HK Housing Society plans unconstrained bond mandate

Hong Kong Housing Society's $4 billion investment fund is seeking a manager for an unconstrained global bond strategy as it strives to reduce portfolio volatility, its head of treasury has told AsianInvestor.

Alan Liu told AsianInvestor there were several factors behind the decision, adding that the fund was handing the process in-house. 

“Many institutions are facing the same problem," he noted. "Interest rates are going up, so should we have all our bond investments benchmarked against the Barclays Global Aggregate index? A lot of our peers are reducing their Barclays Global Aggregate reliance and moving some of these assets to a more interest rate-friendly way of managing their fixed income portfolio.”  

Taiwanese insurer Cathay Life and South Korea's Public Officials Benefit Association are other Asian institutions that have been diversifying into unconstrained, absolute-return funds as they move to cut back on benchmark-driven strategies.

Looking to reduce volatility 

Another reason for HKHS's move is that for a medium-term strategy – one with a horizon of up to five years – the risk inherent in its fixed income portfolio is a little too high for comfort, based on Liu's teams' projections.

“If you use a Sharpe ratio, it’s about 0.5, which means the return is low and volatility is high," he noted. "Our concern is that in the next five years, with that level of volatility, there’s a possibility the investment return may be negative."

Hence one reason for introducing unconstrained bonds is to reduce the volatility of the medium-term portfolio, added Liu, while also making investments that can cope with the rising-interest-rate environment. 

The fund – which is used for developing affordable housing for Hong Kong residents – is split into short-, medium- and long-term portfolios, according to projections of future cashflow.

The short-term portfolio horizon is up to one year and Liu said: “We have about $1 billion in cash deposits and we work with 20-odd banks, placing deposits in US dollars, Hong Kong dollars and renmimbi.”

The medium-term portfolio horizon is up to five years, with about $700 million under management and has a strategic asset allocation of 80% in bonds and 20% in equities, all outsourced to external managers.

“We have five of them – two for global bonds, two for emerging-market local-currency debt and one global equity manager. Every year we project the return for the coming five years. It’s normally between 3-4%, so it’s fairly conservative.”

The long-term pool is the largest, at $2.5 billion, earmarked for future house development, so it needs to match the long-term Hong Kong building industry cost of inflation index. “We need to be a bit more aggressive here [in order to hit the benchmark]," said Liu, "so it has a strategic allocation of 70% equities, 20% bonds and 10% alternatives."

Long-term shifts

The fund has made some significant shifts in the long-term portfolio, such as doubling its allocation to hedge funds in mid-2016. It also added to its equities allocation by moving money from the short-term pool at that time.

“The consideration, a year ago, was that it wasn’t the right time to add to bonds, so if we wanted to move from cash into investments we'd do it within the equities and alternatives," said Liu. "By the time we did all the beauty parades it was already June/July. It wasn’t by design, but it turned out to be good timing.”

For this new mandate, HKHS will draw money from the cash portion. Liu said the in-house team surmised that the reason why the volatility in the medium-term portfolio was so high was because it had 20% invested in global equities and 20% in EM local-currency debt.

The most straightforward option to reduce volatility was to reduce the EM debt and equity allocations, Liu said. But having talked to the managers, he noted, "everyone is telling us equities are going to be doing well and EM fixed income is going to be doing OK, so it’s not the time to reduce. Hence we are moving some assets from the short-term cash pool.”

Waiting on smart beta

Liu's aim is to find asset managers offering lower-volatility strategies. He said the fund had not considered using factor strategies to achieve this.

“We are looking to see how that new style of investing [factor-based, or smart beta] will behave in the coming years. I know a number of institutions are moving into that area, but it’s quite a different way of approaching things.

We do not have the resources to say we’d like to do momentum investing or value investing, because we just don’t have the knowledge or skillset to make that call.”

Historically, he said, the fund has been firmly in the active management camp. “We haven’t even looked at passive investing. The managers we have are doing a good job. For the long-term pool, which has been in existence for 37 years, the return is annualising at 9%.”