May 2010


Pension funds should beware of investment fads and consider asset classes in terms of their risk exposure, says P-Solve boss Mike Faulkner. By Angele Spiteri Paris

Mike_FaulknerShoulder pads may have had a resurgence in the fashion world, but that doesn’t mean they look good on everyone. The same argument holds true of trendy strategies in the world of investment.

Mike Faulkner, chief executive of P-Solve, an investment consultancy, warns pension funds to not get swept up by potential investment ‘fads’ – like emerging markets and fiduciary management.

It is no secret that most pension funds are not au fait with the latest investment trends. But in an effort to reverse that perception, they could sometimes agree to invest in an asset class or implement an investment strategy that may not be right for them, just because it’s in style.

One of the popular trends to emerge in the last few years has been fiduciary management. Clients ask for it and new providers have been coming out of the woodwork in response. P-Solve has been offering fiduciary services with varying levels of delegation since 2003, longer than any other UK provider. So why is Faulkner sceptical?

“We should be over the moon that fiduciary management is enjoying this new wave of popularity, but in some cases it needs to be viewed carefully. We worry that fiduciary management is being sold as a product rather than a solution, and this will mean in some cases it doesn’t actually meet the needs of the fund,” says Faulkner.

He adds: “The definition of fiduciary management is not clear and we’re bound to see a broad spectrum of degrees of delegation. But there is a danger that these ideas become a fad and clients who are not best suited to do it end up doing it. For example, there have been clients who have come to us saying they had been told they need fiduciary management when in our view they don’t look like a fiduciary management client at all.”

Faulkner says that one of the biggest challenges for institutional investors is to avoid these “fads”.  He adds: “We think institutions should make the most of their competitive advantage, the fact that they are able to sit and wait. They are, after all, long-term investors.”

Examples of investors getting carried away with certain investment crazes can be found. For example, in the 1990s index management was all the rage and prosperity abounded. Then, at the turn of the century, the Nasdaq composite index lost over 60% of its value.

Another potential fad is emerging markets. Interest in the asset class has been pervasive and there could come a time when investors put money into such a strategy without regard for underlying valuations. But this is not yet the case.

How to invest
According to P-Solve, institutional investors should concentrate on three things – diversification, hedging liability risk, and rotating capital between capital markets.

“Not everyone would agree with that last point, because it sounds like market timing and we all know that in the 1990s the TAA [tactical asset allocation] managers, on average, didn’t succeed. The main reasons for this were that their time horizon was too short and that they considered too few asset classes,” says Faulkner.

It was the time horizon issue that was the bigger problem. “TAA managers were mainly worried about how their performance was going to look to their clients from quarter to quarter. When actually, timing the market from one quarter to another is difficult, if not impossible,” says Faulkner.

The P-Solve boss suggests pension funds should consider a broader range of asset classes and focus more on diversification. He stresses that diversification does not necessarily mean different asset classes, but rather making sure that the asset classes or strategies have different risk profiles.

Faulkner says: “Rather than considering the virtues of one asset classes versus another, we look at how an asset performs in risk terms. So by these measures, certain alternative asset classes actually have a similar risk profile. For example, take private equity and leveraged loans. Although they are considered to be two separate asset classes, both essentially boil down to corporate exposure, and therefore these two assets are exposed to the same problems if the corporate sector suffers.”

As a result, Faulkner says, there should be a lot of action in the alternative space.

“Investors are going to be asking themselves what their exposures are and they will become more aware that they need to manage the underlying risk exposure of the assets they hold. Clients are being pushed to think about their risk structure and the things that will change the structure of the industry going forward.”

Another change brought about by the crisis is a focus on awareness and understanding by investors. Faulkner says that the intensity and frequency with which clients ask questions has increased post-crisis. “If before they would have wanted certain information once a quarter, now they are asking for it once a month,” he says.

Convincing job
The general perception of the UK pension fund market in which P-Solve works is that it is extremely consultant-led and clients are very dependent on their investment advisors.

Faulkner has a different opinion. He says: “I don’t think the UK pensions market is too consultant-led. In ten years working in the industry I haven’t had a client who agreed to buy into a product, strategy or asset class simply on the back of what we’ve told them.”

According to Faulkner, it’s actually the contrary. “We need to work to persuade the trustees. Consultants have two jobs, essentially. One is to come up with good investment ideas, and the other is to convince your clients that these are actually good ideas,” he says.

Asked whether P-Solve has ever had any investment idea that didn’t catch on, Faulkner says: “All our ideas were taken on board, to varying degrees obviously, but most of them got some reasonable traction.

“That’s not to say we haven’t been wrong. For example, we were early into credit, having invested when credit was cheap, but then went on to get cheaper. But in this case, we made up for that mistake in 2009.”

In addition to convincing pension funds that their ideas are first-rate, consultants also have to factor in the speed at which these investors take decisions.

Time lag
Pension funds are not the most nimble investors and, usually because of the way they are structured, they can take a while to make executive decisions. This adds another dimension to the job of an investment consultant.

Faulkner says: “Ineffective communication between consultant and client is one of the worst things possible. Sometimes the time lag is so great that you could present a pension fund with a good idea and they defer from making a decision until the opportunity has passed them by.

“We usually present an idea with that time lag in mind. If a decision needs to be made within a month, we will tell the client that a decision needs to be come to relatively quickly. If you take the time to educate your clients then they can play a dynamic role in the decision-making process.”

©2010 funds europe

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