Research Philosophy

Mercer has an in-house team of research professionals. Our research activities cover strategic, capital markets and manager research on a global and local basis. Helping to identify investment trends and selecting those investment managers most likely to meet performance objectives is a vital part of the service we provide to our clients.

Strategic Research

The strategic research function investigates a broad range of issues relevant to portfolio structuring. This may involve analysing new investment opportunities and ideas emerging in other parts of the world that may be applicable for local investors.

Examples of recent strategic research projects undertaken include:

• Alternative asset classes and strategies such as private equity, infrastructure, hedge funds, global property, commodities, gold, timber, and agribusiness
• Portfolio construction such as global versus regional, currency hedging, structuring income portfolios, market-cap indices, benchmarks, value versus growth, alpha versus beta, alpha transfer, long/short investing and liability benchmarking
• Manager research processes such as decay of information ratio with time and tracking error, prediction power of past performance
• Market structure changes such as equity market concentration
• Big picture economic issues such as deflation
• Product innovation such as capital guaranteed products, gearing and buy/write strategies.

Capital Markets Research

Accurate capital markets research and assumptions are crucial to create robust asset allocations for a range of economic scenarios. Mercer has a specialist capital markets research team, which focuses on the expected outcomes and interactions between available investment opportunities, forming views on long term asset class risk/return expectations, as well as providing views on relative medium term valuations of capital markets. This team provides inputs for:

Strategic asset allocations

In recommending a strategic asset allocation for model portfolios, Mercer will firstly clarify the desired strategic outcome, investment objectives and applicable risk tolerance of each portfolio. These objectives may relate to competitive positioning relative to peers, minimising the chance of negative annual returns, or achieving a particular long term real return target. After clarifying the strategic outcome, investment objectives and risk tolerance, we apply our strategic and capital markets research, together with our modelling tools, to determine a long term strategic asset allocation.

Dynamic asset allocations

Dynamic asset allocation (DAA) is intended to bridge the gap between long term strategic asset allocations and the shorter term horizons over which active investment managers generally operate. The DAA process produces investment benefits by implementing a different asset allocation to the strategic asset allocation when:

• Near-term expectations for future asset class returns vary significantly from long term assumptions
• Risks associated with specific asset classes vary from long term expectations
• Other specific pricing anomalies or opportunities are identified.

Our approach to forming valuation views is practical. We seek to identify consensus views and then establish why the consensus view may be too optimistic or pessimistic with the intention of forming views as to the likely direction of asset class returns relative to cash and their long term equilibrium forecasts.

Manager Research

Mercer’s manager research process is forward-looking and qualitative. Research meetings with managers focus on identifying:

• Evidence of any sustainable competitive advantages that should give a manager above average prospects for future out-performance (e.g. superior research resources, a superior approach to investment analysis, or something superior about the manner in which the research and analytical resources are harnessed in the investment decision-making process); and,
• Evidence of any significant potential weaknesses which may affect the prospects for future out-performance, or give rise to an above average risk of future under-performance (e.g. a weakness in any of the areas mentioned above, poor risk controls, excessive transaction costs due to poor dealing procedures or excessive assets under management, or broader organisational or business management issues that could potentially detract from performance in some way).

The manager research team uses a globally consistent framework that focuses on four key factors as outlined below:

We believe these four factors encompass the qualities that investment managers must possess in order to have strong prospects for outperforming. Each of these factors is rated as -, =, + or ++. Our overall strategy ratings are then based on an overall research opinion. They do not represent a weighted average of the four factor scores.

Mercer’s rating for an investment strategy signifies Mercer’s opinion as to its prospects for outperforming a suitable benchmark, on a risk-adjusted basis, over a full business cycle. A manager must generally achieve an “A” or “A-” rating before it can be recommended for inclusion in client portfolios.

Mercer >IS< Star Ratings

Mercer rates capabilities of various investment strategies. Since Mercer consultants use these ratings to advise institutional clients who can negotiate fees with managers, these ratings do not generally take into account any fees. Mercer >IS<, our online tool to deliver research to retail investors, converts these capability ratings into fund ratings by mapping them to individual funds and adjusting for fund fees. This note summarises the factors Mercer’s manager research team uses to assign the Mercer Ratings and the process used to convert these into Mercer >IS< Star Ratings.

Mercer supports active management in most asset classes but the fees for active management should be commensurate with the potential out-performance. We believe that active fees should be around 25% of the out-performance, on average. In some asset classes, higher fees may be justified.

We use this principle to convert the Mercer Ratings (pre-fees capability ratings) into Star Ratings which represent post-fees fund ratings.

The Mercer Ratings for multi-manager funds researched in the Asia-Pacific region are based on a weighted average of the ratings on the underlying manager strategies. Hence, Mercer does not assess the research team selecting the underlying managers, whether it is internal or through an external asset consulting relationship.

The manager-of-manager (MOM) ratings are calculated within GIMD for commercial multi-manager funds. The calculated Mercer Ratings are then converted into Mercer >IS< Star Ratings using the process described above.

Mercer >IS< Super uses the same principle to calculate Indicative Star Ratings for industry super fund options, which are essentially similar to multi-manager funds. In cases where ratings are not available on all the underlying assets or funds that the industry fund options invest in, Indicative Star Ratings may still be calculated provided that at least 65% of the underlying are rated.