UN pension fund flags climate risk on ALM and performance

In a nod to headwinds including climate change, evolving demographics, and the future economic outlook the $85.5 billion United Nations Joint Staff Pension Fund, UNJSPF, will use a slightly lower real rate of return on investments to inform its upcoming actuarial valuation. The 2023 ALM study will consider various scenarios for the future, including those incorporating climate risk.

The 2023 ALM study will consider various scenarios for the future, including those incorporating climate risk. Under a baseline scenario based on moderate growth and a suitable asset allocation, the current contribution rate will “remain adequate.” However, another scenario estimated the impact of a financial crisis arising from a failure to transition to net zero and the board heard how in this scenario, the fund will face a much more challenging outlook.

“It is important that the fund continues to monitor the impact of climate risk over the long term. The ALM study provides crucial insight for the fund’s office of investment management in developing its future strategic asset allocation, with an emphasis on continued risk management to ensure long-term sustainability of the fund,” states the fund.

A recent board session also referenced UNJSPF’s recently-published 2022 annual report which reflects on the impact of last year’s equity and bond market volatility. “Both stock and bond markets yielded double-digit negative returns, leading to the poorest performance of a 60/40 portfolio on record,” it states. Last year the fund’s market value plummeted 14.7 per cent, shedding more than $13 billion during the year.

Last year tumultuous returns followed robust returns between 2019 and 2021 that had swelled the UNJSPF portfolio by 30 per cent to a record high to over $91.5 billion by the end of 2021.  In its latest annual report the fund states all asset classes outperformed their benchmark over the one and three-year periods and said the fund “compares favourably” with other pension funds in terms of cost and return of the assets.

The board agreed that a 6 per cent nominal rate of return composed of a 3.4 per cent real rate of return on investments and a 2.6 per cent inflation rate should be used for the actuarial valuation at the end of this year in a change from recent actuarial valuations that used an assumption of 3.5 per cent. The valuation will determine the long-term solvency of the fund based on a wide set of assumptions that include, for example, future growth of participants, investment returns and various demographic assumptions.

Alongside outlining its assumptions for the next actuarial valuation, the board session (the pension fund’s 75th since it was established in 1949) included a discussion of its asset-liability management study (ALM), funding policy, and performance.

Market outlook for the rest of the year

Looking ahead to expected performance in international and emerging equity markets through the rest of 2023 the fund’s outlook is mixed “as relatively attractive valuations are counterbalanced by weaker earnings growth and their sensitivity to a potential US recession.”

Half the pension fund is invested in public equities, most of which is managed internally by four teams covering North America, Europe, Asia Pacific, and Global Emerging Markets. Small cap equities and select markets outside this benchmark are managed through specialized external managers and funds. The internal teams follow a disciplined investment process, centred on equity screening, fundamental analysis, and frequent dialogue with corporate management teams of the companies the fund invests in or is interested in adding to its portfolio.

The fund has a more bullish outlook for fixed income ahead. “Long-term expectations for fixed income returns have also increased, following a decade of historically low interest rates and quantitative easing policies,” state the annual report. “Bonds now appear to offer a reasonable yield and serve as a hedge against a potential recession.”

Fixed income is managed internally in five portfolios comprising US treasuries, US securitized, corporates, government related and global emerging markets. The benchmark for the core portfolio is the Bloomberg MSCI US Aggregate ESG Custom Index while the benchmark for emerging markets is the Bloomberg EM Local Currency Government, 10 per cent Country Capped. Eighty per cent of corporate and government related portfolios are managed externally.

In a recent change of strategy, UNJSPF introduced a new benchmark for fixed income that incorporates a corporate bond component, broadening the pension fund’s asset mix. UNJSPF uses external managers in the allocation as it continues to develop and strengthen in-house capabilities. Over time it expects that the internal fixed income team will progressively assume a larger management of the portfolio as resources and capabilities are added.

UNJSPF’s private markets portfolio includes private equity, real assets, and real estate. Private equity, infrastructure, timber, and agriculture are managed via externally managed funds and co-investments. UNJSP, which began allocating to private equity in June 2010, currently invests with over 100 high quality externally managed funds diversified by vintage year, sub strategy, sector, and geography. A small portion of the private equity programme is invested in co-investment alongside high performing private equity managers.

The real asset portfolio is invested through externally managed funds where selection is based on moderate leverage, strong cash flow and a demonstrated record of realizations.

Similarly in the real estate portfolio (which dates from 1971) the fund invests through around 100 externally managed funds and co-investments. The allocation is 50 per cent core “open ended” funds and 50 per cent non-core “closed end” funds. The Fund’s core funds are diversified by geography and property type, and its non-core funds are diversified by vintage year, geography, property type and risk profile.