According to Paul Niven, head of asset allocation at F&C Asset Management, TAA is a key skill which can provide a quarter to a third of value-added across a fund’s entire return portfolio. He said that trustees could avail of TAA products on a pooled basis, regardless of who their specialist managers were.
Speaking to FT Mandate at a recent investment conference hosted by F&C, he said that regardless of what real bond yields were right
now and “the rights or wrongs” of the regulatory backdrop, it was imperative that pension funds understood and managed interest rate risk.
He advised: “We would not advocate putting your pension fund 100 per cent into low-yielding assets on a geared basis, but you do need a liability-driven investment strategy (LDI) and then you need someone to provide the alpha-generating portfolio.”
Warning that LDI was not a panacea, he said that trustees needed to create real returns above those which are delivered by the hedging activity.
Alpha could be gained by creating an optimised portfolio which uses beta (market return) to generate long-term excess return. Alternatively, a portable alpha strategy could be employed to get the added return. For instance, trustees could allocate a portion of their portfolio to a beta strategy such as UK equities and hedge that beta with derivatives to leave only pure alpha.
Mr Niven predicted a rise in volatility going forward, which would make the stock market’s beta characteristics less attractive, while increasing opportunities to add alpha in equity and credit markets.
However, he noted that while there is a lot of talk about portable alpha, the concept has been little implemented in the UK, although it is gaining some traction in ‘new balanced’ portfolios which combine traditional and alternative assets.
Observing that most UK pension funds were still using balanced mandates, he forecast a greater move towards the new balanced approach over the next two years as UK trustees became more familiar with alternative assets such as hedge funds, commodities and even high yield debt. At the moment, they were “frightened” of derivatives and leverage.
In an address to F&C conference delegates, Alastair Ross Goobey CBE, the former chief executive of Hermes Pensions Management and now a governor of the Wellcome Trust, said that most UK pension funds had not profited significantly from the 80 per cent rise in the value of the equity markets since March 2003. This was because they “had been driven into bonds and few, if any, would have had the courage to switch back in the face of universal disapproval”.
He contended: “The great problem with investing in bonds for pension funds in this market is that their value has clearly been distorted by the regulatory environment. The yields on which these purchases are being made are making it impossible to fund pension costs effectively. The cost of ‘matching’ liabilities is simply too high.”
He asked: “Who is advising pension funds to buy index-linked gilts on a yield of one per cent real? Why are we still piling into ultra-long conventional gilts? The 30-year stock now sells on a yield 75 basis points less than the equivalent US Treasury, a discount unprecedented in my 38 years in this business and a premium of under 10 basis points to the long German Bund, equally staggering. Does a 4 per cent nominal yield really compensate for the prospective risks of renewed inflation at some stage, or the opportunity cost of buying equities when they are attractive?”
He urged trustees to challenge the advice they were being given and, above all, to try to buy low and sell high and not the other way round.
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