IRELAND - A sharp decline in Irish equities over the last 12 months has highlighted the “inherent lack of diversification” in Irish balanced funds and driven managers to look at other asset classes, Hewitt has revealed.

Figures from the latest InVision Survey for the second quarter of 2008 showed the average Irish managed fund returned -4% in the three months to June 30 2008, and a return of -15% over the year to date.

The best performing fund in the quarter was Standard Life Investments with a negative return of -2.2% compared to the Hewitt Managed Fund Index of -4%, closely followed by Eagle Star which had a negative return of -2.8%, closely followed by Oppenheim Investment Managers with a negative return of -2.9%.

Canada Life/Setanta produced the worst performance with a negative eturn of -5.1%, although Hibernian was close behind with a return of -5% and ILIM also performed poorly with a return of -4.8%.

Betty O’Reilly, investment consultant at Hewitt, said pension scheme trustees have traditionally looked to balanced or managed funds to achieve a good long-term return at moderate levels and balance other asset classes such as property, bonds and cash.

She said this strategy had “worked very well for pension schemes over most of the last 10 years” as a significant part of balanced funds had been invested in Irish property and Irish equities, and the asset classes were generally moving upwards.

However, she warned “the sharp decline over the last 12 months in equity values, particularly Irish equities - and property to a lesser degree - has highlighted the inherent lack of diversification in the typical Irish balanced or consensus fund and the consequent high level of risk that they carry”.

“We have referred previously to the unjustified bias towards Irish assets in such funds. The risks of this strategy have now come home to roost as exceptional declined in Irish equity values have eroded returns,” said O’Reilly.

Hewitt said diversified funds are increasingly being seen as “an efficient means of giving pension funds exposure to a broader range of asset classes and reducing risk, without necessarily impacting on long term returns”.

To reflect this, Hewitt highlighted the recent addition of a limited number of diversified funds to the range covered by its quarterly InVision survey, and although those included have a “very short” performance history, Hewitt claimed the profiles and performance of typical asset classes included in diversified funds - such as commodities and emerging markets - can be used as guidelines to volatility and performance.

Some of the diversified funds included in the InVision survey are the Eagle Star diversified assets fund, which returned 2.8% in the second quarter of 2008 compared to the Hewitt Managed Fund Index returns of -4%, and in the year to date it achieved a return of -2.4% in comparison to -14.8% achieved by the Hewitt index.

Meanwhile, the ILIM diversified growth and diversified balance funds both outperformed the Hewitt index with returns of -2% and -2.2% respectively, while in the year to June 30 2008 the two funds returned -13.7% on the diversified growth and -10% on the diversified balance.

Hewitt pointed out the diversification benefits of a broadly based equity portfolio - as found in balanced funds - are diminishing, and this is driving investment managers to look for other asset classes which have a low correlation with equities in order to produce an ‘optimal’ portfolio allocation for pension funds.

O’Reilly said many of these ‘alternative’ asset classes would have been ruled out by managers in the past for being excessively illiquid, difficult to trade or legally complicated, however the “proliferation of indexed funds and developments in derivative instruments has made such categories more accessible”.

As a result, she claimed managers are now offering strategies that include categories or ‘themes’, such as alternative energy and emerging markets or water and infrastructure, and admitted that “in principle” a combination of more diversification and additional alpha should result in a more ‘efficient’ portfolio or better risk/return profile for investors.

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