How can schemes know which manager will perform? In the last part of the Fixed Income Live series, Dalriada’s Simon Cohen, Hymans Robertson’s John Walbaum, Mercer’s Joe Abrams, PGIM’s Edward Farley and Willis Towers Watson’s Chris Redmond discuss whether schemes should let their consultant worry about finding the right specialists and what trustees should be spending their time on.
Ian Maybury, independent trustee (audience): How do you reconcile contractual certainty with absolute return?
Chris Redmond: This is another example of the phrase ‘absolute return’ being an unhelpful piece of terminology.
Contractual cash flows will give you income with low risk and the return from those will be made up of alpha and beta, potentially, but ultimately you will get a total return or an asset return.
It is no good just coming in and saying, ‘I have decided this is a great asset class, so I am going to do it from tomorrow’
John Walbaum, Hymans Robertson
The problem is that absolute return is this incredibly ill-defined thing. It often means either beta packaged up and sold as alpha, or it can mean lots of risk taken without you even understanding it. It can mean all of those things, so I would separate those things and say, contractual cash flows are good if they come with a good return.
Joe Abrams: Applying the phrase ‘absolute return’ to a contractual obligation-type strategy can be a little bit misleading – there is nothing definitive about that cash flow because you can default, and even if you have higher recovery, even when it is secured, you are not guaranteed your money back.
John Walbaum: If you want an absolute return, then you require a guarantee. Some sort of cash plus or RPI plus is an aspiration, so put that phrase to one side and look at what you are investing in.
Pensions Expert: How does a trustee board know which manager provides what it says on the tin?
Edward Farley: To have the confidence in the managers, it is no good me telling you, other people have to come and assess and say, ‘Have they got the resources; have they got the commitment; how do they analyse risk both from a credit point of view and from a structure point of view to make sure you are protected?’
If the pension fund does not have the resources to do that analysis themselves, it is outsourcing it to somebody else to make sure that managers, like ourselves, are doing what we say.
And you have the historical performance to say that during the last crisis this is how we performed and this is why we performed. This is our culture, this is our strategy, and this is how it can play out in the future.
Walbaum: It really is important to have the right specialists doing the right things. It is no good just coming in and saying, ‘I have decided this is a great asset class, so I am going to do it from tomorrow’. You need to have the experience of doing this and the people who have actually got their hands dirty.
Pensions Expert: Lately pension funds are being told to spend less time looking at managers and more on asset allocation. How do you choose the right managers without spending too much time on it?
Farley: The complex stuff has a bucket, then you can use more mainstream products for a larger chunk, whatever those more mainstream products may be.
Equally there has been a push to stay reasonably simple, but out of the sterling market and into opportunities in the US and Europe. So you can take advantage of what Draghi has just done if you are thinking more actively and short term.
And when European credit gets far too expensive, as a result of central bank policy, look at opportunities in the US investment credit market, or back in the sterling market.
It is all about utilising pockets of attractiveness, but you do not necessarily need to be overly complex in your portfolio as a whole.
Walbaum: It is how much bandwidth you have got and how you apply it. If you are going to have quite a lot of money invested in credit and debt that have been resourced then that is probably where your bandwidth needs to be, and you need to think about spending more time on this with the right partners – you cannot do it all yourself – than spending so much time on what this 5 per cent global equity manager is going to deliver for you.
Abrams: Undoubtedly the strategic asset allocation is where 90 per cent of the return driver will be. But we think about fixed income in terms of the best way to access different alphas and betas in benchmark-agnostic ways that increase the ability for managers to capture pockets of opportunities. That is where the interaction comes in – between manager research and strategic asset allocation. We are trying to enhance the risk-adjusted return proposition of those different betas and alphas.
Simon Cohen: What we are talking about is a greater reliance on managers and potentially a greater reliance on consultants from a pension scheme’s perspective, and maybe that leads to a greater level of delegation as well because of the complexity of the areas that are being discussed.
Schemes are not keeping away from manager selection. I think they are being more selective about when they use manager selection than they have been historically.
I agree that some things are just best kept away. You have a beauty parade when the managers come along and talk to the trustees, and really you do not learn anything extra than before you met them. You have just got sales people to show you their product, but do you really understand what is going on underneath the bonnet?
To a degree you rely on your consultant to really know what is going on with that manager and how to select a manager because you are not in a position to do it yourself.
Walbaum: I completely agree with you. Do not spend your bandwidth on that; trust us to get the right people.
Abrams: There is an area in the middle between more beta-dependent strategies and alpha, where there is some uncertainty as to what the managers actually deliver to you.
I think one of the aspects we have to work hard at is helping you understand what it is you are buying into, what the proposition is. Are they going to deliver you a beta of some sort or are they looking to deliver you alpha?
