Implementation of investment strategy is a bigger key to investment returns than the strategy itself, Russell Investments has claimed.
Lloyd Raynor, associate director within the fiduciary manager’s Pension Solutions Group, argued that a focus on asset allocation over implementation as the main driver of pension fund returns was inappropriate if a pension fund’s investment strategy did not change.
He claimed this highlighted a flaw in a 1986 study by Brinson, Hood, and Beebower which has formed the basis of the asset allocation argument ever since. The study found that variation in returns between investment funds was primarily down to differences in strategy.
Raynor said this result had been “wilfully misinterpreted”, resulting in clients being told to focus on “high-level asset allocation at the expense of implementation”.
Citing a pension client with a static risk tolerance—and therefore a static strategy—Raynor said in cases such as this “far from being unimportant, implementation becomes the key contributor to investment returns”.
“If there’s very little ability for a fund to adjust its high level strategy then that by definition no longer becomes the primary driver of performance for that fund,” he added. “Yes, an extra 1% per annum from adjusting strategy would be great but if it requires an extra 25% in equity and all the extra risk that that would involve, it’s unlikely to be a workable option in practice.”
He added an argument in favour of active management, saying “for the winners at active management full funding can be reached meaningfully earlier and with little impact on funding level risk”, if investors’ focus is on the implementation of strategy.