How pension schemes reacted to volatility amid a turbulent 2015

Volatile markets and economic uncertainty drove pension schemes into multi-asset strategies and alternative assets in 2015, data show, as they looked to mitigate losses from equity markets.

The economic environment in 2015 proved difficult for many institutional investors to find returns. Interest rates in the UK and US remained at historic lows for much of the year, while the European Central Bank cut rates and introduced quantitative easing. At the same time, fears over China and other emerging markets’ slowing growth sent markets astray.

This pushed many investors into multi-asset funds, where managers can curb downside risk by moving between asset classes.

However, some experts say the falling market in the first part of this year could prove trying for some diversified growth funds.

According to data from Financial Times service MandateWire, European institutional investors awarded more mandates to multi-asset investing than any other investment strategy in 2015.

The data found that the demand for multi-asset funds came mainly from UK pension schemes. Of the 32 multi-asset mandates awarded last year by institutional investors that MandateWire spoke with, 30 came from UK pension funds. Local authority schemes accounted for 13 of these mandates.

The majority of inflows took place in the last half of the year, with recorded inflows of £540.2m in the third quarter of 2015 in multi-asset funds and £371.3m in Q4.

Smoothing volatility

Research released last year by consultancy Punter Southall shows institutional investors have significantly increased their allocations to DGFs over the past five years.

At the end of March 2015, institutional investors had £117bn allocated to DGFs, compared with £25bn five years ago.

When you talk to consultants, schemes aren’t looking to add new allocations, they are changing managers

Peter Gibson, William Blair

Alison Bostock, client director at professional trustee company PTL, says trustees are looking for a way to smooth out volatility. “Trustees are looking at multi-asset as an alternative to equities,” she says.

The allocation to multi-assets can hover around the 10 per cent mark, says Bostock. “But others will go the whole hog, allocating 50 per cent to 60 per cent of the whole portfolio to DGFs.”

While DGFs have become commonplace in many schemes’ allocations, she warns that trustees need to look at manager skill when allocating to the strategy, as much of the success comes from being able to spot when to move between assets.

Simon Cohen, head of investment at Spence & Partners, says: “Trustees should be looking at the manager – their process, philosophy and track record.”

However, he warns of being lured by star managers or complex investment strategies. Cohen gave the example of one asset manager’s popular dynamic asset allocation fund, which saw major outflows and was put on consultants’ watch lists after the group’s head departed.

Schemes with higher allocations are also considering dividing this between managers with complementary investment styles.

Spreading risk

Nick Smith, head of Fulcrum Asset Management’s institutional business, says: “A large amount of inflows went into DGFs in 2006, 2008 and 2009. As these assets have grown, many investors have had to look at the second stage, such as spreading out manager risk or adding a strategy.”

Peter Gibson, who leads consultant relations at asset manager William Blair, attributes much of the activity in DGF mandates to schemes changing or adding managers.

“When you talk to consultants, schemes aren’t looking to add new allocations, they are changing managers,” he says, and pension funds are also looking to diversify the fund style or to add funds with different return expectations.

He anticipates the trend to continue into this year, as some multi-asset funds may not perform as expected in the current volatile markets. “Consultants are reviewing managers and replacing them if they aren’t performing,” he says.

Multi-sector credit

Many schemes are also looking at multi-sector credit, which can include allocations to high-yield and securitised credit, with MandateWire data showing that alternative credit investments were on the rise. “Multi-sector credit is the next big thing,” says Bostock.

These allocations can also sit nicely alongside derisking strategies for smaller schemes. Nick Ridgway, head of manager research at consultancy Xerox, says: “Schemes looking to improve their hedge ratio with an LDI solution might feel that corporate bonds [are] an imperfect solution, so they might look to alternative credit to manage the cash flow needs.”

It doesn’t come with some of the problems you get with broader multi-asset funds, such as lack of expertise

Phil Edwards, Mercer

However, he warns that schemes must be aware of the default risk associated with credit. “Schemes should look for a manager that will have a team of credit analysts that really do get under the bonnet of these potential companies that are issuing these loans, so you are benefiting from the extra credit risk but not exposing yourself to more default risk,” he says.

Phil Edwards, European director of strategic research at consultancy Mercer, says multi-asset credit has been used across the entire size-spectrum of schemes.

“It doesn’t come with some of the problems you get with broader multi-asset funds, such as lack of expertise,” he says. “However, with the multi-asset credit funds you get deep credit expertise in those firms and funds.”

Edwards says larger schemes are also making use of more idiosyncratic multi-asset funds, which he defines as funds that are more driven by alpha and have exotic beta such as illiquid exposure.

“You would also expect them to be more dynamic and provide more downside protection,” he says.

Alternatives

European institutional investors also ploughed a huge amount of money into alternatives throughout 2015. According to MandateWire data, inflows into these assets were approximately £17.8tn.

This trend looks set to continue into this year, as investors expressed more interest in investing in alternatives than any other asset class in the last quarter of 2015.

Edwards says that according to Mercer’s asset allocation surveys, the allocation to alternatives has risen meaningfully over the past couple of years.

“The reason schemes are going down the alternatives route is to diversify away from equities, the main driver of growth portfolios, and to control risk at the same time,” he says.

“Some of the alternative asset classes can provide some degree of liability-matching, such as long-lease property and infrastructure.”

Edwards says there is a lot of discussion taking place around hedge funds. “There has been a theme of tilting portfolios from beta to alpha. We think the environment for alpha has improved, so we are having more discussions about long-short equities and macro hedge fund strategies,” he says.