Mercer flags big increase in alternatives exposure

Mercer Global Investments will follow its dramatic review of Australian equities with some changes to the strategic asset allocation of its $14 billion fund.

According to Russell Clarke, Mercer chief investment officer, the review of strategic asset allocation will likely result in a significant increase in alternatives, with a “small amount” of this coming out of Australian equities. The Australian equities review, announced last week, has given a massive boost to concentrated equities managers, and put another nail in the coffins of traditional core active managers. The restructure of the $4 billion Australian equities component of the fund has gone against the multi-manager trend by dramatically reducing the number of managers handling the portfolio. Prior to the review, Mercer’s Aussie equities portfolio was managed by 10 firms. However, only 10 per cent of the assets under management from the Mercer mandates were considered ‘higher-return seeking’, while 85 per cent were considered ‘low-to-medium risk’. The final, unchanged, 5 per cent is in small caps. Under the new structure, only five managers are being used – four of the previous managers and one new one – but they represent an increase to 70 per cent of the portfolio being classified as ‘higher-return seeking’. Mercer says the low-to-medium risk managers generally have targets of 1-3 per cent above benchmark, while the higher-return seekers have targets of 3-5 per cent above benchmark. Clarke said that the absolute volatility of the portfolio was unlikely to change following the review but the relative volatility (tracking error) would increase from about 1.3 to 1.7 per cent. “We think the tracking error got down to levels which were too low,” he said. The other advantage of the new structure is that it forces Mercer to be more focused on its manager selection and allocation too. “If you have 10 or 15 managers in a portfolio it’s easier to take no action,” he said. “Now, we can’t fence sit… In a practical sense, it comes down to how much conviction you have in the strategies.” The new manager is BlackRock, which has been awarded $1 billion to be managed by its quant unit in a tax-efficient style, as reported last week. But four of the existing managers – Alleron, Ausbil Dexia, Perennial and Tyndall – have been given increased mandates of about $700 million each. The Tyndall and Alleron mandates are specifically for the managers’ concentrated portfolios, while the Perennial mandate includes a ‘high-yield portion’ which also tends to be more concentrated. The five managers terminated by Mercer are: AXA Rosenberg, Barclays, BT, Lazard, Schroder and Wallara. Clarke said that over time Mercer had become increasingly confident with the long-term ability of return-seeking managers to deliver higher returns than traditional managers. “As this degree of conviction has increased, the expected benefits of including a higher weighting to return-seeking strategies in a multi-manager mix have become more demonstrable.” Clarke said that the reduction in managers and focus on higher-return seekers were in contrast to a multi-manager industry trend of adding more managers to control risk. He said Mercer believed this trend could be at the detriment of returns. “The rationale for the new structure is based on the premise that fewer investment managers can increase the ability of each to add meaningfully to the performance of the asset class as a whole.”