Seeking new sources of return

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The first of its kind, the New
Sources of Return Survey
for 2005 undertaken by
asset manager
JP Morgan Asset Management,
questioned 125 representatives
of 120 of the largest US pension
plans. Both corporate and public
plans were included, as well as a few
non-profit, Taft-Hartley, and other
Differences in attitude between
corporate and public plans were
apparent throughout the survey. For
example, while equities dominate
the portfolios of both corporate and
public plans, accounting for more
than 60% of the asset allocation mix,
they diverge on the types of alternatives
deployed. “Corporate plans
appear to be somewhat greater users
of private equity and hedge funds,
while public plans have a greater
allocation to real estate – both public
and private,” points out the report.
They also differ in their current
funded status. More than half the
survey participants classified their
plans as less than 95% funded, “with
corporate plans faring somewhat
better than public plans.” The survey
found that 42% of corporates, and
68% of public plans, are less than
95% funded; and 10% overall of the
survey respondents acknowledged
that maintaining funded status is a
major concern.
Current benchmarks seem to suit:
93% of respondents said that they
did not plan to change how they
measure performance. Despite concerns
about meeting target returns,
99% of plan sponsors still rely on
market benchmarks, and 78% measure
themselves against their peer
group or their rivals.
The report concludes that this is
“indicative of a period of change and
exploration, one in which success
metrics are a step behind the innovative
solutions being explored”.
However, the study also notes that
a significant number of plans - 44%
of corporate plans, and 28% of public
plans - are measuring themselves
against pension liabilities; this, however,
does not mean that they use
duration extension strategies to
effect asset/liability management –
only 11% do so.
In general, though, plan sponsors
are open to change: 82% are considering
different asset classes or new
investment strategies for a variety of
reasons, the most commonly cited,
by 73% of respondents, is to diversify
risk. There is an interesting difference
in motivations between the
corporate and public funds here.
More public funds were concerned
with diversifying risk and delivering
higher returns, while the corporates,
had the edge on wishing to hedge
The report addresses the fact that
this strong desire to diversify seems
to contradict the stated concern with
maximising returns: “Our interpretation
is that recent experience has
made investors keenly aware of the
risks of being too dependent on concentrated
traditional markets to consistently
generate required returns.
Investors are looking to diversity
their sources of return – and their
risk – in reaching their return destinations.”
In terms of new asset classes, those
funds looking to diversify risk were
most interested in private real estate,
inflation protected instruments
(TIPS) and emerging market equity.
Even here, there was a distinction
between the corporates and public
plans: more corporate plans were
considering commodities, hedge
funds, absolute return and tactical
allocation, while public plans had
higher hopes for emerging market
equity, high yield, and REITs. The
report “initially found these results
surprising but believe that this interest
on the part of public plans may
represent planned diversification to
areas where corporate plans may
already be allocated”.
In addition, 65% of plan sponsors
did say that they would consider
change to deliver higher returns, and
were looking at private equity,
emerging markets equity and private
real estate. Public funds were slightly
more interested in public real estate,
while the corporates were looking at
commodities and long-only return
The plan sponsors questioned were
also open to new investment strategies.
The report noted: “We see evidence
in our findings that they have
a level of confidence in active management
and of experience and comfort
with derivatives – the tools
embedded in absolute return, alpha
transport, and tactical allocation
overlays. It remains to be seen to
what extent these factors will support
continued exploration and
implementation of these potential
investment solutions.” While the
majority of plans were content with
their current active/passive mix,
those considering a change favoured
a move towards more active management.
Derivatives have “gained a significant
level of acceptance among
plan sponsors” – 64% are currently
using derivatives and another 16%
are considering doing so. Far more
corporates (70%) than public plans
(54%) are using them, but it
appears that the public plans will
catch up, since 24% of public plan
respondents stated that they are
considering their use. Those not
using derivatives were put off either
by policy guidelines or by the perception
that derivatives were an
implicit form of leverage. Derivatives
are mainly judged useful
either for rebalancing or to hedge
against interest rate risk.
In addition, more than half the
plans were using or considering
using absolute return strategies,
“with a higher proportion of users
among corporate vs public plans”,
the study points out. Those plans
not interested in absolute return
strategies were put off by a need to
do more research. This was the case
for almost 40% of the public plans.
Only 28% of plans used absolute
return benchmarks.
The group was fairly evenly divided
on the issue of portable alpha strategies.
Around one-third of the corporate
plans questioned have used
portable alpha strategies, compared
with only 15% of the public plans.
But the public plans are likely to
catch up, as 37% say they are considering
using such methods. The
report points out that there is “a
strong correlation” between those
accounting for alpha and beta and
those employing portable alpha
strategies (72% of those separating
alpha and beta already use or are
considering using a portable alpha

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