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from Global Investing:

Pension funds cover the table

As gloomy first paragraphs go, you'd have to go some to top Schroders' Jonathan Smith's introduction to a report touting his firm's momentum investing offering.

"As the global economy continues to de-leverage, the next decade looks likely to be a period of weak growth and low interest rates, punctuated by bouts of heightened instability and crisis."

Oh but hang on!, here's Legal & General Investment Management having a go.

"The global economy continues to grind onward, but we don’t see this as a sustained trend: growth is fragile and remains vulnerable to shocks."

Hmm.. too similar, call it a draw. And anyway, both are cribbed from the popular, and I think unattributed, quote that "war is long periods of boredom punctuated by moments of sheer terror."

So how do you prepare to battle this unpredictable lost decade (aside from taking the hint and calling the Schroders and LGIM sales teams at the earliest opportunity)?

Well there comes some confirmation of sorts that longer-term investors are making some fresh moves to tackle inscrutable markets. Barings has found evidence of managers scurrying anew to spread their risk; diversifying assets and stepping up portfolio reviews in an effort to deal with volatility.

from Global Investing:

Big Fish, Small Pond?

It's the scenario that Bank of England economist Andrew Haldane last year termed the Big Fish Small Pond problem -- the prospect of rising global investor allocations swamping the relatively small emerging markets asset class.

But as of now, the picture is better described as a Small Fish in a Big Pond, Morgan Stanley says in a recent study, because emerging markets still receive a tiny share of asset allocations from the giant investment funds in the developed world.

These currently stand at under 10% of diversified portfolios from G4 countries even though emerging markets make up almost a fifth of the market capitalisation of world equity and debt capital markets.  In the case of Japan, just 4% of cross-border investments are in emerging markets, MS estimates.

But change is on its way. MS surveys show most classes of global institutional investors intend to boost allocations to emerging markets, including the more conservative investor groups -- Japan's $1.3 trillion government pension insurance fund, for instance, plans to start buying emerging equities later this year.  MS analysts calculate allocations to emerging markets could rise 3.5% over the next five years.

That may not sound like much until one realises the true scale of the global pool of investable institutional assets and compares them with current market cap values in developing countries . These assets currently exceed $212 trillion, meaning a 3.5 % allocation increase will bring over $2 trillion into emerging markets. That's over half the capitalisation of EM equity market, more than 80% of bond markets and a third of the combined market cap of both sectors.

Take a look at some more numbers:

-- Based on current market values, a 1% increase in allocation to EM by pension and insurance funds represents a $524 billion flow to EM assets.

from Unstructured Finance:

Whither the Yale model?

David Swensen has been called "Yale's $8 billion man" for outperforming the average university endowment by that amount during the first 20 years of his tenure as Yale's Chief Investment Officer. Chalk that outperformance up to the success of what's become known as the "Yale model," or the insight that institutional investors like endowments or pension funds can achieve outsize returns by allocating a large chunk of their assets to hedge funds, private equity, real estate, and other alternative investments.

As Swensen explained in a lecture he gave to Yale MBAs in 2008 , the Yale model rests on two core tenets: 1) "an equity bias for portfolios with a long time horizon," because equities and equity-like alternative investments tend to rise in value in the long run; and 2) diversification, because by spreading investments among several asset classes with varying degrees of liquidity, "for any given level of risk, you can increase the return."

These days, though, it seems both of Swensen's credos have become passé in the community of corporate pension fund managers, as Reuters' Sam Forgione reported late last week:

For the first time in over a decade, more of the $1.246 trillion assets represented by the 100 largest U.S. corporate pension funds is now in bonds instead of equities, according to pension consulting firm Milliman...

"There will definitely be less demand for equities from corporate pensions if you look out the next several years," said Aaron Meder, head of U.S. pension solutions for Legal and General Investment Management America. Corporations are "tired of the volatility in the stock market, so they want to de-risk their pensions," he added.

What's striking here isn't that pension funds no longer share Swensen's fondness for allocating money to hedge funds or private equity -- after all, Swensen himself believes that the majority of institutional investors who can't match the resources or qualifications of Yale's Investment Office "should be 100 percent passive." Rather, it's that Swensen's golden rules of asset management -- stocks for the long run and diversification -- seem to be out of fashion. Pension-fund managers that have years to ride out losses on their stock portfolios until they turn into gains are increasingly throwing in the towel in favor of less volatile, lower-returning bonds. The advantage of endowments and pension funds that Swensen has touted for years -- a near-infinite time horizon -- is being ignored.

This risk aversion among institutional investors is trickling down to the retail level, too. Mom-and-pop investors withdrew $4.43 billion from equity funds last week, the largest amount since the start of the year, data from the Investment Company Institute showed today. These investors are also showing a preference for fixed income: bond funds saw with $6.12 billion in inflows that same week, for a total of over $26 billion in the previous three weeks.

The question institutional investors are now asking is whether the events of the past few years require a re-appraisal of principles underpinning the Yale model. Hedge funds, one of Swensen's darling asset classes, had a particularly bad 2011, with the average fund down nearly 5 percent and some stock-picking funds down 19 percent. The New York Times published a story earlier this week that claimed that over the past five years, a set of public workers' pension funds that had more of their assets in hedge funds, private equity, and real estate posted lower returns and paid higher fees than those with stodgier portfolios.

from Global Investing:

Japanization of euro zone bonds?

Fear of many years of stagnation in the major western economies has everyone fretting about a repeat of  the "lost decades" that Japan suffered after its banking and real estate bubble burst in the early 1990s. Indeed HSBC economists were recently keen to point out that U.S. per capita growth over the noughties was already actually weaker than either of Japan's lost decades.

But in a detailed presentation on the impact of two years of soveriegn debt crisis on euro zone government bond holdings, Barclays  economist Laurent Fransolet asks whether that market too is turning into the Japanese government bond market -- where years of slow growth, zero interest rates, current account surpluses and captive local buyers have depressed borrowing rates for years and turned JGBs into an increasingly domestic market dominated by local banks, pension funds and insurers. Non-residents hold less than 10 percent of JGBs, compared to more than 50 percent for the EGB as a whole, and Japanese banks hold up to 35 percent of their own government bond market.

But is the euro government market heading in that direction after successive crises have seen foreign investors flee many of the peripheral markets of Greece, Portugal, Ireland and even Italy and Spain? Fransolet argues that the seniority of substantial European Central Bank holdings built up in the interim (now about 15 percent of each of the five peripheral markets) may be one reason why these foreign investors will be wary of returning. Meantime, euro zone banks, who have traditionally held a high 20-25 percentage point share of euro government markets, withdrew sharply late last year amid balance sheet repair pressures but have  rebuilt holdings again sharply in early 2012 after the ECB's liquidity injections -- particularly in Italy and Spain.

In answer to the longer-term question of whether euro bonds will turn into a more insular market dominated less by interest rate signals than liquidity, regulatory and balance sheet issues, Fransolet is equivocal. On one level they are still very different -- state-sector holdings of euro debt are still far from Japan's, the euro market has clearly fragmented and net new issuance of euro debt is also still way below Japan.

However, the trend is clearly toward a more domestically driven market in the periphery of euro bloc in particular and local banks are becoming bigger players.  And, crucially, although foreign investors may not return en masse soon, their impact on those markets via futures and CDS markets and index weightings may still be high.

from Global Investing:

Pension funds’ hedging dilemma

Pension funds have no shortage of concerns: their funding deficits are rapidly growing in the current low-return environment, and ageing populations are stretching their liabilities.

But a recent survey of pension funds trustees by French business school EDHEC has found that their biggest worry, cited by nearly 77% of the respondents, is the risk that their sponsor -- the entity or employer that administers the  pension plan for employees -- could go bust. Yet 84% of respondents fail to manage the sponsor risk.

So how do you hedge against such a risk?

You could buy credit default swaps of the sponsor company or buy out-of-the-money equity put derivatives to seek protection. But both options are costly and illiquid. Moreover, it might send a negative signal to the market: after all, if the company's pension fund is seen effectively shorting the company in an aggressive manner, investors may wonder "What do they know that we don't?"

Erwan Boscher, head of Liability-Driven Investing and Fiduciary Management at AXA Investment Managers, says:

"Using market instruments like CDS and out of the money equity puts were suggested as a way of hedging sponsor risks, but we seldom see them implemented because of the cost, liquidity or reputational risks for the sponsor."

from Global Investing:

Quarter-end rebalancing: A myth?

With world stocks up more than 10  percent since the start of the year, it must be tempting for investors to cash in their gains before the quarter-end/fiscal year-end. Or is it really?

JP Morgan, which analysed equity buying of institutional investors including pension funds, insurance companies and investment funds in the United States, euro zone, Japan and the UK, finds that there is no empirical evidence of quarterly rebalancing by pension funds or insurance companies.

Below are the charts showing their findings on the amount of equity buying as a share of equity holdings in each quarter against the difference between equity return and the return on total assets. If pension funds and insurance companies do not rebalance at all, the amount of equity buying should be unaffected by the relative return of equities against total assets. And this is the result they found in Chart 1.

The regression line is horizontal suggesting no impact from returns to equity purchases.

from Global Investing:

Credit rally: Bubble or not?

Corporate bonds are back in vogue this year but how sustainable is it?

Just to highlight how bullish people have become, see following comments from fund managers:

"We do see scope for 2012 to deliver narrower corporate credit spreads and that will be the major positive contributor to fixed income returns this year." - Chris Iggo, CIO Fixed Income, AXA Investment Managers)

"Corporate bonds should be a major source of performance for the bond component of Carmignac Patrimoine (fund) in 2012." - French asset manager Carmignac Gestion

Bank of America Merrill Lynch's performance data as of end-Jan shows high-yield bonds are the second best performing in the bond group with YTD gains of 2.9%, ahead of 10-year Treasuries at 0.8 percent. The best performing is "preferreds", a sort of hybrid bond/equity instrument which returned 4% this year already.

BofA's investment team thinks equities will catch up and outpace bonds over the medium term however, because equities have had secular underperformance, pension funds and other clients are structurally under-positioned in stocks, and relative valuations favourequities.

The bank also warns: "Recent inflows into high-yield funds have been bubble like, with record-setting inflows into HY bonds."

Iggo from AXA is also cautious.

from Global Investing:

How socially responsible is your investing?

Is your investment ethically sound and socially responsible?

A new survey by consulting firm Mercer finds that only 9% of more than 5,000 investment strategies achieve the highest environmental, social and governance (ESG) ratings.

Socially responsible investing (SRI) involves buying shares in companies that manage ESG risks. For example, firms that make clean technologies are favoured, while businesses which pollute the environment, are complicit in human rights abuses or nuclear arms production are shunned. All this sounds good, but the performance of such investments has been somewhat mixed -- meaning being good doesn't always mean doing well. But the SRI industry is hoping that greater involvement of funds, especially long-term ones such as pension funds and sovereign wealth funds -- may generate flows into the sector and lead to better performance.

Of the 5,175 strategies assigned ESG ratings, 57% are in listed equities, 20% fixed income and the remaining 23% across real estate, private equity, hedge funds and others.

Private equity has the highest proportion of highly rated ESG strategies, while hedge funds and fixed income had the fewest. From a geographic perspective, emerging markets and Asia-Pacific have the highest proportion of top ratings, while Canada -- and this may come as a surprise to some -- has the least.

from Unstructured Finance:

Hedge funds try to hook up with pension funds

by Svea Herbst-Bayliss and Katya Wachtel

In investing, as in life,  it is critical to find the right partner.

On Tuesday in Boca Raton, big hedge funds including Tudor Investment Corp., Marathon Asset Management and York Capital, as well as smaller rivals like Voltan Capital Management and Titan Capital Group crowded into a large conference room for the hedge fund industry's version of speed dating.

Seated at tiny round tables, the managers (who are in Florida for the GAIM USA investor conference) eagerly awaited visits from potential investors like state pension funds from Wisconsin and North Carolina, and fund of funds firms like Rock Creek Group.

Every few minutes a bell tolled telling the roughly 50 investors there to move on to the next date. The ratio was about two managers for every investor. Time was of the essence as managers rattled off their skills.

The conferences organizers had advice for participants: "Drink plenty of water, and have something to write with."

GAIM USA, the first major event on the hedge fund conference calendar, follows one of the industry's worst annual performances in its history. Despite losses of about 5 percent for the average hedge fund last year, pension funds and other big investors are still looking to put money in.

from Breakingviews:

Leverage too risky for U.S. public pension funds

By Agnes T. Crane and Richard Beales The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

U.S. public pension funds are in a pickle. Lackluster returns and underfunding have left their $2.3 trillion of assets inadequate to cover future obligations in many cases. In addition, pension fund managers can no longer count on the 8 percent annual return they typically assume for the future. They need to bring expectations down to earth. But instead, some are considering borrowing to juice returns.

A new Breakingviews calculator shows how untenable the 8 percent assumption is. Using an asset allocation mix typical of big pension funds and assuming the continuation of the average returns on each type of asset in the five years to 2010, a more reasonable target would be around 4 percent. But without big extra contributions, that’s going to make funding shortfalls even worse.

That is leading some managers to explore the dangerous idea of borrowing to juice returns. One strategy making the rounds would shift funds out of the usual stock allocation of just over 50 percent and into a new bucket of supposedly safe fixed income assets. Managers would then lever up this allocation, borrowing say $3 for every dollar of the fund’s money to buy more assets and thereby turbo-charge returns.

Suppose they take about half the typical existing equity allocation and treat it in this way. The difference between a traditional fixed-income annual return of say 6.7 percent and a (relatively high) cost of borrowing of just under 3 percent allows this part of the portfolio to deliver annual returns north of 15 percent to the fund. Bingo! The potential return suddenly tops the 8 percent hurdle.

Yet recent events in Europe suggest borrowing to buy even highly rated sovereign bonds is riskier than it looks - and with leverage, any losses make a bigger hole in the underlying fund. Moreover, if pension funds go this way, they will be more vulnerable to rising interest rates, which would bring bond values down and funding costs up. Also, bets with borrowed money are simply not what pension fund managers are good at. Sure, they invest in leveraged private equity and hedge funds. But that’s probably already enough underlying debt for what should be ultra-safe repositories of retirement funds.