“Strategy without tactics is the slowest route to victory. Tactics without strategy is the noise before defeat.”

The above quote is often attributed to Sun Tzu of Art of War fame, though it never appears in any print translations. It is however a mantra that has been well held by UK pension schemes in designing their investment portfolios. The traditional approach of designing a fixed strategic asset allocation and then allowing discretion to apply tactical or active positions to that asset allocation was a common approach.The quote remains instructive. However, we need to remove the disaggregation of the activities. A strategy is a necessity. A fixed strategic asset allocation has passed its sell by date. the investment portfolio needs to be adaptive and far more nimble. For most schemes, there is insufficient time to set a long-term strategy and hope that the hare will fall asleep.

Changing legislation, scheme circumstances and corporate needs have rendered the set and forget strategy worthless. Similarly, schemes can ill afford the cost and distraction of reacting to every bit of noise in the markets. The answer is a plan that is applicable to multiple time horizons (the annual reporting frequency, the triennial valuation frequency, the deficit recovery period, and the life of the fund). Additionally, the plan needs to be fully adaptive to the market environment and changing scheme circumstances.

When viewed through a liability relative lense, the portfolio should not expose the scheme unnecessarily to the impact of changes in interest rates and inflation. Similarly, when analysing the portfolio for sources of return above the growth in liabilities, there should be sufficient diversification and access to complementary strategies to achieve the objectives with an acceptable level of risk relative to the liabilities.

Prior consideration should of course be given to how the portfolio might be changed in light of changing circumstances (for example improvements in the funding ratio) and these should be documented. However changes to the portfolio that are responses to market conditions or expectations of future market returns (eg equity valuations or levels of interest rates) should be managed on a continuous basis. The latter are not simply ‘tactical views’, they need to be considered across all the time horizons that are important to the scheme.

 

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About herbertcrumb

Blogging about pensions issues View all posts by herbertcrumb

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