Taiwan's BLF eyeing diversification moves

Taiwan's Bureau of Labor Funds, launched in February to consolidate oversight of six public funds with combined assets of US$84 billion, is looking to alternatives strategies as key drivers in the bureau's efforts to diversify its investment portfolio.

But BLF executives say they will maintain a cautious approach in stepping onto that alternatives path, with high hurdles for transparency and liquidity ruling out a full embrace of the endowment model anytime soon.

Hedge funds and private equity might be considered in the long run, but more liquid, transparent assets will be considered first, said Chao-Hsi Huang, director-general of the BLF, in a recent interview. With that in mind, “we chose to make our initial investments in real estate investment trusts and (listed) infrastructure,” said Mr. Huang.

The push into alternatives was started in 2012 by the BLF's predecessor administrative arms. In March of that year, the Labor Pension Fund, the “new” defined contribution plan launched by the government in 2005, awarded US$1.55 billion in global REIT mandates to three overseas managers. As of Sept. 30, the value of those mandates had grown to US$1.76 billion, with Atlanta-based Invesco Ltd. managing $682.5 million; New York-based Cohen & Steers Inc., $616.8 million; and London-based EII Capital Management Inc., $465.4 million.

Smaller global REIT and global infrastructure mandates have been awarded more recently.

As previously reported, those asset segments will remain the focus of RFPs due to be issued early next year, that should lift the weight of alternatives in the BLF's NT$2.572 trillion (US$84.3 billion) investment portfolio to 6% by the end of 2015 from less than 2.5% in mid-2014, BLF executives said.

Among the BLF's three biggest funds, the Labor Pension Fund should see alternatives accounting for 8% of its NT$1.241 trillion investment portfolio by the end of next year from 4.4% at the close of 2013, executives said. The corresponding figures for the NT$619 billion Labor Retirement Fund, a defined benefit plan, will be 4%, up from 0.79%, while the NT$596.4 billion Labor Insurance Fund will jump to 5% from 0.64%.

Mr. Huang said amid growing market uncertainty, the BLF increasingly is looking to share information with pension plans in other countries in hopes of building better asset allocations. He also cited a 2012 report by the bureau's investment consultant, Towers Watson, which showed the average allocation to alternatives by a sampling of seven sophisticated overseas pension plans rising to 18% by 2012 from 5% in 1995, as contributing to the BLF's focus on alternatives.

“The BLF is constantly looking for ways to diversify our assets by investment in different asset categories, especially alternatives,” said Mr. Huang.

“For now, we invest in stocks, bonds, REITs and infrastructure,” with a small — US$20 million — allocation to hedge funds of funds run by the BLF's in-house team as “a kind of experiment for us to check out that market and understand how it works,” said Mr. Huang.

Some alternatives managers note that the price of focusing on REITs and listed infrastructure, as opposed to unlisted assets, is less diversification, as those listed assets move — at least over the short to midterm — more in line with broader equity markets.

Asked why the BLF was not considering options such as direct property investments, hedge funds and private equity that other big institutional investors have come to favor, Mr. Huang suggested it was simply a matter of cautiously advancing along the learning curve.

“We've only allocated to alternatives for two or three years now, so this is a new area of investment for the BLF,” he said. As an entity answerable to the government, and one that other institutional investors in Taiwan follow closely, taking a conservative, step-by-step approach is only prudent, he said.

While that 18% average in the Towers Watson study isn't a target for the BLF, “we are looking to gradually increase our allocations to alternatives over the long term,” said Mr. Huang, adding that “to get anywhere close to 18% would require us to broaden our allocations beyond REITs and infrastructure.”

For the moment, he said, the BLF's efforts to research additional areas for investment might focus on commodities, leaving hedge funds and private equity as topics for longer-term study.

Meanwhile, the BLF's allocations to smart beta strategies over the past year or two already have provided some diversification benefits.

“Investing in smart beta strategies has already achieved our expectations,” providing advantages such as diversifying risk and lowering the volatility of our portfolio, said Mr. Huang.

Fundamental index strategies perform well when markets are in an up cycle, while low volatility performs well when the market is down, and over the long run the BLF team believes both strategies will perform better than market-cap weighted indexes, said Mr. Huang.

He said the BLF will increase its allocations to smart beta, and could add a third factor to its lineup in 2015.

More broadly, the Bureau of Labor Funds “was just established this year, so our first job is to make sure our integration works,” said Mr. Huang.

One of the goals of that integration is to build an in-house investment team that can take over more of the fund's domestic equity investments, in pursuit of “more flexibility when it comes to timing and stock selection,” said Mr. Huang.

The in-house team should be overseeing roughly 2% of the BLF portfolio by the end of 2014, up from 0.6% the year before. By the end of 2015, that total should rise to 5%, he said.

Meanwhile, the continued move into alternatives won't require the BLF to alter a fee negotiation process that a number of external managers call unique.

According to executives with three separate money management firms who declined to be named, after the BLF selects an external manager for a mandate, that manager gets five chances to propose a fee arrangement the BLF will accept.

If it gets to the final proposal and the BLF rejects that as well, the mandate is offered to the next manager in line, said one of the executives, who compared the process to a game of poker.

Mr. Huang said the BLF is a leader in Taiwan when it comes to outsourcing mandates to foreign managers, and the country's pension fund association has found widespread acceptance of the process. “We will continue to use that process for new mandates to alternatives and smart beta strategies,” he said.