Border to Coast Pensions Partnership, the United Kingdom’s public sector pension pool which manages £55 billion ($75 billion) on behalf of 11 partner funds, has just committed an additional £1.2 billion ($1.6 billion) to private market fund managers. It’s part of a £2.7 billion ($3.6 billion) private markets program announced in July 2021 deployed across infrastructure, private equity, and private credit. Securing access to the latest cohort of sought-after managers is a coup for the pool and follows a carefully structured process of outreach and engagement.

Early engagement with target managers long before the formal fundraising process began was key, explains Mark Lyon, head of internal management at Border to Coast. As was leaning on existing relationships with partners to secure introductions and open the door to the brightest and best GPs.

Once the conversation began, Border to Coast made much of its scale – it’s one of the largest UK pools – long-term outlook and ability to act quickly. Enabled by putting in place a due diligence process that ensures clear guidance for GPs over the likelihood of the pool committing to a strategy, allowing managers to reserve capacity with confidence.

Fees

Despite mandating to expensive, sought-after external managers, the private markets allocation is on track to deliver promised fee reductions.

“At launch in 2018, we anticipated we would generate annual fee savings of 25-50 bps per annum from our private markets program over the long-term and we are proud to report we are on track to achieve this,” says Lyon.

A process he also credits to early engagement, the ability to commit larger amounts of capital with allows the fund to access lower fee rates, plus leveraging the pool’s collective size and relationships with the wider LGPS which comprises a total of eight pools of capital.

“Key ways we negotiated included requesting LGPS fee rates, targeting strategies with lower fee loads – such as private equity co-investment funds – and challenging expenses arrangements.”

Co-investment

Speaking to Top1000funds.com last year, Border to Coast CIO Daniel Booth explained the extent to which co-investment drives down fees.

“We are generating quite meaningful savings through the aggregation of the assets and getting discounts. Alternatives have a very costly implementation cost, so we are making sure we are as efficient as possible on funds and co-investment which is usually fee free or half fees.”

As well as putting fee pressure on external managers, Border to Coast also expects higher returns. The fund targets a 2 per cent outperformance from external managers versus 1 per cent outperformance for internal management.

“We expect more for external management. We look at the relative cost savings to manage internally, the probability of success and the alpha potential among other things. There are about 10 things on our checklist.”

Factors external managers will have to consider as the pool expands its private markets allocation.

“The three-year Series 1 of the private markets program will come to an end in March 2022 and we anticipate making five more fund investments.

“We expect to launch Series 2 of the private markets program in April 2022, with a similar number of commitments to Series 1 across all of our strategies.”

 

The Dynamic US Equity (DUSE) story officially begins in 1989. However, its origins date back to the 1970s. Bill Fouse and Tom Loeb, the two co-founders of Mellon Capital (predecessor firm prior to joining Newton Investment Management), pioneered the practical application of economic theory and are credited with creating the first equity index strategy. In the mid-1980s, Mellon Capital also developed expertise in global tactical asset allocation (GTAA) and calculating valuations (or premia) for global stock and bond indices.

DUSE was an outgrowth of these competencies. The catalyst came from an index client that had grown disenchanted with traditional active equity management and asked if there was an alternative method to generate alpha. The challenge then, as it is now, was to produce an excess return over the S&P 500® utilizing asset-allocation concepts while maintaining a similar level of market risk.

DUSE sought to utilize the market structure as highlighted by the Capital Asset Pricing Model (CAPM) to generate excess returns. Conceptually, the idea was to blend index exposures in the S&P 500 (stocks), long US Treasuries (bonds), and cash while also allowing for modest leverage. We believed the approach would generate more consistent returns over the S&P 500 than was possible with traditional active strategies that rely on stock picking.

Modern portfolio theory in practice

The investment process relies on forward-looking asset premia, risk and correlations to determine the optimal allocation to stocks, bonds and cash and the appropriate level of leverage. The first question we ask is, “Are stocks attractive?” The second question is, “Are stocks attractive relative to bonds?” If the answer to both questions is yes, we overweight stocks (usually 15-20%). Next, we blend in an allocation to bonds and cash for diversification and additional sources of alpha. Put succinctly, the process encompasses:

  • Our proprietary expected return calculation for stocks, bonds and cash (asset premia).
  • Our proprietary expected risk calculation for each asset class and their correlations.
  • Mean-variance optimization to arrive at the optimal allocation (highest Sharpe Ratio).

The optimal portfolio is the ideal blend of stocks/bonds/cash that offers the highest return per unit of risk. In the illustration below, this optimal portfolio lies on the efficient frontier at the point of tangency(1). The tangent portfolio, however, has a notable limitation in that both the expected return and risk are typically lower than a 100% stock portfolio. Given DUSE’s objective to outperform stocks, this limitation would be a non-starter. This is where leverage comes in. By allowing a modest amount of leverage, we can move up the capital market line(2) (the straight line connecting cash and the point of tangency) to construct a portfolio that has a similar risk as stocks but also offers the opportunity for excess returns above stocks.

Sample Efficient Frontier

Leverage in DUSE is modest. The leverage is used prudently to move up the capital market line when risky assets (stocks and bonds) are attractive or underpriced. We allow up to 50% leverage, and often do not use the full amount. Furthermore, leverage is obtained through listed and exchange-traded index futures and index option contracts(3); there is no direct borrowing. Finally, the equity leverage is implemented through S&P 500 options only; thus, during a market correction the options reduce the equity overweight as the options’ exposure shrinks to zero. Nonetheless, for some investors the use of leverage understandably conjures up nightmares of outsized losses. DUSE’s intelligent design and multi-tiered risk control have yielded robust downside protection over its 32-year live history.

  • The strategy’s risk-mitigation factors include:
  • Tail-risk mitigation through use of options
  • Multiple risk models employing fundamental, macro and credit market data
  • Long US Treasury bonds as a defensive hedge
  • Extensive scenario analysis / stress testing

Over its full history, DUSE has produced a compelling 90% down capture versus a 106% up capture.

When launched in 1989, most agreed that DUSE was an innovative yet unconventional approach. Today, interestingly, not much has changed. In harmony with its design, based on sound and well-recognized financial theory, the return stream has exhibited low correlation to more traditional, active approaches that engage in security selection or factor tilts.

At the end of the day, investors care about alpha, and DUSE has delivered. Since its launch in September 1989, the strategy has produced an annualized alpha (net of fees) of 2.8%. Moreover, the realized returns and risk over this period resemble the conceptual diagram of the CAPM diagram shown above.

Proof statement

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. Inception date: August 31, 1989. 1 On an annualized basis, net of fees since inception. 2 The Bloomberg® Barclays US Long Treasury Index, FTSE 1-Month US Treasury Bill indexes are being shown for comparison purposes only and are not official benchmarks for this strategy. A definition of these indexes can be found at the end of this paper. The graph on the left-hand side is for illustrative purposes only and does not reflect actual returns. Performance presented for measurement periods prior to February 1, 2018 represents the portable performance results of a prior affiliated firm which have been linked to the ongoing track record for the composite or the composite’s representative account shown as supplemental information. Data sources: Firm Research, S&P 500, Bloomberg®. Performance is expressed in US dollars. The information shown above is supplemental to a corresponding GIPS compliant presentation, which has been prepared and presented in compliance with the Global Investment Performance Standards (GIPS®), in the back of this presentation. See Additional Information in Disclosure Statements.

While DUSE was originally designed to outperform the S&P 500, through client demand we continue to expand the Dynamic Equity platform to include other equity markets. The requirements to expand DUSE to additional equity indexes are fairly basic: we must be able to evaluate the premium of the underlying equity market (e.g. using consensus earnings estimates and company-level fundamentals), determine the risk and correlation profile, have access to a reasonably liquid futures market, and be able to buy options for leverage and tail-risk protection.

Today the Dynamic Equity platform covers a wide spectrum of equity markets, including global equities, style indexes (value and growth) and, most recently, US small cap stocks. We can also implement Dynamic Equity as a pure overlay, effectively porting the excess return stream over any market exposure. With over USD 18 billion in assets under management as of August 31, 2021, the Dynamic Equity platform is gaining traction in the marketplace as investors search for reliable and uncorrelated alpha that can be deployed at scale.

Finally, we must recognise the implications that digitalisation has on sustainability. The consideration of environmental, social and governance (ESG) factors can be a useful tool to achieve a more holistic picture of companies. There are various ESG issues that are prevalent in the technology sector, in particular around social media, cyber security, and (as mentioned) data privacy. In addition, many of the large technology companies have voting structures that can be detrimental to shareholders. All of these risks must be monitored.

We look for businesses that will survive and thrive for not just the next few years, but for the next few decades, and the focus on sustainability has led to new business opportunities. A good example of this is a global leader in industrial software. The company essentially creates a digital representation of a physical asset for industrial businesses. This virtual model is able to study the asset and suggest potential improvements, thereby improving the efficiency of industrial processes. Not only does this have financial advantages, but also significant environmental benefits, including reduced waste and lower carbon emissions.

Dynamic Equity assets under management

USD Million Total Assets Separate Account CIT UCITS Mutual Fund Inception
Dynamic US Equity (DUSE) 8,771 2,724 1,936 576 3,536 Sep-1989
Dynamic US Small Cap Equity (DUSE R2) 7,120 7,119 Jan-2021
Dynamic US Large Cap Equity (DUSE R1) Jan-2021
Dynamic US Equity Overlays! 1,740 1,740 Dec-2019
Dynamic Global ex-US Equity (DEXUS) 567 30 537 Jul-2018
Total 18,198 4,494 9,592 576 3,536  

Important information

This is a financial promotion. This article is for institutional investors only. Material in this article is for general information only. The opinions expressed in this article are those of Newton and should not be construed as investment advice or recommendations for any purchase or sale of any specific security or commodity. Any reference to a specific country or sector should not be construed as a recommendation to buy or sell this country or sector. Please note that strategy holdings and positioning are subject to change without notice. Newton manages a variety of investment strategies. Whether and how ESG considerations are assessed or integrated into Newton’s strategies depends on the asset classes and/or the particular strategy involved, as well as the research and investment approach of each Newton firm. ESG may not be considered for each individual investment and, where ESG is considered, other attributes of an investment may outweigh ESG considerations when making investment decisions.

Issued by Newton Investment Management Limited, The Bank of New York Mellon Centre, 160 Queen Victoria Street, London, EC4V 4LA. Registered in England No. 01371973. Newton Investment Management Limited is authorized and regulated by the Financial Conduct Authority, 12 Endeavour Square, London, E20 1JN. ‘Newton Investment Management Group’ is used to collectively describe a group of affiliated companies that provide investment advisory services under the brand name ‘Newton’ or ‘Newton Investment Management’. Investment advisory services are provided in the United Kingdom by Newton Investment Management Ltd (NIM) and in the United States by Newton Investment Management North America LLC (NIMNA). Both firms are indirect subsidiaries of The Bank of New York Mellon Corporation (‘BNY Mellon’). Newton Investment Management Limited is registered with the SEC as an investment adviser under the Investment Advisers Act of 1940. Newton Investment Management Limited’s investment business is described in Form ADV, Part 1 and 2, which can be obtained from the SEC.gov website or obtained upon request.

Personnel of certain of our BNY Mellon affiliates may act as: (i) registered representatives of BNY Mellon Securities Corporation (in its capacity as a registered broker-dealer) to offer securities, (ii) officers of the Bank of New York Mellon (a New York chartered bank) to offer bank-maintained collective investment funds, and (iii) Associated Persons of BNY Mellon Securities Corporation (in its capacity as a registered investment adviser) to offer separately managed accounts managed by BNY Mellon Investment Management firms, including Newton.

Certain information contained herein is based on outside sources believed to be reliable, but their accuracy is not guaranteed. Unless you are notified to the contrary, the products and services mentioned are not insured by the FDIC (or by any governmental entity) and are not guaranteed by or obligations of The Bank of New York or any of its affiliates. The Bank of New York assumes no responsibility for the accuracy or completeness of the above data and disclaims all expressed or implied warranties in connection therewith. © 2021 The Bank of New York Company, Inc. All rights reserved.

In Canada, Newton Investment Management Limited is availing itself of the International Adviser Exemption (IAE) in the following Provinces: Alberta, British Columbia, Ontario and Quebec and the foreign commodity trading advisor exemption in Ontario. The IAE is in compliance with National Instrument 31-103, Registration Requirements, Exemptions and Ongoing Registrant Obligations.

1) Sharpe, William F. 1964. “Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk.” Journal of Finance. 19:3, pp. 425-42.

2) Tobin, James. 1958. “Liquidity Preference as Behavior Toward Risk.” Review of Economic Studies. 25:2, pp. 65-86. Tobin added the notion of leverage to portfolio theory by incorporating into the analysis an asset which pays a risk-free rate. By combining a risk-free asset with a portfolio on the efficient frontier, it is possible to construct portfolios whose risk-return profiles are superior to those of portfolios on the efficient frontier. By combining a risk-free asset with a portfolio on the efficient frontier, it is possible to construct portfolios whose risk-return profiles are superior to those of portfolios on the efficient frontier.

3) The index futures and options are based on the S&P 500 and the 30-year US Treasury bond (adjusted to reflect the Bloomberg Barclays Long-Term US Treasury Index).

In our latest episode of Double Take, we investigate the links between Covid, consumer demand, cargo, and the current supply chain crisis.

In our latest episode of Double Take, we explore this year’s red-hot payment installment program that is supercharging holiday gifting – buy now, pay later.

SWFs invested record amounts into venture capital last year with VC allocations ballooning. Overall assets were boosted by four new SWFs: Azerbaijan, Bangladesh, Cape Verde and Rio de Janeiro. While Israel, Namibia, Bahamas and Mozambique will all launch this year.

Global Sovereign Wealth Fund assets increased 6 per cent in 2021 exceeding $10 trillion assets under management for the first time, according to the latest report from Global SWF, the data platform that tracks the worlds SWFs. The report links growth to SWF allocations to booming equities; the recovery in the oil price and new funds coming on stream and is indicative of the sector’s robust health despite many being tapped to help rebuild domestic economies after the pandemic.

Overall assets were boosted by the arrival of four new SWFs last year. Azerbaijan Investment Holdings (AIH) was the most significant one in terms of assets. Bangladesh, Cape Verde and Rio de Janeiro also launched funds, while Israel, Namibia, Bahamas and Mozambique are scheduled to launch SWFs in 2022.

In 2021 state-owned investors deployed more capital than in any of the previous six years, both in terms of number of deals and deal value, investing 19 per cent more than 2020 levels and ploughing US$106.1 billion into 500 transactions.

GIC dominance

Singapore’s GIC invested much more than its peer funds, deploying an estimated $34 billion in 110 deals, almost double what it did in 2020. Almost half of that capital was invested in real estate, with a clear bias to logistics, the report finds.

Emerging markets only attracted 22 per cent of SWF capital in 2021, one of the lowest figures in six years.

SWFs continue to plough money into private markets. Abu Dhabi’s ADIA recently raised its allocation target bands for private equity and infrastructure, and Korea’s KIC is aiming to boost alternatives from 15 per cent in 2021 to 27 per cent by 2027.

Yet some sovereign funds like Saudi Arabia’s Public Investment Fund increased their allocations to public markets. At the onset of the pandemic the PIF invested $7.7 billion in 23 stocks in energy, entertainment, and financial services hunting short term gains report author Diego Lopez describes as untypical for SWF.

PIF has since “changed its strategy and consolidated its position by holding mainly ETFs and technology stocks,” states the report

China and India are providing an alternative to diversify public holdings. Most SOIs proved to be bullish on Chinese stocks, especially ADIA, which shut down its Japanese program to focus on China, and PIF, which recently applied for QFII status. Appetite for Indian stocks on the other hand was dominated by GIC, with $ 14.8 billion in holdings.

SWFs were also active sellers in 2021, divesting from properties and infrastructure assets particularly. Abu Dhabi’s Mubadala was active with two IPOs and sales of stakes in Aldar, Cologix, MATSA and Oil Search; PIF raised US$ 3.2 billion from the sale of 5 per cent stake in Saudi Telecom, STC, and ADIA exited Scotia Gas and various properties in Australia and China.

Venture

Although allocations to venture remain only a small slice of SWF total allocations, investment in venture capital ballooned.

“Not only did VC investments by SOIs surge by 81 per cent to a record $ 18.2 billion in 328 deals, but VC also contributed to the globalization of their portfolios,” writes Lopez.

Only 120 of these investments went to Silicon Valley, with the rest being distributed across 32 countries. Moreover SWF have shifted to later funding series, focusing on growth and late-stage investments. Sovereign funds invested more than $ 3 billion in pre-IPOs – a sixth of the total value in 2021 – with many of them acting as anchor investors in public floats of start-ups they had backed in earlier stages.

“Temasek, GIC and Mubadala.. are joined this year by QIA, which is showing more activity in VC than in any other department.”

The report notes how funds including ADIA and Temasek have profited from investments in vaccines with ADIA funnelled hundreds of millions of dollars into Moderna’s development of Covid-19 vaccines. Temasek also moved quickly and invested in BioNTech in June 2020. In the latest nod to the future, SWF interest in the space race and space tourism is growing led by Mubadala, already “heavily invested” in the Fourth Industrial Revolution (4IR).

Finally, the report notes SWFs are investing more capital in renewable energy compared to oil and gas.

“State-owned investors spent $ 22.7 billion in 37 green investments, including stakes in brownfield assets, investments in greenfield assets, shares in listed companies, and commitments to new climate-focused funds.

 

 

 

The world’s economic future is uncertain and inflation is likely to remain under a persistent pandemic, according to long-term major central banks adviser Professor Warwick McKibbin.

In a model scenario where the Covid-19 pandemic never goes away, McKibbin expects a permanent increase in the risk to economies where capital stock is too high and has to be reduced to raise the marginal product of capital to the real interest rate.

“This was unambiguously a big shock on real interest rates both because the marginal product of capital was hit really hard but also because the central banks just cut to zero and beyond and put in place a whole range of other policies,’’ he says.

Real GDP in Australia and elsewhere is likely to fall in step with the number of pandemic shock waves, as investment collapses and demand stimulus in the economy is taken out.

“Uncertainty is bad for investments, it’s bad for financial investments and it’s bad for the real economy,’’ he says.

“Sectors that get really hurt in the persistent pandemic shock are the durable manufacturing sectors that make capital goods as the investment has been hammered by uncertainty and you’re not buying durable goods.”

McKibbin and co-author Roshan Fernando’s “Global Macroeconomic Scenarios of the Covid-19 Pandemic” captured world leaders’ attention on how to respond to Covid-19 shortly before the World Health Organisation declared the disease a pandemic.

Former Federal Reserve Chairman Ben Bernanke and US Treasury Secretary Janet Yellen were among the first to see a draft of the paper and its seven scenarios which explored the global economic costs to form the basis of policy decisions.

McKibbin says the idea is simple but the model complex, and really “just tools to think through complex problems” by studying individual behaviour of households, firms and governments and central banks and monetary and fiscal authorities and how they interact in markets and how these markets interrelate across countries.

“We have 20 countries, four regions, six sectors and individual behaviour,’’ McKibbin says.

“(There is) change in risk premia, production chains, market prices are being valued differently and some countries are worse than others. There’s been a shift in allocation and above this there’s been a change in health responses.

“It’s full of assumptions but the beauty of the model is it is full of assumptions, so you can change those assumptions and you can look at the implications for the results you get.’’

The idea that you keep vaccines in the developed economies shows a complete misunderstanding of the way epidemiological shocks occur

Starting with the world in 2016, with assumptions about population and labour force growth by countries, McKibbin surprised the model with a pandemic in 2020 and introduced shocks to labour supply, consumption due to supply disruptions versus a change in demand and productivity shocks or increasing costs due to shutdowns.

It modelled volatility, equity risk shocks, country risks based on health governance, financial risk and vulnerability to the pandemic.

Whether Covid-19 is a permanent or temporary pandemic, prevention is the key which means spending on public health in emerging markets, McKibbin says.

“Macro fiscal and monetary responses globally are important,’’ he says.

“There are a lot of countries that have no fiscal space that have been going through a severe pandemic in their emerging markets and who are way behind the capacity to respond and recover.

“That’s going to weigh a lot of commodity prices. Of demand in the world economy, emerging markets are more than 50 per cent of the world and the idea that you keep vaccines in the developed economies shows a complete misunderstanding of the way epidemiological shocks occur.”

McKibbin’s G-Cubed model is also being used by the Network for Greening the Financial System, a group of 83 central banks looking at the climate risk scenarios.

“In our modelling most of the economic costs come from human behaviour not the shutdowns themselves,’’ he says.

“Whichever scenario you look at, a pandemic, of any nature no matter how many waves, causes massive economic disruption and should be avoided at all costs.”

 

Read the paper here – Global macroeconomic scenarios of the COVID-19 pandemic