In presenting to the board for the first time this year CalSTRS’ long-time chief investment officer Chris Ailman borrowed an image used by Goldman Sachs in its economic outlook for 2022 of an icebreaker smashing through icebergs.

“Images of icebergs are just the best example of the forecast and the outlook for the year. It’s pretty frightening, there are submerged problems everywhere,” Ailman said in an interview with Top1000funds.com citing the Ukraine and Russia, climate change, supply chain shocks and the ongoing uncertainty of the virus as issues causing concern.

“For at least the last two years we have had central banks pushing us but now we don’t. When we look back at the history of US markets usually after two years of double-digit returns the third year is up but in single digits. But none of that research reflects living through a pandemic. I don’t know we can use the past as a guide given the strange uncertainties of the future.”

With this cautious outlook Ailman is expecting lower returns than the fund has experienced recently. Mind you, it’s 2021 return was a record where it outperformed its benchmark in every asset class to deliver 27.2 per cent for the year against a return assumption of 7 per cent. Standout performers were the large allocation to global equities and the outperformance of the private equity portfolio which returned 51.9 per cent.

“The last two years have shown us the unknowns: two years sitting in our own rooms working in isolation,” he says. “And now with interest rates where they are we expect it to be a tough return year.”

In response CalSTRS is adding to the defensive allocations in its portfolio and concentrating on diversification.

“With rates so low but likely to go higher fixed income may have a negative return for the year. It’s going to be tough to make returns,” he says. “We are finally at the market weight in private equity and had a great return last financial year. But I doubt that can keep up. We are adding to the diversifying and defensive areas, not a tonne to fixed income but other things we think will diversify.”

But when probed about where he is looking to allocate his cautious perspective prevails again.

Ailman thinks the fund is at the limit of what it can do with commodities and is looking at different inflation-hedging investments; he thinks real estate is priced to perfection and the fund is underweight because of a lack of things to buy; he is concerned about private debt because of the flow of money; and while he is watching agriculture and timber he won’t buy “at these prices”.

Emerging markets, he says, have been cheap for two and a half years and are still cheap, but investors are now afraid to allocate.

Overall from a historical price perspective he says most asset classes look like they are priced near perfection, supporting the strategy to focus on diversification.

“We have been a little bullish due to the Fed and that worked well in the past two years. But right now it is hard to have conviction,” he says. “I’m always worried in my spider senses and now I’m super worried about all the things that could happen.”

2022: A focus on net zero

After many years leading the ESG charge in the US among large asset owners, last year the CalSTRS’ board finally made a formal commitment to net zero by 2050 with the caveat it would take a year to figure out the plan to get there.

“If you use Google maps you can pipe in a destination but it has to know the starting point for their to be a path,” Ailman says.

The fund is due to come out with a measurement report in May this year which will map public markets. Ailman says the fund is also working with the real estate and private equity industry on how to measure carbon intensity, noting that many in private markets use estimates.

The fund will also invest in opportunities and look at the portfolio from a risk standpoint with regards to net zero, Ailman says.

“We will make strides this year. We are starting to talk to the board about the path to take, there are multiple routes,” he says.

But Ailman takes a slightly different approach to his view of net zero looking to a closer alignment of Wall Street and the High Street as an indicator.

“I could make my portfolio net zero but if we are not living our lives closer to net zero – like driving electric cars – then as investors we are making a big bet on the future. The world should get there, but the pace of governments is so slow. A good chunk has to come from the companies changing their behaviour,” he says, citing the need for companies like GM to stick to their carbon neutral plan.

His prediction is that from the year 2025 there will be a huge corporate governance push on companies especially if global governments haven’t put demands on consumers.

As part of this focus on net zero a special team within investmenst has been set up to do research – Ailman himself is tasked with doing research on hydrogen.

He says the team will focus on two main areas: climate solutions and net zero and engagement with dirty industry.

Size matters in institutional investing, but how exactly does it result in better returns? Research by CEM Benchmarking shows large, internalised, active investors produce more net value added than small, externalised, passive investors. When private equity and unlisted real estate are included into the analysis, internalisation of asset management becomes a significant predictor of value add.

Analysis of Toronto-based data insights group CEM Benchmarking’s database of large asset owner costs and performance data, shows that the largest institutional investors do add incremental value over and above smaller funds. Net of costs, funds with more than $10 billion in assets under management have consistently delivered excess returns that are significantly higher than smaller funds with under $1 billion in assets under management.

“The larger the funds are the more consistent outperformance on a both a gross and net basis you will find,” said Rashay Jethalal, chief executive of CEM Benchmarking speaking in a presentation hosted by Canadian Club Toronto accompanying publication of the report. “Scale really matters.”

The research found that large funds have been able to achieve these positive results while taking on less active risk than smaller funds. The advantages of scale most prominently manifest in these investors’ ability to implement private assets internally, resulting in much lower overall private asset management costs.

Net of costs, the largest institutional investors deliver more value added than smaller funds in both public and private markets, an advantage driven almost entirely by lower staffing per dollar invested and lower fees paid to external managers. On average, smaller funds delivered 47 basis points of outperformance before costs, 36 basis points lower than the 83 basis points of outperformance delivered by funds with more than $10 billion assets under management.

Scale trends

Typified by the successes of the large Canadian funds, there is an increasing belief within the investment community on the benefits of scale in asset management.

In the Netherlands, the pursuit of economies of scale by defined benefit pension funds has been underway for more than 20 years. In 1997 in that country there were 1,060 defined benefit pension funds. By 2015, consolidation had reduced the number of Dutch pension funds to 290.

In the UK, over 90 previously stand-alone local government pension schemes are merging into eight larger asset pools.

Nor is the trend unique to defined benefit as evidenced by the rampant merger activity with the Australian superannuation funds.

Value added

The CEM research focuses on value added, the difference between a fund’s policy benchmark and the actual return realised by the fund.

Value added is the sum of both manager value added within asset classes and tactical portfolio decisions between asset classes. Value added has the advantage of being relatively agnostic to asset mix, enabling comparisons across funds.

One possible explanation for larger funds’ outperformance is that the largest funds are taking on more active risk than smaller funds. However, the research shows this not the case – not only are larger funds generating higher value add, but they appear to be doing so while taking a lower level of active risk – or as likely, diversifying away more of their active risk.

This observation is especially important considering the almost complete lack of persistence observed in value add. Put another way, much of the variability in value added can be attributed to randomness rather than skill.

Prior research conducted by CEM Benchmarking has shown that the most important quantitative features of funds for determining value added are active management, internalisation and economies of scale. Private equity and unlisted real estate are large contributors to gross value added at the fund level and reflecting their higher allocations to private equity and unlisted real estate, more of the gross value added realised from these asset classes accrue to large investors. While it would be easy to suggest that smaller funds should simply invest a higher proportion of their fund in private assets, one cannot ignore the impact of costs.

“There is a small list of things that improve returns but don’t involve taking more risk,” Bert Clark, president and chief executive officer of IMCO says.  “There is a free lunch of diversification and building a better portfolio; costs are also a free lunch – get your costs down you will have better returns. Sadly a lot of risk-free, return-enhancing strategies are only open to bigger investors.”

Public markets

Moreover, the economies of scale advantage of large investors in public markets is also driven by cost advantages and not skill differences. The research found that as assets under management increases efficiencies in public markets are found which improve the bottom line by approximately half, if not more. Economies of scale are found in investment costs for external managers as well.

For example, total investment costs for externally managed active US small cap equity portfolios increases slower than assets under management. Where an external $200 million portfolio of active small cap. US stock is expected to cost 55 basis points, a $2 billion portfolio is expected to cost only 40 basis points.

For public market assets the data is clear; as you get bigger, costs increase slower than AUM which translates directly into improved net value added, even excluding the impact of private market assets.

Large, internalised, active investors produce more net value added than small, externalised, passive investors. When private equity and unlisted real estate are included into the analysis, internalisation of asset management becomes a significant predictor of value add; internalising private equity and unlisted real estate improves net performance.

While internally managed portfolios of private equity and unlisted real estate perform marginally worse than external investments gross of costs, the cost savings, measuring in the 100s of basis points, far outweighs any difference in top line return. Investment costs alone may not be the only cost benefit of internalising private equity and real estate. A second advantage that can be gained by internalising private equity and real estate is the ability to exert control over the use of leverage.

Returns in private equity or unlisted real estate are usually amplified with leverage, either through subscription lines of credit or portfolio company bond issuance in the case of private equity, or through mortgages or capital structures financed with debt in the case of real estate.

Large Canadian funds such as CDPQ, CPPIB, HOOPP, OMERS and OTPP all issue debt and participate in repo markets at significantly lower rates than are available to real estate funds or private companies. Doing so however requires scale.

Successfully internalising private equity and/or unlisted real estate demands scale. While smaller investors have some internally managed real estate, the asset base is usually low, and the performance tends to trail those of larger funds.

“It’s not easy to access private investments, typically people invest through funds – certainly smaller investors. The fees you pay to invest in a fund may well eat up all the benefits of being in that asset class. Scale typically allows you to get the fees down, and co-invest alongside in select transactions,” IMCO’s Clark says.

Bringing private equity assets inhouse is an activity limited to the largest funds – the smallest investor in the CEM database that reported having substantial internal private equity investments in 2020 had $18 billion in total assets, while the average investor with internal private equity investments in 2020 has total fund AUM of $152 billion.

This is the real win for scale, the ability to deliver cost-effective and diversified private asset management by leveraging scale to implement these assets internally.

When PensionDanmark’s chief executive Torben Möger Pedersen meets members of the $49 billion labour market pension fund, the conversation doesn’t just focus on the fund’s healthy spate of returns. Lately, his regular tete-a-tete with stakeholders has focused on PensionDanmark’s growing renewable energy investment in assets that churn out the equivalent to the fund’s 800,000 members yearly energy consumption.

“It’s a compelling story,” says Pedersen. “We are not only a pension fund for our members, we also provide them with green energy.”

Denmark: A new Norway

The narrative is about to become even more compelling. PensionDanmark is investing in Denmark’s first energy island, a North Sea hub the size of 18 football pitches that will serve 200 wind turbines, linking production to the shore by a single cable. PensionDanmark’s investment, part of a consortium of other long-term investors, is small at around DKK 2.5 billion and from a construction perspective, the energy island is not a particularly complex, or risky investment.

Its allure lies in its scalability. The investment will be a stepping-stone to the pension fund financing bigger projects in the North Sea needed to fulfil Europe’s green power targets as well as further afield in South-East Asia.

“This is the investment case for us,” he enthuses. “It is a chance for Denmark to become a new Norway not in oil and gas, but in green power.”

The energy island still has hurdles to overcome. New wind farms around the hub need to get up and running.

“It is important for us that the construction of the island is in sync with the construction of the windfarms. We don’t want to build the island and ask ‘where are the wind farms?’” he says. Other steps include reaching an agreement with the Danish government on a payments structure that will determine returns, he says.

Skills

PensionDanmark’s ability to conceive, construct and operate ambitious energy infrastructure is rooted in a pivotal decision taken 10 years ago to become a developer of infrastructure and real estate assets. Back in 2012, led by Pedersen who has been CEO since the fund was established in 1992, PensionDanmark decided that investing in brownfield sites wouldn’t bring the same return as development, construction, and management of an asset.

“The only way to get access to attractive returns is to accept the risk of being a developer,” he says.

In PensionDanmark’s real estate allocation, he estimates that around 50 per cent of the returns are associated with development.

“If you are not able to be involved with this stage of the project, you have to accept half of the returns and that the other half will go to someone else,” he says. “If you are buying an office building, the return is 3 per cent but if you are involved in the whole value chain it is 5-6 per cent. That difference is attractive.”

It has required building an alternatives team that includes architects and engineers with boots-on-the-ground expertise across the whole value chain in contrast to desk-bound, listed market investment expertise.

PensionDanmark’s skills and expertise in green infrastructure are housed in fund management company Copenhagen Investment Partners (CIP) founded in 2012 by the pension fund with senior executives from the Danish energy industry. Today it invests on behalf of some 140 other investors too, and has a reputation as one of the largest investors in renewable energy globally.

“In the beginning, CIP was active in the UK and Europe. Now we are in the US, South East Asia and established in emerging markets like India and Brazil an Vietnam.  It’s become a global business.”

With that, CIP’s reach has extended beyond on and offshore wind to green energy storage and transmission and green hydrogen. As the transition gathers pace, investments will include using renewable energy to generate ammonia at scale used to produce carbon-free fertilizer and as a fuel for shipping and the logistics industry, he says.

“The clock is ticking if Denmark is to fulfil its promise to have reduced CO2 emissions by 70 per cent by 2030 compared to 1999,” he says.

Economic outlook

The investment case for alternatives,  an allocation PensionDanmark plans to increase from 30 per cent to 35 per cent of total AUM, has become more compelling given Pedersen’s belief that the long period of low interest rates and buoyant equities is drawing in.

“Looking forward, we are comfortable with a large allocation to real estate and infrastructure, the type of assets with a low correlation to macro-economics and listed equity markets.”

Even small increases in interest rates will diminish the benefits of holding bonds, he says.

“We have had 8-10 per cent in annual returns for the last decade and we are now looking to having to be satisfied with something between 2-5 per cent that is only attractive if inflation is kept to 2 per cent. An allocation to alternatives although difficult and resource demanding will be necessary to deal with the challenges in the listed market,” he concludes.

 

It is fundamental that asset owners contribute feedback to the exposure drafts on climate and general sustainability disclosures issued by the International Sustainability Standards Board (ISSB) according to Janine Guillot, special adviser to the ISSB chair.

In March, the ISSB-issued prototypes will become exposure drafts and after the consultation process and will ultimately be the first two standards issued by ISSB.

“We expect some time in the first quarter for those exposure drafts to be issued. It is very important for asset owners to be part of the consultation process,” Guillot says.

The climate prototype has largely been based on TCFD and SASB and many asset owners had significant input into those, but it will also have a cross-metric industry component which is new. There is also a prototype on general requirements for sustainability disclosures.

Guillot says the ISSB will finalise a climate standard and general requirements standard by the end of the year partly because there are many regulators keen to mandate climate disclosures and the ISSB standard will be a helpful tool for those regulators.

Asset owners are increasingly challenged by the disclosure requirements of climate risks in their portfolios. Guillot says the most efficient way to implement those is to have globally accepted sustainability disclosure standards which are used by companies around the world. “If that happens asset owners can source the data they need for their own disclosure requirements sand integrate climate risks into their assessments,” she says. “It is vitally important they give feedback to what those disclosures might look like.”

The formation of the ISSB has been described as a historic opportunity to establish a global sustainability disclosure standard-setter for the financial markets. The ISSB is the second standard setting board, alongside the International Accounting Standards Board, under the umbrella of the IFRS Foundation.

Guillot suggested that as well as issuing two standards in the next year, there will be other significant priorities for the ISSB. While these have not been endorsed by the board, her opinion was there were three big research themes for the ISSB to focus on.

These include the next generation of climate risk metrics, human capital and biodiversity.

With regard to human capital, the SASB standards team had a two-year research project underway on human capital to get feedback on the issues most relevant to value, and where disclosure could improve. The main theme to come out of that is DEI and Guillot said a standards-setting project has begun on that.

“There is high demand for quality metrics but it is hard to do globally,” she says, encouraging asset owners to give feedback on priorities for the board’s agenda.

At COP26 the IFRS Foundation consolidated the Climate Disclosure Standards Board and the Value Reporting Foundation, itself a merger of the Sustainability Accounting Standards Board Foundation and International Integrated Reporting Council.

Guillot, who was a founding executive of SASB and before that chief operating investment officer at CalPERS, says while she feels a sense of collective accomplishment with the establishment of ISSB there is still a lot of work to do.

“When I did that first interview with you back in 2016, did we ever envisage these years later we would be talking about ISSB with support of the regulators and SASB would be rolling into that? It is important to acknowledge what a monumental and historical moment this is and the important role investors have played in driving the understanding of how important standardised sustainability reporting is. It is a tremendous collective accomplishment and a huge shout out to asset owners and managers,” she says. “Having said that, this is like another beginning. It’s not like the mission is truly accomplished yet.”

Fiduciary duty principles must be adaptive to change and the US has fallen behind. The authors argue that a more comprehensive application of fiduciary duty principles in the US is necessary to protect the life savings of ERISA plan participants. In particular impartiality is important for pension plans where funds are managed for multiple generations.

Recently proposed US Department of Labor regulations on fiduciary duties under the Employees Retirement Income Security Act on consideration of environmental, social and governance (“ESG”) factors by private pension plans are a vast improvement over existing Trump Administration rules but they completely ignore the fiduciary duty of impartiality and related principles.

The proposed DOL rules, issued on October 14, 2021 “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights,” should address the full range of fiduciary duty principles that are material to ESG issues and to the exercise of shareholder rights.

Comments submitted to DOL by the Intentional Endowments Network highlight the overlooked fiduciary duty principles that can be highly material to consideration of ESG factors and the exercise of shareholder rights. The comments argue that final rules should emphasise the following:

  • The duty of impartiality, which is part of the duty of loyalty and requires identification of and good faith efforts to balance divergent inter-generational risk tolerances and return needs of plan participants;
  • Presumptive use of longer investment time horizons that link investment processes with the timelines for obligations to fund participants; and
  • Dynamic aspects of the duty of prudence, including that it does notimpose a “lemming” standard of care that mandates herding behaviors or discourage adoption of improved investment practices.

The IEN comment letter, which two of this article’s authors helped write, provides guidance on why a more comprehensive application of fiduciary duty principles is necessary to protect the life savings of ERISA plan participants.

Fiduciary duty of impartiality

The United States Supreme Court in 1996 recognised that ERISA fiduciary duties include a duty of impartiality. When interpreting §§404 and 409 of ERISA in Varity v. Howe, the Supreme Court cited the following common law principle as part of the foundation for its holding. “The common law of trusts recognises the need to preserve assets to satisfy future, as well as present, claims and requires a trustee to take impartial account of the interests of all beneficiaries.

This common law principle referenced by the Supreme Court is now set forth in the Restatement (Third) of Trusts:

“The ‘Duty of Impartiality’ requires that fiduciaries identify and impartially balance conflicting interests of different trust fund groups, including current and future beneficiaries.” Restatement (Third) of Trusts §79.[i]

Impartiality is of particular importance for pension plans, where funds are managed for multiple generations. Since different generations of participants will become entitled to distributions at different times, they are likely to have different risk tolerance levels and time horizons. Inter-generational obligations also raise the potential for uncompensated transfer of risks and returns across fund participant generations. The duty of impartiality mandates careful consideration and good faith efforts to reasonably balance these conflicts.

In addition, systematic risks, costs and opportunities are often invisible to fiduciaries that focus exclusively on generation of short-term returns or evaluate investments against only a market-relative performance benchmark. Nevertheless, systematic risks and costs can spread across portfolio companies and compound over time, increasing risk exposures and degrading future returns to fund participants. For a diversified investor, systematic risks drive most of returns.

Climate change presents perhaps the most obvious set of both company specific and systematic risks that raise potentially conflicting inter-generational investment risk and return impacts and implicate the duty of impartiality. For example, failure to address climate risks and opportunities over the near term is likely to generate increased future economic costs and risks that will be primarily borne by today’s younger fund participants.

However, climate change is not the only systematic financial cost or risk with duty of impartiality implications.  For instance, other financially material ESG factors with varying inter-generational or other beneficiary group impacts can include things like water and air pollution; growing microbial antibiotic resistance in the food chain; shareholder pressure on companies to generate short-term earnings at the risk of undermining future growth; inadequate attention to product safety and health; ecosystem limits on future economic activity; effects of growing income inequality on consumer demand; and political instability fostered by social media business models based on distribution of misinformation.

The duty of impartiality is a fundamental aspect of fiduciary law that governs ERISA funds, as well as other institutional investor trustees.

We believe that a major flaw in the proposal is its failure to explicitly recognise and apply this principle of fiduciary law. We also see the duty of impartiality as driving a need to address time horizon issues.

The tragedy of the horizons

The proposal states that investment analyses should apply the appropriate time horizon.

However, given the overwhelming long-term duration of pension fund liabilities and the current influence of irrational short-termism in the markets (discussed below), we believe the final rule should explicitly recognise a presumption that a long-term investment horizon will nearly always be an appropriate primary time horizon (although perhaps not the exclusive time horizon) for an ERISA fiduciary’s strategic investment decision-making processes.

From a duty of impartiality perspective, it seems implausible that an investment strategy developed without attention to long-term risks, costs and inter-generational wealth transfers could meet standards referenced by the Supreme Court in Varity v. Howe.  The duty of prudence obligation to investigate material facts also poses increasing questions about the influence of irrational short-termism on investment decisions.

Nicholas Stern, Professor of Economics and Government and Chair of the Grantham Research Institute on Climate Change and the Environment at the London School of Economics, highlighted the perverse impact of irrational short-termism in a recent speech:

“The economics profession has also misunderstood the basics of discounting, in relation to, particularly, its dependence on future living standards. It means economists have grossly undervalued the lives of young people and future generations who are most at threat from the devastating impacts of climate change. . . . Discounting has been applied in such a way that it is effectively discrimination by date of birth.”[ii]

The Bank of England has expressed similar concerns:

“In the UK and US, cash-flows 5 years ahead are discounted at rates more appropriate 8 or more years hence; 10 year ahead cash-flows are valued as if 16 or more years ahead; and cash-flows more than 30 years ahead are scarcely valued at all. The long is short.”[iii]

The CFA Institute undertook a study in 2020 to examine the costs of this short-termism for investors.

“CFA Institute partnered with the firm Fund Governance Analytics to take a more academic approach to the issue of short-termism. We took a quantitative look at the data concerning the issue of short-termism between 1996 and 2018 to see whether any short-term behaviors were evident that investors and issuers should better understand. 

We found that companies that failed to invest in research and development (R&D); selling, general, and administrative (SG&A) expenses; and capital expenditure (CapEx) tended to underperform in the midterm (three to five years). . . .

 The study summarized in this report estimated the agency costs (foregone earnings) of short-termism at $1.7 trillion over the 22-year period covered by our analysis, or about $79.1 billion annually.”[iv]

We recommend that the final rule affirm presumptive application of a long-term investment horizon by ERISA fiduciaries.  This could be linked with the duty of impartiality, the duty of prudence and the reference in the proposal’s preamble to evolution of investment fiduciary practices over time.

Implementation of fiduciary duties evolves over time

We believe that the final rule should emphasise how application of fiduciary principles is a dynamic process that evolves in response to changes in knowledge and circumstances. ESG-related developments and advances in knowledge since the turn of the twenty-first century present a challenge for ERISA fiduciaries. However, change is a natural constant, and fiduciaries should understand the perpetual obligation to identify, evaluate, and respond to changed circumstances and new information.

This is not a new concept.  The most recent major transition in implementation of fiduciary duties took place in the last half of the 20th century. It involved an evolution from legal lists of permitted investments and the prudent person standard of care to the application of Modern Portfolio Theory and adoption of the prudent expert standard.

That shift in practices took several decades, leaving fiduciaries caught between two seemingly inconsistent investment approaches. One 1988 commentator described the tension during that transition between adopting modern investment practices and being held back by outdated rules:

“A fiduciary cannot behave as a careful, wise, discreet, judicious and prudent man if he acts within the strictures of a prudent man rule that forces him to behave imprudently in the contemporary economic marketplace.”

In response to this late 20th century evolution of the investment industry knowledge base, the following provisions were added to the Restatement of Trusts to incorporate lessons learned from the transition:

“There are no universally accepted and enduring theories of financial markets or prescriptions for investment that can provide clear and specific guidance to trustees and courts.”  Restatement Third) of Trusts §227, Comment (f).

“Trust investment law should reflect and accommodate current knowledge and concepts.  It should avoid repeating the mistake of freezing its rules against future learning and developments.”  Restatement (Third) of Trusts, §227, Introduction.

These statements speak to us today as investor fiduciaries face similar industry transition challenges. We believe that including more of this background in the preamble would provide clarifying historical context to demonstrate that fiduciary duty principles must be adaptive to change.

However, it should be stressed that the direction of change in the current evolution of investment industry knowledge and practices is clear and is largely being driven by mainstream global investors and by regulators in other countries. The US has fallen behind other markets in this transition.

Comparisons to the 20th century evolution from the prudent person standard to Modern Portfolio Theory could help the US move forward by demonstrating that evolution of investment industry theory and practices are to be expected when knowledge and circumstances change.

In order to address the full range of investor fiduciary duties, the final DOL rule should be modified to:

  • Explicitlyincorporate principles from the fiduciary duty of impartiality, which has been applied to ERISA by the US Supreme Court;
  • Establisha presumption that ERISA fund investment analyses nearly always require inclusion of a long-term investment horizon in order to reflect pension plan obligations;
  • Containadditional preamble background commentary on the principle that prudent investment practices have evolved in the past, and are expected to evolve in the future, in response to changes in knowledge and factual circumstances. Prudence is not a static

 

Keith Johnson is former co-chair of the Institutional Investor Services Group at Reinhart Boerner Van Deuren s.c. and was chief legal counsel for the State of Wisconsin Investment Board. Susan Gary is a Professor Emerita (formerly Orlando J. and Marian H. Hollis Professor) at the University of Oregon School of Law and served as reporter for the Uniform Prudent Management of Institutional Funds Act. Tiffany Reeves is head of investor fiduciary and governance services at Reinhart Boerner Van Deuren s.c. and was previously deputy executive director and chief legal counsel at the Chicago Teachers’ Pension Fund.

 

 

 

The United Nations Joint Staff Pension Fund plans to explore impact investment for part of the $90 billion portfolio including in developing and emerging markets like Africa. Alongside exploring investing for impact in consultation with its investment committee and board, the asset owner plans to boost diversification of its investments across developed, developing and emerging markets, according to the UN General Assembly’s recent Resolution on 2021 Pension Matters, published in January.

“The General Assembly noted the fund’s consistent outperformance of the 3.5 per cent annual real rate of return benchmark for the 10-year and 15-year periods and requested continued diversification of the fund’s investment portfolio among developing and emerging markets, including impact criteria for a part of the portfolio,” states a report on the Resolution. UNJSPF has had a 15-year rolling annualised return of 4.6 per cent.

The value of UNJSPF’s assets grew by more than 10 per cent in 2021 after an increase of 13 per cent in 2020, to reach an estimated $90 billion as of the end of December 2021. As it stands, the UNJSPF is fully funded, and in a position to assume pension liabilities for decades to come, said the statement. Around 82 per cent of the fund is managed internally and growth assets account for about 71 per cent of the allocation.

Streamlined governance

Regarding governance, the General Assembly endorsed an earlier vision expressed by the board regarding a more efficient and effective decision-making process.  Governance reform includes updated and strengthened terms of reference for board members, chair, bureau and committees. Elsewhere, the board will meet more frequently during the year, making use of virtual meetings. The annual in-person meeting will be shortened from seven to five working days or less but the composition of the board’s 33 members, representing the 25 member organizations on a tripartite basis, remains unchanged.

“These important changes initiated at the request of the General Assembly should assist the United Nations Joint Staff Pension Board in effectively administering the fund in the coming years,” said the statement.

Sustainable investment

UNJSPF’s approach to sustainable investment incorporates forward looking methodologies in evaluating the impact of climate change on the investment portfolio. The fund has created partnerships with climate specialists and alternative data providers to supplement its internal resources and build ESG technology. For example, the office of investment management, in charge of the UNJSPF assets, has signed a strategic partnership exploring predictive climate analytics.

According to UNJSP website, OIM is also conducting research on developing quantifiable SDG scores using artificial intelligence (AI) to leverage big data and systematically measure companies’ impact on the SDGs. This research will aim to provide empirical evidence that will address the widespread perception that there is a trade-off between incorporating ESG or SDG considerations into investment decisions and generating strong financial returns.

“It will strengthen our understanding of the interdependencies between a firm’s long-term economic value and its societal impact,” states the website.

Asset allocation

UNJSPF’s global public equity portfolio (57.5 per cent) is managed internally by four teams: North America, Europe, Asia Pacific, and Global Emerging Markets (GEM). The global fixed income portfolio (25 per cent) seeks to achieve an above benchmark return by investing globally in local currency, investment grade securities. The portfolio is traded actively.

Real assets

The 7 per cent allocation to real assets comprises real estate, infrastructure, timber and commodities through around 100 externally managed funds. The real estate allocation (6.7 per cent) comprises 50 per cent core “open ended” funds and 50 percent non-core “closed end” funds. The fund’s core funds are diversified by geography and property type, and its non-core funds are diversified by vintage year, geography, property type and risk profile.

The real assets team also invests in externally managed infrastructure funds. Selection is based on moderate leverage, strong cash flow and a demonstrated record of realizations. Modest allocations to timber and commodities funds, invested on a global basis, are also part of the portfolio.

The alternative investments team is responsible for investments primarily in private equity (6.7 per cent) through externally managed funds in a program begun in 2010 diversified by vintage year, private equity sub-sectors and geography.