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IPE 360: Pension funds and managers 'have to know why they are winning'

Pension funds need to better brief their active managers on which strategies fit into their portfolio, rather than just giving them restrictions, according to speakers at IPE’s 360 conference.

Alfred Slager, professor of pension fund management at TIAS School for Business and Society, told delegates: “The future has to be trustees providing design principles and asset managers trying to fit in, rather than pension funds trying to accommodate certain mandates.

“This makes a more honest discussion necessary which is more evidence-based.”

For this, pension funds needed to “connect the relevant data”. Slager recommended setting up an “open data room” with all a pension fund’s available information available to share with asset managers at an early stage.

“This way active managers could be asked to simulate their strategy to convince the pension fund it would actually add value to the portfolio,” the researcher said.

Slager pointed out trustee boards were “not ready yet” for a new form of information exchange but he is optimistic for the future: “Talking to trustees who only just started on the boards you see people much more used to new regulations and a two-way dialogue with asset managers.”

The €27bn French civil service scheme ERAFP awarded a mandate last month based on data from a “virtual asset management platform” allowing managers to replicate their strategies.

Rob Arnott, founder and CEO at Research Affiliates, also emphasised the importance of collecting evidence and using information sensibly, from a fund manager’s perspective.

“When someone beats the market there has to be a loser on the other side of the trade,” Arnott said. “If a manager does not have a clear, succinct answer to who that is then they don’t know why they are winning. Indeed they are then the losers.”

Knowing why a strategy worked was key to sustainable returns for asset managers, but also for pension funds, he added.

“Almost no pension fund committee is willing to record how decisions were made and go back after a few years to see what mistakes they made,” Arnott said. “The same applies to quant managers as they seldom ask whether a strategy enhancement really enhanced the product or just added a performance chaser which weakened the product.”

Factor investing ‘not a panacea’

Arnott, a vocal advocate of factor-based investing, also warned that relying solely on data was not a good strategy.

“It can help as a tool but it tells you nothing about the future – you need to be very aware of the fact that inefficiencies change,” he said.

He said he was convinced that “looking at valuations helps”, emphasising this point with the example of quant managers and factor investing: “Inviting 10,000 quants to mine data means they will all come up with the same factors. So we are dealing in a very crowded territory, and the notion that factor investment is some sort of panacea is naïve.”

The factors on which most products are based were developed by academia “based on the assumption that markets are efficient” and without allowing for future changes to markets, Arnott said.

“Many factors were identified because they were statistical outliers,” he said. “Quants get seduced by data and fail to ask important questions like how can I get hurt, how might inefficiencies change.”

Arnott’s research has shown anti-cyclical investment works for factors such as value and momentum. “When valuation is low, value is working fine – when it is high, not so much,” he said. “You have to buy what is out of favour, unloved, and what people want to get rid of.”

Arnott has warned of the dangers of overvaluation in factors for some time, through several research papers.

In his presentation last week he also reiterated his argument that timing of factor investing was possible, but said it “needs a mindset that is well suited” to one factor, meaning investors should not chase performance when a factor gets cheaper.

Alfred Slager also voiced concerns of a point “where the trouble starts” with factor investing. “With pension funds reviewing strategies one of the challenges is to hold a steady and consistent course in factor investing,” he said.

Slager added that he had a few concerns regarding pension funds and smart beta: “There were some hasty implementations which only hinged on a few moments of a timeline which the investment committee reported about. It is important to know which part of the performance in these investments is revaluation and which is structural.” 

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