After a lengthy review, Mercer has embarked on a significant shift in its thinking on asset allocation for its $16 billion master trust and other funds, widening the net for new asset classes and moving towards a fundamentally different paradigm. Following the review, which took place over much of last year, Mercer has refined its categorisations of growth and defensive assets and has instituted a “new interim” asset allocation with plans to move towards a final goal over the next year or so, depending on markets. Longer term, according to Russell Clarke, the Mercer chief investment officer, the firm would like to move away from its traditional approach to asset allocation and towards a risk premia-based asset allocation.

The risk premia approach should provide for better diversification, however it represented a big change form the status quo, Clarke said, and therefore Mercer would move slowly towards this goal. Under a risk premia approach the asset class drivers are categorised as quantitative or qualitative. Quantitative drivers include equity risk premium, small cap, emerging markets, credit risk, term, liquidity and alpha. Qualitative risk factors include leverage, political and other factors. Mercer has also considered a third approach to asset allocation – a risk parity based asset allocation – but largely rejected this because of the introduction of leverage and other practical issues. Clarke said that while the new approach to asset allocation was a result of the global financial crisis, most of the lessons from the crisis were not new.

“I think the crisis has meant more of a re-learning of fundamentals rather than learning anything new,” he said. “It’s been a very important reminder for many people. He believed that funds did not spend sufficient time looking at diversification at the asset allocation level and insufficient time looking at how asset classes worked together. The final result of the new asset allocation for the Mercer funds would mean introduction of several more alternatives, under a higher weighting to real assets, including natural resources. New investment options include global listed infrastructure, unlisted infrastructure, natural resources and global credit. Clarke said that the financial crisis underscored the importance for funds of understanding all the risks in their portfolios.

People tended to be focused more on the minutiae of their investments rather than the important things, he said. For instance, looking to make small gains through a securities lending program or by holding enhanced cash rather than straight cash might not be worth the increased risks involved. Mercer has redefined each asset class away from a simple growth:defensive categorisation to a more complex distribution of weightings to each investment. In the debt category, for instance, sovereign bonds, which are deemed 100 per cent defensive, are separated from global credit, which is deemed to be 66 per cent defensive and 33 per cent growth.

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