On Wednesday 6th March I was at Heathrow boarding a flight as many other pensions people were; but the flight was not to Edinburgh for the annual investment conference. Instead, I flew to Denver, the mile high city and capital of Colorado state.
The city’s moniker comes from its official height, 5,280 feet above sea level. It’s also the exact height of the Capitol building’s west steps, from which visitors have an expansive view of the often snow-capped Rockies. But I wasn’t in Denver to enjoy the mountains and the famous local micro-breweries. I was attending the US Markets Mountain Institutional Investor Forum at the Grand Hyatt, on Thursday March 7, 2013.
My role was to chair a discussion jointly with Neil Chriss Phd founder and CIO of Hutchin Hill Capital, and then to speak on a panel of experts discussing Investment Risk Management.
Below are some of the conference highlights:
- Greg Smith, Executive Director of Colorado PERA, a $40 billion state retirement plan, presented on the “Colorado Mile High Fund” an initiative to invest pension plan capital back into the state of Colorado. He argued for why this is not only a socially responsible idea but a win-win for plan sponsors and members.
- Lauryn Agnew from the investment committee of San Mateo County Employee Retirement Association, then shared how San Mateo had invested locally. She explained their framework for doing so whilst meeting the plan fiduciary responsibilities – Impact Investing for Small, Place-Based Fiduciaries: The Research Study Initiated by the United Way of the Bay Area
- Michael Golden, director of external affairs for Maryland State Retirement, addressed the topic of effective member communication. He expounded the virtues of social media as an open and transparent, two-way communication channel between members and the plan. I wondered: how long before UK pension funds have a Facebook page to interact with members?
Golden will be pleased to note that I was able to check in every day on the NAPF conference by following the hashtag #NAPF twitter stream (see what I captured using Storify)
Below are some highlights of my speech for this event, which focused on what opportunities pension funds should consider right now, some common pitfalls, what a good governance structure looks like, and how to achieve it.
1) Brief description of your background, your organization, and your role at that organization
I am Rob Gardner, CEO of Redington. We advise large pension funds around the world. We have a 7 step plan to take our clients to full funding, and we design, develop and deliver smarter investment strategies for them. We are known for leaving our clients feeling in control.
2) If you could choose one major structural portfolio change for an institution – what would have the greatest impact? Why?
Implementing a clear Pension Risk Management Framework including specific goals and measurable outcomes (in terms of returns/risk), realistic assumptions (especially pertaining to equity returns) and expressions of time: for example, full funding by 2025.
- This framework allows all stakeholders to express a clear vision for success, developing understanding amongst themselves, achieving clarity of goals and constraints and thereby becoming sufficiently agile to make structural portfolio changes.
- This becomes a Keystone Habit in managing risk first and generating the maximum return possible for that risk.
3) Consider traditional growth dominated portfolios, policy portfolios, LDI, risk-parity, risk based classes, custom tactical overlays, dynamic asset allocation. What has been your experience in implementing these alternative portfolio management paradigms? Who should, shouldn’t use them? Why?
- Risk Management is a key tool for successful outcomes – all our clients in the UK use an LDI hub to manage and control risk.
- Dynamic Asset Allocation is a key “Agile” outworking of a Pension Risk Management Framework; it must be used if pension funds are to capture opportunities and reach their funding goals. Dynamism allows for de-risking from equities to LDI hedging, for example, and between asset classes in order to generate the highest expected return per unit of risk. It also allows for switching assets intra-credit asset class.
- Risk Parity is a great way of achieving risk control and diversification in a liquid, relatively low cost investment; the challenge now is to make risk parity products available to pension funds and create literature and communication to help pension funds understand it as an opportunity.
- Risk Based opportunities can be opportunistically analyzed and accepted/rejected in line with a clear Pensions Risk Management Framework, which takes the guesswork out of opportunity analysis – either something fits the pension fund’s goals and constraints, or it doesn’t. In today’s world, there’s no room for baseless biases.
- Tactical overlays can be run internally for large in house teams or outsourced; they certainly can be something worth considering.
- The key to implementing all these and getting the best out of them is governance. A good governance structure flows from a clear vision for success, understanding and consensus among stakeholders, clarity of goals and constraints, and agility to make structural portfolio changes.
3a) What risks are unique to new / traditional models of institutional investing modeling? What important assumption, if wrong, can blow things up?
- A focus on assets, rather than assets in conjunction with liabilities
- Too little focus on risk management
- Too much risk run on an absolute basis and relative to liabilities
- A concentration of risk in equity risk premia (over reliance on one asset class)
- Unrealistic assumptions for expected returns
4) What tools are valid, helpful or hurtful in managing the modern institutional portfolio? Classes (e.g real assets, hedge funds), techniques (tail hedging, regime based AA), information (expected return, vol, correlations).
- Once a framework is in place, a complete toolset of investment and risk management tools and techniques can be considered. In this environment, there should be no sacred cows.
- Tools can be understood on a 2×2 matrix of Contractual/Non-Contractual and Liquid/Illiquid
- Transparent data is necessary to drive up to date modelling and allow dynamic asset allocation in response to changing funding level and regimes. In other words, different times call for different measures; the key to success is understanding what every tool can offer.
5) What is the most misleading assumption currently in use by institutions that is leading to bad decisions?
- Mean reversion of yields
- Not understanding the impact of carry and roll down on long-dated liabilities
- Negative cashflows resulting in path dependent outcomes
- Over optimistic expected returns for equities
6) Clearly, many illiquid strategies cannot be rebalanced at will. Can liquid and illiquid strategies be compared versus one another on a risk / return basis? How?
- Where possible, pension funds should isolate and identify the illiquidity premium and its term. This can then be analyzed versus the trade-off for future switching.
- Pension funds must ask: is the illiquidity premium for contractual (maybe liability matching) or non-contractual returns? Is this a “buy & maintain” decision? What is your marginal capacity for illiquid assets?