Asset allocation – Cover story
We have to plan for the new normal if we want to be standing in 10 years’ time.
Richard Tomlinson, Local Pensions Partnership Investments
But Roe does not dismiss alternatives entirely. “If and when these growth assets re-price, then yes they could be interest- ing,” he adds, “in offering a high initial real yield and some sort of contractual, or at least approximate, inflation hedge to the heightened uncertainty investors face.”
The great transition While fixed income is becoming more attractive, demand for alternatives continues to rise for open schemes such as the LGPS pools and charities. Infrastructure, property, healthcare and higher-income long-term real assets are proving attractive in the current environment. “We are looking at some of these [assets], particularly in relation to the transition to a low carbon economy,” Esmée Fairbairn’s Matthew Cox says. The shape of private market assets also appeals to George Gra- ham, fund director at South Yorkshire Pensions Authority. “Certainly, they are a key emphasis in our overall investment strategy and will likely be areas into which cash flows in the coming years, in part because of their strong income character- istics,” he says, adding: “The problem, of course, is that this could result in prices being bid up potentially eroding returns in the short term.” This poses a natural dilemma for pensions funds like South Yorkshire’s. Graham expects further asset allocation modifica- tions to his fund. “We see some shift into alternatives although we don’t make big allocation shifts. Listed equities will have a key role in the portfolio, as we remain an open scheme we need to maintain an exposure to growth assets,” he says.
Cyclical headwinds Illiquid assets also come with risks, especially if the economy
takes a turn for the worse. Property could also prove a safe investment option, Mikulskis says. “UK property saw some quite big falls toward the end of last year, but there are some real cyclical headwinds there, such as the decline of the high street and changing use pattern of offices.” Mikulskis recognises that infrastructure has been a popular asset class. “And if anything,” he says, “an issue in the UK has been a lack of supply of projects at good return levels.” How this can be addressed is still open to question. He also notes that privately owned infrastructure assets have held their value pretty well over the past year, adding: “That makes them a candidate to rebalance away from where possi- ble, rather than add more due to overall portfolio allocations.” For pension funds there are other considerations beyond what looks good from an investment point of view within a portfolio. Graham says this is the case for local government funds like South Yorkshire. “For LGPS funds we also need to consider the implications of the Edinburgh reforms and the steer from the government in terms of ‘levelling up’ investment, as well as any changes in the pooling guidance.”
Go forth and diversify
The whole debate raises bigger questions about diversification within a portfolio. “A core belief for us is that diversification needs to be much deeper than just equities and bonds,” Roe says. “So, including alternatives and also ensuring that within asset classes there isn’t too much risk in one region either.” With higher volatility, diversification becomes particularly important – by asset class, regional risk exposure, currency and avoiding too much exposure to one stock or sector. “The main three economic blocks of North America, Europe and China face different challenges and upside opportunities,” Roe says. He, therefore, offers another perspective for investors to con- sider. “All else equal, investors should aim to be contrarian,” Roe says. “This will mean they tend to buy assets after they fall in value and avoid jumping on the bandwagon of assets that have recently done well.” But Tomlinson stresses the limits to diversification. “You can- not have a portfolio for every scenario,” he says. Last year LPPI undertook a war game scenario in which the investment com- mittee raised many of these issues. “The conclusion was to be cautious on liquidity,” Tomlinson says.
There is a sense in all this that it can become something of a continued argument about an investment portfolio. But keep- ing the long-term in mind remains crucial, Tomlinson believes. “We have to plan for the new normal if we want to be standing in 10 years’ time,” he says.
This highlights that investors cannot, and should not, ignore the challenges – and with it opportunities – offered by the new normal.
Issue 121 | March 2023 | portfolio institutional | 19
Page 1 |
Page 2 |
Page 3 |
Page 4 |
Page 5 |
Page 6 |
Page 7 |
Page 8 |
Page 9 |
Page 10 |
Page 11 |
Page 12 |
Page 13 |
Page 14 |
Page 15 |
Page 16 |
Page 17 |
Page 18 |
Page 19 |
Page 20 |
Page 21 |
Page 22 |
Page 23 |
Page 24 |
Page 25 |
Page 26 |
Page 27 |
Page 28 |
Page 29 |
Page 30 |
Page 31 |
Page 32 |
Page 33 |
Page 34 |
Page 35 |
Page 36 |
Page 37 |
Page 38 |
Page 39 |
Page 40 |
Page 41 |
Page 42 |
Page 43 |
Page 44 |
Page 45 |
Page 46 |
Page 47 |
Page 48
