Private credit might be less attractive than it was last year as investors rush into the market, but there are sweet spots to be found.
At a seminar organised by the firm last Friday, Janet Li, Hong Kong-based investment consultant, notes Hong KongÆs pension universe now accounts for around $400 billion of assets under management, making it the 11th largest in a global pensions market of $23 trillion. It has grown quickly due to the introduction of the Mandatory Provident Fund regime as well as investment performance.
ôThe use of alternative assets has gone up to 14.4% in other markets [from 7.7% five years ago],ö Li says. This includes allocations to hedge funds, commodities and property. But Hong Kong has seen a modest decrease. Watson Wyatt believes this reflects sub-optimal governance at the pension fund level.
Watson Wyatt polled the roughly 40 institutions represented in its audience and found roughly half of them agreed they lacked the governance set-up to diversify into non-traditional asset classes.
The consultancy believes, however, that pension funds worldwide are going through a rapid shift away from traditional low-risk, long-only investment mandates. Pension fund assets have doubled in size in the past decade across the top 11 markets, and by 13% in 2006 alone (in US dollar terms). Funds that focus on their long-term objectives are finding they need to reduce total volatility and boost returns by seeking unconstrained and absolute-return types of investments. Watson Wyatt also argues funds that add more managers often fare better, provided itÆs done in a cost-effective manner.
But to do so requires an internal capacity of relative sophistication. Watson Wyatt says funds generally fall into one of three camps. First, æcost minimisersÆ with a single board covering everything, which rely on passive management. Second, funds with an investment committee to handle some of the work and make certain asset-allocation decisions. Third, those with a dedicated CIO and independent investment team which can dedicate time and resources to seeking out quality fund managers and diversifying into new asset classes.
But too many funds focus on chasing high-alpha managers without concentrating on more basic functions, often paying their trustees below-market rates for such expertise.
ôMany scheme administrators do not pay a commercial rate to their investment team,ö says Roger Urwin, Watson WyattÆs London-based global head of investment consulting. ôThey will say that it is not a problem because they can get enough people for $15,000 a year but at that price you have to call into question the quality and commitment of those people.
ôBad governance can cost up to 6% a year,ö he adds. ôThe best pension schemes in the world have produced an average compound annual return of 15% over 15 years as markets have gained between 8% and 10%. Compared to other schemes their real success is in alpha generation through asset allocation and manager selection. Some have even gained direct access to hedge funds.ö
This example, according to Watson Wyatt, is the key reason Hong Kong pension schemes should increase the quality, and independence, of those that make, or are delegated to make, investment decisions. Often it is the basic issues of liability driven investment û or what it prefers to term æliability hedgingÆ û will make a far greater difference than clumsy efforts to pick good alpha-generating fund managers. (The consultancy, of course, makes a business out of advising funds on manager selection.)
Watson Wyatt argues that the shift to liability driven investments and growth of independent investment committees in other markets, including the United States, United Kingdom and Australia, has to some extent been a result of a disastrous spate of disasters among defined-benefit schemes, but has clearly affected long-term performance.
The company admits that setting up an independent investment committee and sufficiently remunerating its members can be expensive but, according to investment consultant Philip Tso, this can be mitigated to some degree.
ôWe recommend using active management for alpha,ö he says. ôThis includes investments in high yield debt and emerging market debt, emerging market equities, fund of hedge funds and infrastructure. But beta, including commodities, property, global bonds and equities, can be managed passively.ö
The seminar was the firmÆs annual industry get-together in Hong Kong. This year the consultancy introduced electronic spot voting for participants. It also organised the pension funds and investment managers into teams to use governance, LDI and other precepts to turn around a hypothetical struggling pension plan.
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