In the aftermath of the recent financial upheaval, research shows that pension fund investors are reviewing their investment managers and the diversification of their asset allocations.
The financial crisis has cemented the desires of pension fund investors to diversify further outside of domestic markets and also into alternatives. According to a bfinance survey of pension funds in Europe and Canada, more than one-third of respondents intend to decrease their equity exposure within the next three years. Sixty-three percent of survey participants said they will review their investment policies as a result of the crisis, and 77% said they plan to review their investment managers.
Conducted in the aftermath of the stock market rout in October 2008, the survey covered a diverse spectrum of geographies and plan types, with assets under management ranging from less than €500 million to more than €5 billion.
Desire to Diversify
Fifty-four percent of respondents said the crisis has increased their desire to diversify their assets, and 19% intend to decrease domestic exposure. However, 77% have no plans to change their exposure to domestic markets.
In the short and medium terms, absolute return strategies appear to be the winners, with 30% of respondents favouring this type of approach. The broad meltdown also seems to have solidified pension fund investors’ desires to increase their exposure to alternative assets and strategies, and to decrease their reliance on equities in the longer term. Canadian plan sponsors invested in Canadian equities may have felt this sentiment more acutely as the crisis, combined with sharp reductions in oil and commodity prices, saw Canadian equities drop substantially in the last five months of 2008.
More than one-third of respondents plan to decrease their exposure to equities in the next three years, compared to just over one-quarter for fixed income and a mere 4% for hedge funds. Pension fund investors are also planning a marked increase in allocations to alternative assets and strategies over this period. Private equity leads the way, with 30% of respondents planning to add aggressively to this asset class, followed by hedge funds (26%), commodities (26%), currency (22%), socially responsible investing (22%), global tactical asset allocation (15%) and portable alpha (15%). With the growing demand for alternative strategies, 26% also plan to increase active management.
Short-term Strategies
In the short term, there will likely be some rebalancing activities in favour of equities. Canadian plan sponsors may also consider less directional equity mandates, such as extension (130/30 or long/short) strategies, as well as unconstrained approaches with more downside protection, that are less sensitive to the usual equity benchmarks.
Notwithstanding the weakening of the Canadian dollar, Canadian plan sponsors will continue to consider both active and passive hedging strategies to address the currency exposure emanating from their non-domestic equity and alternatives allocations.
Finally, 30% of participants plan to increase their use of investment advisors while 11% plan to reduce their use of advisors. However, the majority (59%) of respondents are not planning to make changes.
Recovery and Results
As with the previous crisis earlier in the decade, the current situation will likely lead to a more rigid regulatory environment and an increased need for governance. The crisis could act as a catalyst for pension funds to seek more independent and transparent advice. There may also be greater scrutiny of the investment process—from manager selection to ongoing portfolio performance— resulting in pressure on management fees and greater alignment of incentives.
While pension fund investors are currently taking stock and re-evaluating their strategies, they will likely implement their decisions and reallocate assets in early 2009. Investors will need to make these adjustments soon to protect their portfolios while ensuring that they are well positioned in the event of a market upswing.
Marc Godin is managing director, bfinance Canada, and Vicken Berberian is a research associate with bfinance.
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© Copyright 2009 Rogers Publishing Ltd. This article first appeared in the February 2009 edition of BENEFITS CANADA magazine.