Since he began his career in 1992 and throughout his tenure as senior investment consultant at Hewitt Associates LLC in London, Kerrin Rosenberg has sought to apply the financial theories of economics to actuarial questions. Along the way, he has become one of the leading voices in the U.K. to challenge the conventional wisdom in portfolio management. Mr. Rosenberg is credited with helping some of the U.K.s most prominent pension funds become early adopters in the use of derivatives, unconstrained strategies and alternative assets.
Now he wants to the revolutionize the investment consulting industry in his new role as chief executive officer of Cardano U.K., which opened in London on July 1. Cardano U.K.s parent is Cardano Group, the Rotterdam, Netherlands-based specialist investment and risk adviser straddling investment consultancy and fund management.
In the U.K., the aim is to provide a sort of in-house investment team that, up until now, only the worlds largest pension funds could afford. It has about 60 employees, about half of whom have a masters or more advanced degree and 85% of whom are former banking practitioners. Cardanos target clientele is the small and midsize corporate fund, and in November, the U.K. team announced its first client the £3 billion ($6.25 billion) AstraZeneca U.K. Ltd. Pension Fund, Macclesfield, England.
In an interview earlier this month, Mr. Rosenberg explains why the time is ripe for a portfolio management service that can advise and execute an asset allocation study, combining derivatives, risk management and manager selection skills.
What sets Cardanos approach to liability-driven investing and risk management apart? So many pension funds understand LDI to mean that they try and hedge all of the interest rate and inflation risk, and then manage their assets separately. This approach separates assets and liabilities. We feel thats not the optimal solution. You really want to keep an integrated approach by looking at the interaction between your assets and your liabilities, and think about your hedging in an integrated way.
Can you give an example of how hedging might be executed in an integrated way? For example, when interest rates are quite low, you do need some protection in case they fall even lower. But equally, you might think that theres a reasonably high chance they will rise, and what you dont want to do is lock it in at that level. So you dont want a swap, you want a swaption (or an option on a swap). And what the swaption gives you is protection in the event that interest rates continue to fall. But if interest rates rise, you benefit. It gives you a one-sided protection, but it doesnt lock you in. As interest rates rise to a more normal, decent level, it then makes sense to lock into a swap. So we have strategies with clients in which we move between swaps and swaptions, depending on the level of interest rates. That approach has actually generated a positive return through a more intelligent use of a hedging strategy. It is integrating the risk and the return.
Are there other important misconceptions about the use of derivatives that youre seeing in the pension industry? When youre looking at derivatives in a portfolio, there are two huge challenges most asset/liability models dont cope very well with derivatives. Typically, an asset/liability study is done without derivatives, and then derivatives may be examined afterwards. The problem is you might end up relying on a bank to add in the derivatives, but theyre using a different model with different assumptions, and its often not necessarily consistent. Being able to model the derivatives as part of the asset/liability study, we think, is very important The second important point is to take into account current pricing conditions in the analysis. The optimal derivative strategy in January of this year was not the same as the optimal strategy in August.
How do you see the attitude toward pension risk management developing in the U.S., compared to Europe? Now in the States, I think there is quite an impetus towards mark-to-market valuations and a regulatory regime that looks more European. If these trends continue, then I cant see why American pension funds wouldnt start adopting risk management approaches that are similar to those now common in Europe. The banking and insurance worlds are not very differentiated; if you look at a European or an American investment bank, risk is talked about and managed in exactly the same way. Why should pension regimes be different? Its hard to see why you would have a long-term sustainable difference between the U.S. and Europe. My feeling is that America will follow.
Why are you better able to provide these services than, say, traditional investment consultants? What were trying to do is to align interests. We dont want to think about the business in terms of assets under management, or charging an asset-based fee; wed much rather charge a solvency-based fee... If we have a mandate that is about improving solvency, the idea is that trustees could delegate decision powers to us, so that if something turns up that we think makes sense, we could just buy it on the trustees behalf. Our interests are aligned, and were only getting remunerated if solvency improves, or risk is reduced. Thats a very strong incentive to make sure that what were buying is appropriate. For example, there were some fantastic opportunities from this summer, some of them you had to act upon within a couple of weeks. That type of investment opportunity is just not even feasible for many trustees within the advisory decision-making structure that theyve got, so wed like to break the mold.
There has been general skepticism of opaque instruments, particularly since the events of the summer. How does Cardano approach these more complex products? We do spend a lot of time trying to disaggregate (the more opaque, bundled (instruments) into the component parts, to figure out what the fair price is. Perhaps the recent crisis has made it slightly clearer to the public how opaque they really are One has to be really cautious when you go into the more opaque, complicated vehicles because you dont always know where the value for money is. There are two questions: are they good value for money, and have they been overengineered and have margins hidden in them? Thats separate from the question of whether they are appropriate to your needs.
In order to answer both of those questions, you need to unwrap the thing, pull it apart and look at its various components. Because all derivatives, no matter how complex, are a bit like atoms. If you take lots of atoms and you put it together, you get something quite complicated at the end of it.