It will be a while before we get hard data on actual asset allocations by all super funds at the end of June, but anecdotal evidence is mounting that the average allocation to cash will be way above those same funds’ strategic allocations.
Estimates range from 5-6 per cent to well above 10 per cent, even for the largest and most sophisticated funds. This would compare with the average strategic allocation, according to Chant West’s multi-manager survey, of 4 per cent.
That survey points out that industry and other not-for-profit fund performance figures for most periods to June 30 were comfortably above their master trust counterparts again. According to Chant West, this was primarily due to their allocations to alternatives including unlisted property, infrastructure and private equity.
Fees, manager selection and implementation efficiencies did not matter so much. Chant West reiterated a concern the firm has raised consistently in recent years about super funds allocating more than 20-30 per cent to illiquid assets. The firm points out, as does the cover story in this issue of Investment & Technology, that US endowment funds which have had great success due to higher allocations to alternatives are fundamentally different to super funds.
They never have to repay the monies gifted to them, for instance. If the estimates that super funds have let their cash allocations mount up to 10 per cent or more are true, then liquidity is not a problem right now. In fact, the problem may be the reverse.
The problem is, of course, that they may miss out on a significant market bounce. The share market can move 5 per cent or more in a day, in an afternoon even – 10 or more per cent in a week.
So, what should funds do? This is where it gets complicated. They shouldn’t ignore the current market volatility and simply rebalance to their strategic allocations. The current economic and financial problems around the world which have caused the volatility are not going to go away anytime soon.
But funds need to have a new strategy which reflects the current climate. Trustees need to ask themselves again how much volatility they are prepared to wear. They need to redo the numbers on the relative risk premia attached to shares and bonds versus cash and need to get advice from as many sources as possible on valuations.
All that is difficult enough, but what they also need to do is examine more efficient ways to protect their portfolios through strategies which will provide reasonable liquidity with better returns. Better cash management is essential. The major custodians usually earn a good return from handling cash and foreign exchange requirements from their custody clients.
Sometimes they will earn more from that than from their traditional custody services. While the margins are slim, the sums involved are large and there will invariably be ways found, with some nudging, to eke out a few more points for the client.
More importantly, funds can explore the new types of structured products being offered by the investment banks, which provide downside protection on share market returns with higher guaranteed rates of return than cash. These products will involve counter-party risk – they are not the same as getting the “risk-free rate” – and their terms will be more to the medium term than short term.
They are proving increasingly popular in the US at the moment, even though the institutions offering them have been battered by the share market in recent months due to sub-prime-related losses.
One popular group is the “autocallable notes”, offered by Merrill Lynch, Goldman Sachs, Morgan Stanley and a few others. One of the architects of Merrill Lynch’s “enhanced liquidity note”, Michael Heraty, says derivatives such as autocallable notes are a must-have tool for more efficient access to higher returns. They are medium-term non-principal protected notes which can be linked to the performance of an underlying stock, basket or index, providing potential for a high yield at maturity.
The automatic call will be triggered if the share price of the underlying investment is at or above the initial strike price three days prior to any of the call dates or at the date the contract expires. The note may offer a guaranteed return of, say, 12.5 per cent as long as the index returns between a certain range. If the note is redeemed early, the investor would get the principal back plus 12.5 per cent. Maturities range from three to 10 years, however, Merrill’s Heraty says most public funds have purchased notes with a five-year maturity.
The notes are also offered by Merrill Lynch in Australia, according to director, synthetic and alternative asset management, Nicholas Allen. He believes that super funds are mainly worried about volatility at the moment and not so worried about liquidity nor cyclical market valuations.
Timely conference on market ‘dysfunctionality’
The second annual conference being organised by the University of Technology Sydney is timely for the Paul Woolley Centre for capital Market Dysfunctionality. The Centre, of which UTS is a network partner, funds a range of research projects on market efficiency.
This year’s conference, on October 1-2, is for invitees only but UTS’s Professor Ron Bird says interested industry practitioners should contact the UTS School of Finance and Economics for details. One of the star presenters this year is the well-known behavioural finance expert Nicholas Barberis, of Yale University, who will speak on ‘Are Markets Efficient and Does it Matter?’
Professor Dimitri Vayonas and Dr Paul Woolley, both of the London School of Economics, will address: ‘An Institutional Theory of Momentum and Reversal’. Woolley, a former funds manager with GMO in London, has provided most of the funding for the Centre. Information, email: [email protected]