Tough markets force funds to act smarter

At nearly 30 per cent, alternative investments form the largest chunk of awarded mandates in 2015 so far, according to Financial Times service MandateWire, followed by fixed income with around 26 per cent.

For the first time multi-asset solutions come third after already doubling the percentage of mandates awarded last year, currently at around 20 per cent.

Equities are noticeably absent from the top three asset classes, at least in terms of mandate wins, as the percentage of awarded equity briefs has been roughly halved to less than 17 per cent since the heights of 2012.

However, asset inflows show a slightly different picture, as nearly £1.5bn of pension money has gone into equities so far, making it the second-most invested asset class after fixed income.

This represents in part a continuation of the previous year’s findings, when the rush towards equities of 2012 and 2013 had already started to slow down.

This year, the slowdown of equity mandate awards could be a pointer that UK pension funds might be preparing for a further correction in the equity markets.

Pension fund money has been for some time now moving towards both illiquid alternatives, in particular infrastructure, property and private debt instruments, and to less traditional types of fixed income, which often overlap with the latter.

Fixed income reinvents itself

Lee Dodds, investment partner at consultancy LCP, says the low yields on government bonds mean pension funds have to be savvier bond investors than in the past.

Some of these investments are bordering on the alternatives space.

He says that whereas in the past schemes used to hold investment-grade corporate bond mandates, funds have to be prepared to look harder in fixed income.

“In terms of trends there is a view that investors have to be working harder to get a higher yield in the fixed income area,” he says.

Pension funds are increasingly including more exotic instruments, such as overseas bonds, secured loans, high-yield bonds and asset-backed securities in their fixed income allocation.

John Walbaum, partner and head of investment consultancy at Hymans Robertson, says that while there has been a lot of movement towards illiquidity in credit markets, “that has become more difficult this year as spreads have tightened”.

Absolute return bond strategies are now much more popular, with managers being able to deviate quite a lot from the benchmark, so they don’t have to hold bonds which they know are going to potentially fall in value

Celene Lee, Buck Consultants

The general expectation in the market that interest rates will rise at some point, however, means other factors, such as the investment style, have gained importance in the fixed income area.

“That’s continued to fuel the demand for absolute return-type bond strategies,” he says.

Walbaum has also noticed loans have become more prominent as an investment option this year, for the same reasons.

He considers this move towards less conventional fixed income instruments to be “continuations of trends, not a move in a different direction”.

So far this year, MandateWire has recorded around 8 per cent of mandates being awarded for investment in absolute return strategies, although it is not clear whether these allocations are associated with bonds or other asset classes.

Celene Lee, senior investment consultant at Buck Consultants, also says absolute return-type products are considered a good choice by investors this year, particularly on the fixed income side, due to the widely held expectation that real gilt yields are set to rise.

“The absolute return bond strategies are now much more popular, with managers being able to deviate quite a lot from the benchmark, so they don’t have to hold bonds which they know are going to potentially fall in value,” she says.

Index followers converted to active?

The discussion about which investment style to apply has once again gained prominence, it seems, and not just in the fixed income space.

Lee points out that as equities have generated double-digit returns for a number of years now, save for the second quarter of 2015, the expectation is that equities will not continue to go up in this manner.

“And so we have seen a shift of clients who very much believed in passive equity management going into active equity management,” she notes.

“If you are not expecting high future equity returns, and you think that equities is still the place you want to be… you’re going to need every bit of extra return out of a good active manager you can find,” she says.

However, David Hutchins, lead portfolio manager of multi-asset solutions at AllianceBernstein, does not see investors re-embracing active management.

He says there is still a “sizeable move towards passive, but towards smarter passive; something that’s more refined than just market cap-weighted indices”.

Drilling down into the 2015 MandateWire figures neither completely disproves nor confirms either view so far: out of nine equity mandates where the investment style is known, five mandates are for active management, while two are for traditional index investing and another two are alternative index mandates.

The jury is therefore still out on whether UK pension funds have indeed found their love of active managers again or are becoming more fond of alternative indices.

Multi-asset mandates up

One of the biggest trends this year, compared with the previous three years in terms of mandate wins, is multi-asset products.

Oliver Frey, head of multi-asset management at Union Investment, says more investors are going into multi-asset strategies “due to the low interest rate environment, the strong run in many markets over the recent years, short-term risk aversion and increased market volatility recently”.

Walbaum too observes this trend, saying that one of the areas in which Hymans Robertson conducted many manager searches this year is “frustratingly still in the multi-asset category, like diversified growth funds”.

You have to be clear that somebody has the skill in asset allocation and will make the right call at the right time

John Walbaum, Hymans Robertson

“These funds clearly have their place, but essentially you have to be clear that somebody has the skill in asset allocation and will make the right call at the right time,” he cautions about such mandates, where managers have a large amount of discretion as to where and when to invest.

He goes as far as saying that he is wondering if people will be disappointed by the returns generated by such investments.

Consultancy Cambridge Associates said in its 2015 publication, ‘Navigating the Diversified Growth Fund Maze’, that the annual performance dispersion of DGFs has been “significant”.

“In the current low absolute return environment, trustees need to maximise their chances of being in the top quartile by adopting a rigorous evaluation approach that leaves no stone unturned,” the report says.

Interest in infrastructure

One other type of investment that has overtaken many others this year is infrastructure, where pension funds might be seeking the security of a regular income and profiting from the premia available on illiquid assets.

Hymans conducted a comparatively larger number of manager searches in the asset class this year.

Infrastructure also figures high on the MandateWire top invested list, as the service recorded 10 briefs being awarded so far this year, ahead of other illiquid asset types such as private debt and property.

Hutchins confirms he has seen “significant flows” on the infrastructure side.

And although he calls it a “big boys’ game”, he says smaller schemes might soon be able to play along too.

“People are starting to build vehicles which can be used by smaller investors. We’ve seen it in private equity, you can easily see that happening in infrastructure and other private placements,” he says.

But there is one problem, he notes: “The danger is that as you make these things accessible, the opportunity disappears.”

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