Super fund executives who attended last month’s Watson Wyatt Ideas Exchange conference in Melbourne – and there were nearly 100 of them – were not impressed with the performance of their portfolios of alternative investments.
In what has become a feature of the Watson Wyatt event, the fund representatives and 50-or-so managers present were polled of their views on a range of topics.
For one of the questions, the fund representatives only were asked whether their alternatives strategies, since inception, had performed: better than expected, broadly in line with expectations, worse than expected or ‘I can’t tell from my reports’. A total of 55 per cent said they had performed worse than expected and 30 per cent said they were broadly in line with expectations.
Only 6 per cent said they had performed better than expected and 9 per cent could’nt’t tell from their reports. No-one pretended that the polls had statistical significance but the numbers were sufficient to give a reasonable indicator of general opinions. And the funds were not happy with their alternatives.
But traditional managers present could not rejoice at this. In answer to another question, 53 per cent of the investors present said they did not expect the active managers in the room to, on average, beat a passive index over the next 10 years, after fees. Interestingly, 72 per cent of the managers thought they could beat the index.
As Hugh Dougherty, Watson Wyatt’s head of Australian manager research, said: 10 years was a long-enough time to demonstrate skill over luck. The managers’ clients were almost evenly split on whether they had skill. The theme of this year’s Ideas Exchange (they are held about every 15 months in various countries) was “Risky Business” and Graeme Miller, Watson Wyatt’s Australian head of investment consulting, started the day with a quote from Grace Murray Hopper, a navy admiral and computer genius: “A ship in port is safe, but that’s not what ships are built for”.
Risk dominated proceedings. Roger Urwin, the firm’s London based head of investment content, said risk was all about beliefs. And beliefs were personal. “In investments, you usually don’t have a single right answer to an issue,” he said. “This means you need teamwork so that beliefs are shared.” He said that risk and return should get equal attention from a fund’s investment committee. But this is not what normally happens. It takes a special effort on behalf of committee members and investment staff.
“Risk is always there but seldom clear, “ Urwin said. Some tests of risk – and Watson Wyatt recommends funds use several – are difficult to measure. “Not everything that counts can be counted,” Urwin said. It is easier to think about returns than risk. Risk frameworks are difficult to understand and the models on which they are based are not easy to play around with.
People tend to focus on what is most urgent or what is easier than what might be the most important. Martin Goss, Watson Wyatt’s head of client consulting, said that funds should look at risk and return together, combined with a number of risk measures. Watson Wyatt last year launched what it called a ‘Dashboard’ to assist funds in their assessments and decision-making processes around risks and return. Currently a tailored system for funds, the firm is currently looking to turn Dashboard into a more generic product for all funds.
Goss said that one of the areas of Dashboard which has been most appreciated by funds is the way it enables a risk management framework to be presented. He said that two of the characteristics of the global financial crisis with respect to pension funds were: the intensification of effort by trustees and fund staff, where governance budgets have been largely found lacking; and the necessity of having a risk management framework.
Urwin said after the conference that Watson Wyatt had been supportive of clients who had decided to not yet rebalance
their portfolios. This was quite controversial, he said. But Watson Wyatt was not publicly predicting how long the financial crisis would last. Instead the firm worked through a variety of scenarios but did not necessarily put probability numbers to each.
“Several scenarios are plausible,” Urwin said. “It’s implausible that over 2009 things will right themselves. If things go really well then it’s plausible it could be over in 2010. If you put a gun to my head I would be prepared to say that the most likely scenario is that it will go past 2010.” Carl Hess, the New York-based head of investment consulting, said that,
with hindsight, many market participants should have been able to see the warning signs of the crisis: “why did we ignore so many red flags?”
The crisis was a ‘black swan’ event – referring to Wassim Taleb’s book of the same name – whereby people underestimated the role of a high-impact random event in determining history. “The future can be different in ways that we can’t possibly imagine,” Hess said. “But it is possible to conceive outcomes if you work at it. You need to invest the time and effort in risk management.”
He predicted that pension funds would continue to invest in alternatives, notwithstanding their disappointment with performance in the past year or so. And he said after the conference that Watson Wyatt was looking to have deeper and more involved relations with its clients, as the firm’s heritage involved working one-on-one with them.