UK - As asset managers launch a stream of new liability driven investment solutions marketed as an answer to pension funds' asset liability mismatch, Mercer Investment Consulting has warned the benefit of such solutions must be weighed against the cost of implementation.
Mercer says many of the new investment strategy approaches, including LDI, incur higher governance and transaction costs. The pay-back, the consultant says, must be large enough to justify these costs.
“Trustees should consider what is being offered by LDI in the context of their overall investment policy, including the extent to which they can essentially replicate what individual managers are offering more cheaply and in a more diversified way,” said Andrew Kirton, head of UK investment consulting.
“As a principle, we do not advocate incurring unnecessary transaction costs or yield loss to achieve spurious matching.”
In a recent paper Current Investment Strategy Initiatives, Mercer said it supports diversification measures, reduced reliance on equities, portable alpha as a balance or risk, reducing interest rate and inflation risk and adoption of less constrained approaches to equity and bond investment.
However the firm warned the benefits may not always outweigh the costs.
On the move from equities to bonds, Kirton said: “We expect equity markets to return lower absolute returns than in the past but there is a danger that the removal of equity risk is being oversold. Most pension funds are just as exposed to interest rate and inflation risk, and many of the alternative sources of return diversification have considerably higher hurdle rates, reflecting higher associated fees.”
He described the promotion of the death of the benchmark as “misguided” and said risk overlays were not always the best way for trustees to reduce inflation risk.
“There is a difference between less constrained investing with a defined benchmark and performance target, and giving blanket freedom to managers as to how they invest with no regard to a benchmark at all,” he said. “The promotion of such ‘anti-benchmark’ investing is in our view misguided.”
He continued: “Maximising duration and inflation risk reduction across a fund’s liabilities can be achieved through the use of more complex risk overlays. However, trustees need to balance the additional benefit gained with the additional cost, both governance and transactional, of implementing them.”
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