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F&C calls for greater use of tactical asset allocation by pension funds

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Pension fund trustees can improve scheme returns and control risk through Global Tactical Asset Allocation (GTAA), according to F&C Asset Management.


“Final salary schemes are on their last legs,” says Tim Watson, F&C’s Director, Client Relations. “And the decline has been exacerbated by the new fiduciary duties placed on trustees combined with the new regulatory environment. In addition, trustees are now confronted by an increased array of assets and instruments to consider investing their pension scheme into – such as hedge funds, derivatives, convertibles, commercial property and structured products.


“Most trustees would probably admit that they need greater education to better understand these new instruments, especially in the UK where funds have traditionally invested in fewer asset classes than in Europe. The traditional asset classes, such as bonds and equities, will remain as the predominant investment medium nonetheless,” explains Watson. “Pension funds need to adapt to maximise their returns whilst controlling their risk. At present, too many UK pension funds are over-exposed to a single source of risk – predominantly UK equities.”


For traditional balanced mandates, risk-budget analysis advises re-allocation of risk away from large asset class positions (i.e., just broad, domestically-biased equity and bond positions) and into smaller asset classes (i.e., core/specialist equity and bond positions, property and other non traditional assets) thus providing a more balanced risk profile for the total fund.


“Balanced mandates are becoming something of a misnomer,” adds Watson. “We should really call them multi-asset, multi-strategy portfolios.”


F&C has committed significant resources to developing a Global Tactical Asset Allocation (GTTA) platform to deliver tailor-made solutions for institutional clients to suit their risk and liability profiles. F&C currently manages in excess of GBP 70 billion of assets utilising GTAA.


“Tactical asset allocation has been an under-developed skill-set at many fund management firms, which is primarily a function of the eighties and nineties being a one way bet on equities,” says Tony Broccardo, Chief Investment Officer. “But times have changed and the City is waking up to the importance of utilising GTAA to both manage risk and enhance returns.


“GTAA is a good risk diversifier compared to stock selection, so it should rightfully play a bigger role in portfolio management. For many pension schemes re-allocating risk in an optimal way will require less exposure to the traditional asset classes, equities and bonds, and a greater focus on niche asset classes and alternatives.


“GTAA is a four-step process,” he adds. “Firstly, we need to analyse and evaluate the current state of play, and set a target for active return based upon the long-term needs and goals of the pension fund. Step two, we have to measure the active risk of the existing mandate structure. We then need to attribute the active risk. Traditionally in UK pensions we see that the risk budget is highly concentrated in a single source – usually UK equity. The fourth stage is that we start to manage the active risk looking at the ideal and optimal scenarios.


“What we are trying to achieve is a balanced allocation of risk with no over-reliance on a single source of risk, but in practical terms this is not readily achievable. The solution is through an optimisation process whereby we allocate away from the active risk-stretched classes to the less risk-stretched classes.


“One major lesson that has come from our experience of GTAA is that balanced mandates which are built using index products combined with high alpha portfolios are actually less optimal than portfolios comprising low-risk portfolios combined with high-alpha products,” concludes Broccardo.

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