Funds need to redesign their portfolio building process from the ground up if they are to understand the combined impact of many thousands of investments, and push them towards greater social and environmental stewardship, experts say.

A complete re-design of the investment process is required for large funds to understand the impact of their wide-ranging portfolios, and stimulate them to be more impactful towards sustainability goals, according to the principal director of €241 billion Dutch fund PGGM.

In a panel discussion among investment leaders embracing 3D portfolios shaped around risk, return and impact, Jaap van Dam, principal director, investment strategy, at PGGM, said the fund is gradually increasing its minimum investment standards over time, aiming to invest 20 per cent of its assets in Sustainable Development Goals by 2025.

“SDGs are the framework that we look at when we think about creating impact, and we’re nicely on target to realise that,” Van Dam said at Conexus Financial’s Sustainability in Practice forum held at Harvard University.

The fund has also “sharpened” its climate objectives, committing to net zero by 2050 and using “smart engagement” with companies on a sustainable path.

There are “a couple of complications” to this process, Van Dam said. One is that investment objectives are predominantly set using a strategic asset allocation process with a broad benchmark, and “the sustainability dimension is an afterthought to that two-dimensional framework.”

“I think that is something we really need to overcome when we want to build 3D portfolios that make sense both from a financial and from a sustainability standpoint,” Van Dam said.

Another complication is the sheer size of PGGM’s fund. With so many holdings it is impossible to know all the companies, let alone understand whether they are impactful, or stimulate them to be more impactful, he said.

Integrating sustainability in a truly 3D sense entails a “whole new design of the investment process, from the objective setting to the strategic asset allocation, to the building of portfolios,” Van Dam said.

It will require a “well-shaped portfolio” which is “a portfolio consisting of a lot less holdings which are much more explicitly targeted to be impactful.”

Also speaking on the panel was Jane Bienerman, senior advisor with American strategy consulting firm Tideline. Bienerman said investment strategies often blur across different approaches. Categorising strategies between traditional, bottom-line investments, ESG-themed investments, or more strictly-defined impact investments, can be difficult, she said.

For this reason, Tideline has developed its own framework grounded in the commonly understood definition of impact investing. This comprises three characteristics – on top of traditional investments.

These pillars are “intentionality, contribution and measurement,” meaning that investments explicitly target specific social or environmental goals; that the investor enhances outcomes that would not have occurred without the contribution; and that there’s a commitment to measure those outcomes.

This framework has been effective for a number of different reasons, Bienerman said. One reason is that it reflects the non-binary nature of these three pillars.

This could include a low contribution strategy whereby the investor passively engages with management on ESG. This contrasts to a high contribution approach with very active engagement to drive specific social or environmental outcomes, Bienerman said.

High-intention, high-contribution investments are a relatively small part of the market, she said.

“We find that when many asset owners and other investors say they’re looking for opportunities with impact, what they’re really talking about is this broader set of impact-focussed opportunities, not narrowly-defined impact investments,” Bienerman said.

Sarah Williamson, chief executive of US non-profit organisation FCLTGlobal, said investors have been “drilled in risk and return,” but the work now is to “introduce this concept of resilience as a third R.” She argued this should be a fundamental concept of investing, particularly for those investing for the long term.

“We’re all managing money in a world of changing expectations,” Williamson said. “Now perhaps you have a climate commitment, perhaps you have other sorts of responsibilities that you have from your constituents or other commitments that you are trying to hit.

“We all know that when investors ignore these other sorts of responsibilities, bad things happen, usually at the wrong time, and people then make very short-term decisions which typically cost them a lot of money.”

Investors today need to build portfolios that are “resilient to changing expectations…over these very long-term time horizons,” she said.

The term “resilience” is “more intuitive than perhaps ESG as a term or even impact,” and is “easier to explain…to constituents why it’s important for your portfolio,” she said.

Andrew Siwo, director of sustainable investments and climate solutions at the $272 billion New York State Common Retirement Fund, said the Fund’s sustainability portfolio targets nine themes that are split equally into three categories: human rights and social inclusion, economic development, and resources and the environment.

This portfolio has just under $19 billion in assets, having started with $8 billion in January 2020. Around 75 percent of this $19 billion has a climate orientation.

ESG is neither an asset class nor investable entity, Siwo said, “you cannot invest in ESG.” Rather, it is a tool to aid decision making. Each investment must first win the appeal of an asset class team from related risk/return expectations before sustainable attributes are adjudicated.

“Our view from the top is that climate risks are investment risks,” Siwo said. “There are areas of the market that we don’t want to be in, if it is unlikely that future performance will be accretive due to outsized transition risks.”

Engagement, advocacy, “and to some degree divestment” are important tools for the Fund when executing our fiduciary duty,” he concluded.

 

The convergence of three forces is driving a revolution in impact investing that is re-shaping industries and clashing with powerful lobbies that are keen to avoid disclosure, according to Sir Ronald Cohen, a pioneer of the impact investing sector.

But as it was when slavery was declared illegal in the United States, powerful voices will oppose change, and it will take time for harmful practices to cease, he said.

Values

The first force is a change in values, particularly among the younger generation, said Cohen, speaking with Fiona Reynolds, chief executive of Conexus Australia, at the Sustainability in Practice forum held at Harvard University.

Younger generations in particular are distancing themselves from companies that are doing harm, driving huge changes in capital flows, he said.

“This trend has been noticed by investors and today we have more than $40 trillion invested in ESG,” Cohen said. “When I left the G8 Social Impact Investment Taskforce in 2013, that figure was $13 trillion.”

There is already a correlation in some sectors between companies that pollute more and have a lower stock market value, Cohen said, and the exponential increase in the flow of ESG-related data will increasingly see valuations of companies affected.

Technology

The second force is leaps in technology including artificial intelligence, machine learning, augmented reality, the genome and big computing which will enable the delivery of impacts globally in ways that formerly could not be imagined, Cohen said.

“The combination of impact and technology coming together is going to drive the huge rotation in our investment portfolios,” Cohen said, giving the example of Tesla building a trillion dollar company over a period of 20 years, disrupting the automobile industry and changing the industry’s strategies.

“The reason Tesla was successful is that it brought impact into consumer decision-making,” Cohen said. “Consumers didn’t want to buy polluting cars and that made it easier for Tesla to get started. Talent wanted to join them and thoughtful investors saw the opportunity and thanked them.”

Entrepreneurs combining risk, return and impact in their business models are emerging in all kinds of industries, including education with the provision of remote learning; remote health models that can accurately diagnose people in remote locations; and fintech where new platforms are revolutionising the flow of funding to those who are well off, Cohen said.

Transparency

The third force is impact transparency, delivered through impact accounting, which is “only three to five years away in my view,” Cohen said. The ongoing standardisation of impact data will increasingly hit company stock prices, he said.

“The efforts at Harvard Business School with George Serafeim have shown that we can publish 3,000 companies’ environmental impacts in monetary terms based on public information, where 80 per cent of the necessary information is available and we impute less than 20 per cent,” Cohen said. “You can compare ExxonMobil’s pollution from its operations at $39 billion dollars a year.”

“And while fossil fuels will be around for decades and I agree that the transition will take a long time, there’s going to be a shift away from the laggards to the leaders.”

This is because greater flows of venture capital, talent and more customers will go to these corporate leaders, and the laggards will be hit harder by regulation and taxation, he said.

Measurement

The measurement of risk starting in the 1950s revolutionised the way portfolios were constructed with the arrival of the concepts of risk-adjusted returns and diversification, Cohen said. Today, the measurement of impact will see a similar rotation in portfolios, he said.

“We see it in the shift away from fossil fuels, we see it in the money going into clean energy companies, and it’s quite simply going to happen, because it’s a necessity and it delivers better returns,” Cohen said.

Reynolds asked about the current backlash against sustainability and the efforts of some states in the United States to ban certain kinds of ESG impact investing.

Cohen replied that when slavery was declared illegal in the United States, it took 20 years to ban the trade in slaves.

“There are very powerful lobbies, corporate lobbyists that want to avoid the disclosure of that impact,” Cohen said. “But it’s going to happen, because consumers want it as well.”

He pointed to the years following the stock market crash of 1929 where “investors realised that they hadn’t known what the profitability of companies was because each company picked its own accounting policies and there were no auditors,” which led to GAAP accounting and the use of auditors.

A similar process is taking place today with organisations like the International Sustainability Standards Board taking big steps in the direction of transparency, he said.

“You can’t have $40 trillion being invested to achieve impact without the faintest idea of what impact has been created,” Cohen concluded.

“It’s an interesting time to be an investor,” says chief investment officer of Ontario Teachers’ Pension Plan, Ziad Hindo in an interview with Top1000funds.com from Toronto.

He’s reflecting on the past 30 years where many countries and markets have benefited from globalisation and related tailwinds, the unwinding of which has led to a different environment going forward. How he positions the fund to take advantage of the opportunities of that new environment, while minimising the risks, is where he spends most of his time.

There are three neat themes contributing to the new investment environment: sustainability; policy uncertainty; and the end of (hyper) globalisation.

“Climate is not just an environmental issue it’s an existential issue for all of us,” he says pointing to the impact on economies, policies, energy security and the depletion of natural capital. “The combination of this is going to present challenges and risks and we think that these risks may be reaching a tipping point beyond what many people appreciate, with far reaching consequences for countries, societies, communities and investors.”

“We are looking at this in the context of how we are investing to protect the fund, but also the opportunity set for a decarbonised world and our role as an active investor to help the world decarbonise.”

Another characteristic of the new investment environment will be short-term economic policies creating continued uncertainty for long term investing. Added to this is what Hindo calls the end of the hyper globalisation, noting that globalisation over the past 30 years saw the entry of a massive labour force into the global economy and related beneficial disinflationary impacts, as well as optimization of the supply chain, trends that are now reversing.

“There are a lot of changes as the world moves away from hyper globalisation to probably a more fragmented political system. And embedded in that is increased geopolitical risk and the hegemony of the US being challenged, particularly by China. The world doesn’t know how to absorb that, so this will be a major focal point for investors, to navigate the complexity of transitioning to perhaps a very different world that what we were used to for the last 30 years,” he says.

“When you put those things all together – the environmental, political and social issues – with the digital disruption taking place they are all interacting together in ways that are very hard to predict.”

Because of this lack of linearity, and the increased probability of more shocks to come, investment organisations need to be resilient, he says.

“We are humble enough to know we can’t predict these shocks,” he says. “But we are confident we will be resilient, we have good talent, we trust each other, and we are agile enough to pivot and change when we have to allocate differently.”

Resilience and agility in the asset mix

Given these deep-seated changes in the economy and continued inflation volatility, he believes that agility and the ability to mix up the active/passive mix as well as dynamic asset allocation will be key. “Organisations need to be more resilient to deal with ambiguity and unpredictability and have a culture that is resilient to constant change,” he says.

“It also requires internal expertise to manage the total fund, mix the top-down and bottom-up, and act with conviction in dynamic asset allocation, and ultimately invest differently in a more agile way than most organisations are used to. And you need organizations that will put sustainability at the centre of everything they do – this doesn’t mean less return, I would say it delivers as much return as well as delivering the social licence to operate and attract talent.”

OTPP, which is 107 per cent funded, has generated a total-fund net return of 9.6 per cent since the plan’s founding in 1990. It has always been actively managed, with more than 80 per cent of assets in house.  OTPP’s governance structure, and the delegated authority, means it has an ability to be agile which Hindo believes positions it well for the current environment.

But he says the agility in the asset mix is not about short term or being tactical. “It’s hard to know for how long that environment will last,” he says.

As an example, he points to the changes in the fund’s fixed income allocation over the past few years, peaking at 46 per cent in March 2020. By the end of 2020 the allocation was down to 16 per cent.

“With rates rising in 2018 and 2019 fixed income looked attractive for the first-time post GFC and we had ramped it up significantly. When Covid hit rates fell significantly so we acted quickly to almost completely unwind the interest-rate sensitivity of the portfolio. That was a lot of capital to move around. We didn’t know for how long they would be low, but we acted with conviction.”

With aggressive hikes in interest rates by central banks, OTPP has just started to buy back fixed income and build the position again. “We had to be ready. It’s about how you manage the balance sheet, the derivatives exposure, budget risk and have the right governance to do that. All this provides you with an ability to be agile, so you are not scrambling for capital, approvals or balance sheet room.”

Leader in private assets, more to come

While OTPP has a private assets allocation of more than 50 per cent there is no set public to private asset target, rather the asset class ranges are viewed through a lens of liquidity.

“We are more focused on the building blocks of the seven asset classes we have, and how to mix and match them to design a portfolio to withstand shocks, without having the full benefit of knowing what the future will look like,” he says.

“Many outsiders think we are well-known for private assets, but actually how we mix and match the public and private, and active and passive together seamlessly has been one of our secret sauces.” It means that both private and public assets are levers and can provide diversification if there is dislocation in one market.

OTPP has a long and prestigious history investing in private equity, most recently expanding that to include venture capital and growth equity, building an internal team and strong portfolio in the past three years.

“Three years ago, venture capital was restricted to external managers and was a smaller component of our portfolio. But we saw that the disruptions that we were likely to see over the next decade from technology, would not just disrupt selective industries but the whole economy,” he says. “So, we created an internal team as a defence mechanism to understand the potential disruption in the sectors we were in and to understand where they were headed.”

In three years, the fund has built an internal team of 25 people in venture capital and growth equity, and an $8 billion portfolio with 24 holdings including SpaceX.

Private credit the missing piece

But while it has a skilled team and impressive portfolio in the context of most asset owners, Hindo believes there is a missing link in the private assets portfolio which will allow it to be a more “seamless full capital solutions provider” to portfolio companies.

“We need deeper capabilities in private credit. We have been good in public credit, but private credit has been a missing link in our private asset capabilities.

“We have been addressing that and we are in the process of putting together an internal private credit team in London. We mostly had exposure through external managers but there was opportunity to build internal capabilities. Bridging the gap allows us to be a full capital solution provider to the portfolio companies we invest in. Just like we moved quickly in venture and growth capital, we will do that with private credit.”

London seemed like a natural fit for the team, given the opportunities and expertise available, as well as the fund’s head of EMEA, Nick Jansa, having deep credit expertise. Geographically OTPP has teams in Toronto, London, San Francisco and New York with Asia covered with offices in both Singapore and Hong Kong.

A couple of years ago OTPP did a massive deep dive into India. OTPP had already invested in the market, noting the attractive investment fundamentals contributing to increased interest in the country by sovereign wealth funds and others.

To date it has completed four major investments, and will now open an office later this year. Hindo says it is in the process of starting up a much larger presence in the country. “We were struck by how quickly the SWFs had set up shops and got on with it.”

Sustainability and purpose

Hindo, who became CIO in June 2018, has been with the fund for 22 years. It’s a lived ethos that human capital is the biggest asset at OTPP, and employee incentives align with the long-term performance of the fund.

“There is a lot of passion to be here,” he says of the staff. “My mom was a university lecturer, and we all have a story to tell that links us to education. Genuinely and authentically people who work at OTPP have a purpose when they come to work.”

He says the investment program was set up to think about how to invest for a better future, and that resonates throughout the organisation. It started with the retirement of teachers and is now a broader purpose.

“Organisations must put sustainability at the centre of everything they do. Having that social licence to operate will mean you can attract talent,” he says.

OTPP’s climate strategy is multi-faceted with net zero at the heart of it.

In September last year it committed to the ambitious targets of reducing portfolio carbon emissions intensity by 45 per cent by 2025 and 67 per cent by 2030.

“When we designed the interim targets, we wanted to make them industry leading on purpose. That’s who we are,” he says. “We have never shied away from being leaders and doing things differently and taking calculated risks. We know our actions can influence peers.” Hindo says the targets are also aimed at demonstrating the urgency needed.

“A ton of carbon abated now is worth a lot more than one abated in 10-years’ time,” he says. “1.5 degrees is unattainable without active, focused efforts. The longer you delay the less likely it will be achieved. If we had waited and did every bit of planning needed, we’ll never get there. We did a lot of robust work and I’m very proud of how the asset class groups and responsible investment group came together. We are good investors, and we are passionate about this and will get there one way or another.”

OTPP developed the Virtual Energy and Renewables Team (VERT) made up of members of each of the asset class groups to look at sustainability holistically as a thematic for the fund, the first time it has taken that approach.

OTPP is heavily focused on investing in green assets with VERT looking at sustainable fuels, electrification, industry 4.0, sustainable resources and enabling solutions. “VERT allows all our investing capabilities to come together and discuss what they are seeing in things like hydrogen and renewables which are very fast moving.”

Some of its investments include offshore wind, battery storage, waste management, bioenergy, and a carbon credit platform. OTPP has also been an anchor investor in the Brookfield Global Transition Fund and in TPG Rise Climate fund. “We are leaving no rock unturned here,” Hindo says. “We are in a capital deployment mode, and we are also wanting to learn with some of the best investors out there.”

Hindo believes capital allocators have a keen role in the energy transition, especially encouraging investee companies to set targets – the fund is working with 100+ portfolio companies to also set ambitious targets for them. “Internally we are saying by 2030 we want 90 per cent of the emissions of our portfolio companies to be covered by a credible net zero plan,” he says. “The ball is rolling on this, and we are in active dialogue with companies and sharing information. This is a massive risk and a massive opportunity as the entire world economy figures out how to retool itself to net zero.”

Nebraska Investment Council is poised to increase its allocation to global listed equity to 22 per cent (up from 19 per cent) of the $40 billion portfolio, shaped around a specific push into active management. The NIC is in the process of hiring active managers, says state investment officer Michael Walden-Newman, explaining that mandates will be shaped to give managers the agility to invest wherever they see most opportunity, in or outside the US.  “This is where we are putting our manager money to work – on these active, looser mandates.”

The changes in global equity follow on the heels of earlier alterations in NIC’s 30 per cent allocation to fixed income. Although the Council has retained its core fixed income managers as the basic building block to the portfolio, it recently changed the value-added piece, eliminating dedicated bank loan managers and high yield mandates and hiring multi-asset managers to create nimble, diversified mandates instead. “We did away with trying to guess what would add value in the fixed income portfolio over the next five years,” says Walden-Newman who oversees 32 programs spanning retirement pools, public endowments, savings plans and various trust and funds.

Both portfolio alterations are the consequence of NIC’s blank sheet review process which Walden-Newman developed as CIO in the State Treasurer’s office at Wyoming where he worked for a decade before joining the NIC in 2014. In a constantly rolling process, each asset allocation is subject to an in-depth review lasting two years; changes are made and it is then left, largely untouched, for a five-year cycle. “We cycle through the portfolio asset class by asset class,” he explains. “Slow work at the front end makes for better decision making at the back end; we don’t leave any stone unturned.”

Private equity

Other changes on the horizon include a likely increase in the 5 per cent private equity allocation. In February 2023 NIC is due another deep-dive board meeting (it conducts two annually) dedicated to broad educational topics. “I’m certain, come February, we will have a discussion about increasing our private equity allocation,” says Walden-Newman who wants the future conversation to focus on a sizeable increase to 10 per cent. “We know we lag our peers in private equity. It’s done nothing but reward us in the eight years I’ve worked here. It’s time to up the ante.”

The current allocation comprises buyouts, some secondaries, and venture exposure with the manager NEA. Private equity investment is shaped around minimum $50 million allocations to reduce the number of investments and names, typically around 3-4 investments are made over a rolling 18-month period. The focus is on re-ups with existing managers, although Walden-Newman says there is some flexibility in this approach. “We are not a seed investor, and not even a first or second investor. However, if you are a new name coming to us raising fund three and can handle $50million, we will be there for funds four, five and six.”

Risk

Walden-Newman stresses that any future increase in NIC’s private equity allocation isn’t motivated by funding issues. Many peer funds, he believes, are being driven to allocate more to private markets to avoid having to ask for additional funding support from their Legislature; increase employee contributions or request more payments from their broader tax base. His concern is that returns from private markets won’t be realised until 10-15 years hence – and are far from certain.  “Allocating to private markets is easier for some Boards and Plans than approaching the Legislature to bail them out. They are betting on a future that might happen – it may work, I hope it does.”

He says the NIC doesn’t have to stretch for yield and return in uncertain private markets. NIC pension funds are well funded in a state renown for high taxes and where public employees pay a high percentage of their salary into their pension, he says. “We can stick to a more basic asset allocation with public liquid markets,” he says.

ESG wild fire

The NIC’s most recent, bi-annual, deep-dive board meeting in July focused on ESG. Like many public US funds, NIC has become embroiled in the sweeping politization of ESG and the July board requested BlackRock, manager of its index allocations and target date funds alongside a small allocation to active fixed income, come and explain how – and why – it steers ESG investment.

“ESG has landed in Lincoln, Nebraska. It’s a wildfire,” says Walden-Newman. “As an Investment Council we are trying to figure out what to do. We had a Q&A, not just on BlackRock’s approach, but the the larger issues within ESG.”

The process has fanned the flames even more. Since then, Nebraska’s State Treasurer, who sits on the board as a non-voting member, and the Attorney General, another state-wide, elected official, have publicly criticized BlackRock’s strategy. As the blaze rages, Walden-Newman is holding firm to his core role: to run the portfolio as best he can for the benefits of recipients.

He notes that the respect NIC wields amongst policy makers and elected officials has stopped any political interference in the past, and says state law also protects the NIC from divestiture movements. It remains to be seen if NIC beneficiaries will start requesting ESG divestment.

Still, he also holds tight to his faith in the inherent competition of free markets, encapsulated in NIC’s passive exposure structured to tap every kind of economic and sentiment risk. “I trust markets, and where we are buying indexes, we have the broadest exposure to those markets.”

 

 

 

 

 

 

 

 

 

 

 

Denmark’s largest pension fund, the DKK 732.6 billion ($98 billion) ATP, has just posted its worst loss ever, shedding nearly DKK 58 billion ($8.2 billion) mostly in its investment portfolio. Rising interest rates and falling equity markets hit the allocation, impacting investments in government and mortgage bonds and listed equities particularly.

The return-seeking fund, run on a risk-parity basis since 2005, introduced four risk factors in 2016 based on equity, interest rates, inflation and other risk factors – namely illiquid risk factors and an allocation to long/short hedge funds or alternative risk premiums. The strategy has always sold itself on an ability to function well in almost any market environment due to its perfect balance between different asset classes.

Despite the latest results and other investors losing faith  with risk parity, ATP’s CIO Mikkel Svenstrup tells Top1000Funds he is sticking with the approach.

“ATP’s long-term strategy for the investment portfolio is to follow a balanced risk strategy in our four factors,” he says. “That hasn’t changed just because this year the rates factor has underperformed equity. A more traditional 60/40 portfolio would only have done slightly better.”

Svenstrup continues that in today’s stagflationary world, where central banks are fighting inflation by rising rates, none of the three main factors will perform. The largest positive contributions in the recent results came from the holdings of inflation-related instruments.

It means the most important decision lies around whether to increase or reduce the risk level, and during the first six months of 2022,  Svenstrup says ATP reduced the level of risk in the investment portfolio. Levels published at the end of 2021 marked market equity factor at 47 per cent, interest rate factor at 32 per cent, inflation factor at 14 per cent and other factors at 7 per cent.

Risk parity experts say that when interest rates are rising, risk parity can open the door to hidden interest rate risk seeping into other factors and upsetting the balance. For example, high interest rates can convert into lower equities. Rising inflation is another source of disruption because of its impact on interest rate risk. In short, the different factors may end up throwing off the same cashflows and stack up the same exposures. It can leave risk parity investors struggling to diversify and reduce risk – or running more risk than they thought they had.

Positives

Svenstrup  stresses that despite the losses, the basic security of ATP’s guaranteed pension is unchanged because of its large hedging programme.  “ATP protects its pension guarantees by hedging the interest rate risk allowing us to ensure that all our members – more than 5 million in Denmark – receive the pensions promised regardless of interest rates rising or falling. ATP will maintain its disciplined approach to risk management as a long-term investor.”

The funded ratio is secure, he continues. “ATP started 2022 with a funding ratio of 120 per cent after paying 4 per cent general bonus to all our members and now the funding ratio has dropped to 117.4 per cent which is in line with the historical levels.”

“No doubt we have had a large loss in the investment portfolio. However, given that the returns the last three years were 44.2 per cent, 23.3 per cent and 35 per cent – a half year return of -36.4 per cent is a poor outcome but not at all inconsistent with our high risk strategies,” he concludes.

Cryptocurrencies do not live up to the investment hype and offer nothing but enormous volatility to institutional portfolios, according to PGIM’s mega-trend research team.

Cryptocurrencies “have no place in an institutional portfolio,” but investors should be on the lookout for the emergence of collateral technologies that will be critical to the distributed ledger ecosystem, according to award-winning macro economist Shehriyar Antia.

While it is too early to tell exactly what role distributed ledger technology will play in the future, it will rely on a range of supporting technologies if it does truly change the world, in the same way the internet revolution was enabled by things like Wi-Fi and mobile phones, Antia said.

Antia is the head of thematic research at PGIM, the investment management business of American life insurance company Prudential Financial. Speaking with Julia Newbould, managing editor at Conexus Financial, on the Insights for Outcomes podcast, Antia said PGIM’s megatrend research team was drawn to the phenomenal growth of crypto assets, with close to 20,000 different crypto tokens and crypto currencies, and enormous valuations bringing the crypto market to around $3 trillion at its peak last year.

Institutional clients were asking how suitable cryptocurrencies were for fiduciary investors, and whether they would bring anything new to their portfolios, Antia said. Was it an inflation hedge? Did it offer returns uncorrelated to other asset classes, or strong risk-adjusted returns?

Being detached from governments, financial markets and central banks, these assets may indeed offer some unique investment traits, Antia said, so his group set out to “cut through the hype,” concluding ultimately that they had little to offer.

“We looked at all of Bitcoin’s, 13-year history and we found very little evidence that cryptocurrencies had any enduring investment superpowers,” Antia said. “It simply does not live up to the investment hype.”

A good example is Bitcoin plummeting more than 60 per cent this year despite inflation soaring around the world, Antia said, destroying its credentials as an inflation hedge. And when markets around the world crashed in parallel during the onset of Covid-19 in early 2020, Bitcoin and Ether fell even more sharply than equities, commodities and fixed income.

In its 13 year history, Bitcoin has had more than 25 episodes of 20 to 25 per cent drawdowns, and a handful of 50 per cent drawdowns, while stock markets during this time have had only two or three drawdowns of 25 per cent, Antia noted.

“One big conclusion from our research was that cryptocurrencies have no place in an institutional portfolio, and this is just as true at $60,000 back last year as it is today with Bitcoin at close to $20,000,” Antia said. “Bitcoin’s only extraordinary superpower…is to add to portfolio volatility in really big seismic waves.”

But while highly critical of cryptocurrencies, PGIM’s research did find strong potential in the underlying distributed ledger technology and the real world applications that come out of it, although “it’s probably a bit too early to tell right now exactly what those would be.”

Likening distributed ledger technology today to the early days of the internet in the late 1990s with enormous excitement around Netscape, Hotmail accounts and askjeeves.com, Antia said the internet “proved to be a transformative force that genuinely changed the world [but] it was not these first manifestations that did it.”

Collateral technology like Wi-Fi, mobile phones, standardised internet protocols and others played crucial roles, and it took the world at least a decade to figure out “what exactly to do with the internet.”

Such collateral technology for investors to seek out could be infrastructure supporting the ecosystem and solving major challenges such as interoperability–that is, one blockchain speaking to another–or fraud prevention mechanisms that may have a first-mover advantage as central bank digital currencies emerge.

But currently it remains unclear what the technology landscape will look like, and how it will be monetised, Antia said.

As it stands, cryptocurrencies are “not very good currencies,” Antia said, as they fall short of meeting the three basic functional requirements for a currency. They are not a reliable store of value, they are rarely used as a medium of exchange, and they are not a unit of account as very few real world goods and services are priced in cryptocurrencies.

Some investors will no doubt argue Bitcoin will regain its value to reach new heights as it did after last year’s crash of more than 50 per cent, Antia said, rejecting this as “hogwash”. This time the drawdown has wiped out critical infrastructure including multiple exchanges and crypto lenders, severely damaging investor sentiment and revealing “some of the hidden fragilities and vulnerabilities in the broad ecosystem [and] there are likely more,” Antia said.

Bitcoin is also “really slow,” Antia said, processing about “seven transactions per second compared to the five or six thousand per second of the Visa network.” From an ESG perspective it is highly problematic as well. One Bitcoin transaction has a similar carbon footprint as almost two million Visa transactions, he said, with the Bitcoin blockchain alone using as much electricity annually as the entire nation of Thailand.

Being trustless and decentralised, cryptocurrencies have uses for nefarious actors in evading sanctions and taxes. This lack of transparency poses issues for authorities around money-laundering, and presents red-flags for ESG-minded investors as well.