by Rupert Brindley
As the Brazil Olympics approach, it is useful to reflect upon the lessons of the London Games in 2012. As we all fondly remember, Jessica Ennis won a glorious victory in the women’s heptathlon, a gruelling track and field event combining seven skills. She achieved this despite her relatively petite stature, which placed her at a significant disadvantage in disciplines such as the shot put, high jump and Javelin.
Imagine your possible thought process if you had been selecting heptathlon athletes for Team GB ….
- You might have been worried about the shot put, because the Lithuanian athlete Austra Skujyte was in a league of her own. Hence, you might have felt obliged to select a shot put specialist to neutralise some of this threat. (In fact, you would have been right to worry, because in London she did beat her rivals in this event by a huge margin.)
- You were also worried about the high jump. So you might have also selected a high jump specialist to cover that risk.
- Finally, your analysts identified risks surrounding the Javelin competition. So you “hedged” that one too.
At the end of this exercise, you ironically may not have found any room for poor Jessica!
One hopes that the heptathlon committee would have soon remembered that all competitors must enter all events, and a shot put specialist is unlikely to be a first class 800m runner! Nevertheless, the seesaw of considerations thrown into account above serves to illustrate how tempting it might have been to privilege one-dimensional specialisation over a well rounded skill set.
But why does this matter to pension funds, and what lessons can we learn from it about pension fund selection decisions?
Pick the best “all-rounder”, not a specialist!
Effective allocators will consider performance over multiple scenarios, rather than dwelling too long on a single scenario. But how many trustee groups build their portfolio from a “growth” sub-portfolio to deliver return and a “matching” sub-portfolio to deliver hedging?
They perhaps forget that the “growth” assets must also perform in the deflation event, and the “hedging” assets must enter the reflationary event?
Using this analogy, it becomes quite clear that a robust portfolio will contain assets that perform quite well under both deflation and reflation scenarios, rather than being specialists in just one. The widely-adopted growth / matching dichotomy or “barbell” is not a helpful mental construct.
So which asset types are investment “all-rounders”?
An all-rounder asset should provide three main features simultaneously.
Firstly, it should provide some duration exposure at a reasonable price. Secondly, it should limit the level of losses under a recessionary shock scenario. And finally, it should outperform a simple blend of equities and Gilts under a healthy reflationary scenario.
An “all-rounder” portfolio will include an allocation to long duration corporate bonds, some hard currency emerging market sovereign debt and some high yield bonds. This blend will benefit from the wide level of credit spreads, to earn an equity-like risk premium while also offering some of the rate hedging benefits of Gilts.
Behind every great performance … the trainers and selectors
The trainer’s job is to squeeze the maximum performance from each athlete, and portfolio manager’s job is to find the best securities within his or her sector.
However, the ranking of all-round athletes may change over time, as their skills and fitness wax and wane. Just as the selector needs to monitor performance, so the CIO may adapt the portfolio to reflect the evolving outlook for asset classes over the market cycle.
The lesson from history
Taken in isolation, Jessica Ennis did not win the shot put event, nor did she conquer the high jump event. However her average points score across all disciplines swept her to a comfortable overall victory. By contrast, the poor Lithuanian shot put specialist went home without a medal.
We fear that trustee groups may pay a heavy price for either expensive “LDI” hedging programs or for aggressive growth strategies that specialise in only one event, by definition falling short of more holistic goals.
Wise selectors understand the value of seeking strong all-rounders to meet the multi dimensional challenges of current markets.
Rupert Brindley is the managing director at JPMAM Pensions Solutions.
