With so many pressures to focus on the short term, consultants are having to craft more sophisticated investment advice - and in some cases, re-think business models - to help clients attain their long-term objectives. Gill Wadsworth reports

Conventional wisdom underpinning pension investment strategies has been thrown into chaos by some of the most turbulent economic conditions in living memory. Periods of simultaneous negative performance across all asset classes; a decade of lost returns on equity markets; indices leaping from highs to lows and back again - all serve to undermine hitherto accepted pension investment strategies employed throughout Europe.

At the same time, swathes of new regulations and accounting regimes are sweeping across the continent at both national and international levels, causing funds and their advisers to review portfolio construction.

Long-term thinking retains its position at the core of most investment strategies, but there is a louder call for more sophistication, a greater focus on risk and an ability to react to sudden changes in market fortune.

Nigel Cresswell, head of Towers Watson's German investment business, says if pension funds operated in isolation from outside influences they could maintain an entirely long-term focus, allowing them a competitive advantage over short-term investors and an ability to endure limited periods of volatility. However, he notes that other factors, whether accounting-driven, regulatory or sponsor-focused, can make multiple timeframes relevant.

"To this end, our proposition often goes beyond the pure long-term, strategic thinking to assisting our clients in managing their conflicting goals, maintaining their focus on the ultimate goal, and taking advantage of their competitive advantages, where these exist," he says.

It is no surprise, then, that ‘dynamic' is the current buzz-word for pension fund investment consultancies keen to prove they can go beyond standard investment advice.

Jesper Kirstein, managing director at consultancy Kirstein Finance in Denmark, says: "Almost all pension funds are looking at the long term when devising asset allocation and investment strategies, but Nordic pension funds are becoming more dynamic, looking at semi-strategic changes to their portfolios."

And it's not just the Nordics. Geert-Jan Troost, investment consultant at Towers Watson in the Netherlands, says he has witnessed a greater desire by Dutch pension funds to focus on their long-term strategic investment goals while simultaneously managing their more short-term risk exposure.

"In the last year to year-and-a-half, I have seen a shift in the way pension funds are more
appreciative of their strategic risk allocation," he says. "That makes for a more complicated discussion [than focusing on asset allocation alone] but on the other hand it makes the pension fund better prepared for big changes in market behaviour."

Aon Hewitt estimates that 20% of UK pension schemes now include funding triggers in their long-term investment strategies. These allow for a more dynamic tactical asset-allocation strategy, capitalising on favourable market movements and de-risking when appropriate. The consultant claims that the growth in these kinds of strategies is a direct result of consultants making more tools available to the market.

Alongside trigger-based solutions, investment consultants must also prepare clients for the impact of more extreme market conditions. Since the market chaos of 2008, pension funds want to be better equipped to deal with crises and, at the very least, understand how their strategies will react under stress.

Towers Watson offers crisis management alongside risk management, providing analyses over very short time horizons of 1-3 years that encompass a range of extreme economic scenarios. Troost says the idea is to give clients a good picture of how much risk they are really carrying in their portfolios should the worst happen.

"This is different to risk management where you have a plan and expectation of how markets might deviate," he explains. "Crisis management is about understanding your plan when markets are in chaos. Short-term crisis analyses have become much more important to pension fund clients."

For European investment consulting giant Mercer, the move to more ‘dynamic' investment thinking has led to an organisational restructure. In January 2012, the firm announced a raft of changes to its business model, integrating its investment consulting arm with its asset management operation. The consultant says it is responding to client demand for more support in investment decision-making - particularly during challenging markets.

"Many of our clients are asking Mercer to move beyond investment consulting and to assume a greater role in helping them manage their investment programmes," says Phil de Cristo, president and group executive of investments. "Some clients may not want to staff internally to oversee their alternative investments or other complex investment vehicles, or to monitor fast-moving markets."

Mercer's structural overhaul was also prompted by the well-publicised changes in UK defined benefit (DB) pension provision. Final salary provision's long, slow march to extinction has led plans to revise their investment strategies, with added weight given to a fast-maturing liability profile. De Cristo says: "In cases involving DB pension plans, our clients have transitioned to a de-risking model where the speed of decision-making enabled by outsourcing of implementation is critically important for clients."

In the UK, the rise of the buyout market, offering sponsors a way irrevocably to offload their pension liabilities to an insurer, has added to this shorter-term approach to investment thinking.

Kevin LeGrand, president of the Society of Pension Consultants in the UK, welcomes the arrival of insured solutions but notes that schemes should beware of having their heads turned too far by the attractiveness of buyout. In particular, he says that schemes should ensure they do not introduce short-term strategies that could leave them vulnerable if the buyout deal collapses before completion.

"The securing of liabilities with an insurer is generally viewed favourably as an improvement in the security of benefits," he says. "However, ambitions to move to buyout on behalf of the sponsoring employer can cause disruption, particularly if the ambitions are ultimately unfulfilled, as during the period of uncertainty the trustees may shelve investment-strategy initiatives which might otherwise have been progressed."

The requirement to adhere to accounting regulations is yet another factor driving changes in investment time horizons. Cresswell says that German corporate pension funds can be very focused on the volatility of the accounting metrics in the short term to reflect the mechanics of annual accounting "fence posts", while at the same time trying to meet longer-term funding targets. "This leads to an approach of managing conflicting shorter-term and longer-term goals," he says.

The Pensionskassen, overseen by Germany's financial regulator, BaFin, are less accounting-focused and able to take a longer view in funding strategies, but with the threat of stringent new funding requirements as part of the EU-wide Solvency II legislation, Cresswell says that even Pensionskassen are being forced to revise their approach to asset allocation.

"The current regulatory regime of recording assets at book value and liabilities using long-term discount rates has led to buy-and-hold fixed income dominating portfolios," he says. "Potential regulatory changes and increased experience with economic and accounting driven approaches have led Pensionskassen to increasingly consider the impact of this regulatory-driven approach on their long-term solvency, with a view to looking how to manage the conflicting regulatory/economic approach to investing their pension assets."

In the case of the Dutch market, regulation actively encourages pension funds to focus on the short term. The Dutch supervisory authority, De Nederlandsche Bank (DNB), imposes a funding ratio with an emphasis on short-term goals, and has made clear its dislike of pension funds venturing into riskier assets, whether or not these might be rewarded over the long term. Consultants operating in the Netherlands say funds have been discouraged from allocating assets to classes such as infrastructure and private equity, which are widely seen as ideal matches for pension funds' long-term investment needs.

DNB has forced several pension funds to sell assets it didn't like, even where schemes have put forward diversification or risk-hedging arguments. For example, Stichting Pensioenfonds Vereenigde Glasfabrieken (SPVG) was forced to sell a 1% allocation to gold, since it was deemed too volatile, even though the scheme said it was a hedge against the unpredictable euro.

"I see the logic of investing in long-term assets like infrastructure and I think quite a number of pension funds would agree, but they still won't do it," says Troost. "The regulator in the Netherlands says if you are in an uncertain position you are not allowed to deviate from the strategic path and introduce new risk. You could argue that you are compensated for that risk through extra yield, and in the long term that might prove to be the case, but the regulator doesn't see it that way."

Of course it is not just regulation that has precluded investment in long-term assts. The desire to retain liquidity has been an important deterrent to Dutch pension funds.
Jeroen Koopmans, partner at Lane Clark & Peacock in the Netherlands, says that because of the current economic circumstances and the fact many pension funds are looking to wind up in the near future, schemes want to retain as much flexibility as possible within their investment strategies.

"To be positioned to do this, pension funds need to maintain liquidity in their investments," he says. "Private equity, infrastructure and other illiquid investments are therefore increasingly seen as unattractive propositions."

However, this approach does not sit well with the investment consultants' much-loved diversification mantra and, as such, consultants expect to see a greater investment in multi-asset funds which offer exposure to long-term asset classes without losing liquidity. Of course, returns would still have to be high enough to convince investors to move into longer-term asset classes.

Koopman says: "We would expect that those responsible for the investment of schemes' assets would need to be persuaded that an attractive premium can realistically be expected on these types of investments, compared to more liquid alternatives, to compensate them for the loss of liquidity."

Meanwhile, Nordic consultants who advocate the use of longer-term assets have an easier time convincing clients to invest, since appetite for these asset classes is still high.
Kirstein says his firm is "looking carefully" at asset classes like distressed debt, infrastructure, real estate investment trusts, commodities and catastrophe bonds.

The advent of dynamic solutions allows investment consultants greater control, steering schemes away from danger and, potentially into calmer, more profitable waters. However, since this kind of implemented consulting is still in its infancy, it remains to be seen whether advisers can live up to expectations.

As pension funds are expected to manage ever greater external influences on their pension funds, investment consultants will need to keep evolving if they want to retain their position at the right hand of pension funds, allowing them to react to short-term demands without straying too far from their long-term goal.