"Genuine all-rounders are rare," states Cardano's Steve Catchpole as he likens pension fund assets to cricket players.
The England cricket team's recent Test series in India included many successes for the tourists and culminated in their first series win there since 1985. There were fine contributions from many players but, unfortunately for him, not from Samit Patel. Poor Samit was selected to play on the side because he was considered to be an 'all-rounder'; a player capable of making a contribution with both bat and ball. Genuine all-rounders are rare, as batting and bowling are quite different arts and few players are worth a place in the side as both a specialist batsman and specialist bowler.
If such a player can be found then they are very precious indeed, as it is like having an extra player in the team. As a result, many sides select a player who is quite good at both batting and bowling but who, in reality, is not quite good enough at either of them to be in a Test team. Samit Patel scored just 69 runs in the first three Tests and took a solitary wicket before being dropped for the final match.
What does all this have to do with pension fund investing? Broadly speaking, pension funds require two types of assets; return seeking assets (the 'batsmen') and liability matching assets (the 'bowlers'). Pension trustees would love to be able to select an 'all-rounder', an asset that can generate superior returns as well as match liabilities but unfortunately these are very hard to find. There have been several candidates put forward by consultants and managers in recent years; for example long dated corporate bonds, long lease property, ground rent funds, and infrastructure funds.
In many cases these assets suffer from the Samit Patel problem – they are not really good enough at either liability matching or return generation to warrant a place in the portfolio on the basis of one of these qualities alone. Instead they are selected because they offer a bit of both and capital is scarce. However, this approach doesn't take into account the fact that pension fund trustees can 'cheat' in their team selection by using a Liability Driven Investment (LDI) overlay strategy. This allows trustees to match their liabilities very closely using only 30%-40% of their assets, meaning that they can effectively 'play an extra batsman' and select the best 'batsman' from a broader universe of equity, credit, private equity and real estate assets.
These funds can be chosen purely for their return and reliability characteristics, rather than from those that offer some imperfect liability matching. The England cricket team will continue their search for the next 'genuine all-rounder', but trustees can focus on the easier task of finding the next star batsman.
Written by Steve Catchpole, senior client manager, Cardano
