Asset managers honing focus on investment beliefs

About 68% of money managers work in companies with an official and/or published set of investment beliefs, according to a survey on long-term investment beliefs conducted by Pensions & Investments and Oxford University.

That's higher than the 50% of asset owners and 60% of consultants whose organizations use an official set of investment beliefs, according to the survey.

“It's terribly important for managers” to base investment decisions on a clear set of investment beliefs, said Gordon L. Clark, professor at Oxford University's Centre for the Environment, Oxford, England, who led the survey. “The whole logic of their business is premised on being able to articulate beliefs, testing beliefs and being able to revise beliefs in a very uncertain world.”

As a result, more investment managers “now focus on the structure of their investment beliefs, how the beliefs translate into the design of the investment framework and how that framework is executed,” said Rob Bauer, professor of finance and chair of the institutional investments division at Maastricht University, Maastricht, Netherlands. “The more sophisticated investment managers are really trying to have a coherent structure.”

The notion of institutional investors aligning their investment beliefs with those of their external managers isn't new, but the financial crisis has helped investors to sharpen their focus when doing so. “Investors want to know whether managers are going to add value. ... If so, do they believe in the way that those managers will be adding value? It's fundamental manager selection,” said Carl Hess, global head of investments at Towers Watson & Co. in New York.

At Goldman Sachs Asset Management, one of the firm's investment beliefs is that diversification should be across risk premiums rather than asset classes. “I think it's undeniable: An asset class is nothing but a way to invest. What's important is the relationship (between the return stream of an asset class) and its risk factors,” said Charles Baillie, head of global portfolio solutions at GSAM, London. “We have been investing in factor-based models for a long time,”

About six months ago, Mr. Baillie's group introduced a new factor model called Varimax — “a more intuitive and flexible version of principal component analysis, which takes a (portfolio) return stream and decomposes it into risk factors,” Mr. Baillie said. The new model is generally able to explain 90% to 95% of the factors that drive performance, compared to 80% for older models.

For the typical institutional investor, it's not unusual to discover that the equity risk exposure accounts for between 80% and 95% of the investment portfolio, even though the actual allocation is much less. “Many don't realize just how much equity risk exposure they have,” Mr. Baillie added. For investors wanting to hedge against a repeat of the 2008 financial meltdown, for example, knowing the risk exposure “allows them to do so more efficiently and cheaply.”

At Pacific Investment Management Co., Newport Beach, Calif., investment beliefs underpin the entire investment process, which is built on “several important pillars,” Douglas Hodge, PIMCO's chief operating officer, said in an e-mail.

One pillar is the firm's quarterly and annual investment forums, from which PIMCO establishes a macro investment outlook and related implications for clients. Another is the investment committee, led by co-Chief Investment Officers Bill Gross and Mohamed El-Erian, which looks at the key investment themes and portfolio strategies.

“Embedded within our investment culture and reflected in our approach is something that we call "constructive paranoia,' an ongoing self-critique of our own ideas,” Mr. Hodge said.

Oxford's Mr. Clark added: Managers will increasingly be differentiated by “their strong belief systems and a rigorous investment process that matches those beliefs.”

An area in which managers are under more scrutiny, particularly in Europe, is in environmental, social and governance issues.

For example, the e261 billion ($318 billion) Dutch pension fund Stichting Pensioenfonds ABP, Heerlen, Netherlands, “expects external managers at least to not have beliefs that are conflicting with ABP's beliefs,” spokesman Harmen Geers said. “In most cases, we go even further. For example, when it comes to ESG criteria, we expect (it) to be integrated in the investment process of external managers.”

Mr. Geers added that ABP's investment beliefs are not linked to specific strategies, but concern “the whole portfolio and the strategic thought behind the construction of the portfolio.” ABP's beliefs extend far beyond ESG and include the fund's views on such topics as diversification (“Diversification is a free lunch”), the efficient market hypothesis (“Financial markets are not perfectly efficient and we can benefit from this”) and valuations (“Over the course of time, valuations conform to an average”).

ABP's investment beliefs, which are published on its website, have influenced others, including the £4.2 billion ($6.5 billion) London Pensions Fund Authority, where fund executives are in the midst of refining the fund's own investment beliefs, according to Mike Taylor, LPFA's chief executive officer.

In addition to 10 supporting investing beliefs, LPFA has two core principles: “Given the duration of our liabilities, we are responsible long-term investors” and “we wish to encourage environmental, social and corporate governance best practice in the companies in which we invest, as we believe this will deliver the best long-term returns.”

About 8% of the investment portfolio is specifically dedicated to sustainable equity strategies, and the majority of external managers are signatories of the United Nation's Principles for Responsible Investments. During the selection process, for example, managers must demonstrate they have adequate ESG resources and a track record in integrating ESG as risk factors in investments.

“We want to see that there's close integration between the ESG team and analysts. We'll ask managers for their UNPRI submissions and ask specific questions about them,” Mr. Taylor said. “It's part of our due diligence.”

One of the LPFA's managers is Pantheon Ventures, which was chosen partly for its ESG credentials, Mr. Taylor said.

“We have a very structured approach to ESG,” said Dushy Sivanithy, principal at Pantheon Ventures in London, responsible for evaluation, selection and monitoring of European investments. Over the past five years, Pantheon has developed an internal responsible investment group with eight members covering all divisions and geographies.

In addition, all Pantheon portfolio managers are formally trained “to be more attuned the ESG factors relevant to investments,” Mr. Sivanithy said. “This is so we can spot risk, as well as spot opportunities. ... Then it's the monitoring if there exist certain (ESG) risks in the portfolio — where they are and what are the mitigating factors. If we can improve an E, an S or G factor, that's an opportunity for alpha.”

In the post-financial crisis environment, “all investors are more keenly aware of risk — financial and non-financial,” he said.