Too much, too little, too late in alts: CREATE

Pension funds had diversified into alternatives at the wrong time, CREATE’s chief executive, Professor Amin Rajin said, claiming pension funds were taking too long in their decision-making to make the most of opportunities available.

At Principal Global Investors’ teaser for CREATE’s 2011 report (to be launched in June), Rajin commented on many pension funds’ decisions to diversify into alternatives – hedge funds and private equity primarily along with real estate, commodities and infrastructure.

This occurred in the early stages of last decade, following on from the decrease in funding levels from around 115 per cent in 1999 to around 83 per cent within three years.

This caused a “real crisis”, according to Rajin, and the beginning of the financial crisis at the end of 2007 and early 2008 saw pension funds lose money in every asset class in which they had been advised to invest as a result of going into alternatives at “the wrong time”, when peak returns were history.

“When it comes to alternative investments the opportunities appear quickly and disappear quickly,”
Rajin explained. “Timing is very important, if you don’t get the timing right you may find that all the opportunities you thought you were going to capitalise on are long gone.

This mistimed venture into alternatives was a governance issue, according to Rajin, who said once the decision was made to enter into alternative investments, acting quickly was the key.

“When they make the decision to (diversify into alternatives to) when they implement the strategy there is usually anywhere between a year to 18 months’ time lag, that’s too long,” he said. “Once they’ve made the decision, the thing to do is to move in very quickly or wait on the side till the new lot of opportunities arrive.”

Rajin suggested pension funds should meet more frequently and delegate more authority to the funds’ professional investment staff to solve this issue.

“In the world of alternatives you are talking about real-time investment not calendar-time, and to go from real-time to calendar-time you need to have people on the ground who can make quick decisions,” he said. “Delegated authority is the key to exploiting the alternatives.”

At Principal’s meeting, Rajin also discussed the key issues keeping CEOs awake at night – ranging from topics of investment innovation to reforms in the UK and Europe, focusing initially on the theme of investment innovation which was the primary focus of the 2011 CREATE report.

Shorting and liability driven investments (LDIs) were cited as innovations that CREATE’s preliminary research showed had faced challenges.

Shorting, while a good idea in theory, was hard to implement practically as very few assets managers were very good at market timing, Rajin explained.

“The investment graveyard is full of CIOs who tried to time the market,” he added.

Also, LDIs had caused problems in the US due to pension funds viewing them as some kind of Holy Grail.

“In the US, many of the pension plans, because they have been under severe stress, have tried LDI at a time when they weren’t really fit to do it; their funding levels didn’t really permit it,” Rajin said.

The theme of innovation, while the focus for 2011’s report, is set to be a theme for years to come with Rajin expecting to see a lot more in this decade as result of the impact of the financial crisis.

“Crisis is usually the mother of innovation,” he said.

The UK’s retail distribution review would dramatically change the asset management industry in Europe.

Rajin highlighted a tendency in Europe to issue new funds with different phases of the market cycle, which benefitted the fund distributors which picked up upfront commissions and a reoccurring fee.

“Regulators are really stepping on that kind of practice,” he said.

The review would eliminate this commission, according to Rajin, and distributors would not be entitled to upfront or trailing commissions from asset managers.

This would prevent distributors placing money with the fund managers who gave them the highest commission, irrespective of client needs and managers’ faults.

The review would also eradicate the 1.5 per cent charge currently being passed onto clients from distributors, and ensure that the distributor’s focus and allegiance was primarily to the client as opposed to the fund manager.

As a result of this, Rajin believed distributors would try to drive out fund manager fees.