Asset Allocation

OTPP, SSGA and USS reflect on the future

Three investors reflect on the what lies ahead highlighting a buoyant 2021 but challenges beyond. Their suggestions include allocations to real assets and diversifying out of traditional fixed income.

There is a solid backdrop for risk assets ahead, said a group of expert panellists speaking at FIS 2020 Digital. Fundamentals around earnings expectations, price momentum and valuations has left investors like State Street Global Advisors underweight fixed income and overweight equities, particularly in the US where SSGA’s Dan Farley, executive vice president and chief investment officer, investment solutions group, sees real economic growth.

Meanwhile, increased allocations to gold and credit are providing a hedge against unexpected risk he said, predicting an above average economic recovery in 2021 followed by a tailing off to pre-pandemic levels.

Elsewhere, Canada’s Ontario Teachers’ Pension Plan holds a similar view. Millan Mulraine, chief economist at the fund which he joined in 2016 where he oversees macro-oriented research to inform the fund’s investment decisions, told delegates that 2021 is shaping up to be “a good year” as markets reap the vaccine premium.

However, Mulraine is cautious about what lies beyond 2021. He said that Central Banks are close to being out of the fiscal and monetary ammunition they need to manoeuvre, while the challenges impacting markets before COVID remain. Investors can look forward to a burst of growth, but it has been “bought forward from the future” by lower interest rates and government leverage. “How are we going to grow going forward if we don’t expand global production capacity,” he questioned, casting a wary eye on below trend growth coming down the track, lower yields and all the challenges of designing a portfolio therein.

USS Investment Management, the UK’s largest pension fund, is similarly concerned. Bruno Serfaty, head of dynamic asset allocation and senior portfolio manager in the multi-asset allocation team since 2015, said the fund’s focus is on a post-COVID world, and the impact of the vast policy response.

Although the pandemic is relatively short term in the context of the pension scheme’s long-term investment strategy, the impact of unprecedented government spending will reverberate for years to come. “The scale of the policy response is unprecedented, particularly given the fact we started with a high level of debt before COVID. The debt overhang is not going to go away.” He said fiscal stimulus combined with monetary policy left a highly liquid environment and fierce competition for real assets.


Next panellists turned their expertise to inflation. SSGA’s house view is that inflation will remain low for the next few year. However, Farley warned that the market is susceptible to an “inflation shock,” whereby a spike in prices catches participants unprepared. He also noted that inflation proofing portfolios must go beyond inflation-linked bonds because of their poor return. Instead, SSGA’s focus is on real estate, infrastructure, commodities and gold.

“There is a lot of money chasing these investments and you have to be discriminate,” he warned. “If we get an inflation shock, it will put pressure on price multiples and equity markets, and having that hedge is really important: a total portfolio context vital.”

Inflation expectations are also key to informing OTPP’s view on returns and asset performance going forward.

“If you can answer the inflation question, you have a much better view on asset returns and the policy response,” said Mulraine. It led him to reflect on how accommodative policy over recent decades has supressed inflation but, like SSGA, warned an inflation surprise to the upside could be in the offing. It has prompted an extra focus on diversification across geographies, natural hedges and real asset allocations that insulate the portfolio, he said.

“If inflation goes up, we know real yields will be depressed and we consider this when navigating the environment over the next five years.”

Inflation has benefits and a negative side, USS’s Serfaty acknowledged, noting how the positive impact of inflation on asset prices, stoked by monetary policy, has benefited the pension fund.

“Asset owners have benefited disproportionately from this – relative to economic activity,” he said. Inflation’s dark side appears when costs and wages start to rise and impact corporate profitability. He also flagged how tariffs (in the context of both US and China, and Brexit) will also push costs up.

“Tariffs have an impact on costs and profitability, and we need to be prepared for this.”

Panellists also reflected on the challenges of diversifying their portfolios and building defensive allocations when bond yields are so low. Their advice is to keep hold of fixed income as a diversifier, but also innovate and adopt a total portfolio view. Alongside government bonds and gold, other assets providing downside support include low volatility equities or options hedge, they suggested. However, Farley flagged these strategies come with a cost.

OTPP’s Mulraine warned that there is no easy alternative to owning government bonds or obvious escape from yields languishing close to zero. Alternative allocations come with constraints on leverage, limited depth and liquidity. However, he noted how some large asset owners are increasingly looking at alternatives like Chinese bonds and gold.

Serfaty urged delegates to think afresh at their reasons for holding bonds. Are they a source of diversification from growth assets, or are you holding them because you think inflation will remain low, they provide a good real return and store of value, he asked.

“If you decompose the reasons why you own bonds, you can try and find alternatives,” he said. He said that credit opportunities also exist as a hedge against equities in case of a risk event, and that governments’ mass printing of money threw into question whether bonds are actually the safest store of money. Gold or currencies provide alternatives, he suggested.

“We have built a matching asset portfolio at USS and have found real assets in private market or the credit space that will match these long-term liabilities.”

As for where the most promising returns lie, Farley highlighted interesting opportunities in emerging markets, particularly Asia (ex-Japan) because of the Chinese halo effect. He also flagged that emerging market debt provides a diversifying source within fixed income, although warned this market “isn’t as deep” as others. Elsewhere, real estate coming out of COVID provides opportunities for long term investors alongside inflation protection.

At OTPP the focus is on private assets in geographically diverse locations. Mulraine also espoused the importance of internal management given it allows investors to “ride out the business cycle,” enabling smoother returns by selling assets and benefiting from the upside. He said the strategy was an important part of OTPP’s revenue generation, concluding that OTPP has “pensions to pay” and can’t “just play in public markets” or “sit in its hands.”

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