Money managers under the microscope
Where pension funds went wrong
Knut Kjaer, adviser to some of the world’s biggest asset pools, and former head of Norway’s government pension fund, told pension funds some home truths at the CFA Institute’s European Investment Conference on Tuesday.
Kjaer said the financial crisis had exposed two main pitfalls in institutional investment – the tendency to run with the herd, and the adoption of overly complex portfolios.
He was especially critical of investors who had made an allocation to hedge funds or private equity as a form of diversification without properly thinking through the implications for overall risk levels. He pointed out that some so-called diversified portfolios had performed very badly during the financial crisis.
So what is a poor pension trustee to do? Kjaer said they needed to construct portfolios that differentiated better between alpha and what is just costly beta: “Particularly in alternative assets you see a lot of beta dressed up as alpha.”
He also suggested pension funds should think about reducing the overall risk they are taking. Pension funds tend to set the risk level too high in good times, blame the asset manager when things go wrong, and then downscale the risk at the worst possible time.
Kjaer believes pension funds need a more disciplined risk framework with decision rules that enforce regular rebalancing to top-slice frothy assets and buy undervalued assets.
“This prevents the assets with the highest drift from dominating the portfolio and gives you an automatic value bias,” said Kjaer. “It also prevents you entering markets where the upside is small in comparison to the downside.”