Appetite for alternative investments is only set to increase among institutional investors globally, with long-term contrarian external managers very hard to find, an AsianInvestor forum heard last week.
But while the evolution of institutional investment models falls into a similar pattern, starting with traditional public market exposures before expansion by geography and asset class, state funds' views on the use of external managers varies markedly, speakers revealed at our China Investment Forum.
Addressing the audience during a panel discussion on best practices in international investing, Tomas Franzen, chief investment strategist for the second Swedish national pension fund (AP2), outlined how it plans to insource all its investments bar alternatives within the next two years.
“Our investment philosophy has not changed, it has remained the same [since inception in 2001] irrespective of where we are invested. But the investment model has changed,” he told the forum.
“As we expanded outside of Sweden, we were not able to actively manage these portfolios. So we started as a manager of managers, but we were not successful in this.”
AP2 subsequently moved to use an in-house quant-based model to gain broad market exposures, and also developed tilted indices to capture targeted risk premia.
“In a couple of years we will have no external managers at all. The exception is alternative investments, which need to be managed externally,” he explained.
Franzen noted that AP2 has just taken all its emerging-market equity portfolios in-house, and within a year would take back all its emerging-market debt exposures. However, he said it would keep one external manager in global equities “which lays golden eggs all the time. We will keep them for alpha and for diversification.”
The difficulty of sourcing good external managers was underlined during the discussion. Scott Anderson, head of equity research for Japan at Russell Investments, said managers that were long-term and contrarian were like gold dust.
“We crunch the data to find managers going in a different direction from the crowd, but we tend to find quite a few managers going in the same direction,” he said, to general agreement from the panel which included Fan Hua, head of fixed income and absolute return at China Investment Corporation, and Lee Dong-ik, former CIO of Korea Investment Corporation.
Both KIC and CIC are of a similar maturity, with the former having been launched in 2005 and the latter in 2007. But while KIC outsources one-third of its exposures, CIC uses external managers for a more significant two-thirds of its international investment portfolio. Both have been increasing investment into alternative assets, for which they require external help.
Recalling his time at KIC, Lee said the institution used a lot of data to analyse third-party managers and took a year to rebalance its external managers to eliminate overlaps. He highlighted style drift as something KIC could not tolerate.
He explained that from 2008, KIC started to expand into alternatives, namely private equity, real estate and infrastructure, and two years ago it gained hedge fund exposure. It has started to adopt much more of an absolute return approach and now 15% of assets are invested in alternatives.
CIC had a freer rein initially to invest in anything from public equity and fixed income to the private markets and alternatives. It, too, has sought to build internal capabilities for equity, fixed income and multi-asset strategies, but the private sector remains externally managed.
Franzen noted how AP2 had diversified in global equity by using alternative benchmarks, with increasingly less exposure to market-cap-weighted indices. It now has about 5% in private equity, 7% in real estate, 2-3% in timber and agriculture and 3% in alternative risk premia, typically hedge funds. It also invests in alternative credit, as discussed in an earlier panel.
“For our timberland and real estate exposures we have chosen to go through club deals, so that we are with like-minded investors who are better aligned with our own interests,” he explained, noting this had expanded AP2's investment horizon from seven to 20 years.
All comments made by CIC staff during the China Investment Forum were non-attributable by prior arrangement.