The SEK10 billion Church of Sweden fund invests all its assets through a sustainability lens. It’s had stellar performance driven largely by a chunk of the fund invested in the Generation Investment Management global equity fund, an investment that was diluted last year to manage concentration risk. Amanda White spoke to CIO, Anders Thorendal.

Until the year 2000, the government of Sweden had been a 500-year owner operator of the Church of Sweden assets. At that point the now $1 billion in church funds was transferred to a new organisation to be managed independently in what is a rainy day fund. It has no inflows and no real outflows, although about 1-2 per cent is set aside for annual operational expenditure. But for the most part it has a very long-term focus and so can manage assets accordingly.

Anders Thorendal the CIO of the fund says it has a pretty traditional asset allocation including Swedish and global equities, fixed income and credit, real estate and alternative investments. But one defining characteristic is that all of the assets are managed through a sustainability lens, and 20 per cent of the entire fund is invested in global equities managed by Generation Investment Management, a manager it has had a relationship with for nearly 14 years.

“They are a big inspiration for our investment capabilities and their global equity fund is one of the top global equity funds in the world returning 4 to 5 per cent above the MSCI world annually after fees,” Thorendal says.

In 2020 the Generation IM Global Equity Fund returned 5.9 per cent against a benchmark of 1.9 per cent, measured in SEK.

“When I started with the Church I had a treasury and risk background, not an investment background. It was an honour to meet with Al Gore and David Blood they have the strong belief you can do investing differently with a concentrated portfolio really focused on sustainable companies and good management and that sustainable products would make a difference,” he says. “They identified winners in the transition to a lower carbon society and have been good at identifying those companies.”

While sustainable investing is in vogue today, back in 2008 excluding fossil fuels was more difficult to do both philosophically and from an implementation perspective, but this is what the church fund did, divesting its holdings from oil and gas in 2008-09.

“Excluding coal and oil is not an issue today to reach financial goals but 12 years ago when we started it was,” Thorendal says.

While the relationship with Generation has been a driver of investment philosophy, and returns, it also presented a risk for the fund to manage, and in the past year Church of Sweden has slightly decreased its reliance on Generation. In a bid to diversify some of the concentration risk Ownership Capital and Mirova have both been allocated about 2-3 per cent of the fund.

“We want to work with managers that have sustainability in their DNA. We get approached by managers constantly that think today sustainability is becoming more vanilla, more the flavour of today, managers who see sustainability as another theme, or an overlay. We were even approached by a manager who said give us the exclusion list and we’ll take it from there. This is not what we want, we need them on the ground, we need them to focus on companies you want to have in the portfolio not just exclusion, that is part of the manager DNA, and more what we want,” Thorendal says. “Generation doesn’t have two separate teams they all can see the companies from both a sustainability and finance point of view. The future will be that sustainability will be more part of the traditional way to assess companies.”

Equities make up the majority of the assets at Church of Sweden with 34 per cent in global, 15 per cent in Swedish and 9 per cent in emerging market equities.

The fund has a further 25 per cent in fixed income, 10 per cent in real estate and 6 per cent in alternatives. It is in the alternatives bucket that it really tries to have a direct impact.

“Alternatives are a way to reduce the risk for the overall portfolio with investment not correlated with equity, and from an impact perspective if we want to really make a difference on the ground in developing countries for example in direct investments and micro finance then the alternatives space is a good place,” says Thorendal.

One of those investments has been micro finance, with the Swedish bank SEB issuing to smaller banks in Asia and South America which then lend to small companies and individuals.

“They lend to individuals, women in particular, and this is a good way to build up society,” he says. “We have seen very few defaults and we have had steady returns of 7-8 per cent a year.”

Last year the fund also made a couple of follow up investments in a Swedish venture capital company, that provides micro finance aid.

In the 10 years to 2020 the fund returned 8 per cent per annum, which was double its real rate of return target. And as with many  investors as Thorendal looks to achieve his return targets he has his eye on inflation, which in Sweden is currently 1-2 per cent.

“We are seeing inflation increase right now and the $10,000 question is will that continue or go back to the new normal. With the lower expectations for interest-related investments it’s a challenge if you want to get 3 per cent real return, it could put you too far out on the risk side,” Thorendal says. “Is it still feasible to have 3 per cent above CPI as a return target, our board believes so, but we are saying if you want return you have to take some risk which is another reason we are going into alternatives.”

Key Takeaways

  • The global pandemic has accelerated and elevated social concerns within the sustainable investment debate.
  • The growing activism of clients is being turned on asset managers, pushing them to hold themselves to the same standards that they demand of others.
  • A lack of tangible data has historically made it harder to directly link social impacts to financial performance.
  • Looking five years ahead, we believe the growing awareness of the systemic nature of social issues should ensure that they get the prominence that climate change receives today.

Five years ago, climate change was a topic that most investors acknowledged as a systemic risk, yet, when discussed in terms of portfolio management, it was largely viewed as an externality that had failed to manifest itself in financial returns. How times have changed.

Now, nine out of ten of the world’s largest economies have committed to achieving net-zero carbon emissions, one third of the world’s asset managers have joined the Net Zero Asset Management initiative, and, more importantly, the economics of the fossil-fuel industry have been transformed by the internalization of climate change into companies’ business models. What was previously a movement led by activists has now become an economic imperative that promises to reshape the world.

Social Concerns to the Fore

In the (we hope) soon-to-be post-Covid world, social concerns have been elevated in the sustainable investment debate. While investors are increasingly vocal about issues such as human capital management, there is frustration that a lack of tangible data, and limited evidence that social considerations are linked to financial outcomes, are hindering progress towards achieving a more comprehensive inclusion of social factors in portfolio decision-making. Despite these challenges, however, we believe that investors may well be at the same tipping point in the social debate that climate was at five years ago. The question is, therefore, are we about to see the transformation of the social dimension of ESG into a transformative economic force too?

Businesses as Social Enterprises

The Covid-19 crisis reminds us daily that all businesses are de factosocial enterprises. Institutional investor surveys, such as the Edelman Corporate Trust Barometer 2020 report,[1] highlight the increased prominence of social issues. These findings are echoed in a recent Pensions Policy Institute report in which 75% of pension schemes surveyed expected members to become more concerned about social considerations in investment decisions. [2]

The rising awareness of social matters for individual savers reflects their immediacy through their own experiences or in their own communities. The increased focus on stewardship by pension funds and wealth managers is a mechanism for elevating these concerns, and one that provides a voice to a wider range of stakeholders and makes all investors potential activists now.

Hard to Measure

The broad scope and qualitative nature of social factors can make it hard to measure impact and understand how to implement the management of these risks effectively. The growing awareness of the topic is also increasing the range of factors being considered, which adds to the challenge. However, the complexities of a topic matter little if there is a growing clamor for tackling stubborn systemic challenges.

Institutional investors are increasingly using their voice for social matters too. The absence of data is being filled by engagement activities that call for greater disclosure and clear goals for achieving inclusive and diverse workforces. Strong governance is needed to translate easy corporate rhetoric into tangible action through clearly defined goals. Here, shareholders are calling for stronger evidence of intent, starting at the board and executive level, and exercising their voting power to underscore the imperative for change.

Future of Human Capital

The investment industry is also being forced to look at its own performance on social matters, which is often sadly lacking when it comes to inclusion and diversity. The growing activism of clients is being turned on asset managers, pushing them to hold themselves to the same standards that they demand of others. While more is needed, programs such as the Thirty Percent Coalition, #100BlackInterns and Women Returners are signs of progress.

When backed by greater efforts on improving cognitive diversity, the industry can be helped to break out of its own echo chamber. The power of social movements is illustrated by the success of #100BlackInterns, which has rapidly spread to over 20 industries beyond financial services and morphed into #10000BlackInterns.

Mental Wellbeing

The rapid recovery from the Covid-induced recession is revealing skill shortages and changing how companies organize human capital management. In many industries, the pattern of work may never be the same again. Covid has demonstrated that flexibility can bring productivity benefits, as well as giving access to a more diverse talent pool. The arrival of children in many a video conference call has humanized the work experience for many and reminded us that there is a life beyond the office. The pandemic has also raised awareness of mental illness as the downside of those productivity gains. There is now greater appreciation that mental wellbeing needs to be managed in the same way as physical wellbeing.

Focus on Supply Chains

It is not solely in direct activities that social matters are coming to fore. Issues in supply chains, such as forced labor, have come increasingly to prominence, often amplified by political and legal pressures. Scrutiny of supply chains is notoriously hard, but the positive side of social media and the internet is that issues can be rapidly revealed and can cause damage to reputations and sales. While traditional reported social data remains elusive, other forms of information can be even more powerful.

Collaborative action is an important element of achieving greater corporate accountability. Not-for-profit organizations, such as the Workforce Disclosure Initiative,[3] have played a central role in driving improved transparency in all forms of human capital management to fill the data gap.

Five Years Ahead

Looking five years ahead, we believe the growing awareness of the systemic nature of social issues should ensure that they get the prominence that climate change receives today. It is an opportunity for business to show leadership and innovation – especially in a world where so much of government policy has been outsourced to the private sector.

In our view, the activism of shareholders needs to be built upon and turned into engagement, with a forward-looking perspective on a multi-stakeholder world. The data will follow and should be no excuse for inaction. Behavior is visible and shapes outcomes more than reporting will ever do. The prescient corporation will see that effective stakeholder management is about ensuring future relevance.

Sources

[1] https://www.edelman.com/sites/g/files/aatuss191/files/2020-11/Edelman%202020%20Institutional%20Investor%20Trust_FINAL.pdf

[2] https://www.pensionspolicyinstitute.org.uk/sponsor-research/research-reports/2021/2021-04-22-engaging-with-esg-environmental-social-and-governance-factors/

[3] https://shareaction.org/workforce-disclosure-initiative/

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Private credit markets – opportunities opening up across the spectrum

With countries around the world rolling out their vaccine programmes and with growing optimism about the outlook for the global economy, has a potential return to normality been reflected in private and illiquid credit? In their latest Spotlight on private credit markets, M&G Investments offer an overview of the dynamic private credit markets and share their observations on how the private assets pipeline is shaping up as we look ahead to the second half of the year. They also discuss the appeal of low duration, floating rate private credit assets amid concerns about rising inflationary pressures.

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The C$23 billion Canadian fund OPTrust is using AI to reduce risk in a strategy it hopes to roll out to the wider portfolio. Wei Xie explains the benefits and challenges of machine learning including AI’s ability to identify complex dimensional relationships.

The C$23 billion Canadian fund OPTrust is embracing the power of AI to improve investment outcomes via two new strategies based around re-enforcement learning and uncertainty modelling.

The latter approach, in place since late 2020, is currently used to pare risk in a risk parity strategy and is already giving actionable signals on how to adjust risk in the portfolio. Going forward, Wei Xie, co-head of the multi-strategy investing team at the fund told FIS Digital 2021 delegates he hoped to deploy the strategy at a total fund level and combine it with the equity beta portfolio to create a risk reduced equity allocation.

Uncertainty modelling

OPTrust began exploring how to integrate AI with the support of external quant managers. Next, the fund began to build its own internal, proprietary capabilities with just Xie and an associate overseeing the project. At a high level, AI is used to better understand and inform risk in a scalable approach, he explained.

“As long as the algorithms are robust, we can adjust the approach and use it for total fund management,” he said.

Xie said that whilst very promising, machine learning is also complex. Particularly from a personnel perspective, creating challenges for investors around hiring people with the right skills. It also involves investment in a data supply chain. Indeed, even with a reasonably large investment team, OPTrust found it difficult to use AI to tap a competitive advantage because of limited resources around data and personnel. Instead, the pension fund decided to focus on risk management solutions.

“Risk management is scalable across different types of strategy and doesn’t need exotic data as it mainly involves working with price data,” he said.

Expanding on how the process works, he described the typical quant model as injecting ingredients or inputs. OPTrust sought to design a process that used AI to discover when assumptions might be ineffective due to the function of changes in the market.

The domain set out to identify times when the prevailing logic falls apart, alerting Xie to changes in external markets and the ensuing impact on risk.

“If something has changed the risk may have increased because what we are doing becomes less effective,” he explained. “The process is telling us that our strategy is less accurate, and that we should take risk out.”

Re-enforcement learning

Re-enforcement learning gives greater insight into the factors driving price action. AI allows investors to detect the non-linear impacts on prices that humans struggle to track, he said.

“Although humans are good at understanding two-dimensional linear relationships, when it becomes more abstract and relationships get to three, four or five dimensional, humans stop having any ability to interpret – accept through maths. In contrast, machine learning and AI can identify these complex relationships,” he said.

Addressing the challenge of how humans get comfortable with AI outcomes that are difficult to intuitively understand, he said the process involves testing the models and a simple checklist.

“You can do a sanity check around what is happening in your model,” he concluded.

In an interview during FIS Digital 2021 Joe Lonsdale, founder and general partner, 8VC talks about his unique approach to venture investment with Todd Ruppert, chair, INSEAD endowment.

Venture capital investment involves working with the most talented individuals to build companies, which in turn hold the seeds of future companies, said veteran venture investor Joe Lonsdale. Success depends on moving with top talent and being across key trends and their wider ripple impact – like, for example, how smart phones triggered ride sharing.

Successful investment involves finding out what is newly possible that wasn’t five years ago, said Lonsdale.

“It is all about the talent you are with and the big, conceptual gaps in the world. What is it possible to do now that wasn’t possible five years ago?”

At 8VC investment in the biotech sector involves getting to know the technology and how it is driving innovation around key themes like cheap sequencing, gene editing, cell manipulation and therapy.

“We are doing a lot here,” he said, adding that biotech investment has the potential to be both profitable and good for the world. Most notably on the eve of the pandemic, when supply chain issues in the US pharmaceutical sector threatened the US response.

Seeing the challenge, Lonsdale was involved in establishing a first-of-its-kind manufacturing and technology company dedicated to broadening access to medicines and protecting the supply chain against disruption. Set up after two rounds of funding raised $800 million, Resilience Bio is both a good investment and good for the world.

Lonsdale is also at the forefront of investing in financial services, increasingly transformed by data, the cloud and APIs.

“There is a new demand as to how this stuff should work,” he said. One-8VC backed firm operating in this cutting-edge space is Addepar. The leading private wealth management technology company is an increasingly important investment platform in the family office space.

Indeed, it is this kind of investment services technology he wants to harness to allow more people to invest in alternatives where he says top talent and expertise overwhelming flows.

“The smartest people are all going to build private companies. This is where your money should go.”

He predicts capital will increasingly flow into private alternative investment yet notes how lots of people are confused about how to access the space.

“My vision is help more people access the alternative world, providing the content and technology,” he said.

In a final note, Lonsdale urged institutional investors to come together to create a prize to help finance and develop cutting edge carbon capture technology.

“It could be a key to incentivising the market and harnessing the best minds to solve one of the world’s biggest problems,” he said.

His suggestion sees pension funds back a prize to help fund carbon capture solutions, awarded to the company that develops the best technology. The investors would retain intellectual property rights and if the winning company captures carbon at a low enough cost with sufficient scalability, pension funds would then work to lobby governments to adopt the technology.

Perhaps the biggest threat to Chinese growth is the lack of education and skills of its people, said Stephen Kotkin, Professor in History and International Affairs at Princeton University speaking at FIS Digital 2021. In a presentation on investor risk and opportunity in China he argued that unless China can improve its education system, the country will remain in the middle-income trap. Kotkin questioned whether investors might seek growth in Asia outside of China.

Globalisation has helped low- and high-income countries, but surprisingly few middle-income countries have been able to climb into the higher bracket.

Countries like Spain, Portugal and Greece climbed higher with the support of the EU, others like Australia and Japan have done so via investing in their human capital. China, unlike neighbours in Taiwan or Singapore, has not invested in its people to the same extent with an estimated 70 per cent of the population uneducated and only 30 per cent passing through high school. Kotkin compared China’s challenges to Mexico which “hit a wall” because of a lack of investment in human capital, ending its growth story and triggering an investor exodus.

Kotkin said that China has grown fast without investing in its people and the government understands the challenge and risk afoot. It is now playing catch up with initiatives like introducing vocational schools in rural areas. Yet he said these initiatives have also struggled. These schools became a box ticking exercise rather than a solution to the shortfall in education, he said. China needs to invest in its human capital in other areas too. For example, poor diet and health in rural areas are a blight on productivity, he said.

In contrast, Kotkin said other challenges often linked to a potential brake on Chinese growth are now less likely. For example, China’s absence of secure property rights or the lack of freedom and transparency is now less likely to halt progress. Arguments that China’s SOEs are crimping productivity, or the economy will stall on weak investment in the private sector and over capacity have worn thin by new trends like state firms seeking private sector partnerships to make them more efficient, and private firms participating in industrial policy.

He also urged FIS 2021 delegates to not to be naïve, and understand that the Chinese regime would accept slower growth for more control.

ESG

Kotkin said that China will have capacity to navigate some aspects of climate risk via its strength in engineering and infrastructure, noting how China is now buying nuclear capacity from Russia. If infrastructure and engineering solutions manage to counter climate risk, China may not hit a wall he said. Moreover, China can navigate its demographic challenge by encouraging older people back into the workforce in the same way Japan has done. Under the communist regime, the retirement age is low; a substantial population in China are able bodied and retired, he said.

Kotkin said that investors will increasingly struggle to integrate ESG in China. China fails on governance standards in most ESG calculations, he said. That said, he counselled on the importance of not painting China with a single brush, noting that many Chinese companies score well on governance but the government scores badly.

He urged investors to explore the difference and said running away from China because of genocide will not only punish retirees back home with lower returns by not investing in companies that are doing the right thing – it will also punish Chinese workers and populations. Against the backdrop of ESG reticence, he also noted a scramble and ambition among Wall Street firms (Amundi, Goldmans and JP Morgan amongst others) to capture the Chinese savings market.

In a discussion that included a range of questions from investors, Jay Willoughby, chief investment officer at TIFF asked for insight into decoupling trends between the US and Chinese economies. Kotkin responded that some supply chains are already moving out of China, although this is also linked to trends around wages and supply chain diversification. By relocating supply chains in countries like Vietnam firms can still benefit from Chinese growth, he said.

At US pension fund CalSTRS, China strategy is a board level issue and governance a particular concern. The pension fund is also navigating federal legislation regarding pension fund investment in China. Geraldine Jimenez, director of investment strategy and risk at the pension fund noted how China’s shortfall in skilled workers and human capital challenges meant the country didn’t have enough qualified workers for a knowledge economy. One consequence could be the emergence of value-add economies in cities and coastal areas but struggling interior economies; she also noted that the change of stance on the one child policy has eased the demographic challenges.

Tony Broccardo, chief investment officer at the United Kingdom’s Barclays Bank Pension Fund has focused his China strategy on private, venture investment. Describing a very positive experience, he explained how the fund has invested in China alongside many US venture capital firms. Now, as China’s markets begin to open up, he said questions remain around market access for capital providers. Moreover, investment comes against the backdrop of a hardening of narrative between the US and China and the risk of western policy makers becoming a barrier to investment. Broccardo noted how investors are already having to make a choice and pick sides against the backdrop of growing tensions.

Fellow panellist Olivier Rousseau, executive director at France’s FRR, argued that China made strategic mistakes by not taking earlier action to reverse demographic challenges. He also questioned why China continues to pour money into infrastructure and not invest in education. Kotkin responded that part of the problem has come from the pace of Chinese growth.

He said it is easier to throw money into construction than build an education system. He concluded that in China’s cities the universities are impressive but got outside the cities, and education lacks all nourishment.