In the city of Hillerød outside Copenhagen in Denmark, a small group of Danes want to teach the United Kingdom’s pensions industry a thing or two. Where UK trustees tend to see fund choice as a blessing, Denmark’s DKK579-billion ($101.6-billion) public pension plan ATP has always viewed picking and choosing between different managers as more of a curse. It has applied the ethos to its UK subsidiary, defined-contribution workplace pension-scheme provider, NOW: Pensions, which sells itself to UK companies looking to automatically enrol staff on the strength of one single investment strategy. Having set up a year ago, it’s still early days but NOW: Pensions Investments A/S chief investment officer, Mads Gosvig, is convinced he’s on the right track.

“Many schemes in the UK have been set up for people with higher incomes used to taking investment decisions, but you don’t want the same tool for everyone,” he says from Denmark where the NOW investment team sits alongside ATP’s. “With auto-enrolment, more people will be taking out pensions and our research shows it’s best to keep the number of decisions small because pensions are a specialist area.” NOW won’t ever pool assets with ATP but the two funds already share ideas and processes and, as NOW’s assets accumulate, the funds will implement the same strategies and buy into the same third party investment vehicles.

What’s NOW?

NOW offers members access to three funds catering first to a savings phase via a Diversified Growth Fund. A decade before retirement, members’ assets pass into a Retirement Protection Fund, in which returns from the growth phase are safeguarded through long-term gilt allocations and interest rate swaps in a hedged portfolio. Finally, assets pass to the Cash Protection Fund. The Growth Fund, split 60/40 between equities and bonds, targets a return of 3 per cent above cash, a target Gosvig believes is easily achievable given trial results from a $15.3-billion synthetic portfolio have returned 10 per cent. NOW only began accruing assets midway through 2012; Gosvig won’t be drawn on current assets under management just yet.

Like ATP, the Growth Fund is built around risk allocations rather than conventional asset allocations. It’s an approach that better manages risk since most asset classes have “an inherent exposure to equity risk,” explains Gosvig. The fund favours five classes comprising interest rate risk, credit risk, equity risk and inflation risk with allocations to government bonds, high yield bonds mostly in emerging markets, global listed equities, commodities and inflation-linked bonds. It’s a strategy eschewing any exposure to illiquid assets and although this could change, Gosvig isn’t convinced returns from the likes of private equity, infrastructure or property are worth the risk for NOW just yet. Liquidity, he says, is not only key to his scheme’s success, giving it an edge over other UK providers like NEST which don’t allow members to transfer assets in or out, but is also crucial in encouraging people to keep saving under auto-enrolment. “The average person in the UK changes jobs twelve times in their working life. You need liquid assets so they can take their pension with them.”

How NOW manages

In the same way other multi-asset funds rebalance a portfolio between asset classes as they see fit and aren’t locked into static allocations, the Growth Fund’s balanced allocation will make managing volatility easier. “Any losses in equities will be cancelled out by gains in bonds,” he says. NOW will actively manage volatility in “risk-on” and “risk-off” strategies. In what Gosvig calls a first line of defence, NOW will first alert trustees of the need to reduce allocations to riskier assets in the fund. A second “risk-on” tool kicks in automatically if the value of the fund falls 25 per cent over a twelve months period. “In this scenario risk is automatically taken off the portfolio with all risk classes reduced by 10 per cent,” he says, using a driving metaphor to illustrate his point. “From time to time we will need to take speed out of the portfolio and this way we can.”

Equity exposure will come via investing in indices. Gosvig believes this is the best way to buy into equity risk, but it’s a strategy that has still presented challenges since many indices include exposures NOW would rather not hold. Emerging markets equity indices, often characterised by clusters of big companies, bring a concentration of risk. How to buy into European equities without exposure to banking stocks is another challenge. “We’ve discussed creating own indices with ATP, but you need somebody to trade the index with and there’s a cost to that,” he says. Rather than buy bond indices, NOW will buy bond futures, primarily in the UK, US and Germany, but will access commodities via commodity future indices.

NOW’s UK subsidiary has no external managers, bar a handful of allocations to exchange traded funds, and its own investment team comprises just three people. Of course NOW isn’t the only fund built around a simple investment strategy; variations of the no-frills approach are apparent in a raft of much bigger and proven schemes. But it’s a low-cost model that APT could take beyond the UK to nations such as India, which is currently opening its pension sector to foreign investment. The concept that choice isn’t necessarily a good thing could be about to take off.

Innovation is associated more with bold new businesses than gently declining ones, but Denmark’s Lønmodtagernes Dyrtidsfond (LD) is embracing change as it enters its final years. The pension fund’s inevitable disappearance has nothing to do with any lack of competitiveness or poor investment returns – the 9.9-per-cent net return it generated in 2012 is testament to that. Instead it simply finds itself in the autumn of its investing cycle. Entrusted with investing assets promised to more or less the entire Danish workforce in the late 1970s, LD’s contributions dried up over 30 years ago and its members will all reach the age at which they are able to withdraw their savings in just over a decade from now. Investments are expected to dwindle to half the current 52 billion Danish Krone ($9 billion) by 2020. Except they aren’t dwindling at all – last year they climbed by $170 million, despite three times that amount being withdrawn.

Lars Wallberg, LD’s chief financial officer, explains how investment success has come as a consequence of a focus on intelligent outsourcing ensuring strategic flexibility and a focus on remaining competitive in both investment returns and costs. Curiously, the fund’s philosophy on outsourcing and controlling costs would not be at all out of place among the cost-sensitive lean start-up movement. Low investment costs are a “very important strategic point” says Wallberg, who is aware that they are a particular point of scrutiny for members of defined contribution schemes like LD. Lars Wallberg

Wallberg, pictured right, enthuses about how costs remain below 0.40 per cent. “When we did a tender for our investment managers in 2010, we deliberately designed our mandates to be relatively large and ensure there was truly global competition in what was one of the most extensive search and selection processes undertaken in Europe,” he explains. “That enabled us to get some very competitive offers.” Wallberg also says that LD keeps the competition going by closely analysing external managers’ performance to their benchmarks. It found in 2012 that the managers – who invest actively – added an extra 0.3 per cent of overperformance to the return figures (net of costs) with an additional 0.2 per cent coming from LDs own asset allocation choices and risk management.

Responsibility and risk

A top-down approach to outsourcing is cited as a priority in LD’s annual report, and there is a clear sense of responsibility for the 15 staff at the fund’s Copenhagen office. It is difficult to judge their efficiency from the outside, but certain feats point to it being a highly organised and engaged fund. Lønmodtagernes Dyrtidsfond was able to publish last year’s investment returns as early as January 2 and takes part in a Myanmar engagement forum as part of its many sustainable investing activities. As far as the investment strategy is concerned, an intense focus on asset allocation and risk management is the chief inhouse job. That itself had been outsourced to a fiduciary management subsidiary in 2005, only to be brought back in house five years later.

Lønmodtagernes Dyrtidsfond has commissioned Morningstar to monitor the risk of its fund, and it continues to place the default fund that covers over 90 per cent of its assets in the lower end of the medium risk category (LD also offers members a range of separate funds covering equities and fixed income, which are used by members wanting to invest individually). The medium risk appetite could explain why as much as one-third of the fund was held in equities at the end of 2012, in line with LD’s own benchmark weighting. This approach seems possibly at odds with that of nascent defined contribution funds in the United States and United Kingdom that generally propose ‘lifestyling’ away from equities in the years directly preceding retirement.

While LD is currently carrying out an asset-liability management study – including an analysis of its members’ perceived risk appetite – that will determine its approach for the years to come, Wallberg says this will probably not be a case of simply reducing risk. “The easiest thing to do would be to put the money we expect to be withdrawn in the near future in the bank and most of the rest in bonds”, he says.

Instead LD wants, in Wallberg’s words, to “honour the expectations of the members. We have to ask how much risk and illiquidity we can assume while still being able to disburse funds at any time. As long as we structure the portfolio to ensure the cash flow can service withdrawals, our analysis shows we can accept more risk than you might expect.”

Wallberg speaks about deploying a “multi-dimensional risk metric” at LD, rather than one driven by a traditional risk-return relationship. Illiquidity risk is a vital consideration for a fund that has to prepare for unexpected withdrawals (members can withdraw from age 60, but many wait beyond then). The pattern LD has seen of members preferring to withdraw after disappointing investment results further complicates that illiquidity risk.

Credit where it’s due

A bold move already undertaken by LD was to increase its corporate bond holdings in 2012 as it plans a 20-per-cent weighting to credit, double that of the past. Credit investments “proved very lucrative in 2012, no doubt about it,” says Wallberg: an enhanced $1-billion allocation to non-investment grade corporate and emerging market bonds returned 14.3 per cent. “We expect credit to offer a reasonable risk-return ratio and a good solid cash flow,” he says. “That’s the best of both worlds for us.” Lønmodtagernes Dyrtidsfond’s unique challenge is that 40 per cent of its assets belong to members over 60 years old and therefore must be convertible to benefits at short notice should the need arise.

Among the riskier asset options, LD plans to continue its significant position on Danish equities – currently around 10 per cent of the overall portfolio and “overweight to most if not all Danish pension funds” says Wallberg. This position delivered a huge return of 24.5 per cent in 2012. An increasing proportion of emerging market equities is one of the tools LD uses to diversify the risk of concentrating on the limited Danish equity market.

Wallberg expects equity holdings to gradually decline as LD nears its end. Private equity is an asset class that is losing favour slightly more rapidly as the illiquid assets pose problems in the case of sudden withdrawals and the ultimate winding up of the fund. Wallberg emphasises that LD is “still active” in private equity, mostly via funds, having begun from a large base. That should perhaps be no surprise after a glimpse at 15.8-per-cent annual returns for 2012 on its Danish non-listed equity and 13.3 per cent on its smaller overseas unlisted-equity holdings.

Lønmodtagernes Dyrtidsfond’s members have no doubt welcomed the strong returns of 2012, but how can the fund limit its classic volatility risk in an investing environment with few safe options? A sudden rise of interest rates could seemingly have a dangerous impact on LD’s 65 per cent allocation to fixed income. Wallberg says this threat has been discussed intensively with futures and other derivatives an option on the table to try to mitigate it, in combination with possible changes to its bonds managers’ risk profile.

Wallberg is confident that LD’s asset strategy can allow its remaining members to withdraw their savings “when the time is right for them”. It must be working as over 250,000 people who could have already withdrawn their money are keeping it in. If LD’s strategy needs further innovating in its final years to keep the members so satisfied with the results, then LD stands fully prepared to do that.

The idea of referendums setting the agenda for institutional investors may be a frightening pipe dream in much of the world, but Switzerland’s unique brand of direct democracy is set to revolutionise its funds’ priorities.

Swiss funds are due to be anointed as no less than the country’s official guardians against “rip-off” executive salaries. That is according to a referendum that received the overwhelming backing of the Swiss electorate in March.

Funds do not appear to be hugely thrilled at their boosted future responsibility, however – enhanced by binding annual votes on executive pay and appointments at all publicly listed companies in Switzerland. Some grumbles about cost implications have made their way from investors into the local media.

Referendum reaction

The Swiss pension fund association, ASIP, says it does support greater shareholder rights “but not at the expense of members”. Director of ASIP, Hanspeter Konrad, says funds felt a less stringent government counter-proposal would have been more effective in advancing the underlying principals behind the referendum.

Sabine Doebeli, Zurich-based vice chair of the Sustainable Investment Forum of Germany, Austria and Switzerland (FNG), believes the referendum result is likely to prove a shot in the arm as “the culture of being an active investor is not well anchored in Switzerland”. sabine_doebeli

That challenge centres on the introduction of mandatory voting for pension funds at annual general meetings. It is an obligation funds would definitely not be advised to ignore though as the text of the referendum – championed by the head of a family cosmetics company – envisages jail terms and hefty fines for violations.

Doebeli, pictured right, says that “with existing legislative challenges in Switzerland and low funding ratios at many funds, the commitments add an additional complex aspect to the strategy of time-pressured investors”.

Stephan Skaanes of investment consultancy, PPC Metrics, says the reactions of funds to the results have been more mixed. Nonetheless, he explains that the first shock to the country’s unengaged investors may come as temporary regulation is introduced within a year to pave the way for full implementation of the referendum’s terms within around five years.

Doebeli believes that pension funds will likely wait for votes on executive pay to become mandatory before they assume all their new voting rights.

Naturally, the largest investors should find the task of becoming permanently active shareholders easiest. A spokesperson for the CHF21-billion ($23-billion) BVK fund for civil servants in Zurich, says that given “the scale and scope” of the fund’s organisation, it is “very well positioned” for the new legislation.

Within days of the referendum gaining the approval of the electorate, BVK began publishing the results of the shareholder votes it casts, thereby revealing that it had rejected a controversial remuneration scheme at pharmaceutical giant Novartis in February.

Disclosing the votes they make is another responsibility that the referendum is to hand pension funds, although Skaanes explains there is plenty still to debate as to how and to what audience disclosure is made.

Other Swiss funds to demonstrate engagement include the 90 pension funds, such as the $10.25-billion Basel Stadt pension fund, that are party to the Ethos Engagement Pool – an initiative that seeks shareholder dialogue with the largest companies in Switzerland. That grouping, however, is a small minority of all Swiss funds.

Doebeli says that a likely scenario as the initiative is implemented is that stretched funds will increasingly look to turn an ear to proxy shareholder voting advisers like Swiss firm Ethos or ISS. There has been a wave of activity in that space in recent months, with a new voting advisory firm Swipra launched just days after the referendum, Inrate announcing a new product range ‘for active shareholders’ in January and Ethos reportedly due to go on a post-referendum hiring drive.

Another requirement of the measures approved by referendum is, however, that pension funds vote in the interest of their members. Skaanes says that could place a block on fund’s controversial reliance on proxy advisors while the Swiss parliament interprets the referendum result into legislation. Doebeli says this could instigate some interesting broad-based dialogue with members on investment priorities – “a new element in the Swiss pensions landscape”. Konrad says that as funds are already structured to fully heed the interests of their members, this won’t need to go as far as polling members on their opinions prior to shareholder votes.

Will it work?

The radical new rules will surely boost the workload associated with domestic equity holdings, which averaged 11 per cent across the country’s pension funds in 2012, according to Mercer.

Skaanes says he would be “very surprised” if a drive out of Swiss equity holdings results, even though the tough regulations are not set to apply to overseas equities.

“There might be a switch from direct investing into domestic equity funds if the government decides that collective investment schemes are exempt from the mandatory voting requirements”, he adds.

In the ideal world of the sustainable investment business, perhaps Swiss equities will also gain added outside appeal for the stringent shareholder checks imposed on executive pay?

Leaving aside the obvious objections from the business community to that reasoning (they fear such strict rules will drive investment out of the country), the initiative must first prove it can perform in its chief task of checking pay. Critics point out that with domestic pension funds making up a tiny fraction of domestic share ownership (6.5 per cent according to ASIP), their potential to transform the country’s boardroom culture is limited.

Beda Dueggelin, a spokesperson for Thomas Minder, the businessman who proposed the referendum, agrees that Swiss institutional investors can only do so much on their own. “Foreign pension funds and investors are in the position to have a say on pay due to their voting power,” he says. “If they exercise their increased rights, something will change.”

The current regime was, after all, sufficient to persuade Novartis to recently drop a planned $78-million payment to its outgoing chairman. Credit Suisse and UBS have both also faced shareholder rebellions on their executive compensation plans in the past two years.

While determining “correct” rates of pay is something for newly empowered shareholders and boards to wrangle about in the years ahead, the new rules might not have such an obvious limiting impact on pay. Doebeli says that the experience in the UK shows that increased transparency on executive pay does not necessarily curb it as the keenest observers of salary reports could be rival executives hoping for a raise, although the clout of binding shareholder votes mandatory for pension funds “should definitely make it easier to prevent exaggerations”.

Skaanes adds that funds might be able to simply have a default position of voting in favor of the board under the new rules – perhaps in cases where they currently decide not to vote on a company, as they have no desire to closely monitor it. Should this indeed be a common pattern, the referendum’s impact would seemingly be limited.

Coming to a boardroom near you?

Doebeli says that “the strong international reaction” to the referendum has been noted with interest in Switzerland. Being home to several giant multinationals, particularly in finance and pharmaceuticals, makes the radical changes globally important.

Dueggelin says the proponents of the referendum “are sure that you will see more similar actions like the one in Switzerland in the foreseeable future”.

The European Commission is known to favour legislating for EU-wide binding shareholder votes on executive pay later this year. Days after the Swiss referendum result, the German government also announced that it will look to empower shareholders before then – most likely with binding votes. That is despite Germany’s Industrial Federation warning against “rash conclusions from the Swiss debate” and arguing that Germany’s tradition of employee and shareholder representation on supervisory boards makes new legislation unnecessary.

Gary Lutin, head of the Shareholder Forum in the United States – a group that moderates between boards and shareholders – says “that whether it works well or not, the Swiss adoption of binding compensation votes will certainly encourage others to try it”.

The US enforced the holding of advisory votes on executive pay at large public companies as part of the 2010 Dodd Frank Act.

Speaking on whether there would be demand for binding votes in the US, Lutin says: “You can expect the views of US fund managers on binding votes to be as mixed as they are on everything else. Some will see it as an opportunity to increase their influence, and others will see it as an imposition of increased burden that adds nothing to their portfolio’s performance or to their ability to compete for assets.”

In any case, there might not be a straight path to increased shareholder power.

Before the radical new corporate governance framework takes shape in Switzerland, militant funds might have to confront a growing academic backlash against increased shareholder power emanating from the US. Critics such as Lynn Stout, author of The Shareholder Value Myth, contend that shareholder pressure is actually a major driver of the short-termism in corporations that has spawned the kind of result-linked compensation schemes the public dislikes.

Increased rights should also logically bring increased responsibilities. Lutin poses one of the questions that he feels would result from a Swiss-style radical shake-up of corporate-shareholder relations. “If shareholders now have the kind of real authority to approve compensation that had traditionally been assigned to corporate directors, do they also have the same kind of fiduciary duty as directors to make informed decisions?”

Pension funds can face a lot of turbulence in the course of their investing journey and many funds thrown into shortfalls have found the need to de-risk their portfolios.

There might be a few investment officers at those funds casting an enviable eye upwards to the pension fund of Dutch flag-carrying airline KLM. Toine van der Stee, director of the €16.5-billion ($21.2-billion) group of funds says: “We want to take more risk when we can… the way solvency has to be managed in Dutch pension funds, the poorer you are, the less risk you can take on board and the more chance you will stay poor. As the rich can afford to take risk, the rich get richer.”

It is clear which side of that divide the KLM fund finds itself on. While many pension funds around the world are still unable to match their liabilities – figures from JLT suggest there was still a $75-billion combined deficit at the end of 2012 across the pension funds of UK FTSE 100 firms – the KLM funds have healthy coverage ratios of 127 per cent for its largest fund (for cockpit staff) and 116 per cent for the other two major funds (covering ground staff and cabin crew).

Van der Stee says a high level of contributions have helped those coverage ratios.

Furthermore, he can trace the positive results across all the funds (14.8 per cent for the ground staff fund and 13 per cent for the pilots fund) to a decision to up their risk by underweight bonds and make the plunge into overweighting equities in 2011. Equity holdings varied between 34 and 44 per cent of the individual funds at the end of 2011 after the top up, and delivered in excess of 16 per cent last year, allowing KLM to keep its risk-seeking portfolio intact.

Knowing where the break is

Despite their appetite for risk, the KLM funds remain checked by the kind of hedging instruments typical for Dutch funds. Some 75 per cent of the equity risk is covered by equity put options for instance. These dragged results down with a minus 1.2 per cent performance in 2012, but naturally also offer breaks when markets go sour.

Currency hedges also lost the funds a little in 2012 but these reverses were compensated for by a 1.7-per-cent yield from interest rate hedges, covering between 45 and 55 per cent of risk in two of the three main funds.

The absence of interest rate hedges in the $9-billion cockpit fund shows that unlike some multi-fund investors, which replicate a single investment strategy, KLM is happy to tinker slightly different approaches to each fund.

Van der Stee explains that the less risk-seeking stance of the cockpit fund, with the lowest equity share and highest real estate holdings (13 per cent at the end of 2011), means there is no need to shackle it with the same level of hedging. “Also, we can afford to take the risk as it has a substantially higher solvency ratio than the other two.”

He also argues that a rise in interest rates “that we don’t want to get hit by”, together with future inflation, are greater risks to the KLM portfolios than even lower interest rates. He is confident that a reduction in government bond holdings as part of the switch to equities in 2011 will help to mitigate that.

Some 20 per cent of the fund assets, around $4 billion, are also held in global inflation-linked bonds.

Should KLM’s real estate holdings continue the 15-per-cent returns they achieved in 2012, they will surely more than cover any remaining inflation risk. The 25-per-cent returns on public real estate (about half KLM’s total in the asset class) were “very nice” says Van der Stee, congratulating his external managers for delivering them. His assessment is that the real estate managers “seem to have picked the right funds – meaning mostly international ones”.

Just a fraction over half the KLM fund’s real estate exposure is European, so there is little exposure to the struggling Dutch real estate sector. The sight of empty buildings from his office in Amstelveen, a usually thriving town just to the south of Amsterdam, suggests Van der Stee does not have to look too far for evidence of its woes.

Beyond hedging and real estate, the KLM funds have resisted the allures of other alternative assets up to now, but Van der Stee says they are “looking into infrastructure, which seems very attractive as a hedge.”

Cruise control

The KLM funds will keep their asset strategy “more or less the same” for the foreseeable future, according to Van der Stee. “We don’t expect a rise in inflation or interest rates in the short term, but it may happen in the medium term, which threatens returns on government bonds,” he says.

Otherwise, Van der Stee confesses to being “moderately optimistic. Of course there are some risks in the European financial markets, but these can be contained to quite some extent.”

The KLM funds’ fixed income strategy appears to have paid off handsomely in 2012, with 14-per-cent returns. Allocating some 20 per cent of the fixed income assets to emerging market and US high-yield debt has worked well, but Van der Stee cautions that there are “two faces” to the good return figures, with liabilities rising last year as interest rates and government bond yields declined further.

Van der Stee oozes contentment when he talks about the funds’ external management. “We have active management in emerging market, small-cap and mid-cap equities as well as emerging market debt, as you need it there, but the rest is passive” he says.

On being asked about his relation to the member base, Van der Stee says “managing a pension fund is very different to flying planes”. The KLM funds anyhow seem fully under control for now with their tried and tested asset mix guiding them.

As the world and companies globalise, George Siguler, managing director and founding partner of private equity firm, Siguler Guff, has a simple recommendation for investors.

“My recommendation for stock investors is to look at great global companies,” he says. “Look at companies like Johnson and Johnson, Unilever or Boeing. They all have great balance sheets and are great businesses. They are unique businesses.”

Siguler, who is also on the board of MSCI, serves on the pension advisory committee of the International Monetary Fund and is on the board of overseers of the Hoover Institute at Stanford University, says the current environment can “justify good quality companies”.

“Warren Buffett doesn’t need Riskmetrics to understand his portfolio,” he says. “If Buffett was running a pension fund he would buy good companies like Amex, Coke or McDonalds, and hold them forever.”

Siguler says that despite the recent crisis, the US is in recovery, and points to the considerable growth among small companies, of which there are 40,000 in the US where, as a private equity firm, Siguler Guff invests.

“We have 250 small companies in private equity and they grew through the crisis. We had 45,000 jobs at the beginning of the crisis and 55,000 at the end,” he says.

He believes the US economy is in recovery.

“The US economy is still a mess, but it is in recovery. It is slow but moving in the right direction,” he said. “It’s been a rough ride.”

It is not only the US federal debt, which at $17 trillion is equal to the debt around the time of World War II, but the social security unfunded liabilities are also around $17 trillion.

“There are only four ways a government can fix this. They can tax, spend less, grow or inflate,” he said. “Can we effectively make this happen? We have to.”

Similarly, on the upside Siguler said the US is going through a revolution in energy, with its natural gas at a quarter of the world price and a newfound self-sufficiency in oil.

His experience tells him that the current crisis is nothing new and points to the fact the purchasing power of the Harvard Management Company declined by 80 per cent from the mid 1960s to the early 1980s.

Siguler, who wrote the business plan, strategy and team structure for the evolution of the Harvard endowment, says its recent private equity problems are more perceived than real.

But Siguler is also adamant the players in the financial services good chain need to take some responsibility and that there has to be some criminal punishment for the “creativity of Wall Street”.

“There was a time when your investment banker was your partner, your fiduciary. Now every transaction with a financial services firm is adversarial. If the word fiduciary was introduced in legislation that would solve the problems of Dodd Frank – people need to behave ethically,” he says.

Siguler Guff, which has a number of multi-manager funds including distressed opportunities, BRIC and small buyout as well as direct funds, was an early investor in Russia. It also has a strong presence in Brazil and China, where Siguler describes its reported demise as exaggerated, and recently made its first investment in Turkey. The next frontier for the firm is Africa.

In terms of industries, Siguler says “we really like healthcare.”

The area surrounding the British city of Wolverhampton, near Birmingham, is still called the Black Country although the polluting coal mines and steel mills that sprung up during England’s nineteenth-century explosion of wealth have long gone. Today there is little evidence that Wolverhampton was the cradle of an industrial revolution and the 300-odd public sector and private employers in the area from which the local government pension scheme, the £9.8-billion ($14.93-billion) West Midlands Pension Fund, draws its contributions are involved in new and modern employment. The defined benefit occupational scheme set up in 1972 has earned a reputation among its peer group of local authority schemes for its growing size and innovative, diversified investments. However, now it could have to adjust its strategy to meet the challenges and shifting circumstances of what you might call a mid-life crisis.

Black-Country-1872-200x150

Of the pension fund’s 253,000 members, less than half are now contributing members, and Geik Drever, head of pensions at the fund, notices more of the scheme’s small-member employers are closing their pension funds. It’s a maturing profile hastened by the UK government’s austerity policy forcing public sector cuts. The response among many local government authorities has been to encourage voluntary retirement, triggering an early shift in maturity for many of the pension schemes these employees have paid into. “We are open to new members, the profile of the scheme isn’t too bad and auto-enrolment will definitely help,” says Drever, who joined last year from Scotland’s Lothian Pension Fund where she was head of investment and pensions. “We’re not de-risking, but we are maturing and there has been a huge reduction in headcount.”

How to meet maturity?

Results of an actuarial review this year will inform any shift in investment strategy to reduce risk and prioritise protecting funding levels once they improve from current levels of around 75 per cent, “symptomatic of the current climate,” or whether to continue the push for income and total returns. It could be that West Midlands joins a de-risking trend evident for a while among UK and European schemes, such as Dutch funds in which the deficit crisis is the most severe in the industry’s history, but also cropping up in Canada and the United States. Here some of the largest corporate pension funds, including General Motors and Ford, have pursued de-risking strategies in recent years.

Drever is still unsure which strategy West Midlands will follow to meet its growing maturity. Options she is considering include running lower, medium and higher risk strategies to suit the scheme’s different employers, although she says “we won’t be able to manage too many strategies – three or four at most”. Employers will have to gauge their own appetite for risk according to their liabilities and cash profiles. “Each individual employer has a different profile.” It’ll be down to them, she says, to decide whether they can afford to pay more in contributions and reduce their risk or to “not close down risk.” Low risk strategies will comprise the usual “bond-like” allocations; the fund has no liability-driven investment strategies yet, unlike other schemes using the increasingly popular fixed-income-derivative strategies to reduce interest-rate and inflation risk.

Although a maturing scheme will need more cash to pay pensions, Drever is not convinced trading out of illiquid assets like infrastructure and private equity is necessarily the answer. West Midlands has a long track record of infrastructure investment and was one of the first schemes to leap on board the government’s Pension Infrastructure Platform. She says the fund has “ample cash,” particularly through its large quoted-equity allocation. Moreover, the scheme’s well established private equity and infrastructure investments have matured beyond the tendency for negative returns these assets have in their early years and provide a good cash yield. “We’ve got cash coming in from our infrastructure investments,” she says. “In private equity our investments are also paying out, so we’re less worried about our J Curve.” In another indication of the fund’s continued risk appetite, she welcomes the government’s decision to increase the cap placed on the amount local authority schemes can invest through limited partnerships, a structure though which many access property, private equity and infrastructure, from 15 per cent to 30 per cent.

Diversity now

Whatever the future holds, for now strategy at West Midlands is still based on diverse allocations set after the financial crisis. The scheme follows a customised benchmark that targets a 7-per-cent beta return, from assets in quoted equities and alternatives primarily, and a 2-per-cent alpha return from private equity and alternatives, including infrastructure and an absolute return allocation. In the 10 months to January 2013, the fund made an absolute return of 8 per cent. “It hasn’t been too bad, but we’re not shooting the lights out,” says Drever, adding that the pared-down 45-per-cent global equity allocation, where the biggest allocations are to stalwart mining and resource groups, has actually bought the fund its best returns so far. “Overall equities have done tremendously well. If we’d had an extra 15 per cent allocated to quoted equity, we’d have done even better.” A 10-per-cent private equity allocation “hasn’t done too badly,” infrastructure (3 per cent) and property (9 per cent) have “been fine” but commodities (3 per cent) have been “dire.” West Midland’s 20-per-cent fixed income allocation is split between stabilising assets and an allocation to return-seeking fixed income including high-yield and corporate bonds and unsecured loans. A 10-per-cent opportunities allocation includes catastrophe bonds (with which investors cover insurers’ extreme losses from natural disasters), a growing asset class for pension and sovereign funds and endowments seeking a truly uncorrelated market. “Hurricane Sandy put a spanner in the works, but you have to take the good with the bad,” says Drever.

It’s a strategy born from the need to diversify after 2007 when the fund wracked up paper losses of 18 per cent at one stage during the crisis. Drever says West Midlands was able to come back from the lows because it didn’t have to sell anything and crystallise losses; not concentrating assets in any one area became the new mantra. In house, the fund directly manages $4.57 billion in low-risk passive allocations, mostly equity. Another third is actively managed in LP structures, with the remaining third managed externally – the fund uses around 30 managers altogether. The portion managed externally has crept up as the scheme has increased its push into alternatives requiring specialist management, although the pension fund also uses specialist managers in mainstream assets where inefficiencies or market opportunities exist. It’s a strategy for growth that doesn’t acquiesce to the demands of its growing maturity – just yet.