Foreign equities managed through tailored mandates
Danish pension fund Industriens Pension has won the themed award for its work in optimising the manager structure for its foreign equity portfolio. Over the past year, IP has switched to a combination of external and internal management, choosing external management for a specific segment if it is better in terms of cost and anticipated return/risk.
The fund’s foreign shares are therefore managed externally, and a high level of expertise in selecting and monitoring external managers has been built up. Tools used in both selection and monitoring include statistical key figures.
Although it is too early to link this restructuring to returns, IP says that it has recorded significant outperformance so far in 2005, both on all mandates and in the tactical allocation to regions and large/small cap sectors.
The Dkr7.5bn (€1bn) of foreign shares make up 20% of total assets on a strategic basis, with the ability to move between 12.5% and 27.5% for tactical asset allocation decisions.
The fund was formed on 1 January 1993 and throughout the first year of its existence, foreign shares were managed as part of a balanced mandate. IP says this was a natural choice, given the relatively small amount of capital under management. However, the balanced mandate was supplemented by, and eventually replaced by, global share mandates.
When the assets under management had grown, the global mandates were supplemented by regional mandates. But IP then found that while its global managers usually chose the correct geographical allocation, they generally had problems creating added value from the choice of shares, especially in the US. IP says that this shows there are difficulties in using a “one-size-fits-all” philosophy and process for different stock markets around the world.
In 2004, it therefore broke down the manager structure even further, so that individual managers’ methodologies can be adapted to different regions and segments. The new structure is split up into regions and gives the ability to choose different processes for large and small cap shares.
As part of the restructuring, three mandates were ended and seven new mandates were appointed. Searches for two further mandates are still going on.
The portfolio is divided into five regional segments, with the two most important, the US and Europe, split into large and small cap mandates. The US large cap mandate is shared between Invesco and Quantitative Management Associates, who both use an enhanced index strategy based round the S&P500, but with slightly different remits. AXA Rosenberg runs the small cap mandate on an active basis. In Europe, large caps are managed by JP Morgan and UBS, with State Street Global Advisors running the small caps. All these mandates are actively managed.
SSGA also runs the Japan portfolio, while Pictet runs the global emerging markets mandate. A second manager is yet to be appointed to share this mandate, and a further manager is sought for the developed Asia region.
IP says, however, that cost and minimum size constraints for individual mandates mean that structuring the management of a portfolio in this way is only suitable for the bigger pension funds. IP’s own assets under management have now grown to Dkr33.5bn (€4.5bn).
IP’s new regional manager structure makes it possible for the fund to choose the investment philosophy and process that is considered most suitable for generating an additional return in a given region and segment.
For example, it is well documented that additional returns from US large cap shares can be generated using an enhanced index strategy, but this does not seem to be the case with more active strategies. However, in other markets such as Europe and Japan it may be preferable to use strategies with a larger tracking error. This argument has become more important with the development of stock markets worldwide and ‘product development’ in portfolio management.
The new structure – using only regional mandates, rather than both regional and global – also gives a greater opportunity to put the portfolio manager structure together so that the mandates complement one another. Hence, compared with the previous structure, the overall level of risk elsewhere in the portfolio can be reduced.
Furthermore, it gives the opportunity to take risks where they pay off best, using the risk budget effectively. So the biggest risks are taken in the least effective markets, such as small cap and emerging markets.
The new structure exploits any special skills which the managers have in specific geographical areas. On the other hand, IP itself can if it chooses make tactical geographical and large/small cap weightings.
The new structure can also be adapted over time to make use of new ideas. For instance, the divisions into large and small cap mandates can be complemented with growth and value mandates. It will be relatively easy to set up portable alpha strategies.
But, if added value can no longer be created in a given region or segment by asset management, it will also be easy to replace the active mandates with indexed ones.
Last but not least, the overall cost of management can be reduced. For example, the mandates chosen for all US large cap shares – which make up about 40% of the foreign shares – are enhanced index mandates. The management fee for this type of mandate is typically low.
Highlights and achievements
Industriens Pension has moved away from globally-based mandates to a system of mandates which are chosen on a regional basis. This means that investment processes can be tailored to specific markets, rather than using a “one-size-fits-all” strategy, so that, for instance, US large cap shares can be managed using an enhanced index strategy, while the small caps are actively managed.
In addition, managers can be chosen to run the segment in an area where they have expertise, in contrast to the previous arrangement, which allowed global managers to run mandates for areas where they were not necessarily strong.
The new structure also reduces the risk of overlapping between different investment managers, and it also gives the opportunity of increasing risk in markets where it will pay off best.
The reorganisation of the portfolio also gives scope for new ideas to be incorporated, for instance, subdividing some regions into growth and value portfolios. It should also be relatively easy to change the investment processes in particular segments, such as replacing active mandates with indexed mandates.
The signs are that the restructuring has been a success, with IP reporting significant outperformance so far in 2005.