Few pension schemes can afford to sell off their equity holdings and pursue a strategy that excludes this major asset class. The UK's pharmacist and drugstore group, Boots, famously did it a few years back, but the sensationalist media failed to mention that theirs was a very mature scheme that no longer relied on the long-term returns equities - despite downturns and volatility in recent years - still offer.
Austria's €2.5bn multi-employer scheme, APK Pensionskasse, may not be about to create headline-grabbing news in the national press with its ideas for equities, but the pensions world across Europe will be impressed with its approach to maximising the potential equities offer, as this award testifies.
"A truly long-term global equity strategy will benefit from economic developments that translate into higher equity prices over time," the fund says. The trick is, it continues, is how to maximise returns by picking the best performers from an equity universe that is split between regions, countries, sectors and investment styles. "Equally important is the question which optimisation rationale or model should be used, as is the role of benchmarks," it adds.
In what it calls a radically different approach, APK began its review by taking a closer look at the world in 20 to 50 years' time. One region stood out in its evaluation. "The world in 2027 to 2057 is expected to be a world with much more Asian influence than today. Given Asian population dynamics, the associated economic growth, the massive build-up of foreign currency reserves - China as a state and the Chinese population with their savings accounts today could virtually buy the entire current US government debt - a global equity portfolio based on current MSCI World Index weightings with about 5% weight in Asia ex Japan barely makes sense," APK argues.
This assertion has led to APK favouring a particularly long-term top-down allocation approach, with projected regional GDP weightings in 20 to 50 years' time, coupled with a strong dose of realism by discounting overly optimistic projections, as the basic algorithm for the fund's regional equity weightings.
SMALL IS BEAUTIFUL
Taken an even more forward-thinking approach, APK also now looks beyond market listings for potential long-term investments. "It is evident that typically only a small part of a developing country's GDP is represented by companies listed on its stock market," the fund says. "The bigger part of economic activity and value creation is in companies that are not yet listed on the stock exchange. Further, it is the smaller companies that experience stronger growth," it adds.
Working towards a truly a diversified investment approach, APK therefore believes it can establish reasonable weightings across the board to benefit from the growth and value of smaller and unlisted companies. "Any portfolio weightings based on current market capitalisations of listed stocks contain a backward-looking bias and thus can't fully capture economic growth potential. If a well-established benchmark is used as a framework for portfolio construction, an underweight of small cap companies is highly likely," APK says, adding that this may mean losing out on small-cap premium.
EMERGING MARKETS - SAME STRATEGY
Implementing a much wider and radical approach in just one region calls for particular expertise. So APK began a manager search and selection process for Asian specialists that could build portfolios with a strategy or bias towards small and mid caps. Consequently, it sees the small and mid-cap funds not as satellites but as part its strategic core.
"Our corresponding manager line-up includes 14 core managers who are chosen according to regions and investment styles. We do not run global emerging markets equities as a different strategy because we have included emerging markets companies through our fundamental weighting approach from the very beginning in regional weightings."
KEEPING IT UNDER WRAPS
APK adds a central characteristic of this "unorthodox" approach is a higher degree of non-euro investments and it says it thus requires an efficient and effective ongoing currency managing process. This takes the form of a hedging process that focuses on managing US dollar risk and a sophisticated market risk management programme, which was developed once the currency programme was in place. "As 50% of our equity portfolio is strategically allocated to Europe, we are using the EuroStoxx50 contract traded on Eurex. For the non-Europe element, we use the S&P500 futures contract.," the fund explains. "We established the process, cleared organisational and settlement requirements and undertook the first trades to check systems and processes in December 2006."
The success of APK's redesigned approach to its equity investments, which has been gradually introduced as part of its integrated portfolio management process in the past couple of years, is already visible. The fund confirms it has already achieved a cumulative outperformance of over 3,788 basis points since the summer of 2002, or 641 basis points a year over the same period. Volatility is 10.5% and outperformance against the benchmark is 15.6%. APK says these figures are externally audited. "Analysis of the outperformance shows that about 45% was generated by our style and regional weighting strategy, with 40% thanks to the external managers stock selection skills and 10% by the currency overlay and tactical process," it says.
HIGHLIGHTS AND ACHIEVEMENTS
Not wanting to shun the returns equities can provide, Pensionskasse APK has widened the net to capture the best deals from growing and emerging regions, particularly Asia. This is not only imaginative but very forward-thinking as most of the sustained return potential lies in the future. But the potential is undeniable as countries like China and India continue to catch up fast with their more developed and transparent Western rivals.
Implementing a strategy of this nature is not without risk, so the imagination APK has shown towards Asia is matched by efficiency and organisation towards its risk management in being able to contain this new foray into somewhat unexplored territory.