Research Perspectives - Vol 5, Issue 1
This is our first issue of 2017, and it contains five articles that cover nuanced topics across various asset classes. We begin with a discussion of secured finance strategies, which have grown in popularity and variability over the last couple of years. We make a case for a multi-asset approach to secured finance.
Our second article, Seeking Returns in Private Markets, we encourage investors to consider private market investments in order to take advantage of three specific return drivers that are not available to the same extent in the public markets. We follow this with an important piece directed at investors considering a commitment to the Divest Invest pledge as a means of addressing climate change concerns within their investment portfolio. The article focuses on Mercer’s TRIP risk factor modelling framework (that is, Technology, Resource availability, Impact of physical damages, and Policy).
The fourth article, Long Horizon Equity Investing, explores two distinct styles of long-term equity investing and a framework to better measure their success. And finally, we are reintroducing the Postcard feature. In this case, Deb Clarke, Global Head of Investment Research, closes out this edition of Research Perspectives with a Postcard report from Johannesburg where she is working with colleagues at Alexander Forbes on investment issues with universal application.
The Global Economy: 2017 Outlook and Beyond
What do we foresee for 2017? As we end 2016, there are at last some signs that the global economy is starting to reflate, with slightly stronger growth and higher inflation seen in 2017. Globally, fiscal policy has started to turn more stimulative, while a recovery in emerging economies seems to be taking hold after several years of very weak growth. These reflationary signs, while welcome, will raise monetary policy challenges, with policy becoming less supportive for economic activity and financial markets. The impact of the new administration in Washington, DC, adds a new layer of uncertainty, with markets focusing on the degree of fiscal stimulus and whether trade restrictions are imposed.
2017 Themes and Opportunities
The ideas outlined in this paper represent our observations on the challenges and opportunities present in the current investment environment. We provide these ideas with the aim of provoking useful discussion, but the appropriate response at an investor-level will be heavily influenced by the specific beliefs, objectives, and constraints of each investor.
Top Priorities Checklist for DC Plan Sponsors Moving Into 2017
In a world where change is a constant, it’s important to retain vigilance over your defined contribution (DC) plans. However strong your governance structure is, all plans need to evolve with changes in legislation, regulations, industry trends and the changing needs of individuals. What may have been ideal three or five years ago may not be as ideal today.
With this in mind, we encourage DC plan fiduciaries to consider the following as we move into 2017.
Defined Benefit Top Areas of Focus for 2017
The investment environment became less certain at the end of 2016, with rising interest rates and volatile equity markets. For defined benefit plans, this has created opportunities and risks. Increasing discount rates and equity markets have improved funding ratios rapidly, moving plans back to or above their highest funding position of the year. This may present some plans with a range of opportunities, such as executing risk transfer actions or locking in gains and cutting risk. However, the prospects of increasing inflation and government spending on infrastructure could create a meaningfully different market environment than investors have faced since the financial crisis.
Top Ideas for Endowment and Foundation Investment Committees in 2017
In past years, endowment and foundation (E&F) portfolios benefited from strong equity markets, and philanthropic giving more than fully recovered from the fall experienced during the financial crisis in 2008–2009. Signs that the global economy is starting to reflate and a changing political landscape will likely lead to higher volatility, and as such, committees will revisit their investment and risk management strategies and shift further into alternative sources of alpha.
Top Considerations for Not-For-Profit Healthcare Organizations for 2017
Many providers experienced a stable operating improvement in 2016 as patient volumes grew. These organizations still face the challenge of costs growing faster than revenues and potential post-electoral changes to the Affordable Care Act. As healthcare organizations begin 2017, we believe their investment priorities will include assessing and consolidating retirement plans and taking an enterprise-level view of investment strategy and risk management.
Top Priorities for Wealth Management Firms in 2017
Regulatory changes continue to preoccupy wealth managers worldwide. At the same time, robo-advisors and leaps in fintech are changing the very fabric of the industry. How can you stand out in this increasingly complex and competitive environment?
Mercer has identified Top 10 Priorities List that wealth management advisory firms should consider in order to best serve their clients in 2017.
Top 10 Investment Ideas for Insurers in 2017
In our “Top 10 Investment Ideas for Insurers in 2016,” we warned of a possible sea change in the economic environment during 2016, with the potential for material unforeseen risks emerging at some point. While we could in no way have predicted with any conviction the dramatic change in the geopolitical environment that occurred over 2016, there is little doubt that a sea change has occurred.
Mercer has identified 10 investment ideas that we believe are pivotal to the successful management of an insurer’s assets through this period of uncertainty. We highlight the nature of the likely benefit for each idea – split between governance, financial and operational. While not all of these ideas will be appropriate for every insurer, they are intended to provoke debate around an appropriate course of action. We would be happy to discuss these ideas with you in more detail.
US Presidential and Congressional Elections – Potential Economic and Market Impact
US presidential elections have always captured the world’s attention, but this year’s election has become a global soap opera thanks to the intense media coverage and bitter tone of the campaign. The polarizing candidates will take the discussion of where America should be headed to a new level: the Democratic candidate, Hillary Clinton, under the slogan “Stronger Together,” will likely maintain the course established under the Obama administration, while the Republican candidate, Donald Trump, is pledging to “Make America Great Again,” indicating that fundamental change would be his course of action.
This paper reflects our view today, discusses recent polls, current dynamics, long-term themes, and addresses impacts for investors.
Robo-Advice and Its Impact on Wealth Management
Given the rapid growth of robo-advisory firms, some have questioned whether robo-advisors will replace human advisors. Because creating and/or purchasing a robo-advisor has become an attractive solution for the traditional firms that want to gather assets through digital advice platforms, we believe that human wealth advisors will not be replaced by technology; we feel that human interaction will always have a place in the wealth management business. Although computer models can provide the “right” answer based on a questionnaire, they are not developed enough to read body language, assist in the prioritization of goals or uncover potential considerations that may alter the optimal investment allocation. Particularly for more complex clients, there is typically a need for human response to dig deeper to truly understand an individual’s investment objectives and to address subtleties that typically arise in human conversation.
Trillion Dollar Transformation – Climate Change Investment Risk Management for US Public Defined Benefit Plan Trustees
The purpose of this paper is to provide an overview of climate change investment risks and opportunities for US public pension trustees, and introduce both quantitative and governance frameworks that trustees can use to approach climate change as an investment risk (as opposed to a nebulous uncertainty) and inform related tangible actions.
Building a Bridge to Sustainable Infrastructure
Learn about the importance of sustainable infrastructure, challenges you may face in coordinating investment for sustainable infrastructure projects, and potential solutions to alleviate current obstacles.
Access the full report to learn about the global ecosystem of initiatives focused on overcoming obstacles to investment in sustainable infrastructure—and how to use them to address the sustainable investment funding gap.
How Low Can You Go? An Introduction to Low Carbon and Fossil Free Passive Equity
What led to the emergence of low carbon and fossil-free indices? While climate change has long been on the world’s radar from an environmental point of view, now investors must consider its impact on their portfolios as well.
Mercer’s recent study Investing in a Time of Climate Change highlighted that investors should consider the risks posed by climate change — in particular, policy risks. Following the positive outcomes of the recent meeting of global leaders in Paris, where a new global agreement to manage carbon emissions and tackle climate change was reached, we anticipate that the policy response to managing climate change will become more urgent in the coming years.
High Yield and Distressed Debt
The year 2015 was one that most corporate credit investors would like to forget. Marked by severe volatility, deterioration in credit quality, and quite possibly a new paradigm for the price of liquidity, all US-based leveraged credit indices finished in the red, posting the worst returns since the 2008 crisis. Selling momentum was strong and a second consecutive year of outflows from the asset class has left spreads on the edge of pricing in a global recession. In Europe, the high-yield bond and leveraged loans markets outperformed risky US distressed debt.
Despite the uncertainty and volatility in credit markets, we believe it is an exciting time in which investors should focus on the risk and return characteristics of the underlying assets rather than just the structure and liquidity terms of the holding vehicle itself.
The Role of Alternative Investments
Alternative investments is an umbrella term encompassing a wide variety of investments and strategies that can offer enhanced return opportunities, diversification and/or some measure of inflation protection to investors. We believe that the key to successfully capturing these benefits is dependent upon conducting thorough due diligence on each potential alternative investment opportunity, and then building a well-diversified alternatives portfolio.
Infrastructure - A Primer
Infrastructure is an asset class that can serve as a powerful addition to many investment portfolios and it continues to gain greater acceptance from institutional investors. Against this, it is often oversimplified and/or poorly understood by institutional investors at the expense of effective portfolio construction.
This house view aims to define the types of assets that represent infrastructure and discusses how to invest in the asset class effectively. To be a successful long-term investor in unlisted infrastructure (the primary focus of this paper) requires an appreciation of the range of alternatives across the asset class, detailed upfront due diligence of investments made and effective portfolio diversification. At the same time, there are many ways to invest, including options for overcoming the governance burden that building a direct-fund program can pose, and investors should consider their own circumstances and preferences before deciding how to proceed.
Ebb and Flow of the Hedge Fund Industry
Based on articles in numerous periodicals and given the actions of a few prominent investors, it would be easy to view 2015 as a forgettable year for the hedge fund industry. Uncertainty in China, dramatic downward pressure on commodity prices, shifts in federal policy, and other factors rolled the capital markets during the second half of the year. Such instability seemingly should have been of benefit to hedge funds given their supposed idyiosyncratic approaches and their ability to be short to capture return while others are suffering losses. So, on the surface, it was somewhat surprising that the year ended on an uninspiring note for hedge funds as a whole, with the average portfolio declining slightly. Year-end 2015 also marked the first quarterly outflows from hedge funds since the fourth quarter of 2011 — and the largest number of fund closures in any year since the financial crisis. As a result, we believe it is appropriate to address many of these concerns specifically.
Beta-Heavy Multi-Asset: Weighing You Down?
Multi-asset investing, or allocating to one manager with the flexibility to invest across a range of asset classes, has evolved significantly over the past few decades. The universe of multi-asset strategies is a broad spectrum, ranging from traditional long-only funds to some that start to resemble hedge funds.
The focus of this paper is on multi-asset strategies that rely heavily on market returns across the major equity and bond markets (“beta”) as the key driver of return, with relatively little active management overlay, resulting in fairly static asset allocations.
How to Be a More Opportunistic Investor
The relatively stable market environment of 2013 through mid-2015 gave way to a period of market volatility in the third quarter of 2015, as concerns over the growth outlook in China and the prospects of Fed rate hikes destabilized risky assets globally. This volatility has continued in 2016, and we expect to see more such disruptions in the coming years as market participants react (and overreact) to ongoing macro uncertainty. Meanwhile, low interest rates and above-average equity valuations present a challenging environment to meet long-term return objectives, making alpha generation all the more important. An opportunistic approach to investing can take advantage of market volatility and mispricings to add alpha at the total portfolio level.
Hedge Funds 101
Alternative investment strategies seek to achieve positive returns by pursuing investments that are outside the traditional long-only portfolios of equities and fixed income.
Many of these strategies have low correlations to traditional stock and bond asset classes, which helps improve return potential compared with traditional-only portfolios at equivalent risk levels. The popularity of alternatives has grown rapidly since the 2008 financial crisis. According to Prequin alternative assets under management stands at $7 trillion in 2015.
Small but Not Irrelevant – Small Caps Within a Global Equity Portfolio
Investors commonly neglect a segment of the investment universe with one of the most promising amalgamations of alpha and beta: small-capitalization equities (small caps). This is remarkable given the opportunity for excess returns and diversification presented by actively managed small-cap exposure.
Real Assets - Real Environmental Risk
In a low-yield environment, investors seek alternatives to bolster their long-term-risk-adjusted returns. Real assets — investments tied directly to tangible properties, generally in the real estate, infrastructure, and natural resource sectors — offer one such alternative, which is becoming increasingly attractive to investors. However, such investments are not without risk and are on the front lines of climate change given their direct exposure to extreme weather and their reliance on functional and efficient insurance markets for financing. Here’s how Mercer, in conjunction with Marsh, can help investors manage such risk.
Investing in a Time of Climate Change: Post COP21 Update
The 21st UN Climate Change ‘Conference of the Parties’ (COP21) in Paris concluded with a landmark agreement celebrated worldwide. Mercer contributed to this ‘Paris Agreement’ through our Investing in a Time of Climate Change report, and we’ve pledged to do more.
Mercer is a leading thinker on integrating climate considerations within modern investment practice. For the first time nearly every country in the worlds has committed to lowering greenhouse gas emissions to a level that should keep a global temperature rise well below 2°C this century. This increases ‘climate transition’ risk and opportunity for investors – a combination of development in climate policy and technology. These are two of the four climate risk factors included in Mercer’s TRIP climate risk framework. This Dispatch explains the Paris Agreement and considers its implications for investors.
Understanding Absolute Return Fixed Income – A Primer
Mercer continues to support the role of growth fixed income assets as part of a well-diversified and balanced growth portfolio. The focus of this paper will be on absolute return fixed income, which can act as a useful diversifier within growth-fixed income portfolios. Specifically, this paper will re-introduce the strategy and its investment rationale, provide an overview of the different investment approaches/styles adopted by managers in the universe, and consider the case for absolute return approaches in the current environment; it concludes with thoughts on how investors might access these strategies.
A Broader Perspective on Risk
Today’s highly quantitative risk management industry is the product of the simultaneous advances in computing power and finance theory we have seen since the 1960s. Exponential increases in computation speeds have allowed academics and practitioners to create a wide range of mathematical models able to process vast amounts of historical data and develop numerous projections of the future. Although they are undoubtedly helpful when used appropriately, the resulting tools (now ubiquitous across the industry) have led to an over-reliance on numerical estimates of risk. The language of risk is dominated by the terms “volatility” and “value at risk,” creating an unintended blind spot in relation to risks or trends that are inherently difficult to measure or quantify.
The Role of Liquid Alternatives in Wealth Management
It’s no secret that investors are looking for uncorrelated return sources for their portfolios. Low interest rates and the experience of the global financial crisis are leading many to include “liquid alternatives” in their toolbox. At Mercer, we define liquid alternatives broadly as strategies that follow alternative strategies, such as those typically used by hedge funds, and that are available as commingled/pooled funds that trade at least weekly.
Understanding Private Equity – A Primer
In this paper we will review some basic asset class characteristics, the return expectations, return drivers, evidence of outperformance, implementation considerations, and discuss the optimal use of private equity in a portfolio. Because private equity investing involves some concepts not found in other asset classes, we have provided a glossary of terms at the end of this paper.
Why we believe The Economist is wrong about hedge funds
The Economist published an article in its August 1 edition, titled “Fatal Distraction,” arguing that pension schemes are making a mistake in employing hedge funds to manage assets on their behalf: “For the pension schemes that are the hedgies’ latest target, handing over cash makes no sense.” Many of the arguments used in the article are open to debate and we would urge institutional investors to challenge their conclusions.
Low Volatility Equities and High Valuations
In 2010 Mercer issued guidance recommending that clients have an explicit allocation to low volatility equities. Since then equity markets have risen significantly, and despite these strong market returns, low volatility equities have kept pace with the broader market.
Risk Premia Investing – From the Traditional to Alternatives
In this paper we provide an overview of the risk premia concept and focus on a set of liquid “alternative” (or non-traditional) risk premia in particular.
An Investment Framework for Sustainable Growth
In Mercer's Investment Framework for Sustainable Growth, we distinguish between the financial implications associated with ESG factors, and the growth opportunities in industries most directly affected by sustainability issues. Mitigating emerging risks requires flexibility, foresight, and fresh thinking about risk management and capitalize on new opportunities.
The Pursuit of Sustainable Returns - Sustainability by Asset Class
Mercer's portfolio reference guide, 'The Pursuit of Sustainable Returns: Integrating Environmental, Social, and Corporate Governance Factors and Sustainability by Asset Class' outlines the drivers for addressing sustainable growth trends at a portfolio level for each major asset class.
Multi-Asset Strategies – An Overview of the Choices
Multi-asset strategies have seen a surge in popularity over recent years. Liquidity, simplicity, and relatively low fees have made them attractive components of defined contribution pension schemes, as well as appealing to smaller institutional investors for whom governance issues are a key consideration.
Building Equity Portfolios with Style
Much has been written recently about “smart beta,” “advanced beta,” “intelligent indexing,” and various other buzzwords — broad terms that are not always well-defined. Looking beneath these catchy titles, Mercer believes that it is important to focus on the underlying drivers of return and how this can help investors with constructing and monitoring their portfolios.
Private Capital: Getting the Governance Fund Right
A commitment to a private capital fund is the beginning of a long-term relationship and requires strong conviction in the manager’s skills and considerable trust on behalf of investors. Detailed due diligence on the capability of the manager is critical. An evaluation of a fund should extend to an assessment of the fund’s commercial terms and the strength of the manager’s alignment of interests with investors.
Multi-Asset Strategies – Redefining the Universe
Loved by many, reviled by others, multi-asset strategies are undeniably a key feature of the investment landscape. In the US they are typically known as balanced strategies; in Europe and other parts of the world investors have been enticed by a category of investments known as "diversified growth funds". Whatever the label, however, the variety of strategies is broadening across the globe.
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