The contrarian approach works
The Japanese pension fund industry has its veteran practitioners, who are recognized as opinion leaders and best practitioners, but many pension fund directors are still rotated in and out of the job, in line with the sponsor’s HR reshuffle practice. So there is always a pool of operators going through a steep learning curve to be effective, in a job that has become more and more complex over the years.
Last month I organised an event bringing to the Japanese audience a case study from The Netherlands: the ABN AMRO Bank Pension Fund, winner of the IPE award for best European Pension Fund in 2010. At the event, under the guidance of guest-speaker Cees Dert, Managing Director of the fund, we re-enacted, in a workshop setting, the decision making process of this pension fund’s board of trustees, giving participants the same information that was made available to the board members of this fund at the time.
One of the reasons why this fund won the IPE award is the uniqueness of their decision making process. The board is given a fair number of strategies to choose from. Each strategy is assessed on the basis of criteria that directly matter to the stakeholders of the fund. Broadly, three stakeholders are relevant: participants/pensioners (interested in the level of the benefit), the sponsor (interested in the amount of regular contributions as well as the risk and size of unexpected additional contributions) and the regulator (requiring a certain minimum level of funding and limits to the risks of under-funding).
What came as a surprise to many is that the board does not know what the contents of each strategy is before they select the one to implement. In fact, each strategy contains a comprehensive investment policy in terms of equity-bond split, hedging policy etc. but the board does not know in advance what is in the bag they choose. The reason for this made sense to the practitioners in the room, who deal with board of trustees meetings themselves:
(1) by disallowing the Board to discuss investment technical issues, both investment-savvy board-members and board members with little investment knowledge (often participant or pensioner representatives) can have a fair discussion based on what is relevant to stakeholders without one or two specialists monopolising the discussion;
(2) by offering a choice of comprehensive strategies that are internally consistent, the board is safeguarded against deciding about sub-issues (eg: how much FX risk to hedge, invest passively or actively etc) of which the impact on the total scheme and the interests of its stakeholders is not fully appreciated.
Like the board of trustees of the ABN AMRO Bank Pension Fund, our Japanese audience, weighing the trade-off to the stakeholder’s interests, chose overwhelmingly a dynamic asset allocation strategy, reallocating the fund’s assets dynamically between a liability matching portfolio and a return seeking portfolio, based on the prevailing funding ratio of the fund (more risk at higher funding ratios). The adoption of this type of strategy since 2007, was the second reason for the award: the fund outperformed its peers substantially during the Lehman crisis and beyond.
The results achieved by the fund caused an interesting discussion, about the pros and cons of trend-following, versus contrarian investment strategies. As we have reported on these pages previously, one of Japan’s largest funds, the Pension Fund Association, adheres to the latter, where equity exposure is increased as the funding ratio falls.
Cees Dert pointed out their strategy is only trend-following in-between the annual meetings of the board of trustees. The strategy selection process is an annually recurring event, where the board can select a strategy that leads to a different asset allocation altogether. Although, again, the strategy selection is done “blindfolded” the ABN AMRO experience shows that the procedure can very well (and actually has) result in contrarian investing.
The strategy chosen by the board of trustees in early 2009 was one of increasing equity exposure at what, in hindsight, was the bottom of the market. Overall, the combination of a trend-following protection-oriented strategy during the year, with decision moments built-in to reassess the situation, and the possibility to behave in a somewhat contrarian manner, provides a pension fund the benefit of time. A dynamic protection-oriented strategy makes sure that the funding ratio at the next decision moment will at least not have sunk to a level from which recovery has become impossible. No wonder that, assessed on the basis of the interests of the pension fund’s stakeholders, such a strategy beats a passive buy-and-hold or an automatic “rebalancing back to strategic weights” strategy.
With markets showing developments resembling 2007 and 2008 as the seminar progressed, the audience took note.
Oscar Volder is head of institutional sales for BNP Paribas Investment Partners in Tokyo