a similarly sized hedging portfolio is invested 50 per cent in bonds and 50 per cent in swaps (both purely in Denmark and the eurozone. The purpose of the hedging portfolio is “to generate the promised interest rate, which is the accrual of our guarantees” as well as hedging interest rate risk, according to Jepsen.

Liquidity focus

A new liquidity-risk management model is identified by Jepsen as another key recent adjustment to ATP’s investment activities. “Liquidity is only a problem when you need it and we have seen how debilitating liquidity crises can be, so we developed an extreme focus in making sure we never get caught with insufficient liquidity,” Jepsen states. The fund has initiated a system of stress testing its ability to generate liquidity and liquidity needs to daily, weekly and annual horizons.

“As we have a very large portfolio of interest rate swaps, our business model is largely dependent on a well functioning banking system, and managing risks like that is a focus,” says Jepsen. A new need to post “a very large sum” of collateral for derivatives in European central clearing rules has also had an important part to play in increasing ATP’s focus on liquidity.

Cockroach approach

ATP’s investment strategy naturally faces the same demands as its international peers in navigating a low-yield environment, which Jepsen also argues is prone to shock. “One of my concerns is that we have all these statistical models that generally underestimate the number of big shocks that we have every five years or so,” he says.

ATP is aiming for robustness in this environment. Jepsen cites a thought from veteran Wall Street risk manager Richard Bookstaber that investors can learn from the cockroach. The cockroach has a very good risk management approach due to the wind sensors in its hairs, he explains. “If you’re a pension fund, you want to survive in the long run and you can maybe focus less on specific statistical models,” says Jepsen.

Maintaining a balanced portfolio and extending diversification to protect against shocks are also outlined as guiding principles for ATP in the current environment. Jepsen urges his fellow investors to focus on their comparative advantages and adds that patience is needed, as “no investment strategy will work at all times”.

Jepsen says ATP has been able to buck a trend for risk parity portfolios to underperform this year as “we have been much higher with our equity allocation than is usually the case”. That shows the importance of being adaptable, adds Jepsen, despite stating that ATP retains its long-term faith in qualities such as diversification and balance.

For years metals such as aluminium, zinc and nickel have been persistently oversupplied. The copper market, in contrast, has been much tighter, primarily because China needs to import the metal but is largely selfsufficient in other metals. This has seen copper trade at a premium to other base metals and be recognised as a good proxy for investors tracking China’s economic growth.

New chairman Ruston Smith’s inaugural speech at the United Kingdom’s National Association of Pension Fund annual conference in Manchester focused on building trust in the pensions industry. Talking about the need to create “pensions people trust to deliver a decent income, pensions people trust to be there when they retire and pensions people trust not to rip them off”, he set out the main themes that will govern his two-year tenure at the organisation that represents 1300 pension schemes with a  combined £900 billion ($1.46 trillion) under management.

As auto-enrolment promises to see between 6 to 9 million people start to save for the first time, so Smith’s focus will be on improving governance and regulation to protect savers, maximise retirement incomes and nurture confidence in pension saving. He promised more emphasis at NAPF on defined contribution, “the future of pension’s provision”, and more support with investment strategies and regulation.

In what he called “building on today for a better tomorrow”, Smith, who replaces outgoing chairman and former Barclays pension chief Mark Hyde Harrison, set out four “big steps” that the industry needs to take in order to adapt to the challenges of auto-enrolment, whereby every company in the UK will be obliged to offer all staff a pension. Staff will be automatically enrolled unless they opt out.

Quality mark

Firstly, he asks the industry to encourage savers by increasing awareness of the NAPF’s Pension Quality Mark, a tool to help people recognise more easily what quality schemes look like. Smith called to make pensions simpler by “junking the jargon” and encouraging “simple conversations” about them. Adding in a third point: “We need to develop more innovative and creative products and services to recognise pension savers’ changing needs, particularly at retirement. We need to recognise the need for products that reflect people’s retirement choices and life patterns when they get older. Linked to this, we need a more flexible pensions framework for individuals and employers. People’s lives and expectations have changed. So we need to face into that challenge together,” he said.

Smith also talked about the need to build confidence in saving to overcome pension apathy and cynicism. “This means we need trusted institutions. And it means we need to tackle the difficult questions and vested interests so that saving for retirement is something that works in the interests of the saver – and not against it.”

Top-shelf issues

An industry heavyweight, Smith joins the NAPF from his role as pensions director at Tesco since 2002. The retailer’s $11-billion defined benefit scheme has 300,000 members and is internally managed by Tesco Pension Investment, where strategy is headed up by Steven Daniels, the former chief investment officer at Liverpool Victoria, an insurance company. Smith has held a non-executive role at NAPF since 2007 and lobbied on behalf of the industry earlier this year when he represented the NAPF at a Parliamentary Treasury Select Committee. Together with other experts, he argued how quantitative easing has affected pension fund investments and liabilities.

In a wide-ranging speech, Smith also looked beyond the next two years, talking about the need for a vision for the next decade. He pointed out that an ageing population and the country’s future economic needs pose challenges that extend beyond pensions to questions that “we haven’t even started thinking about as a nation, never mind tackling”. He also asked how best to create more employment opportunities for older generations when youth unemployment is now running at 20 per cent.

Smith’s new tenure promises a fresh set of priorities or “step change” at the organisation, which he is determined to ensure continues to serve its members. “Having worked in retail for the last decade, I believe the customer is at the heart of everything we do,” he said referring to the gathered delegates as his customers. “For me, this will be no different at the NAPF.”

Sylvester Eijffinger, a Tilburg University professor and renowned international monetary policy expert said “financial repression is everywhere in the OECD” in a keynote address to the Fiduciary Investors Symposium in Amsterdam.

Eijffinger says “the globalisation of monetary policy makes it very hard for emerging economies to shield themselves from these influences”.

Eijffinger points to negative real interest rates in northern European states and elsewhere as a clear sign of a global era of financial repression. Eijffinger highlighted Japan’s expansionary ‘Abenomics’ monetary policy as being the “most extreme form of the phenomenon”, but mentioned the recent nomination of “dovish” Janet Yellen as the next head of the US Federal Reserve as another clear sign of the times.

Eijffinger reckons fiscal interest gained dominance over monetary policy in the midst of the financial crisis in 2008 to create financial repression via negative real rates. “It’s a wealth tax in a very opaque way, which is likely to continue for another five years if not 10 years,” he argues.

The professor identified clear motives for governments to continue a policy of financial repression. Firstly, he explains “it is very difficult to cut government expenditure – even in Germany, which is the most stability-oriented country you could imagine.” Populism is forcing governments into a corner when it comes to deficit cutting in many countries such as the Netherlands, he argues.

The possibility of governments reducing deficits via strong growth also appears slim in the years ahead, says Eijffinger, making inflating away deficits via downward pressure on interest rates an attractive option. “Negative real interest rates allow governments to deleverage at the expense of investors and private savers,” adds Eijffinger.

Independent spirit

Financial repression seriously irks Eijffinger, who states “I’m a believer in the independence of central banks, I am convinced it is the best thing for a country in terms of social welfare”. He is dismissive of continued claims to independence by the worlds’ central banks, saying “an independent central bank is one that can say no to politicians.” He reckons the US Federal Reserve’s official position of being “independent within government” is false.

Eijffinger sees a power grab by governments over monetary policy occurring in the aftermath of the financial crisis in 2008: “Politicians stepped in to save banks and they thought ‘Gosh, we really are important!’ The balance of power between politics, banking and central banks was completely reversed as 20 years of monetary dominance and fiscal accommodation was replaced by fiscal dominance and monetary accommodation.”

Eijffinger argues that a consequence in 2013 is that “politics is making a mess” of the economic upswing in the Netherlands, in words in defence of recently criticised remarks from the president of the Dutch central bank.

History of repression

Eijffinger’s prognosis of another five years of financial repression is based upon his detailed take on monetary policy history. “If you look at periods of financial repression, going back to even before the Second World War, you’ll see they last 15 years on average,” he says.

Eijffinger gleefully cites the lessons from history as he argues “people forget that financial repression is nothing new”. He outlines a 30-year period from the end of the Second World War, with interest rates “effectively zero” in the US from 1948 to 1952, “direct monetary financing” introduced in a 1952 accord and negative real interest rates seen during the stagflation of the 1970s.

Eijffinger says that the lessons learnt in the 1980s and 1990s of the virtues of central bank independence are now being forgotten.

Future

Eijffinger believes the tapering of quantitative easing is the US will now start in spring 2014 in the earliest but will be “very grave” for investors. Eijffinger recalled former Federal Reserve chairman William McChesney Martin’s well known maxim of taking the punch bowl out of the party to describe what federal banks should be doing. In reality, Eijffinger believes there is now a lag of 18 months to two years developing in monetary transmission.

Eijffinger urges investors “to think about what financial repression means for investment policy decisions on bonds and stocks”. Clearly it is something they could be thinking about for quite some time.

 

Asset owners seeking comfort regarding Europe’s growth prospects had their hopes dashed by an expert panel speaking at the Fiduciary Investors Symposium in Amsterdam. Recovery in Europe, and with it implications for the stability of global market forces, the investment allocations of investors and the political and social well being of EU residents, is still a way off.

Sir David Cooksey, member of the SPV Advisory Council and former director of the Bank of England, argued that Europe’s lack of competitiveness and moribund banking sector remain hurdles to recovery.

The high unit labour costs in all countries relative to Germany lies at the heart of the continent’s inability to compete. It’s led to a process of “internal devaluation” where most European countries have “pushed down their unit labour costs by reducing their amount of labour.”

Cooksey adds: “Europe has to make itself more competitive. It can’t go on spending and taking out credit while not competing in world markets.” He identifies a two-stage Europe with the overwhelming majority of economic growth coming from Germany and Netherlands. “There is nothing to show that things are getting better,” he cautions. “And it is no good thinking Europe can muddle along. European countries need to compete with each other – and against Germany in particular,” he says.

Cooksey also urges banks to do more to dispose of their non-core assets. Governments “pouring” more regulation on banks, asking that they hold “enormous amounts” of extra capital, makes it all the more important for banks to focus on core lending. Unless they free up capital, redeploying assets into what is going to prompt growth will be more difficult, he says.

Similarly Sharan Burrow, general secretary of the International Trade Union Confederation argued the key to growth in Europe, which she says is still “a long way off” is “jobs, jobs, jobs.”

Not only is growth weak but unemployment is at pre-crisis levels. She says that 60 per cent of the labour employed in the global work force is in formal jobs with 40 per cent in the informal sector.

“There is no sustainability in this equation,” she warns. Statistics from the OECD also show inequality has increased with disposable incomes in the UK at 1997 levels. In Germany 40 per cent of the population earn less than they did 15 years ago, while in the US incomes are at a 35-year low.

Burrow also urges banks draw a line between investment and speculation. “Banks drive me crazy,” she says, adding that they are too concentrated and have “thrown too much money” into anti-regulatory initiatives. She urges asset owners to invest in infrastructure, the green economy and the care economy including education and health, and urges for new pools of capital for SMEs. She calls for better disclosure by investors. “It is imperative we know where our money is invested,” she says. “Only then can we talk about the risk and outcomes.”

Sony Kapoor, managing director at think tank Re-Define and an advisor to long-term investors, told gathered delegates that they were also responsible for the problems facing Europe’s banks.

“It’s your fault,” he said. “You sit on their boards and allowed them to invest in silly assets.” He also urged asset owners to set more realistic return targets. “You are collectively blind,” he said in reference to the contradiction between today’s global environment, and asset owners continuing to target returns of 8-9 per cent. He urged long-term investors to contribute more to the ongoing debate around regulation and recovery saying they are “missing in action.”

Investors “faced a choice” at the beginning of the crisis when they could “have bitten the bullet” and allocated losses at the point the crisis occurred. Instead they chose to slowly allocate losses over time. The result, Kapoor argues, is additional cost. He also urged investors to invest more in alternatives, particularly the green economy. “Good investment opportunities do exist,” he says.

 

Fundamental questions of pension system design and regulation are serious barriers to fulfilling the global long-term investing agenda, according to a panel of major European asset owner heads at the Fiduciary Investors Symposium in Amsterdam.

Eloy Lindeijer, chief of investment management of €140-billion ($191-billion) Dutch investor PGGM said “maybe politicians still don’t realise that there is a war for long-term capital going on, and it’s just begun.” He criticised politicians for lacking understanding of “the importance of the investment industry for their own economies and what kind of regulatory framework would fit that.” Lindeijer said “we would very much like to see a regulatory framework for long-term investors that recognise certain assets have liability-matching characteristics.”

Lindeijer explained the he has fears of a number of regulatory measures in the long-term investing context. He said: “We have a large worry about a combination of factors, like the financial transaction tax, the fact that under the new Dutch pension contract we need to keep hedging nominal interest rate risk and that the cost of central clearing is going up.”

Angelien Kemna, chief investment officer of ($450-billion) €330-billion APG agreed “major world leaders like Obama and Merkel do not understand us very well even though we are effectively major shareholders in their countries.” Kemna reflected on some positive developments of leaders acknowledging investors’ views though, explaining that an exchange of ideas between her fund and Angela Merkel on the EU’s financial transaction tax led the German chancellor to better appreciate its “unintended consequences.”

“The policymaker who understands us most will get the most long-term capital, it’s as simple as that,” said Kemna. She added that she was concerned about potentially dramatic cost increases from the central clearing of derivatives as well as the hindrance of collateral requirements from a “one-size-fits-all regulation system.” She also explained that the increasing internationalisation of regulation, whether on the European level or beyond, is making it a more difficult challenge.

Defined benefit drawback

Roger Gray, chief executive of the UK’s Universities Superannuation Scheme (USS) Investment Management, said the defined benefit basis of his scheme, and much of the UK’s pension investors, was inhibiting long-term risk taking. Gray said “I’m pretty sure that a degree of acceptance of risk sharing is absolutely essential for a long-term investment programme.”

“I would say there has been too much emphasis on protecting the pie instead of growing it, and if there is short-term investing that pie would be smaller in the long run,” said Gray. He added “there is a tension between a triennial and annual funding review and taking on risk.” Kemna agreed that “because we have liabilities we are severely restricted in seeking returns if we haven’t hedged our liabilities.”

Gray said, as far as potential infrastructure investments are concerned, that the £37.9 billion ($61.3 billion) USS is seeking a “holy grail” of illiquid assets with strong inflation linkage that keeps pension promises affordable with little risk. Given the limitations of the USS’s defined-benefit liabilities, Gray explains “what we have ended up doing is looking for brownfield assets that give us a reliable return.” “As presently structured I don’t think we are the big growth engine that governments would like to tap,” Gray added.

Matching needs

Lindeijer says there are opportunities from the developed world’s infrastructure investment needs within a context of constrained government finances and deleveraging banks. A key for PGGM, he said though is that “we need to be able to manage the risks in a proper way and keep costs low, so we’re building internal capabilities to harvest yields at a low cost.” He added that PGGM has been engaged in discussions to try to increase its “limited” investment capacity in Dutch infrastructure to match some its global infrastructure moves.

Kemna says that APG also finds brownfield projects offered by governments as “very attractive” on both the equity and credit side. With a lot of like-minded investors seeking the same kind of assets, Kemna argues that there are now possible overpricing issues with brownfield infrastructure projects. She added that she hopes governments could shed some brownfield projects to allow investors to back more greenfield-type investments “that we are shying away from”. “We need governments willing to co-operate with us under terms and conditions that are fair for our participants – it should not be an implicit subsidy,” Kemna warned.