Pension funds face growing pressure from stakeholders and trustees to focus on short-term issues. One common question queries why they haven’t invested more in US mega cap equities, for example. Meanwhile, CIOs and investment teams have little time spare to step back and take in broader themes and hear from different voices, threatening investment with group think.
Speaking during the closing session of the Fiduciary Investors Symposium at the University of Oxford, Richard Tomlinson, chief investment officer of LPPI, Mirko Cardinale, head of investment strategy at USSIM, and Mark Walker, chief investment officer of Coal Pensions shared some of their reflections on the current investment climate.
Tomlinson noted the importance of clarity of purpose for investors. Yet he said that purpose has become more complex. It used to be simple (financial returns) but today investors in the UK have to balance other priorities like investing in UK infrastructure, making the mission statement more hazy.
Investors are unsure of the extent to which they are investing for impact or financial return, or if they will come under pressure to divest. It makes working to clearly defined values and beliefs essential.
In the past, pension funds used to just focus on outperformance and alpha. A reference portfolio provided a simple framework for outperformance. Now many other factors have come into play that complicate decision making make it harder to judge performance.
Tomlinson welcomed greater transparency as helpful, but also noted that transparency creates challenges if investors lack clear goals. CIOs need “crystal clarity” on which decisions they are responsible for making and work to clear mandates, he said.
Despite today’s challenges, panellists reflected that investment is rarely straightforward. The days of stable, predictable equity premiums have long gone and pension funds are used to navigating a range of outcomes, anticipating change and understanding the different themes that drive macro outcomes.
Governance and remembering history
USSIM’s Mirko Cardinale noted that investors multiple priorities makes management and governance important.
“Having a good delegation framework is very important. Make sure non execs focus on the big picture,” he said.
Tomlinson stressed the importance of CIOs recalling history. Only this way will they open up their imagination to alternative risk scenarios. Younger people have no experience of higher interest rates, for example.
“It’s about looking more broadly and looking through the industry to have a broader risk conversation about what is plausible and possible. Big political and economic cycles, challenge your assumptions.”
LPPI conducts war gaming workshops to open up its thinking on geopolitics. The team mull questions around the outcome of attacks on assets like wind farms, or how the investor would navigate a dramatic fall in markets if China invaded Taiwan. The discussions provide a valuable window into risk appetite and bring past experience to bear.
At Coal Pensions, CIO Mark Walker’s key priority is ensuring liquidity on hand to pay pensions at the mature fund which has a very high pay-out ratio. “Where I get the money to pay the benefits is my first big worry,” he said, adding he faces growing short term pressure from stakeholders to find cashflows to pay pensions.
His biggest risk is a fall in economic growth, recession, or geopolitical instability impacting returns. “Taking stakeholders with you is important if you are a risk-taking organisation. You have to be really clear what the risk is,” he said.
Key risks
At USS, climate risk is viewed as a systemic risk and integrated into the investment process. The pension fund is a universal owner, and investment is framed against a thematic framework that includes the energy transition, alongside other factors.
Key issues front of mind include if the private sector has the capacity to provide solutions to the climate emergency. Elsewhere, Cardinale explained that USS plans for a series of different environments and scenarios. He said that inflation risk is likely across different scenarios and the investor is structuring in the impact of of supply shocks and structural pressure of inflation.
Panellists reflected on the importance of positioning for technical disruption, including tapping opportunities in the sectors most likely to benefit from AI. Walker reflected that Coal Pensions, dependent on external advisors, lost out from underweighting Nividia.
However the pension fund has netted other big wins. It was an early private equity investor in Space X, committing £20 million 10 years ago. “The rewards are good for tech investment; the early stage can be huge.”
LPPI’s Tomlinson reflected on the risk of investments suddenly becoming obsolete in a fast-changing world full of disruptive tech. In the coming years, will a new technology replace wind turbines? An asset might have a 30-year life but then suddenly become uneconomic to operate because something else comes out to leap frogs incumbent technology.
Cardinale agreed that AI and robotics will increase productivity and voiced his expectation that new technology will lead to new scientific discoveries.
Panellists reflected that it remains unclear if the benefits of AI will be accrued by different sectors in a disruptive process that leads to far more dispersion than the current investment landscape, dominated by big tech with the bulk of gains going to just a handful of winners.
