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Shaken, but not stirred

In this month’s Off The Record we asked whether you thought that the pundits were correct in saying that volatile markets are here to stay and, if so, what you felt the implications would be for pension funds.
An emphatic 71% of you believe the shaky start to the markets this year will carry on throughout 2001. Only 29% predict less volatility, with a small number predicting a pick-up by the fourth quarter.
A single reply predicts increased buffeting ahead. Let’s just hope it’s not the lone voice of reason.
One manager formulates a neat treatise on why markets will stay at current levels of volatility: “The recent downside market has scared a lot of small investors away. This will increase the importance and impact of the behaviour of institutional investors.
“As we know, institutional investors are less impulsive and have a more fundamental approach to investment decisions. Therefore, I think the volatility will stay about the same; it will be tempered by the institutional players on one hand and kept up by the small individual investors who might become attracted again looking for bargain stocks if these low pricings stay at their current level.”
For another the worst is over and markets can only calm down from here: “Normally stock markets have the highest volatility in turning points, as volatility in this sense means very nervous investors.”
And to some there appears to be an inherent equilibrium in the way markets go: “A long positive period might be followed by a long negative period,” says one scheme chief.
A slightly higher percentage (79%) of pension plan heads believe that volatility itself is on the cards for the foreseeable future.
So what are the reasons behind the maelstrom then? Well just over half of you attribute the rocky ride to misalignments in financial markets, while almost four fifths ascribe the problem to adjustments in the real economy. Interestingly, a number of responses point to derivative instruments as the guilty party… but then disappointingly fail to explain their rationale.
One respondent knows exactly what the cause is, though, spelling it out succinctly: “FEAR”.
Another takes a sideswipe at market mentality, claiming the shaky stock exchanges are caused by “greed” supported by “too much liquidity”. For some, the swings have led to a welcome shake-out of private investors, with one manager blaming the nervousness of the investment minnows: “ Every ‘hit’ overshadows the ‘misses’, which leads to a …” Ominous blank that.
On a more macro analytical level, one respondent lists the ‘issues’: “Over-capacity in IT sector, reducing earnings growth in line with the ability to ‘absorb’ production, global adjustments to change – the euro, Japan, Korea, Latin America.”
One thing is certain, none of you are having a good time from this period of fluctuation. Not one reply can see any beneficial aspects of volatility, while three quarters are taking hits and forecasting negative impacts on portfolios.
The eyes of many are on the longer term, though, with a third of you predicting that over time the effect on investments will be neutral. Around half of you believe that the impact will be moderate, as opposed to a gloomier 14% who sense “severe” damage occurring, although the same number felt that the buffeting would have ‘minimal’ consequences over time.
Whatever the outcome, it is heartening to hear that 100% of funds are sticking to their guns and maintaining their long-term approach to investment.
No panic here, thank you!
Maybe time for a little look at the asset allocation policy though, eh?
Around a third of you are just about ready to dig out the performance charts, although most point out that this is part of the normal working process.
Nevertheless, shaky markets stir minds. One pension fund lays out its current reasoning on allocation decisions ahead: “We are allocating new inflows to bonds, marginally decreasing equity exposure and entering a research phase on alternative investments – private equity, real estate.”
Other areas up for examination, it appears, are the US market – with a couple of plan sponsors looking over the pond at what they deem an “undervalued” market, and a few others contemplating an increase in euro-based assets.
Trustees, you believe, are also on the whole not quivering in their investment boots over a bit of market turbulence. Only 29% of respondents thought their trustee board was likely to become more risk-averse in the current climate, although one stipulated a fairly reasonable clause to this confidence: “As long as reserves are large enough to compensate the losses.”
Most noted that risk was monitored on a regular basis and defined at acceptable levels to ensure that trustees did not have to worry.
However, one slightly worried party answered: “I hope not…” claiming that what was required was: “judgement as opposed to herd mentality”.
Those that do see their trustees battening down the hatches say it is only natural, citing: “Human behaviour in difficult times.”
A further comment, adds: “Unstable markets always lead people to feel more uncomfortable about their asset allocation decisions from the past and the risk involved in those decisions.”
Undoubtedly, the risk factor is an area where many pension funds are in a period of reassessment, with 43% asserting that analysis was under way.
Value-at-risk (VAR) measurement was mentioned several times as a prime appraisal tool. One manager explained this was taken down not just to the asset class level but also to the sector level for equities.
Others say they have hired specialist risk measurement firms, which must be making hay while the investment sun doesn’t shine.
So, is it time to look at alternative investments as a way of boosting returns or reducing market impact?
Well, opinion is divided straight down the middle, 50/50, showing just how contentious an issue this can be in the pensions arena.
For the advocates it seems higher returns are the goal with most mentioning hedge fund and private equity allocation as a way of securing additional profit.
A scheme manager comments: “We are looking at a mix of hedge funds at the moment because higher returns than bond markets are needed.”
Another hedge fund argument sounds somewhat like the proverbial dipping of toes in the water to test for temperature: “A mix of absolute performance with somewhat less correlation to equities may be interesting.” Conversely, one pension fund head says they have heard it all before – putting forward a resounding ‘No’ to the question.
A third of you are nonetheless deploying tactical asset allocation (TAA) strategies. For the most part these are done in-house, with only a solitary scheme stating that they use a TAA specialist for such decisions.
A couple of funds mention that they seek external advice, but on the whole those that go the TAA route seem comfortable in doing so.
“We already work with TAA, but don’t have a specialist, rather a committee with members from different departments of the management organisation,” says one fund.
And only a fifth of replies say they believe that absolute return benchmarks could be more appropriate in the present market climate.
One manager underscores the difficulty with absolute return: “Absolute return benchmarks better align the assets of the funds with the liability evolution. However, how would one set a realistic benchmark without the asset manager being either too conservative (if a low benchmark is set), or being too aggressive and risky by setting the benchmark too high.”
Similarly, a relatively low number of you (29%) believe that consultants can provide useful advice in volatile markets. One fund sounds like it has had a bad experience: “No, we do not.” Performance-related pay anyone?

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