The rationale for core-satellite investing is becoming more widely accepted - at least in theory - say asset managers, and the approach gives specialist active management a high profile role.
Pension funds are increasingly adopting a core-satellite approach to their investment, says John Cleary, chief investment officer at Standard Asset Management. While core investments are typically held in indexed products, clients are happy to go away from benchmarked products for their satellite holdings, using, for example, emerging markets securities and high-yield debt.
Particularly when investing in bonds, there are some clear reasons for moving away from benchmarked investment. “In an equities index, if you invest in the stock with the highest weighting, arguably you hold the most favoured stock, but within debt, you would be holding the most indebted issuer,” he says.
“Increasingly, investors are seeing the point of not having an index approach. On the equities side, people want strategies that make money in good conditions or bad,” he says.
In the new environment, hedge funds have inevitably come to the fore. The term encompasses many different strategies, including those that can hedge, the long-short funds, and also many that are long only.
The approach that investors are seeking is a certain return for a given volatility. “They are seeking superior risk-adjusted returns as opposed to a benchmarked return,” says Cleary.
“The amount of money going into hedge funds is growing exponentially,” he says. “There is a growing frustration with benchmarking.” Pension funds are under more pressure than ever with an ageing population and people now living longer. They are being forced to seek alpha further afield.
Sizeable chunks of their portfolios are now going into absolute return strategies, he says, with some funds putting 10%, 20% or even 40% into the sector.
The low-yield environment of the last couple of years has made the active, or alpha component of performance more important relative to the passive, or beta component, says Wim Vermeir, global head of sustainable and responsible investments at Dexia AM.
“Investors are looking for a more active asset allocation, including rather recent asset classes like high yield, hedge funds, etcetera, and a more active security selection within these asset classes,” he says.
There is no simple way to define the most effective form of active management, says Vermeir. “In general, a winning active strategy needs to be build on a generation of investment ideas thanks to original and proprietary research, a disciplined execution within a rigorous investment process, a critical risk management… and in any case, the motivation of talented people.”
Some forms of SRI are able to generate alpha, he says, especially for long-term investors. “Sustainable investing, for instance, is based on the analysis of how a company creates risk and opportunities by managing its stakeholder relations. This extra-financial information can be used to detect companies with superior long term risk-return characteristics.”
But while in theory, the investment community has been coming around the seeing the efficiencies of separating alpha and beta, the reality is different. Mike O’Brien, head of relationship management at Barclays Global Investors says that although many big Dutch pension funds have embraced it, there is a lot of reluctance elsewhere.
Why? For two reasons, he says: the fact that alpha is expensive, and the effort required to chase it. Pure alpha costs can be 150 basis points plus 20% in performance fees, while pension funds think of traditional active management fees costing 30 to 40 basis points, he says.
“Trustees struggle to pay that to any manager,” he says. Apart from the fees, alpha management is often seen as too time consuming. “The chances are if you look for alpha, you will have four or five managers – that’s more than the trustees can talk to.”
BGI has positioned its business for the alpha/beta separation. As asset managers, they will, says O’Brien, track everything that has an index, and are also major players in the pure alpha game. “We believe it will happen, it is just a matter of time,” says O’Brien.
Patrick Rivière, Head of institutional Sales at INVESCO in Continental Europe, says the problem pension funds are facing with the pursuit of alpha, is determining exactly what is the right number of managers to have in the portfolio segment.
“The issue for pension funds is you can’t allocate too much to one manager, so you have to allocate to more than one,” but if you allocate to several different managers, then you lower your chances of high returns.
“It’s something that needs to be put into perspective of the whole pension fund,” says Rivere. “How much is being allocated to high alpha as opposed to the core portfolio.”
Choosing which alpha manager or boutique to go for is often tricky. Often, the products are very “human-driven”, he says, and it is a matter of luck if the people that the investor has confidence in stay at the firm. “It is not an area that’s easy to monitor and target,” he says.