This time last year, Sweden’s four buffer funds reported the best returns in their history. Fast forward 12 months, and the four funds have  posted losses thanks to allocations to equities and fixed income dragging their portfolios down. It’s left all four funds doubling down on strategies that focus on low costs linked to sophisticated internal management, ESG integration and a keen eye on the long term.

Across all AP Funds, allocations to fixed income and equity suffered most damage, pulled down by high inflation, rising interest rates and war in Ukraine. At SEK421.2 billion ($40.4 billion) AP1, where strategy focuses on robust, active decision-making and a bold risk mandate in a large internally managed allocation, strategy in 2022 focused on pro-actively changing positions including lowering equity exposure and reducing the duration of the fixed income portfolio, said CEO Kristin Magnusson Bernard. AP1 reported a total return of minus 8.6 per cent for the year.

Alternative investments in real estate, infrastructure and private equity funds countered losses in fixed income and equity. Challenging market conditions, particularly the European energy crisis triggered by Russia’s invasion of Ukraine, has had implications for the transition. Magnusson Bernard notes it has resulted in “difficult short-term and long-term trade-offs for societies and corporates”.

Still, like all the AP Funds, AP1 doubled down on sustainability through 2022. For example, one of the components of its new ESG strategy, adopted by the Board in 2021, includes all new investments in private equity should actively contribute to one or more of the global SDGs. In listed equity, the carbon footprint of the portfolio has fallen by 57 per cent since 2019.

AP2

It was a similar picture at SEK407.1 billion AP2 (which reported a loss of -6.7 per cent) where falls in equities and fixed income were also stalled by gains in non-listed assets. Eva Halvarsson, CEO of AP2 noted that despite the turbulent year for both equities and fixed income the portfolio proved more resilient than other indices including OMX Stockholm (which declined by approximately -13 percent during the same period) and MSCI World which fell by approximately -16 per cent.

“Over time, we’ve built our portfolio for situations like the one that arose in 2022,” said Halvarsson. “We’ve placed great value on spreading the risks as far as possible between different types of asset classes and markets, between listed and non-listed assets and between different management models. Our assessment is that, over time, this creates a good and stable return, in line with our long-term mission.”

AP2 has also focused on sustainability, developing new processes to better understand and measure impact. In timberland the fund now invests in line with ten criteria including biodiversity. “This is our latest prioritised focus area within sustainability,” says Halvarsson. The majority of the fund’s timberland investments are in Australia and the USA, in assets that produce saw timber and pulpwood.

AP4

AP4’s bigger loss (-11.9 per cent) left the buffer fund losing its size lead over its three peers, with SEK460.5 billion ($44.1 billion) currently under management compared to SEK527.6 billion ($50.5 billion) a year ago. Equities, which make up 51.7 per cent of the portfolio, where whacked across the board. AP4 has around 17 per cent of its portfolio in alternatives. Elsewhere the portfolio’s CO2 emissions decreased by 3 per cent in 2022 contributing to to a decrease across the whole portfolio of 61 per cent since 2010.

AP3

AP3 ended 2022 with SEK468.4 billion ($44.8 billion) under management and experienced a loss of -5.8 per cent. AP3’s alternative investments returned 8.9 per cent, mainly due to investments in infrastructure and timberland. Elsewhere the fund has focused on developing sustainability goals around corporate governance, climate, human rights, and biodiversity over the last year.

In a recent interview with Top1000Funds.com, Pablo Bernengo, CIO of AP3, explained how the buffer fund is positioned to actively navigate and benefit from volatile markets since a reform process replaced decade-old separate alpha and beta allocations with a traditional asset class structure and appointed new asset class heads.

Long term

Despite the difficult year, all CEO’s see losses in the context of their long-term focus, burnishing long-term return numbers. AP1’s average real return amounts to 5.6 per cent over the past ten years while the fund continues its low expense ratio at 0.06 per cent.

AP4’s Ekvall notes that measured over a slightly longer time perspective, including 2021, AP4’s portfolio has generated a positive result of more than SEK23 billion ($2.2 billion). “If we stretch out the time horizon, to five and ten years, which is more relevant for a long-term investor like AP4, we can report favourable annualised portfolio returns of 6.9 per cent and 9.2 per cent respectively,” he concludes.

 

As British Columbia Investment Management Corporation (BCI), the $211.1 billion asset manager for around 30 Canadian pension funds and insurers, has transitioned to being an active in-house global investor requiring robust systems, processes and specialised expertise, it has also built a value-added, modern centralized trading framework.

In an industry first white paper, the investor explores the benefits and drawbacks of centralized trading for institutional investors, sharing its experiences. BCI argues that an innovative, centralized trading framework provides clients with greater portfolio returns, lower fees, and allows for improved risk management.

“Our framework was designed with a cross-asset mindset to enhance portfolio returns, lower costs and better manage risk,” said Daniel Garant, executive vice president and global head of public markets at BCI where he oversees a $124.7 billion allocation to fixed income and public equity (around 60 per cent of the net assets under management) the bulk of which is managed internally.

“It was imperative that our platform deliver best trade execution, as well as have strong governance to help influence ESG practices with our global financial partners, in addition to streamlining processes, efficiencies, and scalability for our continued growth,” said Garant.

Better decision making

BCI’s centralized, end-to-end trading approach ensures connectivity at the highest levels and enables one cross-asset desk to execute for the entire corporation. Having a complete picture of trading activities, fees, and data allows for better aggregated pricing on total transactions with partners, and further allows for better decision making grounded in centralized data sources.

Promoting collaboration in what is typically a siloed function at many large institutional asset managers, BCI’s centralized trading framework also shifts the role of the trader from operations to advisor, allowing trading professionals to add significant value to the investment process.

Samir Dhrolia, senior managing director, global derivatives, trading and indexing portfolio management explains more. “Joining BCI at a time when the corporation transitioned to active management allowed me to lead a trading team implementing processes and frameworks from scratch. There has long been an established, back, middle and front office approach to trading, coming in to create something new without legacy frameworks to constrain us was very exciting.”

key benefits

As outlined in the White Paper, the key benefits of a centralized trading framework include:

Cross-asset view that enhances portfolio returns, reduces costs and allows for better risk management.

A central voice facilitated via BCI’s One Wallet platform, a relationship management tool that manages a total view of payments across BCI, negotiating with external parties for the best possible results for clients on commissions, deal flows and third-party services. This is increasingly important as BCI’s operations spans the globe with teams in Victoria, Vancouver, New York, and this year, London, UK

Fosters a performance-focused team, and offers an environment where employees collaborate across the portfolio management, cross asset risk and liquidity functions

Streamlines processes, effectiveness, and scalability for continued growth

Optimizes management oversight, and strengthens legal, compliance and operational controls thus reducing a variety of operational and investment risks

Best practice

The paper details how best practices to implement centralized dealings comprises governance, regulatory requirements, defining order types and cross-asset best execution. The analysis draws on the existing body of research for trading desk structures, industry trends and scenario analysis to estimate the benefits net of costs. It also draws on case studies from global asset management firms.

BCI says continuing to invest in its internal capabilities is the most significant lever it has for reducing total cost for clients of value-added active management.

Costs

BCI’s total costs, consisting of internal, external direct, and external indirect costs, were $2.2 billion or 1 dollar and 8.1 cents per $100 of assets under management for fiscal 2022, all of which are netted against investment returns. This compares to total costs of $1.6 billion or 88.5 cents per $100 in fiscal 2021.

The increase in costs was driven primarily by strong performance and value-add in private equity and real estate, which resulted in higher external costs on the proportion of assets managed externally. While strong performance results in higher fees paid to external managers through profit-sharing agreements, our clients retain most of the value added by these managers.

BCI’s $78.0-billion fixed income program accounts for 37.0 per cent of net assets under management. The $64.3-billion public equities program represents 30.5 per cent of net assets under management. Private equity represents $24.8 billion and 11.8 per cent of net assets under management.

A move away from “naïve engagement” between the US and China affords the opportunity for genuine diplomacy and stabilising relationships over the longer term according to Professor Stephen Kotkin, senior fellow at Stanford’s Freeman Spogli Institute for International Studies and the Kleinheinz Senior Fellow at the Hoover Institution.

Speaking to Top1000funds.com in a video interview on the anniversary of the Russian invasion of Ukraine, Kotkin said a significant armed conflict between the US and China is the “real” geopolitical risk and must be avoided because of its broader systemic impact.

“Geopolitical risk is exaggerated for the most part, most geopolitical risk does not affect markets in the way analysts claim,” he says. “The consequences on a humanitarian level are vast but on an investment level they can often be ignored. With China though it is much larger and systemic and so investors can’t ignore it.”

“I was never one to think that globalisation was at risk but I was one to think that China’s role in globalisation was going to shift radically, that trend was apparent before Russia’s full scale invasion of Ukraine and it has accelerated since.”

Kotkin, who is also the emeritus Professor in History and International Affairs at Princeton University, where he taught for 33 years is a world expert in geopolitics and authoritarian regimes including Russia.

He said amid all the atrocities, as well as the heroism, the Ukraine war has two invaluable achievements: it demonstrated both to China and to the West just how much strength the West possesses, and it showcased an outcome no one should want.

“This is no guarantee of statesmanship.  It is, though, a basis for it,” he said. “One can, justifiably, be both more pessimistic and more optimistic at the same time, as a result.”

Kotkin said there were many surprises as a result of the conflict in Ukraine including Russia’s ability to withstand the sanctions. Althought hard to measure accurately he said Russia’s GDP decline was probably 2-4 per cent last year and may even see growth this year, while Ukraine has lost at least a third of GDP.

“The biggest surprise for me is the absence of another area of the world that has tried to take advantage of the situation, that has tried to do something while the world was distracted by Ukraine,” he said. “That hasn’t happened so that has been a pleasant surprise. It shows you have to be careful and humble with your forecasting but it also shows we are early in this war and there is much more that could come including economic dislocation.”

The use of technology has the potential to transform the investment industry bringing down the cost of asset management, exponentially increasing innovation and building more resilient and adaptive portfolios. So investors need to move now to keep pace with the change. Amanda White talks to Herman Bril about why investors need to become ‘technologized investors’.

At the beginning of this year MSCI teamed up with Google to build a cloud-native investment data acquisition and development platform using Google’s AI and natural language processing technologies. The idea is this will allow MSCI to “acquire, ingest and process” structured and unstructured data at scale and more quickly than ever before.
It’s an example of the use of technology by finance firms to revolutionise their operations and result in the ability to be more productive, have broader analysis and build bespoke strategies at lower cost. Ultimately they can serve their clients better, quicker and with more bespoke offerings.

According to Herman Bril who with co-authors Georg Kell and Andreas Rasche, published a new book in December 2022, Sustainability, technology and finance: Rethinking how markets integrate ESG, these tools and data sets are changing the landscape in profound ways and driving down the marginal cost of asset management.

“We can build tools and put technology in place to build bespoke investment strategies in 15 mins. We are getting closer to autonomous asset management which is highly bespoke and can reflect preferences and values for investors. Five or 10 years ago that would be a big job with an army of people, that is changing,” Bril said in an interview with Top1000funds.com.

The book written with a swathe of contributors looks at three broad topics ESG and technology, ESG through technology and ESG as technology.

Becoming a technologized investor

According to Bril the data available to investors today is transformational compared to the finance industry of old.
“The whole technology stack available today allows for insightful analytics,” he says. “Besides the standard ESG rating disclosures you also have access to lots of different alternative data sets. The question is how do you take that into your systems and benefit from that? How do you build insightful information with all this data suddenly available?”

Bril, now head of sustainability and climate innovation at PSP Investments, acknowledges that the data points are not “perfect” but with so many different data points available from different angles due to natural language processing, machine learning and AI “you can allow for a bit of noise in the data”.

“AI is better than humans in identifying connections and trends in a massive amount of data. We were not able to do that back in the days using excel spreadsheets.”

Bril is empathetic with the call to action by Stanford University’s Ashby Monk for investors to become “technologized”.

“Becoming a technologized investor is really to say asset managers and owners need to become more like information technology companies than traditional investment companies and start using different tools,analytics and data sets.”

This means hiring people with completely different skill sets from the traditional finance analyst sitting behind Bloomberg, and instead look for those who can code, data engineers and climate engineers.

“That is driving massive change in the asset management industry and is ongoing. More and more organisations are making big improvements and investing a lot of money to become technologized investor.”

The book has contributions from many technology experts including Ashby Monk and Dane Rook both from Stanford and an insightful chapter by PSP Investments’ CIO Eduard van Gelderen and the fund’s chief technology officer David Ouellet among others.

PSP Investments’ is now collecting and reporting on sustainability information based on a technology-enabled, data-driven approach that spans a bespoke, green taxonomy for climate investing to ESG scores derived from AI. (See How Canada’s PSP Investments is getting to grips with climate data).
Clearly forward looking data is important.

“We want to have a better assessment of where things are going,” he says. “Investing is all about the future so we need more analytics to help build a better cone of future scenarios and probabilities. Using these tools, analytics and data will increase the risk / return profile of your portfolio. The future is unpredictable, but these tools can help you to become a better, more resilient sustainable investor.”

The authors first book, Sustainable Investing: A path to a new horizon, was published in September 2020. (See Finance teaching not fit for purpose).

Swiss pension fund MPK has withstood a difficult year in bonds and equities thanks to its large allocation to real estate. More people tend to rent than buy apartments creating steady demand for rental properties says chief executive, Christoph Ryter.

A large allocation to real estate at Migros-Pensionskasse (MPK) the CHF28.25 billion ($30.3 billion) pension fund for Switzerland’s largest retailer, Migros, supported returns in a difficult year, says MPK CEO Christoph Ryter in an interview with Top1000funds.com from his Zurich office.

“Real estate has been helpful in reducing our losses in equities and bonds,” he says. “Our high strategic asset allocation to real estate has been the main reason we performed better than other pension funds.” The fund has just recorded a loss of 5.6 per cent last year and a 9.4 per cent decline in the funding ratio to 124.5 per cent.

MPK’s strategic allocation to real estate and infrastructure (37 per cent) is larger than most of other pension funds in Switzerland. Other allocations comprise nominal value investments (33 per cent) equities (28 per cent) and gold (2 per cent). The real estate allocation is divided between a larger direct investment portfolio in Switzerland managed internally, and an international allocation that includes infrastructure, comprising fund investment and collective vehicles.

Returns

The bulk of MPK’s local real estate allocation is invested in rental apartments where valuations have escaped the impact of rising interest rates, and demand has been buoyant thanks to a jump in the number of people coming to live in Switzerland.

Moreover, unlike the United Kingdom or US market, more people in Switzerland tend to rent accommodation rather than buy their own properties in a cultural norm that means MPK has no plans to tweak the exposure. “In Switzerland, it’s more common to rent,” says Ryter. Around 80 per cent of the local real estate portfolio is rental apartments with the remainder invested in offices and commercial premises.

A single apartment lying empty will not really influence the total portfolio, he adds. In contrast, empty shops hit malls hard. “The volatility in rental apartments is much lower than in offices and commercial spaces.”

However, Ryter believes valuations are set to decline ahead. “Real estate valuations will decline over time although there will be some lag,” he predicts. Although he expects enduring rental demand for apartments, long-term, he expects gains in valuations to vanish or turn negative.

Ryter says another ingredient adding to the success of the portfolio comes from the fact most of the people running the properties the pension fund owns (cleaners to estate agents showing people around) are also employees of MPK. The identification with the portfolio is therefore much greater, he says.

One of the biggest challenges to the strategy in recent years has been finding enough properties in Switzerland to fill the target allocation. As MPK’s assets under management grew with buoyant returns from bonds and equities, it struggled to fill the illiquid allocation where buying and selling is slow and finding projects and securing permits time-consuming. Now bonds and equities have fallen back the target allocation is back on track.

“We are under less pressure to find new projects and to increase the allocation,” he says.

ESG

MPK has long-term targets to integrate ESG across the real estate portfolio, retrofitting heating systems and installing installation. However, Ryter charts slow and steady progress  to protect returns.

“We have to be careful, and take the long view,” he says.

“Real estate is the best asset class to do something good for the environment. It is really possible to change things for good, unlike bonds or equities where you can sell but someone else buys it.”

 

European football clubs are not an obvious asset class for most institutional investors and don’t spring to mind as a typical investment for organizations stewarding the long-term health of a pension pot – or nation. Yet the $450 billion Qatar Investment Authority’s reported interest in English football club Manchester United could be the latest in a line of club purchases by Gulf SWFs.

Saudi Arabia’s $620 billion Public Investment Fund (PIF) bought Newcastle United in 2021. In 2011, Qatar Sports Investment acquired French team Paris Saint-Germain (PSG). Qatar Investment Authority, the country’s main sovereign wealth fund, is a different entity to Qatar Sports Investment, although both are state vehicles and QSI chairman Nasser Al-Khelaifi sits on QIA’s board. Elsewhere, Manchester City is owned by Sheikh Mansour, the chair of the Emirates Investment Authority (EIA), vice-chair of $284 billion Mubadala and board member of the Abu Dhabi Investment Authority (ADIA), three of the world’s top 20 sovereign wealth funds.

Soft power

The key rationale for Gulf SWFs buying these clubs is rarely financial. Amenity value in the football-crazy Gulf and soft power seem to come first.

“There is clearly both a soft power dimension and an aspect of regional rivalry to these purchases. Like in other areas of state investment, neighbours often copy each other,” says Steffen Hertog, associate professor at The London School of Economics and Political Science (LSE)

Buying a football club brings international visibility and offers a great opportunity for country branding, adds Javier Capape Aguilar, director of the Sovereign Wealth Research at the Center for the Governance of Change and adjunct professor, at IE University.

“It’s a channel to encourage people to visit a country and engage in business relationships.”

Good Investments?

What is less clear is if they are good investments – in contrast to North America where major league franchises NFL and NBA bring owners prestige and financial rewards.

“European football has not made any money historically. Look through the financial statements of any club in Europe, and there is no record of generating profits,” says Stefan Szymanski, Professor of Sport Management at University of Michigan, who says player fees eat into any profit unlike in North America, where there are salary caps on players and mechanisms to stop spending.

Still, Szymanski says profitability at leading clubs is starting to change thanks to live broadcast rights, particularly in English football, and merchandizing.

And a lack of profitability doesn’t mean they don’t make good investments. Another way to make money is profiting from the sale.

“The appreciation in value is not connected to a growth in profitability of the business. It is more down to the growing demand from billionaire investors and a scarcity of trophy assets,” says Szymanski.

For example, PSG’s Qatari owners bought the club in 2011 for about €70 million. Notwithstanding the billions on players and wages spent since, PSG was recently in talks with investors to sell a 15 per cent stake for €4 billion.

“They are taking risks, and in some cases, like Qatar’s very large investment into PSG, it is not clear that the investment has really been commercial,” adds Hertog. “But they can afford to take a long-term view and can absorb losses as long as the purchases help them build diplomatic relations and, at least in the Global South, prestige.”

are the Risks only on the pitch?

And as long as new owners can keep spending money on players, the risks of owning a football club are surprisingly contained. The biggest risk seems to be the team doesn’t perform in line with what the owners are spending on players.

But Szymanski’s analysis reveals player spend always, eventually, equates to achievements on the pitch.

“There is a perfect correlation between where you stand in the league and your wage bill.”

Sure enough, PIF’s spending on players has turned the fortunes of Newcastle United around and the team has risen up the league. Since Manchester City changed ownership and new money for players and wages poured in, the club has picked up multiple trophies and risen up the table. Qatar’s current investment in PSG has led to success on the pitch — the team has won eight of the past 10 French titles although, like Manchester City, PSG has yet to win the European Champions League.

Gulf sovereign’s human rights records could turn the fans and viewers off, although the evidence suggests little link between football fans’ moral stance with enduring support for their club.

“All the evidence says fans are not changing their behaviour no matter who the owner is,” says Szymanski .“Let’s face it, the current owners of Manchester United are hated by the fans. And this has done no harm to the value of the club.”

Still, owning a football club does, nonetheless, draw attention to these countries’ human rights, jeopardizing the soft power influence.

“The main non-commercial risk is that of drawing unwanted attention to local state’s human rights record in the Western public sphere, as has happened with Qatar, Abu Dhabi and KSA,” said Hertog.

Reputational damage is also a risk. Man City is currently charged by the Premier League with numerous alleged breaches of financial rules spanning a period from the 2009-10 season to the 2017-18 campaign when the club breached league rules requiring provision “in utmost good faith” of “accurate financial information that gives a true and fair view of the club’s financial position.”

“If recent allegations of financial violations at Man City in the Premier League are confirmed it could lead to Pep Guardiola leaving, which would be a big blow to the club and its commercial prospects,” says Hertog. Coach Guardiola has made it clear he will leave if the allegations are proven.

Interest in the premier league could decline – but again, this is unlikely.

“If we all decided tomorrow we wanted to watch e-sports it would be catastrophic, but I don’t think this will happen,” says Szymanski, who cites one last risk: a lack of potential buyers if the world runs out of billionaires.