Latest Research and Publications
Research Perspectives - Vol 4, Issue 1
This issue of Research Perspectives presents a variety of topics across multiple asset classes. We begin with a piece that embodies one of our continuing themes — “Tilting from ‘Beta’ to ‘Alpha’” and recommend that investors which not facing significant fee and governance constraints consider reviewing allocations to beta-heavy multi-asset strategies. We follow that with a practical example that makes the case for total-return-oriented emerging market debt strategies that are less benchmark specific. The third article takes a closer look at activist investing.
This edition also features an article on the importance of a broad understanding of portfolio risks; specifically, the kind that can’t be effectively measured quantitatively. For our fifth piece, we return to the debt markets, but this time, it’s to consider investment in two other hard-hit segments (high-yield and distressed), particularly in the US. We close with an article titled “The Color of Asset Management,” which takes a lighter look at the use of colors in the names and logos of investment management firms.
Ebb and Flow of the Hedge Fund Industry
Based on articles in numerous periodicals and given the actions of a few prominent investors, it would be easy to view 2015 as a forgettable year for the hedge fund industry. Uncertainty in China, dramatic downward pressure on commodity prices, shifts in federal policy, and other factors rolled the capital markets during the second half of the year. Such instability seemingly should have been of benefit to hedge funds given their supposed idyiosyncratic approaches and their ability to be short to capture return while others are suffering losses. So, on the surface, it was somewhat surprising that the year ended on an uninspiring note for hedge funds as a whole, with the average portfolio declining slightly. Year-end 2015 also marked the first quarterly outflows from hedge funds since the fourth quarter of 2011 — and the largest number of fund closures in any year since the financial crisis. As a result, we believe it is appropriate to address many of these concerns specifically.
Beta-Heavy Multi-Asset: Weighing You Down?
Multi-asset investing, or allocating to one manager with the flexibility to invest across a range of asset classes, has evolved significantly over the past few decades. The universe of multi-asset strategies is a broad spectrum, ranging from traditional long-only funds to some that start to resemble hedge funds.
The focus of this paper is on multi-asset strategies that rely heavily on market returns across the major equity and bond markets (“beta”) as the key driver of return, with relatively little active management overlay, resulting in fairly static asset allocations.
How Low Can You Go? – An Introduction to Low Carbon and Fossil Free Passive Equity
Investors are increasingly looking to manage the carbon exposure of their portfolios in a world in which the cost of carbon is likely to rise. Multiple low carbon and fossil free indices have recently emerged as a potential risk management tool to enable investors to passively reduce their carbon exposure. These indices aim to track broad market indices whilst providing the potential for outperformance if policy measures develop to reward lower carbon activities. The following paper aims to:
- Introduce low carbon and fossil free indices,
- offer an overview of the different index approaches,
- present Mercer’s investment view on the use of these indices, and
- help investors determine the most suitable index for their needs.
High Yield and Distressed Debt – Where are we, where are we going, and how do we get there?
The year 2015 was one that most corporate credit investors would like to forget. Marked by severe volatility, deterioration in credit quality, and quite possibly a new paradigm for the price of liquidity, all US-based leveraged credit indices finished in the red, posting the worst returns since the 2008 crisis. Selling momentum was strong and a second consecutive year of outflows from the asset class has left spreads on the edge of pricing in a global recession.
Despite the uncertainty and volatility in credit markets, we believe it is an exciting time in which investors should focus on the risk and return characteristics of the underlying assets rather than just the structure and liquidity terms of the holding vehicle itself. This paper helps to assess today’s credit markets and opportunity set while taking into account return objectives, liquidity budget, time horizon, and threshold for mark-to-market losses.
How to Be a More Opportunistic Investor
The relatively stable market environment of 2013 through mid-2015 gave way to a period of market volatility in the third quarter of 2015, as concerns over the growth outlook in China and the prospects of Fed rate hikes destabilized risky assets globally. This volatility has continued in 2016, and we expect to see more such disruptions in the coming years as market participants react (and overreact) to ongoing macro uncertainty. Meanwhile, low interest rates and above-average equity valuations present a challenging environment to meet long-term return objectives, making alpha generation all the more important. An opportunistic approach to investing can take advantage of market volatility and mispricings to add alpha at the total portfolio level.
Hedge Funds 101
Alternative investment strategies seek to achieve positive returns by pursuing investments that are outside the traditional long-only portfolios of equities and fixed income.
Many of these strategies have low correlations to traditional stock and bond asset classes, which helps improve return potential compared with traditional-only portfolios at equivalent risk levels. The popularity of alternatives has grown rapidly since the 2008 financial crisis. According to Prequin alternative assets under management stands at $7 trillion in 2015.
Small but Not Irrelevant – Small Caps Within a Global Equity Portfolio
Investors commonly neglect a segment of the investment universe with one of the most promising amalgamations of alpha and beta: small-capitalization equities (small caps). This is remarkable given the opportunity for excess returns and diversification presented by actively managed small-cap exposure.
Real Assets - Real Environmental Risk
In a low-yield environment, investors seek alternatives to bolster their long-term-risk-adjusted returns. Real assets — investments tied directly to tangible properties, generally in the real estate, infrastructure, and natural resource sectors — offer one such alternative, which is becoming increasingly attractive to investors. However, such investments are not without risk and are on the front lines of climate change given their direct exposure to extreme weather and their reliance on functional and efficient insurance markets for financing. Here’s how Mercer, in conjunction with Marsh, can help investors manage such risk.
The Global Economy: 2016 Outlook and Beyond
What do we foresee for 2016? We continue to expect the developed world economy to grow at an above-trend pace, having mostly resolved the key issues that depressed growth over the last few years: fiscal tightening, weak banking systems, risk of eurozone collapse, and corporate- and personal-sector deleveraging.
But there are risks on the horizon, too. 2015 marks the year the Fed raised rates for the first time in over a decade. How quickly will the Fed continue raise rates, and how will that affect financial markets and the economies of developing countries? We expect the impact would be significant.
2016 Themes and Opportunities
As we enter 2016, investors are faced with many sources of uncertainty in the economic and political environment, from the international refugee crisis to China’s rapid deceleration. Despite these volatilities and conflicts, investors can look forward to substantial opportunities in 2016—if armed with the right strategies.
The ideas outlined in this paper represent our observations on the challenges and opportunities present in the current investment environment. We provide these ideas with the aim of provoking useful discussion, but the appropriate response at an investor-level will be heavily influenced by the specific beliefs, objectives, and constraints of each investor.
Investing in a Time of Climate Change: Post COP21 Update
The 21st UN Climate Change ‘Conference of the Parties’ (COP21) in Paris concluded with a landmark agreement celebrated worldwide. Mercer contributed to this ‘Paris Agreement’ through our Investing in a Time of Climate Change report, and we’ve pledged to do more.
Mercer is a leading thinker on integrating climate considerations within modern investment practice. For the first time nearly every country in the worlds has committed to lowering greenhouse gas emissions to a level that should keep a global temperature rise well below 2°C this century. This increases ‘climate transition’ risk and opportunity for investors – a combination of development in climate policy and technology. These are two of the four climate risk factors included in Mercer’s TRIP climate risk framework. This Dispatch explains the Paris Agreement and considers its implications for investors.
Understanding Absolute Return Fixed Income – A Primer
Mercer continues to support the role of growth fixed income assets as part of a well-diversified and balanced growth portfolio. The focus of this paper will be on absolute return fixed income, which can act as a useful diversifier within growth-fixed income portfolios. Specifically, this paper will re-introduce the strategy and its investment rationale, provide an overview of the different investment approaches/styles adopted by managers in the universe, and consider the case for absolute return approaches in the current environment; it concludes with thoughts on how investors might access these strategies.
A Broader Perspective on Risk
Today’s highly quantitative risk management industry is the product of the simultaneous advances in computing power and finance theory we have seen since the 1960s. Exponential increases in computation speeds have allowed academics and practitioners to create a wide range of mathematical models able to process vast amounts of historical data and develop numerous projections of the future. Although they are undoubtedly helpful when used appropriately, the resulting tools (now ubiquitous across the industry) have led to an over-reliance on numerical estimates of risk. The language of risk is dominated by the terms “volatility” and “value at risk,” creating an unintended blind spot in relation to risks or trends that are inherently difficult to measure or quantify.
The Role of Liquid Alternatives in Wealth Management
It’s no secret that investors are looking for uncorrelated return sources for their portfolios. Low interest rates and the experience of the global financial crisis are leading many to include “liquid alternatives” in their toolbox. At Mercer, we define liquid alternatives broadly as strategies that follow alternative strategies, such as those typically used by hedge funds, and that are available as commingled/pooled funds that trade at least weekly.
Understanding Private Equity – A Primer
In this paper we will review some basic asset class characteristics, the return expectations, return drivers, evidence of outperformance, implementation considerations, and discuss the optimal use of private equity in a portfolio. Because private equity investing involves some concepts not found in other asset classes, we have provided a glossary of terms at the end of this paper.
Why we believe The Economist is wrong about hedge funds
The Economist published an article in its August 1 edition, titled “Fatal Distraction,” arguing that pension schemes are making a mistake in employing hedge funds to manage assets on their behalf: “For the pension schemes that are the hedgies’ latest target, handing over cash makes no sense.” Many of the arguments used in the article are open to debate and we would urge institutional investors to challenge their conclusions.
Low Volatility Equities and High Valuations
In 2010 Mercer issued guidance recommending that clients have an explicit allocation to low volatility equities. Since then equity markets have risen significantly, and despite these strong market returns, low volatility equities have kept pace with the broader market.
Risk Premia Investing – From the Traditional to Alternatives
In this paper we provide an overview of the risk premia concept and focus on a set of liquid “alternative” (or non-traditional) risk premia in particular.
An Investment Framework for Sustainable Growth
In Mercer's Investment Framework for Sustainable Growth, we distinguish between the financial implications associated with ESG factors, and the growth opportunities in industries most directly affected by sustainability issues. Mitigating emerging risks requires flexibility, foresight, and fresh thinking about risk management and capitalize on new opportunities.
The Pursuit of Sustainable Returns - Sustainability by Asset Class
Mercer's portfolio reference guide, 'The Pursuit of Sustainable Returns: Integrating Environmental, Social, and Corporate Governance Factors and Sustainability by Asset Class' outlines the drivers for addressing sustainable growth trends at a portfolio level for each major asset class.
Multi-Asset Strategies – An Overview of the Choices
Multi-asset strategies have seen a surge in popularity over recent years. Liquidity, simplicity, and relatively low fees have made them attractive components of defined contribution pension schemes, as well as appealing to smaller institutional investors for whom governance issues are a key consideration.
Building Equity Portfolios with Style
Much has been written recently about “smart beta,” “advanced beta,” “intelligent indexing,” and various other buzzwords — broad terms that are not always well-defined. Looking beneath these catchy titles, Mercer believes that it is important to focus on the underlying drivers of return and how this can help investors with constructing and monitoring their portfolios.
Private Capital: Getting the Governance Fund Right
A commitment to a private capital fund is the beginning of a long-term relationship and requires strong conviction in the manager’s skills and considerable trust on behalf of investors. Detailed due diligence on the capability of the manager is critical. An evaluation of a fund should extend to an assessment of the fund’s commercial terms and the strength of the manager’s alignment of interests with investors.
Multi-Asset Strategies – Redefining the Universe
Loved by many, reviled by others, multi-asset strategies are undeniably a key feature of the investment landscape. In the US they are typically known as balanced strategies; in Europe and other parts of the world investors have been enticed by a category of investments known as "diversified growth funds". Whatever the label, however, the variety of strategies is broadening across the globe.