Ever since it was recognised that the conventional approach of benchmarking a portfolio to a limited range of low yielding assets was perhaps not the best approach in meeting a variable set of liabilities, the asset management community has been promoting a range of solutions to pension fund investors with a risk budget.

As institutions seek new sources of alpha, they also encounter the issues of active risk in their portfolios. Experience in other parts of the world suggests there are numerous approaches that can be used, but which of these are likely to be appropriate in an Asian context?

The established investing institutions in Asia all have well-developed risk control and asset liability management policies. In our regular ‘How run our money’ section in this edition, GIC’s director of risk and performance management talks about the processes his team have in place. Rather than carry out an actuarial study every three years, the Hong Kong Jockey Club carries out the study every year, to help it identify opportunities and rebalance accordingly. The Jockey Club has the resources and the sophistication to remain in control of its portfolios. But in Asia, there are many investing institutions who are less well resourced and who need the help of asset managers, insurers and investment banks in devising practical solutions.

If Asian fund sponsors are going to embrace the ALM and risk management ideas that have been embraced in Europe, the US and Australia, they need to spend some time in understanding and managing their liabilities. So, says Conrad Yan, managing director at AIG Global Investment Group in Hong Kong: “It’s not just a question of optimising cash flows. It is understanding how these factors will change over time, how the nature of their business will change, and what this means for their long-term performance.

“We are already working with some clients in quantifying their liabilities, even though this is more of an actuarial job. And we are taking a different approach from the asset consultants, in that we have more focus on alpha generation and, using our ‘integrated asset/liability management’ approach, finding solutions based on uncorrelated sources of alpha.”

Yan describes it as “really more of a way of thinking - a bit like the concept of ‘healthy living’. This sort of risk budgeting approach isn’t practised as much as it should be in Asia. My view is that most companies have not studied this as closely as they should have. Most are still handling investments on a casual basis. They devote very little of their governance resources to it. But without an understanding of risk budgeting, they will not able to practise ALM.”


iability-driven in-vestment hasn’t been well-received in Asia, perhaps because of the way it was presented, more as a product solution rather than a policy to be moulded to the needs of a particular investment approach. Most practitioners in this space contend that an approach such as LDI is not really an end in itself.

The more sophisticated corporate treasurers in Asia, such as the Hong Kong Jockey Club’s Jacob Tsang, claim the whole idea has been over-played. On page 16, our actuarial columnist Victor Wong looks at how LDI should work in practice, while highlighting its flaws in a pension fund context. The article on pages 12-14 by the team at AIG looks beyond LDI and sets out some solutions for fund sponsors looking to increase returns while managing their risks.

Elsewhere in this special focus section of IPA, we assess some of the practical solutions available to investors in Asia, including the short extension strategy, popularly known as 130/30 (see page 10). According to Russell Investment’s George Oberhofer, the primary rationale for 130/30 mandates is more efficient diversification of active management risk: “As always, the primary means a client has to control active manager risk is to know the investment philosophy, professionals, process and portfolios of the managers they hire. The manager given a 130/30 mandate should have the sophistication to measure and manage the risk, the operational ability to manage short positions effectively and be inclined to make active bets of sufficient size to take advantage of the mandate.”


Quantitative managers, with their focus on measurement of expected risks and returns, have naturally taken the lead in offering 130/30 products. Anthony Fasso of quant managers Axa Rosenberg observes the greatest adoption of 130/30 and its variants in Australia and New Zealand. “There’s a lot of talk about it in Asia and we do have a few sizeable clients using the 130/30 approach. But it’s nothing compared to what we see in Australia and New Zealand. From our perspective, they (typically, the superannuation funds and government investment agencies) would be the world’s most sophisticated investors in terms of alpha/beta separation.”

In some ways this approach has been forced on them by the relative lack of local investment opportunity. Once their currencies were deregulated in the 1980s, institutions in Australia and New Zealand had to embrace globalisation, long before their counterparts in the US.

Fasso says fund sponsors in Asia are still learning about these approaches. “At a senior executive level, people can see the logic of it, as a first step for those looking into higher alpha strategies. And we know they prefer dealing with a traditional fund house rather than a less well-known hedge fund group.” Which raises the question of whether traditional fund houses can demonstrate a shorting capability. Fasso observes: “As fund sponsors diversify into the long/short area, they need to be more aware of the ability and breadth of experience of the managers they are working with. This is particularly important when it comes to shorting and risk management procedures, so a lot of responsibility then falls on the trustees or their consultants.”

The quality of the research that generates shorting ideas is a key advantage for a quant manager such as Axa Rosenberg. It has the scope to evaluate a wider range of potential shorts. Its systems generate a ranking of 21,000 companies globally. They are ranked from most attractive to least attractive, which sets up well for identifying both long and short opportunities.

“It’s our view that the 130/30 is the perfect bridge between the alternative space and traditional long-only strategies,” says Fasso. “It can be included within a long-only benchmark strategy, while adding the enhanced alpha and information ratio aspects investors are looking for.”

Lochiel Crafter, chief investment officer, Asia Pacific, for State Street Global Advisors, one of the biggest players in the 130/30 space, observes: “130/30 typically improves the return for each unit of risk resulting in a better information ratio. Our analysis suggests that for a global portfolio with a target active risk of 5% the IR can be increased by 50% through the introduction of shorting. This means that for clients utilising risk budgeting there is a better use of risk in generating return”

These short extension strategies are expected to be one of the next big trends for Asian asset managers. Plan sponsors were the early adopters but now retail products are finding their way into the marketplace. As this trend gains acceptance, 130/30 strategies will be an opportunity for significant asset growth for managers and an evolution of options for investors.

Crafter says, “We increasingly see clients changing the way they think about this type of strategy. We see increased interest in Asia both for local market active 130/30 strategies and global 130/30 strategies. It has very quickly gone from being considered an alternative investment strategy to now being incorporated into mainstream asset class portfolios”

On page 14, ABN Amro’s George Coppens demonstrates how structured products can be used effectively in an institutional portfolio. This is likely to be another area of growing cooperation between the investment banking community and fund sponsors, as investors become more comfortable with the idea of structured notes.

Patrice Conxicoeur, chief executive of Sinopia Asset Management in Hong Kong, believes that even the more sophisticated investment boards in Asia could make use of the structured products market. “Many of them think they are simply too sophisticated for structured products. Think of all the big names in the region. They have their own investment teams and committees and a clear idea about their asset/liability modelling. And, rightly or wrongly, they assume they will pay high fees for a structured product, so they don’t use them.

“While I can understand the view, I would actually take issue with it in more than a few cases, where investors seem to hold, sometimes for very long periods, a portion of their assets in cash or quasi-cash, without necessarily the need for immediate liquidity and overnight safety that cash represents. Guaranteed and structured funds can help them increase the return on this cash, without surrendering the safety net.”


Conxicoeur agrees with the view put forward by ABN Amro, that there is scope for structured products to be used for both DB and DC schemes, but particularly for DC. “The asset management industry has responded by offering ‘lifestyle’ funds, which tend to be very mechanistic in the way they allocate investments. Rather than say to an investor ‘you’re 40, therefore your maximum allocation to equities is X%’, we’d rather look at the optimal portfolio as a function of the investor’s risk appetite, investment horizon, and, importantly, available market opportunities, including risk levels and valuations. Then we look at things in terms of a risk budget rather than in rigid, pre-ordained allocation terms. This risk budget tends to get reduced over time, ie, to provide higher guarantee levels, as a percentage of NAV, as the individual gets closer to retirement.”

Opportunities identified by Sinopia include transitions from DB to DC, where the investor has a precise risk budget and return profile.

And for the more long-term approach, Conxicoeur says LDI is a way of smoothing out the future, but it is not the whole story: “To hedge liabilities correctly, you need an accurate picture of these liabilities, which is not always possible. Even assuming you could forecast your liabilities with 20/20 foresight, it would still make sense to have un-correlated performance engines to accumulate reserves for a rainy day, such as the liability hedge that doesn’t perform quite as expected, the counterparty risk in some structures, the unexpected regulatory or tax change - all of which have examples in real life.”

Conxicoeur agrees with Axa’s Anthony Fasso that Australian investors are implementing concepts that those in Asia are only talking about. “There are some very interesting examples of this going on, as we speak, in Australia. With portfolios which are well hedged against inflation risk, and outsourced alpha management from specialist high return solutions that have as little correlation as possible to the beta portfolio. We saw cases of institutions thus looking at a GTAA / Global Macro mandate purely from an overlay perspective, over an already established portfolio which they had no incentive to change.”

So, for the most effective active return and risk management policy, Asian institutions should talk with the product providers, because the solutions exist. Sinopia’s Conxicoeur concludes, “Our biggest recommendation would be to have a significant proportion of your liabilities hedged into the future, as conservatively as you can, while retaining an active management approach for the remainder.”