UK – Alan Brown, group chief investment officer of State Street Global Advisors, has called for an end to strategic benchmarks.
“We need to throw away strategic benchmarks and put in strategic policy,” Brown told delegates at the Asset Allocation Summit in London yesterday.
“Our best practice today is seriously flawed,” Brown added. The current conventional wisdom was to adopt a four-stage model, Brown said, of asset liability study, implementation plan, manager selection and monitoring.
Asset-liability modelling, he said, was of very little use as it is a single period optimisation. “In reality it’s about as sensible as the flat earth society.”
He made the point that an investor’s risk appetite changes with wealth, or in a pension fund’s case, as the surplus position changes. It was “common sense” to expect an investor’s risk appetite to change, he said.
He said that clients needed to articulate what their risk preferences are in terms of, for example, shortfall risk or solvency ratios.
Brown criticised “accounting madness” such as US pension accounting, where stocks are valued more highly than bonds. He saw “the same kind of idiocy over here”, where the actuary sets the discount rate, which effectively enables profits to be booked before they are earned.
Brown said he supports the FRS17 accounting standard, which takes a market snapshot of assets and liabilities. “In reality the liabilities are the liabilities,” he said.
Under Brown’s proposed model for best practice, the first stage would be to examine the structure of the covenant between fund and sponsor. He said there was a need for “real honesty” here about how much risk the fund can bear.
The second stage was the implementation plan – which would acknowledge the fluctuating risk budget. He floated the term “dynamic hedging”, where the risk budget would be dynamically managed.
This was “the direction the industry needs to go in – real world mandates”. But he saw not only technical problems, but also a need to change mindsets, as well as the “glacial” pace of change in the industry.
A show of hands among the approximately 200 delegates at the conference showed that only around one-third foresaw Brown’s ideas taking root over the next five years.