Are managers delivering what we need?

Peter Hansson, president and CEO of SPK, the pension fund for Sweden’s savings bank employees, which has AUM SEK14.9bn (e1.6bn)

“The coming into effect of the legislation that implemented the EU pension directive has changed the Swedish pensions map. And the marking to market valuation on the liabilities side is the
key element. Where previously there were clear restrictions from the government on how pension funds could invest the directive has introd- uced the prudent person concept.

“So it is becoming more difficult to oversee the investment process and pension funds need to be more aware of what is going on and the toolbox needs to be bigger.

“At SPK we don’t do any asset management in-house, so we began preparing for this change in the middle of last year. Since then we have re-examined a lot of our relationships regarding such added value services as stress testing, number crunching, scenarios, think tanks, and we prepared our board of trustees for what was about to happen with the new legislation, and for what the possibilities would be under certain circumstances.

“But those pension funds that don’t have the capability to undertake such preparations or long-terms partnerships with asset managers are going to have a hard time entering the new world.

“There have been two responses from asset managers. First in the area of value-added services, those that are closest to us, that we talk to on a regular basis and that we see as partners to our asset management team have prepared themselves in the areas of stress testing, ALM testing and so on.

“The other part includes those that have not understood that there is going to be a need for new and improved products like absolute return solutions targeting equities instead of US hedge funds.

“So some have adapted and some have not. The division between which categories asset management firms fall into is not a matter of size of whether they are international or local.

“Those that are more free-thinking, more asset allocation-oriented - and they tend to be more in the European area than the US area - are able to have a view of why one should be in certain classes.

“And those, small or large, that have always taken relative approach and a traditional view, will have a hard time rethinking their outlook
and realising that they need additional communication points. If they are just trying to continue with what they have been good at in the past, for example providing equities in a traditional way in certain markets, then they will not have adapted and will not need the new needs of pension funds.

 

Paul van Gent, fund manager at PME, the industry-wide Metalektro fund, which has AUM of e19bn.

“Investing is trying to get a return and we can differentiate between three aspects: the drivers of return are beta and alpha, and the limits on it are regulation. On the beta side managers are trying, gradually, to provide more beta opportunities. But they wait until the demand is really there before they start offering more interesting products. For example, over the last couple of years we have seen commodities enter the mainstream, and although you still will not see as many people offering alpha on commodities as on equities, at least compared with a couple of years ago there are at least people providing a commodity beta.

“There aren’t that many different types of beta around anyway. Sometimes there are half-hearted attempts to make art investable and make a new beta. Over the past couple of years investment-linked bonds have also made their way to be recognised as a new beta category, although managers often just stayed with offering inflation-linked as an alpha source for nominal bond mandates, not seeing that this is an asset class that has different characteristics from a nominal bond.

“And on the alpha side the traditional managers have, as we say, ‘let all the cheese be eaten from their bread’ by the hedge fund community. While in the past there was an integrated delivery of beta and alpha, say European equities beta, and the alpha picking the best stocks, the hedge funds have split it out a bit and concentrated on alpha.

In essence the traditional players have either not caught on to the fact that there are two different return drivers and that people might want a different mix of the two and so were caught napping, or those that did understand were plagued by defections and so didn’t grasp the whole picture and so certainly were not ahead of the game.

“And even today it is only in very minute quantities, let’s say 130% long and 30% short portfolios, that are being introduced by the traditional managers. They appear to have forgotten that they are there to deliver alpha and that they should package it to a different group of less traditional clientele.

“On the regulation side, they are not hugely onerous, after all regulations are usually just the laying down in code of what is the smart thing to do, but sometimes they don’t get the code completely right. And regulation is usually a beta story, in that in essence matching liabilities is just ensuring you buy the betas needed to reduce risk. There are very few funds that have so much alpha risk that it is their constraining point.

“It’s difficult to get enough alpha risk into a fund. In our fund, for example, we want around 7.5% of risk but it would be a lot if we managed to add much more than a percent in alpha risk, it’s a lot because of all the correlation effects. But a whole new community has sprung up that understands this.

 

Valentin Fernandez, strategy director for institutional investor relations at Fonditel, the pension fund of Telefonica de España, which has AUM of e5bn

“The asset manage- ment industry in Spain is different from that in many other European countries. Here most of the market is still occupied by big banks, which have a huge network throughout the country. And this acts as a real barrier for competition from other agents.

The situation has arisen because a pension fund, particularly for an individual, is considered a product to be sold like any other financial product, like a mortgage.

Occupational pension funds are only offered by big companies, and are not an issue for most Spanish companies, which tend to be small or medium sized enterprises. And some of the big companies are major banks, so their asset management arm will look after the bank’s pensions portfolio, while others - like Telefonica, Endesa or Repsol - have arrangements with management companies.

“We do most of our research and management in-house, and we manage both the company pension fund and individual pension funds. But we outsource certain specific mandates.

“The providers tend to be investment banks and big brokers. Here at Fonditel we are used to receiving people from the big investment banks - Merrill Lynch, Goldman Sachs, Morgan Stanley - as potential providers of products. And we see them as both in-putters of information and, finally, as product providers when we have made a decision to invest.

“And again the risks from financial reporting standards and the implementation of the EU directive are different in Spain than in other countries. Here they are much lower because most large companies with pension fund schemes externalise the management. So it would be difficult to find a case where in the event of a market collapse the pension money would be lost.

“And the regulatory environment has reinforced this protection. It is now more sensitive to risk control and in recent years the regulator has shown itself to be concerned about risk control rules in terms of diversification of the counterparty. It sets a ceiling on the amount of a portfolio that can be invested in a single provider or in one product. And there is a further diversification in juridical terms in the area of value at risk. In fact all these measures are applied to asset managers more stringently than in the past.

“As a result asset management companies are able to provide different products in terms of risk, typically for individuals. Here is Fonditel, for example, we have three levels of risk - a high level, a medium level and a low level - and it is the individual who comes here to open a pension fund who decides what level of risk to take, depending on their appetite for risk, their age or whatever. Big bank asset managers will have a wider range of risk alternatives, they can offer different bond durations and mixes of equities and bonds.”