PGGM finds alpha via internal management of illiquids

PGGM Investments, the 17th largest institutional investor in the world, as ranked by the Watson Wyatt top 300, has introduced a number of new investment strategies and has plans to significantly increase its in-house investment management this year.

Amanda White spoke to head of strategy Jaap van Dam.

Despite, or in light of, the global economic crisis, Dutch giant PGGM Investments is beefing up its internal investment team, with the aim of reaching about 110 investment professionals by year end.

In the past year it has undergone a number of structural and investment strategy changes that have buoyed this move.

PGGM employs six core investment beliefs which include the philosophy that returns are not achievable without risk, risk diversification is essential, cost-efficiency makes a difference, a plan to use its strength as a long-term investor and that sustainability is essential.

In recent times the sixth of these core beliefs has been tweaked slightly from ‘alpha’ is an achievable goal, to ‘value added’ is an achievable goal.

According to head of strategy, Jaap van Dam, PGGM which manages assets of €70 billion (US$ 90 billion) abandoned classical alpha in late 2007. “So far as the ‘zero sum game’ is concerned we have stopped, we weren’t very good at it and cost us a lot of resources. So we have re-allocated resources to illiquid markets,” he says.

Now in liquid markets about 80 per cent of fixed income and about 50 per cent of equities is managed in-house.

“We are increasing how much we will manage in-house, and have invested a lot in beta competency, mainly through investing in the team. This increases the in house capacity” he says.

Since becoming chief investment officer in July last year, a job that saw the combination of two roles – CIO of strategy and structured investments and CIO of portfolio management – Johan van der Ende has created four “columns” within the investment department.

Now investment professionals fall under the strategy area; beta asset management; alternative assets; or the fundamental team. Within those four areas there are 16 teams each manned by a minimum of four or five professionals who all have specific objectives and where they add value.

Van Dam, who heads the strategy area and reports to Van der Ende, employs eight people who act as one strategy team, and is tasked with the strategic design of the portfolio following the ALM.

Their allocations start from the asset liability modelling framework and then how much risk relative to liabilities is determined with the strategy benchmarks and asset allocations follow suit.

“We have one top down portfolio construction team with the other guys each having one part of the strategic portfolio under their ownership – fixed income, equity, credit, alternatives etc – continuously improving the design of the portfolio,” he says.

More generally, van Dam says for the most part the last quarter of last year was very much focused on the day-to-day management. “Internally there as a daily question of how the world was developing and do we have a grip on what we do. Now we are looking further ahead again to determine what we should do on a long horizon.”

The ALM is refreshed once a year and then the strategic benchmark is built around that. The most recent refreshment included six changes, of which the introduction of a third alternative equities strategy dubbed ‘quality’. “We call it a ‘better beta’, not alpha, and it is framed in absolute risk not relative risk terms,” he says. “a quality strategy combines getting access to companies with strong cash flows with defensive characteristics, very much aligned with what our clients are looking for – this was a long-term project but its implementation was timely.”

The ‘quality’ allocation next year will form 16 per cent of the total equity portfolio with the team making the first significant allocations this year, with a shift away from the classical equities strategies from the FTSE all world. Other decision were increased weightings to Infrastructure, Structured Credit and High Yield.

PGGM has a long history of innovation in its investment policy and the introduction of ‘quality’ is another stepping stone in that path.

Its major client the pension fund Pensioenfonds Zorg en Welzijn (PFZW), which currently has pension assets of about EUR 67 billion and separated policy and implementation from the beginning of 2008, has supported that innovation and thinks in terms of risk-return sources rather than investment categories. In 2006 the pension fund dispensed with the traditional classification based on shares, bonds and real estate and began to base the portfolio strategy on common characteristics in the investment categories of beta, alpha and illiquid assets.

“It has been largely disappointing for our clients that we are down 20 per cent on our assets since last year that at the same time, most of the improvements in the portfolio construction and diversification that we added over the past few years showed their added value. Without these innovations, the result would have been worse.” Van Dam says.

PGGM was one of the first institutional investors in the world to include commodities in the investment portfolio, and to recognise private equity as an attractive alternative to equities investing about $4.3 billion in private equity via Alpinvest which it  co-owns with APG. Under its maxim that sustainability is essential, PGGM has partnered with a number of providers of corporate governance and responsible investment expertise including Eumedion, Dutch Sustainability Research and is a signatory to UNPRI.

This wider issue of governance, according to van Dam, is becoming an emerging discussion amongst institutional investors.

“Some argue in public equity markets for example that governance hasn’t been very successful, and if we as asset owners collectively had done a better job then the financial sector wouldn’t have taken as much risk. This leads to a discussion what the governance model should be. We have 4500 companies in our equities portfolio and we vote on all but there is no way of knowing them all” he says. “We ask is there an argument for decreasing diversification and increasing knowledge and control over companies. It is a standpoint that is defendable – but it will always be very challenging to get companies -Â management to be perfect agents for what we are trying to do.”