The COVID crisis ushered in the paradigm shift to the MP3 world, characterized by the unprecedented combination of fiscal and monetary policy responses around the globe. In the time since, there has been an emergence of geographic and economic divergences that haven’t been seen in over a decade. This session looked at how those divergences might play out and what the expectations from the global economy might be going forward.

Speaker

Rebecca Patterson joined Bridgewater in 2020 as director of investment research. In this capacity, she helps shape the firm’s agenda for researching and building systematic strategies to trade global financial markets. Rebecca is a frequent author of Bridgewater’s Daily Observations and meets regularly with investors and policymakers. She is also a member of Bridgewater’s executive committee, investment committee, and commercial and business strategy committee, in addition to being a partner and helping to lead the firm’s diversity & inclusion (D&I) efforts.

With more than 20 years of investment management experience, Patterson came to Bridgewater after serving as chief investment officer at Bessemer Trust, where she oversaw $85 billion in client assets. She was also a member of the firm’s management committee and helped launch its D&I committee. Before joining Bessemer in 2012, she spent 15 years at JP Morgan where she worked as a researcher in the firm’s investment bank in Europe, Singapore, and the US. She also served as a chief investment strategist in the firm’s asset management arm and ran the private bank’s global currency and commodity trading desk.

She is currently a member of the Council on Foreign Relations and the Economic Club of New York and is on the board of the Council for Economic Education. She has served on the New York Federal Reserve’s Foreign Exchange and investor advisory committees and served on and chaired the University of Florida’s Investment Corporation’s advisory board. Rebecca has been named to American Banker’s Most Powerful Women in Finance for six consecutive years. She holds an MBA from New York University, an MA in International Relations from The Johns Hopkins University School of Advanced International Studies and a BS in Journalism from the University of Florida. She is married and has two teenage girls.

Investor response
Moderator

Tate has been an investment industry media publisher and conference producer since 1996. In his media career, Tate has launched and overseen dozens of print and electronic publications. He is the chief executive and major shareholder of Conexus Financial, which was established in 2005, and is headquartered in Sydney, Australia.

The company hosts more than 20 conferences and events globally each year and publishes three digital publications, including the global website and strategy newsletter for global institutional investors Top1000Funds.com, Professional Planner for financial planners, accountants and private bankers in Australia and Investment Magazine for Australian superfunds and institutional investors. One of the company’s signature events is the bi-annual Fiduciary Investors Symposium attended by global asset owners and hosted in the Americas and Europe.

Conexus Financial’s events aim to place the responsibilities of investors in wider societal and political contexts, as well as promote the long-term stability of markets and sustainable retirement incomes.

Tate served for seven years on the board of Australia’s most high profile homeless charity, The Wayside Chapel; and he has underwritten the welfare of 60,000 people in 28 villages throughout Uganda via The Hunger Project. In 2021 was appointed as a Member (AM) of the Order of Australia (General Division) for significant service to the community through charitable initiatives.

UK pension scheme NEST’s first foray into private equity offers hope for investors looking beyond standard operating models in the asset class. The £20 billion defined contribution fund received 60-plus initial expressions of interest and is currently sifting through submitted applications, aiming to allocate more than £1 billion at the beginning of next year. The fund is quietly confident it will be able to hammer out a deal with GPs to make the expensive asset class known for 2:20 fees affordable.

Investing in private equity via fund-of-funds typically involves paying fund managers a management and performance fee, while further allocations to other third-party managers in the fund-of-fund charge another layer of fees. Although NEST will pay “some margin,” Stephen O’Neill, head of private markets at the pension fund says it won’t pay traditional private equity fees.

“Private equity investment often involves two layers of fees when even just one level of fees is probably beyond the affordability of NEST and most other DC schemes. We will not pay any performance fees or carried interest – we don’t like to pay people for a service twice and think that a management fee should be enough motivation to come in and do the job,” he told Top1000funds.com in an interview.

NEST hopes a series of other carrots will be enough. Fund managers often don’t get to transact on as much co-investment deal flow as they would like because they lack dry powder to stand behind deals. Under NEST’s model, GPs can hunt for co-investment sure in the knowledge of NEST’s permanent capital and ability to commit a large amount of money that can be drawn over the years in an evergreen structure, reducing the need for repeated fundraising.

“GPs will be fund raising for their vintage three or four funds besides working with NEST, but we offer a permanent arrangement and capital,” says O’Neill. “We can accommodate things that GPs’ existing client base haven’t explored or don’t have the appetite for. For example, they could use NEST’s capital to buy a big portion of a deal then syndicate a portion out and leave us as the permanent investor in the remainder.”

Following next year’s initial £1 billion, the fund aims to deploy £250 million every year with a target of 5 per cent of the portfolio invested in the asset class by the end of 2024 and £80 billion invested over the next 20 years.

O’Neill is confident that some of the responding cohort are up for the challenge – despite many dropping by the wayside.

“We have met dozens of managers and the attrition rate is high, but we wouldn’t have launched our procurement process if we didn’t think we had a solid base that would bid on the basis of us not paying carried interest – we aren’t catching anyone by surprise.”

NEST’s promise of continual allocations to winning GPs rules out closed-end fund structures where allocated money is locked up for 10-14 years. Instead allocations will be shaped around new, bespoke vehicles that offer the highest quality. Moreover, rather than opaque closed-end funds, O’Neill wants transparency and regular updates on pricing and reporting.

NEST is targeting growth but also small and mid-cap funds, avoiding allocating too much to large mega-cap buyout funds where O’Neill says the risk return tradeoff is less attractive. Moreover, well-storied ESG risks lurk that could impinge on NEST’s 2050 net zero ambitions with a goal to halve carbon exposure in the portfolio by 2030.

“We want to avoid mature companies without much growth and where extracting private equity returns relies on limited tools like leverage and slash and burn.”

The only caveat will be if a small, growth company grows to become large cap.

“We won’t sell it just because of this hard limit.”

O’Neill is only planning to mandate one or two managers, keeping the number in the “low single figures” that strikes a balance between ensuring NEST’s two-strong private markets team aren’t overwhelmed managing the managers, but capital is successfully deployed in today’s constrained market.

UK DC pensions have until now largely steered clear of private equity because of concerns that performance fees levied by private markets managers would put them at risk of breaching a 0.75 per cent charge cap on retirement savers’ fees. This year the government loosened the annual charge cap to better accommodate performance fees. Still, O’Neill says it is “very difficult” for DC funds to accommodate performance fees from an operational point of view since the so-called smoothing regulation isn’t in place and explaining to beneficiaries that “they are paying X as well as a variable Y underneath” is challenging.

Two trends

Today’s private equity allocation began with a first step into private credit in 2019 (where fund manager fees are cheaper and the carried interest component less pervasive than in private equity) subsequently followed by infrastructure equity where NEST onboarded three managers earlier this year. Allocations driven by the pension fund amassing enough AUM to approach private market managers to ask them for the kind of pricing the fund requires to access the asset class.

“We felt we had reached a critical mass,” says O’Neill.

Alongside a larger AUM, the private markets push is a consequence of NEST having grown wary of increasing concentration in global developed equity markets due to outsized exposure in indexes to a combination of certain stocks: big oil in the UK and tech stocks in the US.

Elsewhere, share buyback activity and companies that had achieved the scale to go public deciding to stay private for longer, has also pushed the pension fund towards private equity.

“A lot of factors made us feel that public markets were shrinking and concentrated, and collective returns declining.”

O’Neill plays down NEST blazing a trail for others or that the pension fund’s refusal to pay performance fees heralds a shake up in the asset class. He maintains that private equity is notoriously sticky around its business model and demand far outstrips supply, making it easy for GPs to defend their profit margins.

Nevertheless he does conclude “it might” change as DB schemes increasingly “step back.”

Absolute return strategies are an important skeleton key to building a resilient portfolio according to Ben Samild, deputy chief investment officer, portfolio strategy at the Future Fund.

“Absolute return strategies can provide an airbag for the things you are worried about in a cost-effective way,” says Samild who is responsible for asset allocation and portfolio construction and was previously head of alternatives.

The $245 billion Australian sovereign wealth fund has a long history of investing in absolute return strategies committing to the strategies since its formation in 2007. Historically it emphasised more macro directional strategies and now the thinking has evolved to fit more specific environments.

He says absolute return strategies have an important defensive role to play in the portfolio, as government bonds and duration lose their efficacy.

In addition the correlation benefits that Australian investors have gained from the pro-cyclical nature of the Australian dollar are changing and creating uncertainty.

“If you lose duration and currency then it is very difficult to build this portfolio with confidence and embed any level of defensiveness in it. We could pay for that protection but that gets expensive over time,” he says. “Absolutely we think a certain kind of hedge fund alternative asset has a really important part to play, it can be hard to communicate that and for stakeholders to understand that.”

The Future Fund’s absolute return strategies have traditionally been quite macro dominated, which goes back to the timing of its formation in 2007 and the opportunities that arose in 2008 as some investors withdrew money from strategies such as Bridgewater and Brevan Howard.

“It also made sense from a portfolio construction point of view, they felt and looked defensive,” Samild says. “As a young organisation with a small investment team they were also a really valuable source of information and gave us the ability to leverage the good thinking of the world’s best investors, which is another thing we try to do quite assertively. As the world develops and we go through this dramatic decline of interest rates, and strong asset returns our thinking changed.”

The fund uses absolute return strategies in a number of ways including looking for the “rare alpha pieces” but also some very specific purposes.

“Do you address things like inflation in a direct way or do something else? This is one of the areas we think you can set up some really interesting solutions where you can increase portfolio resilience without making a binary bet, and that limits the cost and increases your resilience,” Samild says. “We think alternatives have a real place in the world where risk premiums and discount rates are changing in time series and cross sectionally.”

Samild says the Future Fund uses many different strategies from quasi market making, very fast trading equity strategies to explicitly defensive strategies, reinsurance, fundamental quant, systematic macro, fixed income, commodities, convergent and divergent strategies.

“All of these are different and the class of managers are different and how much alpha we think they can put their hands on is different,” he says, which means due diligence for these managers is also different.

Samild challenges asset owners to think about their usefulness to the managers providing these alternative strategies.

“Your job as an asset allocator is to find a way to be useful to them. There is a giant international queue out the door for that capacity. Decide how comfortable you are with that alpha stream and what it means for you – and then do what you can do to be useful to that manager, that’s a really upside down thing for people to comprehend.”

 

Culture is key

Samild says it is the total portfolio approach that enables the Future Fund to use absolute return strategies to achieve goals rather than fill a bucket.

He says the culture is built around that one purpose and people are remunerated and judged and valued on how well they embrace that purpose, how well they collaborate and work together. This is very different from being judged on beating a benchmark.

“If the culture was about beating benchmarks there is no way we could run a hedge fund program the size of ours and the way we do it,” he says.

“You can’t run the kind of investment program we do without the culture of one portfolio in place from the beginning. That only becomes obvious when you step through the door and start living it. When you walk in the place and understand from the moment you are there, there is a degree of trust in you. And you have a project and everyone in the place is happy to make that project their project and their priority, there is no threat, you’re remunerated on the same fund return.”

Samild says instead of thinking of allocating in a pure Sharpe ratio return-focused way, which he says “is reasonably unhelpful” the culture and organisational structure means the team has the freedom to look at using the alternatives portfolio in many ways and as a skeleton key for total portfolio construction which is a “far more useful and interesting”.

“For a start hedge fund benchmarks are a mess, and if I was measured against that I’d have small allocations to some star managers and beat it every year. And I’d probably be adding to similar common factors that are in the broader portfolio and doing it in a way that is less interesting, less diversifying and less helpful to the broader purpose of the fund, and probably not sharing information with other groups the way we do that is completely natural.”

 

A range of global investment service providers, from stock exchanges to index providers, have signed up to the new Net Zero Financial Services Providers Alliance committing to align their products and services to net zero.

Global investment service providers including credit rating agencies, stock exchanges, auditors and index providers have come together to form the Net Zero Financial Services Providers Alliance (NZFSPA) to accelerate the transition to net zero. It’s a move that Nigel Topping, the UN High Level Climate Champion for COP26 has called turning ambition into action.

The world’s two largest credit rating agencies, six major audit networks, three leading index providers, and two global stock exchanges are among the 18 organisations behind the alliance. All have committed to aligning all their relevant products and services to achieve net zero by 2050 at the latest, and to set meaningful interim targets for 2025 within 12-months of joining.

Asset owners and managers, banks and insurance companies have already committed to net zero goals, aligning their collective tens of trillions of dollars of investments, lending, and underwriting to net zero. They won’t be able to do it unless the critical services and products that support how financial decisions get made are also aligned with net zero. The data, products and services of financial service providers are among the critical components informing that flow of capital.

For example, NZFSPA-member index providers has committed to provide net zero aligned indices by default for all main markets, making it easier for investors to choose to anchor their investments to the net zero transition. For investment advisors, committing to net zero could include ensuring that advice includes net-zero aligned options, that net zero considerations are drawn out in advice or advocating for new products and solutions.

Elsewhere, a stock exchange could require companies to disclose their alignment with net zero, and to provide other necessary data for the market to make investment decisions. Auditors will take companies’ net zero commitments and strategies into account when auditing their financial statements.

“Financial services providers can help turn the trillions of dollars of capital already committed to net zero into the real and tangible investments we need. I welcome the ambition of this alliance in going beyond reaching net zero in their own operations to help turn ambition into action,” said Nigel Topping, the UN High Level Climate Champion for COP26.

Alliance members will set science-based targets for their own emissions and have committed to report on their progress, including publishing disclosures aligned with the recommendations of the Taskforce on Climate-Related Financial Disclosures. The PRI, the UN-supported network of investors, will advise the alliance and help coordinate with net zero asset owners and asset managers.

“It has never been more vital for net zero considerations to be built in at every stage of the investment process. The resources made available by signatories to the initiative will enable strong implementation, helping investors move from commitment to action on net zero by setting clear and practical targets to enact meaningful change,” said Fiona Reynolds, CEO at the PRI.

Allocations to real assets by asset owners globally are increasing in light of the outlook for inflation, but the performance of the entire asset class won’t be linear nor will it be predictable, Harsh Parikh, a principal in the institutional advisory and solutions group at PGIM explains.

Different assets will have different sensitivities to inflation and economic growth variables depending on investment horizons and economic environments, Parikh outlined.

Allocations to gold, for instance, might be increasingly discussed as an inflation hedge within investment teams, but the extent to which gold and gold proxies make their way into portfolios will depend on a fund’s respective time horizon and economic views, Parikh said. Investor disclosures in the United States in the last year have revealed increasing gold allocations among the largest pension plans compared to historical allocations.

Real assets with higher inflation and growth exposure such as energy commodities, natural resource equities, real estate and REITs, infrastructure equities and timberland might be coveted by funds and schemes worried about an overheating environment, Parikh noted.

Meanwhile, funds with more concerns about stagflation might be more interested in farmland, gold, infrastructure, natural resource and real estate debt, he said.

“The biggest risks [investing in real assets] are in some of the portfolio construction aspects; not aligning the investment objectives and using a broader real assets basket as well as also not property aligning with investment horizon,” he said.

Getting the sensitivities right is one of the four important principles CIOs and investment teams should consider when building and augmenting their real asset portfolios, Parikh continued.

Alongside understanding sensitivities of each individual asset, Parikh included knowing your time horizon, incorporating estimation uncertainty and reflecting your own individual economic environment outlook as the other important principles to consider.

Relying on averages and generic time horizons can hamper decision making around real asset portfolios, he said. Using off the shelf benchmarks can be problematic for funds building their real asset allocations too, he added.

For instance, a CPI [consumer price index] beta for commodities might imply a 11 per cent up-move for every 1 per cent increase in inflation, but that up-move might range from 8 per cent to 14 per cent with 90 per cent confidence, he explained.

“CIOs looking for inflation protection would rather have assets with sensitivities that are more certain rather than assets that have less certainty,” he noted.

Allocations to real assets among pension funds globally have increased between 10 to 15 per cent in the last decade, Parikh noted siting PGIM’s Institutional Advisory & Solutions research on the topic.

Real estate is still one of the dominant real assets as a proportion of this increasing interest, he added, drawing on the PGIM insights. Average allocations to other real assets including to natural resources, infrastructure and farmland have also increased risen from 2.5 per cent to 5 per cent in aggregate during this timeframe, he noted.

Baseline inflation expectations have risen to 2.3 per cent for the next decade compared to 1.7 per cent for the last decade, Parikh noted.

 

With a massive, nationwide effort the United States could reach net zero emissions of greenhouse gases by 2050 using existing technology and at costs aligned with historical spending on energy. Research from the High Meadows Environmental Institute plots a Blueprint for the next decade showing the key is overcoming execution challenges including the infrastructure deployment and the mobilisation of capital and labour.

Achieving net zero would involve an unprecedented infrastructure build over the next three decades and huge electricity generation to meet demand from electric vehicles and electric households making solar and wind energy the “linchpins” in the transition, said Chris Greig, Theodora D. ’78 & William H. Walton III ’74 senior research scientist in the Andlinger Center for Energy and the Environment at Princeton University.

Speaking at Sustainability in Practice, Greig said that positioning wind and solar installation would depend on social and demographic criteria, considering the lowest cost of production and cost of delivery. A huge build out of offshore wind, transmission infrastructure and solar farms would have far reaching implications for the landscape. Elsewhere, new infrastructure would include natural gas turbines critical for balancing intermittency in the grid.

Achieving net zero would also spur a new bioenergy industry, said Greig. This sector could produce energy for aviation and petrochemical industries.

He predicted a strong push back from the arable industry spurring a food versus fuels debate but reassured that only existing crops used for energy should go into the mix. Instead, bioenergy could come from new sources like municipal waste. Despite “all kinds of challenges” including bringing farmers on board and a lack of infrastructure, he said the opportunity was tremendous.

Elsewhere, hydrogen will become a key component to the transition. It could be used in chemical and steel production and Greig predicted enduring demand for liquid fuels. Carbon capture will be another vital pillar taking carbon from everything from cement plants (“we are going to need a lot of it,” he said) to biofuel plants and natural gas power stations.

He said the transition needed fossil fuel companies “to get good” at carbon capture and that without carbon capture and storage it would be impossible to get to net zero.

Noting that it is a difficult industry to develop, he said the oil and gas industry is uniquely positioned to build out the infrastructure needed like pipelines and storage capacity.

“It is like building the oil and gas industry over again – but in 30 years,” he said.

He said that the cost of new energy services could remain affordable, but that it also depended on the mobilisation of capital. Bringing assets to fruition takes decades, and depends on technical studies, feasibility and a successful build. He noted that fund managers tend to allocate to investors who own operating assets and seldom provide risk capital to build greenfield infrastructure. “The real challenge is mobilising at risk capital to construct the assets.”

The massive infrastructure build will require a huge workforce and shape new communities. “On the face of it is a great political story,” he said.

However, he said the surge in jobs and growth would not be homogenous or on a state-by-state basis. Some oil states would go through declines, underscoring the need for a Just Transition.

The conversation also touched on investor caution given potential changes in the US political landscape. “What is your level of conviction that this will actually happen; what level of confidence can investors have?” asked Alexandra West, chief strategy officer – investments at Cbus.

Greig countered that Republican (or Trump states) also prosper in a net zero pathway. The wind and solar industry would provide huge jobs and “bring the mid-west” along, he said.

The conversation also touched on how car companies will build electric cars no matter who is President – and how Republican governors will quickly solicit investment in new energy assets for tax revenue and jobs.