Kick-starting the flow of ideas

Pension plans consider the latest batch of asset allocation innovations to maximise returns

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Asset managers are a thick-skinned and resolute bunch when it comes to product innovation.

Often on the receiving end of criticism when products do not always live up to the expectations of their clients, fund firms continue to dust themselves off and press ahead with new and innovative investment techniques.

Given that market turbulence over the past four years has thrown even the sturdiest of investment strategies off course, whether asset managers deserve all the blame for product failures is debatable.

Fortunately for them, a majority of pension funds remain open to new investment ideas.

“A number of asset managers are very good and do come out with products that enable us to change our investment strategies for the better,” says Mike Taylor, chief executive of the £4.2bn London Pension Fund Authority.

A report published last year by consultancy Create Research, which collated the responses of 108 pension plans, showed that schemes maintain a strong appetite for innovation, despite a number of strategies that have tried and failed over the last decade.

In particular, liability driven investment (LDI) and exchange traded funds were among those asset allocation innovations considered to have delivered the most value for pension funds over the last 10 years.

Meanwhile, structured and leveraged products, portable alpha, private equity and currency funds, were among those innovations pension funds said had failed to deliver any benefit.

Divyesh Hindocha, global director of consulting at Mercer Investment Consulting, cites LDI as the “the biggest innovation” pension funds have seen from asset managers over the last decade.

A popular investment strategy among defined benefit (DB) schemes, LDI is an approach that aims to more effectively match investment returns to the current and future liabilities.

“[LDI] started off with relatively simple concepts, and seems to have had some momentum and has kept evolving,” says Mr Hindocha.

A study by investment consultant Aon Hewitt in June suggested that demand for LDI strategies from pension schemes is likely to “intensify significantly during the next 12 months to three years”.

Eager to capitalise further on their innovative streak, maintaining a dialogue with asset managers is crucial if pension funds want to ensure that the ideas keep coming.

“Some managers will come to us with innovation, which we probably would not have otherwise have spotted,” says Mr Taylor.

“You need to be in a situation where managers understand what it is you are looking for, but some managers may have ideas that better fit your strategy than you thought yourself.”

Mr Taylor adds: “We try to make sure we are an intelligent investor client, so that managers feel confident they are not wasting their time coming to us with complex ideas.”

Despite some innovation triumphs, not all product ideas rolled out by asset managers have been a big hit with investors.

One area which also gained a lot of focus, but which failed to gain any steam, is a concept known as 130/30 – a strategy that shorts poor-performing stocks while at the same time purchasing those expected to achieve high returns.

While timing may have played a part for investors abandoning 130/30 (a number of approaches were launched just prior to the market downturn), having a better idea of client needs could have prevented some other product failures.

“The motivation for asset managers is fundamentally commercial – that is just how the business works,” says Mr Hindocha.

“While 130/30 got a lot of attention, arguably there could have been more of a dialogue between the supply and demand sides.”

Although several approaches have failed to gain traction, “most asset managers do have clients’ interest at heart” when designing new and innovative products, says Amin Rajan, chief executive of Create Research.

That said, pension funds still want “significant improvements” from asset managers with existing product features, says Mr Rajan.

“[Pension funds] want to improve the old rather than create the new,” he adds.

“A new asset class won’t help while the bulk of money remains locked in the old.”

With the growing demise in popularity of DB schemes, Mercer’s Mr Hindocha says defined contribution (DC) is “fertile for innovation”.

Indeed, some DC schemes have expressed an interest for products that can tap into some of the successes of an LDI approach adopted by DB arrangements.

The challenge for asset managers, however, will be to create products for DC scheme members who are more concerned with transparency, low cost and simplicity.

“Whether there is the willingness to push the boundaries with DC, we will have to wait and see,” says Mr Hindocha.

Mr Taylor suggests pension funds are open to other ideas.

“There are a lot of developments around credit, and the relationships managers may have with banks and their ability to take over bank debt. Some managers are leading the way with this,” says Mr Taylor.

Pension funds are also looking more into opportunities where there are distressed sellers, such as banks.

“This is an area which seems ripe for further innovation. Given there is all this debt on bank balance sheets, how do you recycle that in way to find an owner for that as part of a return seeking strategy?”

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