European pension funds have moved away from the belief that asset allocation drives investment returns after having grasped the true impact of internal governance, research has showed.

A survey of 190 European pension funds conducted by CREATE-Research showed that schemes were increasingly aware of the concept of ‘implementation leakage’.

Speaking at the IPE Conference & Awards in Vienna, CREATE chief executive Amin Rajan said the trend of investors grasping their governance responsibilities was a significant change from the survey of three years ago.

‘Implementation leakage’ – a term coined by a survey respondent, according to Rajan – relates to the structure and governance behind investors’ asset allocations and investment practice.

He said, over the last decade, pension funds investigated the difference behind expected and realised investment returns and found their own implementation strategies were at fault.

“Pension funds realised what they do has a big effect on the outcomes,” Rajan told the conference.

“The old mantra that asset allocation would be followed by returns does not apply any more.”

He said this was a painful lesson for many funds in the last decade during the growth of alternative investments.

“Investors moved into alternatives only to find that they struggled,” he said.

“The key lesson there was, if you go into anything different, you need to have the skills and governance structures to facilitate that.”

Rajan said the research showed the mindset had changed, and that where 80% of returns was attributed to asset allocation, it was now around 50%, and the remainder allocated to implementation.

“Implementation largely depends on governance practices and the execution capabilities,” he said.

Rajan said that, while the funds continue to study asset manager performance, they are continuously looking at how much their own structure contributes to lower-than-expected investment returns.

“This will serve as an interesting development,” he said. “Before, the tendency was to blame asset managers, but now there is an recognition that investments have become very complicated. In this situation, what investors do matters – as much as what their service providers do.”

Rajan’s research also showed that more than 25% of pension funds still set investment targets at 6% or higher, despite the ongoing low-yield environment.

He also spoke to IPE regarding his research’s detail on the growing dynamism of pension fund investments.

CREATE’s research was originally published in IPE’s November magazine.