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

Investors with a large proportion of educated female members have extra reason to take socially responsible investing seriously, but can possibly relax about poor returns. That is a fascinating finding of Rachel Pownall, an associate professor of Tilburg University, who has published groundbreaking work on the nuances of responsible investing.

Pownall, together with Arian Borgers another Tilburg University researcher, polled over 1,000 Dutch households, in order to gain their views on the topic of responsible investing and its values.

They found that close to 45 per cent of respondents were willing to give up a ‘substantial’ amount of pension income in exchange for a more responsible investing approach – a result that seems to challenge the return focus of investors the world over.

“It seems that educated females, and more females in general are more happy to prioritise responsible investing over maximum returns, no matter their own income,” Pownall says in summarising the key demographic results of her research.

While her research showed widespread support for responsible investing from pension fund members, this trend was intriguingly muddied.

Some 17.5 per cent of respondents to the survey preferred a non-responsible equity portfolio no matter the returns it delivered under a scenario as part of the survey. Pownall and Borgers believe this can be explained by poor financial understanding, but the implication seems to be that investors should strive to gauge their members’ potentially complex preferences on responsible investing.

 

Into the thick of responsible investing

Pownall had already observed before doing the research that within the somewhat fuzzy and all-embracing concept of sustainable investing there were clear opinions indicating what Dutch pension fund members expected of investors.

For instance, there has been clear pressure on Dutch pension funds to exclude investments related to the production of cluster bombs, a development “that really ignited the whole responsible investing debate in the Netherlands” says Pownall.

On the other hand, when a couple of large Dutch funds made big charity donations following the 2004 Indian Ocean tsunami, some criticism resulted of this overstepping their responsible investment mission.

These developments in the Netherlands have to some extent been mirrored elsewhere, but another key result of Pownall’s research is that social norms informing responsible investing actually seem markedly different in different societies.

“We have found that Europeans are much more driven by social issues when it comes to thinking about responsible investing and are less worried about the likes of gambling and alcohol,” explains Pownall.

This should naturally serve to steer any investors away from simply emulating a responsible investment approach of their international peers. “I think investors really need to find out what their members want when it comes to responsible investing,” she says.

Other preferences shown by the research are that smokers and drinkers are (perhaps inevitably) less concerned on the whole about their pension savings being invested in tobacco or alcohol companies. Good employee relations were meanwhile rated as the quality that the Dutch value most highly in responsible investing.

 

Responsible menu

“We also wanted to see if individuals are responsible and able enough to express their responsible investing preferences or should there be a top-down approach,” explains Pownall.

The results of some basic investing scenarios conducted as part of the survey indicated widespread misunderstanding – if not financial illiteracy – something that Pownall says is all too common when the public are tasked with hypothetical investment games.

Pownall reckons investors have a role in empowering individuals by offering responsible investing options whenever possible. She sees much more potential for that in the burgeoning defined contribution plans of the UK and US than the big benefit-promising funds of the Netherlands.

“Lots of people want to have a say in what they invest in, and a menu of investment choices would allow those how want to make these decisions to act,” argues Pownall. Large state-connected funds are probably best positioned to set a positive example in this, reckons Pownall.

Pownall feels responsible investing could also come under a wider financial education drive by governments.

A mindset shift from investors might also be needed, Pownall reckons, with the relative lack of importance that her research suggests members place on returns challenging conventional performance horizons. “It’s always a worry that pension funds could be part of the same game when it comes to the quarterly returns that investment managers obsess about, whereas there is a need to focus on the long run,” she says.

While her research shows how decisions are probably best made with the particular environment of the fund in mind, Pownall feels that the Netherlands will continue to make a hefty contribution in pushing the responsible investment debate further. Strong media attention and a questioning public are particularly vital components in the helping the country to the forefront of the responsible investing movement, she says.

 

You can read Arian Borgers and Rachel Pownall’s paper, ‘Social Norms of Pension Funds’ here

 

Norway and Britain have both announced plans to buy carbon credits, giving the United Nation’s struggling Clean Development Mechanism a boost.

 

Sovereign institutions have thrown a lifeline to the United Nation’s struggling Clean Development Mechanism, CDM, set up under the Kyoto Protocol which awards tradable carbon credits to projects like wind farms or solar power that reduce emissions.

Norway’s Ministry of Finance has just invited submissions under its plans to purchase carbon credits from struggling green energy projects threatened by low prices for the offset they generate. In another development Britain says it plans to buy £50 million worth of carbon credits.

Norway plans to purchase UN Certified Emission Reductions, CERs, up until 2020 spanning the second commitment period of the Kyoto Protocol.

Initial purchases of up to 30 million CERs will be made via specialist fund the Norwegian Carbon Procurement Facility, NorCap, set up in October by the Norwegian Ministry of Finance and the Nordic Environment Finance Corporation, NEFCO, an IFI owned by the five Nordic countries that specialises in financing environmental projects.

“We have asked for authorisation from Parliament to spend up to 2 billion Norwegian Krone up until 2020. The 2014 budget appropriation, which is yet to be confirmed by Parliament, is about 316 million Norwegian Krone,” says Sigurd Klakeg, Deputy Director General at the Ministry of Finance.

“Buying these credits is not an investment by the Ministry of Finance. It is for compliance purposes,” says Tommi Tynjala, a senior advisor in carbon finance and funds at Nefco which has assets under management of EUR 230 million.

“It is about helping Norway comply with its Kyoto requirements and helping the carbon market by purchasing from vulnerable projects.”

The carbon market has floundered on oversupply of allowances and reduced emissions eight years on from the first credit being issued. Prices for credits have crashed to less than 50 cents from over 20 euros five years ago.

Under the agreement rich country governments buy the credits to count towards their emissions-cutting targets. Companies can also buy credits to offset the effect of their activities on the climate.

But government institutions are very rarely involved in buying and selling carbon credits. Instead they use the credits to cancel out emissions back home. The financial return comes in that it is often cheaper to buy carbon credits from international projects than reduce domestic emissions.

Klakeg says that Norway’s strategy differs from other institutions weighing in to support the market in that it specifically targets the most vulnerable projects. Those that are either at a standstill or “stranded,” and projects which have no other source of revenue but from carbon prices, he says.

Although 30 billion tonnes “is quite a small amount if you compare it to the total oversupply” and “won’t have any impact on carbon prices” Norway’s purchase is very important for the projects selected, argues Tynjala.