Managing liquidity stresses is a fact of life for defined contribution funds, but the unprecedented early release schemes introduced by both the Australian and United States governments during the onset of Covid-19 brought this challenge to a new level.

The superannuation landscape may be permanently changed on the back of this precedent, and collective defined contribution plans such as Australian superannuation funds and UK master trusts need to be prepared for either participant actions such as member switching, or government actions such as early release schemes, argues Michelle Teng of PGIM in a new research report (Super Funds & Master Trusts in a World of Member Switching, Early Release Schemes & Climate Calamities, available via the link).

Speaking to Conexus Financial managing editor Julia Newbould on the ‘Insight for Outcomes’ podcast series, Teng said funds were facing the confluence of two liquidity-challenging trends: the introduction of early release schemes and encouragement from governments that they support economic growth by investing in illiquid private assets like private equity and infrastructure.

Prudent CIOs are unlikely to keep asset allocations unchanged in the face of this new landscape, Teng said.

“Generally, CIOs would move some of the risk-seeking assets, which tend to be less liquid, to lower-risk and more liquid assets, for example from private assets to stocks, or from stocks to bonds and cash,” Teng said. “This change of portfolio allocation to better manage liquidity risk incurs a hidden cost of expected portfolio performance that affect all participants.”

But holding extra liquidity comes at a cost to performance, and funds cannot afford to respond to heightened liquidity risks by simply becoming defensive, particularly now that Australian funds are subject to the Australian Prudential Regulation Authority’s annual performance test, Teng said.

Rather, they need more advanced tools to help them quantify the cost of adapting their portfolios and make more confident asset allocation decisions.

“The challenge for CIOs is to coordinate their top-down asset allocations with their bottom-up private asset investing activities, and in the meantime they need to meet a number of liquidity demands,” Teng said.

Newbould asked whether early release schemes had shown governments may be willing to make funds available during natural catastrophes, which may become more frequent as the planet warms up.

“The short answer is we don’t know, but there is a possibility,” Teng said.

Members may rightfully question the point of having a retirement plan if they cannot afford to rebuild their house, she said, noting the United States passed legislation in 2021 allowing disaster distributions from retirement plans for calamities other than the Covid-19 pandemic.

More broadly, the impact of these decisions from governments will go far beyond the Covid-19 pandemic, Teng said, raising awareness across the industry about how to better manage liquidity.

Industry participants, including policymakers, need to better understand the tradeoff between the liberality of early access programs and expected portfolio performance in the long term, she said.

“Our research may help governments and policymakers identify portfolio allocation consequences and costs of contemplated rule changes,” Teng said. “These costs would be borne by all participants.”

Globalisation hasn’t died, it’s just going native.
Until recently, globalisation was perhaps the second-most fervently held article of faith for asset managers and allocators. The conviction was twofold: first, that globalisation was a good thing, and second, that it was on a one-way track.

In the words of economist John Maynard Keynes, referring to how contemporaries viewed the pre-1914 golden age of globalisation, “…most important of all, he regarded this state of affairs as normal, certain, and permanent, except in the direction of further improvement, and any deviation from it as aberrant, scandalous, and avoidable.”

Globalisation in asset management was born on portfolio managers’ trading screens, with ever-more integrated capital markets and vanishing capital controls. Its next manifestation was in fund passporting schemes (UCITS being by far the biggest).

Soon enough, allocators the world over started relying on similar yardsticks to identify and select managers (midwifed by investment consultants who themselves went global in the 2000s). Finally, globalisation made its way to regulators, with talk of “harmonising” approaches to regulating markets and the fund industry.

For allocators, what mattered was the substantial expansion of their investment universe and the frictionless deployment of capital across borders. For asset managers, globalisation meant scale: a single platform housing investments, operations, and business management, ideally in one location, powering a common set of strategies and products for sale globally. The 2008 financial crisis slowed things down a bit, particularly regulatory harmonisation, but the direction of travel didn’t change.

This model was upended, first gradually, and then suddenly. The gradual shift was the rise of the individual investor, who eclipsed institutions in terms of total dollars deployed, expected future flows, and fees paid. The primacy of individuals is leading to a more regulated industry centered on local vehicles, focused on local asset classes, and characterised by investors with diverging needs and levels of financial literacy.

The sudden shift was the steady staccato of ruptures in the global financial fabric: trade wars, pandemic, hot war, sanctions. Here the impact has been in the investment function: impeding the free flow of capital, policies that channel savings locally, permanently altered supply chains, and introducing politics as a major non-economic driver of asset valuations. All of these factors tilt the balance in favor of deeply local investment strategies and managers.

But globalisation isn’t gone. For one thing, the diversification benefits are too compelling. Furthermore, the majority of markets remain lopsided in one way or another: for example, not enough local debt issuance, or equities that lack any meaningful exposure to younger, dynamic, future-oriented companies. The potential exceptions are China and the US (bearing in mind that in China capital controls are firmly in place, and ESG adds further hurdles).

The post-2022 globalisation is a series of deeply rooted local investments that together result in a global portfolio. This model lacks the simplicity, ease-of-use, and scale of the 1991-2021 globalisation. It requires a thoughtful approach, guided by political inputs rather than solely financial inputs. For managers, the pursuit of global synergies will lead to disappointment: other than in a few corners of the industry (large institutions, select alternative strategies) there will be very little global operating leverage across the four major asset management markets of the US, EU, China, U.K. (that together account for over 80 per cent of investable assets). When it comes to demographics, product preferences, regulatory model, the role of ESG, and the role of policy in the markets—US, EU, China, and UK are sui generis.

Staying global will be an exercise in prioritising a few markets to go deep, rather than trying to access every market. The effort required to be successful in any one place will inhibit all but the very largest players, and local leaders will usually have an embedded advantage—sometimes explicitly, via regulatory favor.

This new, fractured globalisation is creating new winners and new investment opportunities.

The rise of politics and ESG as major non-economic valuation drivers requires a fresh look at investment processes and philosophies built on a now-irrelevant pricing data set. Diverging individual investor needs creates demand for new products and investment approaches. What remains unchanged is the single most fervently held article of faith for both managers and allocators: markets, in the long run, go up.

Daniel Celeghin is managing partner at INDEFI

Investing for sustainability impact is relevant for all investors and they should consider doing so where it can help meet their financial objectives, said David Rouch, partner at law firm Freshfields, Bruckhaus Deringer and lead author of ‘A Legal Framework for Impact’, the so-called Freshfields Report.

Published last year, it explores to what extent can and should institutional investors use their power and influence to generate a positive sustainability impact, exploring the role of the law in supporting this process.

Speaking at Sustainability in Practice at Cambridge University, Rouch told delegates to continue seeking to influence companies for impact as an effective way to achieve their financial goals.

“Continue doing what you are doing,” he said.

The report, launched by PRI, UNEP FI and The Generation Foundation, lays the foundation for the financial policy reforms needed to reorient investors, markets and economies towards net zero and inclusive, sustainable economic growth.

It follows on from the first Freshfields report of 2005 which concluded that investors are permitted, and arguably required, to integrate ESG factors into their analysis, and the subsequent UNEP FI, PRI and Generation Foundation program: Fiduciary Duty in the 21st Century, which determined that ESG factors must be considered for investors to meet their fiduciary duties. All these legal developments amount to building blocs to the infrastructure supporting sustainability and impact investment.

legal pinch points

The latest report found that across 11 jurisdictions, investors are able to pursue sustainable impacts (via, for example, stewardship, policy engagement or divestment strategies) if they are an effective way of achieving financial goals. Rouch said investors can pursue impact to achieve their financial goals that are put at risk if those impact are ignored. In this way, investors are instrumentally seeking sustainability goals to achieve broader financial goals.

The study has revealed various legal pinch points however. For example, how will pension funds assess if they are having any influence on the third party?

It flagged potential issues around a pension fund’s ability to divest and the importance of investors and asset managers remaining unbiased, continuing to represent all their investor or beneficiary cohort who might care about different impacts.

“Investors have to be impartial,” he said.

Pension funds will also have to factor in cost, balancing the cost of engaging with the impact on the fund. It makes collective action an important decision, he said.

Evidence is a crucial element of the legal process. If investors are ever challenged in court, they may have to provide evidence that the benefit outweighed the cost. He said in such a circumstance, the court will always look at the process behind the decision making; charting how investors take responsible decisions based on evidence and properly consider the risk of sustainability and what the fund can realistically do about it.

“A court will be influenced by good industry practice – but it is virgin territory.”

Collective action

Rouch also noted how successful sustainability and impact investment requires collective action, however this can come with legal challenges.

For instance, one of the challenges with collective action is that the results are enjoyed collectively – and success depends on collective action. It could leave investors struggling to define what contribution they have made to the collective outcome – or what benefit they derived from the collective action.

He said that if by pursuing sustainable impact investors can protect the value of their fund, then logically they should be doing it.

He concluded that one of the biggest challenges is getting people to understand the legal arguments, noting that US investors are particularly anxious around these issues. He said the investment community needed to embed this into their practice outside the legal and consultancy world which is more familiar and comfortable with these concepts.

The €268 billion Dutch pension provider PGGM is leading its global peers when it comes to shaping 3D portfolios based around risk, return and impact.

Speaking at Sustainability in Practice, Piet Klop, head of responsible investment at PGGM, charted the investor’s journey from building an actively managed €2.5 billion impact equities portfolio five years ago to targeting nearly 20 per cent of the entire portfolio contributing to the SDGs today.

Klop said steering capital to positive impact requires measuring real-world impacts wrought by investment decisions, and he said investors also need a clear mandate to invest for impact. PFZW, the pension fund for Dutch healthcare workers, which is PGGM’s biggest client, specifically aims for climate and healthcare solutions at market-rate return expectations.

“Our board of trustees wants more than alignment with the SDGs, they want to make a difference,” Klop said.

He added that reputations matter, and trustees are increasingly aware that also means the avoidance of negative impacts.

real world impact

Klop said that capturing real world impacts requires investors look at what companies are actually doing to meet the SDGs – and not just their conduct.

“What problem are they solving?” he asked.

Investors must understand how companies make their money, from what solutions, and how these translate into real world outcomes .

“Few companies report their real-world impact, how much water is saved; how much carbon is avoided, or healthcare provided thanks to their products and services.”

He noted that some companies score well in a traditional ESG rankings (the ‘how’) but when investors look at  products and services through the problem-solving lens (the ‘what’) the scores change. Companies like Unilever and BAT may have sector-leading ESG scores, but what SDGs do their products solve?

semantics: impact v outcomes

Measuring impact is hard work; data constraints remain a challenge because of limited company reporting on SDGs and climate impacts.

It also requires conviction: Klop said that clearly pursuing real-world impact incurs extra effort even though the difference on the SDGs will be marginal . He also cautions that, technically, the word ‘impact’ requires knowing the context in which solutions are put to work. Better perhaps then to talk about ‘outcomes’.

He suggested investors engage companies to improve on outcomes that they may have approximated using revenue-to-outcome models first.

Klop explained that investing with impact (outcomes) requires quantifying impact in a way beneficiaries readily understand.

He said that although beneficiaries rarely dig down to the finer detail of impact strategies, it is easy to overclaim impact and therefore lose trust.

“If you overclaim, it will only be a matter of time until you get caught out  ” he said.

He also noted the importance of trying to find impact investments close to home in beneficiaries’ own countries.

“Even so, beneficiaries take comfort from the knowledge that  their pension savings are delivering  a global benefit.”

 

 

 

Net zero objectives are not enough, and the world needs to do much more to create a manageable future, said Professor Sir David King, founder and chair, Centre for Climate Repair at Cambridge University and UK government chief scientific advisor from 2000 to 2007.

King said ongoing extreme weather throughout the northern hemisphere is no coincidence, and warned that the world’s chances of staying below 1.5 degrees of warming “don’t look very good.”

Temperature rises reveal that the Arctic is heating up at a faster rate than the rest of the planet, creating a tipping point whereby the temperature rise causes the ice covering the Artic to melt during the polar summer. As the Artic soaks up sunshine and warms, so the air above it warms the surrounding land masses, including Greenland’s permafrost.

Jet stream impact

King said this in turn impacts the jet steam, causing it to meander lower. The jet stream keeps cold air in the North Pole and warm air out. However, the cold region of the planet is no longer centred around the North Pole, which is now above zero for the summer months as warm air supplants the cold air, pushing the jet stream into distortion.

“Warm air is sucked up as cold air is pushed down, causing dramatic changes in the global weather system.”

He said that if Greenland’s ice melts it will cause profound rises in sea level. As permafrost melts it will release methane, a much more toxic greenhouse gas than carbon dioxide.

“This is potentially a disaster,” he said, outlining traumatic temperature rises. “I am not going to say if, and when, this will happen, but it’s not a risk you want to take.”

He noted evidence of explosive releases of methane already happening in Russia where it is bubbling up from under the permafrost. Rising sea levels would impact low lying sea level countries like Vietnam with devastating impacts on global food production. At current levels of warming, he said 90 per cent of Vietnam’s land mass will be under water by 2050 at points in the year.

Borrowing from the future

King said deep and rapid emission reduction needs to be fair and orderly. He said continuing to use fossil fuels equates to borrowing from the future, and noted the growing distrust between the developing and developed world because promises made by the developed world have not been enough.

“The country that has to take a lot of the blame is the US,” he said.

He said decision making and progress in the US is blocked by the fossil fuel lobby.

“They have the Senate and Congress in their pocket.”

He noted how the lobbying system went against democratic elections and said that China has done much more to switch from fossil fuels than other countries, developing nuclear and wind power at a rapid rate.

Technology’s role in resolving the crisis

King suggested that technology could help resolve the crisis. Technologies focused on removing excess greenhouse gases in the atmosphere are developing. Elsewhere, he cited progress around marine biomass regeneration by recreating whale poo on the surface of the ocean around which green matter or phytoplankton blooms forms. It involves learning what the faeces contain; artificially lying it on the ocean and using it to capture tonnes of greenhouse gas as well as feed billions of fish.

Aping natural processes is at the heart of another approach. He also told delegates how scientists are exploring how to refreeze the Arctic in a process the imitates natural processes to brighten marine clouds. Using high-pressure sprays mounted on boats, droplets of salt water would be fired straight into the air. When these evaporate, the salt crystals left behind would rise on natural convection currents and help to form clouds overhead, reflecting sunlight away from the ice and allowing it to form a thicker layer of protection for the summer months.

“If we can demonstrate feasibility, money will flow,” he concluded.

 

 

 

The giant Canadian investor, CPP Investments, has drawn up a proposal for projecting the capacity of companies to abate greenhouse gas emissions. The framework offers a standardised template to measure the extent to which organisations can remove or abate their GHG emissions that is applicable across industries and geographies, with common assumptions.

The data from the template will help corporate boards and executives better understand the least and most polluting elements of their business, and steer investor capital to industries with lower emissions, said Richard Manley, managing director, head of sustainable investing at CPP.

“If you want to build a business case, reframe the debate,” said Manley. “We need to allocate capital to companies that can support the transition.”

He said the paper was born from the fact many companies have set ambitious 2050 decarbonisation plans that are not grounded in reality.

“Companies are not providing any insight into how they are going to achieve net zero,” he said, echoing a theme of the conference.

assessment Steps

The first step proposes companies create a clear, standardised assessment of their emissions across Scopes 1, 2 and 3. Next they conduct an Abatement Capacity Assessment (ACA) to project their capacity to abate them, and finally report their Projected Abatement Capacity (PAC).

When companies assess their current emissions, they can develop an estimate of what portion they can abate using currently available, proven technologies; efficiencies or through greening their power consumption. For example, a cement plant may be able to eliminate all its emissions associated with its electricity consumption by using renewables, but only 10 per cent of emissions from its kilns based on technologies that are economic today.

However, the framework suggests companies don’t factor in cheaper technology costs and new regulation in the future. They should only adjust future projections of abatement capacity in accordance with two standardised carbon price assumptions that exceed current levels.

“We have assumed there is no change in regulation and have not baked in consumer behaviour or dramatic reduction in costs because of technology,” he said.

If companies can’t effectively abate emissions in parts of their business the framework suggests they close or cease the business activity; further technological development or acknowledge that the emissions will likely require offsets.

Investor guide

The framework will lead to new capital allocations: a company with high abatement capacity relative to its industry, will likely have access to more and cheaper capital. Or, if the information provided by these projections reveals that multiple industries are confronting similar regulatory or technical hurdles to lower a specific source of emissions, this framework can help guide policy decisions and prioritise investment in innovation.

Manley noted that the framework isn’t something new, but said effective abatement plans were crucial to test companies net zero commitments. These commitments are changing security prices, but if they prove empty it will lead to the possibility of fraud and market abuse.

“Regulators need to be aware and prepared for false climate claims,” he said. “Issuers need to corroborate their long term guidance with projected abatement capacity.”

Board strength

Away from the framework, Manley highlighted the importance of strong corporate boards.

“We need boards to ensure executives have identified all climate risk and opportunities and integrated this into their reporting,” he said. He added that CPP is prepared to withhold support for re-appointed directors if their climate strategy lacks. It is a process that has spurred some companies to commit to TCFD filing processes lest they lose the investor’s support for their directors, he said.

He said that companies with a boardroom culture to proactively mitigate and capture the business risks and opportunity from climate change will outperform. He also noted that investors have more control in private markets. In public markets, investors count on boards to provide effective oversight and counsel executives to integrate sustainability.

Manley concluded that meeting net zero commitments poses a number of challenges for CPP Investments, and for many investors. The fund is growing fast making reducing emissions more difficult in general. At a macro level, several of the world’s largest economies are not planning to be net zero by 2050 so deploying capital in those economies
will result in portfolio emissions beyond this date unless those economies accelerate their NDC’s