21/10/2009
By Marek Handzel
As a collective group, active managers, including unconstrained ones, have not exactly come out of the financial crisis with glowing returns. So how should trustees react? Marek Handzel finds out
Towards the tail end of September, Hewitt Associates called for pension scheme trustees to 'revisit' the benefits of active equity investing, in light of evidence suggesting that institutional investors were moving more towards passive funds and abandoning active managers following some disastrous figures in 2008.
The consultancy firm's head of manager research, Lennox Hartman, warned that abandoning active mandates would result in schemes losing out on considerable returns. "The opportunities currently available to active managers are arguably greater than usual," said Hartman.
"We believe that it is possible to identify actively managed funds which have the ability to perform better, on average, than the benchmark and to achieve material returns."
His colleague, Mark Howdle, UK head of equity manager research at the firm, warned that investors who had decided to judge active management on the basis of "an unprecedented period" could end up deeply regretting a "missed opportunity" to give an active manager a chance in the current, rather favourable, climate.
Ready?
If Hamish Wood, head of AEGON's investment sales team, is to be believed, then Hewitt is right to worry about pension funds' current attitudes towards active managers.
Wood says that, in the main, trustees are not chasing the market yet, preferring to perhaps put in place a diversified fund strategy, which - at least in theory - should put them in a better position.
"Trustees would probably like to get back into active management because if a defined benefit (DB) fund is in deficit then some trustees will believe that it's possible to invest their way out of it, especially with an unconstrained mandate rather than a standard active fund," says Wood. "But consultants are as yet still shying away a little from appointing unconstrained mandates. There's still some demand out there for them but I would not say it's significant."
Nick Sykes, a worldwide partner at Mercer, has also seen some reticence when it comes to active investment managers. Given the tough time they experienced in 2008, trustees have had much to think about, he says.
And the soul searching doesn't just stop at whether or not funds have appointed the right investment house. They have also questioned the value of their mandates and whether or not there are better ways of structuring the 'reward' or alpha-chasing aspects of their portfolios.
Missed opportunity?
But such scrutiny, explains Sykes, could mask the opportunities that now exist for active strategies. "What we're saying (to clients) is that we think the state of the markets (volatility) is providing active managers with more opportunity than it has done in quite some time. They are in the best position they have been in for a number of years."
According to Martin Hall, head UK and Nordics at AXA Investment Managers, once a pension fund makes an active decision to invest in bonds or equities, whether that is in domestic or global markets, "it seems consistent to opt for active stock selection".
"We believe that pension funds should embrace active management and consider unconstrained mandates that can operate within the risk budget and liability and asset allocation parameters," he maintains.
Pension funds, he adds, would regret it if they were not agile enough, or did not employ a manager with a flexible mandate, to take advantage of the opportunities presented by the current dislocation in markets.
Exceptional circumstances
Then again, if trustees had kept in mind how active managers usually operate, then a flight to passive, if indeed there is one, would perhaps not be taking place.
Marek Siwicki, head of consulting relationships at Gartmore, argues that active fund managers tend to have a 'quality bias' which results in them being penalised in some market scenarios.
The difficulty for managers to outperform the market came down to the fact that, ironically enough, they were doing a thorough job, analysing long-term company prospects and fundamentals, rather than chasing what looked like, at face value, bargain-priced equities, for example.
"Fund managers will naturally look for stronger looking firms with stronger looking long-term prospects. At the end of 2008 and beginning of 2009 - firms that were beating their earnings expectations, those stocks were actually under-performing the market. It was a strange situation, but it's the market ignoring fundamentals and buying stuff that is really cheap," explains Siwicki.
Markets, he adds, have recovered somewhat so it's now easier to see who the long-term winners are going to be. In the last three months, with share prices reacting quite positively, fundamentals have come back into play: "That's important for active managers. When things are more stable and you know what's happening going forward, then good fund managers should be able to outperform."
The less constraints the better
So if now is the time for active managers to shine, then how much freedom should trustees give them?
This can be answered somewhat by a pension fund's strategy, attitude to risk and state of its funds. But, whether trustees decide to go for a large push for alpha, or just want to add some reward to their core passive allocation, it's best to take the shackles off an active manager, argues Pat Wynne, director at Xafinity Consulting.
"People have become a bit frustrated with the tightness of trying to have individual allocations to asset classes and the fights that go on between the investment managers who are trying to all get their bit. They all go into the asset allocation meetings and fight amongst each other," he says.
Whereas, he claims, unconstrained mandates are a better choice and provide some comfort for trustees as they can not only hunt out extra performance, but they can also take the opportunity to hold protective positions when needed. In fact, Wynne has seen clients want to go into more unconstrained 'diversified' funds, such is the conviction of its merits, putting his experience at odds with that portrayed by Hewitt.
What's more, being a proponent of a high likelihood of the economy suffering a 'W-shaped' dip before eventually properly recovering, Wynne stresses the need to give an active manager as much scope to ride out another downturn as possible.
"Unemployment is going to continue to rise and we are a consumer-driven society," he says. "If you have that degree of uncertainty coming, although you can see green shoots in the market, it's not likely to be a straight line recovery. So we are in a way quite keen that investment managers have the opportunity to take some defensive measures in what we see as a dip."
It's not the markets, it's the manager
Beth Wernham-Kemp, an investment consultant at Jardine Lloyd Thompson, agrees to a point, but says that the state of the markets is really neither here nor there.
Rather than tactically appointing an active manager based on the current state of the financial markets, she says, trustees should appoint a manager which they feel can add value to their portfolio through both bear and bull markets, "if there is scope remaining in their risk budget to take on active manager risk".
"Where trustees are confident in an active equity manager's ability to add value we support the move towards mandates that allow managers to be less constrained by the benchmark," she adds.
The passive versus active argument has been fading in and out of the limelight for longer than most investment professionals or indeed pension funds can care to remember. But perhaps it's time to leave the debate behind for good, suggests Patrick Disney, joint managing director at SEI Institutional Investment.
"The idea of the relative merits (of active and passive) is almost a false premise because they're trying to do different things. And of course passive is really a portfolio, it will inevitably occasionally do better. What investors have to decide is what they want to achieve."
