As the number of SWF’s announcing their decision to divest from Russia in response to the invasion of Ukraine grows, SWFs in the Middle East with the largest allocations to Russia are notable for their silence. Australia’s A$204 billion ($147 billion) Future Fund is the latest sovereign investor to announce its decision to divest its Russian holdings  following Norges Bank Investment Management’s decision to sell $3 billion worth of Russian investments held in its giant $1.3 trillion portfolio earlier this week.

“Many sovereign funds have been speaking out against Russia and are divesting Russian assets, but we haven’t heard a peep from funds in the Middle East,” says Scott Kalb, chief executive of KLTI Advisor and the former chief investment officer and deputy CEO of Korea’s $195 billion SWF, the Korea Investment Corporation (KIC).

GlobalSWF, a data platform which tracks the world’s largest SWFs, estimates that foreign sovereign funds hold less than $50 billion in Russian investments, representing a mere 0.13 per cent of their total capital. But of this cohort, Gulf funds are the biggest and most influential investors.

Saudi Arabia’s PIF is the largest SWF investor in Russia with an estimated $10 billion exposure. Mubadala, which first invested in Russia in 2010 and has an investment team on the ground in the country, has a program spanning 45 investments worth $6 billion. Elsewhere, GlobalSWF data reveals Qatar’s QIA has $9 billion worth of assets in Russia with stakes in St Petersburg’s airport and energy giant Rosneft, among others.

Partnerships with russia’s swf

One important seam of sovereign investment in Russia comes via partnerships with Russia’s own sovereign fund, Russia Direct Investment Fund (RDIF) tasked with attracting foreign capital into the country in a portfolio targeting domestic businesses, property and infrastructure.

Its unique model attracts sovereign investors to set the price and conditions for investment projects in Russia and then invest side-by-side with RDIF, explains Kalb who counts around 15 RDIF partnerships, most with Gulf sovereign funds, including KIA, Mubadala, Saudi’s PIF, QIA and Bahrain’s Mumtalakat, but also China Investment Corporation (CIC), CDG in France, and CDP in Italy.

All of these investments face decimated returns ahead on a cocktail of high interest rates, currency depreciation and hyper inflation, he predicts.

“It is a disaster in Russia.”

Losses

Away from these partnerships, SWF losses in Russia are unlikely to make much of a dent in their giant portfolios – mostly because they are small. Like NBIM’s 0.2 per cent allocation to Russia or Future Fund’s $200 million of divestment.

“Russia is not a big market,” explains one sovereign fund expert. “SWFs tend not to invest much in emerging market fixed income especially. Advanced economies sweep up the bulk of SWF fixed income allocations.”

Still, selling in today’s climate won’t be easy. With no buyers in sight the only demand for SWF government bond allocations or stakes in major conglomerates like Gazprom, Rosneft or Sherbank will come from domestic, Russian investors.

“Sellers will lose a lot of value and end up giving these assets away to domestic buyers,” predicts the sovereign fund expert, echoing earlier comments from Nicolai Tangen, NBIM’s chief executive and a former hedge fund manager who flagged the danger of selling stocks now because Russian oligarchs can buy them on the cheap.

All investors involved in quick fire sales of Russian assets will also struggle to repatriate funds since Russia has been knocked out of SWIFT. It could lead to funds opting to freeze assets until they can work out a favourable exit, says Diego Lopez, founder and managing director of GlobalSWF.

Others, particularly the Gulf funds, used to volatility in Russia and less concerned about write offs may hold on, predicts Kalb.

“In my view, a bigger problem for these funds stemming from sanctions will be that they can’t reinvest or average down at low prices.”

impact on China

However Kalb predicts a more challenging environment for Chinese investors. GlobalSWF puts CIC’s current Russian exposure at around $1.4 billion, but data shows that Chinese funds, including CIC, sold stakes in assets like the Moscow Stock Exchange, fertilizer producer Uralkali and gold miner Polyus Gold in 2016 “at a significant discount” because of Russia’s deteriorating economic situation.

It’s a sign of things to come, predicts Kalb.

“In my experience, the Chinese do not like volatility and are not patient investors.  I think losses incurred by China on Russian investments could put pressure on China’s support for Russia,” he says.

SWFs and pension funds will also suffer losses from valuable assets in Ukraine. For example, Japan’s GPIF holds an estimated $179 million in Ukrainian government bonds and Mubadala has a myriad of investments in Ukrainian public and private entities.  Russia and Ukraine are major producers of grains, together accounting for a third of the world’s wheat exports, a fifth of its corn trade and almost 80 per cent of sunflower oil production, according to the US Department of Agriculture.

Meanwhile pension funds across the world are looking at freezing, and potentially divesting their holdings in Russian assets. Across the United States legislators are introducing bills to force state pension funds to divest any Russian assets, including those in California, New York and Pennsylvania.

There is no engagement strategy with Russia, only divestment will prevail.

Pensioenfonds Metaal & Techniek (PMT), the $112 billion Dutch fund for metal and technical workers, has integrated ESG via bespoke equity and bond indexes across all its developed and emerging market liquid allocations. The strategy, which began gradually in 2018, now applies to its €35.9 billion equity allocation and €21.5 billion bond allocation, comprising high yield (€6.6 billion) and IG Credits (€14.9 billion)

Now, in the most recent evolution of the strategy, the pension fund has introduced two additional screens barring ESG laggards from the indexes and raising the threshold to entry. Companies that score poorly (in the lowest 20 per cent) in MSCI’s low carbon transition score are removed, as are all non-metallurgical coal producers.

The latest development of the strategy is enshrined in PMT’s new climate strategy which outlines how the fund will tighten its net zero commitments for companies in the portfolio, and expand its climate engagement program, in an approach shaped by consultation with its beneficiaries, the sectors they work in, and wider society.

It has also been spurred on by sister fund ABP’s decision to sell its entire €15 billion-worth of holdings in fossil fuel companies last year.

“We thought we should also step up and do more,” says PMT’s chief investment officer Hartwig Liersch, who sees the growth in ESG investment at the fund as the most significant and thrilling evolution of his five-year tenure . “Ten years ago, investment was all about the trade-off between risk and return. Now it’s about how you want to achieve that return in a much more data driven approach.”

Data: the biggest challenge

The biggest challenge to the strategy is data. Not only access to data, but deciding which data providers best fit the strategy, how many data providers to use (PMT uses one – MSCI ESG) or whether to use PMT’s own data.

“At the moment we buy in all the data, but we are exploring how efficient it would be to use our own data and if this is something we could or couldn’t do.”

Another key challenge is devising the right boundaries around companies entering and falling out of the index. Companies can always get back into the index if their score improves when the universe is annually re-set.

The challenge around data accuracy and quality is amplified in emerging markets. It’s one of the reasons why PMT has also introduced a country framework that screens out countries according to factors like human rights and corruption. It means many SOEs (classified as where a government has more than 10 per cent of the voting rights) fall out of the emerging market equity and bond indexes, he explains.

“If we exclude a country, we also exclude the SOEs of that country.”

Diversification

The approach has roughly halved the number of companies in PMT’s indexes compared to a the MSCI World Index.

“We’ve dropped a lot of names,” he says. Still, given the size of a traditional passive universe he insists PMT still has well above a thousand companies in which to invest ensuring the diversification benefits of passive aren’t harmed.

“We have excluded companies with a higher risk profile. The risk of the whole portfolio is actually lower and the returns we make are comparable to the general index.” PMT has a long-term excess return target of 1.5 per cent a year above the change in the value of its liabilities.

The strategy is accompanied by annual back testing as new sectors and layers are applied.

“This is our fifth year of back-testing. The longer we do it for the easier it is to learn from back-testing,” he says.

Costs

Liersch says the strategy retains the low-cost benefits of passive.

“The key difference is the cost of buying in the data but we buy in data for the whole fund on a centralised basis which reduces the cost bulge. We do have the cost of the research work, but we think it’s worth it because we want to see this in our portfolio.”

The strategy also comes with more transaction costs as companies adjust to the new index.

“There are more transactions as you adjust to the benchmark,” she says. “But the actual fee is the same as passive and very low.”

The strategy has been built in partnership with MN, PMT’s fiduciary manager and strategic partner alongside MN’s other client fund PME, also developing the strategy.

“We discuss all these topics as a three,” he says. MN also back tests the strategy and runs analysis with other asset managers and members of its network in another element that marks the strategy apart from a traditional passive allocation.

“Our mandate is to work together and keep on learning; there is an added component to work together on our research.”

Engagement

PMT’s strategy doesn’t just stop with screening. The pension fund actively engages with companies via MN in a new, beefed-up strategy. In the past, PMT’s climate engagement was risk-based targeting the top ten carbon emitters. Now engagement targets the companies it seeks to change of which oil and gas companies and utilities that remain in the portfolio after the screening process make up the majority.

“All together there are 50 companies in the program,” he says.

In the first year, engagement focuses on companies net zero ambitions and utilities’ plans to phase out coal. A second year of engagement will involve ensuring companies meet set reduction targets based on Climate Action 100 + and IIGCC.

“We use these standards because it means we are working with other investors. If you do it yourself, it is not nearly as efficient. It’s difficult achieving something on your own.”

In contrast to other investors dialling down engagement, he reiterates the importance of persuading companies to put in place climate strategies.

“Companies have to accept the consequences that if we don’t see changes we will divest,” he concludes.

 

 

 

 

Residential mortgage markets in the UK and Europe are undergoing a period of transformation as new funding models emerge and new players enter the mix, following in the footsteps of the Dutch mortgage market. Long-term institutional capital, in search of attractive returns and diversification potential, is playing an increasingly important role, with the entry of innovative, non-bank lending platforms helping to disrupt the status quo and create a more diversified lending landscape.

Read more

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Asset owners are increasingly looking to technology to more effectively manage complex multi-asset portfolios, enhance returns and better inform risk management decisions. Top1000funds.com looks at how technology is being used by asset owners including LACERA and REST, and the insights of BCI’s chief technology officer, Tony Payne.

Asset owners are increasingly looking to technology to more effectively manage multi-asset portfolios, enhance returns and better inform risk management decisions.

Technology allows investors to manage and draw insights from increasingly large pools of data about the companies and assets in their portfolios, gain insights into total portfolio risk exposures, and improve efficiency.

As “go anywhere” multi-asset portfolios are more common than traditional 60/40 stock and bond portfolios, technology is an enabler for investors to see through the asset classes and identify common or unintentionally overlapping risk exposures.

For the nearly C$200 billion British Columbia Management Corporation (BCI), leveraging digital technology is one of the four strategic pillars of its business plan for 2022-2024.

Tony Payne, BCI’s senior vice president, technology and innovation and chief technology officer, citing the business plan said the fund’s investment in technology has “strengthened our operational infrastructure and talent base to support more sophisticated investment strategies.”

The strategic focus is on using technology across all business functions from using new sources of data to identify and capture investment opportunities – such as in ESG – to applying technology to improve operational efficiency throughout the whole organisation.

“It is definitely an important piece of the capability puzzle,” Payne says.

As an example he says the tools and analytics have enabled BCI to apply a multidimensional analysis of ESG exposures across the whole portfolio.

He shared a “thank you” he recently received from Jennifer Coulson, senior managing director, ESG regarding a data automation project that collects company data and reviews it for quality. Coulson told Payne that the automation enabled her team to save an hour for each of the 53 companies it was collecting data on. Over a year, she estimated that would save roughly 86 workdays of her team’s time, making the team more efficient.

Jonathan Grabel, chief investment officer at the $75.6 billion Los Angeles County Employees Retirement Association, also cited the importance of tools as ESG considerations increasingly are among investors’ priorities, especially to evaluate and monitor portfolio sensitivity to the transition to a lower carbon energy world.

Grabel says LACERA “is now using its systems to calculate the carbon footprint for the portfolio over time, see threats and take a long-term view.”

In the next few years, we will be using advanced technology to generate alpha

For Andrew Lill, chief investment officer of Australia’s A$70 billion Rest superannuation fund ESG is a third lens to any investment decision.

“Technology has to be a way to cut through and determine when you have high and low sensitivity to energy transition,” Lill says.

Overall, the systems allow investors to think of the portfolio holistically, see what is happening and decide what to do about it, Lill says.

“The tools help take investment decisions out of a subjective environment that is largely based on the human experience of staff over the last two decades.”

As an example, for Australian investors accustomed to the Australian dollar being a risk-on currency and a strong tool to buffer portfolios in volatile markets, these systems help to determine if holding the currency will continue to have the same effect in a rising inflation world, Lill says.

He and others pointed to the added complexity of multi-asset portfolios and the need to ensure that institutions are not taking the same risks across public and private assets and are not taking any uncompensated risks as they continue to try to serve the plan’s 1.8 million members.

From asset allocator to investor

Grabel says that tech tools are helping his fund evolve from being an asset allocator to being an investor.

“With greater real-time access to the portfolio as a whole, asset owners can be better risk managers,” Grabel says. “In the past, asset managers’ portfolios were separate and distinct. Now we can see through on a total-portfolio basis are the exposures correct and is LACERA paying appropriate fees for those exposures?”

Robust and sophisticated risk systems are a defining factor of the Canadian Model and help set the Canadians apart and are now an increasing part of the infrastructure used by asset owners in other parts of the world. As an example, the State of Wisconsin Investment Board has been using technology to do better analytics for more complicated portfolios that are multi-asset and unconstrained.

CIO of Canada’s OPTrust James Davis has said that risk management is now as much a source of value creation as a control function and his focus is on building a portfolio that is as resilient as possible which means only allocating risk – a scarce resource – with purpose.

With greater real-time access to the portfolio as a whole, asset owners can be better risk managers

As asset owners look to the future and the uncertainty of the macro economic environment, efficiency is increasingly becoming a focus. And while declining to cite specific savings from the use of technology LACERA’s Grabel did say that the analytics help ensure the fund is getting exposures in the most efficient and liquid ways.

“Tech really does enable us to be much more intentional. In core plus fixed income, we saw that we were taking a lot of active risk for a strategy that was supposed to be risk mitigating. We moved to passive and more core,” Grabel says. When selecting managers and constructing benchmarks the tools have enabled LACERA to “construct relationships based on true alpha.”

The systems “facilitate discussions based on facts, rather than waiting until a month after (something happens) to learn about exposures from third-party managers, we have an early-warning system that allows us to be better about rebalancing,” Grabel says.

Over the last few years, LACERA has made significant investments in a comprehensive risk management platform that includes an appraisal management tool for the direct real estate investment portfolio and helped with the creation in March 2020 – as the staff went to working remotely – of a rolling 90-day cash flow report, adjusted daily, that incorporates information on all uses of cash from benefit payments to investment calls that enables the elimination of cash drag, by through a cash overlay program.

Additionally, the fund’s investment team is structured differently than it was five years ago, says Grabel. The fund now has a group called portfolio analytics that is providing the staff with internal information for risk management, portfolio analytics, strategic asset allocation and ESG and stewardship.

“It allows us better understanding of the sources of return,” says Grabel.

what is next

Funds have been using AI to gain insight into their portfolios with regard to mapping the SDGs. The consortium started by APG is the most notable – with the €600 billion European giant recently setting out the digitalisation of asset management at the core in its next five year strategic plan.

Other funds such as the UNJSPF are also conducting research on developing quantifiable SDG scores using artificial intelligence to leverage big data and systematically measure companies’ impact on the SDGs.

The C$23 billion Canadian fund OPTrust is embracing the power of AI to improve investment outcomes via two new strategies based around re-enforcement learning and uncertainty modelling.

Similarly BCI’s technology head, Payne, says the immediate priority for the fund is artificial intelligence and machine learning and process automation.

“With the vastness of data (available) having the ability to work through data in a meaningful way is crucial. It will augment what the investor or PM will be doing. In the next few years, we will be using advanced technology to generate alpha,” he says.

 

The $197 billion Teacher Retirement System of Texas, TRS, has kicked back against its proxy advisor ratcheting up voting powers on companies subject to its benchmark policy climate provisions.

In a recent board meeting, TRS trustees discussed how companies themselves are best positioned to manage their own climate policies and that proxy benchmarks can be too prescriptive. Rather than blindly follow climate voting advice, TRS will introduce a customised benchmark to give the fund the freedom to vote alongside corporate management on climate policy in accordance with the pension fund’s best economic interests.

“Climate action plans are best left to company board and management’s evaluation of the feasibility and financial impact that such programs may have on shareholder value,” said meeting statements.

TRS has used Institutional Shareholder Services (ISS) – one of the two biggest proxy advisors alongside Glass Lewis – to analyse, recommend and vote on thousands of issues from executive pay to diversity at annual meetings on its behalf since 2013 based, in the main, on ISS’s benchmark policy guidelines. Now recent changes to the benchmark that beef up ISS voting policies against directors slow on climate disclosure and emission targets have made TRS wary.

The pension fund is seeking to develop a custom policy to vote on climate proxies in accordance with its own guidelines, philosophy, and best interests. Noting that an increasing number of sophisticated institutional investors are transitioning to a custom policy to implement their own viewpoint and avoid proscriptive guidelines, Ryan Leary, overseeing TRS’s proxy committee, recommended the fund institute a bespoke policy that makes moderations to the benchmark policy climate provisions.

“According to ISS, a majority of clients with TRS’s profile, customise or are in the process of customising, ISS’s voting policies. Clients using the benchmark policy have shown increased interest in customisation recently,” said meeting statements.

The discussion comes against the backdrop of vocal campaign groups arguing that investors have an over-reliance on the recommendations of proxy advisers. On the other side of the fence, climate campaigners are urging investors to do more to influence corporate climate strategy.  The discussion also offered a window into the value TRS places on its proxies. Board members heard about the importance of the fund retaining control of a valuable “trust asset,” and how it must be well-managed to ensure TRS’s best interests around risk and long-term policy.

While agents like ISS have a slate of polices in place, sometimes these policies don’t tally with the best interests of the fund and benchmark recommendations need a tweak. The board heard how voting is a fiduciary duty and discussed the importance of TRS avoiding a herd mentality. In 2021, TRS voted on 64,687 ballot items at 4,716 companies at 6,458 meetings in 68 countries.

New climate additions to ISS’s benchmark policy include voting against directors at companies without appropriate direct emissions reduction targets, and insufficient disclosure based on a framework established by Task Force for Climate Related Financial Disclosures (TCFD).

In a reflection of growing shareholder pressure, in 2021 the number of ‘Say on Climate’ proposals jumped across the globe with ISS voting to ask companies to publish a climate action plan, and to put it to a regular shareholder vote. In other benchmark modifications, ISS has also expanded gender and racial, ethnic targets in US, Canada, Japan, UK & Ireland.

Alongside favouring a customised approach over ISS’s benchmark policy guidelines pertaining to climate, the board also discussed the importance of a bespoke approach to how TRS votes on Special Purpose Acquisition Company (SPAC) mergers to best protect the fund’s economic interests.

Meanwhile pension funds from Texas recently played an important role in Blackrock’s renewed commitment to invest in fossil fuels according to Reuters, a move that goes further to confuse the position of the manager whose chief executive Larry Fink has touted sustainability as a priority in the past.

Lowering exposure to fossil fuel companies was a key tenet in his 2020 letter where he promised to make “sustainability integral to portfolio construction and risk management” and exit investments that present a high sustainability-related risk, such as thermal coal producers. He also said the manager would launch new investment products that screen fossil fuels.

According to Reuters new legislation in Texas requires the state’s comptroller, Glenn Hegar, to draw up a list of financial companies that boycott fossil fuels. Those firms could then be barred from state pension funds like the Teacher Retirement System of Texas, which has about $2.5 billion with Blackrock.

Last month Blackrock executives wrote to officials in Texas confirming they would continue to invest in and support fossil fuel companies, including Texas fossil fuel companies, and as a large and long-term investor in fossil fuel companies it wanted  to see those companies succeed and prosper.

Railpen, guardian and administrator of the United Kingdom’s £35 billion ($47 billion) Railways Pension Scheme is well known for its belief in the cost and control benefits of inhouse management visible in its large in-house fund management and fiduciary team. Rather than outsourcing stewardship, the investor has also built up an internal engagement team to better align stewardship with its ESG objectives, particularly its ambitious net zero targets.

“We don’t outsource our stewardship activities,” says Michael Marshall, head of sustainable ownership at Railpen. “We are rolling up our sleeves and doing this work ourselves.”

Railpen’s net zero strategy has targets along the way to 2050 set at 2025 (25-30 per cent fewer emissions in the portfolio) and 2030 (50 per cent fewer). With 47 companies making up around 70 per cent of financed emissions, the pressure is on to ensure these companies make most progress on limiting their emissions for Railpen to meet its targets.

“If we outsource engagement to a provider, there is no guarantee that they will target engagement on our largest and most long-term holdings, nor on the themes that we are prioritising,” explains Marshall. “By engaging ourselves we can be much more focused on what adds the most value to how we manage our clients’ money.”

It’s a level of control that is particularly important when it comes to timing engagement and knowing when to escalate it, he adds.

“If we externalised this aspect of strategy, we couldn’t be certain the services rendered would escalate company engagements on a time horizon that aligns with the milestones in our net zero plan.”

stewardship Strategy

Railpen structures engagement both from a bottom up and a top down perspective. In terms of bottom up, the investor seeks to engage all companies in its internal actively managed equity portfolios which is about 80 holdings across three portfolios. This runs alongside a top-down approach via a thematic overlay in recognition that even active investors with a strong record of stock picking are still exposed to systemic risk.

The four themes (the climate transition, the worth of the workforce; responsible technology and sustainable financial markets) captured in the overlay reveal another cohort of companies that can expect Marshall and his team of seven to knock on the door.

“On climate we engage with around 47 companies as part of our net zero plan. These companies contribute 70 per cent of our financed emissions. We also have an exclusions process structured around governance and corporate conduct that runs screens across the whole portfolio, shortlisting around 20 companies for focussed engagement and perhaps, ultimately, exclusion of those companies.”

limitations of Passive

Railpen holds very little passive equity exposure, however it does have some externally managed index allocations with LGIM which also manages stewardship and engagement on the investor’s behalf.

Moreover, Marshall notes that stock allocations in the actively managed portfolio are often repeated in the passive allocation, meaning that in some cases Railpen is already engaging with the company. Large passive houses like Vanguard, BlackRock and LGIM frequently pop up as significant shareholders for many companies and are increasingly influential.

“When it comes to winning votes, companies really want to keep them on side,” he says.

Still, he notes the inherent limitations of the ubiquitous ‘Dear CEO’ letter penned by stewardship teams to thousands of companies in a passive portfolio.

lEven the largest stewardship teams at index investors cannot meet every portfolio company, and the larger the stewardship team grows, the greater the risk of undermining the low-cost benefits of passive investment.

“Passive is a buy and hold strategy: companies know you are unlikely to divest in your mainstream index-tracking portfolios.”

the importance of Relationships

Marshall highlights the long-term nature of Railpen’s bottom-up engagement process. Many holdings in the fundamental allocation date from the beginning of the portfolio seven years ago, resulting in a longstanding stewardship conversations based on trust.

“If a concern surfaces, we would be unlikely to immediately write to the chair. Instead, we might raise our concern in our next company call and then escalate from there if the issue is not getting the attention required, but we are not starting an engagement process from scratch in terms of building the relationship.”

This contrasts with the higher turnover of the quantitatively managed equity strategies, run inhouse by Railpen, where allocations to value, momentum and quality stocks might not come with a long-term relationship.

“Establishing durable relationships of mutual trust with companies takes time if you’re going to do it well” says Marshall. “For our quantitatively run strategies we employ a thematic overlay, focussing on enduring themes rather than idiosyncratic issues at particular companies.”

Within themes companies are prioritised based on size, materiality, equity ownership, and likelihood of achieving change.

Railpen is a member of multiple collaborative initiatives designed to increase investor pressure like the United Kingdom’s Investor Forum. Railpen also uses third party suppliers to advise on proxy voting which talk to companies through the course of the year, advising them how the investor might vote.

“Our success often depends where companies are based. We have good purchase in Europe and UK, but it’s more difficult in emerging markets,” he says.

Alongside climate, Marshall’s team also engage on One Share One Vote. He argues that dual class share structures, which give company founders or the family more votes per share, may suit young, entrepreneurial companies that have just listed. But as a company matures and broadens its shareholder base, it is important investors can hold it to account.

“When investors only have one tenth of the voting power compared to the founder, it’s more challenging for investors to exercise stewardship obligations in the way policy makers want. This isn’t a niche issue as huge companies including Meta and Alphabet have a dual class share structures so many investors will have exposure to this issue.”