LONDON Mark-to-market accounting rules and a more volatile global stock market have combined to pique U.K. pension fund interest in multiasset target-return strategies.
Whats attracting plan executives is the strategies ability to get returns similar to those of equities without all the volatility, asset managers and consultants said.
(Clients) are replacing equity with a basket of different assets in order to obtain equity-like returns with about two-thirds of the risk, said Ian McKinlay, director in the investment consulting services group of PricewaterhouseCoopers LLP based in London. Where it makes a lot of sense is in the middle market (of pension funds), which is why its attracting assets.
Also dubbed diversified growth or dynamic asset allocation, these strategies aim to outperform on an absolute return basis, often targeting about 5% above LIBOR. The portfolio can contain almost any asset and usually has a significant portion invested in alternatives including hedge funds, private equity, commodities, infrastructure and real estate. Derivatives are often used to help smooth returns.
There are significant differences in the various products in the market, Mr. McKinlay said. Alpha could be responsible for up to a third of the total return in some strategies, though Mr. McKinlay to specifically name the managers with higher-alpha approaches. Others strategies are nothing more diversified beta, he added.
Some are strongly engineered, Mr. McKinlay added. Its chock full of derivatives so that if you pour the portfolio out on a table, youd struggle to recognize a lot of it.
Morley, the London-based asset management subsidiary of Aviva PLC – is the latest European manager to launch a multiasset target return fund aimed at small to midsized pension funds. Schroder Investment Management Ltd., Baring Asset Management, Credit Suisse and ABN AMRO Asset Management have also launched such strategies. U.S.-based managers that have introduced alternatives-only variations on a multiasset target return strategy this year include BlackRock Inc. and Morgan Stanley Investment Management (Pensions & Investments, Sept. 3).
Morleys Diversified Strategy Fund, for example, can draw on a broad range of asset classes as well as derivatives and portable alpha strategies to boost returns, said Paul Moody, head of investment development at Morley, a multiproduct firm with £168 billion ($349 billion) in assets under management as of June 30.
Academic evidence suggests that 90% of the variability (of a portfolios returns) comes from asset allocation, not from manager selection, Mr. Moody said, referring to the landmark 1986 study on asset allocation published by Gary Brinson, L. Randolph Hood and Gilbert Beebower. Yet everyone spends most of their time in the (remaining) 10%.
Although the majority of the assets are run internally by Morley, some specialist skills are outsourced. For example, about 8% of the portfolio is divided equally between two external currency funds Barclay Capital Intelligent Carry Index and State Street Global Markets Country Alpha.
Asset allocation is key to the funds investment strategy. At its launch on Oct. 24, about 40% of the portfolio was invested in listed global equities, with an overweight in the U.K., emerging markets and Asia-Pacific. Fixed income, which includes the use of credit default swaps, accounts for 20% of the portfolio. The remaining 40% is invested in alternatives, mostly hedge funds, although Morley is considering investments in two commodity indexes, Morleys private equity fund of funds and an infrastructure fund.
Mr. Moody estimates that the strategy should attract at least about £500 million in the next year.
ABN AMRO Asset Management reported asset inflows of £300 million since it launched the Institutional Dynamic Asset Allocation Fund on April 18, according to data provided by the firm. Baring Asset Management also had about £300 million as of Oct. 31 in its Dynamic Asset Allocation Fund, which was launched in January. The manager started offering absolute return strategies in 2001, and now has a separate £1.3 billion in segregated assets under management in multiasset target-return portfolios in the U.K.
The core skill in all of this is really strategic and tactical asset allocation, said Richard Graham, head of U.K. institutional business at Baring Asset Management in London. There isnt a typical allocation. Its a real mixture of passive and active, direct and indirect (investments).
For example, the fund had no exposure to U.S. equities until very recently, Mr. Graham said. About 45% of the portfolio is invested in listed stocks, 30% in fixed income including cash, 10% if global real estate and the remainder in alternative assets such as hedge funds of funds and commodities. Baring uses shorting and instruments such as derivatives. In the quarter ended Sept.30, the strategy returned 3.2% compared with -1.8% for the FTSE All-Share Index.
Baring Asset Management was appointed by more than a dozen institutional investors to run portfolios ranging from a few million to more than £100 million this year. The mandates include a £6 million multiasset target return portfolio from the £22 million Habitat U.K. Ltd. Pension & Life Assurance Plan, London, in July. Baring also won a £23 million mandate by the £141 million United Norwest Co-operatives Ltd. Employees Pension Fund, Stoke-on-Trent, England, and an £11.3 million mandate from the Yorkshire Co-operatives Employees Pension Fund, Rochdale, England.