A failure to replace bad managers quickly enough is blamed for the unsatisfactory performance suffered by the £3.1bn pension scheme of UK supermarket chain J. Sainsbury over the last three years.
Describing performance as “pedestrian”, Chris Armitage, pension fund investment controller, says that changes have been made whereby poor-performing asset managers are now speedily replaced with more promising managers, as advised by investment consultants Frank Russell.
But although performance has not been as good as expected, Mr Armitage says he is sticking with the investment structure put in place three years ago. “We are well-diversified across markets; we have a very low risk profile and we are well positioned to obtain alpha wherever we deem it to be available,” he explains.
Mr Armitage oversees a pensions investment pot which comprises the assets of two separate defined benefit schemes – one for employees which accounts for 80 per cent of total assets and one for executives.
Some 61.5 per cent of the fund is invested in equities, 28.9 per cent in bonds, 7.2 per cent in alternatives (hedge funds, private equity and property) and 2.4 per cent in cash. A modest 1 per cent of assets is managed in an active currency programme. Alternative assets have been introduced into the portfolio only in the last two years. Hitherto, the asset allocation was 60 per cent equities and 40 per cent bonds.
Further diversification
There are plans to further diversify the investment portfolio by raising the allocation to alternative assets to 20 per cent next year. The 4 per cent real estate portfolio will be the main beneficiary because it is performing well. The scheme invests through a fund of property funds which contains 10 underlying unit trusts targeting 5 per cent above UK inflation.
At the present time, all of the investment is in UK non-residential property and Mr Armitage wants to open up a pan-European ex-UK non-residential real estate portfolio.
The scheme has also taken the fund of funds route for hedge funds and private equity investment. While professing disappointment at “mediocre” returns from hedge funds over the last 18 months, Mr Armitage says he “believes absolutely” in the asset class.
“Over the last year, hedge funds have shown much greater correlations than people would have you believe. But I won’t reduce our allocation to hedge funds. If anything, we will invest more over time. I will wait a couple of years first to see if performance improves.”
He is not concerned about the impact of the extra layer of fees levied by funds of hedge funds. “If the asset class gives us the extra returns we are expecting which is 5 per cent above cash, then I don’t care if I am paying an extra layer of fees because it is a diversifier and an alternative to bonds.” he says.
Private equity investment is proving problematic as Mr Armitage is frustrated by the length of time it takes to actually invest the money committed.
Getting on with it
He says: “ We just want to get on with it. We want to allocate £100m (€147.8m) to the asset class and we have only invested £10m so far. We are holding the committed money in European equities for the time being. We have two private equity managers and we will try to invest with them every other year. Although it takes a long time, there is plenty of opportunity for us to expand our exposure to private equity.
He is also thinking about plunging into the secondary private equity market where committed funds are fully invested immediately.
Portfolio diversification is the scheme’s guiding principle. Mr Armitage says he takes the “pragmatic” view that he doesn’t know where markets are going. Therefore, he aims to have equal exposure in every geographical region.
At present, the portfolio breakdown is 20.3 per cent UK equities, 18.9 per cent European equities, 16.2 per cent US equities and 6.2 per cent Japan and Asia-Pacific equities. The target allocation is more evenly-balanced with 16.5 per cent each in UK, European and US equities and 10 per cent in Far East, Japan and emerging market equities.
About 20 per cent of the total equity portfolio is passively managed, including all of the UK equities and half of the US equities.
“That is based on the our belief that certain markets are efficient and therefore difficult to extract alpha from. So we are passive where we think it is just too difficult. We haven’t quite decided in the US and that is why we are 50/50 passive and active.”
He adds that he is looking for outperformance of 1.5 per cent in the active equity portfolio. For the UK, the benchmark is the FTSE All-Share index. For the US, it is the Russell 2000 and the Russell 3000 indices and for Europe, it is the MSCI Europe ex UK index.
He explains: “We are trying to get the additional return where we can from active management and at the same time keep our risk profile relatively low. And diversifying across markets helps to do that.”
The scheme’s fixed income investments include UK index-linked bonds, in addition to two UK bond portfolios which are a mixture of gilts and investment-grade corporate debt. There is also a global index-linked bond portfolio and three separate global bond portfolios which are targeting 1 per cent above the Lehman Global Aggregate Index.
Mr Armitage has decided to close down the two active UK bond mandates and put the money into global mandates with the inclusion of a benchmark of 10 per cent high yield and emerging market debt to get some extra push in those bond portfolios.
He explains: “This decision is informed by the view that we are a global investor with big liabilities. Therefore, why do we need to have two specific UK bond mandates?”
Fewer managers
Another change in the pipeline is a reduction in the number of managers running investment mandates.
Prior to a strategic review three years ago, the J Sainsbury scheme ran large balanced briefs which were handled by one or two managers. Now the fund retains 22 managers to manage 27 separate mandates. For instance, European equities are managed by four separate managers, while the bond portfolio constitutes seven mandates run by six managers.
The scheme also has four managers running passive mandates– two in equities and two in bonds. Mr Armitage would like to consolidate the entire passive portfolio with one manager.
Although the active currency programme is small and has yet to show results, he maintains that alpha can be obtained because of the inefficiency of the currency markets. As with his hedge funds, he will wait and see before expanding the currency programme.
The keenness to further diversify in the search for alpha has also prompted a consideration of commodity futures.
Socially responsible investment is not one of the scheme’s priorities. Mr Armitage says: “At the end of the day, we have to get performance from our managers, subject to a suitable level of risk. While we expect our fund managers to be responsible, if they choose for their own good reasons to invest in a company that members do not like, I don’t think we should interfere with their choice. Some people might not like an investment in a tobacco company, but if our manager invests there, I don’t think it would be right for us to say no. It is not our job to make judgements about everything.”
Under FRS 17 accounting rules, the scheme had a funding deficit of £450m at 31 March. Mr Armitage claims he is more concerned about risk management than plugging the deficit. To this end, he is considering reducing the equity exposure.
Pointing out that in the last two and a half years the fund has clawed back the £8m it lost when the tech bubble burst, he says he is no mood to lose such a large amount of money again. To prevent this happening, he aims to “immunise” the portfolio against the big equity bet and perhaps also look at lengthening the duration of the fixed income portfolio.
“When we have our controlled our risk we can look at a funding line into the future. But while assets and liabilities move all over the place it is bad risk for the company and the trustees and the members.” he says.
