Defined benefit pension plans are more accepting of unconstrained strategies, as managers continue to educate their clients on the benefits of allowing them more flexibility.
“Plan sponsors have been living the last two or three decades in a very benchmark-oriented world,” said Greg Pai, managing director at Paradigm Asset Management Co., White Plains, N.Y. “The asset allocation model was king. That worked for a while, but now it seems to not be working.”
While the trend is evident, consultants and managers say, it is not clear how much money U.S. defined benefit plans are putting into these strategies. One reason is due to the lack of a common definition of “unconstrained,” as the terminology and thinking around the concept evolves, said David Holmes, partner at Eager, Davis & Holmes LLC, Louisville, Ky.
The major characteristics of unconstrained products include strategies not measured against a benchmark with little or no market capitalization, style and/or geographic constraints. Managers are given discretion based on their skills to pick and choose investments that could include anything from hedged equity strategies to long-short strategies.
“Unconstrained can be a big scary word that scares people off,” said Jim Smigiel, head of investment strategy, for the investment management unit at SEI Investments Co., Oaks, Pa. “But when you peel back the onion a bit, you realize it has a lot of merit.”
While unconstrained strategies have been popular in Europe for the past three or four years, traditional equity managers in the U.S. — including Paradigm — are now turning their attention to developing new unconstrained products. Client interest is there and is growing, they said.
Paradigm announced the launch of its All Cap Core Opportunistic Strategy in July, which removes style and market-cap limitations. For now, the fund invests only in domestic equities, but the firm wants to expand to the global equities and perhaps start using synthetics and derivatives, Mr. Pai said. Defined benefit plan sponsors are jumping on the unconstrained bandwagon because returns have been flat from traditional managers, he added.
“When I sit in front of a client and talk about opportunities to expand alpha, I get attention immediately,” Mr. Pai said. He said six to 12 current clients, which he declined to name, have or are considering loosening constraints put on the firm when it was first hired as an equity manager.
Paradigm is managing $50 million to $100 million total in unconstrained money now, Mr. Pai said, and he expects approval from additional clients soon to loosen constraints.