Study Examines Herd Mentality in Pension Investing

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Pension funds exhibit a herd mentality when formulating investment strategies, according to a new paper that studied the investment decisions of UK pension funds over the last 25 years.

The paper, authored by David P. Blake, Lucio Sarno and Gabriele Zinna, claims that pension funds “display strong herding behavior” when making asset allocation decisions.

More on the paper’s conclusions, from ai-cio.com:

According to the study, there was overwhelming evidence of “reputational herding” behavior from pension funds—more so than individual investors.

Pension funds are often evaluated and compared to each other in performance, the paper said, creating a “fear of relative underperformance” that lead to asset owners picking the same asset mix, managers, and even stocks.

Data showed herding was most evident at the asset class level, with pension funds following others out of equities and into bonds at the same time. They were also likely to herd around the average fund manager producing the median return—or a “closet index matcher.”

The paper can be found here.

 

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UK Pensions Argue For Better Reporting Framework For Responsible Investments From Fund Managers

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A coalition of UK pension funds is calling on fund managers to improve and increase disclosure of the social impact of their investments.

Many of the pension funds in the coalition are taking an increased interest in socially and environmentally responsible investing.

From IPE Real Estate:

Over a dozen schemes with £200bn (€267bn) in assets – including the BT Pension Scheme (BTPS), Universities Superannuation Scheme and Pension Protection Fund – argued that improved reporting and disclosure on public equity investments would help asset owners better assess how well RI matters were aligned with the fund manager’s strategy.

It identified two main principles – of transparent integration of environmental, social and governance (ESG) factors and of good stewardship – as key, and added that only “explicit” reporting would allow schemes to gain a better understanding of how such issues impacted short and long-term risk and performance.

Daniel Ingram, the guide’s lead author and head of RI at BT Pension Scheme Management, told IPE reporting was the “missing link” to allow asset owners to make the case for ESG-focused investment.

[…]

Leanne Clements, one of the guide’s deputy editors and responsible investment officer at the £10bn West Midlands Pension Fund, said that, in the fund’s view, there was a need for “broad improvements” in reporting across the fund management industry.

“This is what makes that alignment of UK asset owners totalling over £200bn so important – we need to send a signal to the market, not just select individual managers,” she said.

“There has been some positive direction of travel with regards to climate change and other environmental issues in select managers – and also governance issues. However, social issues appear to be less understood.”

The coalition consists of 16 pension funds that collectively manage more than $300 billion in assets.

 

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UK Parliament May Require Pensions to Disclose Contracts With Asset Managers

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UK pension funds could soon be facing higher transparency standards after Parliament members proposed measures recently to force pension funds to disclose contracts with asset managers.

From Investments and Pensions Europe:

Michael German, a Liberal Democrat peer in the UK upper house, tabled an amendment to the current Pension Scheme Bill – legislating for the introduction of defined ambition schemes – to allow members of trust schemes to request details of voting behaviour and the “selection, appointment and monitoring” of asset managers.

Nick Bourne, government whip in the Lords, said the amendments would go much further than currently proposed increases to scheme transparency, but that there was nonetheless merit in further examining all ideas tabled by German.

“However, we consider that greater transparency in relation to costs and charges, as well as about how schemes manage their investments, go hand in hand,” he said.

“As such, they would be better considered together as part of the same well-established transparency work programme, which is already under way and we are committed to consult on later this year.”

He said legislating for German’s proposals before the other changes surrounding fee disclosure came into force in April would risk introducing transparency in a “piecemeal and uncoordinated way”.

“Introducing these requirements through the amendment would remove the opportunity to consult all relevant stakeholders,” he said.

Instead, Bourne said the government would include the proposals in a forthcoming consultation planned by the Department for Work and Pensions, and could then potentially enact any changes as regulation.

ShareAction, which had been working with German on the amendment, welcomed the government’s commitment.

The responsible investment charity’s chief executive Catherine Howarth said: “We warmly welcome the government’s commitment to action that will give UK pension savers long overdue rights to information about what happens to their money.

“We urge pensions minister Steve Webb to move swiftly to set a consultation timetable to make these rights a reality in 2015.”

Read more about the proposed transparency standards here.

 

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Study: Pension Trustees Spend Less Than 5 Hours Per Quarter Evaluating Investment Decisions

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Survey results recently released by Aon Hewitt reveal that most pension trustees in the UK only spend about five hours each quarter evaluating investment decisions. The survey did find, however, that trustees were spending more time on investment evaluation in 2014 than they did in 2013.

From Investment and Pensions Europe:

Pension boards and trustees are opting for fiduciary management because they can often only spend five hours each quarter scrutinising investment decisions, according to Aon Hewitt.

The consultancy said the increasing complexity of investment decisions was driving those in charge of pension assets into the arms of fiduciary managers, but that only one-quarter of those using such providers were employing indices to measure successful performance.

Drawing on the results of a UK survey of nearly 360 investors worth £269bn (€344bn), the Aon Hewitt Germany’s head of investment consulting Thorsten Köpke said the questions facing UK investors were also relevant concerns for their German counterparts.

The survey also found that 73% of pension boards and trustees were only spending five hours a quarter on investment decisions, a 10-percentage-point increase over the 2013 survey results – meaning they placed significant trust in managers to monitor investments, according to the consultancy.

However, interest in fiduciary management was largely dependant on the size of a fund’s portfolio, the survey found.

It also found that those managing more than £1bn in assets were more inclined to delegate responsibility for only part of their portfolio, while those with less than £500m in assets delegated the entire portfolio.

Köpke added: “The last few years have seen occupational schemes in Germany as in England – both small and medium-sized ones – work with fiduciary managers.”

The data came from Aon Hewitt’s Fiduciary Management Survey 2014.

UK Study: Pension Funds Losing Money on Active Investment Strategies

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A UK investment firm has released a study measuring the effectiveness of active versus passive investment strategies over the last five years. Their verdict: passive strategies outperform their active counterparts. From Every Investor:

Research from Charles Stanley Pan Asset (CSPA), a specialist fiduciary and multi-asset investment manager, has found that a passive strategy could give large pension schemes an additional £3.8m return per year.

It revealed that over five years to the end of April 2014, passive funds in 14 liquid asset classes have outperformed median active funds by 4.73% on average.

Indeed, in one instance, Emerging Market Bonds, this difference was 12% over the five year period.

The same analysis to the end of June 2013 produced an outperformance of 6.5%. This additional revenue has been coined the ‘Passive Fund Premium’, which is the return to be expected from a portfolio of passive funds over an equivalent portfolio of active funds.

In 2013, CSPA published ‘The Governance Revolution’, which proposed that UK institutional pension schemes, particularly smaller schemes with around £50m of assets, should consider adopting a 100% passive approach, and in doing so could save £3m over five years.

The study comes with a big caveat: The firm that conducted the study, CSPA, isn’t quite a neutral observer in all this. The firm specializes in helping pension funds make passive investments, so they certainly have an interest in promoting passive strategies.

UK’s Largest Pension Fund Foresees “Difficult” Year

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The UK’s Universities Superannuation Scheme (USS), the country’s largest pension fund, is preparing for the possibility that its unfunded liabilities could be larger than reported, and its financial condition more serious than its 85 percent funding ratio might suggest. From Financial News:

USS pays out £100 million worth of pensions a month, and its team of fund managers and traders in London undertake £1 billion worth of transactions every day. The team beat its targets last year, producing a 7.9% return against benchmark performance of 6.5%, according to its annual report to March 31, 2014, published late Wednesday.

Despite all this, the pension fund is struggling financially. It is currently undertaking a full formal valuation of its assets and liabilities as of 31 March 2014, a lengthy and complex process which it is expected to complete by the end of the year.

The pension scheme has provided an interim estimate of its funding level at the same date – 85%, implying a deficit of around £7 billion. This is a fall from the deficit reported at 31 March 2013 – £11.5 billion – reflecting a recovery in markets in the meantime.

However, USS’s trustees cautioned that the final figure might be “materially” different to £7 billion, and could be larger.

Administrators of the fund, along with labor groups and other parties, are already planning various cutbacks and cost-saving measures to head off the potential news of higher-than-believed liabilities. Reported by Financial News:

The main proposals are to close the old final-salary section of the scheme to its existing members – it was closed to new joiners in 2011 – and to introduce a new cap on the pensions that can be built up under the new career-average benefits section.

At the same time a new defined-contribution section, offering pensions that aren’t guaranteed, would be opened so that any members earning more than the cap can put their extra savings into it.

According to Universities UK’s July proposal: “This threshold has not yet been set but, depending on affordability, Universities UK’s aim is to maximise the number of scheme members who will fall below the salary threshold.”

The Universities Superannuation Scheme became the largest pension fund in the country this year after its assets grew to £41.6 billion.

Could Climate Change Deplete Your Pension?

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If oil, gas and coal companies were to face serious financial difficulty, the average person might anticipate the annoyance of a higher heating bill, or having to cough up more cash to fill up at the gas station.

They probably don’t think about their pension—but maybe they should.

Earlier this year, members of the British Parliament sent out a clear warning to the Bank of England and the country’s pension funds: watch out for the carbon bubble.

The “carbon bubble”? Here’s a quick explanation from the Guardian:

The idea of a carbon bubble – meaning that the true costs of carbon dioxide in intensifying climate change are not taken into account in a company’s stock market valuation – has been gaining currency in recent years, but this is the first time that MPs have addressed the question head-on.

Much of the world’s fossil fuel resource will have to be left unburned if the world is to avoid dangerous levels of global warming, the environmental audit committee warned.

To many, it probably sounds like a silly term. But its potential implications are serious enough that many in the UK are starting to worry about its effect on the global economy, and that includes pension funds—UK pension funds are particularly exposed to fossil fuel-based assets, as some estimates say 20 to 30 percent of the funds’ assets are allocated toward investments that would be seriously harmed by the burst of the “carbon bubble”.

But some experts say pension funds in the US should be worrying about this, too, because it’s a global issue. From The Ecologist:

If the impetus to prevent further climate change reaches the point where measures such as a global carbon tax are agreed, for example, then those fossil fuel reserves that have contributed to the heady share price performance of oil, gas and coal companies will become ‘unburnable’ or ‘stranded’ in the ground.

But even if we continue business as usual, value could begin to unravel.

Because to continue with business as usual would require an ever increasing amount of capital expenditure by the industry to explore territories previously off limits – the Arctic, for example and the Canadian Tar Sands – tapping these new resources, quite apart from being a bad idea environmentally, is hugely expensive.

Dividends – the payments earned by shareholders as a reward for keeping their shares, have come under increasing pressure as companies have had to spend their money on more exploratory drilling rather than rewarding shareholders.

So some shareholders are already feeling the impact and rather than see their dividends further eroded, might prefer to sell their shares in favour of a more rewarding dividend stock.

Some don’t have the stomach for all those hypotheticals. But it’s hard to deny the policy shifts in recent years leading us towards a lower-carbon world. That includes regulation in the US, Europe and China that cuts down emissions and encourages clean energy.

That trend doesn’t look to be reversing itself in the near future, and those policies are most likely to hurt the industries most reliant on fossil fuels.

There’ve been calls in the US for public pension funds to decrease their exposure to those industries. From the Financial Times:

US pension funds have ignored calls from city councils and mayors to divest from carbon-intensive companies, despite concern about the long-term viability of their business models.

At least 25 cities in the US have passed resolutions calling on pension fund boards to divest from fossil fuel holdings, according to figures from 350.org, a group that campaigns for investors to ditch their fossil fuel stocks.

Three Californian cities, Richmond, Berkeley and Oakland, urged Calpers, one of the largest US pension schemes, with $288bn of assets, and which manages their funds, to divest from fossil fuels. Calpers has ignored their request.

Calpers said: “The issue has been brought to our attention. [We] believe engagement is the best course of action.”

Pension fund experts point out that it is difficult to pull out of illiquid fossil fuel investments, or carbon intensive stocks that are undervalued, provide stable dividends or are better positioned for legislative change.

CalPERS isn’t the only fund that doesn’t want to divest. Not a single public fund has commited to divesting from carbon-reliant companies.

To some, CalPERS’ policy of “engagement” rather than divestment probably sounds like a cop-out. But some experts think the policy could be effective.

“With divestment you are not solving the problem necessarily, you are just not part of it.” Said George Serafeim, associate professor of business administration at Harvard Business School. “With engagement you are trying to solve the problem by engaging with companies to improve their energy efficiency, but you are still part of the mix.”

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