An investor for all seasons – Judy Saunders, C.I.O. of the West Midlands Pension Fund
Judy Saunders is C.I.O. of the West Midlands Pension Fund and has stated professional ambition; to create a truly all weather fund. Here she shares her thoughts on how she is attempting to do this, through astute strategy and an open mind when it comes to manager selection.
Could you give us a broad idea of the structure of your fund?
At the moment it is about £8.6bn, and the benchmark is 45% quoted equities, 35% alternatives and 20% fixed interest.
Quoted equities includes the usual suspects and the majority of this is passively managed in-house. The exception being an 8.5% allocation to emerging market equities and a 5% allocation to global equities, both being actively managed through external funds.
Fixed interest includes an overweight position in UK Linkers, an underweight allocation to UK Gilts, and a number of actively managed corporate bond and emerging market debt funds.
Finally within alternatives; there is 10% allocation to private equity, 10% in absolute return strategies, 9% property which sub-divides into direct UK and indirect overseas, the balance of 6% being split between infrastructure and commodities.
We have an in-house team of 24 which divides into four areas: quoted equities, treasury management and accounting, fixed interest and complementary – more commonly known as alternatives – and finally compliance and risk management.
How do you access funds?
Through research, networking and word of mouth. We select funds rather than
appoint managers. This arrangement facilitates what’s referred to as real-time
investing, which enables us to take advantage of market opportunities, which can obviously be an advantage in certain conditions.
Does that have an impact on the fees you are charged?
We find that most funds are prepared to negotiate, though certain areas of the industry are more reluctant. We invest around £40m in a fund, which is reasonably meaningful, and we are also regarded as long term or ’sticky‘ investors.
How big is your alternatives team?
The complementary team which also includes fixed interest now stands at eight, and has probably doubled in the last 10 years – this reflects resources required to carry out due diligence and the Fund’s changing asset allocation.
In 2001 the Fund had 83% in quoted equities compared to 45% today.
The alternatives represented 8% in 2001 and now stand at 35%.
Has this coincided with an overall growth in your in-house team?
More resources have been switched into alternatives, as due diligence and the subsequent monitoring is demanding both in terms of human resources and time.
There are also a greater number of funds within alternatives as the majority of quoted equities are passively managed in-house, certainly within the developed markets.
You want to create an all weather fund, what is your investment philosophy?
We are essentially long term sustainable investors and recognise we have a whole different set of challenges to a private sector defined contribution fund.
We take a 20 year view and are predominantly still in growth assets, with a target return of 7.5%, which I expect to be generated by beta. Any alpha is regarded as the icing on the cake and ‚banked‘ to help the funding position.
I am a huge cynic of the industry’s ability to create alpha, especially within developed equities, so most of the alpha budget is targeted at alternatives.
We still very much believe in the equity premium, which is reflected in our 45% allocation.
One of my greatest challenges, is to seek out investments that deliver equity like returns, at a lower volatility. Also, to find funds that deliver positive absolute returns in practice, and not only in theory.
Obviously in a strong bull market the West Midlands Fund is likely to underperform the average local authority pension fund. This is because most local authority funds‘ average allocation to quoted equities is that much higher than ours.
But, I’m comfortable with that, and expect conversely when conditions are particularly challenging we will experience less pain on the downside, with reduced volatility. Obviously the jury’s out on that until theory becomes practice.
You are not a typical local authority pension fund. Is it harder to stand out from the crowd, there must be moments of pressure?
Yes, there are moments of pressure, but the trustees are exceptionally supportive.
The all weather fund can sound very Pollyanna, but essentially it’s all about risk management and diversification. One could argue that at the end of the day poor performance is much easier to justify if one remains within the majority. Personally speaking, not following the herd makes life challenging, in a positive way that is.
You have got a 20 year time horizon, but in reality you must find yourself being judged on two or three year numbers.
We regularly report the Fund’s performance figures for information purposes, but the trustees are not hung up on them as they are aware we take a long term view.
There is also a very full yearly performance review, which is really useful as it helps me focus on those areas I think we need to work harder.
Last year, for example, the area where I saw opportunity was fixed interest.
When I was reviewing performance, industry figures demonstrated the majority of funds were actually outperforming indices, especially within Linkers, which indicated there were some interesting active management opportunities.
So, this year I have been busy exploring the fixed interest arena, to see what’s out there.
Talk us through your absolute return allocation.
We have a 10% allocation to absolute return strategies and have 20 funds. Approximately half of these are hedge funds covering a multitude of approaches.
It is particularly frustrating when hedge funds are referred to as an alternative asset class, when it’s quite obvious they are process or a means to an end. The Fund also has hedge funds in other portfolios such as commodities and also in global equities.
The absolute return portfolio sub-divides into six areas: relative value in credit and fixed interest, distressed debt, macro, multi- strategy, systematic trading and finally, esoteric.
It consists of a real mix of investments ranging from event driven hedge funds to fundamental approaches such as the Ruffer Absolute Return fund and Oaktree, a specialist in distressed assets.
Some of the funds have private equity like structures, so there will not be meaningful short term performance figures. In 2010 we had 10 funds which now have a full one year performance history, they delivered +10.3%.
That was fractionally above my expectations and represents a very respectable return, however it is still far too early to assess its success or otherwise.
Do you see your hedge funds as more of a downside risk insurance, rather than pure alpha hunters?
Ideally a combination of the two. The absolute return portfolio will hopefully protect on the downside but my expectations are that it will generate alpha as well.
The industry constantly tells us this is where the skill is and uses this to justify the fees they charge! Most of the Fund’s alpha budget is allocated to alternatives, so we also expect alpha to be generated by private equity and other portfolios.
One of the more interesting parts of the absolute return portfolio is the esoteric bucket, which is basically where we place funds that don’t fit any one label.
That is quite unusual, most people want the comfort of fitting a strategy in a box.
We have always adopted a flexible approach to investing and this is why we have the esoteric bucket.
We would not turn an attractive investment opportunity away purely because it does not fit in the right box. We do not need that comfort factor, which possibly works to our advantage.
What makes a good in-house manager?
Common sense and gut instinct. Certainly a good analytical mind, the ability to stay calm under pressure and a good team player.
Career progression and succession planning are paramount and we put a lot of resources into training and development at all levels.
I suppose my own career history illustrates this, as I’ve been with the Fund for 30 years (apart from my one year consultancy sabbatical). I joined to head up settlements and oversaw the desk for a couple of years, but thought portfolio management looked really interesting.
So, I studied for the appropriate investment exams and got my qualifications. I then progressed from assistant manager, through to senior manager, prior to being appointed C.I.O.
Having experience in different areas and levels is a particularly useful insight when you are responsible for implementing the investment strategy – you tend to know what is achievable.
We do recruit fresh blood every now and then, but recruiting to the public sector is quite a challenge. Occasionally we do lose members of the team, in particular to the private equity industry.
Unfortunately it goes with the territory, though we do tend to benefit from some very productive years before they move on.
Have you ever been tempted to head off to the City?
Very occasionally. But I get great satisfaction from my role at West Midlands, despite the present challenges of local government. I also enjoy the quality of life that Birmingham offers.
That said, I’d never say never!
What do you look for in a good external manager?
Similar attributes to those required for internal managers plus the four Ps: process, people, philosophy and performance.
Finally a little smattering of humility doesn’t hurt every now and then.
Humility – that is an under used word in fund management.
That was used somewhat tongue in cheek. But, yes within reason, a bit of humility is quite a refreshing thing to find. As is the willingness to negotiate on the issue of fees.
How do you monitor your external managers?
We have regular meetings and receive quarterly reviews, but we are not there to micro-manage.
Cause for concern would include loss of the key person, a change of strategy, investment returns that are actually too high and most important of all a breakdown of trust.
Although performance is critical we are long term players, so if performance is an issue over the short to medium term, as long as we still believe in them, we will continue to support them.
The main reason behind dis-investing from funds recently has been a change of investment strategy on our part.
How does the Fund come up with its investment strategy?
The triennial actuarial valuation identifies the target return required for the Fund to meet its liabilities over the very long term and the investment strategy develops from this, which, post 2008 is re-visited annually.
The crash of 2008/09 represented a steep learning curve from my perspective and certainly re-enforced the risk associated with having an over reliance on quoted equities.
We had already started a programme of diversification, following previous actuarial valuations, so the decision to allocate to absolute return strategies was a continuation of this.
Essentially we decided to take some more risk out of the Fund by further reducing our equities.
It was interesting that hedge funds received so much bad press in 2008 although it admittedly was not just about performance. Some actually did generate a positive absolute return, very much depending on their strategy, but I believe the average hedge fund returned around -13% compared to say -30% from UK equities.
In retrospect I know where I’d have preferred to have had my money, although the non-correlation argument did become very weak.
However, not all asset classes nose dived to the degree that equities did, which re-enforced our view that diversification was still the way forward.
The director of pensions, Brian Bailey and myself did some work on the investment strategy with the Global Solutions Team at Morgan Stanley in late 2008.
In January 2009 we spent two full days with the trustees, training and explaining the rationale behind the proposed investment strategy, which they subsequently approved.
Essentially it involved further de-risking by taking another 10% out of UK equities and the introduction of the absolute return portfolio with an increase to the Fund’s allocation to emerging markets, both debt and equities.
A number of the funds we had researched gave presentations to the trustees, to give them a flavour of what would sit in the absolute return portfolio, as did an emerging market fund with a specific allocation to frontier markets.
The governance structure of the Fund is such that the trustees approve any change to investment strategy or the introduction of a new asset class, but the implementation is fully delegated to the Fund’s officers.
This allows us to embrace attractive investment opportunities without having to refer to the committee. New investments are merely reported, so by July 2009 we had 10 funds sitting in the absolute return portfolio.
You prefer to have your own staff research funds, but you still do use consultants.
We do use consultants when we need them and, yes, they do have their merits. It is very much a case of ‚horses for courses‘.
My one caveat as regards to some of the mainstream consultants is that they can have a tendency to lag behind on the ideas front.
For example we looked at and invested in emerging market debt over five years ago, well before the consultants were recommending it to their clients. Also, their recommended manager list is limited, because they are reluctant to back newer and lesser known names.
In fact this is also one of the reasons why I’m not convinced consultants are best placed to offer fiduciary management, but that’s another discussion altogether.
The lesser known managers can be more hungry to succeed, and more willing to negotiate fees.
The Fund is comfortable investing in them once due diligence has been completed.
What was the main lesson you learned from the crisis?
Don’t panic, as Corporal Jones would say. Continue to diversify and revisit your investment strategy regularly to see if it is doing what it says on the tin!