Stoneport Pensions – Industry view UK public equities

Overseas public equities Unquoted/private equity Hedge funds Property

Total return seeking

39% 47% 2% 3%

10% 100% 8%

44% 11% 21% 15%


Richard Jones is chief executive of Stoneport Pensions


Nobel Prize winner Harry Markowitz, one of the grandfathers of modern portfolio theory, is often attributed with the expres- sion “diversification is the only free lunch in investing”. This expression is designed to illustrate a key tenet of modern portfo- lio theory,

that diversification in your

return seeking assets will enhance the return you can achieve for each unit of risk (or indeed you can get the same return at a lower level of risk). UK defined benefit (DB) pension schemes typically have had limited diversification in their return-seeking assets but, since the introduction of the Pension Protec- tion Fund and its regular update on the industry through the Purple Book, we can see a dramatic shift in how schemes aim to generate their excess returns. As shown in the table at the top of the page, in 2009, public equities dominated the return-seeking portfolios of schemes, with UK equities particularly prominent at 39% of return seeking assets, despite making up only around 5% of the global market capitalisation of stock-markets.

By 2020 we can see that schemes in aggregate have sold down their UK public equities dramatically. This money has not been reinvested in global public equities but, in aggregate, moved to diversify assets with unquoted and private equity holdings increasing by 5%, and hedge funds going from a minor player to pro- viding a fifth of all return seeking assets across the industry. Property investments have also increased their weight in return seeking portfolios. Such widely diversified strategies can pre- sent significant governance issues. Large schemes can work with their investment consultants to walk through the complex issues of allocation between the various asset classes and select the best-in-class managers for each component of the strategy.

Smaller schemes have found this level of oversight and governance of their invest- ment strategy to be somewhat impracti- cal. Thus, many schemes that bought into diversification and had faith in their investment consultant, decided to dele- gate the implementation of a diversified strategy to their investment consultant through fiduciary management. Fiduciary management is something of a compromise at a governance level, allow- ing the trustees to focus on the overall package of risk and return rather than the individual components of the strategy.

Moreover, if the fiduciary manager selects all the underlying managers, some of the benefits of diversification can be lost. The recent CMA findings on fiduciary management have introduced some fur- ther governance requirements for trus- tees wishing to delegate the individual asset allocation and manager selection choices to a third party, with competitive tendering now required on a regular basis.

Current options for ensuring trustee over- sight of the individual asset allocation choices and manager selections before they happen, rather than reviewing the performance implications of these choices in a rear-view mirror, are extremely limited for smaller schemes. Diversification is good; but oversight of a diversified strategy is hard for all but the largest schemes.

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ISSN: 2045-3833 Issue 102 | April 2021 | portfolio institutional | 13

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