Funds talk tactics
In this month’s Off The Record survey, 56% of the 34 pension fund respondents stated that they implement tactical or some other form of intermediate/interim asset allocation. A Danish fund described their process as such: “We review the allocation periodically, at least every six months, to enhance potential returns by exploiting perceived market misalignments, utilise momentum, or take early profits”. A UK fund added: “[We employ] in-house tactical asset allocation relative to the benchmark set by the investment committee, primarily using derivative overlays with clear limits [plus or minus] per asset class.”
Just over half of the respondents (56%) said they rebalanced back to their strategic allocation between strategic reviews or ALM studies. The majority (42%) did so once a quarter, a Dutch fund explaining that the “liquid assets [are rebalanced] each quarter, [with] other assets drifting until such time agreed with the fiduciary manager. Drifted benchmark weights [are] calculated on a monthly basis”. Some 31.5% did so whenever exposures exceed specified under/overweights against the strategic benchmark. A Swiss fund commented: “If one asset class violates the lower or upper boundaries set in the strategic asset allocation, all asset classes will be set to their respective targets”. Just one respondent stated they rebalanced once a year, while two did so according to a tactical view.
Some 38% of respondents said they used derivatives in the asset allocation process. A Spanish fund stated they “[used] equity futures or options to reduce or leverage equity market exposure”, while a Dutch fund said they used “swaps for duration matching, FX forwards for FX hedging and listed stock index options for risk management”.
More than 90% of respondents stated that asset allocation accounts for the vast majority of their fund’s risk and return, with an Irish fund commenting: “Our advisers are telling us to sell equities when they are at their lowest and buy the losses incurred over the past three years.” Just under 60% of respondents felt it made sense to optimise a strategic portfolio using long-term average asset class volatility and correlation statistics, while 65% thought strategic asset allocation should take some account of changing market volatility regimes. Some 56% believed diversifying exposure to growth assets enabled them to allocate more risk budget to their growth portfolio than if they only had equities to choose from.
Respondents were more evenly split on other issues, such as whether it is possible, without introducing new risks, to leverage exposure to one asset class via derivatives to bring its risk/return characteristics in line with other asset classes. Some 41% felt it was possible, while 38% did not and 21% were indifferent.
The same was true of whether fixed income indices are still fit for purpose as benchmarks for pension funds and other institutions, with a clear division of opinion between respondents. Just over 35% of respondents indicated they are. Conversely, 32.5% disagreed with this view, and the rest were indifferent. Just under a quarter of respondents felt that the onus is on index providers to supply a new generation of benchmarks for fixed income investment.
However, respondents were more decided on other issues, with 70.5% feeling that ultimately it is impossible to isolate duration risk from credit or liquidity risks. Some 56% were also happy with their fund’s exposure to PIIGS (Portugal, Italy, Ireland, Greece, Spain) government debt.