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The art of living – a new equilibrium for Europe

As millions were asked to work from home in 2020 to help curb COVID-19 infection rates, the long running debate on the optimal work-life balance was finally put to the test. Many questioned how and where they want to live, along with the quality of their living space. This paper explores commuter and migration patterns, the continual renewal of cities, and the nuances of renters’ needs in different cultures.

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_{For Investment Professionals only. Not for onward distribution. No other persons should rely on any information contained within. This guide reflects M&G’s present opinions reflecting current market conditions. They are subject to change without notice and involve a number of assumptions which may not prove valid. The distribution of this guide does not constitute an offer of, or solicitation for, a purchase or sale of any investment product or class of investment products, or to provide discretionary investment management services. These materials are not, and under no circumstances are to be construed as, an advertisement or a public offering of any securities or a solicitation of any offer to buy securities. It has been written for informational and educational purposes only and should not be considered as investment advice, a forecast or guarantee of future results, or as a recommendation of any security, strategy or investment product. 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While sustainability has been most obviously implemented within public markets, appetite from investors to access private market opportunities has grown. With fewer disclosure requirements, and challenges in providing tangible evidence and data that prove the sustainability of business operations, can allocations to private credit be coherent with a desire to increase sustainability in investment? Catherine Ross and Fiona Hagdrup sit down to explore the compatibility of these two investment aims.

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A recent increase in interest has seen many countries bring forward analysis and trials for central bank digital currencies (CBDCs). Given the complexities involved, we ask: why the rush?

The fast view

While central bankers have been researching central bank digital currencies (CBDCs) for several years, interest has picked up notably in recent months with many major countries bringing forward analysis and trials. Given the complexities involved and the potential seismic changes to the financial system their issuance could herald, why the rush?

We believe there are several factors forcing policy makers’ hands. Firstly, the use of cash as a means of payment has been declining for several years, a trend that has been given a further boost by the COVID pandemic. Secondly, the emergence of Facebook’s token based claim Diem (formerly Libra) has the potential to be rapidly and widely accepted, with the potential to shift large parts of the monetary system outside of central banks’ sights. When it comes to money, moving fast and breaking things will not be welcomed. Thirdly, the technology underlying the digital currency — the distributed ledger — could provide potential enhancements to the safety and efficiency of the payment system. Finally, and somewhat opaquely, many central banks have referred to the advantages in ‘the conduct of monetary and fiscal actions.

Why does this matter? The implications of a new form of sovereign money that is quick and efficient to use are potentially massive. Design, however, is crucial to determining outcomes. A central bank digital currency could provide business and households with a new form of sovereign money and a new way to make payments. It would be as safe and credit-risk-free as physical cash but more convenient to use. Its introduction will likely lead to some substitution away from other forms of money. This threatens to disintermediate banks and be a direct competitor to other e-money payment systems. It could, in theory, be the mechanism by which ‘People’s QE’ is implemented and the way in which the economic lower bound on interest rates is overcome. It would undermine the informal economy, improving tax receipts. It might also become a procyclical defensive asset and undermine bank deposit bases. Finally, it could hasten the demise of the US dollar based international monetary and financial system and impair the ability of the US’ sanctions regime.

As of July 2020, 36 central banks have published detailed CBDC work. Ecuador, Ukraine and Uruguay have completed retail pilots and six are ongoing in the Bahamas, Cambodia, China, Eastern Caribbean Currency Union, South Korea and Sweden according to the Bank of International Settlements. China is possibly the most advanced, given extensive trials at scale, for instance via handouts of digital currency to citizens. Outside of China, Sweden is seen as having made significant progress. The development of CBDCs is moving very quickly and mass rollout is within our investment horizon. To truly appreciate the potential impact of CBDC rollout, it is necessary to understand the nature of money and the difference between sovereign and private sector liabilities.

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Authors
Sahil Mahtani, Strategist, Investment Institute
Alice Timperley, Analyst
Russell Silberston, Investment Specialist, Macro-economic and policy research

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In October 2020 AIMCo, the C$118 billion Canadian fund appointed its first chief investment strategy officer splitting the investment function between the top down strategy and bottom up implementation responsibilities. Amanda White talks to Amit Prakash about how the new function will add valuable investment insights to clients.

While AIMCO formerly created this position late last year the underpinnings and drivers of the investment strategy function at AIMCo have been present for a long time. With the appointment of Amit Prakash as the first chief investment strategy officer they are now present in a focused and deliberate manner. The headline objective of the function is to move the organisation into better alignment with its clients’ investment objectives.

“Our end goal is we are seen more as a trusted adviser, rather than simply an investment manager on behalf of our clients,” Prakash says. “The manner in which we describe what it offers to our clients, is to extend the conversations we have been having beyond the deliverables we have presented them. To look beyond the delivery of alpha to help them with their decisions, with their strategic and top-down views.”

It allows AIMCo to more readily add a top-down strategic portfolio view to what it already does for clients in driving alpha.

“We believe combining those makes for a more robust combination than doing one or the other,” Prakash says.

The fund is now six months into the process of building the team and infrastructure for the strategy function and has started revisiting investment objectives with clients including reviewing their risk appetites, policy mix and alpha targets.

“We are starting at ground zero. That is a journey we will be on for the near term,” Prakash says. “Understanding our clients’ objectives and creating the framework to assess the efficacy of our current solution sets and identify gaps and move from there.”

AIMCo’s clients – which include nine public sector pension funds and a number of endowments – remain fully in charge of their policy mix. The strategy function, and the top down view, allows AIMCo to provide an advisory function to better aligns clients’ needs and the solutions offered. The same process will be used in the longer term to look at portfolio tilts.

The top down view

Prakash says from a top-down view AIMCo believes in the longer-term, risk assets are a better place to be and that illiquid assets provide better value.

“A lot of the portfolio positioning happens within the current strategies that we manage, that is where if you look from the top down we have a very marginal overweight to equities. We have pulled that in over the last little while as markets became a lot more volatile and things starting to look exuberant more than they have in the past. But over the long term we are positive about risk assets.”

Not surprisingly Prakash has a weak outlook for bonds, but he thinks any potential inflation will only be fleeting.

“We believe inflation would be transitory in nature given some of the secular drivers haven’t really changed, thinks like the ageing population, technology and globalisation. We may get a bump in inflation but it isn’t something we believe is a permanent uplift.”

The fund has a negative long-term forecast for fixed income and for the past few years has allocated into the adjacent asset classes such as private debt and loans, which are more attractive from risk return perspective.

“That has played out well,” he says. “And at margin we have been slightly underweight bonds and lower duration has been helpful.”

Since the COVID crisis AIMCo has been cautiously managing its active risk budget and pulled back a bit on risk, and at the same time improved liquidity.

“We are well ahead of liquidity characteristics compared to where we were pre-COVID. We are being careful where we take risk. We are well positioned at the moment, pulled active risk back, and that allows us to step in again if opportunities present themselves. We have done a fair bit of that over past 12 months given their were interesting opportunities.”

The team has been active in private equity and private debt, where it has looked beyond North America and taken advantage of some mid-market opportunities in Europe.

It’s also been active in real estate where its been moving to reduce retail and add more logistics and industrial holdings.

“One of the benefits of AIMCo is many of our clients have long investment horizons and that allows us to utilise our liquidity more effectively, we were not forced sellers through pandemic. On the contrary we deployed capital and are well positioned at the margin to do that now should markets soften more relatively to where they are now,” he says.

There are some investment opportunities that AIMCo is looking at but not yet invested, such as emerging market debt.

“We do have some EMD but we use it as an alpha driver in existing funds rather than a beta permanent delivery.”

But the real role of Prakash’s team, is not so much about the tactical changes, but to look at the risk appetite of clients over the longer term and the strategic mix of the portfolio.

“We have seen clients increase allocation to illiquids, and therefore on the mirror image of that is the assessment of the liquidity profile of the portfolios. Being long term helps with not needing liquidity, but as allocations to illiquids increase its beneficial to keep an eye on the liquidity profile of clients.”

There are other insights clients can gain from a top down view, such as an assessment and better understanding of their factor exposures across the portfolio.

“The first step is to understand the factor exposures relative to liabilities and if there is a potential need to adjust some of that,” he says. “What might come from that, clients might want to manage their rates exposures or growth factor for example, and that is one of the things some of our clients are interested in. You need a top down view for that to ensure the balance is right.”

Having a dedicated department to manage the top down view means all the associated tools can also be project managed. Prakash and his team are working with the in-house technology team to build a robust and scalable client investment dashboard, which would allow them to look at all the different exposures across the portfolio such as sectors, factors, and duration exposures.

“We can do it now, but we want a more robust and scalable process. It is early days in that process working with the tech team.”

Another project underway is the implementation of a new risk model which will be up and running this year. The risk system will sit alongside the asset-liability analytics system from Ortec Finance which was also added relatively recently.

“This will give us more flexibility and tools from a risk measurement perspective,” he says.

Governance structure

In the past year AIMCo has undergone quite a lot of change in its senior rankings. Mark Wiseman, former CEO of CPPIB and global head of active equities at BlackRock, was appointed chair of the fund in July last year, and just last month the former CEO of Canadian fund HOOPP, Jim Keohane, was appointed to the board.

In November it appointed a new chief risk officer, Andrew Tambone and a new chief financial officer, Paul Langill.

With the appointment of a chief investment strategy officer the investment function has been split and both Prakash and CIO Dale MacMaster report to AIMCo’s chief executive and are equal partners in the fund’s investment capabilities and performance. Evan Siddall was recently appointed as CEO and will take over from Kevin Uebelein in July.

“The CIO and I work closely and well together and that’s one of the necessary conditions for us to succeed,” says Prakash. “It is hugely important we are joined at the hip.”

For clients Prakash takes on the top-down, long-term forecasts and policy mix views and the CIO’s investment team implements from the bottom up.

All the client reviews are done in conjunction between the two teams and a governance structure is now in place where all of the client-related portfolio advice goes through a committee co-chaired by Prakash and MacMaster.

“We co-chair this to ensure it has the right level of oversight and clients have benefit from a 360 view that also includes the head of clients and chief risk officer. This ensures investment conversations with clients get a full vetting across the shop.”

Previously the top-down activities were also done by the CIO and investment team but the separation allows an equal focus and engagement on strategy, and alpha delivery and active risk.

“It improves and broadens how we are engaging with clients,” Praksah says. “Most of our clients are not choosing between alpha and beta. Without the right beta most clients would struggle to meet their obligations. Historically they were primarily focused on beta through the policy mix and we were primarily focused on alpha through investments. We want to look at the top down so the decisions about beta are better informed. This way we can improve the betas we are offering and the alphas.”

Implementing net zero ambitions is a huge execution risk for investors, says Frederic Samama who warned of the risk of “everyone doing the same thing at the same time”. He was chairing a session at the Bank of International Settlements’ Green Swan conference on portfolio implementation of net zero ambitions.

Financial institutions around the world representing $70 trillion in assets have committed to net zero but there is still a debate in the industry about how to execute on that ambition, according to Frederic Samama chairing a session on net zero portfolio alignment at the Green Swan conference last week. The event was co-sponsored by the Bank for International Settlements, Bank of France, International Monetary Fund and Network for Greening the Financial System.

Samama observed that broadly speaking there are two schools of thought: those that select the corporates that are already aligned in their trajectory towards 1.5 degrees; and those that look more from a portfolio construction perspective where investment is not about the trajectories of the corporates, but more focused on allocation with portfolios shuffled year after year “in order to spend the budget that mimics the one we have in the planet”.

“It is fascinating to hear there is still a debate within the industry on how to do it, it is extremely interesting to see the industry is still looking for solutions,” he said.

Samama, who is chief responsible investment officer at CPR Asset Management and co-author of The Green Swan, also pointed out the large implementation risk to investors of executing on their net zero plans.

“We all said we have 10 years in front of us, and we have outlined the physical risks, and we know the emissions are on the rise and we have to reduce them by 90 percent. The risk of a massive adjustment by policy makers is pretty big, and at same time there are very large commitments. So given all that there is a massive risk that everyone does the same thing at the same time,” he said. “This has pretty big consequences for everyone, even for stress testing. It’s less about how portfolios will react to a carbon price, but the risk of implementation knowing a lot of players will do the same thing at the same time. It is becoming a huge execution risk.”

Adding to this was Isabelle Motoes y lago, global head of BlackRock’s official institutions group who said the manager believes most of the market repricing will be in the near term, not the long term.

“There is a tendency to say climate change a risk in the long term and it is far down the horizon, and that is probably true for physical risks,” she said. “But it is our view that in terms of markets the bulk of the repricing will be in the next five to 10 years. And so absolutely those who are still ignoring it are putting themselves and their portfolios at tremendous risk and those that are early are going to be the ones catching the best opportunities.”

She said it is still early days in terms of the reallocation of capital with only about 20 per cent of global assets managed in a sustainable way.

“When all of that moves there will be a massive repricing of capital across industries and companies and you want to be well positioned for that.”

The panel also heard from investors on how they are aligning their portfolios with the net zero ambition including head of responsible investment at Zurich, Johanna Kob and chief executive of AP4, Niklas Ekvall.

AP4 is a leader in ESG integration with investments dating back to the 1970s and 1980s, but it wasn’t until about 10 years ago that climate and the environment was viewed as a systemic risk to the portfolio.

“In 2017 we did our first thorough climate analysis, which is now a key part of our investment activities at the fund, it is a fundamental input into our long term economic scenarios which is the basis for our long term asset allocation,” he said.

AP4 was also one of the first investors in green bonds and the fund has had a low carbon equity strategy since 2012 which last year was expanded across the entire equities portfolio. AP4’s equity portfolio has less than 50 per cent of the carbon intensity of normal broad equity index. It is also in discussions to be part of constructing a low carbon index that can be used by other investors as well.

New targets state a further reduction of 50 per cent by 2030 and the fund will be net zero by 2040. This means carbon emissions from AP4 are far below 1.5 degree target.

“We have also developed our low carbon strategy further after extensive work and now include forward looking data. Besides things like carbon intensity and stranded assets we include new data on how well companies’ goals and ambitions are aligned to the Paris Agreement and we also look into how sensitive profit margins are to an increased carbon price in the future,” he said.

The fund also established a team last year for bottom up stock picking for more carbon intensive sectors focusing on energy, utilities and materials.

“In energy for example the only companies that remain are those that have plans to be aligned with the Paris Agreement and have plans to further increase investment into renewables. Within that concentrated portfolio our engagement becomes more efficient,” he said.

Meanwhile Zurich, which was a founder of the Asset Owner Alliance and was the first insurer to sign the Business Ambition for 1.5°C Pledge to limit global warming, has made some concrete plans to reduce emissions in its operations and also in the investments it manages in its $250 billion portfolio

This includes a 25 per cent cut in carbon intensity planned for listed equity and corporate bond investments by 2025 and a 30 per cent cut targeted for direct real estate investments^.Emissions from operations will be cut by 50 per cent by 2025 and 70% by 2029. Zurich also pledges to use its influence as an investor and insurer to press for change, and urge companies it invests in to set their own targets for a 1.5⁰C future.

Investors agreed that in order to scale up investments and have a meaningful impact a price on carbon was essential.

“We need to get a global price on carbon in place, and sufficiently high in price to get an impact. That should be the top priority for every political meeting on climate, it is the key thing to get the market forces working in the same direction,” Ekvall said.

Celebrated economist Joseph Stiglitz, University Professor at Columbia Business School, says the slowness in developing a comprehensive approach to debt in emerging markets and developing countries will result in a weaker global recovery. He urged for a restructuring of debt in a coordinated approach between the public and private sector.

Speaking at FIS digital in May Joseph Stiglitz, University Professor at Columbia Business School and Nobel Prize winner, began by noting the large difference in various governments’ ability and willingness to act to support the recovery leading to an uneven recovery.

“It will not be a global recovery until the disease is under control and there is equal access to the vaccine,” he said.

He noted the big change in US policy in support of equal access to the vaccine. Commenting how the vaccine waiver on IP would allow many countries to produce the vaccine, he said that drug companies are arguing developed countries don’t have the capacity to produce vaccines.

“If they don’t have the capacity, what is the problem?” he asked.

He noted how the biggest producers of the vaccine in India and South Africa also face a clear shortage of supply. And cited other important measures to increase access to the vaccine like the lifting of US export constraints on critical ingredients to make the vaccine.

“There has to be a transfer of technology to make production accessible,” he said, adding there is no place in the world that is safe until every place is safe.

Stiglitz noted that although the US has taken measures to fuel a strong recovery, emerging markets don’t have the resources to do the same and are spending a fraction of their GDP in contrast. Here, he noted that Biden is now supporting the IMF’s Special Drawing Rights (SDRs) which could see additional funds flow to developing economies, especially if advanced economies, which don’t need the additional funds, follow through on initiatives to recycle them to the more needy.

Stiglitz noted that many emerging market economies were in debt before COVID making their current situation unbearable.

He urged for a restructuring of debt in a coordinated approach between the public and private sector.

“We need policies to encourage private creditors to participate,” he said.

Stiglitz downplayed the threat of US inflation. He argued that the only time the US economy has succeeded in bringing marginalised groups into the labour force and have wages rise has been when the labour market is tight.

“I am hoping we have a tight labour market,” he said, welcoming a slightly heated economy.

He noted that the US is leading the global recovery with China and noted ample supply ahead. Even so, if the market grows too overheated central banks have tools to counter at their disposal.

The Fed could raise interest rates, something he described as a good thing. He said near zero interest rates distort capital markets and allocations.

“Getting out of a zero interest environment would be good for the US and global economy,” he said. Elsewhere he noted the need to raise taxes and end a regressive tax system.

Responding to Stiglitz’s remarks, Fiona Reynolds chief executive of the PRI warned that government assistance was removed too early in the wake of the GFC, cutting spending in essential services and leading to economic inequality and warned about falling into old traps.

Regarding the need to build back better after the pandemic she stressed the importance in rectifying underinvestment in health and education, adding that pushing wages down and tax avoidance has eroded the base for essential services. However, she said she was encouraged by trends by activist investors to bring about change at oil majors Exxon and Chevron.

She noted how more investors now understand that having a good ESG strategy is good for business.

“We can see this in the amount of money pouring into ESG funds,” she said. She also urged investors to integrate the SDGs, getting behind them to build back better.

“We can solve most of world’s problems via the SDGs,” she said.

Jaap van Dam, head of strategy at PGGM in the Netherlands also noted the importance of the SDGs in steering investor strategies towards building back better.

“The building blocks are in place and pension funds are motivated to move ahead; they just don’t always know how, and best practice isn’t in place,” he said. Here he drew delegates attention to an SDI Asset Owner Platform developed with APG which combines an SDI taxonomy with AI to assess thousands of potential sustainable development investments.

Like Stiglitz, Sharan Burrow, general secretary of the ITUC in Belgium argued that inflation and rising wages would provide valuable support to the broken labour market currently characterised by insecure and low paid workers.

“We need to look at a different model,” she said urging investors to integrate ESG.

“If we leave people behind mistrust in democracy will grow, moreover a low minimum wage ($15 an hour in the US) is ridiculous in such a rich country.”

She also noted the perils of vaccine nationalism, counselling on the importance of sharing production capacity.

“If we don’t share production capacity how can we meet demand for vaccine shots,” she asked. She said that vaccine cooperation reflects countries’ ability to cooperate in the green transition or if it will still be a winner takes all approach that threatens to kill people’s belief in the future and put democracy at risk. Elsewhere, she said tax reform should be front and centre.

Stiglitz concluded with notes that if governments had spent a bit more on vaccines the disease would have been over, quicker.

“For sure the cost of the pandemic has reached trillions, but if we’d spend a few more we would have reduced that cost.”

He said that investors should interpret their fiduciary response broadly.

“I hope those who are investment managers think about the consequences of how they invest,” he said. “We entrust much power to the people who makes these decisions.”