One of the many challenges inherent in today’s unpredictable financial markets is holding a defensive position that is also nimble enough to benefit from sharp movements in equities, bonds, and currencies like those witnessed at various points last year.

With this in mind, Pablo Bernengo, CIO of AP3, the SEK464.9 billion ($45.6 billion) Swedish buffer fund, currently oversees a lower-than-normal equity allocation –  42.1 per cent of total AUM at the end of June 2022. The cautious strategy is also manifest in tilts to defensive sectors and quality factors within equities, whilst in fixed income, the fund has begun to shift to longer duration assets after positioning for rising interest rates for most of last year.

The belief is that inflation (which he says is waning but still far from beaten) and recession will continue to impact economic health and markets.

“The current market regime is not a good one for risk assets, but from time to time we have rallies that we need to use for the good of the portfolio, so we do need to be nimble,” he says.

AP3’s ability to actively navigate and benefit from volatile markets is rooted in a reform process undertaken by Bernengo when he joined as CIO in 2019. It involved restructuring the portfolio by replacing decade-old, separate alpha and beta allocations with a traditional asset class structure and appointing new asset class heads.

“We have undergone a lot of changes in both the way we view the portfolio and the organization,” he says.

One driver of the reform process was AP3’s portfolio managers requesting bigger investment teams and a better platform via which to share ideas and discuss asset class-specific strategies.

“Teams were a bit siloed and fragmented, and we wanted a better platform to lever our capability,” he recalls. “We wanted to work as an entire organization, and in larger rather than smaller teams, with common goals and purposes. The world is complex, and this was an effort to simplify it as much as we can by making things transparent, both for internal and external purposes.”

Above all, the restructuring made it easier to understand the investment process, particularly around risk.

“Risk analysis of the entire portfolio was somewhat complicated by the old portfolio structure and organization, and we wanted to remedy that,” he says.

more In-house

The reform process also involved bringing more active equity management in-house so that the internal/external split is now 60:40 in favour of internal management – the reverse of when he joined – although allocations like small caps and emerging markets where AP3 doesn’t have the expertise remain outsourced.

Alongside the realisation that AP3’s internal team were more than capable of running the allocations themselves, other factors drove the inhouse strategy. It has lowered costs (expenses in relation to fund capital amounted to 0.08 per cent in 2021) and has also allowed the fund to increase the active risk it needs to meet a return hurdle of 3.5 per cent over time.

Around three quarters of the whole portfolio is now managed in house by a team of around 30.

Sustainability

Bringing assets in-house to get a better handle on active risk also fits with Bernengo’s ambition to accelerate sustainable integration across the portfolio and take greater control of AP3’s sustainable investment process. The new structure and organization has become a central pillar to sustainability strategy, he says.

“Active risk and sustainability go hand in hand. Sustainability is really the biggest thing occupying my mind and it should be the case for every other asset owner. There should be a sense of urgency in the ESG space of which climate is the most acute.”

Sustainability strategy has been taken out from under a team that also looked at macro issues relating to the entire portfolio and put in a standalone division tasked with taking sustainability to “the next level.” The focus is on supporting the equity team, fixed income, and alternative portfolio managers to achieve sustainability in the different asset classes, he says.

Integration has been easier in some allocations than others. For example, Bernengo notes particular success in real estate (AP3’s largest alternatives allocation) where the fund’s ownership stakes in successful property companies allow it to control strategic direction. Like Vasakronan, Sweden’s largest real estate company, which owns, develops and manages commercial real estate throughout the country and is owned by AP3 in partnership with sister funds AP1, AP2 and AP4.

Call to action

Going forward, Bernengo says the sustainability strategy will increasingly focus on corporate engagement. Here his aim is to sift through the multiple initiatives and layers that tend to complicate engagement to focus on a hands-on approach and AP3’s core rationale: to reduce emissions.

“The problem is not that hard to grasp,” he says. Some of the companies in the portfolio have a large carbon footprint, and the fund is now mapping these companies and engaging with them.

“We don’t want to get to net zero by selling our brown assets because if we sell them, we achieve nothing on the ground,” he says.

The listed equity portfolio contains around 1,600 companies and ownership varies from small stakes in large foreign companies to significant stakes in smaller Swedish companies. In foreign companies, engagement usually involves collaboration in the Council on Ethics of the Swedish AP funds and with other institutional investors. When it comes to Swedish companies, AP3 is more active via dialogue and voting. In 2021, the fund voted at almost 1,200 general meetings, including 160 Swedish annual general meetings.

The biggest challenge is where to best focus AP3’s limited resources, concludes Bernengo. The fund’s advanced, active management is already resource-intensive, and engagement involves extensive work although data is making it easier.

“We are expected to do a lot, but our resources are not unlimited. There are so many things that need to be done,” he says. “We are capable, but we are not a large organization.” The solution, he says, is to “keep focused on areas where we can make a difference both for the good of our portfolio and society at large.”

 

Persistently challenging market conditions mean 60:40 needs a re-think according to Raphael Arndt, chief executive of the A$240 billion Future Fund.

“The conditions where that worked don’t exist anymore,” he said. “It’s time for investors to take notice of it and act.”

He said there was a need to rethink investment strategies to cope with the difficult era ahead of stagflation, uncertainty and volatility, the response to climate change and populism increasingly shaping government decisions, prompting them to take a more aggressive approach to regulation.

Arndt said markets would be impacted by central banks withdrawing liquidity from markets- reversing policies which had been provided tailwinds for investors since the global financial crisis, a growing US Federal budget deficit which would “suck in liquidity” from investors around the world, and the pressure for decarbonisation and investment in renewable energy.

He said the period ahead was akin to the period in the wake of the US Civil War and the railway boom of the late 1880s which was followed by booms and busts in the US and Australia.

“We want to start a conversation on this as we think this is profoundly important,” he said.

The fund is keen for the investment community to start discussing the implications of the ideas in its latest position paper: The death of traditional portfolio construction.

Managing the portfolio

In response to the investment challenges Arndt said the Future Fund has reduced its exposure to equities, which are now down to 25 per cent of the portfolio − compared to a more conventional portfolio which could see equities as high as 60 per cent − and increasing investment in private equity, commodities including gold for the first time and infrastructure assets.

The Future Fund has also signalled that it sees value at home in the current environment where it expects the Australian dollar will do well and is cautious about the outlook for the US dollar.

“We’re looking for inflation protection in property and infrastructure assets, especially in Australian infrastructure assets,” he said.

“We think more domestic exposure for an Australian investor makes more sense than it did before because of political risk and deglobalisation issues.”

The Future Fund has picked up a 3 per cent stake in Sydney airport from the New York-based Global Investment Partners which was part of the consortium of institutional investors which took the ASX listed company private in a $24 billion deal finalised in early 2022.

Other recent deals for Australia’s sovereign wealth fund including being part of a consortium in 2021 which bought Telstra’s mobile phone towers in a $2.8 billion deal and buying a 24 per cent stake in Canberra Data Centre in 2020.

Ardnt said he expected Australia’s commitment to move to net zero would provide increasing investment opportunities locally.

In 2021 it bought renewable energy company Tilt in a deal with QIC which saw the company, which was listed on exchanges in Australia and New Zealand, delisted, and its Australasian assets split between two owners.

The Future Fund already had exposure of more than $1 billion to seven different infrastructure assets in Australia.

“We already have a lot of exposure [to traditional infrastructure in Australia],” he said. “We think there is a huge demand [for investment] to decarbonise the economy.”

Investment mandate

Under its enabling legislation, the Future Fund is not allowed to invest directly or to own companies, having to do its investments through external funds.

The mandate for the Future Fund itself includes an investment target of 4 to 5 per cent above inflation over the investment cycle with the other funds under its umbrella each having slightly different mandates.

Ardnt said achieving returns of CPI plus 4 to 5 per cent was “incredibly challenging” in the current environment.

“We’re using every tool in our kit and we have more than most. We think we can, but it will be really challenging for us,” he said.

Arndt, who has a long career in infrastructure investment, joined the Future Fund as head of infrastructure and timberland in 2008 after six years as investment director with infrastructure investment specialist, Hastings Funds Management. He was appointed chief investment officer in September 2014 and was promoted to the role of chief executive in July 2020.

When it was founded, it was feared the Future Fund’s investments could cause shock waves in the Australian share market if it were rumoured to be interested in a specific company or sector.

Arndt said the fund had “vastly reduced the amount of equities we hold” because of its view that unlisted assets such as private equity and infrastructure provided much better protection against inflation.

With expectations of a prolonged period of slow growth for the world economy, the fund believes that returns from the share market will be lower and more riskier than in the years past when they were fuelled by years of low interest rates and other aggressive stimulatory policies from central banks.

The shift in thinking has seen the fund make its first investments in gold.

“Commodities should do well in a period of high inflation,” he said and the push to renewable energy would lead to an increase in demand for commodities which Australia owns.

The next CIO

Arndt said the Future Fund would look for a new chief investment officer in 2023 following the departure of former CIO, Sue Brake, last June for family reasons.

Brake had been CIO since December 2020, taking over from Arndt when he became CEO after six years as CIO.

The Fund last year appointed three deputy CIOs reporting directly to the chief investment officer – Wendy Norris, deputy CIO in charge of change and innovation, Ben Samild, deputy CIO in charge of portfolio construction and Alicia Gregory, deputy CIO private markets. The Future Fund now had 85 people in its investment team.

Arndt said he had been doing the job of CEO and CIO in recent months since Brake’s departure because of the work being undertaken for the position paper but the fund would begin thinking about the new role early in the year.

Craig Thorburn, director, in the CIO’s office at The Future Fund will speak on the position paper at the Fiduciary Investors Symposium in Singapore from March 7-9. For more information and to register click here. For asset owners only.

A recent report by the OECD’s Pensions Unit, Strengthening Asset Backed Pension Systems in a Post COVID World, argues that pension funds in the 38-member country organization can invest to support the post-pandemic economic recovery in a way that also provides long term returns for beneficiaries.

Pension funds in OECD countries are already seasoned and diversified investors and their scale and long-term horizon allows them to consider illiquid investments. They should increasingly invest in less liquid assets like infrastructure and SME financing to boost economic recovery, it argues.

For example, surveys on the impact of COVID-19 on SMEs shows that more than half of SMEs faced severe losses in revenues. Pension providers could complement banks to help SMEs cope with these urgent liquidity needs, but pension providers’ engagement in SME financing remains limited.

Obstacles

However, obstacles impede greater involvement by pension providers in supporting economies by investing in illiquid assets. These include a lack of investment opportunities, regulatory barriers, and limited investor capability to handle complex investments, raising fears of the risk of poor investment decisions in illiquid assets. Investing in these assets may also cause investors to deviate from their strategic asset allocation to seize investment opportunities, say the report authors.

Other challenges are also blocking pension funds’ ability to invest in illiquid assets. For example, members of defined contribution pension arrangements can switch providers. This means individual savers are freely able to switch investments, reducing pension providers’ appetite for illiquid investments, particularly those without a readily ascertainable market value, such as infrastructure.

Beneficiaries can also choose from a range of investment options with varying risk profiles, and transfer between the different options available within certain limits. This means that pension providers may be exposed to significant outflows, reducing the expected duration and investment horizon of their investment strategy. Pension providers may hold more liquid and short-term assets to accommodate for unexpected outflows, reducing the amount they can invest in long-term assets.

Another limit on the ability of pension funds to invest in illiquid assets includes the fact investments may require specific skills and expertise that some pension providers may lack. Several risks are typically more relevant for alternative investments alongside illiquidity like integrity risk, operational risk, limited transparency, valuation weaknesses, control issues, counterparty risk and conflicts of interest, lists the report. Finally, measures taken by governments to grant contribution holidays and help members access their savings during the COVID crisis may reduce room for investment in illiquid assets.

The ability to give employees and employers short-term relief may create liquidity constraints and reduce pension providers’ capacity to invest in illiquid assets, continues the report. Pension providers need to hold cash and liquid assets in their portfolios to address liquidity demands from regular benefit payments and exceptional withdrawals. They also count on contribution inflows to manage liquidity needs. However, certain countries have allowed employers and/or employees to defer or even stop contributions to asset-backed pension arrangements to provide them with short-term financial relief.

In addition, members who have lost their jobs or experienced a reduction in working hours can more easily access their savings early to weather financial hardship in several countries. Not only may this force pension providers to act pro-cyclically by selling assets in falling markets and materialise losses, but it also increases liquidity demands. These measures jeopardise the capacity of pension providers to invest in long-term, illiquid assets, such as infrastructure, as they need to keep a larger share of the portfolio in liquid assets. These measures may also create a precedent for future withdrawals, so that pension providers might not trust that assets will be locked away for the long-term going forward, further reducing their appetite for long-term investment.

The report urges policy makers to carefully consider the effect that policies granting early access to retirement savings accounts have on investment policies. Not only do such policies pose adequacy concerns, but they also limit pension providers’ capacities to invest in long-term, illiquid assets. Pension providers need to hold more cash and liquid assets to face potential withdrawal requests. This leaves less room for other illiquid investments that could support businesses and boost the economy.

Encouraging illiquid investment requires safeguards and appropriate investment structures, write the report authors. Strong governance and well-defined investment and risk-management strategies are necessary to prioritise the interest of members when engaging in new investment opportunities. Policy makers can also facilitate the mobilisation of private capital to long-term investment through public-private partnerships, financial incentives, or special vehicles for alternative assets.

 

 

Peter Branner, chief investment officer of the giant APG, is always looking to develop and implement technology that supports the firm’s investment goals. Since his school days, he has been interested in information technology and now as APG Asset Management CIO, he is hands-on involved with the firm’s multi-million investment programme in new technology.

Investment that is enabling APG to extract information from big data, share it efficiently among the investment teams and remain at the forefront of responsible investing. The programme also aims to develop digital talent, automate the most labour intensive parts of the investment process and allow further client-led segregated mandates.

“We are looking at the investment philosophy/process evolution with a balanced respect for the past while also leaning into the future where our clients are most likely to benefit from scale, information advantage and, not least, our truly long-term perspective,” says Branner in an interview in Amsterdam with Top1000funds.com that was complete with canal views.

“We never jump on new trends without doing serious evidence-based research first. We evaluate the mega trends around us very carefully and make sure that investments are linked to those mega trends.”

The focus includes demographics, climate change, the technology revolution and the ageing population, among others.

“Others look at many of these themes too, that is no surprise. But we try to translate how these play out, so the mega trends are not playing against us, in particular in less rosy scenarios,” Branner says.

When Top1000funds.com interviewed Branner in the summer of 2021, the planning around digitalisation was taking place. This included investment in the large-scale use of (unstructured) data, workflow automation and digital analytical platforms. Now the firm is in the middle of the execution phase, with the strategy deliveries getting more tangible.

“We want to make the investor base ready and flexible for the future. Training is needed around digital tools that we are rolling out as well as for digital leadership,” he says. “We aim to educate our people to be digital investors and to identify where there’s an obvious spot to digitalise. From an HR perspective this is an enabler – that you have people that can do the job themselves.”

To deliver on client’s responsible investment ambitions, the investment teams utilize various types of ESG data, often unstructured. “This is difficult data to extract useful information from, and alongside implementing the technology required we have had to learn techniques such as Machine Learning (ML) and Natural Language Processing (NLP),” he says.

For Branner, digital leadership is about inspiring the organisation to move forward and talk about technology in a meaningful way such that it ultimately enables the value adding investment solutions to clients.

The shift started with digitalising some simple processes. For example, data previously presented to the investment committee was based on a high number of word documents and excel spreadsheets, but is now gradually available in a digital more robust form.

“It forces our people to be more structured and it ultimately frees up time to focus more on analysing the data and preparing quality investments rather than producing “use and forget” data,” he says.

The shift, for now, is culminating with the technology to enable ML and NLP and work on big unstructured data. Increasingly APG processes this in the Cloud making use of the horizontal computation scalability and the ease of data access. “The investment in our data science subsidiary Entis, has been a success story. Entis turns raw text documents into usable data networks. Obviously our quant investment teams feel most at ease using these new technologies.”

Meeting client demand with bespoke tools

But some of the other investment teams have introduced AI as well. One of those is the addition of a fully digital portfolio manager, “Samuel”, which points to anomalies, questioning where the logic isn’t consistent in analytic assumptions.

“That’s what these machines do, they question where the logic does not fit and they say here’s an investment that looks abnormal because it lags pattern recognition,” Branner says.

APG is the asset manager for ABP, the biggest pension fund in the Netherlands, and has a number of other clients as well and client demand for bespoke and tailored solutions is driving the need to use technology.

“We are implementing new tools in the front office, linked to this is our proliferation of client requests for more mandates and tailored solutions so we need technology to provide an increasing number of model portfolios as well as client specific mandates,” Branner says. “We are also creating data warehouse technology, a data lake type of set up, which people can access and use depending on the area they are working for.”

Branner is instinctively comfortable with technology, unusually so for an asset manager investment head. He grew up programming (completing his first course age 14) and has applied technology throughout his career.

“I rebuilt a small insurance company’s digital tools from scratch when I worked in London back in the mid 90s. I took all the tech and workflows, and plugged into an MS database,” he reminisces.

Later, in Luxembourg, he built a prototype multimanager technology toolbox at an asset manager, going on to hire developers to move it to a more robust platform.

And as CEO and CIO of €100 billion Swedish asset manager SEB Investment Management in Sweden, he was part of a front page story threatening that robots were taking over. He’s comfortable working with both quant and fundamental approaches. “I always thought it was silly to say one over the other. I’ve always seen technology as an enabler, never the end solution,” he says.

“Machines are very good at forcing structure, seeing historical patterns and using data in an environment that doesn’t change. As soon as there is an unusual situation or a new paradigm shift then you need smart people. And increasingly so,” he says.

Branner believes techniques such as ML and NLP, though regularly used in quant investing, can be important additional tools for fundamental investors too. “AI is an important additional tool for experts in many walks of life, and that goes for traditional asset management too.”

Technology and sustainability

Sustainability, or RI, is an area where APG has been leading the use of technology to extract information from big (unstructured) data and where the Entis subsidiary has played a key role.

Together with PGGM, and later BCI and AustralianSuper, APG developed the Sustainable Development Investment Asset Owner Platform.

Technology is used to sift through reams of structured and unstructured data to gauge the extent to which companies’ products and activities meet the SDGs.

“From a data perspective, APG developed the SDIs with an intuitive set up linked to the SDGs. The next step is to convert the SDI taxonomy towards Impact Investing and start to say what does it mean for the planet when you invest in an SDI,” he says.

The easiest and most obvious example is carbon emissions with a direct link to the 1.5 degree target under the Paris Agreement. Other SDGs are less intuitive for calculating true impact.

“In measuring zero hunger you could intuitively look at the production of say, milk powder and its use in Africa. What you want to achieve is zero hunger, but how much less hunger is specifically happening due to the use of milk powder is tricky to measure in a scientific, waterproof way,” Branner says.

Nonetheless RI investing will shift towards Impact Investing, it’s the next level of the investment evolution, he predicts.

“To make that transition, we have to be crisp and clear about how to justify the investments in impact,” he says. “It’s interesting to see how it will evolve as well as the intellectual curiosity around technology and how it is being used. Machines can’t work alone, we need to feed it with a framework, it is where people with ESG expertise will matter.”

The investment environment

As a large investor, Branner is occupied with interpreting the policies of central banks, especially interest rates, and how governments are managing their debt levels.

“In the past, central banks have been able to actively control the interest rate levels, and now when we see governments providing debt left and right it has become more difficult for central banks to operate alone. That’s a development I don’t see changing soon.”

In more recent times debt has been issued due to the COVID economic crisis, and now the war in Ukraine and the associated energy crisis.

“That puts more pressure on governments and the EU, I follow that intensely and with some worry for the more dark scenarios,” he concludes.

 

 

Singapore’s GIC invested more than any other SWF last year and fuelled by buoyant oil revenues, Gulf SWFs have had and are expected to continue their investment rampage. Elsewhere, hedge funds have proved one of the most successful allocations, particularly for ADIA, says Global SWF in its annual report.

Mega deals

Once again Singapore’s GIC invested more than any other SWF, deploying US$ 39.1 billion through the year – 13 per cent more than in 2021. Behind GIC, five Gulf funds confirmed their role as major global dealmakers.

In 2022, state-owned investors deployed more capital in fewer deals than in 2021. Global SWF reports a reduction in venture capital investment and an increase in mega-deals led by GIC and Temasek.

The average ticket size of the year was US$0.35 billion and compared to 2021, SWFs invested 38 per cent more, with US$ 152.5 billion in 425 transactions. “The major story of the year is the re-emergence of mega-deals, defined as investments of US$ 1 billion or more. The average ticket size increase to levels not seen since 2014, and there were more than 50 mega-deals in the year,” states the report.

In terms of industries, the activities of SOIs reflect the economic climate. Funds lost interest in venture capital investments in healthcare, consumer, and technology and grew their appetite for infrastructure (mostly transportation), energy, industrials and financials. Real estate remained constant.

Gulf Funds shine

In the global context of geopolitical, economic, and financial uncertainty, Middle Eastern funds shine more than ever. Most funds have shattered stereotypes of following hidden agendas and only hunting trophy assets and are now recognized as sophisticated, flexible, and mature investors that can move the needle at home and overseas, states the report.

The 18 Gulf SOIs manage US$ 3.7 trillion in financial capital and 7,500 personnel in human capital. Overseas, they have more than doubled their investments in Western economies, including the US and Europe, from US$ 21.8 billion in 2021 to US$ 51.2 billion in 2022. The high oil price means that GCC economies with lower fiscal expenditure will continue to have large surpluses. Expect the more liquid and internationally focused SWFs including Abu Dhabi’s ADIA, Kuwait’s KIA and Qatar’s QIA to receive significant inflows of capital, says the report.

In contrast, for those SWFs that are not oil-based, including those in China, Singapore or Korea, the investment momentum is more ominous. Even Norway’s NBIM, which could have offset the paper losses with the significant injections it received in 2022 from rising oil revenue, has been affected by currency losses.

Hedge funds

Hedge funds have been one of the few bright spots for sovereign investors, managing to avoid huge losses and gaining some momentum. ADIA’s US$ 60 billion hedge fund portfolio makes it the world’s largest allocator to hedge funds. The Abu Dhabi fund was a pioneer in the asset class when it started trading through commodity advisors (CTAs) back in mid-1980s.

In 2019, the alternatives portfolio was restructured from the traditional products into two main strategies comprising Diversifiers and Return Enhancers, in addition to an Emerging Opportunities mandate outside of the main allocation. However, a year later, ADIA decided to merge them into a single pool. The department employs 50 staff but most of the investment is outsourced. Since 2020, the team has been actively looking to benefit from a highly disrupted market and has added new managers across most strategies.

New SWFs

In another development, the research notes a jump in the number of new SWF funds. “In the first three years of the 2020s decade, we have already seen 13 new SWFs being set up, and 10 others saw significant progress and could join the club soon,” it states. In 2022, sovereign investors opened 10 more offices overseas in four continents as well as the appointment of new CEOs. However, it notes “the developments in Kazakhstan and Kuwait are worrisome in terms of governance and stability.”

Some of the new SWFs like Azerbaijan’s AIH or Ethiopia’s EIH were conceived as umbrellas of some of their countries’ most important assets. Others like Cape Verde’s FSE and Namibia’s Welwitschia were designed as fiscal stabilization mechanisms. A third group including Israel’s Citizens’ Fund and Australia’s Victorian Future Fund were developed as savings tools.

The latest country to join the SWF discussion is the Philippines, following the proposal to create the “Maharlika Investment Fund.”

The report states that last year proved one of the most difficult years for state-owned Investors in recent history. 2022 was the first year ever that the size of the SWF industry shrank in value. The scale of the drop is debatable as most SWFs report with significant delays, if at all – but Global SWF estimates the impact totalled US$ 1 trillion.

The major challenge of 2022 was the simultaneous and significant correction of bonds and stocks, which had not happened in 50 years. The global listed benchmarks for private markets also dropped significantly, with infrastructure and private credit being the most popular refuge.

 

 

 

Although the Teacher Retirement System of Texas’s $11.2 billion risk parity portfolio has struggled of late, the pension fund remains committed to the strategy that it forecasts could perform better in the economic environment ahead. TRS, which manages around $170 billion, treats risk parity like an asset class and has increased the allocation over time in terms of both the risk level within the different buckets and size with the portfolio currently targeting an 8 per cent trust level allocation. The strategy of balanced risk exposures is designed to perform well in most market environments and is implemented both internally and via external managers.

Speaking at the Risk and Portfolio Management division’s annual update to the board in December, James Nield, chief risk officer, and Mark Telschow, director, RPM Portfolios, reported a difficult year for government bonds and risk parity, although risk parity has performed better in recent months. The problem, Telschow explained, is that virtually all assets apart from energy investments have declined and the strategy suffers when all assets perform badly. Something other investors like Denmark’s PFA say has caused them to lose faith in risk parity.

“When all asset struggle, risk parity is going to struggle,” said Nield. He also noted that risk parity does best when cash is unattractive, yet cash is currently outperforming other asset classes. “Risk parity is going to struggle as it is short cash,” he said.

Looking ahead, falling growth and rising inflation are likely consequences of Federal Reserve tightening. This could create an environment where risk parity does better. Moreover, risk parity tends to compound returns faster than in other allocations, so drawdowns are shorter and the acceleration better.

The team attributed the few bright spots in risk parity’s performance to successful manager selection (TRS uses Bridgewater, AQR and Invesco) and asset mix selection whereby the portfolio held fewer government bonds. TRS actively manages the risk parity tracking error to reduce the range of relative outcomes through both risk level and asset mix. Telschow also noted that cheaper internal management of some of the allocation created a tailwind.

The board heard how risk parity is complicated by the wide range of opinions regarding different risk and design models; what assets to include in the buckets and what risks to balance – whether that balance should be based on risk contributions or economic regimes, for example. Design decisions result in different portfolios and influence the outperformance or underperformance mean reverse over time. However, Telschow and Nield said there is not a huge amount of informational edge in design decisions.

Experimentation

Alongside running the risk parity allocation and a 16 per cent passively managed government bond portfolio, TRS’s 16-person Risk and Portfolio Management team is tasked with research initiatives and experimentation to help expand internal capabilities and reduce fees. The risk parity portfolio initially emerged from this process which has most recently focused on a new diversified and balanced commodities exposure, similar to the approach taken in risk parity. Launched in September 2022 the portfolio particularly aims to balance exposure to rising inflation.

Other tasks assigned to the Risk and Portfolio Management team include financing liquidity and setting liquidity targets, conducting repo activity, managing derivative trading, and finding the best way to source the fund’s cash needs. The team also rebalance the portfolio, optimise balance sheet and oversee securities lending, seeking additional yield where possible. Having these activities housed in one team means a tighter grasp not only on how much liquidity the fund needs, but also the best way to source it.

Asset allocation

The Risk and Portfolio Management team are also responsible for conducting an asset allocation study every five years. The last study, three years ago, led to TRS adding leverage, increasing its allocation to fixed income to add diversification, and boosting investments in private markets where TRS now invests 42 per cent of assets. Recent results show that the additional allocation to leverage has added 63 basis points of positive return, and more money invested in private markets has also been additive. However, adding to the fixed income allocation has had a negative impact.

The risk management team look at around 200 daily risk signals, reporting on macro and portfolio risks and putting in place action plans if needed. Recent action has focused on bubble signals, allocation and counterparty risks. In one example of the process at work, signals flagged risk in the asset allocation limits in the private equity portfolio vs the allocation through time. This ultimately led to raising the policy limit from 19 per cent to 24 per cent. Nield concluded that data is a key contributor to strategy success, enabling “drill through” analysis to enable more useful reporting.