Disastrous equity markets are raising the question of alternative asset classes and investment tools. At the NAPF conference, consultants and asset managers attempted to address this issue, looking at options such as greater allocation to bonds, the use of derivatives, and multi-management as strategic tools.
Stating the case for derivatives, was Trevor Robinson, representing his own investment management company, TRIM.
Robinson explained that derivatives such as put options can protect funds from loss when equity markets are falling. Equity markets, certainly throughout the 1990s were associated with rewards rather than risks, but the last three years has turned this theory on its head, and, says Robinson, “although equity managers try to beat the index regardless of whether the market is falling or rising, what they are more likely to do is outperform in a rising market, and underperform when the market is down.” The boundaries of risk and reward have been challenged, and now positive returns, rather than above benchmark returns are viewed as reward and the use of derivatives could be considered.
What put options can provide is less risk than equities when used sensibly, says Robinson, but as trustees often do not fully understand derivatives, they tend to avoid them as a tool. Certainly comments, like that of Warren Buffett, which describe derivatives as “financial weapons of mass destruction” are not encouraging, but industry participants are trying to make equity derivatives more comprehensive to trustees.
Robinson adds that it is not essential to understand the jargon, neither to understand exactly how derivatives work, but rather it is important to understand the principles. “Trustees don’t need to worry about the details of derivatives, but like equities and bonds need to know principles of what they can be used for and should have a set of rules for the external fund manager.” A guidebook for trustees by the NAPF entitled ‘Equity derivatives made simple’ has been produced for just this purpose.
Robinson advises trustees new to derivatives and interested in using them to speak to peers that are already familiar with derivatives, to look at the rules they have in place for their fund managers and then “dip a toe in the water” and progress slowly.
Addressing multi-management were Jon Bailie of Franklin Templeton and Gareth Derbyshire of Morgan Stanley. Multi-management is becoming increasingly popular among pension funds, and appointments of multi-managers are increasing. Pension funds are moving towards specialisation as a result of poor performance of balanced management. The desire for greater manager diversification, style diversification, greater control over asset mix offered by multi-managers is attracting both large and small funds – the latter now presented with affordable access to specialists.
The effect of the growing market on consultants says Bailie, is that the consultancy market could become less concentrated, and we could see consultants offering multi-management products or some form of multi-manager solution. Consultants will also become more accountable, taking the decision-making strategy away from the trustees. For the investment management market, the effects will also be seen says Derbyshire. Managers are likely to provide more consulting type services, the market will be les concentrated as those “out of the loop” take on a greater role, and short track records will be more acceptable. There may be some downward pressure on fees, but there is a limit to what quality managers will accept, says Derbyshire.
Consultants Watson Wyatt and Mercer Human Resourcing discussed the issue of whether bonds should be the dominant asset class for UK pension funds, but it appears the minds of financial participants is made up. Around 77% of an audience of over 400 disagreed with the proposal, which at the end of the session had only fallen to 75%.