Long-term asset owners should drop their advisor-driven obsession with volatility and focus instead on forecasting returns says Stefan Dunatov, Chief Investment Officer at Coal Pension Trustees, which runs £20bn (€25.2bn) for the closed Mineworkers’ Pension Scheme and the British Coal Staff Superannuation Scheme in the UK.
“Forecasting returns, not risk, should sit at the heart of long-term investors’ asset allocation strategy,” Dunatov writes in a brief paper for the 300 Club, the senior level investment think tank founded by Hermes Fund Managers Chief Executive Saker Nusseibeh.
Dunatov – a former director at Deutsche Asset Management – argues that the investment industry not only fails to identify the right risks but measures them the wrong way. Using volatility as a measure of risk has “potentially dangerous implications” for long- term investors.
He goes on: “Asset owners have allowed the providers of investment services, including investment managers and consultants, to dictate the approach asset owners should adopt.
“External advisers naturally prefer to work with an easily-definable measure that is common to many clients. Their solution has been to replace the traditional focus on forecasting returns and all its difficulties with a short-term metric of volatility to forecast risk, which appears to be a more tractable measure.
“This touches on a separate key issue the industry also has to grapple with: a lack of alignment of interests between the asset owners, consultants and asset managers.”
He adds: “Like the assumption that markets are efficient, the assumption that volatility is a good measure of risk is clearly wrong.”By “succumbing” to their providers’ focus on short-term risk instead of long-term objectives, investors are missing the premium they can get from illiquidity: “This undermines the premise of being a patient, long-term investor.”
“It undermines the premise of being a patient, long-term investor”
The comments come as the Principles for Responsible Investment initiative has launched a discussion paper looking at long-termism and mandates. It follows the formation of a policy and research steering committee last year on the topic, comprising representatives of leading asset owners.
They include James Andrus (California Public Employees’ Retirement System), Justin Atkinson (Alliance Trust), Helena Charrier (Caisse des Dépôts et Consignations), Louise Davidson (Cbus Superannuation Fund), Kris Douma (MN Services), Claudia Kruse/Zöhre Tali (APG Asset Management), Mark Mansley (Environment Agency Pension Fund), and Bryan Thomson (British Columbia Investment Management Corporation).
The aim is to “accelerate the shift from analysis to implementation” of long-termism – to achieve long-term sustainable returns and improve system wide capital allocation, the PRI says. The initiative is calling for case studies and academic research to be emailed to email@example.com by September 12. It’s the latest attempt to wrestle with the issue, which goes back more than a decade to a competition in 2003 launched by the Universities Superannuation Scheme and the consultants then known as Hewitt Bacon & Woodrow.