Separate alpha from beta
Many of the pension and asset management industry’s leading figures gathered at the Institutional Fund Management conference in Geneva in February to discuss key topics, including how to pursue alpha, the structure of trustee boards, and the best way to ‘work’ your assets.
Mark Anson, chief investment officer for the $175bn (e134.8bn) California Public Employees’ Retirement System (CalPERS), told delegates that pension funds should pursue alpha independently from beta. He said schemes should move away from the traditional model and stop trying to get excess returns from their beta portfolio.
Anson told the conference that beta drivers are still “very important” but did not always offer the opportunity for extra returns. “I would tell this to every pension fund manager whether in the US, Europe, Asia or South America,” he says.
“Most large pension funds now realise they are trying to extract alpha from their benchmark beta drivers and it is not easy and they can see it in their investment returns.”
He added that the scheme had changed its attitude to alpha in the past four years. Reflecting on the possibility of the same happening Europe, he said: “The European time would be 20 years.”
He said the fund had committed a lot of money to the “beta part” of the US equity market, without trying to find a source of extra return from large cap equities.
In their pursuit of alpha, pension funds should aim at inefficient markets and sub-assets, like distressed debt – “thinking outside the benchmark but remembering that there is no ‘superior asset class’. Greater returns do not imply superiority.”
Anson stressed that alpha drivers are not a panacea for pension funds as they can retain some measure of beta exposure and leave the fund exposed to the risk that some managers charge for “any amount of positive return generated – alpha or beta”.
He also warned against pension funds’ tendency to forget to optimise alpha drivers and to lose sight of their liabilities.
Meanwhile, Bill Muysken, global head of research at Mercer Investment Consulting, said institutional investors considering non-benchmarked mandates only to reduce equity market exposure risk should consider a number of alternative options first.
He pinpointed the myths surrounding this kind of mandate, which is a hot topic in the UK. Muysken said there could be a potentially “big appetite” for non-benchmarked, or unconstrained mandates. They tend to be popular because they are seen as a remedy to “benchmarkitis”. Muysken says: “There is a feeling that skilled managers should be given scope to take or reduce risk when they judge the outlook to be positive or poor.”
Another common argument Muysken cited was the perception that skilled non-constrained managers should outperform over the long term.
Establishing the performance of non-constrained managers, however, may prove difficult.
Comparison with peer-group mandates would transform the mandate into a de facto benchmarked mandate, he told the conference. The institutional investor could rely on qualitative evidence: “But how do you avoid them pulling the wool over your eyes?”
Roger Urwin, global head of investment consulting at Watson Wyatt, argued that pension funds should have a two-tier trustee system, where “prudent experts” call the shots. He said: “At the moment trustees boards often do everything as one group. They act together and take investment decisions.”
He based his observations on a study carried out by his firm which has outlined a “much more effective model”.
He says that according to the model, trustee board should stick to several “high level issues” and delegate responsibilities to an investment
committee – hence creating a two-tier system.
“The Myners principles say a third of trustees should be prudent experts. We are saying ‘let’s get hold of these people and put them in committees’,” he explains.
Urwin pointed out that some pension funds have two-tier systems in place, which can lead to “quite a lot of overlap”. Watson’s model would tackle overlaps by envisaging the
creation of trustees with financial competence.
The composition of the investment committee, which Urwin says should be small, is “a major point” and very critical to success.
Also at the event was Eric Hunt, group pensions manager at the £1.7bn (e2.5bn) BAA pension fund. He said pension funds should aim to make their assets work smarter rather than harder. “We talk about making an asset work harder and it implies a sort of risky and aggressive approach, whereas smarter just says ‘there is a better was of doing this‚ a safe passage in difficult times’.”
He said that pension funds should try not to panic in the wake of low returns and deficits, but concentrate on finding a safe route. Hunt conceded this philosophy might seem difficult to pursue for pension funds with large deficits.