Many financial advisors seek investment strategies for client portfolios that mimic the investment success of Canadian pension funds. If you’re one of these advisors, you probably sit through many product pitch meetings featuring phrases such as “invest in real assets” or “your personal pension” or “alternatives.” Unfortunately, what works for institutions almost never translates well into a retail context.
Most efforts to replicate pension plan-type investment strategies add cost but no value. That’s a bad combination in this low- return environment. In most cases, the investment exposure is one step further removed from the desired asset and often doesn’t live up to the purpose.
For example, the Ontario Teachers’ Pension Plan (OTPP) has direct ownership of airports, such as Brussels Airport. Forgetting for a moment that the OTPP is a defined-benefit pension plan (thus, plan members don’t bear investment risk), plan members are invested in the entity that owns the airport directly.
Accordingly, the value of the airport and the total return it contributes to the OTPP have nothing to do with what the stock market is doing; rather, the asset’s free cash flow generation contributes to the bottom line. The main risk to which the plan is exposed is the risk of mismanagement of the asset, not whether the stock market is up or down.
In contrast, investors in an infrastructure fund or ETF own units of a fund. That fund, in turn, invests in publicly traded shares of a corporation that owns or operates airports. This introduces an extra layer of ownership, which adds to cost and pushes the investor further away from the underlying asset and its investment return characteristics.
Over a long period of time, the underlying exposure is very similar. However, the infrastructure fund/ETF investor is exposed to both the higher costs of the investment vehicle and the risk and volatility of the stock market.
The closer you can get to the underlying asset, the more pure the investment exposure and the more likely investors are to enjoy the diversification, return enhancement and low volatility benefits that continue to lure pension funds into these assets.
Then there’s the issue of defining “infrastructure.” There are a few infrastructure indices; some are heavier in energy infrastructure, while others have greater emphasis on industrials such as transportation. If your clients are invested in global equities – through either a passive or an active strategy – they already have some exposure to some of the companies in the infrastructure indices. This is particularly true of global dividend strategies. So, the diversification benefits of infrastructure funds are questionable.
Instead of fast-forwarding to a convenient product to mirror pension fund investing, most advisors should start with a more basic step.
Pension funds generally boast a strong governance framework and place a lot of emphasis on process. Part of that process is spending the time needed to quantify the return target needed to fund future spending liabilities. In a retail context, this is goals-based or financial planning – and it’s a key part of the process all advisors should use with their clients.
Prudent financial planning will point toward a particular asset mix and indicate if assets other than stocks and bonds are needed to achieve clients’ funding goals. Only then should the process turn toward specific products. This kind of thoughtfulness can push you much closer to pension plan-style management than any products – especially those that don’t live up to the hype.
Dan Hallett, CFA, CFP, is vice president and principal with Oakville, Ont.-based HighView Financial Group, which designs portfolio solutions for affluent families and institutions.
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