On the back of a continuing shift in corporate pension plans away from defined benefit to defined contribution, Northwestern University’s Joshua Rauh and Indiana University’s Irina Stefanescu look at what causes the resultant freezing of these corporate plans.

The paper takes the further step of looking at the consequences for both employees and plan sponsors, investigating if the freeze results in savings to the companies as well as the impact on retirement-savings outcomes.

To read The Freezing of Corporate Pension Plans: Causes and Consequences, visit the Rotman School of Management’s International Centre for Pension Management.

 

US public-pension funds significantly underperform their global peers in real-estate portfolios due to a propensity to manage the assets externally, according to a new ICPM-sponsored research paper by three Maastricht University academics.

Value added from funds management in private markets: an examination of pension fund investments in real estate looks at real-estate investing among the 880 pension funds on the CEM database from 1990 to 2009. On average the allocation to real estate was 5.5 per cent, but fluctuates over time.

The paper by Aleksandar Andonov, Nils Kik and Piet Eichholtz examined the funds’ approach to investing in the asset class, costs and performance.

The paper found that US funds, both small and large, underperformed their self-reported benchmark by a whopping 127 basis points per year. Furthermore, their costs were twice as high as their global peers.

“I would be asking how it is possible that you do this and you keep on doing this,” Eichholtz says.

“This paper found that a fund’s approach, size and geography determine the cost and performance in real estate. You can’t choose to be a US or non-US fund, but you can learn from your peers.”

The paper found that while large pension funds overall are more likely to invest in real estate, they invest internally and have lower costs. They also have some exposure through real-estate-investment trusts (REITs) and few fund-of-fund investments.

Smaller funds are less likely to invest in real estate and more likely to invest in funds of funds.

Eichholtz said with regard to costs, the biggest driver is the approach decision, how a fund invests from internal management to funds of funds.

He said geographically there were some interesting results: US funds were more likely to invest externally, regardless of their size, and pay higher fees.

“It’s as if the real-estate-investment management industry in the US is able to charge higher fees,” he says. “The costs don’t lie in the pension funds but in the service industry, and in the US it is tens of basis points more. US funds pay far more for external managers and are more likely to retain managers. It’s double crazy.”

Eichholtz describes funds of funds as “way beyond expensive” and believes smaller funds would be better off getting real-estate exposure through REITs than funds of funds.

Another finding of the paper was that the more expensive the strategy, the worse the performance.

Internal management was the best performer across the board, both before and after fees. At the same time, Eichholtz says, funds of funds “destroy value in two ways” through costs and picking the wrong investments.

He has some practical advice stemming from the results of the paper: if a fund is big enough, it pays to manage real estate internally.

“There is a lot of low-hanging fruit, funds that are big enough and could go internal, especially in the US.”

If you’re small, he says, avoid funds of funds and invest in REITs, and if you don’t want listed exposure then he proposes investing in a syndicate.

An example of this is in The Netherlands, where there are three large real-estate funds established by pension funds, Amvest, Aldera and Vesteta, the latter started by ABP and now open to a large group of investors.

They key, Eichholtz says, is that the management organisation is owned by the shareholders of the fund (that is, the pension funds) so there is no conflict of interest.

“The owner pays the salaries. There is a 30-basis-point fee, no bonuses or incentives.”

Access Value added from funds management in private markets: an examination of pension fund investments in real estate here.

 


 

The Rotman International Centre for Pension Management (ICPM) has approved five research projects for funding this year, including a behavioural-finance project by Swedish academics, to investigate plan members’ views of the “extended” fiduciary duty of pension funds.

This project, to be conducted by Joakim Sandberg, Anders Biel and Magnus Jansson from the University of Gothenburg and Tommy Garling from Stockholm University, will develop and test a socio-pyschological model to explain differences in beneficiaries’ attitudes toward an extended fiduciary duty, including social and environmental issues.

Titled Attitudes toward extended fiduciary duty among beneficiaries of pension funds, it aims to help fund trustees gain a better understanding of their beneficiaries’ expectations with respect to fiduciary duty and environmental, social and governance (ESG) investment.

Chair of ICPM’s research committee and head of innovation at APG, Stefan Lundbergh, says this article is interesting because it looks a the issue from the beneficiaries’ perspective.

“As an industry we assume ESG is important, but we haven’t asked the member,” he says.

“This paper on fiduciary responsibility is interesting because it is a different type of research [that] we haven’t done before. Typically, we’ve done quant papers but this looks at behaviour and what drives people. Fiduciary duty has to be solved first. If you don’t solve this, then you can’t solve anything else.”

Lundbergh says the mission of ICPM is to drive knowledge and understanding as well as build an academic presence.

Since its inception in 1995, the organisation has funded more than 20 research projects across pension and governance design, investment beliefs and risk management.

Selected researchers are funded over a two-year period and usually invited to present their findings at ICPM discussion forums, and to write for the @@italics Rotman International Journal of Pension Management @@.

ICPM, which is chaired by chief investment strategist at CPPIB, Don Raymond, and has Keith Ambachtsheer as its president, held its annual June forum in Toronto this week.

The ICPM is supported by about 40 global research partners, which each make a financial commitment to support research, the organisation and execution of the twice-yearly discussion forums, the next of which is in London in October.

Other papers that were given funding for 2012–2013 include  Pension fund asset allocation and liability discount rates: camouflage and reckless risk-taking by US public plans? by Aleksandar Andonov and Rob Bauer (who is also associate director of programs at ICPM) from Maastricht University, and Martijn Cremers from Yale School of Management.

Other papers published by ICPM can be viewed here.

 

 

 

please put a link to the past papers of ICPM

With hundreds of indexes, portfolio and risk analytics, and a growing emerging-markets and environmental, social and governance (ESG) focus, MSCI is a business in constant evolution, but chief executive and chairman, Henry Fernandez, says institutional investors are demanding further development, such as private-equity indexes.

Fernandez has been chief executive of MSCI since 1996, when the company’s revenue was $9 million. Last year it had $900 million in revenue and employed 2500 staff in 20 countries. The firm has grown organically and through acquisition, and Fernandez says he is on the lookout for suitable companies once more.

The last acquisition saw RiskMetrics assimilated into the MSCI fold within nine months of purchase, and each part of that business is now performing well, he says.

He admits he was perhaps too quick to call Institutional Shareholder Services (ISS), the proxy-voting firm that formed part of RiskMetrics’ stable, a “non-core” business.

“The risk business is why we bought the company. I had been pursuing them for five years and a year into the pursuit they bought ISS, and Morgan Stanley owned MSCI,” he says. “When two years ago I bought RiskMetrics, maybe I was too quick to say ISS is non-core and implying it would be sold.”

Now he says the proxy-voting business and a product that checks companies on non-financial factors could be huge successes.

Proof of that is MSCI’s ESG business, an offshoot of the ISS business, which has doubled in the past two years.

“It is a business with a lot of potential,” he says.

Last summer MSCI also launched an executive-compensation data-analytics offshoot of ISS.

“We looked at data in-house but didn’t make it available. It’s been a home run, especially from the issuers, the companies themselves. We’ve done that in the US, and will extend to all countries in Europe and eventually Asia,” he says.

The next cab off the rank in the ESG business will be the rating of sovereign debt on those criteria.

“We’re very brave,” he says.

While typically MSCI has had an equities focus, the recent relationship formed with Barclays to form an ESG fixed-income index is an example of the company looking to expand into other asset classes as investors and other clients demand.

“I have a sense that fixed income will grow a little bit organically or some by sort of acquisition,” he says.

“Institutional investors, asset owners, are extremely interested in creating transparency so their decisions are clear about what they’re buying – the purpose, benefit and measurement of that. We’re in the business of providing that transparency. We provide clarity. They want us to advance the state of the art in what we do. They want us to go in areas we’re not in yet, like private-equity indexes, risk models and fixed-income portfolio management.”

 

Tooling up
Fernandez says MSCI is very focused on creating the tools that help people make investment decisions.

“The broader investment industry attracts a lot of very smart people. We’ve found it attracts talent but the tools to help them navigate are not efficient. We are very focused on creating and maintaining and enhancing and investing in those decision-making tools,” he says.

“We are not in the business of indices per se, or data per se; they are a means to an end.

For example, an index is a performance tool for us, not just an index. The way we build our tools is we look at investment problems then at how to build the tools to fix the problem. It comes of out research.”

An example of that, he says, is the evolution of small caps as a global asset class.

“In the world of high correlations, people want ways to diversify. We make it more transparent,” he says.

The company continues to focus on equity investments as one of its core competencies, with an emphasis on providing equity-portfolio managers the tools they need including performance tools, by way of indexes, performance attribution, in Barra, portfolio construction, market-impact models and the ability to invest according to Sharia compliance or ESG.

But it also continues to evolve into other areas, such as multi-asset-class portfolio analytics, strategy indexes such as volatility or risk premium.

“For a long time indices were about slicing and dicing with market beta, what’s now happening is an evolution in the index world; it’s strategy beta.”

This evolution includes equities long/short, merger arbitrage, momentum (such as fundamental weighted indexes) and will change according to market cycles, for example, inflation-protected equities indexes are on the horizon.

 

 

EDHEC-Risk Institute has released a study highlighting the need to reform retirement systems and pension funds.

The study Shifting Towards Hybrid Pension Systems: A European Perspective also looks at the need to adopt professional management structures and to considerably improve the product offering of defined-contribution funds.

To read the paper click here


A decision by two of Missouri’s public pension plans to adopt a straightforward risk-based approach to asset allocation garnered their best result in two decades last year, while also providing investment staff with the autonomy to react quickly to changing market conditions.

The board overseeing the Public School Retirement System of Missouri (PSRS) and the Public Education Employee Retirement System of Missouri (PEERS) adopted an asset-allocation approach in 2009 that divides the portfolio into three simple buckets: safe assets, public risk and private risk. Both funds are managed by one investment team and overseen by a single board.

Chief investment officer of PSRS and PEERS, Craig Husting, explains that the approach gives clarity to the board by providing a clear, easily understood focus on a set of risks that are to be managed across the portfolio.

“We divided the portfolio into three buckets to try to identify how much money we could lock up in long-term illiquid investments where we could expect a higher rate of return,” Husting says.
The system is one of the best funded public-pension funds in the United States, with PSRS and PEERS enjoying more than 85-per-cent actuarial rates of funding.

This is on the back of a bumper year in 2011, where the combined assets of the two funds topped $31 billion. PSRS and PEERS earned returns of 21.8 per cent and 21.4 per cent respectively.

Husting explains that PSRS and PEERS use what he describes as an “intuitive risk-based approach” that focuses on liquidity, volatility, tail risk and the ability to meet the system’s assumed rate of return of 8 per cent per annum and a real-return target of at least 5.5 per cent per year.

“Sometimes people in our industry get caught up in terms of the value-at-risk in the portfolio or the standard deviation or the tracking error and other quantitative measures,” Husting says.

“What we mean when we take an intuitive approach to risk is that it’s a fairly simple concept to understand because our primary risk is liquidity or illiquidity, the ability to get 8 per cent, which we need to get, and tail risk, which is are we going to get killed by a left-tail event?”

The focus on risk is bearing fruit not only in terms of building a more robust portfolio but also in providing for more efficient returns relative to risk.

The system used Trust Universe Comparison Services (TUCS) analysis to show that the while the PSRS/PEERS total returns over three and five year time periods were marginally below the public-fund median return, they had taken less risk than 70 per cent of other comparable funds in the TUCS universe. Safe assets consist of mainly US treasuries and Treasury Inflation Protected Securities (TIPS). Private-risk assets are essentially illiquid and include private real estate, private equity and private credit assets.

Husting says the public-risk asset is broadly defined as any asset that is primarily liquid and has a risk component to it with this portfolio consisting of both US and non-US stocks, most types of credit, hedged assets and currency plays.

The 8-per-cent-return target, in the upper range for a US public-pension fund, means the investment staff cannot simply take risk off the table if they still want to meet the return objectives.

The public-risk portfolio, with its broad focus on liquidity, gives the investment staff flexibility, Husting explains.

“That [public risk] is a relatively broad bucket, with the intention of giving staff more flexibility to move assets around,” he says.
“For example, if equities seem expensive, instead of taking all the risk off the table by going from equities to bonds, we can lower the beta of that portfolio or bucket by going from full equities to credit or something like that,” he says.

 

Hedging your risk/return
Hedge funds play a vital role for the system, both from a returns perspective and as part of their strategy to manage volatility across the portfolio.

Hedge funds now make up 15 per cent of the total portfolio, with managers focused on providing lower volatility returns compared to the system’s broader equity portfolio, Husting explains.

This aspect of the hedge-fund program was funded out of allocations from equities and typically aims to have a beta much lower than the broader equity market of around 0.4.

“It is really there to lower the overall beta and volatility of the total fund, but still have some ability to capture upside,” he says.

Complimenting this hedge fund strategy are several low-volatility mandates the fund has adopted in its broader equity portfolio. Its private-equity investments also provide a lower volatility source of returns compared to public markets, Husting says.

The focus on low volatility means the investment team can also look to take on more risk in the remainder of the equity portfolio, he notes.

In addition, the system also uses hedge funds to provide an alpha overlay.

“The alpha overlay is essentially buying S&P swaps. We get exposure to the equity market through swaps and then we take the money and buy market-neutral-style hedge funds and overlay those hedge-fund returns over those S&P 500 swaps,” he explains.

Husting says the objective of the 10-manager program is to get alpha over and above the index, which in this case is the S&P 500.

“This program has been very successful providing alpha in excess of 400 basis points a year for the past several years,” he says.

When it came to managing tail risk, Husting notes the fund did consider tail-risk insurance but eventually decided to look to the safe-asset bucket to take on this role within the portfolio.

The fund has about 15 per cent in US treasuries and TIPS, which Husting notes acts as a buffer to potential risk events.

However, the fund is underweight safe assets compared to a policy target of 20 per cent.
“We are underweight because it is such a low-yield environment and we are searching for yield in other places so we have been moving some money out of safe assets into a little more risk-seeking assets,” he says.

The system is also underweight private equity as it gradually builds out its program. Private equity currently makes up 7 per cent of the portfolio with the board setting a long-range target of 10 per cent.

 

Autonomy with accountability
The autonomy enjoyed by the investment team also comes with accountability: the board established a process of benchmarks to hone in on the attribution of performance.

The board has set a long-term asset-allocation target for public-risk assets of 60 per cent, safe assets of 20 per cent and private assets of 20 per cent.

The investment team is given broad policy ranges for each of the underlying asset classes in these buckets.

Actual allocation vs target allocation

Public risk assets Safe assets Private risk assets
US
equity		 Credit
bonds		 Hedged
assets		 Global
equity		 US
Treasuries		 US
TIPS		 Private
equity		 Real
estate		 Private
credit		 Cash &
equivalents
Target
allocation*		 27.0% 12.0% 6.0% 15.0% 16.0% 4.0% 10.5% 7.5% 2.0% 0.0%
Actual
allocation		 30.8% 8.6% 14.9% 15.5% 13.5% 1.7% 6.7% 6.8% 1.3% 0.2%

SOURCE: PSRS/PEERS Asset Allocation

 

The board then annually reviews the internal team’s performance by referencing a policy benchmark consisting of a broad set of market indexes, essentially a passive benchmark against a strategic one.

This benchmark is set monthly and aims to reveal whether the investment team’s decision to overweight or underweight certain asset classes added value to the fund.

In an additional step, the fund compares this strategic benchmark to actual performance of the fund to evaluate whether manager selection has made a positive contribution to performance.

Along with strategic asset-allocation decisions, the 11-person internal investment team has the responsibility, with advice from consultancy Towers Watson, to select managers.

PSRS and PEERS use external managers for all its asset classes.

As a final check and balance, any major moves in asset allocation must be signed off by Husting, the executive director and the consultant.

 

Getting what you pay for
When it comes to selecting managers, Husting says the investment team is focused on only paying for active management in asset classes in which it believes alpha can be consistently achieved over the long-term.

“We are moving more to the view that there are fewer asset classes where you can add alpha in,” he says.
“Definitely [in] private markets and hedge funds, we are fully active and think we can add alpha in those areas. But in large caps and straight bonds, we think it is very difficult to add alpha, so we have gone more passive in those areas. Emerging markets and small caps we are also more active in.”

Fund performance to March 31, 2012

Fiscal year to date* 1 year 3 years 5 years 7 years 10 years
PSRS 2.9% 4.7% 15.3% 2.6% 5.2% 5.7%
PEERS 2.7% 4.4% 15.0% 2.5% 5.2% 5.6%
Policy benchmark** 4.7% 5.9% 16.4% 2.6% 5.1% 5.6%

* The Retirement Systems’ 2012 Fiscal Year began on July 1, 2011.
**The Policy benchmark is comprised of 40.5% Russell 3000 Index, 16% Barclays Capital Treasury Blend, 15% MSCI All Country World ex-US Free Index, 15% Barclays Capital Intermediate Credit Index, 7.5% NCREIF Property Index, 4% Barclays Capital US TIPS 1-10 Year Index and 2% Merrill Lynch High Yield Master II Index.
SOURCE: PSRS, Total Fund Investment Returns