Despite the search for better returns – the median expected three-to-five-year return on assets is 8 per cent – 99 per cent of plan sponsors are measuring performance against market benchmarks, while 78 per cent are using peer group comparisons.
While 38 per cent of plan sponsors also use a liability benchmark and 28 per cent use an absolute return benchmark such as cash or inflation, overall 93 per cent of respondents said they did not expect to change the way they currently measured performance.
One might have thought that as institutional investors increasingly embraced alternative assets such as private equity and hedge funds and innovative strategies such as portable alpha, that the adoption of absolute return and liability benchmarks would happen in tandem.
Garrett Walls, chief executive officer of the Institutional Americas Business at JPMAM, says this paradox “is indicative of a period of change and exploration and one where success metrics are a step behind the innovative solutions being examined in this period of evolution.”
Perhaps so. But could another reason be that some investment consultants are reluctant to advise clients seeking alternative assets or unconstrained mandates to switch to absolute return or inflation-plus benchmarks?
A recent discussion paper published by Mercer and containing sharp reservations about liability-driven investment, portable alpha and unconstrained investment, suggests this is the case. In relation to unconstrained mandates, Mercer “strongly believes” that benchmarks should be investible. Inflation-plus benchmarks are not favoured because they are neither investible nor replicate liabilities.
Pointing out that most unconstrained mandates are largely equity strategies, Mercer advises investors to determine the appropriate benchmark for a product by asking the manager what his or her neutral position would be if they had no market view. Usually, says Mercer, this will reveal the need to use an equity-based benchmark, rather than an absolute return benchmark.
If trustees wish to consider unconstrained investing in the hope of outperforming falling equity markets, Mercer argues that a simpler option is to hold less in equities.
The firm also contends that investors are bound to be disappointed if they think that equity-dominated unconstrained mandates will provide protection in down markets and less volatile performance. The object of unconstrained investing, says the consultancy firm, should be higher long-term performance and not improved short-term performance.
This view might well be challenged by investors considering unconstrained “best ideas” mandates in the belief that they offer the chance to beat traditional market indices in the short term.
Irrespective of type of benchmark used, Mercer says success with an unconstrained mandate will still depend on finding skilled managers who are willing to take more risk in areas where their skill lies. And success or at least the avoidance of disappointment comes down to gaining a thorough understanding of a manager’s investment philosophy and process.
You’re fired
Everywhere you look, the search for alpha is on. Everyone is hunting that elusive animal – the skilled asset manager capable of achieving consistent outperformance.
So upon capturing a talented manager, or more accurately, their alpha, it is only reasonable to assume that the investor will be reluctant to release them. Not so, apparently. A report by Cerulli Associates in the US reveals that professional buyers such as consultants, multi-managers and sub-advisory managers have actually fired managers for performance that is too good!
Why? Style-drift was one reason. For instance, large-cap growth managers have underperformed relative to large-cap value managers in the last three years. So a large-cap growth manager who performed very well was deemed to have cheated by buying large-cap value stocks.
A second reason for dismissing managers might have been investment process, where a percentage of the portfolio was invested in one stock or dramatic sector bets were made.
However, key departures from the portfolio management team was the main reason why professional buyers fire managers.
At the same time, the report says that professional buyers recognise that the success of an investment strategy might not be attributable to a star manager. Instead, the driving force behind product performance could be the chief investment officer or the analysts. Apart from the portfolio manager, professional buyers ranked the CIO as the most important person with whom to meet.
Henry Smith, editor,
henry.smith@ft.com
