Avon asset managers warned over poor performance

None of the scheme’s managers for whom it possesses three-year performance data have reached their outperformance targets, and the majority have underperformed their benchmark returns.

The fund has warned that any serial underperformers will have to be dealt with when it transitions assets to the Brunel Pension Partnership to avoid excess transition costs.

Speaking in response to a scheme member at the pension fund investment panel’s meeting in May, Mercer’s Steve Turner, who advises the scheme, said that Avon’s funding level had fallen.

Mandates covering asset classes including actively-managed equities, diversified growth funds and property have all underperformed three-year targets set by the scheme.

Avon’s assets grew nonetheless to £4.6bn from £4.3bn between March 2017 and March 2018.

Its last actuarial valuation, in March 2016, showed that the scheme was 86 per cent funded.

According to the fund’s latest annual report, pension scheme actuary Mercer has estimated that the funding level as at March 31 2018 rose to 96.2 per cent from 95 per cent at March 31 2017, based on financial assumptions used for the 2016 valuation.

Minutes indicate that Tony Bartlett, head of business, finance and pensions, heaped pressure onto the fund’s ailing managers at the May meeting.

The scheme will look to avoid additional transition costs accrued through the fund’s adjustment to local government pooling.

“If a mandate needs to be terminated for poor performance it will be,” he warned the committee.

Active managers need more volatility

The scheme’s estimated funding position has descended from almost 100 per cent at the close of 2017, according to its annual report.

Liz Woodyard, investment manager at the Avon Pension Fund, declined to comment on any decision the fund might take on the performance of the scheme’s managers, adding that the fund is not currently examining any new investment opportunities.

“We’re not doing anything new at the moment,” she said, owing to the fund’s adjustment to pooling. “Everything’s all over the place,” she added.

Jim Link, managing director of public sector advisors PFM, observed that active equity managers “have struggled”, partly because of relatively low equity volatility.

The CBOE Volatility Index, or Vix, which measures the expected volatility of the US stock market, closed at 14.64 on August 15 2018.

In comparison, on 17 August 2015, the Vix closed at 28.03. “If there’s not much volatility, that means that stocks tend to be moving together… and it’s a little harder to pick winners in those situations,” Link said.

A number of the fund’s equity managers have beaten their three-year benchmarks but have fallen short of their targets.

TT International, which holds a UK equity mandate, delivered returns of 7.9 per cent against a benchmark of 5.9 per cent. It fell short of its target, which was to outperform the benchmark by 3 to 4 percentage points.

Schroders’ global equity fund also fell short of its target of 14.6 per cent, beating a 10.6 per cent benchmark with returns of 11.3 per cent.

The rise of passive equity investment has raised pressure on active managers, according to Link, but a return to volatility may bring a return to stronger performance.

“As we’re starting to see some volatility increase throughout this year, I would be very interested to see what the investment performance looks like through mid-year,” Link said, proposing that active managers’ relative performance might begin to improve.

LGPS must be decisive with underperformers

The pooling of Local Government Pension Schemes has been the subject of intense focus from industry experts since former chancellor George Osborne announced his plan for six pools in his 2015 budget.

The Avon Pension Fund joins nine other LGPS, including the Wiltshire, Cornwall and Devon County Council pension funds, in the Brunel pool.

The schemes were set a deadline of April 2018 to begin transferring assets into their respective pools.

Karen Shackleton, senior adviser at consultancy MJ Hudson Allenbridge, disputed the idea that the market environment over the past six months has been overly challenging for asset managers.

She recognised the need for the fund to act decisively on its manager performance as it begins to transition its assets into Brunel.

“What you don’t want to do is defer a strategy decision just because you’re waiting for the pool to offer a sub-fund in a particular asset class, because that could actually be quite a costly decision,” she said.

Brunel intends to offer its clients 24 portfolios, covering passive equities and bonds, active equities, private markets, fixed interest and liquid alternatives.

Shackleton recognised the difficulties that LGPS are currently facing when deciding whether to retain underperforming mandates.

“I think they won’t be the only fund that has to make decisions like this,” she said.

Certain managers are lacking in conviction

Before making a decision on whether to drop any asset managers, the fund must do its utmost to understand the reasons for underachievement, according to Scott Edmunds, senior investment consultant at Quantum Advisory.

Active equity managers may fail due to their investment style being “out of favour”, he argued. Underperforming individual stocks may also be to blame.

“When you’re armed with that information, you need to understand whether there’s a fundamental flaw in what the manager’s doing,” he said.

Minutes from a May meeting of the fund’s investment panel indicate that increasing volatility “presented a problem for one manager who had opted to unwind equity protection before the full impact of the [fund’s] equity sell-off had materialised”.

While some managers are apparently guilty of pre-empting market falls, Edmunds said that others are costing their clients through a cautious approach to more volatile markets.

“What we have seen more recently is some managers particularly lacking in conviction,” he said. “You need a high conviction manager.”

Is it time to ditch DGFs?

Active asset managers have become the whipping boys of financial services in recent years, partly due to the average manager being incapable of outperforming their benchmark net of fees.

DGFs in particular have been maligned by experts in recent years. According to consultancy KPMG,  DGFs failed to match the performance of global equities between 2006 and 2016.

“Generally, I think they have struggled to keep up with their targets, which is typically a cash plus 3 to 5 per cent per annum target,” Edmunds said.

“Maybe there’s been a concentration on beating the benchmark, that cash return, rather than maybe providing that more elusive second objective of providing an equity-like return,” he said, adding that his consultancy remains in favour of DGFs.

Avon’s DGF managers, Pyrford and Aberdeen Standard, have suffered a disastrous three years of returns.

Pyrford’s DGF returned 3.3 per cent over three years, 4.2 percentage points short of a 7.8 per cent benchmark.

Aberdeen Standard delivered -0.8 per cent returns against a benchmark of 5.6 per cent.

Link expressed his surprise at schemes’ continued involvement in DGFs.

“These [DGFs] are just big funds of funds. In some case they run more like low volatility, ‘work in all markets’ kinds of funds, and they just haven’t produced the [desired] kinds of returns,” Link said.

Link recognised that markets have avoided a prolonged economic downturn for some years.

On August 22, the US equity market will have reached its longest ever bull run. Avon has exposure to North America via its Schroders global equity mandate.

“It would be in the downturn that you would think some of these diversified funds would help outperform,” he said.

Do not blame the consultant

A portfolio of asset managers that has roundly failed to meet its objectives over the past three years might cause tension between a pension scheme and its investment consultant.

But Richard Butcher, managing director at trustee company PTL, observed that the role of an investment consultant is to source and carry out due diligence on new managers.

Likening investment consultants to recruiters, Butcher argued that they themselves should not be expected to guarantee returns.

“I might hire a recruitment consultant to help find an individual to employ,” he said, “but they can’t guarantee that that individual can do the job”.

Butcher, who chairs the Pensions and Lifetime Savings Association, recognised the scheme’s readiness to dump poor managers in order to avoid incurring additional transition costs as “entirely logical”.

“If you’re likely to fire someone at some point in the next year, why not do it now?” he said.