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Cover Story | Equities


Nothing lasts forever, or at least nothing stays the same, and after a decades-long love affair, institutional investors and pub- lic equities have come to a crossroads. Over the past 12 months, the allocation made to equities by UK defined benefit (DB) pension funds shrank at its most rapid annual rate in more than 15 years, according to Mercer’s 2019 Asset Alloca- tion Survey. A 5% reduction was higher than even the 4% move between the crisis years of 2008 and 2009. Today, UK DB pensions allocate 20% on average to equities, with just 6% destined for the London Stock Exchange. In 2003, the total allocation was 68%. Within Europe, UK investors are not alone. The average allocation among the largest pension fund investing countries is in 2019 just 25%. After the longest equity bull run on record – still going at the time of going to press – this might initially seem counterintuitive, but equities have been partially the archi- tect of their own downfall.


BE CAREFUL WHAT YOU WISH FOR After crashing in 2008 and putting a huge hole in pension funding levels, a stellar per- formance over the past decade – a 301% cumulative return in the 15 years to the end of June 2019 by the MSCI All World Index – helped get them back across the line. Funding level challenges and increasing scheme maturity are the number one factor in the shift, according to Nigel Hill, an independent trustee at Pi Pen- sion Trustees. “A lot more boards are discuss- ing risk assessment and man- agement rather than blasting for the stars with their invest- ment performance,” he says.


This maturity is also seeing funds turning cash-flow negative and switching to invest- ments that produce a predictable income stream. “Within this, there is a role for dividends, but there are other devices that produce the same results,” Hill says. “Fund managers are creating clever and complex products


that produce equity-like returns but with much less risk, which are now available to even the smallest schemes. Once, these products, such as LDI, were the preserve of the largest funds.” The Pensions Regulator has also had a hand in this switch, demanding trustees formulate long-term funding plans that cannot be blown off course by the whims of global stock markets.


“There has been a change in pension funds’ attitude to and measurement of risk,” Hill says. “They now have a clearer view of how much equities contribute to a portfolio’s overall risk budget.”


MOVE CLOSER


This clearer appreciation of risk has seen the way in which pensions approach their dwindling pool of equities, too. “Over the last couple of years, we have con- structed an equities portfolio by moving certain parts of the market into passive funds,” says Anders Svennesen, chief investment officer at Danica Pension & Danske Bank Asset Management. The pension fund, which has around €45bn (£40.4bn) in total assets, gains exposure to large caps through passive funds, for example. “We have fewer active managers than before, but the ones we retained are focused on specific areas, such as small cap and


tions were not working. “We expected dif- ferent correlations to what we ended up with. We took some tactical views on banks and the US - it performed badly,” Svennesen says. “We changed part of those strategies and now we have fewer active managers and are more focused on the index part of the portfolio.”


As an investor with a full-time, highly expe- rienced team, Danica can employ a range of tactics to make its equities work harder than the average pension fund. “We can dial up and down the risk in the equity portfolio according to how we see the market,” Svennesen says. “We can dial it up when the market falls due to some- thing other than economic factors, and back down again when we see stocks per- forming in line with what we think is a fair price.”


Danica uses leverage and derivatives, including futures, to take advantage of volatility.


There has been a change in pension funds’ attitude to and measurement of risk. Nigel Hill, Pi Pension Trustees


value, where it makes sense,” Svennesen says. “We also have an index-plus take on the equity portfolio, where we focus on sec- tors and regions and take on fewer compa- nies. We take specific weights in different markets.”


The investment team burnt its fingers in the first quarter of 2018 as it had too much value in the portfolio and the active posi-


30 | portfolio institutional | June–July 2019 | issue 85


“It gives us the possibility to both take advantage and employ risk mitigation strat- egies – a type of insurance,” he says. “If it is cheap to buy, this strategy enables us to be more active. We can leverage up to be 110% exposed in some parts of the portfolio.” In the Netherlands, PGGM, which invests the assets of the country’s second largest pension scheme among others, manages most of its equity holdings passively. This is due to the usual reasons investors have shifted from active management, according to Patrick Groenendijk, head of fiduciary advice in PGGM’s international business, namely disappointing performance and high fees. “We have begun allocating on a factor basis, too,” he says. “It is


interesting to see how poorly many quant managers have performed over the past two years. We have been told that the amount of data they use and how they analyse it is something to watch out for, but it has not really worked so far.” As one of Europe’s largest investors, with around €211bn (£189.8bn) in client assets by the end of 2018, PGGM has taken the


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