NID 2011 Debrief

 

The unprecedented financial upheaval of 2008 was a wakeup call for institutional investors.  Panic gave way to relief during the ensuing years as markets rallied and government stimulus programs took effect around the globe.  The subsequent rebound was so pronounced that some felt it might even risk erasing the important memories and lessons from the crisis.  Thus, in their June 2010 annual symposium, members of the Niagara Institutional Dialogue pointedly asked themselves “Have we learned anything?”

 

A year later, relief had turned to unease in many quarters as fears grow that the volatility experienced by global financial markets may have been the first ominous signs of deeper structural faults.  Despite the common belief that booms invariably lead to busts, could the financial crisis of 2008 have been a symptom of longer-term secular, rather than classical cyclical, pressures on the global financial system?  Should policy makers intervene with sweeping new measures to “protect” pension plans?   These questions and others were addressed at the 2011 Annual Meeting of the Niagara Institutional Dialogue.

 

Geopolitical and Macroeconomic Threats

 

The gathering began with a review of major threats to the world economy with University of Chicago’s Raghuram Rajan, chosen by readers of The Economist as having the “most important ideas in the post-crisis world.”  Rajan’s book “Fault Lines: How Hidden Fractures Still Threaten the World Economy” (2010) was the recent winner of the Financial Times/Goldman Sachs Business Book Award.

David Rosenberg, the Chief Economist at Gluskin Sheff & Associates echoed Professor Rajan’s warnings and applied them to various investment themes facing Canadian institutions.

One of these threats is a dramatic demographic transition facing pension plans.  Over the next 40 years, demographic shifts will have implications for economic growth and living standards, as well as influencing government policies on tax, labour markets and the broader regulatory framework.   However, in spite of the potential magnitude of these changes, the complex impact of demographic change on the global economy is often poorly understood.   Virginie Maisonneuve, Head of Global & International Equities at Schroders Investment Management explained to the gathering that these demographic trends are regarded as very long-term in nature, thus most investors neglect to include them in their analysis of companies’ operating environments and earnings sustainability.

Similarly, climate change has traditionally been viewed as a social or geo-political issue.   But as consumers adjust their behaviours and policymakers respond to growing social pressures, economic and financial issues that once seemed distant now confront investors head-on.  Ron Dembo, founder of ZeroFootprint and Elisabeth Bourqui, head of Mercer’s Responsible Investing Practice in Canada discussed whether traditional approaches to strategic asset allocation adequately integrate these changes.

 

Alternative Investments

 

As institutional investors seek new sources of alpha, the topic of alternative investments was a recurring theme at this year’s annual gathering.

Often policymakers defer to somewhat biased research in their deliberations on hedge funds, resulting in policies that often appear to be motivated by populist rhetoric rather than sound analysis.  Hence the popular perception of hedge funds as “locusts” that strip companies to the bare stalks before moving on for another meal elsewhere.   Sebastain Mallaby, the Paul A. Volcker senior fellow for international economics at the Council on Foreign Relations took a somewhat contrarian view that hedge funds weren’t actually locusts, they were “firefighters” that help allocate capital efficiently.  Mallaby also discussed his latest book on the history of the hedge fund industry.

Deepak Gurnani, the head of hedge funds at Investco, the largest alternative investment manager in the Middle East reviewed proprietary research showing tantalizing signs that hedge funds can be mechanically replicated.

Global economic and geopolitical volatility gives rise to new risks for traditional fund managers.  But it also gives rise to new opportunities for managers who rely on alpha (such as hedge funds), not beta for their returns.  Lionel Erdely, the CEO of Lyxor Asset Management USA was joined by Barry Allan, founder of Marret Asset Management, one of Canada’s largest hedge fund managers, David Franklin, CEO of Sprott Private Wealth and Rob Jackson, Chief Risk Officer of Highstreet Asset Management, to explore investment themes that both mitigate against, and exploit, these new risk factors.

One strategy that often received little attention is currency management.  Currency management is often an afterthought in the decision process of global investors. This is both a missed opportunity and a serious peril. Global opportunities imply currency risk to which an investor must decide if and how it wishes to manage this exposure.  An active approach to this one quadrillion dollar per annum market has often been a rewarding strategy.  Adnan Akant, Head of Currencies, Fischer, Francis Tress & Watts, told the gathering that recent analysis of long-run currency manager performance shows evidence of alpha and beta factors in excess returns, and suggests approaches for selecting active managers.   Adrian Hussey, Director, Portfolio Research & Analysis at University of Toronto Management (UTAM) joined him and provided a framework for dynamic hedging of the Canadian dollar.

Jeff Pentland, Managing Director at Canada’s largest private equity firm, Northleaf Capital Partners, reviewed recent developments in private equity and Josh Parker of Gargoyle, one of the largest options trading firms in the United States discussed tail risk management using various options strategies.

 

Challenging Financial Orthodoxy

 

Several sessions at this year’s Dialogue challenged traditional financial theory.  Blackrock’s Kevin Kneafsey challenged one of the foundations of Modern Portfolio Theory - diversification.  Doug Gratz of Research Affiliates presented several reasons to reject the typical 60/40 allocations made by institutional investors.  And William Shadwick, creator of the widely-used “Omega Statistic” suggested that while market-timing may not be possible, “risk-timing” could dramatically reduce tail risks.

 

Systemic Risk

 

There seems to be almost universal contempt for the performance of risk management in the 2008 crisis, though much of the blame rests with a failure on the one hand to understand the objectives and the limitations of risk management and with an unwillingness to take action to rein in risks when there were recognized.   Richard Bookstaber, author of “Demon of Our Own Design” (2008) reflected on his experiences as both a regulator and a hedge fund manager to present ideas on how we can better apply risk management techniques to respond to ongoing systemic threats.

Larry Harris, of the University of Southern California’s Marshall School of Business and noted financial commentator Steve Wunsch followed Bookstaber’s remarks by engaging in a spirited debate over the SEC’s attempts to mitigate systemic risk through its National Market System.

 

Tying it all together

 

In keeping with the objectives of the Niagara Institutional Dialogue, Bill Moriarty, CEO of UTAM integrated many of the themes covered in the meeting when he proposed a “Yale Model” of endowment management tailored to the Canadian environment.

Noted pension researcher, author and consultant Keith Ambachtsheer draws on his 40 year career to share his views on how Canadian pension plans can adapt to a changing landscape.  Ambachtsheer was interviewed by Don Ezra, Co-Chair, Global Consulting, Russell Investments.

 

Following each day’s sessions, participants took full advantage of structured evening social activities to further explore the ideas, theories and proposals presented in the official program.