The growing threat of cyberattacks at portfolio companies – from the growth in AI, IT skill shortages and geopolitics – is viewed as a key risk at the £34 billion Railpen. The investor outlines how other asset owners and managers can engage on the issue.

Railpen, the £34 billion fund for the members of the UK railways pension schemes, is urging fellow investors to recognise the financial materiality of cybersecurity in their portfolios.

Together with Royal London Asset Management, Railpen has laid out how investors can ensure best practice among portfolio companies, identify and engage on cybersecurity and participate in policy advocacy to help build a supportive regulatory environment. The report, Cyber Security Risk and Resilience, follows on from 2019 when Railpen joining forces with the UK’s largest defined contribution fund, Nest, to produce a joint report on cyber and data security.

“We are seeing a concerning disconnect between leaders’ awareness and preparedness for cyber attacks,” says Sophie Harris, senior investment analyst, sustainable ownership at Railpen.

“We believe investors have an important role to play when it comes to closing the gap and forcing business to start taking cyber preparedness more seriously. Recognising the importance of cybersecurity resilience, we encourage asset managers to develop their understanding of the financial materiality of cybersecurity, use the investor expectations as a tool for engagement with companies that face a high level of risk, and report on progress to their clients.”

How big is the risk?

Cyber risk sits in supply chains and with third parties. The growth in AI, IT skills shortages and geopolitics have also spiked cyber risk in recent years.

“Contagion risk in supply chains can be evaluated through third-party management strategies. Additionally, a company’s employee training programmes and incident response plans can provide insight into its preparedness for AI generated risks,” say the authors.

According to the IMF, cyber incidents with malicious intent have almost doubled since Covid. Meanwhile, the World Economic Forum 2024 Outlook reported that 29 per cent of organisations stated that they had been materially affected by a cyber incident in the past 12 months. Cyberattacks have also become more costly, as the risk of extreme losses has increased, sometimes putting firms at risk of insolvency. Global cybercrime costs are expected to surge to £8.2 trillion by the end of 2025 but the actual extent of the damage is likely to be much higher as many attacks go undetected or unreported.

The report cites figures that put the average loss associated with a data breach and the recovery process at US$4.88 million. In another trend, cybersecurity risk is increasingly being transferred to insurers. An estimated US$12 billion of gross premiums were written in 2023. But insurance doesn’t cover all the risks. Companies share price falls, they face elevated costs of debt and increased audit fees and the threat of regulatory action too.

“The increasing number, cost, and threat drivers of cybersecurity incidents, coupled with a disconnect between awareness of, spending on and preparedness for this risk at a company level, is leading to growing cybersecurity risk across portfolios. We believe cybersecurity needs more attention, particularly due to its systemic implications, and we invite investors to take action,” states the report.

What are the engagement priorities?

Corporates need robust board oversight of cybersecurity practices. Investors need to ensure the boards at portfolio companies are actively involved in cybersecurity governance, helping to set the right tone at the top and aligning cybersecurity strategies with business objectives.

It’s an area pension funds like Nest are keenly focused, explains Diandra Soobiah, director of responsible investment and a member of the UK’s Cybersecurity Coalition set up in 2019 to address the systemic risk posed by cyber security alongside Brunel Pension Partnership, Border to Coast and USS.

“We expect corporate boards to be adequately prepared for cyberattacks with operational resilience at the heart of a cybersecurity strategy. We will use the guidance to enhance our engagements with companies to help protect our 13 million members from this systemic risk,” she says.

Comprehensive due diligence and proactive risk management of external parties are critical. This includes assessing the cybersecurity posture of suppliers and acquisition targets to mitigate risks and ensure the integrity of the supply chain.

Fostering a resilient culture is fundamental and should be supported by strong vulnerability management and penetration testing; obtaining relevant cybersecurity certifications ensures that daily operations are secure and reduces the risk of cyber incidents.

The report also stresses the importance of working with peers and government bodies to enhance cybersecurity standards. “Collaborative efforts can lead to the sharing of best practices, threat intelligence, and coordinated responses to cyber threats,” it states.

Other key areas where investor engagement can reap dividends includes timely disclosure of cybersecurity breaches and the inclusion of information security and cyber resilience in executive compensation KPIs. The authors suggest corporates introduce cyber covenants in supplier contracts and develop innovative and tailored training programs across the workforce.

“We encourage investors to use the expectations outlined in this report to assess companies’ baseline approach to cybersecurity and to measure companies’ progress towards best practice,” write the authors.

Investors should focus their efforts on identifying and engaging with companies that face high-risk exposure. Identifying the laggards in vulnerable sectors (healthcare, manufacturing, finance and utilities, to name a few) can enable investors to proactively engage with companies.

Investors should also be prepared to escalate. When a company fails to respond to questions on cybersecurity or is deemed to fall far below investor expectations on best practice, escalation can be a useful tool to secure a response or encourage change

Actively engaging in public policy advocacy regarding cybersecurity, including responding to consultations such as those from the SEC on cyber reporting is another approach. By undertaking public policy advocacy, investors can help shape the regulatory landscape to support positive cybersecurity outcomes and ensure that the standards set by bodies like the SEC are practical, effective, and aligned with the realities of the market.

“Cyber incidents will continue, with increasing frequency and sophistication. Investors can only protect value by understanding the risk factors, governance and strategy, and by knowing what questions to ask. This collaborative engagement has built on our understanding and provided valuable insights on set expectations,” concludes Faith Ward, chief responsible investment officer, Brunel Pension Partnership.

Just days after Alberta Investment Management Corporation’s New York office celebrated its first anniversary it has been shut down entirely, along with the Singaporean office, for cost-saving reasons. 

It’s a further sign of the ongoing upheaval at the C$169 billion ($119 billion) Canadian pension manager since a scathing political review last year led to a purge of its leadership team.  

AIMCo started doing business from a Singapore office in September 2023 and opened its New York unit six months later. It held ribbon-cutting ceremonies for both, and the Singapore office touted high-profile hire Kevin Bong, who jumped ship from Singaporean sovereign wealth fund GIC. 

The move to close both short-lived branches has led to the departure of at least Bong, chief investment strategist at AIMCo; and of David Scudellari, global head of private assets, who opened the NYC office. 

An AIMCo spokesperson told Top1000funds.com that the decision was a “strategic realignment of resources”. When asked if further overseas office closures are on the cards the spokesperson did not directly respond. 

“We remain committed to pursuing investment opportunities in the APAC region and globally, leveraging our extensive network of partners and our existing offices to provide continued value to our clients,” the spokesperson said.  

The bulk of AIMCo’s assets are invested in North America, with 42 per cent in Canada and 33 per cent in the US. Asia represents just 3.2 per cent of the asset allocation. 

The move came after AIMCo made 19 non-investment related positions redundant last month, which included its diversity and inclusion program lead. 

Not out-of-whack 

Despite the scrutiny it receives on costs, AIMCo’s expenses are not out of line with its peers. It is worth noting that AIMCo is a Crown corporation and investment manager for several public pension plans, and those operating under similar arrangements include giants such as the C$434 billion CDPQ, the C$229 billion British Columbia Investment Management Corporation (BCI) and the smaller C$77 billion Investment Management Corporation of Ontario (IMCO). 

In the 2023 fiscal year, AIMCo’s total costs per C$100 of AUM were 66.4 cents, compared to CDPQ’s 59 cents, BIC’s 80.4 cents and IMCO’s 80.6 cents, according to their respective annual financial statements. 

AIMCo’s latest annual report shows that total costs for the fiscal year ended 31 March 2024 were C$1.08 billion, compared to C$993 million in the previous year. The jump was primarily attributed to expenses related to a business transformation program – a multi-year initiative that chief financial officer Paul Langill last October told an Alberta Senate committee began in April 2023. 

“We are buying an integrated investment platform, and we’re building a modern data platform,” Langill said. “The total program cost is estimated at about (C)$130 million over a four-year period.” 

Other elements that lifted total operating costs included higher headcount, more assets under management and higher performance fees. The fund had at least 600 employees working in global offices at this time. 

Pressure to invest locally 

The closure of AIMCo’s overseas offices comes at a time when the Alberta government is attempting to mobilise more assets to invest locally. The province’s premier Danielle Smith last month unveiled a plan to grow the Alberta Heritage Fund, currently managed by AIMCo, to C$250 billion by 2050.  

The fund was established in 1976 to invest a portion of the province’s resources revenue. Its primary goal will be to support technology, energy and infrastructure investment in Alberta. 

The government simultaneously established a “sovereign-wealth style” agency, Heritage Fund Opportunities Corporation (HFOC) which will give directions to AIMCo on how to manage the existing C$24 billion assets of the Heritage Funds, but will itself invest the additional C$2 billion seed capital from the government in fiscal 2024. 

As the HFOC’s investment model is proven, more assets could be moved from AIMCo, the government said. Canadian press reported that discussions on how to grow the Heritage Fund’s returns were held between Smith and AIMCo before the latter’s entire board was ousted in November. 

At the Top1000funds.com Fiduciary Investors Symposium last year, industry luminaries who helped shape the contemporary “Canadian model” warned that it is under threat today from an increasing politicisation of the pension sector.  

Mark Wiseman, who served three years as AIMCo chair before stepping down in 2023, told delegates: “When you see trillions of dollars in assets, when you see a government that is running deficits, when you see economic malaise – and we’ve seen this in other jurisdictions – this is the time when pension assets get raided. And I’ll use that term, because that is the risk that I think the Canadian model faces today.”  

AIMCo’s recent woes began last November when Alberta’s Minister of Finance Nate Horner lashed out at the ballooning costs of running the fund. Horner said in a statement that AIMCo’s third-party management fees had increased by 96 per cent, the number of employees by 29 per cent, and staff wages by 71 per cent between 2019 and 2023, all while the fund managed less money.  

In an unprecedented decision, Horner sacked the entire AIMCo 10-person board and then-chief executive Evan Siddall. The board has since been replenished with five members and is now chaired by former conservative Canadian prime minister Stephen Harper. Ray Gilmour has been acting chief executive since November last year, but a permanent chief executive is yet to be installed. 

Much anticipated reform of Sweden’s five buffer funds will liquidate AP1, dividing assets between AP3 and AP4. Private equity specialist AP6 will also merge with AP2, expanding the opportunity for the private equity investor and securing the future of the specialist team.

Katarina Staaf, chief executive of SEK 75 billion ($6.8 billion) Sixth Swedish National Pension Fund, AP6, says the recent reform process that has reduced the country’s five buffer funds to three has expanded the opportunity for the private equity specialist.

Under the reforms, AP6 will finally be integrated into the wider buffer system by merging with the Second Swedish National Pension Fund (AP2) forming a new entity in Gothenburg (where both funds are already domiciled) that will be given increased opportunities to invest in unlisted assets in accordance with AP6’s existing expertise. The reform process took account to two “very important” aspects that AP6 put forward in its consultation response, explained Staaf.

“As the proposal previously looked, there was a risk that the share of unlisted shares in the buffer fund system would decrease, as well as that the expertise acquired by AP6 was not fully utilised. The pension group has supported a proposal in which they want to give room to utilise accumulated expertise by AP6 and where the merged fund is given expanded opportunities to invest in unlisted assets up to and including 2036,” said Staaf.

AP6 was founded in 1996 and has generated a positive net profit every year for the past decade. The portfolio had a 3 per cent net return in 2023 and a 15.3 per cent return over the last 5 years.  Assets are divided between buyout (44 per cent) buyout co investments (38 per cent) and venture/growth (14 per cent) secondary opportunities (4 per cent).

Most investments sit in IT and healthcare and the portfolio has gradually internationalised over time so that today around 31 per cent is invested in the US. Co-investment partners include EQT, Nordic Capital, Permira and Carlyle.

The consultation process flagged that integration of AP6 could be facilitated by removing the legal requirement of currency hedges, allowing inflows and outflows linked to the pension system and by enabling AP6 to borrow from The Swedish National Debt Office (Riksgälden).

But Staaf declined to speculate on next steps. Implementation and reorganisation will be overseen by two special investigators targeting completion in January 2026. A bill will be presented for a vote in the Riksdag during the second quarter.

“Only after this is it possible to have an idea of ​​the way forward,” she said.

Policymakers have committed to private equity. But a drive to create economies of scale, reduce costs and tighten governance, AP1, the SEK 476 billion ($43 billion) buffer fund will be  liquidated and its assets transferred equally to AP3 and AP4.

“We will prepare for the change and will contribute with our expertise and experience for the benefit of the pension system and affected organizations,” said chief executive Kristen Magnusson Bernard in a statement.

Chief executive of AP4 Niklas Ekvall says his focus is now on implementation.

“The government and the pension group, with representation from all parties, have now communicated their view of changes to the buffer fund system. It is now our task to implement their decisions in the best possible way for the pension system,” he said.

“It is good and natural to regularly review the pension system and buffer funds to ensure that it lives up to its objectives and to ensure confidence in the pension system among the Swedish people. The AP Funds were involved in the investigation that was carried out and we were given the opportunity to comment via our consultation responses.”

Ekvall also stressed the strength of the funds.

“The starting point for consolidation is to manage the fund capital in the best possible way in the future. The AP funds are proud to have delivered high returns that have helped to strengthen the pension system. The AP funds have built up competent and professional organisations with a strong culture and investment processes. The good returns, cost-effectiveness and our sustainability work are at the forefront of international comparisons.”

Elsewhere, the reforms have tightened the statutory competence requirement for board membership. They have also adjusted the investment cap for Swedish-listed companies.

AP3 and AP4 (the two remaining Stockholm-based funds) will now be able to hold up to 3 per cent of total market capitalisation, up from 2 per cent though voting rights remain capped at 10 per cent.

 

Machine learning forecasts of corporate earnings outperform analyst forecasts, by revealing new information, economically important predictors and capturing non-linear relationships. Investors can use ML models as a less-biased forecast and a decision-making tool for when there is a vacuum of analyst coverage, an award-winning research paper has found. 

Machine learning (ML) forecasts of corporate earnings have been proven to be significantly more accurate than analyst coverage over long horizons, thanks to the technology’s ability to capture subtle, non-linear interactions between economic data points, new research has found.

The paper, Fundamental Analysis via Machine Learning, which won the 2024 Graham and Dodd top award from CFA Institute, highlights ML model’s potential for use by investors and “considerable promise” to save costs and enhance efficacy in fundamental analysis. 

Co-authored by independent researcher Kai Cao and Haifeng You, Chair Professor of Accounting at Shenzhen International Graduate School at Tsinghua University, the research combined three popular algorithms including decision trees and artificial neural networks to create an ML forecasting model, and trained it on a comprehensive set of financial statement items.  

The model is then used to generate forecasts for firm data – outside of those used in its training – from 1975 to 2019. The paper found that the ML model performed well against analyst forecasts produced over similar time periods, even though the latter usually has access to more information than just financial statements.  

“ML forecasts are as accurate as consensus analyst forecasts over a one-year forecast horizon and are significantly more accurate than them over longer forecast horizons,” the study said.  

“And ML forecasts contain significant incremental information beyond analyst consensus forecasts even if analysts have access to all the financial statements used in ML models (and much more), suggesting that analysts fail to fully incorporate the information in key financial statement items into their forecasts.” 

The ML model in the research was trained with 60 data points, which include companies’ historical earnings; advertising and R&D expenses; individual balance sheet items such as assets and liabilities; and operating cash flows.  

“Corporate earnings are the cumulative result of a myriad of transactions, each reflected within various financial statement items that can have disparate impacts on future earnings,” the research said. But ML’s ability to capture subtle, non-linear interactions between economic data points may have contributed to better forecast results.  

This presents not only an opportunity for investors to use ML models as an alternative and “less biased” forecast compared to that of analysts and stock pickers, but also as a decision-making tool when there is a vacuum of analyst coverage – for when a company only operated for a short period, for example.  

Other parts of the research highlighted the ML model’s superior accuracy when compared against six other existing earnings forecast models such as a random walk model.  

“Cross-sectional analyses indicates that the ML model leads to even greater accuracy improvements among firms with more difficult-to-forecast earnings,” the research said. 

“We then test whether the new information uncovered by the ML model can lead to significant improvements in investment decision-making… The results show that the new information component has significant predictive power with respect to future stock returns.” 

The research noted there is room for an even more powerful application of the ML model if sophisticated investors integrate it well with their risk and transaction models and other portfolio optimisers.  

Meanwhile, Empirical Evidence on the Stock–Bond Correlation, co-authored by Edouard Senechal, senior portfolio manager at State of Wisconsin Investment Board won the 2024 Graham and Dodd Scroll Award. 

Presenting his findings at the Top1000funds.com Fiduciary Investors Symposium at Oxford last November, Senechal identified macro variables such as inflation and real rates have a material impact on stock-bond correlations. He warned investors not to take past correlations between asset classes as a given in the future.  

“Most people use data from the last 20-30 years, but that is not necessarily reflective of what we will get in the next 20-30 years,” Senechal said.  

US and Australia have the fastest growth in pension assets among the world’s seven largest markets, as defined contribution-dominated countries helped push global pension assets to $58.5 trillion by the end of 2024.

The number was released as a part of the annual Thinking Ahead Institute Global Pension Assets Study, which examined asset size and allocation trends 22 major pension markets. It found that the largest seven pension markets (P7) – Australia, Canada, Japan, Netherlands, Switzerland, UK and US – alone represent 91 per cent of the global assets.

The US leads the world by a considerable margin, with an estimated $38 trillion in pension assets, but the market with greatest exponential growth within P7 was Australia, which reached $2.6 trillion at the end of 2024. The latter’s assets increased by almost 500 per cent in the past two decades.

“The rise of DC becomes more pronounced every year that we conduct this study,” said director at the Thinking Ahead Institute, Jessica Gao.

“While global pension assets continue to reach new record levels, it is those markets with larger pools of DC assets that are the main engine behind this continued growth.”

DC assets dominate both the US and Australia, representing 69 per cent and 89 per cent, respectively, but it is compulsory for Australian employers to make pension contribution that is 11.5 per cent of an employee’s salary. The mechanism is known as Super Guarantee and its rate will increase to 12 per cent in the 2025/26 financial year.

Since 2014, the value of Australian pension assets has grown by 110 per cent in local currency terms and in US by 75 per cent.

Elsewhere, Canada surpassed the UK to become the third largest pension market with $3.2 trillion in assets as of the end of 2024.

The UK was the only market that shrank (-0.7 per cent) for the year. It also recorded the slowest growth among the seven largest markets over the past decade – its assets represented 8.8 per cent of the largest 22 markets in 2014 but only 5.4 per cent in 2024.

Switzerland has the largest pension-assets-to-GDP ratio in local currency, as the nation’s retirement savings represented 152 per cent of its economic output. It is followed by Canada (147.5 per cent) and Australia (146.4 per cent).

Asset allocation trends

Thanks to the dominance of DC funds, US and Australia also have the largest allocations to equities – 50 per cent and 52 per cent respectively – while P7 funds on average allocate 45 per cent.

Over the past decade, US and Australia have had the highest allocations to domestic equities while Canada, Japan and the UK have had the lowest among the P7.

The UK significantly increased its bond allocation in the past decade, allocating 38 per cent in 2014 while 56 per cent in 2024. It closely followed by Japan (55 per cent) in 2024.

The report observed the trend of asset owners seeking diversification and higher returns in alternative asset classes, such as private debt and infrastructure more recently.

“In the past, alternative investments were often grouped into a single category distinct from traditional assets like equities and bonds,” the report said.

“However, the newer versions of alternative investments have become more granular, allocating capital across various distinct asset classes such as equity, debt, real estate, commodities, liquid alternatives and infrastructure.

“Beyond financial returns, alternative investments can play a bigger role than listed assets in contributing to achieving broader societal goals, particularly those related to climate change and sustainability.”

The $946.9 billion Federal Retirement Thrift Investment Board (FRTIB) the Washington-based defined contribution plan for US federal civilian employees has finally integrated a new index that excludes China and Hong Kong for its $86.2 billion I Fund after a year-long implementation process.

Speaking during FRTIB’s November 2024 investment committee meeting, Sean McCaffrey, CIO of the retirement fund for 7.2 million federal employees said the fund’s investment managers had completed integrating the new index MSCI ACWI IMI ex USA ex China ex Hong Kong, replacing MSCI Europe, Australasia and Far East (EAFE).

FRTIB’s strategy has inspired action from US state treasurers helping oversee other public pension funds in the country. At the end of last year, a coalition of 15 state treasurers issued a joint statement urging state governments to follow FRTIB’s lead and divest their pension funds from the People’s Republic of China (PRC). The letter warns pension fund fiduciaries that “investments in China are no longer prudent investments” continuing, “the time has come to divest from China: investments in China increasingly present red flags.”

FRTIB’s decision to change the index followed a routine view of the four benchmark indexes used across the whole portfolio. Aon, the fund’s investment consultant, wrote at the time that tensions between the US and China, restrictions in tech investment and the export ban of US technology to China, outweighed the benefits of expanding the I Fund to include China or retaining exposure to Hong Kong.

Aon also flagged the risk of unforeseen events incurring transaction costs and causing performance and volatility swings. The announcement of investment restrictions can cause the value of a stock to decline at a time where the investor is forced to sell. Given the asset size of the I Fund, forced selling or restricted investments could incur higher than average market impact costs due to liquidity challenges, wrote Aon.

Tapping additional returns

The decision isn’t only rooted in eliminating China risk. By broadening the index, FRTIB aims to expand investment opportunities and improve the I Fund’s risk-return profile. The new index provides exposure to 5,621 large-, mid-, and small-cap stocks in 21 developed markets and 23 emerging markets, representing 90 per cent of non-US market capitalisation. The adjustment to the I Fund will more than double the number of countries included in the fund, and will change the number of equities by 700 per cent.

In contrast, the old index provided the fund with exposure to 798 large- and mid-cap stocks in 21 developed markets, representing 55 per cent of non-US market capitalisation.

The new index is also expected to outperform on a risk-adjusted basis over the long term: historical analysis shows the risk-adjusted returns for the new index have exceeded those of the MSCI EAFE Index over the past 20 years.

During the transition period, the managers followed unique transition benchmarks they developed with MSCI. However from now each manager’s performance will only reflect the new index. To implement this change, the fund’s managers BlackRock and State Street independently coordinated with MSCI to develop transitional benchmarks.

The bulk of FRTIB’s assets (43 per cent) are invested in the $415 billion Common Stock Index Investment Fund (C Fund). Other funds comprise the $110.6 billion Small Capitalisation Stock Index Investment Fund (S Fund) and the $34.8 billion Fixed Income Index Investment Fund (F Fund) Around $299.8 billion is invested in a G fund, an internally managed passive Treasuries allocation.

Until 2021, BlackRock ran four key funds. However, following a consultation in 2015 that flagged concentration risk FRTIB hired State Street Global Advisors to reduce its vulnerability to BlackRock suffering a black swan event following a series of RFP’s.