The steady increase in investors allocating more to private assets comes at the same time as a new period of heightened macro uncertainty including supply-driven inflation, less-credible central bank policy, rising real rates and slowing productivity growth.

Navigating these two challenges could require a fundamental evolution of the asset-allocation process, argue Grace Qiu Tiantian and Ding Li from Singapore’s GIC in a paper written with MSCI’s Peter Shepard entitled Building Balanced Portfolios for the Long Run.

Long term investors seeking to construct portfolios resilient to macro uncertainties should focus less on backward-looking, short-term risks, argue the authors in their latest paper, building on previous research into portfolio construction.

Instead, they should focus on understanding the long-horizon investment landscape, including the benevolent effects of mean reversion, a broader opportunity set of private assets, and the risks posed by potential regime shifts in the macro environment.

“This framework could provide long-term investors such as GIC with a consistent and long-horizon view spanning all asset classes, support with strategic portfolio positioning, and offer a practical tool to build greater macro resilience into portfolios,” say Qiu and Li, both senior vice presidents, total portfolio policy and allocation, economics and investment strategy at GIC, Singapore’s sovereign wealth fund with an estimated $799 billion assets under management. GIC doesn’t disclose its AUM.

Potential scenarios

Qiu, Li, and Shepard map five potential macro scenarios for the decades ahead focused on shocks impacting demand, supply, trend growth, central-bank policy, and long-term real rates. Their research then applies asset cash flows and discount rates to these underlying macroeconomic drivers. Next, they integrate macro risk into an allocation framework spanning public and private assets.

By putting public and private assets on the same footing, long-term risk and return may be systematically managed across the total portfolio. The underlying macroeconomic drivers provide a common lens to view all assets consistently and intuitively, allowing comparisons and trade-offs across public and private markets.

The multi-horizon nature of the framework also enables decision-making over different time horizons, potentially facilitating strategic and tactical positioning. The long-horizon view also allows asset-allocation decisions to more closely align with investors’ mandates to meet liabilities and preserve wealth over the long run.

Case study

Qiu, Li, (pictured) and Shepard construct a hypothetical macro-resilient portfolio, able to withstand long-term macro risks while maintaining the same level of expected returns as a portfolio optimised to a shorter horizon. The macro-resilient portfolio has less exposure to nominal bonds and more to real assets and the equity risk premium.

The authors also generate a macro-resilient efficient frontier, demonstrating how asset allocations may vary according to the level of tolerance for long-term macro risks. The new frontier lies above the expanded mean-variance frontier, suggesting that by accepting more short-term volatility, long term investors can align with their long-term objectives.

The expanded mean-variance portfolio substitutes public equity for equity-like private assets (private equity and equity-like infrastructure). Government bonds continue to play the role of portfolio diversifier, even though a portion of bonds are replaced by real estate.

For the same level of volatility as in a 60-40 portfolio, the expanded mean-variance portfolio has a much higher expected return (4.8 per cent annual real return versus 3.1 per cent for the 60-40), predominantly driven by the assumed private-asset returns. But it is still largely a barbell portfolio, loading up high-risk, high return asset classes and using bond-like assets to balance the risk profile.

The macro resilient allocation is constructed to have the same expected return as the expanded mean-variance portfolio while minimising long-term macro risk rather than volatility. In this example, the authors measure long-term macro risk as the real-return impact at the 10-year horizon, averaged over the five key macro scenarios.

Investors can choose a different time horizon to align with their mandate or assign different weightings among the macro scenarios to reflect a view of their likelihood and importance.

Private assets are not uncorrelated over a long horizon, but their spectrum of exposures to macro risks may enable them to be used to help manage long-term risks across the total portfolio. In addition, while equity is highly volatile over a short horizon, the authors find that volatility driven by fluctuating equity risk premia may be much milder for the long-term investor.

Good beta bad beta

Long-term investors stand to benefit by allocating more to the return opportunities that are typically riskier for short-horizon investors. For example, market dynamics like discount-rate shocks and mean reversion tend to benefit long-term investors.

Higher discount rates typically lead to lower asset prices in the near term – but also lead to higher expected returns. A long-term investor benefits by harvesting the higher returns and can eventually come out better off in the long run, they explain. Discount-rate risk therefore tends to be much more benign to a long-horizon investor and is an example of the concept of “good beta/bad beta.”

However, long-term investors are more exposed to other types of risk. They are vulnerable to the risk of a persistent economic slowdown or a trend growth shock. This may have only small, short-horizon effects but can build up gradually to significantly impact the long-horizon investor.

Secular change and regime shifts are also risks for long-term investors. Today, potential regime shifts include the effects of deglobalisation and the decarbonisation of the economy which require a fundamentally forward-looking asset-allocation process. Elsewhere, many investors are considering the possibility that new levels of high inflation could persist and worsen into stagflation, they conclude.

The world is changing so rapidly, traditional five-year investment plans are increasingly difficult to implement. Asset owners, head-down and concentrating on just the next five-years, risk “opening the curtains” to find the world around them has moved on much faster than they realised, said Geraldine Leegwater, CIO, PGGM speaking at FIS in Maastricht.

Leegwater, who took the helm in 2020, cited new European ESG legislation as an example of the fast-changing investment landscape. Elsewhere, NGOs are putting more pressure on investors and pension fund participants are demanding action. “You cannot work with a five-year plan because the world is changing. There needs to be a better solution,” she said.

Leegwater urged delegates to come up with a vision that extends into the future. “Let’s go to 2030 and look at what the world will be like and what this means for pension funds and goals in the investment portfolio,” she said, adding that five-year plans accentuate the gap between the financial world and the real world.

PGGM’s current five-year plan dates from 2019. It is focused on sustainability and ESG integration, including an allocation to SDG compliant investments. Strategy at PPGM, founded in 2007 as the asset manager for the healthcare scheme PFZW, is shaped around a large allocation to long dated fixed income. Risk assets comprise real estate and listed and non-listed equities in a long-term strategy that avoids tactical allocations and is increasingly focused on providing inflation protection, she said.

Knowing what you own

Sustainable investment involves many active decisions – even if investors are tracking a benchmark ESG integration involves taking out pieces of that investment universe.  Given the scale of the transition ahead and the implications for risk premiums, investors will increasingly move from traditional benchmarks to “knowing what they own.” This more active approach around portfolio construction will also be driven by the need to invest for impact, she said.

Insight and knowledge of the assets held in a portfolio requires data, also key to measuring impact. It is challenging building portfolios with return targets and impact targets, demanding correlation analysis, a strategic asset allocation and a robust framework amongst other things, she said.

Mapping and measuring a portfolio for impact is also easier in some asset classes. For example, investment in infrastructure is easier to measure. While in real estate, it’s possible to measure net zero improvements in properties but these are often only a small part of the portfolio. Measuring impact in listed, passively managed mandates is more challenging. “We have thousands of holdings and measuring what you have in there and all the types of SDG indicators is very difficult.”

She said investing for impact still comes with more questions than answers – and not everything can be measured. Digging into SDG themes is complicated: a euro invested in emerging markets has more of an impact that the equivalent investment in developed markets. Yet governance unknows complicate emerging market investment. It involves investors questioning themselves when they can’t realise impact goals – and realising “you can’t do everything.” Affordable housing for healthcare workers is a good place to start, she said.

Cultural change

PGGM is characterised by a long stakeholder chain comprising participants, advisors, board members and executive officers amongst others, complicating the ability of the asset manager to integrate real world issues and change allocations. However, shortening the chain is also difficult, especially given PGGM’s responsibilities to its beneficiaries and the importance of beneficiary participation. For example, PGGM’s  seven SDG goals are based on the issues its participants care most about.

PGGM’s strong culture has been shaped by these multiple layers, ensuring issues are thoroughly debated and analysed. Now Leegwater’s priority is to try and foster a culture that also contributes to a bigger goal and avoids silos. She espoused the importance of looking at people’s potential rather than at what they have done in the past, and said PPGM, with one main client, was able to do something different to a typical commercial asset manager.

One way to achieve this kind of change is via incentives aligned to team goals. “It is about finding people around you with the same language and drive,” she said.

Leegwater concluded that it will be difficult to fulfil PGGM’s impact goals and the Netherland’s new pension contract if the asset manager continues to stick to the way it has worked in the past. “Sometimes you need to change the tools to achieve your goals,” she said.

 

 

 

At the height of the GFC, CalPERS was forced to sell assets it didn’t want to sell at the worst possible time. “What was actually liquid, was the high-quality stuff,” recalled Dan Bienvenue, deputy CIO at CalPERS who joined the fund back in 2004, speaking in a recent board meeting.

The Californian pension fund found itself overweight assets it no longer wanted to hold but finding a bidder was like staring into an abyss. In short, the GFC exposed a profound liquidity crisis, revealing that the giant fund had lost control of its own funding levels with a large securities lending book lent out for cash, liquidity spread throughout asset classes, and poor visibility on what capital calls lay around the corner.

Lessons learnt during those traumatic months rewrote CalPERS approach to liquidity, fed into the decision to add a 5 per cent strategic allocation to leverage and instilled a determination to be able to lean into opportunities in a down market.

Years in the making, these changes are now crystallised in the fund’s latest strategic asset allocation, in execution since July this year. “I can think of few things that are more important than we are prepared to be a buyer as opposed to having to be a seller when the market turns,” said board member Lisa Middleton.

Strategy in Action

Today, the $429 billion pension fund has dry powder on hand to invest, recently witnessed in an ability to buy into opportunities during the pandemic-induced sell off. Unfunded commitments sit ready in dry powder for partners. Dry powder also sits in separately managed accounts, at the ready to deploy alongside handpicked strategic partners in co-investment vehicles. Unlike in the past, all capital calls are in line with assumptions and models, and come at the right pace.

CalPERS sources of liquidity are deliberately diverse. Alongside dry powder stores or the ability to tap pension contributions as a source of liquidity, the fund can seize the opportunity to invest in distressed assets by selling equities, using that cash to purchase the asset while using an equity future to maintain the equity exposure. It amounts to liquidity on demand from the fund’s huge pool of liquid public market assets that are both saleable and desirable. A centralised approach also allows the fund to choose which funding sources best optimises the cost and composition for the portfolio at the time.

Today CalPERS has shrunk its securities lending book, and collateral calls are based on equity for equity the means collateral levels don’t change but move at the same pace as the market, Bienvenue said.

CalPERS regularly reports on its liquidity and leverage position – liquidity levels have been lower in recent months and could fall further on another leg down in markets. But a central pillar to the strategy and mark of its success lies in the fact the investment team doesn’t need to continually focus on liquidity because the pacing and framework is set in place. “We can focus on investment,” CalPERS’ investment director Michael Krimm, told the board.

Today, liquidity provisioning takes into account capital calls and margin for derivatives all with an eye on market movements and volatility based on internal forecasting models. Managing liquidity involves participation from across the fund, forecasting rebalancing needs, planning for capital calls and identifying market trends in a robust process.

The board heard how deep dive analysis over the years involved an exploration of the liquidity inherent in CalPERS assets, exploring the ease with which an asset can be traded and the income it generates. Findings revealed cash, government bonds and equities have the highest level of liquidity and are easily sold to meet funding needs. In contrast private equity and private debt have higher returns, but less opportunity to generate cash on demand.

Private markets

Alongside a new strategic allocation to leverage, CalPERS latest asset allocation promises a boosted allocation to private markets spanning private equity, real assets and private debt. November’s board meeting saw the investment team petition again for fresh tools and flexibility in managing the allocation – namely an increase to staff delegation limits.

“We need more tools and a refresh of policies put in place when the fund had a lower allocation to private assets,” urged CIO Nicole Musicco,  determined to build an agile investment philosophy that goes beyond simply setting a SAA and pressing the button. Set every four years using capital market assumptions stretching 20 years into the future, assumptions must also be reviewed along the way, working with partners and checking the governance, she said.

Although hard to accurately account the opportunity cost for not allocating more to private assets because of staff delegation limits (knowing CalPERS would be unlikely to invest, GPs don’t tend to come forward with opportunities) the investment team warned the cost had been high. For example, every $1 billion invested in co-investment earns around $335 million more over ten years than the same $1 billion invested in fund investments.

Higher delegation limits mean the team can accept the larger deal sizes needed to ramp up private equity exposure as CalPERS targest an annual commitment pacing of over $15 billion to achieve a target allocation of 13 per cent. The private equity team will have to look at as many as 50 deals per year to get close to annual coinvest commitment targets, making the ability to accept larger co-investment deals critical while reducing the monitoring burden of smaller deals.

As for private equity fund investment, CalPERS expects that 70 per cent of commitments will exceed the investment team’s current delegated authority limits. The team expects to commit to around 20 funds this year leading to over 70 core managers over time.

The team made 116 fund commitments in the last 5 years about half of which have exceeded the delegated authority. Two recent investments exceeded the CIOs authority and were scaled down. “It’s difficult to achieve scale with lower delegated authority limits and detracts from our ability to reach our SAA,” said Musicco.

It’s the same problem in infrastructure where investment needs to more than double in size over the next three years to meet SAA targets.  The team needs to commit $5 billion per year to infrastructure with an average commitment size of $1.25 billion per deal. The infrastructure team have made around 19 commitments in the last five years and 32 per cent were above the delegated authority and were approved by the CIO. Two deals exceeded the CIOs authority, and were scaled down to meet the CIO’s delegation limit.

Decision making culture

In the last investment committee meeting of 2022, Musicco explained that a crucial element to building CalPERS private market expertise includes revamping the Investment Underwriting Committee. The committee, one of three CIO-chaired committees and tasked with reviewing all private market allocations above a certain size, is now structured to draw on expertise from all corners of the investment team in a collaborative process.

“I chair it, but the real secret sauce is the asset class heads and other experts providing a diverse lens,” said Musicco. “You have better decisions when you have the right eyeballs round the table,” she said, concluding that a collaborative approach allows the team to  “learn a ton from each other.”

The German economy will feel the impact of the energy crisis more than other European countries, and energy dependent industries will increasingly explore moving production to the US and Canada where energy is cheaper, said Jeroen van der Veer, Chair, Phillips and former chief executive, Royal Dutch Shell speaking at FIS Maastricht.

van der Veer, who warned that stalemate between Russia and Ukraine means Europe’s energy crisis will endure for some time yet, said Germany’s particular crisis lies in previous Chancellor Merkel allowing the economy to develop a 40 per cent dependency on Russian gas. A trajectory mirrored to a lesser extent in countries including Italy, Belgium, and the Netherlands. Europe is now sourcing from Norway and Algeria, and extra LNG from the US. However, suppliers in the Middle East are unable to divert much production to Europe because they have long-term contracts with China and South Korea, he said.

High gas prices in Europe are linked to the unique characteristics of the industry, explained van der Veer. Oil is globally available, but gas is semi-regional evident in European gas prices trading much higher than in the US. It is possible to export LNG, but this is costly and requires infrastructure. “It is not a market with the same flexibility as oil,” he said.

Europe’s energy market is also distinct from the US and Asia, he continued. US energy demand is in synch with supply while Asia, a huge net importer, taps diverse supply from Australia, Indonesia and Russia, amongst others. “Asia has many alternatives if one source falls away,” said van der Veer. Europe is not only a significant importer of energy – the region has also carved ambitious net zero 2050 climate targets. “Europe is in a different situation to the rest of the world,” he said.

Refill storage

Come 2023, Europe’s key focus will be on refilling storage capacity, but this will be difficult without using Russian gas. “Europe has enough gas this winter, but next year could be more challenging,” he said.

Governments will face difficult decisions around slowing their economies, or switching to diesel or coal, he said. Strategies for Europe’s large energy users include raising prices while industries like fertilizer and steel are exploring mothballing European production and increasing production in other areas of the world. However, not all industries – for example cement producers – can do this.

Germany will struggle to drive economic growth in Europe. German companies pondering relocating production to countries like Canada and the US, risks the de-industrialisation of Europe and the loss of manufacturing jobs. This will accelerate Germany’s transition, but is challenging for social solidarity and job creation, things that have built German economic success.

But moving production may not pay off for Europe’s energy intensive industries, he warned. Building new plants involves huge investment, paid back over the long-term, but high energy prices might not last that long. “I think I would wait a bit,” he cautioned. And he argued that although moving heavy industrial production elsewhere will reduce Europe’s carbon footprint, CO2 is harmful to the planet wherever it is produced. “Short term, there are big problems for the chemical industry,” he surmised.

Nuclear

Europe’s ability to come out of the crisis depends on how quickly governments can create other forms of energy at scale of which nuclear is a key component. As Europe explores alternative energy sources key factors come into play. Renewables are capital intensive, and as such require incentives for companies. Nuclear requires building plants in a steep learning curve – and France’s experience shows it takes years to finally garner cheap electricity. He urged investors to explore opportunities in nuclear power, and said that Germany’s decision to close its nuclear power stations now looks naive.

Carbon capture and storage

One of the biggest challenges with carbon capture and storage is the energy intensity of the technology required to capture and pump carbon  into the ground. “It equates to running up a down escalator,” he said. He suggested countries build carbon capture and storage facilities close to industry away from populated areas. “I see it coming, but it will not make much of a dent in the problem,” he said.

van der Veer said transitioning to a green economy will be impossible without partnering with oil majors with the skills and expertise. “I don’t believe the energy transition will be done by a bunch of start-ups,” he said. It is only the oil majors who know how to develop offshore wind and nuclear power stations. He also urged delegates to never underestimate US companies, slow to transition. “They can accelerate too,” he said.

He counselled against shale gas (where much depends on the type of shale gas) as an alternative. “Without capturing the carbon, shale is not viable.” Moreover, new coal fired power stations take too long to build. “One day there will be peace and part of that peace will mean the west has to buy gas from Russia, although it will be nothing like the levels is was” he said.

The energy transition also requires industry working with governments and consumers. Putting all the pressure on companies to solve it, and punishing them, doesn’t work if consumers are still demanding fossil fuels. Moreover, the energy transition will take years to achieve.

He also counselled on the importance of the world working together. Europe’s transition won’t stop the climate crisis if the rest of the world doesn’t also transition. van der Veer concluded that the energy industry will become more capital intensive per unit of energy; it will attract huge amounts of capital but he said investors will only finance the transition if they can make a decent return.

As Border to Coast approaches its 5th birthday chief executive Rachel Elwell reflects on the achievement of building a sustainable organisation, what investment capabilities are still to develop and the priorities for the underlying partner funds.

When Border to Coast became an entity in July 2018 the initial five-year strategy was focused on building a sustainable corporate function and the capabilities for funds to pool assets. In that time it has gone from an organisation with zero to 130 employees and £47 billion of pooled assets.

“It was a complex project to deliver,” chief executive Rachel Elwell says. “It’s going pretty well. COVID slowed us down a little bit, so it will be a couple more years to get there.”

The fund is the result of 11 local government funds pooling their assets, and of the £60 billion in total funds between the underlying partners, about £47 billion has been pooled with Border to Coast responsible for £38.3 billion.

Already the pooling has resulted in net cost savings of £20 million, with a total savings target of £145 million over 10 years and £340 million over 15 years. But more than just cost saving it allows the underlying partner funds to access asset classes that would be difficult to invest in without pooling.

In the past year alone Border to Coast has launched a multi-asset credit fund, a listed alternatives fund, a £1.35 billion climate opportunities investment proposition within private markets and increased allocations to private markets to £10 billion with fee reductions of 24 per cent.

“The cost savings show one of the benefits of pooling,” Elwell says. “It is understandable at the beginning that people focus on that cost saving, that is important. But over time we need to move the conversation towards what value we are producing, which is generating returns and opportunities the partner funds didn’t have before. We need to really judge ourselves on whether we are adding value for money with the scale we have got and whether we are delivering well on what our partner funds set out to do.”

Private markets

Private markets are a good example of the value add of the pooled vehicles.

“We bought forward that build, recognising quickly that our partner funds were looking to get exposure there,” Elwell says. “One of the things we were keen to do is understand what our partner funds needed, rather than rush in and build something.  We spent a lot of time understanding the key features and needs, and really honed in on the important things from a risk, return, income and liquidity perspective. This will stand us in good stead in the future, we are in it for the long term.”

The offering is a combination of external managers and internal capabilities which were cultivated from the existing capabilities of three of the partner fund internal teams.

About a third of assets ae managed internally, a third externally and a third in a hybrid model for private markets where Border to Coast is selecting funds but acting as a fund of funds managers.

“We could bring in people with experience in deploying capital through funds and co-investments so we are not paying fees to fund of fund managers, we are the fund of funds. And we are deploying more scale so could get better fees.”

Other advantages include allowing some of the smaller partner funds to access private markets for the first time; and for all the partner funds it allows for new and tailored investment opportunities.

The newly launched Climate Opportunities Fund is an example of that. The fund will be invested over a three-year period across private equity, infrastructure and private credit focusing on clean energy, technology, transport, industry (such as low carbon cement and steel production), agriculture and carbon sequestration.

“Talking to partner funds they are really excited to deploy capital to help the transition and more actively contributing to that not just taking out carbon,” Elwell says.

While infrastructure investments were already targeting some of those areas, including a recent €100m commitment to the Clean Hydrogen Infra Fund, the Climate Opportunities Fund allows for smaller and different types of investments.

“It is hard to get into the smaller funds doing niche things, so we are exploring doing something aimed at different types of investments not just big wind farms, there is a massive interest in that.”

Roadmap to net zero 2050

The fund recently published its roadmap to net zero 2050 which includes clear interim plans. It targets a 53 per cent reduction in financed emissions across its portfolios by 2025 and a 66 per cent reduction by 2030, reaching net zero by 2050 at the latest.

Currently about 60 per cent of the assets are covered by the plan’s emission reduction targets and Elwell says a big focus is to try and figure out how to get the rest of the portfolio covered as well.

The focus will be working with industry to improve data quality and methodologies to enable the remaining 40 per cent – made up of private market and some fixed income assets – to be brought into scope over time.

“We want to be working with the industry on private markets and how to get a recognised standard. If we can get a standard then GPs can consistently provide the data that is needed. The industry needs to work together to get the information to understand the risks,” she says, pointing to the ESG data convergence initiative.

Of the total assets about £2.5 billion is in emerging markets, with about £1.5 billion of that in emerging market equities and a bit more in a multi-asset credit and private markets.

“One thing close to my heart is supporting the just transition in emerging markets,” Elwell says. “Knee-jerk reactions to divest from emerging markets doesn’t feel the right way to go. It can be harder to engage in and influence some of those markets but we really need to collectively think about how to do that as asset owners. For emerging markets where there is such a reliance on coal we need to understand the transition.”  Border to Coast is one of the founding members of the £400bn Emerging Markets Just Transition Investor Initiative.

The fund is also working on collective action and involved with Climate Action 100+ and the TPI transition initiative.t

“It’s really captured people’s imaginations internally and the purpose we have is very important, and means a lot for us,” Elwell says. “It motivates us all to try and do the right thing for the 1.1 million members we have.”

What next ?

The fund is also looking to invest in some green, social and sustainability bonds as well as develop a few more equities capabilities.

But the big area of focus over the next 12 months will be real estate.

“The single biggest capability we are still to build is real estate. It’s a complex asset class and particularly because we are looking to go direct.”

Another focus over the next little while will be how best to support partner funds with their passively managed holdings, which are managed outside of Border to Coast. Historically these have been market cap traditional passive mandates, however Elwell says that over the past couple of years there has been interest from partner funds to introduce an ESG tilt.

“As partner funds start to think about overlaying responsible investment into these, we are exploring how to ensure appropriate oversight and the most effective way for partner funds’ objectives to be achieved, as usual nothing is off the table,” she says.

And finally as the local government funds have been challenged by central governments to invest money in the United Kingdom, Border to Coast will help partner funds with that proposition and launch a UK Opportunities Fund.

Asset owners are increasingly under pressure to find alpha via active management because of declines in beta, but active investment may not offer a holy grail.  Speaking at FIS Maastricht, Rob Bauer, Professor of Finance, Institutional Investors chair; director of the European Centre for Sustainable Finance; Maastricht University highlighted challenges in active management around returns and fees.

Drawing on key points from research published earlier this year of which he was co-author, that looked at the active management strategies of the largest sovereign wealth fund in the world, Norway’s Government Pension Fund Global, Bauer argued that NBIM’s 200-odd active strategies weren’t making sufficient returns. Despite NBIM’s low active risk profile, many people work across the active programme in a complex process, but returns at the fund mostly derived from market beta.

NBIM’s active strategies also introduced a conflict of interest, he continued. For example, the sovereign wealth fund was seeking to beat the benchmark but also engage with companies to decrease carbon emissions. This typically leads to underweighting a company and therefore lower returns compared to the benchmark. “It is a trade-off – where do you use your resources?”

Arguing that academic evidence suggests it is very difficult to beat the benchmark in fixed income or equity allocations, Bauer warned investors active management is a “zero-sum game, minus costs.” Still, he noted that incentives for asset owners to adopt active strategies abound. Asset managers busily market active management, but there is little feed back via public statements on what these strategies have actually achieved.

Asset owners tend to mandate to active managers that have done well in the past but where performance subsequently declines. “After a period [managers] reverse to the mean,” he said. Typically, asset owners then take their money out and reinvest with better performing funds. “You end up with one flower in a field of flowers that don’t look so well,” he said.

The conversation also turned to the importance of asset managers measuring alpha against a fixed time horizon.  Manager selection is often based on three years, yet active strategies should match the time horizon of the strategy. Moreover, outsourcing active investment can amount to passing the buck – investors still need to understand the mechanics behind their active strategy.

Beliefs and testing

Fellow panellist Peter Kolthof, chief investment officer, PGB, countered that even small returns in active management can make a difference and are relevant. He noted that active investment involves consistency and should start with beliefs; it involves regularly testing assumptions in an approach that should be implemented throughout the portfolio, consistently monitored and results published. “It’s easy to generate outperformance if you don’t have a relevant benchmark,” he said.

Asset owners in the Netherlands are renowned for developing low cost, passive strategies. They are similarly renowned for developing numerous benchmarks, driven by ambitions to integrate ESG and reflect the wishes of participants, said Kolthof. The process raises questions about whether these strategies are still passive – after all ESG integration is an active decision to make the portfolio more sustainable. “These benchmarks make it subjective, and you get to a point where each fund has its own benchmark,” he said. “If you put more choices into the benchmark, what is left for active?” He noted that benchmarks can be implemented by third parties in cost effective strategies and bought off the shelf.

Still, he reasoned that the most important element is for asset owners to create a benchmark that incorporates all elements of their decision-making process. “To me, it doesn’t matter if it is active or not.” This approach allows investors to monitor and evaluate the investment process and consistently implement. Delegates concluded that labelling these strategies active or passive lies in the eye of the beholder.

Private markets

Investors are increasingly switching to private markets to access alpha, adding segments to their allocations that are outside the benchmark. Investing in private markets requires skill – and investing in fund of funds means investors risk losing the extra return in fees. Bauer also warned delegates to be careful interpreting private equity numbers; ask GPs how they calculate their return and if the IRR makes sense. Delegates also discussed the importance of valuing private market allocations correctly. Private markets lag public markets values and are likely to fall in line with lower public market valuations.

PGB is currently building out its private equity allocation in the hunt for niches and corners of the market it is difficult to access via the listed market. “We won’t seek exposure to segments that are available in listed markets,” said Kolthof.

Elsewhere, delegates questioned the extent to which UK pension funds will continue to move into private markets. The rise in bond yields has improved the funded status of many pension funds, meaning that they may reassess their private market allocations – high solvency levels could focus minds on getting rid of private market exposure.