Feature – Equities
capacity might find it easier to develop a strategy that is to some degree independent of indices. One example is Railpen. The £30bn Railways Pension Scheme manages the bulk of its equity assets itself.
As part of that, the scheme has employed a blend of factor expo- sures, as Craig Heron, head of public markets for the scheme, explains. “We have about a decade of experience with exposures to different factor investments, which have evolved over time. Most of that was done internally 10 years ago, but now the vast majority of our strategy is internally managed by a nine-person team dedicated to running quantitative equity strategies. “We’ve expanded the range of factors we invest in, the first one was low volatility. We now have four individual strategies: low volatility, quality, momentum and value. We construct our port- folios using a combination of portfolio blending and signal blending. The basic idea is that by taking on this exposure from the start, we are harvesting premia above the equity risk premi- um,” he adds. Taking risks does not always pay out in the short term, Heron says. For example, the scheme continues to hold about £2bn of its assets in an internally managed value-strategy, despite value as a factor having consistently underperformed growth assets during the past decade. But Heron insists that the strategy should be judged within the entirety of the portfolio and over the long term. Year to date, the MSCI All Country Enhanced Value index has performed -14.3% below the MSCI All Country. Heron points out that the scheme’s strategy has declined 13% throughout that period, somewhat less than the index, at an active share of up to 90%. Combined with other strategies the scheme runs, such as a high conviction equity strategy, the average active share is still in the range of 40% to 50%. Border to Coast’s Booth also stresses that long-term investors should not dismiss the potential for a turnaround in stock mar- kets. The £45bn LGPS pool manages a large proportion of its equity assets in-house, with three internal equity funds and two external equity funds.
“The predictive power of stock valuations is quite strong over a 10-year period but over a year it is quite weak. So, there is not much predictive power in those valuations for the next one-year returns. When you’re looking over a 10-year horizon and you are at extreme valuations that you are seeing there should be a benefit to investing in value over growth stocks,” Booth says. While Booth is keen to stress that the pool has not placed any significant bets on underdogs, he says that the scheme is bal- ancing risk neutral positions out of over-performing growth companies and into underperforming value compa- nies. “We don’t have a huge factor exposure within funds, but we are cognisant of the market environment. Within our inter- nally managed funds, we are taking profits on outperforming
48 | portfolio institutional October 2020 | issue 97
The divergence between the expensive stocks and the cheap stocks is at record levels.
Daniel Booth, Border to Coast
stocks and rotating them back into cheaper stocks. As part of that, the scheme has taken profits out of some large cap tech stocks. In contrast, financials could be an area to increase expo- sure to in 2021, with many banks having improved their Tier I funding levels substantially and not having immediate refi- nancing requirements they had during the last crises, he predicts. Meanwhile, many DC schemes which invest predominantly in passive strategies might find it more challenging to position themselves independently from mainstream market views. Indeed, the default funds of DC schemes in their growth phase are positioned similarly to mainstream equity indices. However, Nest says that as the scheme has grown rapidly has increasing- ly been able to integrate different risk factors into its investment strategy, explains Katharina Lindmeier, responsible investment manager at Nest. Earlier this year, the scheme shifted £5.5bn, it’s entire global equity exposure, into a climate aware fund, which overweights low carbon emitters.
Overall, schemes continue to remain cautious about embracing the label of contrarian investor. But stretched market valuations and increased levels of concentration might drive them to new perspectives. “As CIO or asset manager, you need to be an inde- pendent thinker, which means you should not always follow the herd or be a contrarian,” Heron says. “Perhaps, in our case, thinking outside the box means trying not to pay too much attention to the short-term noise and actu- ally sticking to the long-term plan,” he adds. While the strategy is unlikely to feature in a Hollywood blockbuster, it might help pay secure member’s benefits over the long term.
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