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Back in May, aiCIO sat down with the European members of our Forty Under Forty to discuss the pressing issues that face the next generation of uber-investors.
One of the key concerns to arise from the debate was the fear that, as a collective, European investors would not put risk back on the table quickly enough. So burned were we by the financial crisis, and so indoctrinated had we become by the cult of de-risking, that our CIOs feared we would sit in fixed income for too long and miss out on any returns from growth assets.
Six months on, we decided to revisit the subject to see if our investors had been bold enough to begin re-risking—and, crucially, to see how they did it.
The CIOs aiCIO spoke to for this article had all increased their equity allocations since the start of the year. Claus Stampe, CIO of the $26 billion Danish pension fund PensionDanmark, revealed he had increased the equity proportion of his portfolio by 10% since January, deployed across global equities.
“As we see it, the risk of a setback in the global markets has decreased,” he says. “In the US in particular, there is no doubt that the economy has come a long way from the days of the financial crisis. I’m confident that the US recovery will remain intact over the next couple of years.” Stampe believes the most likely scenario now is for the global economy to produce returns of around 2% to 2.5%, more than enough to outperform government bonds—“particularly Danish government bonds”.
Theodore Economou, CIO and CEO of the CERN pension fund, has also tilted his portfolio to take advantage of recent equity rallies. The fund’s unique governance framework allows the investment staff to move assets within certain constraints put in place by the board. It’s used that flexibility to shift towards stocks.
“This year, we have operated at close to the maximum risk budget we are allowed to use because the environment has been right,” Economou says. “In June, we thought that with our current position and the environment at the time that it would remain favourable for risk assets for another six to 12 months. We’ve since extended that by six months again: we’re looking at it being favourable for risk assets until the end of 2014, maybe even through to midway into 2015.”
Consultants are feeling the love for stocks, too. Paul Francis, director at JLT Employee Benefits, says most of his pension fund clients were looking to re-risk. “The thing is, everyone wants to de-risk, but not everyone can afford to,” he says. Each client has to assess their strategy by looking at their current financial position, he continues. For some, reaching their endgame means putting risk back in the portfolio.
“I think there’s still some way to go on equities’ recent run, and we’re supportive of clients having positions there,” Francis says. “As yields begin to rise, that could be seen to be bad for bonds. There could be a further headwind for equities from rising rates.”
Dan Mikulskis, co-head of asset and liability modelling at Redington, notes many of his clients were coming around to Economou’s way of assessing their strategies. They’ve been agreeing on an explicit risk budget with their boards and setting an investment plan around it, which rewards efficiency. “That can mean that risk budgets freed up by hedging liability-related risks can be better ‘spent’ by increasing investment in return-seeking assets, such as equity,” he says. “It isn’t simply a case of institutions uniformly de-risking by reducing their allocations to equities, although we do see that occurring.”
Mikulskis adds that the year-long period of low volatility in equity markets has led to many risk-based allocation approaches having relatively high exposure to equities when compared with the past five years.
If you haven’t got the stomach (or the risk budget) to accommodate more equities on your portfolio, though, where else can you look? In recent months, many investors looked to credit assets to fill the gap between near-zero returns from their bonds and the punchy returns of stocks.
But the tightening of credit spreads in the past quarter has resulted in investors having to look elsewhere—either further down the seniority of loan and credit markets, or out of the asset class altogether. Emerging market debt and equities have been popular alternatives to traditional credit, according to JLT’s Francis. For the bolder CIOs still, frontier markets offer enticing returns.
For other investors, it’s about seeking out the more unusual, less liquid assets. PensionDanmark’s Stampe spoke of his fund’s move outside of the listed markets, where in his words there is “less competition and higher barriers to entry”. The past year has seen PensionDanmark partner with Burmeister & Wain Scandinavian Contractor to build, own, and operate biomass power plants internationally. It has also invested in windfarms and most recently bought 40% of offshore pipe network owner NGT.
“We have a focus on energy infrastructure: We think these assets will generate an investment return of between 7% and 10% with a risk profile far less than equities,” Stampe says, adding that around 16% of his portfolio is currently based in real estate and infrastructure assets.
“There’s a lot of talk about direct investment in infrastructure, but there are not many investors who are actually doing something about it,” he adds, noting that the reluctance was likely driven by the level of specialist knowledge needed to do so effectively.
PensionDanmark has a team of around 20 specialists it uses when entering into a direct investment negotiation. Eight of them work inside the pension fund, with the remainder coming from a separate asset management arm set up by the pension fund for exactly this sort of purpose.
It would be wrong to assume these stakeholders are totally bullish about the future. All of the commentators here caveated the decisions taken thus far by saying they are under constant monitoring. There continues to be uncertainty about the impact of, for example, the unwinding of quantitative easing on both sides of the Atlantic, or the US’s debt ceiling problem.
But where it genuinely pays to take on some more risk, and your fund has the experience, know-how, and ability to take advantage of it, wouldn’t you consider taking on a few more growth assets?