Looking back over her 10-year career at France’s €36.3 billion ($41 billion) Fonds de Réserve pour les Retraites (FRR), chief investment officer Salwa Boussoukaya-Nasr observes that despite steady innovation, all change at the public fund has come against a backdrop of enduring continuity.
Boussoukaya-Nasr was appointed chief investment officer in 2012 at the fund which was created in 2001 to build reserves for the country’s public pension system. The reforms under her watch include introducing strategic hedging options, investment in a wider selection of asset classes, and most recently de-carbonising the passive equity portfolio.
“Since I joined we have gone through many changes but we still have the same goals, and much of the same team,” she says.
FRR is split between performance and hedging assets – 48.9 per cent versus 51.1 per cent respectively – and returned 3.08 per cent net of charges last year.
The largest allocation in the performance bucket is to developed market equities, with the rest in emerging market debt and equity and high yield euro and dollar bonds. In the year ahead she believes small cap European stocks, high yield and emerging debt and equity will be the star performers.
“Emerging markets were disappointing, but they are now doing well,” she says.
Hedging assets include French treasury bonds as well as euro and dollar-denominated investment grade corporate bonds. Eurozone and US corporate bonds together account for more than 45.6 per cent of the hedging component.
FRR is required by law to use external managers across the portfolio and active management strategies also dominate.
At the end of last year around 53 per cent of total net assets and 59 per cent of equity investments were actively managed.
Boussoukaya-Nasr believes these active mandates have helped shield the fund from enduring structural weakness in the Eurozone and Brexit fallout.
Here, additional hedging through option strategies ahead of the UK referendum, also dampened the impact of post-Brexit volatility.
Now she believes active strategies will position the portfolio for new trends, particularly slower UK growth and a “normalisation” of US and Eurozone valuations as Eurozone earnings improve.
FRR increased its exposure to the Eurozone with allocations to the region’s investments rising from 41 per cent in 2012 to 49 per cent in 2015. She also favours active management in US investment grade credit.
“Credit is a good place to find active returns above the benchmark.”
Growing Eurozone optimism
At the heart of FRR’s building Eurozone optimism lies a sizeable stake in the French economy.
Investment includes listed shares in French small- and mid-cap companies, debt and private equity and French real estate, with particular focus on long-term illiquid unlisted assets, after the French government granted the fund permission to invest beyond 2024.
Although the strategy is actively encouraged by the government, Boussoukaya-Nasr believes it is mutually beneficial both for the fund and the wider French economy.
“France is an obvious place for us to focus. We have a micro economic impact where we help companies develop and create jobs. It’s important because companies lack capital to the extent that many promising companies go abroad to the US for financing or go to public markets too early because they can’t find the capital. It’s challenging but interesting and we have the money and time to invest. We are also investing where there are less actors, so there is more opportunity and we can find attractive premiums.”
More than two thirds of the passive equity allocation in Europe, North America and Asia Pacific, excluding Japan, is now in low carbon strategies using MSCI Low Carbon Leaders indices that FRR worked with MSCI, AP4 and Amundi to help develop.
“We think that in the long-term, stranded assets will penalise equity valuations,” she says.
The indices exclude 20 per cent of the highest emitting companies, with a maximum 30 per cent – by weight – exclusion of companies by sector. They also exclude the largest owners of fossil fuel reserves with the objective of cutting both the carbon footprint and fossil fuel reserves of companies in the index by 50 per cent, compared to the relevant parent index. The most challenging aspect of the strategy so far has been minimising the tracking error compared to the performance of the standard indices in Asia.
“We have had a higher tracking error in Asia that has made it difficult to achieve the objectives of the low carbon leader in Asia so far – it has been very volatile but we began less than a year ago,” she says.
Boussoukaya-Nasr has also begun to de-carbonise the smart beta allocations which she admits is a “challenge without changing the characteristics of smart beta.”
“We gave our managers a maximum tracking error target that they have applied to their in-house processes. From what we have seen so far it’s encouraging.”
Smart beta strategies at the fund focus on value, small cap and low volatility factors in the Eurozone and North America, and represent 24 per cent of FRR’s allocation to developed-country equity and 42 per cent of its total passive equity mandates. There is a fixed weight between the different smart beta strategies.
“Some of the strategies behave better than others, but all have cycles,” she says.
In contrast, de-carbonising the bond portfolio is still a way off.
“Working to reduce CO2 and divesting from the worse emitters in equities makes sense because the valuation of those companies will fall. But in bonds the link is less obvious because as long as a company doesn’t default – even if there is a higher financing cost and the spread increases – there is still a return from investing in a company with high carbon emissions.”
She also questions the “ownership” ethos of a bond investor.
“If you have equity in a company, you are an owner of a part of that company and responsible for emissions, but bond holders are not owners. As an equity owner the emission belongs to you; as a bond holder you’re responsible for financing emitting activities.”
The fund is also working to combine active strategies with its de-carbonisation ambitions, considering reducing exposure to coal by divesting from companies that use mostly coal as a primary source of their energy.