Asset Allocation - the Beautiful Game?
“It’s not about the long ball or the short ball, but about the right ball” – Bob Paisley OBE (spent almost 50 years with Liverpool as player, physiotherapist, coach and manager)
Following the next triennial actuarial valuation in England and Wales (which will be undertaken as at 31 March 2012), and the year after in Scotland, it’s likely that most LGPS funds will turn their attention to reviewing their respective investment strategies. Of course some funds may well have ‘tweaked’ them in between valuations, but for most the formal strategic review is also a triennial experience. Regardless of the extent to which you undertake modelling of different investment strategies, this task is arguably the most important piece of work that a Pensions Committee will undertake. Given that most LGPS funds have remained predominantly invested in equities, the poor investment returns experienced since the last valuation may well concentrate minds even more so on how each fund’s assets could – or should - be allocated.
I quite like football, and every year dabble in Fantasy Football for the English Premiership. Having said I like football, I’m by no means an expert, and don’t follow it with the religious fervour that some of my ex-colleagues exhibit on this topic. For those who don’t know anything about Fantasy Football, here’s the five most important points to be aware of when playing:
- Each participant in the fantasy league is given a notional £100m to spend on players;
- They have to select a team of 15 players (2 goalkeepers, 5 defenders, 5 midfielders and 3
- They can only select a maximum of 3 players from any single Premier League team;
- Each player will ‘earn’ points each week, depending on how well they perform in their relative positions,
with the total of the entire fantasy team’s performance being recorded every week; and
- The participant whose team has the highest number of points at the end of the season wins.
Fairly straightforward, I hope. Since I don’t really know which players are the best, I have to employ a different tactic when picking my team. Historically, forwards and midfielders tend to score the most individual points – well, the ones who can actually play well have! – and so this year I decided to spend the largest proportion of my £100m on three really expensive forwards, and two expensive midfielders. The rest of my team could kindly be described as being filled with ‘place mats’ (the cheapest players still have a minimum cost of about £4 million each, so it becomes an interesting exercise trying to trade off the cost vs benefit of different team permutations).
Why am I telling you all this?
When doing it, it reminded me (sadly!) of making asset allocation decisions in a pension fund framework. There’s quite a few similarities:
- Each pension fund has a limited amount of assets to invest (regardless of whether its measured in the £m
or the £bn;
- Most funds want to spread their cash across a selection of asset classes, with the standard approach
being to focus mainly on equities, bonds and property (the historic good performers);
- Diversification suggests that you shouldn’t concentrate too much of the fund in any one asset or asset
- Historic performance of individual asset classes tends to feature heavily when deciding on the
composition of the overall long term investment strategy
At the moment, my fantasy football team seems to be suffering from the same kind of problem that pension funds have experienced over the last 10 or so years with equities – namely, past performance is no guide to the future! So far, my expensive assets are not performing as expected (thank you messers Rooney and Van Persie), but it is early days.
I’d be really interested to know what LGPS funds are thinking, with regards long term strategic asset allocation. Using data provided by The WM Company that shows the changing asset allocation of the WM Local Authority Universe for the last 20 years it becomes clear that equity allocations have been slowly, but surely, declining over the last twenty years. Bonds and property allocations have both slightly increased, but the most noticeable change has been the increased exposure to alternatives.
What does the next round of strategic reviews hold for the LGPS? Are funds sufficiently fed up with equities that they will continue to fall as an overall percentage share of asset allocations? If so, where will the money go? Conventional wisdom says that fixed interest assets are expensive by historic standards, and that the ‘safe haven’ effect that has driven their values up and yields down will have to unwind sometime – but when? When will the property market recover, held back as it is by the limited availability of lending? The same problem is likely to make some parts of the private equity spectrum also struggle.
What does that leave? Hedge funds? Infrastructure? Alternative Credit? Emerging Market debt? Social housing? Long lease property? What, if anything, does the average Pensions Committee know about these areas? How much time are they willing to spend between now and the end of 2013/2014 preparing for the strategic review by learning about possible new investment opportunities?
Maybe the historic star player, equities, will rally between now and next March. Maybe there will be a corresponding fall in the value of bonds, as investors move their cash back to risk asset. Either, or both, would be a welcome result for LGPS funds – but given the current economic environment, and the general view of a continuing bumpy ride for the global economy, how likely is either?
It’s still early days for my fantasy football team, but I am currently languishing at the foot of the league that I compete in with my friends. I’ll give my star players a few more months to perform – but if they don’t, I may have to take action and put my faith in some up and coming, less expensive talent. I wonder if my friends who look after LGPS funds will be having some not dissimilar thoughts in the coming months?
First published August 2012