Germans ‘deeply unhappy’ warns academic

The asset allocation of corporate pension plans should be driven by corporate finance not asset management according to Bernd Scherer, affiliate professor of finance at EDHEC Business School, and instructor of an upcoming seminar on portfolio construction and risk budgeting in Singapore.

“I’m not a fan of the term ‘risk budgets’,” Bernd Scherer, affiliate professor of finance at EDHEC Business School, says. “Of course, if you say you don’t have a risk budget it sounds like negligence.”

However in truth, a risk budget is just portfolio optimisation in disguise, Scherer argues, where optimisation just spits out results in portfolio weights not risk contributions. “The marginal contribution to risk/return – that is, the risk budget – is the same,” he says.

Scherer will lead a two-day seminar in Singapore this month, that addresses portfolio construction and risk budgeting in practice.

The course is timely as the asset management industry undergoes an assessment of its performance-generating skills.

There is no difference between portfolio construction using various portfolio optimisation tools that attempt to trade-off expected return against expected risk, and risk budgeting, he says.

“Risk budgeting looks at a portfolio and says these are the hot spots, where I take risks then expect most of the return,” he says. “Investors using the term ‘risk budgeting’ often mistrust portfolio optimisation. My course is on teaching the tools that let investors trust in their results,” Scherer continues.

The course aims to build viable and stable portfolio models, taking into account the lessons from the global financial crisis.

Scherer, who in addition to his professorship at EDHEC, is the chief investment officer of alternative asset manager FTC in Vienna, wrote an article for a German paper about 18 months ago, outlining the optimum portfolio for times of market turmoil.

The thinking still applies, he says.

“I’d look at having a portfolio of good governments – Canada, Switzerland, Australia – and have a currency exposure to them. I’d also have inflation-linked bonds, some non-oil commodities, and gold,” he says. “I set that 18 months ago but it still applies. There needs to be an allocation to this portfolio for not-quite normal times. The balance, how much to allocate to that, is up to the investor.

“I wouldn’t trust governments, they want to get money back from private investors. I’d tell people to protect their money from their governments.”

He also believes there are not so many different asset allocation classes as most investors believe.

“Many assets have one common factor, for example high-yield bonds, private equity, hedge funds all have equity risk. You think you have diversified risks but you have a lot of equity risk.”

While Scherer has advice for the setting of an optimum portfolio in these difficult times, he believes corporate pension plans are off the mark.

He says in general corporate pension funds look too much to asset size.

“Liability Driven Investment is a term I truly hate,” he says. “It’s an excuse to continue to do what you’ve been doing in the past. It is corporate finance, not asset management, that determines the asset allocation for corporate plans. It is corporate finance that should be the framework. The same reason Lufthansa hedges out oil price risk should be the same reason that their pension fund should hedge out interest rate risk. Pension funds are riddled with corporate governance issues.”

Based in Europe, Scherer has a unique perspective on asset allocation. He says there has been a tendency to allocate assets “across demarcation lines of past wars”. What counts is factor risk diversification and less geographical diversification.

But with the regard to the recent turmoil, he says, Germans are “deeply unhappy”.

“In order to make Italy, Greece and Spain competitive those countries need to experience  falling prices, but that would be civil war, so it’s not allowed. Instead the central bank has decided to distort markets and restore southern competitiveness by raising German prices, effectively eroding German wealth. Germans are deeply unhappy.”

The ECB is the ultimate manipulator of the price of risk. Credit to the German Mittelstand is effectively rationed while the money goes to Greece which is unlikely to pay back (unlike the German Mittelstand), he says.

Perhaps one of the only positive side-effects from the crisis, he says, is that an interest and understanding of economics in the public is rising.

For information on the course go to www.edhec-risk.com