In fact, it’s not uncommon for equities to not meet their objective over long time periods. A final issue concerns governance and agency risk. Superannuation trustee boards approve an asset allocation designed to meet their investment objectives. They then break the portfolio up into small parcels, often giving each investment manager a relative return mandate. That is, a mandate which has no relationship to their members’ long-term objectives but rather ties the manager to indices which are inefficient, prone to bubbles and full of momentum. As McKinsey (note 3) puts it: “Institutional investors historically optimised at the sub-asset class level leading to a sub-optimised portfolio overall, and one that didn’t align with their overall objective to meet their longterm obligations.”

A lot of pension funds around the world are now dealing with this challenge by (re-) recognising that asset allocation is the primary determinant of risk and return. They are looking at diversifying their overall approach to portfolio strategy rather than the more traditional tactic of relying on one asset allocation and an over-diversified set of investment managers. To implement this they are developing multi-sector “inflation plus” mandates for single managers – managers who might have the ability to be highly active asset allocators, think differently about their approach to diversification and/or perhaps use leverage. The rationale has a lot to do with aligning the objectives of fund managers with members and diversifying the most significant risks in a portfolio. The inflation plus 5 per cent target, however, remains a challenging one for trustees to defend.