In an attempt to stay relevant in increasingly complex financial markets, more and more investment managers are thinking outside of the asset allocation box.

Janet Rabovsky, senior consultant of Watson Wyatt Worldwide, says she’s starting to see a blurring of asset classes. “Private equity managers are getting involved in real estate, hedge funds have put their money out longer and getting involved in private equity deals,” Rabovsky told attendees of the Canada Cup of Investment Management conference on Tuesday. “In three to five years we won’t be talking about asset allocation at all.”

She also sees investment managers starting to diversify their own skills. “Investment managers are starting to think broadly about what is their offering,” she says. “They’re looking at skill sets and what capabilities they have. If they can value income from a real estate property then they can value income from a toll road.”

The move toward diversified asset allocation has been increasing lately, says Rabovsky, who attributes this to more people shifting jobs. “Where people might have stayed in one type of career, they’re now moving around more and bringing skills with them.”

On the surface, this seems like a good thing. More diversity can translate into higher returns, but Rabovsky says that the trend toward mixed asset allocations has made it more complicated for pension sponsors to invest their money. “With all the new types of strategies and instruments out there, actually determining what you want to achieve and then setting an investment structure and governing that can become infinitely more complicated.”

That’s one reason why the Canadian Pension Plan has a “total portfolio view” for its investment strategy. “The CPP has been blessed where we had the opportunity to start things from scratch,” says Daniel Chiu, director of public market investments for the Canadian Pension Plan. “We don’t see asset classes in isolation, how much money should be allocated to equities, private equity or this or that.”

Instead the CPP looks at investments by risk and return, and focuses on the efficiency of the total portfolio. Currently, its portfolio holds about $116.6 billion in assets, which include 65% equities, 25% fixed income and 10% inflation-sensitive assets. According to the CPP’s recently released annual report, some of the organization’s assets are in value-added returns “expanding the range of investment programs to include private equity, real estate and infrastructure, achieving greater global diversification and implementing a variety of active investments strategies.”

Splitting from the norm to create its own investment strategy forced the CPP to develop their own reference portfolio benchmark, which they introduced last year. “This is easy to implement at a relatively low cost,” notes Chiu. “Everything runs long and short against this reference portfolio.” Right now CPP’s reference portfolio includes 25% of Canadian fixed income, 25% of Canadian equities, 40% of foreign equities and 10% of Canadian real return bonds.

The total portfolio method seems to be working for the CPP. They beat their reference portfolio benchmark by 2.5% last year.

Of course, not everyone has the resources to stay on top of the market as well as CPP, or develop a new investment model. Rabovsky says smaller or mid-sized pension plans can buy pre-packaged products that will help allocate assets for them. “If you’re trying to get away from relying simply on equity risk premium or you’re looking to do more liability matching, but you don’t want to enter the agreements that are required for the derivatives, you can buy pre-packaged products of long-bonds that might have plus sectors in them,” she says.

What’s the catch? These products don’t come cheap. Rabovsky says plans can reduce costs by buying the assets on their own, but that takes a lot of extra work.

If a plan does take the pre-packaged route, they’ll need to make up the additional price tag. “They need to make sure they’re getting compensated for extra costs,” she says. “That they’re still going to be enough coming back to them to pay for that extra cost.”

An alternative to buying pre-packaged products is going to a manager who allows plans to allocate to different asset classes. This allows plans to pick and choose where they want to invest. “They set the investment policy, instead of being based on what the managers view of the market is. It’s much more of an asset liability approach, but it’s more accessible for smaller plans.”

With so many investment methods out there, choosing the right one isn’t easy. But with more diversified investment managers, there’s no question that the landscape is changing. Rabovsky calls this “forever evolving a moving goal post.”

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rog`ers.com

(06/12/07)