An Absolute Return for Your Pension

Adapting an Institutional Concept for Pension Distributions

Feb 15, 2009

Major institutional investors are adapting the "absolute return" concept in increasing numbers in their asset allocation models and strategies - perhaps you can too.

World class size pension plans as well as endowments and foundations are adapting the concept of "absolute return" for a portion of their overall asset allocation. Depending on your level of affluence, perhaps you can do the same with your pension distribution funds.

What is an Absolute Return Strategy?

Definitions can vary but a generally accepted one for "absolute return" is a class of assets that have low volatility, show consistent returns, offer downside protection and more often than not are "non-correlated" to the overall market or particular benchmark or measure of the market.

In a nutshell, these assets are very often "alternative" in nature, such as hedge funds, funds-of-funds, commodity trading advisors or pool operators, leases and so forth. Other types of alternative assets for an absolute return strategy might be private equity, real estate or natural resources. Any one of these assets would fall into the absolute return category as they are not linked to a benchmark.

Suitability

Suitability of any of the above assets for investment is very critical as none of the above asset classes are intended for investors of modest means. Yes, your pension plan most likely uses them but that does not mean you should. These asset classes can be quite risky (or not) and the level of transparency in some cases leaves a lot to be desired.

For example, while commodity trading advisors participate in exchange traded contracts and are quite transparent, many hedge funds are involved in over-the-counter, dealer traded assets that are not. The bottom line for any investment in these type of assets is caveat emptor – let the buyer beware.

How Much is Enough?

Asset allocation for anyone is very much a matter of suitability and temperament. Allocation among institutional investors can vary widely. For example, while endowments or foundations tend to be more aggressive, pension funds opt to be more conservative. According to research conducted by the world class consulting firm Greenwich Associates, asset allocation between these groups can be as little as 2% to 30% with targets generally seen as increasing to 10% to 45%.

Target Returns

While these large institutional investors dedicate a portion of their funds to absolute return strategies because of their non-correlation to a benchmark, they never-the-less have to have a target return. That target very often floats, such as Treasury Bills (or what ever sovereign debt you choose) + 5%, LIBOR (London Interbank Offered Rate) + 3% or perhaps an equity index (S&P 500, Financial Times, DAX, CAC, Nikkie, etc.) + X number of basis points.

It is important to view investments in these assets classes as well as the managers running them over the long term. Even a year or two is too short a period to accurately judge a manager. Five years or even 10 are not an usual length of time to examine a manager’s performance. Remember, you’re looking for non-correlated returns, less volatility and perhaps a measure of downside protection.

The copyright of the article An Absolute Return for Your Pension in Portfolio Management is owned by Dean Lundell. Permission to republish An Absolute Return for Your Pension in print or online must be granted by the author in writing.