A push towards standardised data and more appropriate incentives is bringing more private sector capital into play on the path towards net zero emissions by 2050.

The world is approaching an inflection point on climate investing, says the Asia-Pacific chair of one of the world’s largest asset managers, with developments on standardised data and appropriate incentives that are speeding the pace towards net-zero emissions.

Ben Meng, chair of APAC at asset management giant Franklin Templeton, which has around $1.5 trillion of assets under management, pointed to the International Atomic Energy Agency’s estimate that it will take energy investment of $5 trillion every year to achieve 2030 climate goals on the path to net zero.

Given the high level of public indebtedness, the majority of this estimated capital will have to come from the private sector, but fortunately there have been strong developments in the areas of information and incentives that are bringing the private sector to the table, Meng said.

Speaking at Top1000funds.com’s Fiduciary Investors Symposium held between May 23-25 at the Chicago Booth School of Business, in a panel discussion on climate strategy and net zero portfolios chaired by Conexus chief executive Fiona Reynolds, Meng said strong climate risk data will be needed, and welcomed the International Chamber of Commerce’s proposal to make climate risk disclosure mandatory.

“Climate data needs to be regulated, just as financial data has to be–you know, comprehensive, reliable, timely, auditable,” Meng said. “With investment grade information, Wall Street, or the private sector is fully capable of developing the analytics so that the investor can do a risk and return trade-off analysis.”

Investors also need incentives, Meng said, and the removal of disincentives. The United States should get rid of unnecessary fossil fuel subsidies and put a price on carbon, he said.

“Put a price on carbon, let it be taxed, or carbon pricing as the private sector prefers, so any investment I make in reducing carbon emissions, I can turn that into the carbon pricing market to capitalise on that,” Meng said.

With mounting action on these two fronts of information and incentives, and with Europe considering a border carbon adjustment tax which could have ripple effects globally, Meng said he believes the world is approaching an “inflection point” on climate investing.

Also on the panel was Ariel Babcock, head of research at Focusing Capital on the Long Term, a global not-for-profit research organisation backed by members including asset owners, asset managers and multinational companies. FCLT does evidence-based work to help better focus capital on longer-term investment horizons.

Babcock said climate came onto her organisation’s agenda in recent years after hearing from a growing number of members that they were under increasing pressure to make net zero commitments and rapidly decarbonise their portfolios with divest and exclude policies.

“From our perspective, that approach was very short term in nature,” Babcock said. “It produces paper decarbonisation that hasn’t actually changed the real world or done anything different for the planet.”

Organisations focussed on decarbonisation often struggle with collecting all the data required, she said. Even for those who get a full picture of their current carbon footprint, they aren’t always sure where to go from there.

The process begins with clarifying investment beliefs, then thinking about risk appetite, then selecting appropriate benchmarks and making sure your evaluations process and incentives are aligned with those benchmarks, Babcock said. Finally investors can think about how they might incorporate some of those beliefs and risk assumptions into their investment mandate and contracts with external advisors.

Hard questions investors may need to ask are: What is the competitive advantage gained from investing in new technologies? Are you getting appropriately compensated for the risk you are taking on, or are there some uncompensated risks? Will near term emissions go up in the portfolio as you acquire new assets and put plans in place to clean them up? Transparency on these matters is crucial, he said.

“The things we were also hearing that were tripping people up in starting to implement and move towards a decarbonisation objective was sort of making sure that there were very clear lines and very clear communication,” Babcock said. “Being really transparent up front with your stakeholders about the fact of that, right from the beginning, is really important.”

Aaron Bennett, chief investment officer at Canada’s University Pension Plan – a new asset owner which is not even one year old, with about C$12 billion of assets – said while better and more standardised data will be crucial, investors in the meantime can gain an advantage if they have the ability to extract insights from messy and non-standardised data, he said.

Engagement with managers is also critical, and needs to be done in a structured and clear way, he said.

“Really work with them to understand what it is you will and you won’t do, the kind of reporting you’re looking for and the kind of reporting you don’t care about,” Bennett said. “Because I have been on the asset management side, and I know that the requests can sometimes seem endless from clients, and I really appreciated that element that said ‘that’s fine, we appreciate your reporting on all this, these are the three data points that matter.”

Investors who don’t plan to divest need to have a plan to transition, he said, and be transparent about it to members.

“And that gets you away from the conversation that says well, I just need you to sell all your oil and gas companies right now and everything will be fine,” he said.

“Horrible” sentiment towards technology stocks is dragging down the value of some of the “best business models on the planet,” experts say.

The biggest technology wipeout since the tech bubble in 2000 is producing some “amazing opportunities” to choose quality technology stocks that are being dragged down in value, according to John Donnelly, managing director at New York based asset manager Jennison Associates which has around $214 billion of assets under management.

Sentiment is “absolutely horrible” right now towards technology stocks, Donnelly said, speaking at Conexus Financial’s Fiduciary Investors Symposium held between May 23-25 at the Chicago Booth School of Business, in a panel discussion looking at technology and its role as an enabler and a disruptor.

But with hundreds of billions in value wiped from the NASDAQ this year, Donnelly said there are particularly good opportunities for investors in software. Cloud computing is “less than 30 per cent penetrated by any measure” and there is strong, ongoing growth in giants like Amazon Web Services, Microsoft Azure and Google Cloud Platform, he said.

Despite falling in market capitalisation, the world’s top 25 software companies have strong revenue, high customer retention rates and the ability to grow with their existing customer bases “without adding one dollar of sales and marketing,” Donnelly (pictured) said.

 “These are still the best business models on the planet,” Donnelly said. “That didn’t change just because we had a liquidity induced bubble.”

E-commerce is a tougher area, he said, with a plunge in low-end consumer spending after strong sales during the pandemic. Consumers are returning to physical stores now that lockdowns have been removed, and there is a shift from buying goods to experiences as consumers are fatigued on buying goods, and these trends are working against e-commerce, he said.

“So the growth in e-commerce is going to be more linear and you don’t have that accelerating S-curve type growth where you hit the adoption point in the curve,” Donnelly said.

Subscription businesses like Netflix are also “more penetrated than people think” leading to weaker growth in subscribers, he said.

Donnelly also pointed to enormous promise in blockchain and the applications that will be built on top of it, although we don’t yet know what the winners will look like, he said.

“There’s too much young talent going into the space for this to not be real,” Donnelly said. “There will be a killer use case that evolves, and comes out of nowhere. We don’t know exactly what it is today. And when that happens, there will be a lot built on top of it and then the use cases will start expanding.”

technology as a disruptor

Also speaking on the panel was Brandon Gill New, director and co-head, multi-strategy investing and digital assets, at $25 billion Canadian Pension Plan OPTrust

OPTrust has a digital assets sleeve with a team of three, which Gill New described as a “risk mitigation strategy” in anticipation of digital assets being a “very disruptive asset class to capital markets” and an important asset class for the fund to better understand.

“It’s not about just Bitcoin, it’s about all of the technology behind it that is actually quite innovative,” Gill New said. “There is a serious amount of momentum behind it and it is a bit of a revolution that’s bubbling up and we want to make sure that we understand that really well, and we’re mitigating any risks in our portfolio certainly around that.”

The tokenisation of private assets is set to dislocate and disrupt real estate markets and other private markets, she said, with tokenised real estate holdings no longer requiring a single cashed-up buyer.

 “You can actually chop that up into little pieces and actually, you know, invest in real estate in a very liquid way and that’s obviously something that our real estate team needs to understand,” Gill New said.

The disintermediation of asset exchanges and the displacement of brokers is also a significant trend the fund’s private equity and private markets team needs to understand, she said.

Ali El-Annan, head of technology at SWIB which has around $165 billion in assets, described how the asset manager had created a data science team which produces various analytics and automates aspects of the fund’s asset allocation process.

“You’ll hear me use the word ‘automated’ a few times, [about] different things in our asset allocation process, and what that does is, it reduces operational risk,” El-Annan said. “It frees up our investment staff to focus on things more investment related.”

 

Investors should shape strategies that protect against the downside, said Jeff Gardner, senior portfolio strategist, Bridgewater Associates.  Speaking at the Fiduciary Investors Symposium at the Chicago Booth School of Business, he said that investors should prioritise protecting against losses in the current environment: increasing returns can be additive to long-term wealth, but missing the big losses is just as important to driving long-term wealth creation. Strategies using put options that protect against downside outcomes can help raise the consistency of returns and lower volatility.

In an environment where it isn’t clear which, if any, asset will be protected, reducing downside outcomes is a powerful tool. Even if two different assets have the same return over a long period of time, the asset with less risk will give more wealth because it avoids the losing periods.

Put options protect against drawdowns, but often at a cost that outweighs the long-term benefits. He suggested a strategy that offers downside protection but also positive returns when equity markets are performing. He said put options can protect investors in the peak to trough of equity falls, offsetting declines, adding that options premium is at its highest after the decline in markets making protection expensive.

The strategy offers investors a diversifying solution in a market environment where few assets look truly diversifying.  Every asset has a bias and performs better – or worse – in a particular environment. Biases amount to inconsistent returns and have led to classic strategies like holding diversifying assets or creating overlays that hedge exposures – for example hedging liability risk by overlaying with duration.

The challenge today, however, is that there is little option to diversify. Traditional assets can provide some level of diversification, but it is possible that all assets suffer at the same time and bonds may not provide traditional diversification.

“Everything can go down and there is very little that can protect you,” he said. Gardner warned, however, that moving away from structural diversification to tactical strategies comes with timing risk.

Looking back

Gardner set the scene by outlining the causes of the current economic climate. The decline in inflation and historically low interest rates over many years has driven financial returns – returns that have also been fuelled by globalisation. In another trend, returns over the last decade have gone to capital and not benefitted labour.

“Political pressure is changing this,” said Gardner. He also noted how assets in underlying portfolios have outperformed their underlying economies.

Central bank stimulus in response to the pandemic has been highly inflationary and equivalent levels of stimulus have only ever been seen in war time.

“We combated the Covid war with a war time policy: this cycle is now playing out” he said. He noted that US household wealth increased during Covid, creating a nominal demand which supply couldn’t match, making the economy vulnerable to shocks – like war in Ukraine and Covid’s resurgence in China. The large stimulus to cushion the impact of Covid on less fortunate households was important, yet he added that the Fed could have pulled back on the stimulus earlier.

Gardner said policy makers are in a tough spot, caught between trying to support growth and bring inflation down yet unable to accomplish both simultaneously. It leaves investors focused on mitigating risks – and holding onto how well assets have done recently.

The future

Reflecting on what the Fed might do next, he noted that a small tightening – enough to bring inflation down – is priced in by markets. However, equity markets have not priced in any adjustment to earnings: the drop in equity markets is so far due to rate rises.

Gardner said that European economies, hit by the loss of Russian energy, are most likely to experience stagflation and shared concerns of a food crisis in northern Africa that could kick off further unknowns. He noted the bifurcation in equity markets, where the US has outperformed Asian and European indices, could signal opportunities in Japan and China and urged investors to hold more real assets. He noted how investors have been unwilling to hold real assets because they have dragged on portfolios, and have historically under allocated to real assets compared to financial assets. He advised investors to focus on the cash flows in their investments, warning that cash flows in real estate may not offer inflation protection.

Western economies are balancing tightening with weak growth, but other economies, like Japan, don’t have the same inflation problem. He added that emerging markets also look cheap. Elsewhere delegates noted that gold has not reacted to market turmoil, despite rate cuts and the dollar strengthening.

“Gold is underperforming and it’s interesting it hasn’t had a bump [up] from crypto selling off,” said Gardner.

Looking ahead, Gardner said China’s Covid challenge (where low vaccination rates among the elderly and less effective vaccines prevail) has been priced into supply chains. He said that moving from a zero Covid strategy in China carries risks, and shifting to effective vaccines is not a short-term fix. Still, China is now focused on finding the right policy mix to support growth, and has the tools to ease interest rates and allow the currency to weaken.

He said that Bridgewater has predicted more downside than has yet occurred, missing the forces that led to the continued extension, and the willingness of the Fed to keep stimulating the economy. However given today’s inflation levels he concluded:“It does finally look like a turning point.”

 

 

Chris Hulatt, founder, Octopus Group, and Olivier Rousseau, executive director of France’s FRR, reflect on the European energy crisis. Speaking at FIS Chicago, they warn of consumer pain ahead, urging governments to do more to build renewable energy infrastructure.

Cripplingly high energy costs in the UK where the average annual household bill is forecast to near £2000 is already compressing discretionary income and leaving one in five UK households in fuel poverty. “The sheer brutality of the rise in bills is different to anything in the past,” said Hulatt. He noted how the rising cost of energy will also impact businesses like supermarkets with high energy usage, low profit margins and little pricing power. “Profits will be under pressure at businesses like this,” he predicted.

Building renewables is the solution, but it comes with complexities, particularly bureaucracy. Red tape stalls quick construction around solar farms and onshore wind, the lowest cost renewable energy that can be built quickly once grid connection and planning are in place. “Governments should shorten this process to build new assets,” he said.

Leadership

Hulatt outlined the role of western nations in helping developing nations move away from coal and said that political leadership plays a crucial role in delivering the transition. In South Africa, the move away from coal is essential; power stations are old and South Africa can’t grow its economy if it doesn’t have access to electricity.

Most governments now recognise the need for change. When the United Kingdom’s former Prime Minister Theresa May put in place a net zero commitment it was deemed radical in a way that it wouldn’t be today. Reflecting on the importance of the “tone from the top,” Hulatt noted how Australia’s new prime minister Anthony Albanese is already signalling a change in Australia’s approach to renewable energy.

Still, he noticed how war in Ukraine and the ensuing spike in energy costs has paused talk on the transition and net zero. “It feels like the topic is on hold,” he said. He noted that bigger European economies failed to diversify from Russian energy but shifting to other energy suppliers is difficult. For example, Germany’s ports are not equipped to import LNG, posing a logistical challenge with no easy solutions.

Nuclear option

European countries are going in different directions around nuclear energy. France has an established nuclear industry; Germany is closing its nuclear plants, but the UK is building more. Panellists heard how nuclear is costly and takes years to build – future nuclear supply will do nothing to reduce bills or wean the UK off Russian energy today.

Olivier Rousseau, executive director, FRR, counselled on the correct policy response to the spiralling cost of living. The wrong policy response in France provoked social unrest. France’s Gilets jaunes (yellow vest) protesters took to the streets following a hike in diesel fuel and petrol taken by a political elite that effected poor people the most. Policy makers have learnt from the protests and are now targeting relief from energy prices to the neediest, he said. “This was a good response after a misunderstanding,” he said.

France developed its nuclear energy industry in response to the oil shock in a rare example of long- term decision making. The massive programme was completed in the 90s and today France derives 85 per cent of its power generation from nuclear and 10 per cent from hydro.

However, Rousseau observed how some sectors of French society have grown sceptical of the nuclear industry. The Fukushima disaster and Germany deciding to shut down its nuclear power have increased resistance to the industry. He said that countries investing in nuclear need to be mindful of the risk posed by huge power plants and associated grids.

Panellists heard how many pension funds are reluctant to invest in nuclear power. Although nuclear has been included in the EU’s new taxonomy of sustainable investment, many pension funds have restrictions on their ability to invest. It means the British government has been unable to tap long term pension fund investment to build Hinkley power station in Somerset. “Traditional providers of long-term capital are unlikely to be big contributors; the government needs to find different types of funding mechanisms,” said Halett.

Rousseau countered that nuclear is a sovereign risk and should be financed by governments. It is too risky for the private sector to finance, and investors would demand too high a premium, he said. In an example of the risk of outside investment,  panellists reflected on how the UK is now trying to roll back on China’s 20 per cent stake in Hinkley.

Rousseau said that FRR’s pioneering decarbonisation strategy involved convincing conservative colleagues but drew impetus from Paris hosting COP 2015. The fund has created indices to support the reduction of its carbon footprint and is also decarbonising its smart beta and factor investing allocations.

Real assets

Hulatt noted how real assets have become an increasingly compelling investments for pension funds. Real assets also have an inflation linkage and wind energy offers stable long-term growth that is compelling against the backdrop of falls in equity. Investment is also being driven by pension funds own net zero targets.

Pension funds have grown much more comfortable investing in the construction phase of renewables; they understand the risks and fierce competition for operational assets has pushed them into new sectors. Investors could buy operational assets that are bond like and offer 4-5% returns, but more are choosing to build assets from scratch for a bigger return.

Hulatt concluded that building renewable energy infrastructure incurs a high carbon footprint. Investors are mindful of the concrete and supply chain issues in solar products sourced from China. But analysis supports the lifetime benefits of building renewable infrastructure. “A solar farm earns its keep,” said Hulatt, noting the importance of looking after local communities and counting decommissioning costs.

 

 

 

 

 

Globalisation, the cross border flows of trade, capital, people, and information, has had a profound impact on efficiency, competition, growth and inflation, all factors keenly watched by investors and influencing asset allocations. It is no surprise the appearance of de-globalisation trends has investors worried, but speaking at the Fiduciary Investors Symposium at Chicago Booth School of Business, Patrick Zweifel, chief economist, Pictet Asset Management, said although trends in globalisation are changing it is not about to disappear.

History

The origins of globalisation date from steam power. More recently it has grown with the globalisation of information dating from the mid-90s. Against a backdrop of growth, globalisation has also gone through phases of decline however. The most recent decline began in 2008, visible in protectionist measures like the US-China trade war while the pandemic slowed trade and the movement of people, reducing tourism and business travel. “The question is whether the pandemic and war [in Ukraine] will exaggerate the trend over time,” asked Zweifel.

Other factors are also feeding into the de-globalisation narrative. Emerging economies are producing more goods of their own than they used to; consumers in emerging markets are wealthier and consume more domestic production. US foreign direct investment has declined since 2008, and he noted a decline in companies investing abroad or outsourcing production.

Elsewhere, weak institutions are exacerbating the trend like the WTO, struggling to influence decision making. However, Zweifel noted that this hasn’t stopped regions in the world making their own free trade agreements like the Regional Comprehensive Economic Partnership (RCEP) made up of 10 Southeast Asian countries, as well as South Korea, China, Japan, Australia, and New Zealand.

Climate change has also changed consumer behaviour, leading people to buy more locally and travel less. However, Zweifel noted that the energy transition is creating new trade flows. For example, new trade corridors will open up as flows from oil exporting regions in the Middle East give way to flows from metals exporters in countries like Chile, the DRC and Australia. Moreover, although protectionism is rising, he said it may be confined to certain protected areas like technology and medical supplies where he says re-shoring is most likely.

Reshoring vs friend shoring

Re-shoring will bring challenges for many companies. Often touted as the best response to reducing supply chain vulnerability, companies that re-shore will lose their comparative advantage and see their labour costs rise. Moreover, reshoring is happening when labour markets are already tight. The only way to counter higher wages will be for countries to open their borders to immigration creating a paradox. “Countries could be forced to import a labour force into their own country,” he said. Countries with better demographics are best positioned to reshore, he said. “Demographics will make a difference.”

Near shoring, or friend-shoring, provides an alternative that successfully reduces or shortens the supply chain but does not rely on domestic production. Zweifel also counselled on the importance of companies diversifying their supplier base.

Drawing on several, diversified, suppliers ensures companies are better positioned to always be able to produce their goods. He suggested companies see this strategy as a kind of insurance premium. Although it will cost more, it means they won’t have to halt production or see their margin impacted by reshoring. He noted how European economies have woken up to the risk of not having a diversified energy source away from Russia. Only now are countries making deals with other producers like Algeria.

New trends

He noted how internet access is fuelling growth in emerging markets – however internet access is still low across Asia, creating room for these economies to catch up. This will allow societies to have more access to the services like banking and finance on their phones that are essential for economic growth.

Elsewhere, Zweifel noted how the pandemic has fuelled tech innovation and reduced the cost of face-to-face contact, leading to new telemigrants (people sitting in one nation and working in offices in another) allowing companies to reduce the cost of labour by employing talent overseas and holding benefits for emerging markets. Elsewhere the cost of production of goods is falling because of technology and AI.

All these changes will feed into the inflation narrative. The price of goods might rise with reshoring, hitting companies cost of production and profit margin, however technology will also drive down production costs. Zweifel concluded that  investors should gain exposure to new themes like digitisation, robotics, and clean energy.

 

 

“We’ve had significant success hiring people who care about the mission and have bought into who and what we are,” says Richard Tomlinson, CIO of Local Pensions Partnership Investments, the £22 billion asset manager for three Local Government Pension Scheme funds in the United Kingdom. Public sector pension funds might not be able to pay investment teams as much as the private sector, but as fierce competition for talent rages, particularly in sustainability, asset owners have key ways to attract talent. “It can take quite a while to hire, but you can find good people,” he says.

Success comes down to culture, clarity on goals, appreciation and offering an environment where people can grow and feel valued. “Many people want a job with purpose; they want to be empowered,” says Tomlinson who’s studying of leadership and team building techniques practised by the likes of New Zealand’s All Blacks and the Navy Seals has instilled his own belief that these factors are just as important as pay in recruiting and retaining talent in LPPI’s 57-strong investment team.

It’s a particularly important message to get across in the hunt for mid-career investment expertise where the competition of talent is most intense. Mid-level candidates, often at the most expensive time in their life, will still opt for purpose, culture, and people over salary, he insists. “Money matters much more for the middle bracket but purpose, culture and people really do matter too.” In contrast, the hunt for talent isn’t as fierce at junior or senior levels: junior hires without huge experience can’t command top whack, while senior roles are often filled by candidates who are less motivated by money.

Costs

The rising cost of talent and salary inflation could play into LPPI’s ability to continue to cut costs. LPPI’s total investment management fee savings was £164.13m at the end of March 2021 thanks, in the main, to bringing investments in-house with a third of the portfolio now managed internally.  However, not only are internal salaries going up, Tomlinson explains that sustainability and data systems to support net zero commitments are pushing costs up even more. “When I started, we had one person in the responsible investment team but now it’s five.”

Nor does he see much room to cut costs further via changing the asset allocation or bringing more assets in house. “We can probably do a bit more internally, but we have a healthy spread now between what we are paying externally and internal efficiencies: we have a good frame around our fees, costs and performance.”

He also argues that driving costs down should always been seen in the context of risk and performance – increasing costs can often drive better outcomes. “If you wanted to save on costs, you could buy some ETFs or take out the private equity allocation – it just might not meet your needs. Alternatively, you don’t just want to naively lock money into private markets in search of an illiquidity premium that is not always positive and where fees can be painfully high.”

Looking ahead

LPPI’s long-term, growth-orientated portfolio is already skewed to lower risk with sizeable investments in defensive equities and real assets. It means the portfolio is well positioned for today’s investment climate where Tomlinson is concerned about Central Bank’s clear and hard pivot to get inflation under control and the growing likelihood of a hard economic landing. Any adjustments to the portfolio will only be on the margins, like, for example, selectively buying the hardest hit equity names.

Although he’s not casting around for opportunities, he has liquidity on hand should they arise. LPPI re-forecasts its 12-month cash flow expectations monthly, stress testing cash flows on contingent liability and he can draw on liquid allocations to cash and fixed income if needed. Moreover, because a large part of LPPI’s real asset allocation is internally managed, the fund is protected against untimely capital calls – something he describes as every CIO’s nightmare if liquidity is scarce and pensions need paying. “The need for liquidity doesn’t keep me awake at night,” he says.

Dollars in a downturn

The large allocation to dollar investments will also act as ballast. In a downturn, it is common to see capital getting pulled back to the US causing the dollar to strengthen while any tighter funding lines also see a rush for dollars. “The dollar is a nice place to hide at times of market stress,” he says.

Around 30-40 per cent of LPPI assets under management are in dollars and Tomlinson doesn’t hedge the allocation to US stocks – although he does manage the FX impact at a total aggregate level via an overlay for some clients.  Elsewhere, he notes how the portfolio also gains exposure to dollar earnings via many FTSE listed companies. So much so some UK pension funds hedge the FX exposure – although it’s not a strategy he advises. “The realised volatility of an unhedged UK equity allocation is lower than a hedged allocation.” Away from equities, LPPI does hedge all its dollar-denominated credit and fixed income allocation.