Brunel Pension Partnership, the £31 billion asset manager for 10 local authority funds in the United Kingdom, is in the process of allocating to a new cohort of managers across private equity and debt, infrastructure, and secured income. Around £6 billion has already been allocated to private markets in two previous cycles in 2018 and 2020 with a further £2 billion about to be given to mostly new managers.

The latest wave of mandates offers a bonanza for private market managers. In private debt Brunel is looking for between five and six primary funds and expects to allocate to around ten new funds in private equity. Still working through how the infrastructure mandates will look, CIO David Vickers, who joined Brunel in January 2021 from Russell Investment where he was head of multi assets for EMEA, estimates 50 per cent of the allocation will go to between 6-10 primary funds and the remainder to  co-investment and secondary opportunities.

He is looking for between three to four managers in secured income, although he notes it is likely the allocation will go to Brunel’s existing managers in this space – if they have capacity. “They are doing a good job and secured income funds are more evergreen,” he says.

In the first cycle in 2018, £1.2 billion was transitioned into private equity, infrastructure and secured income, comprising a mix of long-term inflation linked cashflows mostly in infrastructure and property. “Brunel asked partner funds where they wanted to invest and then built the allocation,” says Vickers. In the second wave in 2020, Brunel separated the infrastructure allocation into general infrastructure and renewables and expanded the fund choice to include private debt, attracting £2.9 billion from partner funds. All the capital from cycle one is now committed; cycle two capital is currently being committed.

Picks and shovels

Vickers describes the hunt for new private market relationships as an ongoing and permanent scouring of the market to see which funds are open, and where they are in their capital raising structure. The support of partners, like Aksia in private debt and StepStone in infrastructure, help open doors to independent projects where Brunel can co co-invest and save on fees, as well as expertise on funds and secondary products. In private equity and secured income Brunel has more informal relationships though still calls on Aksia and StepStone for introductions. “We don’t award mandates, we sign on with partners,” says Vickers.

All mandates in cycle three will have to meet Brunel’s strong ESG criteria where Vickers has a particular eye on managers mindful of the evolution in opportunities. For example, Brunel had a standalone renewables fund four years ago, indicative of the opportunities in solar and wind at the time. Today the amount of money going into wind and solar has forced prices up and returns down, while leverage and ensuing risk is also creeping in as investment opportunities move away from the typical characteristics of infrastructure. “Some projects are going onto merchant pricing which increases volatility,” he observes.

Brunel’s focus has shifted to finding the pick and shovel investments of the transition (like battery storage, efficiency gains and mitigation) rather than early- stage gold panning equivalents. He also believes that today’s high oil price will spur more investment in renewable technology to store energy and provide grid stability.

Fee considerations

Although fees are a priority – Brunel has saved £33 million in fees since inception and is targeting a £560 million fee saving by 2030 – Vickers doesn’t filter managers according to their fee. “We choose managers we like and only then do we have the fee conversation.” Moreover, he notes that managers already have a good idea of Brunel’s “rack rate” and that the pool’s buying power is significant: third-party analysis reveals that total manager fees work out at 13 basis points less expensive than the market average. “It’s different being able to negotiate with a pot of money.”

He notes that fee breaks come in as the assets grow and pooling gathers pace, hitting new tier levels without involving further negotiation. He also believes Brunel’s sustainability kite mark carries a halo effect that helps negotiate fees further. “Asset managers say when we invest it helps them open the door to others.” It leads him to reflect on the sense of pride Brunel has in an emerging trend: helping external managers shape and change their approach to ESG, particularly around disclosure. For example, he links ESG integration and change at one manager running a multi-asset credit fund specifically to Brunel’s influence. “There is a nice knock-on effect if we can shape their business.”

Progress

Private market allocations are the last batch of assets still waiting to transition from the individual member funds to Brunel which now runs around 80 per cent of total member assets. Private markets were always going to take longer to transition because legacy programs must first return capital to the partner funds before it can be invested again, explains Vickers. “Global equity and bond funds were always the low hanging fruit.”

Still, he is cognisant of the fact Brunel’s pooling process is well advanced, something he attributes to the collegiate nature of the ten funds in the pool. “We have managed to get so far down the transition path because we haven’t had to bash together organisations that didn’t want to connect.” Partner funds set their own risk and return targets and decide how and where they want to invest. Brunel is responsible for creating the funds required and monitoring them. “We don’t have a hand on the risk on or off tiller,” he says.

Perhaps ESG provides the binding thread between Brunel’s ten. The asset owners combined enthusiasm and commitment to net zero ensures new product offerings and pooling opportunities are quickly taken up like the £3 billion already allocated to a new net zero passive allocation. Brunel worked with benchmark provider FTSE to offer partner funds a passive and net zero aligned investment option via a series of Paris-aligned benchmarks designed to tilt to green revenues. The benchmarks also avoid the common ailment of many green benchmarks – high exposure to lenders financing fossil fuels. “When we looked at what’s out there, we found many indexes are underweight energy stocks but let financials float to the top. Yet these banks are financing oil and gas, and we need to engage with them as much as the energy companies,” concludes Vickers.

 

 

 

 

 

 

We outline a simple & robust methodology to align portfolios with a science-based, carbon budget.

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The 2022 annual CIO Sentiment Survey, a collaboration between Top1000funds.com and CaseyQuirk, part of Deloitte Consulting, finds asset owners most concerned about equity valuations and inflation. After three years of fee rises, asset owners are paying less for their investments with external fees coming down, while CIOs in 2022 are also working with a smaller manager roster than previous years.

The survey, which has been running for six years, finds global CIOs notably concerned about elevated equity valuations and inflation. Touted as temporary by most policy makers last year, inflation now looks more engrained and is driving demand for defensive allocations to assets like infrastructure and real estate. For a breakdown of the full results including graphs and analysis click here.

Asset allocation

Investors’ risk perception is informing their planned allocation shifts, most visible in a spike in the number of funds planning “significant increases” to active fixed income in North America and EMEA.

Elsewhere, CIOs continue to de-risk and reduce equity allocations while the majority of respondents said they planned to increase allocations to alternatives, increasingly tilted toward real assets and private debt. Respondents listed the main defensive allocations in their portfolios as core fixed income (61 per cent) and real assets (30 per cent) and said they are venturing into private markets for yield and diversification. For more results click here

Costs

Despite a planned shift towards higher cost strategies like private markets, asset owners reported a reduction in investment costs linked to managers increasingly offering discounts to gain new relationships. 2022 respondents indicate that costs have stabilised after several years of steady increases, indicating total average investment costs relative to assets at 48 basis points in 2022 compared to 50 basis points in 2021. Importantly, cutting investment costs particularly around new products, operations or outsourcing was a key CIO priority in the 2021 survey.

Most respondents (40 per cent) said that their costs had decreased compared to 31 per cent of respondents responding their costs had stayed the same. For more results click here

External managers

When it comes to sourcing new managers, most CIOs surveyed use existing relationships with providers and consultants to introduce new relationships. Introduction requests via consultants, or making direct enquiries to a new manager themselves, are the least-used route.

The data also revealed more CIOs in 2022 are working with a smaller manager roster. Just under two thirds of respondents said they currently work with less than 50 managers, in contrast to last year when just over half of respondents said they worked with less than 50 managers.

But asset owners using a smaller manager cohort, doesn’t mean 2022 heralds a further reduction in the number of managers. Over two thirds of survey respondents noted plans to either moderately increase” (31 per cent) or “maintain” (33.3 per cent) their manager numbers. For more results click here

Operations and technology

Technology produced some of the most emphatic 2022 responses, highlighting asset owners driving ambition to increase technology within their organisations. In notable spikes from 2021 levels, around two-thirds of respondents cited the importance of process automation to improve staff efficiencies; 90 per cent are currently channelling technology to improve analytics tools and services; 94 per cent are investing in performance reporting and attribution tech and 97 per cent are deploying technology to manage risk. For more results click here

Risk

2021’s roaring equity markets have boosted the funded status of many pension funds and reduced their need to add incremental risk with three quarters (76 per cent) of survey respondents saying they had no plans to increase risk to achieve their return target. Elsewhere, 63 per cent of 2022 respondents said they are confident of meeting their return target compared to 51 per cent in 2020.

For another year running, the majority of 2022 respondents (68 per cent) said they have a return target of over 5 per cent in contrast to 2019 when only 31 per cent of respondents cited a return target of over 5 per cent.

For a breakdown of the full results including graphs and analysis click here.

 

Sophisticated investors rely on scenario analysis to select portfolios. We propose a new approach to scenario analysis that enables investors to consider sequential outcomes. We define scenarios not as average values but as paths for the economic variables. And we measure the likelihood of these paths on the basis of the statistical similarity of the paths to historical sequences. We also use a novel forecasting technique called “partial sample regression” to map economic outcomes onto asset class returns. This process allows investors to evaluate portfolios on the basis of the likelihood that the scenario will produce a certain pattern of returns over a specified investment horizon.

Click here to read full article

Incorporating uncertainty into the asset allocation process is a complicated but essential ingredient of building portfolio resilience, something investors are valuing more than ever in an environment where inflation, geopolitical and climate risks dominate. GIC and BlackRock have both developed asset allocation frameworks that incorporate investors’ aversion for uncertainty.

A health pandemic, war, inflation, fiscal and monetary policy divergence and climate change impacts have all contributed to an ongoing uncertain economic environment for investors in the 2020s. But for traditional asset allocation models like mean variance optimisation to work they rely on inputs including economic certainty to produce the one optimal portfolio. Perhaps this is no longer best practice.

Many institutional investors are recognising there is not one optimal portfolio and are focusing instead on portfolio resilience. However, asset allocation modelling has been slow to keep up with the need to think differently about modelling the future. Until now.

Singapore’s sovereign wealth fund, GIC, and BlackRock have both come up with asset allocation models that factor in uncertainty and have produced a joint paper to showcase the models and how they could potentially be used together.

GIC uses an explicit scenario-based approach while BlackRock’s approach is predominantly simulation-based, while also allowing for scenario analysis.  Both, however, allow for uncertainty and recognise there can be no perfect portfolio.

Grace Qiu, senior vice president, total portfolio strategy at GIC explains to Top1000funds.com that the fund is using a scenario-based approach to minimise opportunity cost, or ‘regret risk’, of any difference from the baseline scenario.

“We construct different scenarios and apply probabilities, and then design the portfolio such that it stays resilient under different macro regimes.” she says.

The BlackRock methodology, meanwhile, uses simulations and return forecast uncertainty incorporated into its capital market assumptions, and then simulates multiple pathways of portfolio return and portfolio resilience.

“They are different in design and good at handling different types of uncertainties. Both share the same core philosophy that helps produce more robust and resilient outcomes,” Qiu says.

Ding Li, Qiu’s colleague who is also senior vice president of total portfolio strategy, says the objective of incorporating uncertainty is not to produce one best outcome in the future.

“The key principle for this technique in asset allocation is to prepare the plausible scenario and possible outcomes in different scenarios so we can find the more conservative but more resilient solution to handle the outcome,” he says. “In reality we never know the scenario that will happen. The best outcome and predictor most likely is not the objective. It is to account for uncertainty and estimation and risk dispersion in portfolio construction. It’s a key difference from traditional mean variance which relies on point estimation.”

Li says GIC’s research shows there are multiple methodologies to incorporate uncertainty into account and the paper compares the pros and cons.

“You don’t have to rely on a single methodology. You can combine the two together to improve the efficiency of the robust portfolio construction.”

Senior portfolio strategist and  UK Chief Investment Strategist at BlackRock Investment Institute, Vivek Paul, says the approach allows investors to have consistency.

At BlackRock there are many investors across the entirety of the firm who may all have different qualitative overlays on top of the quantitative models, he says. To begin with, incorporating uncertainty into the models can improve the consistency of the firm-wide approach.

“When thinking about mean variance or traditional modelling, the trouble is that investors have known for a long time the limitations of those approaches and have biased a problem in a certain way to get a believable outcome. So they’ve been putting so many constraints around the process that in the end,the actual approach isn’t telling you much,” Paul says. “If you have 100 investors and they are all putting on overlays or constraints then you might not get consistency. By explicitly allowing uncertainty at a systemic level, the starting point is a more believable and consistent approach – albeit one that can still subsequently be enhanced by investor judgment.”

 

Uncertainty in practice

BlackRock’s Paul says the unique environment of the past couple of years is evidence of uncertainty becoming more of an issue now.

“No one was forecasting what would happen in 2020 with the pandemic and no one thought war would be on the doorstep of Europe in 2022. These are examples of why factoring in uncertainty is so crucial,” he says. “We should not pretend we know with certainty what will happen.”

Incorporating climate outcomes into the model is one example of uncertainty in practice, says Paul.

“Having uncertainty in the framework that we have is exactly why we can do what we’ve done when it comes to climate,” he says. “Leading scientists have different predictions for the outcome and how it will pan out. All of our capital market assumptions take into account our best prediction of the climate transition but we are allowing for uncertainty because our best guess might be wrong. Uncertainty is a direct part of the process.”

GIC’s policy portfolio has a 20-year time horizon so by nature asset allocation over the long term does not change materially.

Qiu says the process that models different macro economic scenarios, however, and assigns probabilities to them based on the likely path, has brought inflation into the fore in the portfolio construction process and highlights more than ever the need for diversification.

“For a naïve mean variance portfolio you go for  higher return, higher risk assets like equities, and rely on bonds to diversify. But both of those are financial assets and under inflation could get impacted. This process definitely brings out the importance of diversification and the need for more inflation resilient real assets in the portfolio,” she says.

“By explicitly modelling the need for diversification under an inflationary environment you can understand the need for real assets which may not have the same return as equities or private equity. This need to have more inflation resilient diversifying assets in the portfolio is one concrete practical example of the framework in practice.”

Paul also says the biggest risk to investors is inflation and Blackrock has already incorporated it as part of its core macro narrative.

“We believe inflation is under appreciated in market dynamics in the medium to long term, so our approach is already heavily tilted to inflation-sensitive assets, this means the inflationary impact of the war in Ukraine on the global economy has already been taken into account.”

GIC’s Li also emphasises the usefulness of the uncertainty framework across different time horizons, with GIC using long-term modelling as well in the short term across its dynamic and tactical asset allocation.

“For GIC and our peer group this framework is very flexible in terms of the different level of applications, it can be at the top down strategic level for a very long horizon and also applied to near-term uncertainty.”

Becoming a sustainable organisation is one of three pillars in CalSTRS’ new five-year strategic plan, as it also reveals progress on its net zero plan.
Presented to the board in March, the $312 billion fund’s 2022-25 strategic plan includes 10-year vision for the future broken down into three, three-yearly strategic plan cycles, kicking off in July 2022.
The plan is centred around three core pillars: being trusted stewards to ensure a well-governed, financially sound trust fund; leading innovation and managing change, including innovation to grow resiliency and efficiency; and focus on a sustainable organisation, including fully integrating a unified ESG ethos in everything it does. The latter includes investments but also a focus on internal diversity, equity and inclusion to drive organisational outperformance.
Many of the new priorities are a continuation and advancement of the current strategic plan including operationalising sustainable investment beliefs to create long-term value, execute on the CalSTRS Collaborative Model 2.0 and a focus on advanced technology for business agility and to increase efficiency while transforming business processes and digital adoption. The Collaborative Model focuses on managing more assets internally to reduce costs, control risks, increase expected returns and leverage external partnerships. Since 2017 this has saved the fund more than $780 million.
Some of the objectives of the previous strategic plan, which finishes at the end of June this year, will be carried over into the new plan including achieving full funding of the defined benefit program by June 30, 2046; integrating the fund’s sustainable investment and stewardship strategies; implementing the collaborative model leveraging all of CalSTRS resources; and a focus on technology to reduce costs.
In September 2021 the fund pledged to a net zero portfolio by 2050 or sooner but has invested in climate-oriented solutions and integrated climate risk considerations into its investment and stewardship activities since 2004.
When it made the pledge it also outlined that it would take a year to figure out the plan for implementation.
In February CalSTRS released its eighth annual Sustainability Report which shows it is evaluating its internal policies and practices for greenhouse gas emissions in line with its portfolio commitment. This includes business travel, remote work and onsite energy use.
The fund is expanding its West Sacramento headquarters with a new 10-story tower. The project is being financed through tax-exempt, lease-revenue green bonds issued through the California Infrastructure and Economic Development Bank.

CalSTRS head of sustainability, Kirsty Jenkinson, is one of the speakers at the Sustainability in Practice event to be held at the University of Cambridge from April 19-21. If you are an asset owner and would like more information on attending visit us here.