Pension fund investing – the specialist vs. balanced debate
By Loth Angula, Director, RisCura Namibia
In Namibia our pension funds appear to prefer investing their members’ contributions in multi asset class or balanced fund strategies, as they think balanced funds offer a better solution. Given the results of a 20 year study from the UK, perhaps it is time to start asking if this is correct.
The study, performed by renowned Professor David Blake at Cass Business School found that in the UK market pension fund managers that specialise in a specific asset class achieved superior performance to balanced managers.
The primary argument in favour of balanced mandates is that the manager has the full flexibility to decide which asset class to invest in and to change his asset allocation when necessary. As the manager is close to the markets, he will know when to adjust his asset allocation, or so the argument goes. When retirement funds are establishing their overall strategic asset allocation, trustees will often allow for a certain amount of fluctuation within certain parameters. With asset allocation being one of the main drivers of returns, actively fluctuating a fund’s asset allocation within this ‘risk budget’ is crucial. While there is a fee for this skill some managers don’t really change their asset allocation. Then there are tactical asset allocations to consider. If these are taken by the board of trustees, in consultation with their advisers, trustees should ask whether the benefit the fund is getting is worth the cost.
Balanced funds not as simple as trustees might think
The other argument in favour of balanced funds is that they appear to offer trustees a simpler solution. Trustees are understandably attracted by the fact that decision making seems less complex, even as diversification across asset classes is being achieved. Also mentioned is that balanced mandates allow trustees to shift the burden of complying with Regulation 28 of the Pension Funds Act to the manager. What is often misunderstood, however, is that while there is one asset management house to deal with in a balanced mandate environment, there are still multiple asset classes or mandates, and often multiple individual portfolio managers. This means multiple decisions to be made, and multiple performances to be tracked and analysed. A typical balanced fund may be invested in as many as six or seven different asset classes. Then, there is the tactical asset allocation mandate, which may be undertaken by a separate portfolio manager within the team, or by one of the managers also managing an asset class.
When it comes to a large fund it’s not always prudent to allocate all the assets to a single manager, so trustees may decide to diversify across two or more fund managers, in which case the number of asset classes or mandates to manage increases further. In addition, the different managers may be taking asset allocation ‘bets’ that cancel each other out. Not only do trustees have multiple mandates to deal with in a balanced fund, they are unlikely to be getting the best expertise in every asset class. Few asset management houses, if any, have outstanding skills in every asset class.
Specialist mandates can be cheaper
The ability to select the best manager for each asset class, and thereby increase overall returns, is one of the primary arguments for specialist mandates.
The second argument in favour of specialist mandates is that it gives trustees the ability to tailor their asset allocation to match their fund’s liability profile. A moderate balanced fund, for example, may have 50% or 60% in equity, but if a pension fund is comprised primarily of 20 or 30 year olds, it should be invested to the maximum level of equity allowed by Regulation 28, which is 75%. Alternatively, if the fund has a high weighting of 50-60 year olds, the asset allocation should have a high weighting of instruments such as inflation linked bonds, and less equity than a typical balanced fund.
Finally, with proper structuring and negotiation, a portfolio of specialist mandates is less expensive than the average balanced fund. This is because, with a specialist mandate approach, the sum of the fees paid for each component is typically lower, resulting in a lower cost overall.