Bavaria is known as the most independent-minded of Germany’s regions, and the pension fund of Bavarian chemical multinational, Wacker, has shown definite divergence from the norm by shedding its holdings of German government bonds.

It is not just German paper – which has seen yields on 10-year bonds below 2 per cent for more than a year – that the fund has rid itself of. Head of investment, Dr Gunar Lietz, explains that the €1.7-billion ($2.2-billion) Wacker Pensionskasse took the step of divesting its entire European sovereign debt portfolio last autumn.

The aim of this move was to relieve the fund of the risk arising from the abnormalities in European sovereign debt created by the euro crisis. It is the likes of Brasilia, rather than Berlin, whose government debt is now part of Wacker Pensionskasse’s diversified strategy. Lietz explains how the fund has instead turned to emerging market debt and global corporate bonds to help it towards a 4.5 per cent performance target – one that he terms “challenging given the regulation we face”.

This regulation has a hand in ensuring that despite the European sovereign bond exit, fixed income remains the main asset component of the Wacker Pensionskasse. It takes 65 per cent of the portfolio, roughly half of which is invested directly and half via funds. Lietz says a “high level of granularity” ensures a full range of the yield spectrum is incorporated. “We try not to concentrate the portfolio but make sure we have different currencies and rating classes,” he says.

The fund follows indices in its emerging market sovereign portfolio. Lietz explains that these are tailored though to avoid illiquid bonds and certain countries that it would prefer to avoid like Argentina and Venezuela. Its emerging market corporate debt investments, meanwhile, have an Asian tilt.

On the corporate bond side, Lietz recognises a good run might be coming to an end. He says: “We understand that the kind of returns we have had on corporate debt since 2009, even double-digit returns in investment-grade corporates, cannot continue.” Lietz is enthusiastic about his fund’s exposure to US investment grade bonds though, as despite a similar risk profile to Europe longer duration investments and higher yields of 3.5 per cent can still be found in the American debt market, he argues. That marks about the same yield Lietz expects in emerging market debt.

Local foundations

As the fixed income portfolio is currently not expected to fully match the performance target, Lietz explains that the fund’s other asset classes of real estate, listed and private equity “must make the difference.”

Fascinatingly, real estate overshadows equities in taking a larger, 17-per-cent share of Wacker Pensionskasse’s portfolio. Lietz says this is a “historical” feature of the fund, which has retained a strongly performing portfolio of buildings almost entirely in the Munich area. While Lietz says he is aware of the “concentration risk” of this legacy, the stable returns of the “hot” local property market, and a decision by Wacker Pensionskasse to sit back and avoid any buying or selling has seen the real estate portfolio grow strongly. The position has received a further boost recently, adds Lietz, and yields are now rising as Bavarian rental prices have climbed over the past few years. The Munich headquarters of sponsor company Wacker is also part of the fund’s real estate portfolio.

Social lender, lightweight equity

Like several other German pension funds, the Wacker Pensionskasse has a history of granting mortgages to employees of the sponsor. The “resource-intensive” lending, which takes between 1 to 2 per cent of the overall portfolio, is essentially “a social function” says Lietz. As the mortgages are only open to Wacker’s 10,000 or so German employees, it will never grow beyond the edges of the portfolio. Nonetheless it offers a satisfactory yield at a time when Lietz points out that “everyone is talking about real estate debt.”

The Wacker fund’s 10-per-cent equity holdings more or less matches the average for a German pension fund; and it perhaps looks diminutive on an international scale due to the limits local regulation places on “risk assets”. Despite equity markets breaking all-time record highs lately, Lietz is unenthusiastic when asked if the fund could increase its exposure. “You need so many resources to afford to take the volatility of equities,” he argues, “as volatility is your biggest enemy”.

Despite the lightweight equity position, Lietz is pleased that the fund has gained exposure to all capitalisation sizes in its global equity mandates. Lietz says that in both equity and fixed income, the fund “tries to avoid the home bias”. This approach has seen US stock holdings dwarf German holdings and a healthy exposure being made to emerging market equities. Apart from a passive global large-cap mandate, the rest of the equity portfolio is invested actively.

Lietz explains that in addition to the equity bucket, Wacker Pensionskasse also gets some risk exposure from high yield fixed income, from a “significant amount” of convertibles (that bridge equity and bond risk), and a 5-per-cent private equity portfolio.

Seeking alpha in private equity

Lietz confesses to spending most of his time these days on the private equity portfolio. It is an asset class that Wacker Pensionskasse boasts plenty of experience in, having first invested as far back in 1997.

Lietz traces the development of this experience as follows: “We started with fund of funds, and a mix of venture capital and buyout. It then developed into a managed account into different regions and styles.”

As a next step, Lietz says Wacker Pensionskasse is using its experience to bypass fund of funds. It is able to do this as it has gained the confidence to pick suitable underlying funds. It concentrates on three styles – buyout, mezzanine and distressed – and focuses on Europe and the US.

Alpha from private equity is a key to Wacker Pensionskasse thriving in the low yield environment, and Lietz is therefore dedicating himself to improve the performance contribution of last year. Detailed work on cash flow and allocation patterns in the private equity space, as well as benchmarking, consumes a large part of Lietz’s attention.

A 5-per-cent overall return in 2012 and 4.8-per-cent return in 2011 demonstrate Wacker Pensionskasse has been able to consistently perform to its requirements. It is not leaving anything to chance, though, as higher contributions from the sponsor have been needed to match increased longevity risk on the defined benefit plan that closed in 2005. Lietz’s attention to detail will hopefully keep it on target despite the tricky environments of German regulation and globally low yields.

 

The rise of smart beta has just got another boost thanks to a study commissioned by Norway’s ministry of finance for its Government Pension Fund Global. It asked index provider MSCI to look into the feasibility of running smart beta strategies for large portfolios. Very few institutions with the size of GPFG’s $400-billion equity portfolio have implemented smart beta strategies yet, mostly because of challenges around investability or liquidity. MSCI, which has around $40 billion benchmarked against its various risk premia, or smart beta, indicies, explored the feasibility of investing a hypothetical portfolio of $100 billion and found that large assets can successfully run on these indices without liquidity worries.

Heavy lifting

Smart beta, factor-based investing, customised beta, risk premia, call it what you like, it involves investing in an index tilted towards certain characteristics such as low volatility, size or momentum, and is increasingly popular with investors seeking to outperform traditional indices weighted according to market capitalisation. Smart beta indices do what Roger Urwin, global head of investment content at Towers Watson and advisory director at MSCI, talking during an MSCI webinar Designing Portfolios of Risk Premia: Practical Considerations, described as “heavy lifting.” They offer a passive strategy that falls between bulk beta and alpha, but is cheaper than active management. An estimated $200 billion is already invested in smart beta strategies. Examples include Taiwan’s largest pension fund, the $43-billion Taiwan Labour Pension Fund, allocated $1.5 billion to various MSCI Risk Premia Indices last year. In the United Kingdom, Glasgow-based Strathclyde Pension Fund has also ventured, portioning $824 million of its $16.6-billion portfolio to a fundamental index, rating companies on their economic value as opposed to their size.

Tailored to suit

MSCI developed a set of hypothetical indices for Norway’s GPFG tilted towards value, momentum, small cap and low volatility stocks. The brief from Norway was to measure returns, risk and most importantly investability, using a hypothetical portfolio valued at a quarter of GPFG’s equity portfolio and with a daily trading limit of 10 per cent. “They wanted to know if we could build an investable version of risk premia indices and maintain the return premium for a portfolio of this size,” explains Jennifer Bender, vice president in applied research at MSCI. “We built four indices and the return premium was between 60 and 115 basis points – most of our clients would agree this is a significant premium.”

The past does not guarantee the future, honestly

Investability was the key focus of the study. Unknowns around liquidity and costs hitting net returns for big smart beta investors still abound. A tilt towards systematic risk factors means more trades in a portfolio entailing transaction costs like commission for brokers, explains Bender (pictured right).

Bender-J-EDM

Ownership stakes in individual companies and trading volumes in individual stocks can also become large, with trades influencing the price the fund can buy and sell. The study looked at the daily trading limit of stocks and how turnover affects replication costs. “We haven’t answered all the questions yet,” she cautions. “At the end of the day we can’t predict the impact on spreads or prices, which are a big component. We won’t be able to see this until large investors implement these strategies, but we have given some indication of the cost to run this kind of strategy for a large portfolio.”

Nor is there any certainty to MSCI’s findings, she warns. Returns for Norway were based on historical data and simulations. Past performance doesn’t guarantee future results and indices can easily underperform after launch.

Up for the long haul

Like all smart beta indices, the Norwegian test saw periods of weak performance with different indices capturing excess returns at different times. It means investors must sign up for the long haul. “Factor investing requires a strong governance structure with clear investment beliefs and board support to withstand periods of underperformance, while aiming to benefit from the potential premia over a full cycle,” says Bender, adding that varying returns can be mitigated by diversification and pursuing more than one strategy at same time. “Risk premia indices go through underperformance, but by combining them we can smooth out periods of underperformance and limit risk,” she says.

As for GPFG, it isn’t planning to change mandates just yet but the fund says it will act on MSCI’s findings. “The analysis carried out by MSCI suggests that it may be possible to tilt the composition of the equity portfolio of the GPFG towards systematic risk factors to a certain extent,” stated Norway’s ministry of finance. “Investment strategies focused on exploiting systematic risk factors may therefore become important in the Fund.” This could mean GPFG becomes another big investor seeking exposure to risk factors alongside its asset allocation, and so pushing the smart beta trend even further.

In this engaging Edmond J Safra Research Lab Working Paper, Investment consultants and institutional corruption, lawyer Jay Youngdahl looks candidly at investment consultants in the United States. Describing them as gatekeepers between institutional investors and the peddlers of financial products, the author identifies ethically dodgy and widespread practices, and suggests they are at the heart of failure in the financial system. While he points to “a reimagined investment consulting industry”, Youngdahl declines to sell readers a solution, sticking instead to a highly personable litany of consultants’ avarice and the widely held warped perceptions that allow it to continue.

Read it here.

The offices of Nigeria’s biggest pension fund manager sit at the end of a quiet side street on Victoria Island, Lagos’s bustling financial capital.

Inside Stanbic IBTC’s aptly named Wealth House, indicative of Nigeria’s growing savings culture, a throng of customers jostle to query staff on pension matters. Four flights up, 48-year-old chief executive Demola Sogunle is just back from a whistle-stop tour to southern Nigeria, where he is cajoling state governments to introduce a new defined contribution pension scheme for their public sector employees.

It’s easy to see why Nigeria’s pension sector could become one of the fastest growing in the world. In 2004 root-and-branch reform modeled on the pension systems of Mexico and Chile introduced a compulsory defined contribution scheme for all public and private sector employees.

Twenty-odd pension fund administrators (PFAs) where set up to manage the windfall as employees began to save 15 per cent of their monthly salaries, including employer contributions. Nigeria’s defined contribution assets have steadily grown to $20 billion, but are still only a fraction of what the working population saves. As more people come on board, forecasts predict total pension assets will grow by 30 per cent a year, making Nigeria’s savings pot worth $75 billion by 2020.

Like other PFAs, investment strategy at Stanbic IBTC, managed in house by a team of 14, is deliberately cautious to preserve capital and keep Nigerians, with a reputation for eagle-eyed scrutiny of their pension assets, saving.

“Every contributor has their own personal account and we find they check the value of their pension fund on a daily basis. They don’t mind making money but they’ll ring you if you lose any,” says Sogunle. Strategy is also guided by strict rules in a country where pension funds can’t invest outside Nigeria without presidential approval.

Mitigating inflation

As it is, Stanbic IBTC has one of the largest equity exposures among its peers with 16 per cent of its $6 billion assets under management invested in listed Nigerian equities.

Other than this, it has a 65-per-cent allocation to government bonds and a 10-per-cent allocation to money markets with the balance in corporate bonds.

The pension manager saw annual returns of 15 per cent last year but Nigeria’s raging inflation left an adjusted return of just 2 per cent.

“The single biggest problem for us is high inflation and how to mitigate it,” says Sogunle. Still “uncomfortable with derivatives,” regulators prohibit any kind of hedging, although he expects plain vanilla instruments will begin to emerge as Nigeria’s regulator, the National Pensions Commission (PenCom), increasingly sees the market “from the saver’s perspective.”

The battle with inflation is one of the reasons Sogunle is enthused by new opportunities emerging in Nigerian infrastructure, outlined in reforms in 2010.

The government wants pension funds to help finance roads, ports and power plants and is now pushing an asset class that could be key to getting around the inflation hitch. Matching long-term liabilities (60 per cent of IBTC’s contributors are below the age of 40) with long-term assets without the punitive inflation hit from Nigeria’s federal government bonds, yielding 16 per cent and effectively wiping out long-term gains, is Sogunle’s biggest bugbear.

He is looking at Macquarie’s Africa Infrastructure Investment Fund, which has a sub-fund customised for Nigeria PFAs. There is still no local infrastructure fund or infrastructure bond for investors to buy into and, under the new rules, infrastructure investment is limited to 20 per cent of a manager’s assets.

National boundaries

Stanbic IBTC is also exploring other alternative asset classes including private equity, asset-backed securities and real-estate investment trusts. It plans a 5-per-cent allocation to private equity and is exploring opportunities with funds run by African Capital Alliance and Aureos Capital.

“They both have sub-funds that are compliant with what Nigerian pension funds can do,” he says.

Rules guiding private equity investment stipulate that managers must invest in funds that have at least 75 per cent of their assets in Nigeria. It leaves a 25-per-cent window of exposure to assets outside Nigeria in what could be pension funds’ first chance to tap foreign markets.

Far from being frustrated by the limited investment universe, Sogunle says it’s right that Nigeria’s pension funds invest at home for now.

“Every part of the Nigerian economy needs massive investment. We get good returns and our liabilities are all in naira anyway.”

He also believes local investors are best positioned to benefit once Nigeria’s equity market “takes off” – at the moment many of the biggest corporate names in Nigeria aren’t listed on the exchange. He does acknowledge the buffeting of foreign flows hitting the portfolio however, like when Nigeria was included in JP Morgan’s benchmark emerging market debt index last year.

“We see these flows and we have to anticipate their impact.” It is why Stanbic IBTC run a mainly passive strategy but swing into active mode during periods of volatility.

Untapped opportunity

Defined contribution take-up in Nigeria is still fraught with challenges. Under the constitution, the 36 states that make up Nigeria’s federation are now responsible for introducing the new scheme.

The government reformed the system in 2004 but only six states have signed up although 10 “are in the process” of doing so.

Nor does the new pension scheme tap Nigeria’s vast informal work force. Regulator PenCom estimates that 60 per cent of Nigeria’s 80 million-strong working population is actually in the informal sector; it is planning how best to draw these potential savers into the scheme through attaching benefits to paying into schemes and using technology such as mobile phones.

But for Sogunle all this just represents opportunity. Pointing out that since reform in Mexico 15 years ago, 65 per cent of that population now save and pension assets have swollen to $140 billion, he believes Nigeria with its population of 162 million has only just begun. “The savings culture is there – look at our banking deposits – what we’ve achieved so far is just a drop in the ocean.”

Protecting the pension system is one of six key themes at the centre of the CFA Institute’s Future of Finance initiative as it aims to empower the investment industry to take leadership in restoring trust.

Speaking at the sixty-sixth annual CFA Institute conference in Singapore this week, president and chief executive of the CFA Institute, John Rogers, said the industry has a responsibility to lead out of the crisis, and it is a challenge that involves everyone to get involved.

“We want to look at ways to protect pension systems so people everywhere can improve their retirement,” he says. “We need to champion standards for sustainable pension systems.”

The $30-trillion global pension industry provides the investment management industry with fees of more than $87 billion a year, Rogers says.

At last year’s event he spoke of the “serious trust issue” the industry has with the people it is supposed to serve, and that more leadership was required.

“If we don’t act, the industry will lose credibility and it will be regulated into a state of irrelevance,” he says. “The crisis in trust is not behind us. We believe we have a role to play by mobilising the industry.”

To better serve society

The aim of the Future of Finance project is to shape a trustworthy financial industry that better serves society, and it is advised by an impressive board, led by John Kay.

The project has six themes of reform to focus on:

One of those is putting investors first, which should be a defining fiduciary principle of the industry.

“The industry’s oxygen is trust,” Rogers says. “When the industry breaches trust, it invites regulation.”

The first step in the project, which fits under this theme, is the launch of the statement of investor rights, which is a list of principles outlining what the consumers of financial products are entitled to expect in return for their business.

It includes rights such as objective advice, disclosure of conflicts of interest, and fair and reasonable fees.

The project also aims to raise the level of financial knowledge across the industry.

“The industry is still very young, compared to, say, law and medicine. It is very profitable and there are low barriers to entry,” Rogers says.

It also champions transparency and fairness, and has launched the principles for investment reporting; and will focus on regulation and enforcement to identify the key areas of regulation.

The sixth area of focus will be contributing ways to reduce systemic risk.

“The GFC showed the connectivity of the system, and it cost society $12 trillion,” Rogers says. “We need to drive change in these critical areas.”

Rogers called on the industry to use these critical building blocks to improve the system, and ensure the survival of the investment industry.

“These building blocks will come to life when you put them into motion.”

The CFA Institute has 110,000 members across 140 countries.

 

Q1 2013 Public Engagement Report from Hermes Equity Ownership Services (EOS). This report contains a summary of the responsible ownership activities undertaken by EOS on behalf of its clients. It covers significant themes that have informed some of our intensive engagements with companies in Q1 2013.

The report also provides information on our voting decisions and the steps we have taken to promote global best practice, improvements in public policy and collaborative work with other shareholders.