Page 165 – Top1000funds.com

Asset allocators should prioritise creating their own accountability system for diversity, equity and inclusion in 2022 according to Jason Lamin founder and chief executive of DEI specialist Lenox Park Solutions.

Lamin says processes and behaviours including regularly reporting to the board, whether formally or informally, become a catalyst for change.

“One of our clients’s CIO reports regularly on DEI to its board and by doing that the staff, executive management team and CIO have to get very serious about what they are going to be reporting on,” Lamin says.

Importantly these practices can address the structural barriers to improvement such as goal setting.

“It comes down to fundamental business management, that is the only way this works,” he says. “Clients that want to check a box will fail. The only way it works is organic, bottom-up change that starts with being accountable and that rolls into data and measurement.”

Lamin advocates reporting to some governance structure and some level of accountability as an important catalyst. What comes next is measuring progress with analytics that give context to the entire industry.

“People want to know what to do on Monday morning. One of the biggest impediments to DEI advancement is we have made the discussion in rhetoric and have laid out grand expectations but come Monday morning when I get to the office what do I do?”

Lenox Partners, whose work is rooted in a metrics-driven approach, now has asset owners with combined $5.5 trillion as clients including CalPERS, Illinois Teachers, Mass PRIM and New York State Common. Financial services clients include JP Morgan, Prudential and NY Life.

Lamin says being able to scientifically measure DEI is an important step in incorporating it into decision making and has developed a statistically rigorous methodology to rank asset management industry participants on diversity data.

The Lenox Park Diversity Impact Score (LPI) is calculated using 10 components related to gender and ethnic diversity data for firm ownership, leadership, and total workforce. The score is constructed so more components – such as disability, LGBTQ and gender pay equity – can be added as the data becomes available. Clients survey their managers collecting data to create the score that can be used as a benchmark for change. The score is shared with the client, and the underlying managers.

Holding managers to account

While asset owners in many ways set the rules for DEI among their managers, Lamin warns against setting those rules in terms without context.

This means asset owners demonstrating they have also made progress in their own organisations so there is a collaborative effort to improve the industry.

“LPs showing they have done the work goes a long way to bringing the GPs into the conversation,” he says.

In a peer-aware industry such as financial services Lamin also says measurement needs to be meaningful to the market.

“Measurement needs to mean something in the market which is why the peer score is important. There needs to be realistic benchmarks and expectations of the manager.”

For example he says different asset classes need to be treated differently, pointing to real assets versus public markets where the demographic makeup among managers is very different.

“If we set goals as a blanket x per cent in all asset classes we are not meeting the market where it is,” he says. “We need to be realistic on what the expectation should be and put the scores into context, that’s important.”

The foundation space has been the fastest moving of all institutional investors in the adoption of the LPI metric for assessing DEI among their managers and Lenox Partners is now the standard.

“That makes it easier for everyone. The foundations can hold their mangers accountable and it makes it easier for the managers to have a clear idea of the expectations of them. Our technology makes it easier for all sides. That’s happening most clearly in the foundation space.”

Lamin says when investors have tools they can change behaviour very quickly and this is true for DEI scores also.

“I was surprised at how quickly the decision makers on the allocator side have incorporated the analytics into their decision making,” he says. “One [large pension fund] client already says to managers they need to disclose their DEI score in order to be considered by the investment committee. It’s not exclusionary but is another metric to assessment, we think that is a huge advancement.”

Singapore’s investment company Temasek is at the forefront of blockchain investment. Pradyumna Agrawal explains why going early and deep in tech investment is a sweet spot, encapsulated in the giant investor founding and building tech companies from scratch.

The professional network LinkedIn, founded 18 years ago and positively ancient by social media standards, depends on peer reviews to verify if someone is telling the truth. Singapore’s SGD381 billion ($283 billion) state-owned investment company Temasek recently backed a new job seeking platform supported by blockchain technology that gives people digital identities with verifiable credentials.

Targeting blue-collar job seekers in India, Goodworker helps lower income groups establish their identities in a verifiable manner. It’s one of the companies leveraging self-sovereign identity solutions built by tech company Affinidi – founded by Temasek – designed to give people a verifiable digital presence and allow the seamless capturing and sharing of data.

Temasek’s investment in digitisation and emerging technologies goes beyond the hunt for returns to playing a role in accelerating the trends that it believes will drive returns in the future. The strategy rests on a core belief that as digitisation and technology evolve, the tech world will migrate from today’s extreme centralisation to one of open networks and portable data, ushering in a wave of new business models in its wake.

“It’s taken time and we are only now beginning to see the benefits in specific application areas,” says Pradyumna Agrawal, managing director, investment (blockchain) at Temasek in an interview from Singapore.

Like Partior, a joint venture with banks DBS and JP Morgan, that is revolutionising cross-border payments and settlements using blockchain to enable programable value transfers. Or its partnership with the Singapore Exchange (SGX) that uses blockchain to replace the hundreds of laborious steps multiple parties take around coupon payments, issuing and servicing, OTC bonds.

“Blockchain technology puts everyone on a common workflow. It also adds liquidity because assets can be tokenised,” enthuses Agrawal.

Strategic capabilities

Tech investment at Temasek falls under different umbrellas. In some cases, it invests in funds and in others it goes direct. In a third and most startling seam, strategy involves creating companies from scratch effectively building its own strategic capabilities rather than wait to back entrepreneurs in the space. It’s rooted in the investor’s decision to catalyse solutions to unmet needs, either on its own or working with partners, by bringing businesses to life.

“Creating a business is a pretty unconventional approach,” he admits. “It started as an experiment; asking ourselves if we could solve a particular problem.”

Starting a business involves more than just capital. In a world flush with liquidity there is no shortage. What is just as valuable is Temasek’s credibility, neutrality, networks, talent and its ability to make long term commitments upfront that give staying power. Agrawal also makes much of the investor’s single-minded focus on solving challenges. Indeed, such is the importance of these other ingredients beyond capital that he often finds Temasek executives advocate against inviting other investors in too early on projects.

“Their reaction is often ‘not yet’,” he says.

Sweet spot

And going in early – or at the beginning – and deep particularly chimes with tech investment, an area where it is often difficult to capture the inflection point and access the best risk reward before the crowds arrive.

“We made the decision three to five years ago to systematically go deeper earlier,” says Agrawal. “This is the sweet spot where we find ourselves today.”

Looking through a pure investment return lens, he describes a strong commercial logic to building a business from scratch, particularly compared to the original capital outlay. It is also a virtuous circle whereby successfully solving one problem triggers new investments to deliver other outcomes.

Patience

Temasek’s ability and appetite to invest at the forefront of new technology is rooted in its ability to provide long-term, permanent capital able to see early-stage companies through their long gestation periods and across every stage of their business growth.

“The equity risk opportunity balance is in our DNA,” he says.

For sure, there will be some mortality; not every business will end up a thriving commercial venture. But Agrawal says Temasek has little appetite to sell during any stage up until IPO, at which point it might liquidate its shares or decide to keep a stake if it remains excited by the business – similar to how it evaluates other investment opportunities.

“The ideal scenario is to be able to list all these businesses and avoid selling the businesses to highly centralised organisations,” he says. “By staying focused on the viability and the gap the business is trying to solve, we hope many will end up floating on the stock market, allowing a broader set of investors to participate and support longer term growth.”

Importantly, Temasek never set out to invest a fixed amount of money in emerging technologies. From the very beginning, strategy was shaped around creating a foothold in the space from which organic growth would flow – aka using technology to find answers to solve problems and not viewing blockchain as a technology that needs a solution. And for all its success, his department is still small – although Agrawal says Temasek stopped measuring the significance of a team by its size or investment dollars long ago.

Mandated conviction

As the conversation draws to a close, Agrawal reflects again on the roots of success. Key elements include Temasek’s status as an investment company without any liabilities affording a bold mandate to invest across the life cycle of a company. This also comes with a governance structure that ensures the many companies Temasek wholly owns are independently run. The other pillar is conviction.

“We are only able to do this because our firm has a deep conviction on the potential of technology. There is no way we would build these platforms if we weren’t convinced about the need for a particular solution.”

As for the challenges ahead, he is most concerned by the shortage of talent in the tech space. A looming crisis that is compounded by the time it takes to garner real experience. It will make compensation (he describes a “massive” repricing of talent already underway) and building projects people believe in, key to retaining staff. As for investors, he reiterates the benefits Temasek reaps in its different, operating role.

“Investors can patiently wait for someone else to build something and invest for 3-5X returns – or they can build their own capability.”

In his first interview as the new CEO of the PRI, David Atkin outlines his priorities for the organisation and the areas of urgency for investors focused on sustainability.

Driven by good processes and planning David Atkin has had success in managing organisations through periods of immense growth. In the 12 years he was CEO of the profit-to-members Australian superannuation fund, Cbus, the fund grew from A$12 billion to be more than A$65 billion today with a large internal team.

Similarly the PRI has been an organisation that has undergone enormous growth. Now with 4,718 signatories it continues to grow, with 308 signatories coming on board in the last quarter alone.

“In organisations where there has been rapid growth you have to think about how you organise and deploy resources and how you think about execution might need to change,” Atkin told Top1000funds.com in an interview. “Clearly I’m coming in on really strong foundations – James [Gifford], Fiona [Reynolds] and I are all different in our leadership styles but we all consistently believe in the same idea. I now bring a different phase for the PRI. It’s boring, but process is important. If you plan well and you think about your processes you get better outcomes in my experience.”

Atkin says one of the challenges with rapid growth is how to meaningfully serve each of the signatories.

“We have to industrialise the way we provide opportunities to serve our membership base and our digital strategy will be important. We might need to segment better via groups of interest or region or investment style to provide the right forums and take advantage of the global perspective the PRI brings,” he says. “We are a member organisation and put our signatories at the heart of everything we do and ensure we provide value to them.”

Atkin, who will move to London from Melbourne in March, has had a long history with the PRI serving on the board from 2009-2015, and working with outgoing CEO Fiona Reynolds.

But he is aware that a lot has changed in the organisation and in responsible investment since that time. This year his focus will be on understanding the broader landscape, looking internally at the organisation’s ability to serve its signatories, and then conducting a comprehensive signatory consultation on the PRI’s mission and purpose.

“This is an important opportunity for me to really listen to our signatories and ensure our aims and outputs are aligned with their needs,” he says.

The issue of a generation

Atkin describes climate as not just the most important issue for investors this year, but the issue of a generation.

“It can’t be solved in one year and it’s not going away,” he says. “We are already seeing the consequences of not dealing with it as a managed transition and this will lead to a whole lot of other S and G issues. It is an existential threat. We have to solve it this decade.”

He points to initiatives such as the Net Zero Asset Owner Alliance and the Manager Alliance as really important. But he says that declarations of net zero now need to move from high level strategic intent to clear implementation and reporting plans.

Last October, the Net Zero Asset Owners Alliance released its first progress report with 29 asset owners setting targets to manage their portfolios in line with the 1.5C climate goal, including Axa, Swiss Re and the Church of England. This first round covers the investors’ plans out to 2025. Of the $9.3 trillion under management by alliance members about $1.5 trillion is now in motion towards a 1.5C-aligned target by 2025.

But while climate is the most important issue of sustainability it is not the only issue and in an environment where there is increasing change and focus on reporting, Atkin is prioritising that the PRI ensures the reporting and assessment obligations it is asking of signatories is fit for purpose.

“There are some questions around not duplicating what is being asked from other reporting frameworks and ensuring what we are doing is helping us identify the progression of our signatories in incorporating the principles,” he says.

To that end there are a number of internal projects underway, including one that assessed the reporting requirements of the world’s 10 leading economies. It identified 150 reporting requirements that signatories are being asked or required to participate in.

“With all that emerging we are looking at what is relevant and what’s duplicative,” Atkin says.

While there has been a lot of maturity in the PRI assessment reports they need to cover broad territory from signatories at the beginning of their sustainability journey through to leaders.
“We are asking whether the current structure can still provide useful information for each of those different categories,” he says, “We need to step back and see whether it is a fair ask of our signatories given the effort to complete the whole thing.”

He said that the PRI will communicate with signatories in the next few weeks about changes in the 2023 request, adding there was no doubt some information won’t be required because signatories can report through other obligations.

To this end the PRI is currently recruiting its first chief reporting officer.

“Reporting is a fundamental part of being a signatory and we need someone at the leadership level who has the remit of the program, the accountability and responsibility of that,” he says. “There is so much information that can be shared across the content areas and having someone to bring that out and seed that information across the organisation is really important.”

It’s no coincidence that Atkin is talking about shifting people out of their silos and working in a more integrated way. Under his leadership Cbus became, and remains, a leader on Integrated Reporting globally and its Atkin’s intent to produce an Integrated Report at the PRI as well.

Ensuring the organisation is walking the talk it has also just appointed a head of diversity, equity and inclusion in an effort, Atkin says, to cultivate a culture that genuinely embraces diversity.

The PRI’s current flagship projects:

Climate Action: This project is about moving towards net zero through investor action, corporate engagement and policy reforms. This is composed of a number of workstreams including The Inevitable Policy Response, Climate Action 100+, COP26, the New Zero Asset Owners Alliance, the Net Zero Asset Managers Initiative, the Net Zero Financial Service Providers Alliance and the Investor Agenda.

Driving Meaningful Data (DMD) – This project is about enabling the flow of reliable and comparable data from corporations through the investment chain
Sustainability outcomes and SDGs: –this project is about supporting investors looking to shape real-world outcomes
Human rights: – this project is about maximising investors’ collective contribution to global respect for human rights
ESG in Fixed Income: –this project is about driving ESG incorporation across the fixed income market in response to increasing investor interest and signatory demand
Active Ownership 2.0 – this project is about developing more ambitious, effective and assertive stewardship
Asset Owners: – this project is about providing tailored resources to further the adoption of ESG amongst asset owners, in their position at the top of the investment chain

Trimming exposure to shares

AustralianSuper currently has 57 per cent of its total portfolio in shares. It has cashflows of around A$25-30 billion a year and the fund is expected to double in size within the next five years.

In 2022 Delaney said the outlook, largely positive but with an eye on inflation and central bank tightening, is prompting AustralianSuper to trim back its exposure to shares which was in an overweight position.

“For much of the Covid period we have had quite a constructive approach to the market, being overweight shares, underweight fixed income and looking to increase our exposure to unlisted assets,” he said.

“That has been fuelled on the back of very stimulative policies by both central banks and governments, which has led to very strong economic growth, strong profit growth and an environment where the alternative to buying growth assets was pretty poor.”

“What we want to do with the portfolio is gradually reduce our exposure to shares from a meaningful overweight position. We will increase our exposure to fixed income if rates rise substantially,” he said.

“We have just started to take out the pro-growth (stocks) in the portfolio.”

The fund would also be looking at more investments in unlisted assets such as infrastructure and property which could provide a hedge against inflation.

“We think some of those unlisted assets which have also got some inflationary hedges in them (could still have) a slight risk (but would be less risky than some other investments),” he said.

Push to move offshore

Delaney said the continued strong growth of the fund would mean it would have to invest more of its assets offshore.

“We currently have about half of our assets overseas [and] my expectation is that it will get to two thirds over the next decade,” he said.

Delaney said this would mean that AustralianSuper would also continue to expand its offices offshore. He said the fund currently plans to expand its current staff of around 43 in London to more than 100 in the “next couple of years”. It also has plans to expand its current office in New York by 20 at the end of this year.

He said AustralianSuper had learned from watching funds overseas, particularly the big Canadian pension funds which had aggressively expanded internationally, that it was better to have significant offices in a few strategic places rather than small offices in many places.

He said Singapore was a possible future place for the fund to have an office but he argued he didn’t see Singapore as critical as getting London and New York City “right in the near term”.

He said the fund still found having an office in Beijing was useful to monitor developments in the Chinese economy.

“China is the second most important place in the world,” he said. “We know everything about what is going on in the US but we don’t know anywhere near as much about the second most important place.”

The Beijing office is run by Jing Li, a PhD in Economics from the University of Edinburgh, who was a former economist with HSBC and The Economist Intelligence Unit before joining AustralianSuper in Beijing in 2017.

Australia still an important market

Delaney said there were still plenty of opportunities in Australia for the fund to invest in and that it would continue to be a big player in the Australian economy. The fund did some A$18 billion worth of deals in Australia alone in the past year.

The past year has seen AustralianSuper’s involvement in a A$24 billion deal to buy Sydney airport which is expected to be finalised in the first half of this year.

Other deals have included increasing its stake in Sydney toll road operator WestConnex and being part of a consortium buying into the intermodal logistics hub at Moorebank in Sydney’s west.

The fund has also participated in capital raisings for a number of Australian companies in the past year including one in December by CSL.

“Australia is a pretty big place. It is a dynamic country. There are plenty of opportunities here as well,” he said. “There are only a certain number of airports and ports but there is a lot of digital infrastructure currently being built.”

The importance of liquidity

Delaney said AustralianSuper had a strategy of having no more than a third of the assets in its portfolio in illiquid assets.

“The thinking being, if the share market halved, the percentage in illiquid assets would go to half the portfolio. We wouldn’t want it to go to more than half,” he said.

He said the strong inflow of funds meant that AustralianSuper did not have any liquidity pressures at the moment but he said it still monitored its liquidity position “very closely”.

He said liquidity would become more of an issue for Australian super funds as the system matured in the 2030s and began paying out more in retirement funds than it was taking in.

“The Australian super system is still very young. Liquidity will become more of an issue when it moves into outflows.”

As the real estate industry begins to drill down on planning for net zero, awareness is growing around the need to consider buildings’ carbon impact throughout their lifespan, since a net zero energy building does not necessarily equate to zero environmental impact. Could this incentivise investors to commit capex to the renovation of older office space?

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The largest sovereign wealth fund in the world, Norway’s Government Pension Fund Global, resembles an index fund and is not making the most of its tracking error boundaries according to a review of the active management of the fund by a team of specialists.

The academics who reviewed the NOK11.95 trillion ($1.36 trillion) fund as a directive from the Ministry of Finance, said there was an opportunity to think more strategically and redirect the mandate of the fund towards active ownership.

They said the Ministry of Finance needs to specify the priority in the mandate and that having two goals (active ownership / net zero and active management) is difficult to execute when you just have one instrument (the portfolio).

Rob Bauer, Professor of Finance at Maastricht University, said GPFG which is managed by Norges Bank Investment Management had the complexity of an active fund, with more than 200 strategies and hundreds of investment staff, but the performance features of an index fund.

The academics looked at active management from January 1998 to September 2021 by evaluating sub strategy performance. They found overall the fund returned 7.03 per cent annualised since 1998 with a benchmark of 6.83 per cent, and while there was some evidence of added value in certain strategies overall it behaved like an index fund. Furthermore its tracking error has been 0.3 for the past four years but the mandate allows a tracking error of up to 1.25 per cent. The tracking error across the entire timeframe was 0.6.

The committee’s report urged the Ministry of Finance to investigate why NBIM does not take full advantage of its tracking-error limit and whether any operational impediments or structural barriers play a role.

Related, the committee recommended there be less emphasis on factor models in evaluating the fund’s performance and more focus and emphasis on the qualitative assessments of the organisation such as governance quality, long-term mindset, and creating the appropriate culture for successful execution of the strategy.

The analysis by the academics – which included Charlotte Christiansen from Aarhus University and Trond Doskeland from the Norwegian School of Economics alongside Maastricht’s Bauer – found some evidence of value-adding strategies, particularly in equities. At the total equity level annualised active returns were 0.36 per cent and gross active returns were 0.47 per cent. Security selection strategies, net of costs, were the biggest contributor with positive active returns of 1.27 per cent. In fixed income net gross active returns were 0.13 per cent.

However there was not enough persistence of value add to make a difference to a fund the size of Norway.

“We propose a bold change. This could be not just a requirement to beat the benchmark but perhaps a basis points minimum deviation from the benchmark. The mandate is not ambitious at the moment,” Bauer said in an interview with Top1000funds.com, while also acknowledging the difficulty of a fund the size of GPFG beating a benchmark.

A minimum target of outperformance would force NBIM to take a bit more risk, he said.

A new active ownership mandate?

The limited value add from active strategies combined with an increasing focus on sustainability presents an opportunity to revamp the fund’s mandate to focus on active ownership, according to Bauer who reiterated that combining active management may conflict with the ambition to execute effective active ownership strategies.

“The issue of active ownership is complicated. If you want to address issues of climate change and net zero it is difficult to combine that with the objective of having active management. The portfolio managers on the floor may want something different to what is being asked by politicians who represent the Norwegian people, and someone has to prioritise,” he says.

Christiansen agrees with the mixed messaging demonstrated by the lack of integration between the active investment management and the active ownership.

“This problem is generic for all pension funds – choosing whether to be active/beat the benchmark or have active ownership/net zero. Can only one make investment decision but how do you reconcile the two? Someone needs to have the decision and it needs clarity in the mandate.”

In the report the academics said: “We urge the Ministry of Finance to provide clarity in the mandate on the objectives and prioritization of active ownership strategies, as well as on what parts of this prioritisation are NBIM’s purview versus which are prescribed in the mandate.”

Complexity of benchmarks and the future of real estate

In conducting the review the committee also revealed that the current benchmark gives rise to some potential conflicts of interest as some objectives target active returns (trying to achieve a positive alpha) and others target total returns (diversification of the whole portfolio). Adding a net-zero-emissions targets to the portfolio would add more conflicts of interest to the mandate.

Specifically there was some opacity in the asset class benchmarks which made it difficult to examine. In addition real estate is not in the benchmark but is instead measured against stocks and bonds.

Christiansen says stocks and bonds were not the right performance measure for real estate investments.

“Norwegians like to promote the fact they own properties on some of the well-known streets in London, and it seems like they are quite proud of that. But they measure the performance of real estate against stocks and bonds, to us that is quite strange,” she says. “A quarter to a third of their people are working on real estate and that is mostly unlisted, but they don’t measure returns against an unlisted benchmark, that makes it very difficult to come up with some good information. The finding would be that performance is very bad because unlisted real estate has lower returns than stocks and bonds, but it’s not the right performance measure.”

The committee advises that if the Ministry of Finance deems unlisted real estate to be important for diversification purposes then real estate should be reinstated to the benchmark.

Unlisted real estate is a long term strategy which means attracting good people and retaining them is a long term exercise. The removal of real estate from the benchmark in 2017 could signal to that team that real estate is not an important asset class in the long term. That may lead to people leaving and difficulty to attract new personnel, Bauer said.

Progress in DEI needs asset owner accountability