The Spanish road towards multi-management
The view that the Spanish market is an immature market, is no longer appropriate. Although the Spanish pension market needs to be considered as a young market, a long part of the journey has already been been completed. Today we can say the worries and interests of the Spanish trustees are very similar to those any other trustee has in Europe on the investment side of their pension plan schemes. In that sense the desire to find ways of improving the returns via manager specialisation is now considered to be one of the main subjects on the agendas of the trustee members' meetings in Spain.
The Spanish pension market journey goes back to 1987 when the regulator decided, with some exceptions, to make compulsory the outsourcing of almost all the commitments every company could have with their employees.
As a consequence, the companies that had those sort of commitments, which in fact were roughly the biggest ones, outsourced their liabilities from their own accounts to different vehicles managed by specialist firms, mainly insurance companies and pension fund managers.
It could be noted that the outsourcing tended to be with just one portfolio manager. This, together with the low assets under management, the fact that the Spanish regulation that didn't allow different investment strategies for people in the same company, and the high interest rate scenario, were key factors that held the sector back.
But, when interest rates began to fall in the mid 1990s to levels close to inflation and there was a real probability of major losses, the trustees began to force the managers to change their tack, and vice versa.
Firstly, they started introducing small percentages of equity in order to add more yield to that from increasingly less attractive debt issues. At the beginning, trustees tended to invest only in the securities they felt most comfortable with, ie the Spanish stock market. Progressively, professionals in the sector felt increasingly comfortable with both bringing a higher proportion of equity into their portfolios and investing in different kinds of securities. So little by little geographical diversification into nearby Euro-zone countries and even countries involving currency risk took place.
The years of bull markets made it easy for many trustees to take decisions to accept higher risk in their portfolios. In March 2000 the market dived. This was the start of three years of losses. It was during that period that trustees became concerned about the returns they were obtaining, not just for their global portfolio but for the different parts of it.
This, together with some regulatory changes that made it easier to invest, directly or indirectly, through different managers, has been the catalyst that has made the Spanish market more open to multi-manager approaches.
We can follow this development by looking at some data that we have been collecting through our Pension Investment Performance Service (PIPS), which monitors Spanish pension fund results since 1996.
❑ Asset allocation: a significant increase in the geographical diversification and equity exposure are good reasons to start thinking about multi-management as a feasible option to consider.
The median asset allocation of pension funds in the Spanish market has changed dramatically in the past 10 years.
Back in 1996 about 92% of assets were invested in fixed income, with more than one third of this being cash and the rest Spanish sovereign bonds. Just about 7% of the assets was invested in equity (Spanish equity only), and an insignificant 1% went into property.
Nowadays the situation is really different. The percentage of fixed income has been reduced to 58% and most of it is euro fixed income, not just Spanish assets. The percentage of equity has increased to 38%, with a global geographical diversification. The percentage of property has also increased to 3% and in the last three years the use of alternative assets has become significant, with about 2% of assets in this asset class. The higher risk that pension funds are assuming, due to the higher investment in equity, should be partially compensated by the reduction of risk obtained from the global diversification.
And it is in this global diversification that the multi-management can play its role. So Spanish pension funds should start considering the benefit they could get from selecting the best manager in each asset class.
❑ Historical returns: the significant spread of returns per asset class among managers and the stock selection results are clear evidences of multimanagement as a feasible option to consider.
A significant aspect in the returns obtained by the pension funds in Spain is the wide spread of returns per asset class among managers. If we make a quartile analysis of the returns obtained during 2005 we can observe the magnitude of these differences.
As can be seen, the magnitude of the differences between the lower quartile and the upper quartile returns are quite significant in most asset classes. Obviously the differences between the maximum and minimum returns are even bigger.
Some additional data that reinforces the idea that multi-management can be seen as an opportunity to improve performance appears from the comparison against benchmarks. The accumulated three years median information ratio for the Spanish pension funds against its specific benchmarks is positive.
But, if we analyse this further, it can be seen that the reason for this positive alpha is basically the strategy decisions (underweighting or overweighting each asset class). The stock selection decisions instead have had a negative impact. This can be seen in the table below.
The benchmarks used in this example are global indices from a range of international providers. These data do not refer to the specific benchmark for each pension fund.
From the two tables the differences in the performance per asset class among pension funds and against the benchmark shows a clear opportunity for multi-management to select specialised managers with the aim of trying to get the best performing manager in each asset class.
The Spanish pension market has made a major qualitative leap forward in recent years, with corporate governance principles becoming widespread due to the importance of ensuring retirement objectives are achieved.
The Spanish market is young and has a long way to go, and we think the multi-management route could be beneficial as it has been elsewhere.
Xavi Bellavista and Ignasi Puigdollers are senior consultants with Mercer Human Resource Consulting in Barcelona