Late last month Martin Surguy, a top investment manager from Deutsche Bank Private, one of the largest private banks in the world, arrived in Dublin to meet a group of pension fund trustees and other investors in the St Stephen's Green offices of their local partners, Key Capital Private (KCP).
Surguy was in town to pitch his €2bn "unconstrained" portfolio, a managed fund originally aimed at the exclusive private wealth segment, but which Deutsche and KCP think might be of value to battered pension funds looking for a shelter from the recessionary storm. The fund, which uses active asset allocation to smooth volatility and preserve wealth, has attracted €750m in new money this year as clients switch their focus from maximising return to minimising risk.
According to sources at the meeting, he found an audience more than a little disillusioned with the performance of their existing Irish managers,
who, at the very least, thought Deutsche's proposition was worth a serious look, if not worth switching to. In other words, there's a big shark swimming in Irish waters ready to eat the local lunch.
Now, Deutsche isn't exactly going to sweep into town and hoover up the €90bn in assets Irish firms manage on behalf of pension funds tomorrow, but the German bank's interest in the market here suggests there is an opportunity to exploit – one that local fund managers could be ignoring at their peril.
It's no secret that Irish pension fund performance has been dismal in recent years. According to pension specialists Rubicon Investment Consulting, the average managed fund return has been a grim -9.2% per year over the past three years. The five-year returns to the end of May are also negative, with the average managed fund delivering a return of -0.3% per annum over this period. Irish group pension managed fund returns over the past 10 years have returned only 0.2% per year on average, well below the annual inflation rate of 3.3% over the same period. In fact, none of the managers surveyed by Rubicon outperformed inflation over that period.
In contrast, Deutsche's Unconstrained Fund boasts a 13% cumulative return since June 2004. It has lost -9.2% in the year to the end of April 2009 – the same as the Irish three-year average – but that damage is limited when compared to the -27% loss measured by the Hewitt Irish Managed Fund Index, which aggregates returns from the entire Irish fund market.
Why the big difference? The key reason is asset allocation: Deutsche follows the Continental model, which is risk-averse and geared towards bonds, while the typical Irish fund is heavy on riskier and more volatile equities. Also, where most Irish fund managers would use static, pre-defined allocations among asset classes, the Deutsche philosophy is to constantly adjust weightings to match market circumstances. The result is a smoother, more predictable return curve which looks especially attractive in the current volatile environment.
"This approach was evolved for private clients who had made their money and wanted wealth preservation," said Key Capital Private director Rory Mason. "But we eventually saw it as a solution for other things and that it might be of value for pension funds compared to the way things were done in the past."
Wealth preservation through asset diversification is an idea that's been around for a while, and one that global investment consultants working in Ireland have been pushing, too. But Irish fund managers tend to benchmark against each other rather than against a wide array of peers or indexes, which leads to consensus investing. Ergo, not a whole lot of real choice, which is reflected in the depressingly consistent poor returns through the downturn.
"We've been advising clients for a number of years to manage risk through a well-diversified investment portfolio that minimises the downside," said Michael Curtain, senior investment consultant with Mercer in Dublin. "There is a misperception amongst some investors that spreading investments across managers is the same as diversification."
The problem is that "asset diversification" in an Irish context still means an overwhelming imbalance in favour of equities, including relatively heavy weightings in Irish-listed shares.
The €8bn-€10bn overall recovery in Irish managed pension funds last month, attributable exclusively to a bear rally in global equity markets, reveals just how much Irish pensions depend on stock prices. Obviously, this boost is most welcome – and it's a boost that Deutsche's conservative fund did not enjoy – but if we have learned nothing else from the market volatility of the last two years, it is that even spectacular gains like this can quickly be wiped out by a dose of bad news. Just ask anyone who invested in an Irish scavenger fund in late 2007 when the Iseq looked set to rebound from a "low" of 6,500.
The Iseq's encouraging 3.8% gain in May will give another boost to fund managers with disproportionate exposures to Irish shares, but these gains mask the main structural problem with Irish pension funds: they are essentially stock portfolios leavened with some bonds and property. Even after the hammering stocks have taken in the past two years, the average Irish pension fund manager still allots 65% of assets to equities, according the latest research by Watson Wyatt. Surguy's team is only about 20% in equities, with a broad mix of corporate bonds, commodities, cash and metals making up the rest.
Mercer is "particularly keen" on investment-grade or high-quality corporate bonds, according to Curtin. Likewise, international fund heavyweight Pioneer, which has its European headquarters in Dublin, has been promoting a major shift into this asset class to help bridge the giant funding gap faced by 90% of Irish pensions.
It's no coincidence that this non-consensus thinking is shared by international firms at work in Ireland. Industry sources say Irish fund managers have been vulnerable for years to new approaches from outside. Even though use of international advisors and managers is increasing, the local players still dominate the market. And so the bias towards growth and equities at the expense of diversification and wealth protection continues.