Juggling in Amsterdam
It’s not often you find yourself in a room full of consultants, pension fund and investment managers practising juggling – metaphorically perhaps, but not literally.
However, a light hearted but engaging look at investment efficiency in Amsterdam as part of consultant Watson Wyatt’s seventh global asset study, did just that – perhaps appropriately for an industry often compared to spinning plates.
The study, entitled ‘Investment Efficiency – The Financial and People Equation’, saw delegates asking a number of team questions in a competition format dubbed Euro 2000 – in anticipation of this year’s football championships.
Question one, for example, concerned the estimated shortfall in performance due to poor asset governance.
The answer of 50 basis points, from a choice of 20, 35 and 66, was given by 57% of delegates with 36% plumping for 66.
A variety of questions followed on issues such as fund protection and employee representation on scheme boards, revealing above all that some in the industry have sharper skills than others.
Paul van Aalst, a partner at Watson Wyatt Brans & Co in the Netherlands, then looked at historical institutional asset allocation trends in Europe; producing a chart showing the increasing European consensus in equity investment. The 5% equity level in Finland in 1993 was shown to have doubled to 11%, while the UK had cut back exposure from 83% to 71% in the same period.
The audience was asked what they felt would be the average equity level in 2002 based on a nominal figure of 35% today: 64% believed the level would be up to 40-50%.
Roger Urwin, global head of investment consulting at Watsons, commented that higher expectation levels were not borne out: “These figures don’t move as quickly as you think, they tend to move gradually over time.”
A similar prediction was elicited for the advent of the corporate bond market, with the market percentage noted as 3% today.
Just under half thought corporates would represent between 10-20% of the total bond market by 2002, with 36% predicting it would still be less than 10%.
“In the Netherlands we are already seeing 15-20% corporate spreads. If funds choose broader based indices then the move will come more quickly,” noted Urwin.
Delegates were also asked whether they believed there would ever be a single eurozone equity market with one exchange and one set of rules, to which one optimistic delegate voted that this would happen next year – 41% thought this was a possibility by 2001, with 24% opting for 2005 and 17% saying it would never happen.
Urwin, commented: “The view around the time of the euro was slightly more optimistic but it appears there is a greater degree of scepticism now and I would agree with that.”
The post match analysis of the euro asset allocation game, according to Watson Wyatt, was of an immediate focus by pension funds on new bond ‘flavours’, increased equity portions, but not necessarily less bonds. Direct property would be most likely substituted for indirect and gradually marked down in portfolios. And continued interest in passive investment and growing opportunities for foreign managers in Europe were also cited as future trends.
Urwin then moved on to discuss non-financial criteria involved in asset allocation, which he dubbed the ‘Theta’ element. This he believed would compliment established financial criteria such as ‘Alpha’ – the return relative to the benchmark, and ‘Sigma’ – the standard deviation or ‘risk’. Theta, he said involved the capacity to manage the structure, which he bracketed in two forms. The ‘sleepwell’ control factor, he said, concerned exposure to regret risk – dealing in comfort, loss aversion and the old maxim of ‘you don’t get fired for buying IBM’. A ‘seemsgood’ value was ascribed to other soft biases of trustees – such as expected benefit, cognitive illusions and past performance as a guide to the future.
The point raised was that pension fund managers are not infallible, have subjective preferences and are subject to cognitive illusions – but that these psychological issues need to be factored into investment decisions and manager selections alongside quantitative data.
Questions were also raised over individual stock weightings in portfolios in the wake of mergers such as Vodaphone/Mannesmann and its 15% weight in the UK market cap against current 5% holdings for pension funds.
“We are advising clients that a 10% level could be possible, because the 5% is basically historical and not reflecting current market conditions”, stated Urwin.
The other response is to diversify, as Joseph O’ Dea, consultant at Watson Wyatt in Dublin commented on the Irish situation of exposure to a small number of relatively large domestic stocks: “In Ireland the effect was just to reduce domestic equity allocation to a level where the natural weighting would fluctuate at around 5%.” Hugh Wheelan