The COVID-19 crisis and associated lockdowns may be the crisis that the industry needed to shake-off old inefficient processes and bring in a new era of technology-induced efficiency.

According to Rick di Mascio, founder of Inalytics the crisis has accelerated the industry’s adoption of technology for manager due diligence, an area where it has traditionally lagged.

“The industry has been slow in the past to adopt technology and the efficiency that brings. Lockdown has accelerated that process and as an industry we are much more comfortable in using technology effectively,” says di Mascio.

Di Mascio believes managers and asset owners are more open to doing things differently and to the efficiency that technology can bring, alongside their qualitative measures.

As an example of the efficiency technology can bring, Inalytics is currently conducting a search where 62 managers have been contacted and they can all be analysed in four weeks.

“We could never have got through that amount of information in such a small amount of time.”

He says the adoption of technology needs to be put into the wider context of technology use, where data and technology have become more accepted in everyday life.

“Lockdown has shown there are things in data science and analytics to significantly improve the due diligence process. In the past it was a nice to have, now it is seen as increasing efficiency.”

Di Mascio, who has spent more than 40 years in the industry in roles with the British Coal Pension Fund, Abu Dhabi Investment Authority and Goldman Sachs, says the industry is predicated on the assumption that skill exists, but it lacks tools to adequately assess that skill.

“The tools that people use look at track records, which are useless. They tell you what happened in the past not how those track records came about,” he says.

Di Mascio is critical of the industry’s over-emphasis on the “three Ps” in the manager due diligence process, saying it is a critical part of the process but doesn’t address whether a manager is actually skilful or not.

“It is too strong to say it’s unnecessary to look a manager in the eyes in their office in NYC, you have to be able to trust them. But as a way of identifying skill I don’t think it does the job,” he says, adding that type of due diligence addresses a different need – to establish trust and confidence.

“You have to know that stuff – who they are, what they believe in and how they go about things. But they are peripheral to the central question of do they have skill,” he says. “The Ps don’t say anything about whether they are doing well. You have to know it but it doesn’t address the key question, are they good at it? That is where data science and analytics has a role.”

Inalytics did some due diligence for Brunel Pension Partnership when it was being set up, and analysed nearly 400 RFPs.

“There are two big risks in the selection process. You start with a huge amount of managers and get down to a sensible number. In the process of whittling down you know that managers that shouldn’t have been rejected are rejected; and managers who shouldn’t have made the cut. do. Data analytics and the analysis process can help reduce the risk of those two things happening, so when you get to the shortlist it’s a high quality.”

Critically, di Mascio stresses that due diligence is a process, not just an outcome.

“We don’t give them the answer, we make sure they ask the right questions and they ask questions the managers may not otherwise want to be asked,” he says. “People think it is about coming to the answer, ultimately it is, but the role of questions is critical as through the questioning process you learn a lot as you go along. What we are doing is using data to help them ask the right questions. Helping them ask the right questions will get to the right answer.”

Identifying skill

While di Mascio is quick to point out that asset owners should also not do due diligence exclusively using data, as belief in the people is paramount, he thinks they are not using the full suite of tools available to them and so not getting the real benefits of it.

What data can do, and in the case of Inalytics’ tools, is analyse every decision the manager makes, including everything they do own and don’t own, and identify what is working and what is not.

But crunching the data is only the first step, curating it and putting it into a framework that an investor can use is just as important.

“This is a critical issue. Our clients aren’t data scientists they’re pension funds making investment decisions, they need to know what to do with the data. For us that is a really important step and we can take complicated concepts and communicate them very simply,” he says.

Di Mascio is adamant that skill still exists in the industry, despite the fact that on average funds managers don’t add value net of fees.

“If you took the average tennis player, you wouldn’t be that bothered to pay to watch them. But the 100 turning up for the Australian Open are highly skilled. It’s the same with funds management just because the average funds manager doesn’t add value net of fees, doesn’t mean there isn’t an elite and we continue to find them.”

The Inalytics database, which only contains managers that are tendering on instruction of the client, has an average outperformance of 200 bps gross of fees.

“People have given up that skill exists but maybe it’s because they haven’t got the tools to find it. That doesn’t mean it doesn’t exist.”

Through 30 years of analysing managers, di Mascio says there are four critical criteria for a successful process.

The first, and most important is research, or the ability to have a research process that investigates good ideas and gets the best of them into the portfolio.

“Research is the conerstone of any investment process. Any allocator doing due diligence on a manager needs to understand what their research process is,” he says. A piece of research on 400 portfolios conducted last year separated those that outperformed from those that underperformed and 82 per cent of the portfolios that outperformed had demonstrable research skills.

The second element is sizing and the ability to back the good ideas with conviction.

“If the big positions are not winning it’s difficult for the smaller ones to make it up,” he says.

The third citeria, as outlined in the much-touted paper Selling fast and buying slow, is that managers are bad sellers.

“They can lose 1 per cent through lazy selling,” he says. “Alpha through the first two criteria can be dissipated through lazy selling.”

And lastly is portfolio turnover, where di Mascio observes positions can get stale and “managers can fall in love with their stocks”.

 

The CalPERS board is considering whether to require a new CIO to transfer all of their personal stock holdings into a blind trust while they are a CalPERS’ employee. The move follows the resignation of Ben Meng as CIO last year after an ethics investigation related to some of his personal investments.

In an interview at the Conexus Financial Chair Forum, President of CalPERS Henry Jones said there had been lessons from the experience of Ben’s departure and the board was discussing whether a blind trust was appropriate for the CIO going forward.

CalPERS requires all senior employees to declare their personal investments via a form 700, and to recuse themselves from any decisions around investments they may hold.

Jones said following Meng’s departure the board now shares the responsibility of hiring the fund CIO with the CEO, Marcie Frost. In addition the CEO is required to keep the board informed of any form 700 concerns.

“Hiring a new CIO is an area of high priority for CalPERS right now, we have had multiple CIOs over the past few years,” Jones said. “The experience has changed the governance process and how the board and CEO work together to hire the next candidate. One thing I have to say upfront is our CEO was very transparent with the board in the hiring of Ben Meng and equally so last year when Ben decided to resign.”

Jones said the right candidate would not only have the right investment qualifications but also experience in the public arena.

“The board is focused on the qualifications needed to run a fund of CalPERS’ size, but not only do we need a CIO with the right mix of investment experience, we need a leader who is up to the challenge of being in the spotlight of this very public position.”

Selecting a new CIO is one of two key priorities for the CalPERS board in 2021. The other is the asset liability study which is conducted every four years and includes assessment of the fund’s risk appetite and appropriate strategic asset allocation.

“Our CEO shared our calendar year return of 12.4 per cent at our January board meeting, which was different from our fiscal year return and shows our investment strategy is working,” Jones says. “Much of our focus this year is on the four-year cyclical ALM study and the process will take a fresh look at capital market conditions, our liabilities and risk appetite, and the investment opportunity set available to us as a long-term investor.”

He said the board’s next step was to select a new strategic asset allocation that offers the best risk and return trade-offs. Private equity, which has been a big focus for the fund, will continue to be part of that mix.

The ALM process may also result in the selection of a new policy benchmark and a change to the targeted discount rate, currently at 7 per cent.

The CalPERS board is made up of 13 members and every two years adopts a self-evaluation process.

In the last evaluation, ideas around improved governance, effectiveness and oversight of the system were identified across five areas: board curriculum, roles and responsibilities, meeting materials, code of conduct, and insight tools.

“We have had a few accomplishments already to strengthen the board education program and held five workshops in the last fiscal year,” he said. “Last summer while the US saw a lot of unrest around racism, we held a workshop on unconscious bias and that’s a good example of how the board remains current on relevant subject matters that impact our members.”

 

 

 

Over the past year, the Future of Finance team at CFA Institute gathered insights from investment professionals around the world to better understand their views and vision for sustainability in investment management. Our recently released paper Future of Sustainability in Investment Management is informed by the views of more than 7,000 industry participants, including 3,500+ retail investors, 920+ asset owners, and 3,050+ investment practitioners. It considers a five to 10-year time horizon in terms of what investment professionals, investment organisations, and the investment industry must do to be better equipped to invest in a sustainable way.

The pressure is on for investment organisations to move toward the sustainable investing model, and the alternative of staying put leaves the investment industry vulnerable to decline. Our survey found that 85 per cent of CFA Institute members now consider environmental, social, and/or governance factors in their investing, up from 73 per cent in 2017. Their primary motivations are to manage investment risks and respond to client demand.  We found the most used approaches are best-in-class/positive screening (used by 56 per cent of respondents) and ESG integration (53 per cent), followed by ESG-related exclusions (48 per cent). Voting, engagement, and stewardship are used by 40 per cent, and thematic is used by 35 per cent.

There are many challenges of sustainable investing, but as interest in the area continues to grow, there is a preparedness to tackle these issues, which are understandable flaws in a developing subject. Data, talent, and culture are areas for specific focus.

Data challenges and opportunities

ESG data is substantial and fast growing but unwieldy. Data practices will need to be able to better support decision making so that data goes from being part of the sustainability problem to becoming part of the sustainability solution.

Currently, ESG ratings are widely used, with 63 per cent of survey respondents using them as a part of their data analysis, and 73 per cent expect the influence of ESG ratings on firms’ cost of capital to be greater in the next five years.

Just 40 per cent of investment professionals surveyed incorporate climate risk into their analysis today, but interest is growing. In addition, 71 per cent of our roundtable participants said alternative data will make sustainability analysis more robust, and 43 per cent anticipate there will be useful applications of artificial intelligence for sustainability analysis. The need for greater data analysis plus a need for trust and human judgment when investing with a values orientation will necessitate an AI + HI (artificial intelligence plus human intelligence) approach.

Talent shortage

Sustainability knowledge and skills must be developed to a critical threshold across the industry so that ESG thinking is embedded in all investment settings. An analysis of one million investment professionals on LinkedIn found limited supply of ESG expertise, with <1 per cent disclosing sustainability-related skills in their profile, despite 26 per cent growth in sustainability expertise in the last year. On the demand side, our review of 10,000+ LinkedIn investment professional job posts found that approximately 18 per cent of portfolio manager postings sought sustainability-related skills, and LinkedIn indicates “very high” demand for sustainability talent.

Training in ESG investing has increased, but only 11 per cent of respondents consider themselves proficient in the area. More than 70 per cent have interest in training, and many are starting now.

Among the investment professionals we surveyed, the structure of teams and their ESG responsibilities varied. About one-third of investment organisations have dedicated ESG specialists, a third have portfolio managers conduct any ESG analysis, and a third have no internal ESG expertise. For those with ESG specialists, about half are in a separate function and half are embedded in the investment teams.

The best structure can be related to the strategies employed, with roundtable participants suggesting that exclusionary screening can be done by ESG specialists who are not part of the team since they are simply asked to give a yes or no opinion based on screens. Similarly, if the focus is on impact, a centralised ESG team with a consistent approach is needed or it may be difficult to measure and report on impact. With an emphasis on ESG integration, however, everyone can carry out some sustainability analysis, and fund managers can have different views.

Although there is not a one-size-fits-all approach, most agreed that it is ideal for portfolio managers to learn more about this subject and to have a specialised resource available to teams for the technical aspects of ESG analysis.

Building a purposeful culture

While data and talent are important inputs, an organisational culture that supports sustainable investing will be a differentiator going forward. We need organisations to have enlightened self-interest propositions at their core, meaning that they recognise there is a win-win for clients and the firm when it comes to sustainability. Organisations can demonstrate commitment to sustainability innovation through organisational agility in people and processes and iterative improvements.

We are at a threshold moment for the investment industry as we view the paths ahead and decide which to take. In sustainable investing, we have the ingredients for the sustainability of investing. Investors and the investment industry have a considerable role to play in determining the pathway and shaping a future worth investing in.

Future of Sustainability in Investment Management was co-authored by Rebecca Fender, Robert Stammers, and Roger Urwin.

 

Traditional scores or ratings of a company’s environmental, social and governance (ESG) credentials attempt to translate assessments across a host of criteria into one convenient number representative of overall corporate performance. They have been advertised to investors as relevant metrics that support comparisons across companies as well as computation of aggregate portfolio performance indicators for purposes of reporting and fund selection.

Whereas exclusionary screening, which remains the most widely applied ESG strategy globally, does not rely on ESG scores, other popular strategies often do and they are frequently marketed on promises of superior financial, and especially non-financial, performance.

Extensive academic research has underlined that these scores are not capable of guiding investors concerned with social welfare and environmental sustainability. International organisations as diverse as the OECD and the WWF have warned against viewing ESG scores as a meaningful indicator of an investment strategy’s contribution to the achievement of ESG goals, in particular the fight against climate change.

These dire warnings are buttressed by the amply documented lack of convergence of ESG scores across different providers. This divergence, which we analyse in the first section of this article, is due not only to differing objectives, definitions, methodologies and data, but also to the inherent subjectivity of assessment.

In the second part, we highlight the additional concerns linked to averaging ESG scores across a portfolio and using such an average as a goal or constraint in portfolio construction. Portfolio optimisations based on average ESG scores magnify the estimations errors of individual ESG scores. Moreover, average ESG scores can only be viewed as relevant if one makes questionable assumptions on investors’ utility functions with respect to ESG performances and/or unrealistic assumptions about the link between ESG scores and the ESG risks of companies.

The lack of convergence of ESG scores is nevertheless not an indictment of all ESG data. Indeed, the ESG screens incorporated in our off-the-shelf ESG and climate options do not seek to manage an average score at the level of the index but impose the same minimum ESG standards on all constituents. Thus, concerns about portfolio-level financial or ESG performances are not permitted to distract from the removal of securities of issuers whose activities or behaviours violate global ESG norms – violations that can be documented with reasonable objectivity. We prefer involvement indicators that shed light on inconvenient truths to the convenience of portfolio averages, which may obscure issues, and to rely on data grounded in physical realities, such as carbon emissions, when building portfolios that contribute to tackling climate change.

The divergence of ESG scores across providers questions their reliability

The overall informational potential of ESG scores is low, as ESG scores are derived from heterogeneous data and idiosyncratic methodologies, and may therefore diverge significantly from one data provider to another. This divergence of ESG scores originates from divergences of objectives (what), methodologies (how) and assessments. Scores could (and do) diverge because they relate to fundamentally different concepts, such as measurement of the ESG impact or performance of a company versus measurement of the financial materiality of ESG issues for a company. They also diverge on the choice and weighting of criteria and/or because of differences in data sources and treatment, including arising from subjectivity. Academic studies have shown that more than half the divergence observed is explained by the latter, ie differences in assessment.

Several academic studies have documented the lack of correlation between the ESG scores of different rating providers, with average correlations ranging from 0.40 to 0.61 in the different studies. In Chatterji et al. (2016), for example, this leads the authors to conclude that these metrics cannot guide issuers and that, in the worst-case scenarios, well-intended managerial attention to social metrics could reduce social welfare. Likewise, they note that investment based on these invalid metrics will fail to direct capital toward the most responsible firms. Finally, they observe that the lack of validity or the inconsistency of ESG scores should cast doubt on the validity of score-based academic research on the effects of ESG on performance. An additional problem when it comes to the validity of studies trying to link ESG scores to financial performance is that the scoring history is sometimes rewritten, creating a risk of hindsight bias.

In conclusion, observing the lack of convergence of ESG scores, the OECD warned that “if high ESG scores are simply a judgment that varies significantly across firms, the extent to which investors can be assured that this approach either provides enhanced returns or aligns with particular societal values merits further scrutiny by policy makers and the investment community.” (See OECD, 2020, chapter 1, Robert Patalano and Riccardo Boffo.)

The difference between reliable ESG data and ESG scores: The example of environmental performance

We must nevertheless underline that the above observations on the lack of convergence of ESG scores are not an indictment of all ESG data. They do not apply to issuer-reported data that are accepted as valid or objective data that may be directly measured or modelled with reasonable precision.

Taking the environmental dimension as an example, ESG scores may be viewed as contributing to greenwashing.

At the issuer level, ESG scores are typically averages of indicators of corporate strengths and weaknesses over multiple criteria. Averaging allows certain issuers to achieve strong scores despite association with material ESG concerns and provides rich opportunities for astute and well-endowed companies to take a “strategic” approach to ESG scores by orientating ESG investments and reporting towards “low-hanging fruit”.

This leads to some questioning the very relevance of ESG scores. As an illustration, the World Wide Fund for Nature European Policy Office (WWF, 2019) noted in its feedback on the update of the EU Benchmark Regulation that it was not convinced that ESG scores were very robust. Their consideration of secondary ESG issues (what the WWF called “nice to have”) could lead to overlooking critical ESG issues (what it called “strategic core business issues”) and a focus on process indicators (“box ticking”) could lead to overlooking impact indicators. The non-governmental organisation also objected to the relative nature of most ESG ratings, which leads to sustainable companies being distinguished within non-sustainable sectors.

Focusing on climate change, we observe that academic studies looking at the correlation across greenhouse gas emissions data distributed by different providers find it to be strong for direct emissions (scope 1) and indirect emissions linked to consumption of purchased electricity, heating or cooling (scope 2).  Busch et al. (2018) conclude their comparison of emissions provided by Bloomberg, CDP, ISS ESG, MSCI, Sustainalytics, Thomson Reuters and Trucost with these words:

“When outliers are removed from the data samples, data concerning scope 1 and 2 emissions provides a rather homogeneous picture. Notably, a high level of consistency can be achieved when data gathering and reporting practices follow the GHG protocol. At the same time, the aggregated consideration of estimated data for scope 1 and 2 emissions provides a surprisingly homogeneous result. While the consistency of estimated data – as can be expected – is lower as compared to reported data, the different estimation methods being applied seem to close data gaps in an adequate manner.”

This suggests that climate change metrics based on scope 1+2 carbon emissions data may be much more relevant than environmental scores when analysing a portfolio’s exposure to climate transition risks or an investor’s contribution to climate change.

Indeed, the quantitative analyses performed by the OECD (OECD, 2020, from chapter 2, Robert Patalano and Catriona Marshall) highlighted the risks of relying on environmental scores when defining investment strategies aimed at addressing climate change: “the E score in its current form is not an effective tool to differentiate between companies’ activities related to outputs that affect the environment, climate risk mitigation to improve risk-adjusted returns, and medium-term strategies to align portfolios with lower-carbon activities.” For some of the scoring providers analysed, they even, worryingly, found that good environmental scores correlated positively with high emissions.

The problems with using portfolio-average ESG scores

Average ESG scores at the portfolio-level are only meaningful from a socially responsible investment standpoint if one assumes that the utility of ESG performance is linear, for example that holding a company facing a critical ESG controversy could be neutralised by investing in a company that has earned a corporate sustainability award.

From an ESG risk management angle, average ESG scores provide useful insights only if one assumes that scores very accurately proxy for ESG risks and furthermore that these risks are linear. None of these assumptions are substantiated by academic studies, or even by intuition or casual observation.

With respect to the question of the linearity of investors’ ESG preferences, let us note that high ESG performance at the corporate level rarely attracts as much attention or elicits as much passion as poor ESG performance – companies that are known to be failing basic standards of corporate responsibility receive disproportionately more coverage than those companies that greatly exceed standards.

Likewise, consumers have traditionally been found to consider the ESG performance of companies as a hygiene factor rather than a motivator (Meijer and Schuyt, 2005). Hence, for the average investor with progressive ESG motivations it is unlikely that the non-financial impact of holding a company facing a critical controversy could be neutralised by an investment of the same amount in a company that has earned a corporate sustainability award.

From an ESG risk management angle, the use of a portfolio’s average ESG score as a proxy for ESG risks with potential financial materiality assumes that there is an exact linear relationship between the ESG performance at the constituent level and the expected value of the financial impact of the risk realisation. While such assumptions may be convenient, we do not regard them as conservative, especially for downside risk management. By contrast, exclusions of companies that fail certain demanding standards or thresholds (e.g. controversial weapons producers or coal-related companies) focuses on companies that can be viewed as high risk. Supportive of this orientation are studies such as that by Oikonomou, Brooks and Pavelin (2012) that finds that ESG strengths are negatively but insignificantly associated with systematic firm risk – including downside risk measures – while ESG weaknesses are significantly positively related to these measures; the association is particularly strong for socially irresponsible actions.

Academic research has underlined that ESG scores are not able to guide issuers or investors who are concerned with social welfare and environmental sustainability. In addition, international organisations as diverse as the OECD and the WWF have warned against viewing ESG scores as a meaningful indicator of an investment strategy’s contribution to the achievement of ESG goals, in particular the fight against climate change.

We favour ESG screening, which does not seek to manage an average score at the level of the index or portfolio but imposes the same minimum ESG standards on all constituents. Thus, concerns about portfolio-level financial or ESG performances are not permitted to distract from the removal of securities of issuers whose activities or behaviours violate global ESG norms.

Moreover, attention is focused not on irrelevant constructs built on unreliable data but instead on objective and robust exposure data pertaining to key ESG issues. As such, in the area of climate risk mitigation, to the convenience of portfolio averages that may obscure issues, we prefer involvement indicators that shed light on inconvenient truths and carbon data grounded in physical realities. Indeed, filtering or weighting stocks based on reported emissions and modelled emissions with reasonable convergence is more sensible to tackle climate change than relying on divergent environmental scores, which an OECD study recently described as ineffective tools to assess the environmental impact of companies and counter-productive indicators from the point of view of climate change mitigation.

Erik Christiansen is an ESG investment specialist at Scientific Beta.

Previ, Brazil’s largest and oldest pension fund, has invested the vast majority of its BRL220 billion ($43 billion) portfolio in Brazil since it was founded for Banco de Brasil employees in 1904. That changed a couple of years ago when it shifted strategy, announcing new target allocations to overseas equity and fixed income for the first time with plans to allocate 2-3 per cent of its AUM to overseas markets by 2022 and 10 per cent within the next five years.

As Brazil’s economy reels from the pandemic and high interest rates, long prized by the large fixed income investor, edge ever lower the pressure to diversify has grown even more urgent.

That doesn’t mean Previ’s portfolio hasn’t withstood the ravages of the pandemic reassures Marcelo Otavio Wagner, who joined the fund as director of investments a year ago.

“The financial crisis has provided opportunities for entities with strong cash positions, which was exactly our case. Our concern is the slow pace of recovery for the economy after the vaccine.”

Speaking on Zoom from Brasilia, he says the fund is in a good position thanks to the bulk of its allocation lying in domestic equity and corporate bond exposures to “large and well-structured” Brazilian companies, exchange traded assets and sovereign government bonds.

Previ also benefited from opportunities on the eve of the crisis. For example, it increased its allocation to long-term domestic sovereign bonds when the Brazilian yield curve unexpectedly steepened.

“We had an opportunity to close the duration gap in our LDI portfolio. We never expected this at the beginning of 2020, but the prices got crazy. We had a good cash position and used it as an opportunity.”

Elsewhere, Previ’s 45 per cent allocation to local equity includes a value strategy that has paid off well through 2020 on the back of the steady stream of IPOs: São Paulo’s B3 exchange chalked up 28 IPOs last year, the biggest number since 2007’s all-time record of 64.

“Crises reveal the two types of institutional investor: the type that has to sell assets and the type that is able to buy, and pension funds should always be in the latter,” says Wagner.

However, the investment terrain looks increasingly challenging ahead. He is mindful of the impact on corporate revenues hit by lockdown, especially in the country’s retail sector. Brazilian utilities have also suffered a direct impact from customers not paying their bills.

“Utilities have had a direct impact on their receivables from COVID and the delinquency rate is quite high. It will pass through, but it will take quite a long time.”

The government’s response to the pandemic is another source of concern.

“As institutional investors we are concerned with how the authorities will deal with the fiscal deficit,” he says, flagging that the fiscal budget, “strained” before the crisis, is now “worse.”

Much of Previ’s investment rationale for investing so much in Brazil comes from historically high interest rates. Now his concern is that a slow recovery will keep rates low, denting returns in the 45 per cent allocation to domestic fixed income.

“Until recently we have had very high interest rates in Brazil and have had no incentive to go abroad. Dealing with low interest rates and inflation is new and requires a mindset change.”

Interest rates currently languish at record lows of 2 per cent compared to 14 per cent in 2016 while inflation is tamed at around 3 per cent.

The overseas allocations (divided between Asia, North America, and underweight Europe) will all be outsourced to Brazilian fund managers tasked with selecting assets and managing the allocations.

“We have already chosen them,” says Wagner. “13 international strategies have been approved with 11 managers.”

Previ’s internal team of 60 are responsible for the broad portfolio construction and strategic asset allocation along with screening and manager due diligence. As to whether the growth in the overseas portfolio going forward will see the pension fund mandate to global asset managers he doesn’t envisage a change.

“In this first step, we aren’t planning to use global funds.”

Previ is the big fish in Brazil’s pension sector and its first foray overseas is being closely watched by others who all share a similar home-bias.

However, it is the 117-year old pension fund’s leadership in ESG that makes it one of the region’s most influential investors. Previ is helping drive ESG integration amongst other pension funds and asset managers, providing leadership, support and milestones for others to benchmark.

“We want to help spread market best-practices in governance and risk management. We are very vocal and glad when can see the impact we have,” he says, adding that just that morning he’d been involved in a board discussion on how best to measure ESGI integration amongst the Brazilian asset management industry.

Previ integrates ESG via a rigorous risk analysis.

“Our team asks investee companies to provide us with a framework that shows us their plan to progress ESGI,” he says.

A separate risk division at the pension fund sits behind a Chinese wall from colleagues in investment, analysing all potential investments to produce a specific credit facility that takes into account all ESGI factors. And the team are prepared to increase investment in a company that scores well on ESGI.

“If a corporate bond scores well we will adjust our investment. Instead of investing, say, 10 per cent we will invest 15 per cent. That credit decision will impact the pricing and volume we invest.”

The same process in equity scrutinised the local companies recently coming to the exchange.

“We have an ESGI checklist and the company first needs to match that checklist. Only then does it go through economic and financial analysis.”

Previ has also developed the term ESG to include “integrity” – ESGI. This new seam sits behind governance and is particularly important in countries where regulatory frameworks are less robust, explains Wagner.

“It’s about stripping that I from governance and calling it something specific to help the Brazilian market to improve,” he says. “It so important to further develop our local business environment, especially taking into consideration problems related to fraud, money-laundering, and bribery that several companies have faced over the last decade.”

Alecta’s head of real assets Axel Brändström took the helm a year ago. Charged with building out the real estate allocation in one of the most tumultuous years for the asset class on record, his eye is on e-commerce opportunities and allocations to assets not linked to GDP.

Scratch beneath the destruction of value across office, high street, hotel and leisure, and new opportunities in real estate are beginning to emerge. Logistics offering solutions to last mile e-commerce delivery and assets that aren’t linked to GDP like medical centres and care homes are front of mind for SEK1007 billion ($120 billion) Swedish pension fund Alecta, hunting for properties to fill a growing allocation to real assets that targets a 4 per cent return, undaunted by the pandemic’s trail of destruction.

“We are on a journey to increase exposure that has resilience and diversification at its heart,” says Axel Brändström, who left his role as CIO of Skandia Investment Management a year ago to head up the real assets allocation. “As with all things, we have a long-term strategy and we are on our way to reaching our target in terms of asset allocation. As usual, it will depend on markets and valuation. I am quite confident we will get there.” The real estate allocation will account for around 15 per cent of an expanded 20 per cent allocation to real assets that includes infrastructure (3 per cent) and alternative credit (2 per cent)

The Office

New investment opportunities are beginning to emerge in office despite everyone working from home and companies, sharply aware of these new corporate efficiencies, showing no signs of returning en-masse.

Expect tiers in the market to become more pronounced where office space in bad locations will be punished harder, predicts Brändström.

He also believes that companies will seek to keep staff working mostly from home going forward, but also want office space to gather, and that existing offices will need reconfiguring to meet employee’ demand for more space.

“The use of office space will be different and there might be a smaller requirement,” he says.

Although it’s too early to make a bet on what this means for investors, he advises close contact with tenants so as to be across their changing needs. He also predicts a jump in demand for hubs and co-working facilities, as well as new trends in large companies opening satellite offices to allow employees to have shorter commutes but still work in an office.

“These kinds of structures will increase,” he says.

Retail

He also sees opportunities in beleaguered retail where he expects strained cash flows in the sector to increasingly turn into insolvencies: Alecta’s strategy is flexible and pragmatic, he says.

“We want to invest capital, and this will create opportunities for us to go in and support viable businesses,” he explains. “This goes for retail and most stressed segments, but of course it’s dangerous and we will have to be careful where we invest.”

Elsewhere, the boom in e-commerce will drive an expansion in logistics and warehousing. Here his focus is on logistics that provide smarter solutions to delivering goods to people at home.

“The last line has to better than it is today,” he reflects. “If patterns of living change so that people shop more where they live than where they work, this might change requirements for logistics too.”

The challenge here is that warehousing and logistics assets with strong fundamentals going forward are already expensive.

“They were expensive before and are more so now,” he says, adding that assets like care homes, government-used properties and medical centres also fall into this most sought-after, costly bracket.

Allocations he is also seeking to grow in a bid to diversify from GDP exposure and tap long term trends and demographics.

“There is a lot of GDP exposure in the overall fund given our equity portfolio,” he said. “We are trying to differentiate and create better risk exposures to these cycles. They are expensive because everyone is trying to buy them but it’s important.”

Sustainability, like a building’s energy consumption or water use, is another important differentiator in the hunt for assets given its importance in both attracting tenants or employees to properties, and buyers when it comes to sell.

“In order to be competitive you need to make sure you have an asset that is well run in terms of ESG,” he says. “Our view is that we don’t have to give up returns for ESG. We don’t see any contradiction here and there are plenty of opportunities to invest with good returns and ESG in infrastructure and real estate.”

It’s a strategy that has led to tough conversations with managers in recent years.

“A manager’s view on ESG will decide if we invest with them or not. However, we also work with managers and try to influence them; if we feel their policies are not up to our standards we will try and get them to change. Overtime we need alignment; this is a big issue for all our managers, and they understand the importance.”

Sweden vs overseas

The real estate allocation is divided 45:55 between Swedish and international assets respectively but he says this may change depending on opportunities coming out of the pandemic. The domestic allocation is managed internally and comprises direct investment, plus a number of joint ventures. “We will continue to work with managers where we don’t have the edge but in general in Sweden, we do it ourselves.”

In contrast, overseas investments are with managers, where partners are chosen for their expertise, control and alignment, plus the ability to offer Alecta scale and the potential to deploy large amounts of capital. “We are a small organization but we are quite a big pension fund,” he says, adding that overseas investments typically comprise co-investment alongside managers and club deals. “Our size helps us more than it hinders,” he says, adding that Alecta’s values and expertise make the pension fund a sought-after partner. “We are long term and consistent and this is what most managers want in a client. We will be an investment partners for quite some time and this is appreciated by managers. It is a competitive market, and we have a lot of things that we bring to the table.”

Inflation

Alongside diversification and returns, the strategy is also being driven by the need to ward against inflation.

“It’s fair to assume that the risk of future inflation is not negligible. Central banks will allow inflation to emerge; it is definitely a scenario that exists, and these assets will help our overall portfolio to be more resilient.”

It leads him to reflect on high asset prices across the board, something he says is a consequence of years of central bank manipulation of interest rates to stimulate struggling economies. It’s a trend that will be around for a while yet.

“Show me an asset that isn’t expensive,” he concludes. “Assets are expensive; this is going to continue and increases the risk of unknown shocks to the system for a while yet. Diversification is a good strategy, even though some of the assets we might buy are expensive.”