Pension fund investing – a specialist or a balanced portfolio?
Namibian pension funds appear to prefer investing their members’ contributions in balanced funds, as they believe these offer a better solution. Given the results of a 20-year study from the UK, perhaps it is time to start asking if this is correct.
The study, performed by renowned Professor David Blake at Cass Business School found that UK pension funds that use investment managers that specialise in a specific asset class achieved superior performance to balanced managers who invest in a combination of asset classes. The key lies in liability-matched asset allocation, manager skill and reduced fees.
“One argument in favour of the balanced fund approach is that the manager has the full flexibility to decide which asset class to invest in and to change his asset allocation when necessary,” says Loth Angula, Managing Director of RisCura in Namibia. “As the manager is close to the markets, he will know when to adjust his asset allocation, or so the argument goes.” The other argument is that balanced funds appear to offer trustees a simpler solution, whilst diversification across asset classes is being achieved.
However, the argument in favour of specialist mandates is that it gives trustees the ability to tailor their asset allocation to match their fund’s liability profile. An ‘off the shelf’ balanced fund, for example, may have 50% or 60% in equity, but if a pension fund is comprised primarily of 20 or 30-year olds, it should be invested to the maximum level of equity allowed by Regulation 28, which is 75%. Alternatively, if the fund has a high weighting of 50-60 year olds, the asset allocation should have a high weighting of instruments such as inflation-linked bonds, and less equity than a typical balanced fund.
When retirement funds are establishing their overall strategic asset allocation, trustees will often allow for a variation within a certain tolerance level. With asset allocation being one of the main drivers of returns, allowing for movement of a fund’s asset allocation within their ‘risk budget’ is crucial.
In addition, when it comes to a large fund that favours a balanced investment approach, it’s not always prudent to allocate all the assets to a single manager, so trustees may decide to diversify across two or more fund managers, in which case the number of asset classes or mandates to manage increases further and then there is often multiple individual portfolio managers. This means multiple decisions to be made, and multiple performances to be tracked and analysed. In addition, the different managers may be taking asset allocation ‘bets’ that cancel each other out. Not only do trustees have multiple mandates to deal with in a balanced fund, but they are unlikely to be getting the best expertise in every asset class as few asset management houses, if any, have outstanding skills in every asset class. Some houses may be admired for their skill in picking equities, but are coming in last on the performance tables in cash or bonds, for example.
The ability to select the best manager for each asset class, and thereby increase overall returns, is one of the primary arguments for specialist mandates.
Managers in a balanced space often hold quite a large portion of cash, often as much as 10-15%. This means they are earning a high fee for doing relatively little on 10-15% of the assets. Finally, says Angula, with proper structuring and negotiation, a portfolio of specialist mandates is less expensive than the average balanced fund. This is because, with a specialist mandate approach, the sum of the fees paid for each component is typically lower, resulting in a lower cost overall.
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