China is a simultaneous threat and an opportunity for investors. This discussion looks at how to navigate a worsening geopolitical situation and what it means for economic growth. Is the current course a steady state, or are big shocks, for the better or for the worse, possible and even likely? Geopolitical expert, Professor Stephen Kotkin, examines what lies ahead for investors.

About Stephen Kotkin
Stephen Kotkin is the John P Birkelund Professor in History and International Affairs at Princeton University. He is the co-director of the program in history and the practice of diplomacy and the director of the Princeton Institute for International and Regional Studies. He established the Princeton department’s Global History initiative and workshop, and teaches the graduate seminar on global history since the 1950s. Professor Kotkin received his PhD from the University of California, Berkeley in 1988, and has been a professor at Princeton since 1989. He is also a senior fellow at the Hoover Institution at Stanford University. At Princeton Professor Kotkin teaches courses in geopolitics, modern authoritarianism, global history, and Soviet Eurasia, and has won all of the university’s teaching awards. He has served as the vice dean of Princeton’s Woodrow Wilson School of Public and International Affairs, and chaired the editorial committee of Princeton University Press. Outside Princeton, he writes essays and reviews for Foreign Affairs, the Wall Street Journal, and the Times Literary Supplement, among other publications, and was the regular book reviewer for the New York Times Sunday Business section for many years.  He serves as an invited consultant to defence ministries and intelligence agencies in multiple countries.  His latest book is Stalin: Waiting for Hitler, 1929-1941 (Penguin, 2017).  His previous book was a finalist for the Pulitzer Prize.
About Amanda White
Amanda White is responsible for the content across all Conexus Financial’s institutional media and events. In addition to being the editor of Top1000funds.com, she is responsible for directing the global bi-annual Fiduciary Investors Symposium which challenges global investors on investment best practice and aims to place the responsibilities of investors in wider societal, and political contexts.  She holds a Bachelor of Economics and a Masters of Art in Journalism and has been an investment journalist for more than 25 years. She is currently a fellow in the Finance Leaders Fellowship at the Aspen Institute. The two-year program seeks to develop the next generation of responsible, community-spirited leaders in the global finance industry.
What is the Fiduciary Investors series?
The COVID-19 global health and economic crisis has highlighted the need for leadership and capital to be urgently targeted towards the vulnerabilities in the global economy.
Through conversations with academics and asset owners, the Fiduciary Investors Podcast Series is a forward looking examination of the changing dynamics in the global economy, what a sustainable recovery looks like and how investors are positioning their portfolios.
The much-loved events, the Fiduciary Investors Symposiums, act as an advocate for fiduciary capitalism and the power of asset owners to change the nature of the investment industry, including addressing principal/agent and fee problems, stabilising financial markets, and directing capital for the betterment of society and the environment. Like the event series, the podcast series, tackles the challenges long-term investors face in an environment of disruption,  and asks investors to think differently about how they make decisions and allocate capital.

About Joseph Stiglitz

Joseph E. Stiglitz is an American economist and a professor at Columbia University. He is also the co-chair of the High-Level Expert Group on the Measurement of Economic Performance and Social Progress at the OECD, and the chief economist of the Roosevelt Institute. A recipient of the Nobel Memorial Prize in Economic Sciences (2001) and the John Bates Clark Medal (1979), he is a former senior vice president and chief economist of the World Bank and a former member and chairman of the (US president’s) Council of Economic Advisers. In 2000, Stiglitz founded the Initiative for Policy Dialogue, a think tank on international development based at Columbia University. He has been a member of the Columbia faculty since 2001 and received that university’s highest academic rank (university professor) in 2003. In 2011 Stiglitz was named by Time magazine as one of the 100 most influential people in the world. Known for his pioneering work on asymmetric information, Stiglitz’s work focuses on income distribution, risk, corporate governance, public policy, macroeconomics and globalization. He is the author of numerous books, and several bestsellers. His most recent titles are People, Power, and Profits, Rewriting the Rules of the European Economy, Globalization and Its Discontents Revisited, The Euro and Rewriting the Rules of the American Economy.

About Amanda White
Amanda White is responsible for the content across all Conexus Financial’s institutional media and events. In addition to being the editor of Top1000funds.com, she is responsible for directing the global bi-annual Fiduciary Investors Symposium which challenges global investors on investment best practice and aims to place the responsibilities of investors in wider societal, and political contexts.  She holds a Bachelor of Economics and a Masters of Art in Journalism and has been an investment journalist for more than 25 years. She is currently a fellow in the Finance Leaders Fellowship at the Aspen Institute. The two-year program seeks to develop the next generation of responsible, community-spirited leaders in the global finance industry.

What is the Fiduciary Investors series?
The COVID-19 global health and economic crisis has highlighted the need for leadership and capital to be urgently targeted towards the vulnerabilities in the global economy.
Through conversations with academics and asset owners, the Fiduciary Investors Podcast Series is a forward looking examination of the changing dynamics in the global economy, what a sustainable recovery looks like and how investors are positioning their portfolios.

The much-loved events, the Fiduciary Investors Symposiums, act as an advocate for fiduciary capitalism and the power of asset owners to change the nature of the investment industry, including addressing principal/agent and fee problems, stabilising financial markets, and directing capital for the betterment of society and the environment. Like the event series, the podcast series, tackles the challenges long-term investors face in an environment of disruption,  and asks investors to think differently about how they make decisions and allocate capital.

When behavioral economists get a secret handshake, it will be a shrug, a self-deprecating nod to how financial institutions initially greet their ideas.

Ricardo Research’s brilliant analysis of how short-term behavior predictably ensues from the usual mandate contracts between asset owners and asset managers – together with the commentary in Top1000funds.com – is what brings this to mind.

“The first step towards a more effective monitoring approach is to recognise that short-term performance data are at best a weak indicator of success for strategies with long-term objectives”, write Paul Woolley, Phillip Edwards, and Dmitri Vayanos. “Investment cycles can be long-lasting, so even over periods of 5-10 years investors should be wary of drawing overly strong conclusions from performance data alone.”

FCLTGlobal’s experience bears this out exactly.

Last year we released the second edition of our toolkit for investors to build long-term mandate contracts. A key part of this update was adding case studies of how asset owners and asset managers have used these provisions in the real world. The most widely used provision, by far, is a seemingly-minor behavioral nudge: reordering performance tables so that longer-term data comes before short-term returns.

The list of institutional investors that have made this change and talked publicly about it is long, including Ontario Teachers’ Pension Plan, CalSTRS, MFS, Federated Hermes, Kempen, and Brazil-based NEO Investimentos. The evidence of this nudge’s effectiveness is the enthusiasm investors have for talking about it with others.

It must be noted that this is not a change of the performance data that gets presented. All of the return figures remain. These long-term investors merely have reordered the data. The impact comes from knowing that people give the most attention to the information that they see first, often to the point of not giving any attention to the last information in a sequence, so these investors are being intentional in how they use this focus.

It’s really no more complicated than saying what you mean to say (and not saying what you don’t).

This longer-term mandate practice is most widely-adopted, but it is far from singular. Woolley, Edwards, and Vayanos also emphasize the importance of fee arrangements, and very appropriately so. It is stunningly common how often asset owners get what they pay for – but pay for something other than what they want.

Fee arrangements can nudge longer-term focus in a number of ways. Just for example, OTPP also has used a longevity discount with asset managers, accepting higher up-front costs in exchange for steeper reductions over time, and agreed that it would pay a penalty in the event if no-cause termination. Both provisions give OTPP’s asset managers confidence that it really is committed for the long term, and that they must be too.

Risk parameters also need to be on the list because they frame the investable universe for asset owners and managers. Woolley, Edwards, and Vayanos emphasize how multiple times horizons matter. Investors with sincere and strongly-held beliefs about the long term often are surprised by short-term disruptions in the interim period and panic – even though such disruptions are generally foreseeable. Long-term investors agree in their mandate contracts to project risk across multiple time horizons so that they have sound estimates not just about where they are going but also what it will be like to get there.

“Short-termism” is a euphemism for a suite of behaviors in which one individual’s or institution’s time horizon does not match another.

Woolley, Edwards, and Vayanos are entirely correct that the origin of these behavioral mismatches often is the mandate agreement that asset owners and asset managers use to set the incentives and parameters for their relationships. The investors referenced above are leading in this regard.

Practical – indeed, practiced – alternatives are available for other long-term investors that are ready to follow suit.

 

Matthew Leatherman is a research director at FCLTGlobal, a non-profit organization whose mission is to rebalance capital markets to support a long-term, sustainable economy.

Mercer will incorporate DEI considerations into its manager research the same way it pioneered the incorporation of ESG factors in its manager ratings process back in 2012. The integration of DEI is a parting gift from long-term global head of investment research, Deb Clarke, who retired yesterday. Amanda White spoke to her about her legacy and the investment industry’s unfinished business.

For nearly 10 years to get a high ESG rating from Mercer, fund managers have had to demonstrate ESG considerations across the generation of ideas, construction of portfolios, implementation of active ownership and a firm-wide commitment to ESG.

Now Deb Clarke, one of the most senior women in the global investment industry and a trailblazer in manager research, says the consultant will give more emphasis to DEI issues in its manager assessments.

“We want to integrate the DEI data. If we are going to give our highest conviction then DEI will need to be evident at the asset manager,” she says.

Clarke, who says quotas just encourage portfolio managers to consider diversity as an HR problem, says Mercer is tackling the issue by focusing on data transparency.

“We will be more intentional. Diverse teams make better decisions and so deliver better returns for clients;  if you don’t have a diverse team, we will be less likely to have high conviction in the strategy. And it must be genuinely diverse and not just ‘bringing along a female to the finals’,” she says, quoting a fund manager who sought her counsel on diversity. (Her response was “don’t bother coming to the finals”.)

The focus of the data will not be on a certain point in time, but what the manager is doing about the pipeline of talent to increase diversity of thought.

For many years Clarke has been advocating ESG and DEI issues and after her retirement will continue to campaign for change.

“While I have been in the industry there has been a shift away from a star fund manager towards the team. Recent events have also shown that people are more comfortable if there is a team effort and oversight. People want to feel their money is secure, and they are dealing with people with integrity.”

Similarly, she’s observed the evolution of ESG from nascent beginnings to universal claims.

“When Jane [Ambachtsheer] and I first started looking at ESG, many PMs didn’t even know what ESG stood for. We’d ask them if they incorporated ESG into their process and they’d say, ‘absolutely not’. They didn’t want to be associated with it,” she says. “In the last three years PMs are now saying ‘of course we do’. It’s totally reversed.”

Clarke’s hope is that in five years’ time there is no conversation around ESG because it is just embedded into everything investors do.

But between then and now there is a lot of work to do, like other consultants Clarke believes many investors have made a commitment to net zero without any real idea on how to get there.

“If you just sell the companies that you think will do badly it’s like throwing your rubbish over your neighbour’s wall,” she says. “The only way to solve this is through industry cooperation.”

Clarke retired this week after 16 years as global head of investment research leading more than 125 manager research specialists covering hedge funds, fixed income and equities.

“One of the things that strikes me about what has changed in that time is that information is now so freely available. When I started there was still a prize around people getting really good information, now there is a deluge of information. The important thing is not the information but the way you use it,” she says. “The skill set of managers has changed in that time and will continue to change. There is a synthesis of information and having someone who can step back and join the dots is a skill.”

“Many investors have made a commitment to net zero without any real idea on how to get there.”

And while there has been some evolution, her reflection on the industry is one that is very slow to innovate, with a difficulty in identifying any real innovation.

“The industry hasn’t been very good at innovation really. It’s created some new asset classes like LDI and secured finance to meet client needs, and there has been a move from indexing to ‘solutions’ but I’m not sure it’s really innovation. Even something like AI is not really innovative,” she says.

Clarke believes the industry is at risk of disruption and calls for the industry to be inventive.

Fees are an area that are ripe for disruption, and under Clarke’s guidance Mercer has presented some radical ideas for a fee structure revolution including fixed amounts, loyalty fees, share of alpha and cost of capital.

“We were trying to solve for a different fee structure; managers are using the clients’ capital so they should give some of the return upfront. There were some challenges with this around how managers would need more cash on their balance sheet, but the principle is right. You don’t know in advance which managers will do well or badly and there is no alignment of interest. It’s skewed to when the manager does well, and it feels like someone could disrupt that.”

Clarke points to the last 15 months as a case study for the need to create alignment of interest between the industry and the people whose money they are managing.

“The industry has done really well over the past year, while in many other industries people have been furloughed or have lost jobs. We don’t want to see headlines of our industry getting the biggest bonuses ever. Does that feel right? At times I worry the industry can appear tone deaf.”

Clarke does however think there is a sea change in the industry, moving back to focusing on the end client.

“It’s not about the portfolio managers but about creating genuine value for the police, teachers and fireman whose money they are managing. For too long the industry was focused on the PM.”

“Don’t take too many meetings with managers, don’t waste time on things that don’t fit your values and beliefs.”

Clarke leaves Mercer’s global investment research role to Jo Holden, and while genuine retirement beckons, she has taken a non-executive director role with Blackrock EMEA.

“We have a great team and a good inclusive culture where people can progress. We have taken our research to the next level and had good results with that. So that is a good legacy to leave.”

After a lifetime researching managers, Clarke has some parting advice to asset owners regarding their asset manager partners, centred around values and beliefs.

“Really understand what it is you want from your asset manager and hold them to account on that. Do you want them to act like an owner on your behalf? What are they doing that aligns with your values and is not just them managing your money in a silo? Don’t take too many meetings with managers, don’t waste time on things that don’t fit your values and beliefs. Partner with the people that culturally fit with you,” she says. “Use tech to your advantage as best you can, and definitely take the long-term perspective, there could be something creative in the fees that way.”

 

 

 

When we think of a sustainable tomorrow, we likely think of a better tomorrow. Unfortunately, in one respect, that will not be true. Success in addressing climate change will leave us with a worse climate than we currently have.

In other words, the extreme weather events we are currently experiencing – the inconvenience of being evacuated from a flooded home in winter, or the hunger following damaged crops, or the loss of assets or lives to storms – these are all associated with about 1.1°C to 1.2°C of warming above pre-industrial levels. Success is currently defined as limiting warming to plus 1.5°C, which will be associated with extreme weather events that are much worse than now – both in frequency and severity.

So, in climate terms, ‘better’ does not mean ‘better than now’. It means ‘better than it could be’ if we don’t get emissions under control.

Then we ought to move ‘tomorrow’ from the abstract to the more tangible. Few of us have a single time horizon that matters above all others. Most of us not only care about our financial performance as at our retirement date, but also for multiple years beyond that. We can combine these two aspects into a single thought: the path we take from here into the evolving future really matters. That path can take us ever closer to a sustainable state, or further away, towards the cliff edge.

Now, we should remind ourselves that sustainability is bigger than the climate crisis. Within the suite of sustainability challenges calling for our attention I suggest there are three ‘biggies’: climate change, biodiversity loss and inequality. But a challenge doesn’t have to be a biggie to warrant attention. The UN Sustainable Development Goals remain the best ordering of the challenges. So while net-zero has stolen the current limelight, the SDGs are the real target.

I think we can now summarise our problem statement. How does the investment industry play a role in securing better futures – which means addressing the SDGs, navigating net-zero (mindful of the inevitable worsening of the climate), while risk managing the path we take between competing demands?

The prize, or opportunity, is a future where we no longer talk about ESG because all investment is sustainable; where all assets benefit from active stewardship; and where portfolios are managed to risk, return and impact goals – via a total portfolio approach that puts every investment into a competition to best meet those goals.

I hope you find that a motivating vision, but we should talk about how to realise it. I suggest there are four questions we need to ask ourselves, which will guide us to two portfolio actions.

The first question is legal, and asks us to consider how far we can pursue impact, while still complying with our fiduciary duty. We use the term ‘fiduciary window’ to describe the set of permissible investment strategies in terms of the financial and non-financial motivations. The key point is that the window is not static – it can shift or stretch. It is our belief, corroborated by polling within the Institute’s working groups, that the fiduciary window will move over the next five years to accommodate a stronger impact stance within the definition of fiduciary duty.

The second question is moral and is generally avoided within our industry. We don’t have time here to do it justice, so I will simply say that morals and ethics are intrinsic to being human. We carry our values with us, even into investment decisions. Being explicit about them will help. Even better would be a process of socialisation and translation into board/leadership beliefs and principles.

The philosophical question asks us to consider whether elements of the system can separate themselves out from ‘the rest’. Are we a discrete entity, or are we intrinsically interconnected with the rest of the system? For me, the resolution is best seen through universal ownership. An individual investee company might consider itself separate, and thereby see an opportunity to boost its profits by exploiting externalities. The universal owner, however, does not see the company as separate. In effect the owner’s response is “fine, you can give me higher profits by exploiting those externalities, but that just raises the costs for my other investee companies”.

The fourth question relates to time. Investment is generally an open-ended endeavour and not many of us can declare victory at a particular point in time. Being accountable does require us to report and monitor regularly, and the new net-zero commitments introduce milestones we will want to assess our progress towards. But most of us will only be able to declare victory when the last liability is settled, or the last DC drawdown is made. Anyone wishing to declare victory in the interim, could be looking to just extract value from the system.

“The investment industry – despite its name – doesn’t do much investment. We mainly shuffle ownership rights, even in private equity.”

A full consideration of these four questions will get us to the two portfolio actions:

Action #1 is active ownership including engagement. The resources of the investment industry are currently split 99 per cent to allocation activities and 1 per cent to ownership activities. We will not be able to address the sustainability challenges if we persist with this split. So, we need more resources, more collaboration, and likely a more aggressive stance when it comes to engagement and ownership.

Action #2 is new primary investment. If I am allowed to be a little provocative, the investment industry – despite its name – doesn’t do much investment. We mainly shuffle ownership rights, even in private equity. We don’t really have people in the right roles (finding investment opportunities, or ‘deal sourcing’), and we may not have the right skills in sufficient quantity to do primary investment at scale. And yet we need to. The climate challenge alone requires new investment on a staggering scale: new generating capacity, the electrification of everything, and the building of negative emissions technologies.

Investment decisions are never easy, because the future is always hidden. But investment feels much harder right now, and the stakes feel higher. I think the investment industry needs to go through transformational change for its own sake, as well as for the planet and humanity. Transformational change hurts, but the prize is so worth it:  living and investing sustainably. The two actions suggested here will not be easy, but I think they are necessary.

Tim Hodgson is co-head of the Thinking Ahead Group, an independent research team at Willis Towers Watson and executive to the Thinking Ahead Institute.

CEOs are accustomed to stretch targets and reward outcomes, not efforts says TIAA’s Thasunda Brown Duckett, the same principals should be applied in the DEI space. She was speaking alongside CIOs from CalPERS and CalSTRS at a diversity forum co-hosted by the funds.

TIAA chief executive Thasunda Brown Duckett said it’s hard to imagine that corporate America has made all the progress it can, given there’s only 41 female CEOs of Fortune 500 companies, with only two being African American.

Speaking at the CalPERS and CalSTRS 2021 diversity forum last week the new CEO also cited a study by McKinsey that documented how black Americans could collectively earn $220 billion less a year than white Americans.

But she maintained that part of the reason more DEI progress hadn’t been made might actually be well-meaning processes and policies that are getting in the way of accelerated progress.

“We don’t say we ‘tried our best’ to deliver… outcomes for our participants. That’s not how we even operate,” she said.

“We don’t even talk in that language. I do think we have to think about why are we talking in a whole different language [in the DEI space] that’s not even conducive to how we manage our business, it’s a foreign way that ultimately won’t drive… sustainable outcomes because we’re kind of code switching here. In terms of progress, I think we just have to operate it like we do everything else, which is tracking relentless drivers and measuring those outcomes.”

Brown Duckett, who heads up the $1.3 trillion US provider of financial services in the academic, research, medical, cultural and government fields, says she likes to call this “elevating with intention”.

“If we don’t really have that true mindset, then we will be able to excuse our way out of why there are not more women or underrepresented minorities in our pipeline.”

CalPERS‘ interim chief investment officer Dan Bienvenue speaking at the same conference was equally definitive about the need to measure performance but was also keen to point out that diversity held some of the answers to CalPERS’ key challenge, a challenge made all the more difficult in a low-rate environment.

“If I have to narrow the CalPERS’ challenge down to one thing, certainly for the investment office, it’s 7 per cent. Right?” he said.

“That’s our assumed rate of return. So how do we take $450 billion in assets, and expose them to a set of risks, investment risks, and try to earn a 7 per cent return over a multigenerational time horizon?”

“That speaks to the need for diversity and diverse perspectives. Because we never know where the best idea is going to come from, we never know where the smartest thought, the best way to structure our business, you name it. So we got to bring diverse perspectives to bear both internally within the investment team at CalPERS [and] the overall team at CalPERS. But then also this question certainly is one that many of our external asset managers and partners have heard me articulate, which is, if you were sitting in my chair, and this was your challenge, how would you do it? Again, bringing those really diverse perspectives to bear and then including them to the calculus is critical.”

CalSTRS‘ chief investment officer Chris Ailman said the tragic events of the last northern summer had really “woken up the country”.

“Now we’ve got lots of funds around the country who are raising this issue,” he said.

“And that’s critical. In the institutional investors like ourselves, they really now are paying attention. And they’re realizing that when they take a company public from private equity, it needs a diverse board, and that the way they recruit out of colleges is lacking, the way they promote people from within has been lacking. And I’m starting to see some really serious efforts… with a lot of the major GPs.”

“There has to be a shift in the process so that we can create space to be able to have access to the full talent”

Brown Duckett quoted a number of times the saying that “talent is distributed equally, opportunity is not”.

But she said for any real shift to occur in accessing talent from diverse sources there had to be a fundamental shift in the processes used to detect and, ultimately, hire it.

“We should not think about it as [if] we’re lowering the bar, because that is not what I’m saying. What I am saying is that there has to be a shift in the process so that we can create space to be able to have access to the full talent,” she said.

“And a real example is when we talk about best talent running P&L or running the bottom line. Maybe we don’t see as much diversity within the P&L lines of business today at mid management or upper [levels]. So maybe we need to say: who’s our talent and HR that [are] leading analytics, who’s our talent in other areas of the business? Where you do have a larger percentage of women or underrepresented minorities, and give them that shot, because they’ve proved that they can perform.”

Brown Duckett went on to say that while a company might make a strong commitment to diversity, equity and inclusion she saw the real question they had to ask themselves was how bold that commitment was?

“Did we just tally up what was already going to be? And it sounds like a really big number? Or do we really say, what is our outcome that we want to drive?” she said.

“And then when I think about being intentional about tracking the outcomes, this cannot be soft. We want to watch it like we do everything else, let’s look at the year-over-year growth, let’s have the accountability and understand the driver. And so again, when we’re thinking about the bold commitment, what outcomes will that drive that we think can be sustainable and create a real chasm shift? And then I would say that what matters is what the best result could be from the commitments we make.

“That’s that boldness.”

Brown Duckett, who took her position as CEO of TIAA in May this year, is the second Black woman currently leading a Fortune 500 firm, and just the fourth Black woman in history to serve as a Fortune 500 CEO. She’s the first woman to head TIAA.