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Innovative funds exploit specialised mandates

Two pension schemes shone brightly in this category: Italy's architects and engineers' pension fund Inarcassa, and the UK's Strathclyde Pension Fund, a local government scheme for the Scottish area that includes Glasgow. Unable to choose between them, the judges decided both should win.
Founded in 1961, Inarcassa started life as a state-sponsored scheme but is now privately run. Inarcassa has spent the past five years shifting from an investment strategy based on balanced mandates to one which focuses on specialised mandates. The scheme refers to this period of modernising its structure as "a revolution in our asset management".
Inarcassa says at the centre of its investment process is a diversified strategic asset allocation policy which comprises asset classes that are determined by and benchmarked against the most representative, transparent and replicable indices. "We use two different ranges of indices. There are the total return gross indices which are determined by the long-term time horizon of the scheme's investments. Then there are the ‘euro-hedged' or ‘local currencies' indices, so called because of the liabilities being valued in euros," Inarcassa comments.
The hedging and exposure to different currencies are managed through a tactical asset allocation strategy through a currency overlay programme. This is implemented in conjunction with the scheme's recently appointed new depositary bank.
To increase diversification as well as improve its efficiency and robustness, the scheme has opted for a top-down methodology. Inarcassa claims this approach enables it to define its asset allocation and determine the type of investments it need to make at asset class level, sub-asset class level and even within the sub-classes.
There have been some changes at asset class level. It has introduced alternatives, inflation-linked products and money market funds to its strategic asset allocation. The strategic asset allocation now comprises six asset classes: equities; real estate; fixed income; alternatives; cash, and inflation-linked vehicles.
"In order to implement such a diversified asset allocation policy and maximise portfolio efficiency as well as monitor its performance consistently, it was logical to shift to specialised mandates," Inarcassa says.
All the asset classes will operate with ‘core' investments that will either be primarily passive and make use of low commission products, such as exchange traded funds, futures, investable indices and managers running passive mandates or Inarcassa's finance department will invest in them directly following a best execution policy whereby brokers will compete for the business.

Scotland's Strathclyde Pension Fund claims a long history of innovation within its investment strategy which includes investing in property and private equity as far back as the late 1980s.
It began exploring emerging markets a few years later and adopted a customised benchmark in the mid-1990s. More recently it has increased its exposure to leveraged loans, high-yield debt and emerging debt.
"The investment strategy is reviewed regularly, with the most recent beginning with the fund's actuarial valuation in March 2005," Strathclyde says. "This fed into an asset liability model which in turn led to a review of the fund's investment management structure," it adds. 
The review had several aims. Firstly, it needed to ensure strategy remained consistent with the actuarial valuation and asset liability study. Next, it sought to highlight new investment opportunities. Finally, it was designed to progressively improve the efficiency of the scheme's risk return ratio.
The results? Strathclyde has added a second private equity fund of funds manager and introduced an active currency programme involving three managers. It has also forayed into "unconstrained" equity investments, essentially a form of active management where the manager is freed from the constraints of tracking benchmarks or indices.
Strathclyde says these changes were guided by the same principles it has always relied on when reviewing its investment structure: uncorrelated or weakly correlated sources of return and eliminating or reducing unrewarded risk.
Strathclyde claims the changes enhance its competitive advantage. "There are some markets where it is notoriously difficult to beat the index consistently using core and constrained approaches, and others like emerging markets or smaller companies where a skilful manager may more easily be able to beat the index. We have constructed our mandates with this in mind, focusing active management in less efficient markets. This theme persists in the new unconstrained allocation and in increased exposures to emerging markets and private equity. We have also always sought to fully exploit our size advantage by making allocations to less accessible asset classes," it explains.
But this does not mean Strathclyde does not approach its investments with prudence, as it is aware of practical restraints. "While it is tempting to appoint ever more managers with particular skills, we are mindful of the administrative practicality, the costs and the fact that strong historic performance means that major change is not justified," it says.

Highlights and achievements
Undertaking large-scale changes to an investment strategy requires a lot of skill. Inarcassa's shift from balanced portfolios to specialist mandates is a bold move but has been well planned. It has identified areas that should remain passively managed and those that would be better invested with an active manager. It has established due diligence procedures to select the managers and its benchmarks. It has overhauled its hedge fund investments and begun investing in private equity and commodities.
The Strathclyde local council fund is no wall-flower either. But it does not incorporate change without reason. The recent extension of its private equity portfolios and its decision to introduce unconstrained equity are the result of its actuarial review last year and its subsequent asset/liability modelling. It has also added an active currency mandate that uses a multi-manager approach.

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