European pension plans have made some notable improvements in these three areas, which has seen them adopt new approaches to investment and risk management that stand in stark contrast to the old ways.
However, while these changes are a necessary step in the right direction, they do not go far enough.
In many cases, trustees have adhered to the traditional model of managing the easy things that don’t matter and avoiding the harder things that do. Many of the changes so far have focused on low-hanging fruit: targeting specific areas that are easy to define and tackle without reinventing operational or governance capabilities.
There have been far fewer improvements in the less tangible aspects of pension business models. To create fundamental and meaningful change, a behavioural and cultural shift is needed for pension funds to navigate the new waters they face today.
Without that behavioural shift we risk merely re-spraying an old car when, in reality, a new model is needed.
Two of the four worst bear markets of the last 100 years rocked the world of investing over a short span of just seven years in the past decade.
During the last decade, three things have become clear: first, the assumptions about risk and return underpinning the traditional asset allocation strategy were not working, as equities were outperformed by bonds over a long period; second, the core/satellite approach did not deliver as actual returns diverged markedly from expected returns for most asset classes; and third, diversification didn’t live up to expectations as excessive liquidity ramped up the correlation between asset classes that historically showed only low correlations.
To make matters worse, the quantitative easing programs unleashed by central banks on both sides of the Atlantic since the collapse of Lehman Brothers in 2008 have further served to weaken the link between asset – and liability – prices and their fundamental value drivers.
Investing, as a result, has become a loser’s game: one in which the winner is not the one with the best strategy, but the one who makes the least mistakes, much like tennis. Risk mitigation is now the name of the game and diversification is its key tool. In the process, increased reliance on consultants and fund managers has become the shield behind which investors increasingly hide.
Prior to 2000, 80% of portfolio returns came from intelligent asset allocation and 20% from implementation. Since then, the ratios have changed dramatically. In today’s world, where effectively implementation has become much more important, intelligent asset allocation accounts for only 50% of returns.1
While it remains debatable whether their impacts can be so neatly isolated and quantified, the unavoidable fact is that any investment strategy is increasingly only as good as its execution.
Progressive pension plans are therefore paying as much attention to two other areas of their business models as they are to asset allocation in order to improve their investment performance: namely, plan governance and execution capabilities. The results of the 2014 Amundi Asset Management/CREATE Research Survey evidence this trend.
1.Amundi Asset Management/CREATE-Research Survey 2014