P-Solve deputy chief investment officer Ben Clissold said schemes had traditionally been reluctant to get actively involved in hedging.

"In the past, most schemes had not hedged, or would hedge and leave it. Now, schemes are more active in using LDI, although trustees still need to be educated in this area," he explained.

He said five years ago, pensions schemes were less active in hedging, although now inflation rates and interest rates may rise, many pension schemes are taking a view.

Professional Pensions

Right now, there is a very public, and at times acrimonious, debate taking place on the relative merits of 'stimulus' and 'austerity' in the economy.
 
Glyn Jones
In fact, the debate is phony because nobody in a position to formulate policy is remotely suggesting the imposition on society of anything like real austerity.

In the UK, the total market value of all the gilts in issue was £374bn in March 2005. Five years later, again in March, it was £803bn – £429bn higher. The last Labour government’s final Budget forecast that this figure would rise by another £567bn over the next five years. That was stimulus.

With a new coalition government, and a new age of financial responsibility, the new forecasts claim that borrowing will now rise by a mere £454bn. And we are told that this is austerity. Why are we told this? Who is this communication actually aimed at?

It is time for openness from politicians, explaining why the choices they offer are about “how much and for how long” rather than whether a deficit-funded stimulus should be the latest fashion.

The problem governments face is their starting point. John Maynard Keynes, well known for his promotion of government spending to combat recessions, backed austerity in the good times to fund spending in the bad: “The boom, not the slump, is the right time for austerity at the Treasury.”

Unfortunately, austerity and prudence were absent in recent boom times and the financial crisis found the developed world needing large-scale public stimulus on top of an already precarious debt position.

Countries can only continue to run deficits while their creditors are prepared to buy their bonds. Greece was a harsh example of what happens when lenders are not, but is lucky to be small enough to be bailed out.

Many other countries are not small enough and so need a different answer. They require policies that balance the need for stimulus with the need to maintain the confidence of lenders. If the latter is lost, stimulus either stops dead or must be funded by printing money.

So we have austerity policies that allow borrowers to predict a declining stimulus and economic growth coming through to make the debt burden manageable. But will these work? Only if sufficient economic growth is generated before savers, both domestic and international, lose their appetite for sovereign debt.

Unfortunately the signs are not good. Private sector deleveraging and stalling demographics in many developed countries suggest future growth will be sluggish at best.

If sufficient growth does not materialise, will we see real austerity to manage the debt burden? Most unlikely. Introducing proper austerity in a slump causes real people to suffer in order to preserve the value of savers’ capital. Looking at history, as more of those real people gained the right to vote, real austerity has become extremely rare.

Equally important, attitudes to debt and default have changed. Until the mid 19th century, many countries imprisoned debtors. Even a few decades ago, personal bankruptcy was painful and shameful. Bankruptcy is now seen, in some circles, as mark of entrepreneurial effort, and excess credit card debt can be easily dealt with by voluntary arrangements with lenders.

Why then is there an expectation, that if economic growth does not deal with the debt burden, the pain of dealing with it will fall on borrowers rather than lenders? It almost certainly will not and poses the question: when and how will the pain be shared?

Outright default is unlikely for most countries, but inflation is not. It is simply the easiest way to share the pain of removing excessive debt. The quantitative easing that we continue to see provides fertile ground for inflation.

We believe that the political will to control this, and inflict all of the pain on the voting public, is unlikely to exist.

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P-Solve deputy chief investment officer Ben Clissold said the DMO was able to issue a lot more than it needed to.

He said: "They're well ahead of schedule - they're 46% of the debt they need to issue at about 16 weeks - so the DMO is doing very well."

Clissold added: "The DMO will look to issue CPI-linked assets, but no time soon. There's no need for them to rush on this. They'll ask lots of people likely to be their main buyers if there's desire for CPI out there - the answer is there will be. I think they will issue CPI, but not until 2011 at the earliest."

Professional Pensions Online

It is too early to assume pension funds will now need to switch all their RPI-linked assets and swaps to CPI-linked ones. Glyn Jones, chief investment officer at pensions consultancy P-Solve, said many schemes could end up with their liabilities split in two: some linked to RPI and some to CPI.

Jones said: “Some schemes explicitly link deferred pensions to RPI in their rules, while others simply refer back to the relevant legislation.” It is also possible that liabilities might become the “best of” RPI and CPI, whichever is higher in a given year.

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They will need to examine the governing documents of their pension schemes very closely, according to Glyn Jones, chief investment officer at pensions consultancy P-Solve. The key question is whether these papers - known as "trust deeds" - explicitly refer to RPI or whether they simply refer back to the relevant legislation. If the former, they may find themselves still on the hook for RPI.

Jones said: "The big unknown at the moment is what exactly the government meant by stating that it intends this change to apply to all pension schemes. Because right now it does not. They will need to bring forward special legislation to make sure that it does."

Financial News

“There's a whole bunch of trust that turned out not be repaid,” says Mike Faulkner, CEO at investment consultancy P-Solve.

IPE.com

But now there is a supply and demand imperative. Ben Clissold, London-based deputy chief investment officer at investment adviser P-Solve Risk Management Solutions, says: "Property values are recovering too quickly because of lack of supply and the strong overseas demand that has surfaced as the pound weakens. While capital growth has been further fuelled by the supply issue the flow of developments pretty well dried up with the collapse of the market"

Building a portfolio

There are several ways to invest in property. There is the traditional fund route, and there are exchange traded funds (ETFs) that track property companies and Reits rather than physical property prices, and have the added benefits of low cost, liquidity and transparency: "Property ETFs are popular because they are cheap, index tracking and easy for retail investors to buy," says Clissold.

P-Solve Risk Management Solutions is launching derivative investments structured by Deutsche. "For the past five years, we have had residential property in eastern Europe" says Clissold. "It is in a fund and it performed well during the economic downturn. We are happy with it relative to some of the other things we could have been in."

Structured Products

Masroor Ahmad, managing director of P-Solve's risk management division, which manages or advises on derivatives exposures worth a net £14.5bn (17.5bn), said equity markets had risen so far and fast in the past 12 months that many clients had met their targeted three-year return in less than a year.

He said: "We said to them that now is the time to bank those profits. So clients have been restriking their option strategies, many of which we put in place around last March. They have now moved their downside protection from a FTSE 100 market level of 3,700 up to 5,600, and lowered their return targets from cash plus 8% to cash plus 4%."

Mark Davies, a director at P-Solve, added: "They are moving their targets back into line with what they need to meet liabilities, rather than trying to outperform giving up some upside in return for more protection."

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"Dynamic asset allocation is another name for capital rotation," says John Conroy, a managing director at P-Solve, a UK investment consultancy. "It is a crucial part of the investment tool kit going back to the 1980s. Then, it was also known as tactical asset allocation. It was badly done, received a bad press, and went out of favour."

Global Investor

"Everybody's more worried about downside risk – even with the recent recovery most pension schemes are now worse off than before the crash. There's a feeling amongst trustees that they need to protect against the same happening," says Ben Clissold, deputy CIO of P-Solve.

Pensions Insight

Despite this P-Solve deputy chief investment officer Ben Clissold said the DMO had been particularly proactive in talking to their main clients to ask what they wanted.

He said: They have done this mainly because they've got so much to issue – long dated inflation linked is a staple all pension schemes want all the time."

Clissold added "Any large pension scheme looking to implement liability hedging will use this particularly as it's index-linked."

Professional Pensions

Despite this P-Solve deputy chief investment officer Ben Clissold said the DMO had been particularly proactive in talking to their main clients to ask what they wanted.

He said: "They have done this mainly because they've got so much to issue - long-dated inflation linked is a staple that all pension schemes want all the time."

Clissold added: "Any large pension scheme looking to implement liability hedging will use this, particularly as it's index-linked."

Professional Pensions Online

“We should be over the moon that fiduciary management is enjoying this new wave of popularity, but in some cases it needs to be viewed carefully. We worry that fiduciary management is being sold as a product rather than a solution, and this will mean in some cases it doesn’t actually meet the needs of the fund,” says Faulkner.

He adds: “The definition of fiduciary management is not clear and we’re bound to see a broad spectrum of degrees of delegation. But there is a danger that these ideas become a fad and clients who are not best suited to do it end up doing it. For example, there have been clients who have come to us saying they had been told they need fiduciary management when in our view they don’t look like a fiduciary management client at all.”

Faulkner says that one of the biggest challenges for institutional investors is to avoid these “fads”.  He adds: “We think institutions should make the most of their competitive advantage, the fact that they are able to sit and wait. They are, after all, long-term investors.”

“Not everyone would agree with that last point, because it sounds like market timing and we all know that in the 1990s the TAA [tactical asset allocation] managers, on average, didn’t succeed. The main reasons for this were that their time horizon was too short and that they considered too few asset classes,” says Faulkner.

It was the time horizon issue that was the bigger problem. “TAA managers were mainly worried about how their performance was going to look to their clients from quarter to quarter. When actually, timing the market from one quarter to another is difficult, if not impossible,” says Faulkner.

Faulkner says: “Rather than considering the virtues of one asset classes versus another, we look at how an asset performs in risk terms. So by these measures, certain alternative asset classes actually have a similar risk profile. For example, take private equity and leveraged loans. Although they are considered to be two separate asset classes, both essentially boil down to corporate exposure, and therefore these two assets are exposed to the same problems if the corporate sector suffers.”

Investors are going to be asking themselves what their exposures are and they will become more aware that they need to manage the underlying risk exposure of the assets they hold. Clients are being pushed to think about their risk structure and the things that will change the structure of the industry going forward.”

Another change brought about by the crisis is a focus on awareness and understanding by investors. Faulkner says that the intensity and frequency with which clients ask questions has increased post-crisis. “If before they would have wanted certain information once a quarter, now they are asking for it once a month,” he says.

Faulkner has a different opinion. He says: “I don’t think the UK pensions market is too consultant-led. In ten years working in the industry I haven’t had a client who agreed to buy into a product, strategy or asset class simply on the back of what we’ve told them.”

According to Faulkner, it’s actually the contrary. “We need to work to persuade the trustees. Consultants have two jobs, essentially. One is to come up with good investment ideas, and the other is to convince your clients that these are actually good ideas,” he says.

Asked whether P-Solve has ever had any investment idea that didn’t catch on, Faulkner says: “All our ideas were taken on board, to varying degrees obviously, but most of them got some reasonable traction.

“That’s not to say we haven’t been wrong. For example, we were early into credit, having invested when credit was cheap, but then went on to get cheaper. But in this case, we made up for that mistake in 2009.”

Funds Europe Online

John Conroy, managing director at P-Solve, a pension fund consultancy, is a keen advocate of what he calls capital rotation, but what to non-experts sounds like market timing. He suggests pension funds should allocate 20-30 per cent of assets to this strategy, which is essentially about responding to market opportunities on a relatively short term view across a range of asset classes.

Like other consultant she sees "a general acceptance of too much exposure to plain or naked equity". He prefers a split with structured equity such as derivatives, suggesting 25-30 per cent as the recommended allocation, with a strong emerging markets bias.

FTfm

John Conroy, managing director of P-Solve Asset Solutions, on what pension funds should do about returns. He says the old model of depending on equity markets is gone because it is too risky. The solution should involve dynamic asset allocation, and goal should be absolute returns.

FTfm

John Conroy, managing director of P-Solve Asset Solutions, on what pension funds should do about returns. He says the old model of depending on equity markets is gone because it is too risky. Part of the solution, he says, is capital rotation, or what is sometimes known as dynamic asset allocation, and the goal should be absolute returns.

Financial Times Online

Glyn Jones, a managing director of P-Solve Asset Solutions, the asset management subsidiary of UK actuarial firm Punter Southall, said: “Longevity swaps are nice in theory but very expensive, and there are some significant practical concerns about them. The main problem is a lack of natural counterparties to take the other side of the risk. As a result, I don’t think the pricing is effective, I don’t think it’s cost effective to remove the risk.”

P-Solve Asset Solutions has a vested interest, in that it offers fiduciary management; its portfolio has outperformed equities by almost 25 percentage points since launch three years ago, with a return of almost 20%. But Jones said: “It’s rubbish to say you have to go down the fiduciary or implemented consulting route.

“It would be over-optimistic for most pension scheme trustees to attempt to time market moves over a short-term horizon, but over the long term, if you look forward, you can see lots of signs indicating that you should move out of equity or into credit.

“The key is making those decisions over the right time horizon. They have to look forward over the long term, and pension scheme trustees have to ensure there is a structure in place that they can move the portfolio in a matter of weeks. Meeting just four times a year won’t work. Our clients meet us within a week of us asking for a meeting, decide and implement the decision within a couple of weeks.”

Financial News Online