Only 16 of the 74 largest public pension plans in the US ($4.5 trillion in AUM) mention ESG or responsible investing in their public documents. Only two out of 74 mention the Sustainable Development Goals of the United Nations.

The world is shifting towards more socially aware and environmentally focused investment practices. During the last 12 months a number of major institutions rejected the traditional definition of fiduciary duty, embracing a wider sense of purpose that includes investing for the long-term, integrating and reporting material ESG factors, upholding environmental stewardship, fighting against climate change and protecting the rights of all stakeholders – employees, local communities, supply chains and shareholders.

Interest in climate change is surging. Greta Thunberg won Time’s person of the year award. Extinction Rebellion shut down London, declaring a climate emergency. Larry Fink placed climate change at the heart of Blackrock’s business strategy. Chris Hohn, CEO of The Children’s Investment Fund, recommended that asset owners fire external managers if they do not pressure portfolio companies to reduce greenhouse gas emissions.

Individual and institutional investors are putting their money where their mouth is. According to the Global Sustainable Investment Alliance, total capital invested in ESG-related funds worldwide has been growing by 30 per cent per annum since 2012, surpassing $30 trillion last year. The US accounted for 40 per cent or $14 trillion of this amount and about one quarter of total fund investment in the US was ESG related.

So, how are US public pension plans, the largest asset allocators in the country with AUM of $4.5 trillion reacting to this rising interest in ESG, responsible investing and climate change? Not very well, according to the Responsible Asset Allocator Initiative, RAAI at New America.

The RAAI analysed 74 of the largest public pension plans and sovereign wealth funds in the US, and it turns out that few of these US public plans scored well on implementing environmental, social or governance (ESG) standards in their investments. In fact, only 16 or 22 per cent of the US public plans analysed even mention the terms “ESG” or “responsible investing” in their annual reports, websites and public documents. This compares with 78 per cent or 96 of the 123 global public plan peers rated by RAAI that take the step of issuing a public statement on responsible investing policy.

Three US public plans made the RAAI Leaders List (the top 25), including CalPERS, CalSTRS, and UC Regents Investment Funds, and three more were finalists (the top 50) including Colorado Public Employees Retirement Association, New York State Common Retirement Fund and Washington State Investment Board, placing the US second among nations with the most plans in the top quartile of responsible investors. However, the US punches below its weight, with 80 per cent or 60 of the 74 rated US public plans finishing in the third and fourth quartiles.

In addition to issuing a statement on responsible investing policies, RAAI researchers rated US public plans on such criteria as having dedicated staff for responsible investing (14 per cent of US public plans scored versus 50 per cent for global peers), providing guidelines for external managers on ESG priorities (15 per cent vs 63 per cent), joining partner organisations on responsible investing like the PRI or Ceres (22 per cent vs 80 per cent), integrating ESG factors into the decision making process (15 per cent vs 60 per cent), and publishing a downloadable report on responsible investing/ESG programs (12 per cent vs 36 per cent).

RAAI researchers also examined US public pension plan actions on the United Nations Sustainable Development Goals (“SDGs”), an ambitious set of targets to be achieved by the year 2030 on everything from eradicating poverty and hunger to building livable cities. They found only two (3 per cent) of US public pension plans reference the “SDG” in their investment strategy, versus 25 per cent of global peers.

Why are US public plans lagging on ESG?

The RAAI points to several reasons why US public pension plans are lagging. First, the US federal government is moving backwards on ESG policy and protections, discouraging public plans from moving forward. The Trump administration has pulled-out of the Paris Climate Accord, rolled-back environmental regulations, enabled greater fossil fuel production and divided the country on issues of human rights, immigration and diversity.

Second, pension fund regulations introduced in 2018 by the US Department of Labor DOL are confusing and problematic on ESG. For example, the DOL April 2018 bulletin states that fiduciaries must put the economic interests of the plan first before considering ESG, (implying that ESG factors may not be economic) and “not too readily treat ESG factors as economically relevant to the particular investment choices at issue when making a decision.” The bulletin makes it clear that investment policy statements are not required to include ESG and that if they do “it does not imply that fiduciaries managing plan assets always have to adhere to them.”

In addition, the DOL bulletin advises that incorporating ESG may warrant independent cost-benefit analysis and crucially, the bulletin offers no insights on liability protection for default plans that consider ESG and offers no recommendations on how fiduciaries may include ESG in the investment process.

Third, US pension-related national industry associations provide little guidance on ESG for fiduciaries. For example, the National Association of Retirement System Administrators NASRA and the Government Fund Officials Association GFOA both publish annual reporting guidelines that are closely followed by public pension plans in the US, but neither association has a position on ESG. It is curious that US public pension plans can receive certificates of excellence for annual reporting from NASRA or GFOA without ever mentioning the term ESG let alone issuing a statement on their responsible investing policy.

Finally, many US public pension plans still follow the outdated notion that by considering ESG factors, they could be jeopardising financial returns, despite evidence piling up from academic study after academic study that the opposite is the case. For example, a 2016 paper by George Serafeim, Harvard Business School, Mozaffar Khan, University of Minnesota and Aaron Yoon, Kellogg School of Management, provides empirical evidence that good performance on material ESG issues contributes to higher financial returns, by about 300 basis points per annum. Over 30 years, that would amount to a 2.4 fold increase in the total value of the portfolio.

Another example – Bank of America Merrill Lynch released a study in 2019 showing that firms with a better ESG record than their peers produced higher five-year returns, were more likely to become high-quality stocks, were less likely to have large price declines, and were less likely to go bankrupt.

Global peers on ESG

Backwards looking government policy on the environment and comprising ESG regulations for fiduciaries stand in stark contrast to countries like France, the Netherlands, the UK, Sweden, and Canada where government is leading the charge on climate change and regulators require pension fiduciaries to include ESG in their portfolios as well as report transparently to beneficiaries about it. Global peers also have better access to industry advice on how to incorporate ESG into investment policy. Moreover, global public plans are more accepting of ESG as a vital part of their investment practices.

Polling data compiled by the Sovereign Investor Institute, including 350 global public pension plans and sovereign wealth funds over the last three years, shows that over 90 per cent of asset allocators consider ESG to be an important part of fiduciary duty. Moreover, about the same percentage believe ESG is helpful for generating better risk-adjusted returns.

What can US public funds do?

Instead of fighting yesterday’s battle, US public pension plans and their boards need to take the initiative and begin to include material ESG factors in their investment process even if it is not (yet) required by law.
A good first step is to work with stakeholders and the board to decide what ESG means to the organisation and what the related investment priorities may be. For example, the plan could decide to prioritise carbon emissions in the portfolio, investing in renewable energy or pressuring portfolio companies to disclose climate-related information that is material to their business, as specified by the TCFD. Another example could be to prioritise board diversity or fair executive compensation.

The next step is to issue a statement on the firm’s responsible investing policy, one that reflects the preferences of savers and that communicates ESG objectives and targets. A third step would be to join a recognised ESG-related organisation to learn about tools, resources and best practices.

There are many other steps public plans can take, for example, benchmarking peers that are leaders in responsible investing (note: the RAAI publishes the leaders and finalists list, providing a benchmark of excellence for peers). Hiring dedicated resources and staff helps to drive the initiative forward. It also is critical to get buy-in from middle management and socialise a culture of responsible investing throughout the organisation.

Other steps include reporting information on ESG-related investments in the portfolio and progress toward achieving ESG goals, for example, metric tons of carbon reduced, or the results of active voting on shareholder proposals. This builds trust and confidence among savers.

Adopting uniform disclosure and reporting standards on ESG-related issues allows for a common language and a better understanding of ESG risks across the portfolio. Adding ESG related questions to the RFP process and prioritising ESG standards for external managers helps to make them better partners in responsible investing. Finally, reflecting the SDG in investment policy, as appropriate, acknowledges that the institution has a role to play in solving global social and environmental issues.

Scott Kalb is founder and director, Responsible Asset Allocator Initiative at New America.

 

There is a 70 per cent chance a recession will occur in the next six months, according to a new index measuring the state of the economy that uses a statistical method first applied to analysing human skulls.

The KKT index, named after is creators Will Kinlaw, Mark Kritzman and Dave Turkington, can put a value on the likelihood of a recessionary or growth period over three, six and 18 month periods.

The index diagnoses the condition of the economy by measuring variables considered by the authors to be vital signs, and whether they are more closely associated with the values that prevailed during past recessions or periods of robust growth, and then converting that data into a likelihood.

The economic variables, or vital signs, the authors use are: industrial production which is a proxy for output; nonfarm payrolls, measuring employment; return of the stock market; and the slope of the yield curve, considered by many to be one of the best indicators.

“We can synthesise these four variables into a likelihood of recession,” says Will Kinlaw one of the authors and managing director of State Street Global Markets.

The index uses the Mahalanobis distance, which was originally introduced in 1927 to analyse resemblances in human skulls among castes in India. The authors have since used it in their research for different applications including financial turbulence and foreign exchange markets to observe unusual correlations in currencies. It’s also been used in diagnosing disease and research to correct self-driving cars.

In this case, the index can measure the distance a particular set of observations is from what prevails during a recession or growth period. The distance depends on the level of the variables but also on the correlation and interaction effect between them.

“What we like about it, is it converts different types of data into something you can understand,” Kinlaw says. “It’s a very powerful tool as it can convert things to common units.”

Kinlaw said the index spiked up to 70 per cent in September which was the first time since 2009 it has been at that level. It shifted up to 71 last month, and as at January 30 it is at 72.

The likelihood of a recession in the next six months when the index is above the 70 per cent threshold is 70 per cent; the likelihood of a recession in the next 18 months at that level is even higher, at 84 per cent. (see table below)

Looking at history by comparison, the index first rose above 70 around the GFC in January 2007, and before the 1990 recession it first rose to that level in October 1989.

At the moment the main drivers of the index’s position are weak industrial production and the yield curve, and it is getting to above 70 despite the strong stock market.

 

KKT Index and recession realisations

Above threshold: 50% 60% 70% 80% 90% Unconditional Frequency
This month 35% 42% 52% 61% 86% 13%
Next one month 40% 48% 57% 65% 91% 13%
Next three months 43% 50% 60% 66% 91% 13%
Next six months 54% 61% 70% 77% 91% 17%
Next 12 months 68% 74% 83% 86% 91% 24%
Next 18 months 75% 78% 84% 86% 91% 30%

 

Kinlaw says the index is quite simple and can be useful for policy makers and investors.

For investors it could be used for stress testing portfolios and scenario analysis. A large sovereign wealth fund is currently using it to measure the likelihood of scenarios in its stress testing, he said.

In stress testing it overcomes the problem of diluted information in volatile periods which can be seen in the typical stress testing process of using average assumptions of standard deviation or correlation.

The authors detail the research behind the index in a MIT Sloan Research Paper titled A New Index of the Business Cycle.

 

Scientific Beta has made a critical appraisal of the proposals of the TEG on climate benchmarks and benchmarks’ ESG disclosures. Our conclusions are that:

  • they do not respect the spirit of the Regulation they are supposed to detail and exceed the scope of delegated acts;
  • they have been overly influenced by commercial interests and champion the interests of a few ESG data and services providers rather than supporting genuine sustainability; and
  • their flaws mean that they do little to discourage greenwashing or support decarbonisation efforts in the real economy, and fail to enhance decision-making on sustainability.

The report is both flawed and misguided

The 2019 update of the European Benchmark Regulation (Regulation (EU) 2019/2089) creates labels for benchmarks that are on a decarbonisation trajectory or are aligned with the Paris Agreement under the United Nations Framework Convention on Climate Change.

It also introduces a requirement for benchmark methodologies and statements to include explanations of how environmental, social and governance (ESG) dimensions are reflected when a benchmark pursues ESG objectives. These amendments are meant to harmonise and improve transparency in the market for sustainability benchmarks and ensure a high level of investor protection.

In this context, the legislator has empowered the European Commission to specify minimum standards in terms of asset selection and weighting and the determination of the decarbonisation trajectory and to lay out the minimum contents of explanations about ESG incorporation and its standard format. To assist in these matters, the European Commission has set up a Technical Expert Group, or TEG, on sustainable finance.

We have reviewed the proposals of the TEG that are to be used in the preparation of the Commission’s delegated acts, we find them wanting and we offer remedies.

1. The proposals of the TEG do not respect the spirit of the regulation and are out of scope

Instead of specifying how explanations on the incorporation of ESG dimensions should be provided, the TEG proposals establish long lists of ESG indicators – 25 for public equity benchmarks – to be computed and disclosed.

If implemented, these disclosures would modify the nature of the benchmark statement and entail considerable administrative and data acquisition costs. As such, they would become an essential dimension of the regulation, which would be inconsistent with the scope of the legislative delegation enjoyed by the European Commission.

We thus contend that the TEG proposals are ultra vires. It should be noted in this regard that the Commission has not undertaken any impact study on the costs and benefits of these proposals.

2. They are unduly influenced by commercial interests and champion the interests of a few select ESG data and service providers rather than sustainability

The composition of the working group that prepared the proposals is marked by a skew towards providers of ESG data and services and the under-representation of the potential end-users of benchmarks, especially pension funds, which are the main European institutional investors.

The regulation aims to protect the end-users, but the extensive ESG disclosures recommended by the proposals would primarily, and arguably almost exclusively, benefit providers of ESG data and services.

Ultimately, by making ESG disclosures especially onerous, the TEG proposals discourage the incorporation of ESG dimensions into benchmarks, create a unique competitive disadvantage for climate benchmarks and other benchmarks that pursue ESG objectives, and de-incentivise the voluntary adoption of these disclosures.

This is particularly worrying with regard to the need to fund the climate transition.  Drowning indicators of climate impact and risk in a mass of metrics unrelated to the subject will make the benchmark statement confusing and the costs of these disclosures will bear on the economic efficiency of climate benchmarks.

3. They are flawed, do little to discourage greenwashing in the financial industry or support decarbonisation efforts in the real economy, and fail to promote better decision making around sustainability

The proposals contain three severe flaws.

  • First, anchoring climate benchmarks on broad-market benchmarks considerably reduces the scope of the regulation by failing to take account of new forms of non-cap-weighted benchmarks, which, for many investors, are seen as more aligned with their fiduciary objectives, given the inefficiency of market indices, which has been widely documented in the financial literature. In relation to this, the crude control of the sectoral dimension of index decarbonisation at best gives a false sense of security in regards to greenwashing and at worst, encourages it.
  • Secondly, the relevance and adequacy of the exotic carbon exposure metric introduced by the TEG has not been established. It is biased towards certain sectors and companies with large cash positions and the consequences of its volatility on the worthy index self-decarbonisation requirement suggested by the TEG have not been thought through. Last but not least, it mixes direct emissions and emissions from the purchase of electricity with indirect emissions throughout the value chain, even though the data in relation to the latter is too crude to support security selection, as the TEG itself readily admits. In this, it can lead to disregarding the efforts made by companies in the mitigation of their greenhouse gas emissions. This final effect is a pathetic travesty of the design of the regulation.
  • The third severe flaw is the dramatic failure of the proposals to enhance transparency and enable market participants to make well-informed choices with respect to the incorporation of ESG dimensions into benchmarks. Indeed, the proposals give a central role to ESG ratings, which are by nature too heterogeneous to allow for meaningful comparisons and that can be easily manipulated, and fail to properly specify or standardise indicators that could have relevance for decision making, such as indicators of exposure to controversial or beneficial activities. Quite perversely, by requiring the disclosure of a list of indicators without guaranteeing their quality and by leaving benchmark administrators with a large degree of freedom in putting these disclosures in practice, the TEG proposals create a false sense of comfort with regard to the ESG quality of the benchmarks, and in this sense institutionalise ESG-washing.

Against this backdrop, we make three remedial recommendations:

1. Promoting high decarbonisation across all index strategies

To avoid narrowing the scope of the regulation, we recommend that climate benchmarks retain full flexibility with respect to sector exposures while being required to achieve a high level of decarbonisation in a manner that controls for any sector effects. The respect of the decarbonisation target of an index strategy should be assessed in relation to its non-decarbonised version rather than the market benchmark.

2. Adopting metrics that recognise the decarbonisation efforts of corporates and investors

We strongly recommend decarbonisation be primarily assessed using the generally accepted carbon exposure metric that the Taskforce on Climate-related Financial Disclosures has recommended for reporting (weighted average carbon intensity, where the carbon intensity of a corporate is the ratio of its direct and electricity purchase emissions to its revenues). The reduction of indirect emissions through the value chain should be promoted separately in a manner that is consistent with the granularity and other limitations of available data.

3. Avoiding misleading or irrelevant ESG disclosures and keeping ESDG data costs under check

ESG disclosures should remain focused on explaining how ESG dimensions are incorporated into such benchmarks. It is critical that ESG ratings not be given regulatory endorsement and that they remain excluded from minimum disclosures.

To be informative, disclosures in respect of ESG factors beyond what is strictly required under the regulation should be focused on exposure to desirable or controversial activities, precisely defined and highly standardised. The informational value of additional ESG disclosures should be sufficient to compensate for the administrative and data acquisition and redistribution costs that they entail and which will ultimately be borne by investors. To increase the informational value of disclosures and keep cost inflation in check, an administrative body should be tasked with maintaining a public list of compliant and non-compliant issuers.

Noël Amenc is chief executive of Scientific Beta and Associate Dean for Business Development, EDHEC Business School; and Frédéric Ducoulombier is ESG director at Scientific Beta.

 

Designing a 1.5°C asset portfolio to mobilise capital for a sustainable future requires some big thinking and intensive collaboration, not to mention transformational change that extends way beyond the borders of the investment industry. So what role do investors play?

I am not sure if it is possible to limit global warming to no more than +1.5°C; but +2°C is too risky, so we must try. By ‘asset portfolio’ I mean the global stock of productive assets, most of which are owned outside of our industry.. The value of these assets is estimated at around $530 trillion, of which the investment industry manages about one sixth or $90 trillion.

By defining the portfolio this way I am allowing a lot of wiggle room; the investment industry owns a subset of the assets, and individual asset owners own a subset of that. So this framing preserves individual freedom but introduces a collective objective to shape the stock of assets so that global temperature stabilises at +1.5°C.

Under business as usual, the current global portfolio is consistent, in my view, with a +4°C world. If we are serious about a +1.5°C objective, then transformational change is required. In truth, this transformational change will extend way beyond the borders of the investment industry. Our part will be to mobilise capital to secure a sustainable future.

To build my argument, I need to lay a couple of foundation pieces.

The 4321 PIN code

Mobilising capital will require the application of influence. Our 4321 PIN code describes how an arbitrary 10 units of influence is allocated across society: four units go to the public sector (legislation and regulation), three to corporates, two to the investment industry, and one to individuals. The trick is to recognise the interactions. The one unit of influence for individuals typically involves choices over recycling, consumption and what products to put their savings in, but it can also exert serious pressure on the public sector – think Greta Thunberg and Extinction Rebellion. This offers a model for the investment industry to use its two units to influence both corporations and public policy.

Allocating capital

I have often seen and heard the justification that the investment industry adds value to society by allocating capital to the right places and, by implication, keeping it away from the wrong places.

I have usually argued with this view by invoking the ideas Keynes outlined in chapter 12 of his General Theory. Keynes called capital allocation ‘investment’, which entails handing over cash to a risky venture (constructing a building, expanding a factory) that will only generate cash flows at some point in the future. What we currently call capital allocation looks more like the buying and selling of shares; Keynes called this ‘speculation’. Our more considered argument regarding the relatively small role of capital allocation can be found in an Thinking Ahead Institute paper: Connecting the dots.

For our current purpose I need to revisit and deepen the argument. While I believe it is true that in the current era of share buybacks there is less capital allocation going on than claimed, it is also true that there were capital allocations in the past that led to the current shape of our economic machine.

Let me suggest that some of those capital allocation decisions were active – a prospectus was issued, considered and new capital was raised – and some were passive – investee company managements were left alone to decide over the reinvestment of cash flows. This highlights the importance of stewardship and engagement. If we do not steward our assets and engage with management then we have no influence over ongoing capital allocation decisions. Because of the wonder of compounding, it also highlights the importance of the initial decision to fund a business model.

So, moving towards the +1.5°C portfolio will involve the direct allocation of new capital, and a new level of engagement regarding the reinvestment of cashflows by investee companies. It could involve engaging with the public sector – not only on legislation and regulation, but also on the management of state-owned assets.

What are we aiming for? The scale of the problem

To illustrate the scale of the problem, I will use a single reference point. It is estimated that the world’s existing energy infrastructure will release 650 gigatonnes of carbon dioxide over its remaining working life. Add in energy infrastructure in planning, with consent, and under construction and the figure rises to 850 GtCO2 – more than enough, on its own, to take us through 1.5°C of warming. In fact, in her address to the UN Climate Action Summit on September 23, 2019, Greta Thunberg stated that the remaining carbon budget before we breach +1.5°C is only 350 Gt. The scale of the problem is almost unimaginable.

Much of this energy infrastructure (valued at $22 trillion) is owned in the $530 trillion global portfolio, rather than the $90 trillion invested (investment industry) portfolio. The issue I am seeking to highlight is this: to keep the world under +1.5°C of warming we need to change the global portfolio, and yet the invested portfolio is only a small part. Is there any reason to assume these two portfolios will de-carbonise at the same rate? Can the investment industry play chicken and assume the state will do the necessary de-carbonising for them? Or are there attractive returns to be had from carbon-negative assets?

It’s those darn externalities

Let me step back briefly, because it’s not just about the carbon. In 2018 the Thinking Ahead Institute published Mission critical which explored the subject of value creation. Among other things, the paper introduced the notion of the value creation boundary; value is created within the boundary, and it is destroyed outside the boundary. It therefore matters where the boundary gets drawn. In case you are thinking “nobody sets out to destroy value”, I agree. And yet it happens. Viewed from 50,000 feet we see increasing carbon in the atmosphere, plastics in the ocean (and food chain), and phosphorus and nitrogen in rivers and lakes (I would add in social dimensions such as child labour and modern slavery which are other ways of destroying value, and which lead to the world’s other great problem – inequality). The economic machine we have built is absolutely destroying value, as well as creating it. The externalities are everywhere – and externalities, in this context, are the costless dumping of waste into an environmental sink. The trouble is, the environmental sinks are now full.

So what do we need to do?

The scale of the problem is stupendously large. It will take a massive collective effort to make the changes required. It is our belief that no-one can possibly know all that is needed, but we are collaborating with our members, and others, to design a 1.5°C asset portfolio to mobilise capital for a sustainable future.

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

A couple of weeks after BlackRock’s CEO Larry Fink announced the world’s biggest asset manager would do more to use its voting rights to influence sustainability in the thousands of listed companies it holds, one of America’s largest public pension funds is calling on the other two in the “big three” to do more.

“It would be very helpful if Vanguard and State Street did the same thing. Then we will have captured the attention of the vast majority of companies in the US,” says Mansco Perry, executive director and CIO of Minnesota State Board of Investment, guardian of the state’s $104 billion retirement assets.

BlackRock’s promise to increase climate engagement and stewardship could trigger significant change across swathes of corporate America, says Perry. Particularly around building transparency that will allow asset owners to make investment decisions based on corporates’ climate readiness.

“It is going to become increasingly critical that we get feedback, or a progress report, from the companies we collectively own on how they are mitigating climate risk on an annual basis,” says Perry. “This will tell us what management is doing regarding climate change, while not losing sight of the fact they still need to provide us with appropriate returns.”

Minnesota hasn’t been waiting for BlackRock’s lead on stewardship. Although the pension fund has large passive mandates with the manager, it has a separate account and votes its own proxy where it already uses its influence to try and mitigate climate risk.

“There is lots of climate risk in institutional portfolios. One way of addressing this is by the way we vote at proxy,” says Perry. Minnesota votes to encourage companies to reduce their reliance on fossil fuels via innovation and what Perry calls “substantial change.” Divestment, he argues, isn’t the answer (yet) given global energy demand.

Private equity

It’s the kind of involved ownership that chimes with Perry’s enthusiasm for private markets, and his conviction that the influence and control manager GPs have in how private companies are run will continue to result in their outperformance. It’s a belief that is now driving plans to begin co-investment in Minnesota’s private equity program, once legislative approval gives the green light.

If the fund gets the capability to co-invest, it won’t lead to an explosion in co-investment anytime soon says Perry, who explains the fund’s small team doesn’t have the capability to carry out due diligence on individual companies yet. However, it would mark an important new sleeve to the portfolio, confined to direct investment in buyouts, growth equity and distressed and opportunistic funds and a limited allocation to fund of funds in niche strategies, which has proved challenging.

Over the last eight years the portfolio has received back more in distributions than private equity managers have called down from its commitments.

“It’s kind of like being on treadmill but not really going anywhere,” says Perry.

It’s left Minnesota’s 25 per cent target allocation to private markets, of which private equity accounts for the lion’s share, underweight at around 15 per cent. The allocation has been built up over the last 40 years there are over 100 manager relationships.  Perry favours increasing the 25 per cent target further.

“I anticipate at some point I will bring the recommendation back to the board to increase our target a bit more,” he says. The allocation includes private credit, distressed and opportunistic assets and a tiny allocation to real estate.

Consultant RFP

Mindful of both the need to deploy more and prepare the co-investment ground, Perry will launch an RFP for a private markets consultant in an extension of staff role next quarter. Minnesota already has a general (Aon) and special projects (Meketa) consultant, but in both cases they report to the board.

“The private market consultant would be, more or less, an extension of staff, reporting to me,” says Perry.

The remit will also include building out the real estate allocation where Perry would like to see more dollars deployed since Minnesota slashed its allocation to 1-1.5 per cent six years ago, pivoting out in favour of private equity.

“We should probably increase some of our focus on real estate. It’s the second, if not the largest, investment opportunity set around the globe,” he says.

Looking ahead, he identifies other tweaks to the portfolio in the coming years. He believes active public equity requires an increasingly “creative approach” that could incorporate more tracking error.

“We’ve always been pretty benchmark focused. I am now thinking how we should allow some of our active managers to have a bit more tracking error than what we were historically comfortable with.”

He is also exploring active small cap international and emerging market opportunities, as well as active equity’s role in accessing China. Historically Minnesota culled active equity strategies when it found duplication across multiple managers.

“We ended up creating unintentionally expensive index funds that because of the fees, ended up underperforming.”

As for active manager fees, he believes the days of fees simply equating to AUM are numbered.

He is also mindful of the need for Minnesota to build its global exposure across asset classes.

“A lot of the world’s growth is going to take place in emerging countries, and we shouldn’t constrain ourselves by only being US focused.” Elsewhere, he is beginning to lay the groundwork for expanding the small investment team which he says will double from a dozen to around 24 in coming years.

Diversity

Perry runs an investment strategy that counsels against “looking for change,” espousing the importance of knowing when the best approach is to do nothing.

He doesn’t have a Bloomberg on his desk and admits some of the changes he outlines may not be realised under his tenure as he approaches his 68th birthday.

Yet it’s a patient, long-term approach that is tested when he reflects on another cause close to his heart.

“I would like to see more women and people of colour in C suit roles at large asset management companies,” he says, noting that only “some” organisations have “got the message” and that it will take another decade for “a degree of change.”

He doesn’t believe emerging manager programs are the solution to the industry’s diversity problem. A belief garnered as CIO of Maryland State Retirement Agency 10 years back, when he oversaw an emerging manager program spanning 100 small managers accounting for 7 per cent of the portfolio.

Many of those managers struggled to compete against the bigger funds, he recalls.

“Rather than diversity coming from small firms that are going to have a difficult time battling larger funds that have been around for a couple of decades, I would rather see diversity from infiltration at the asset management level,” he says.

As in climate change so in diversity, his strategy is strategic and focused on the long-term. Explaining expectations, encouragement and cajoling will ultimately bear fruit, he hopes.

In a recent project Redington worked with Ford Motor company to develop the first, world-wide pensions data analytics tool.

Ford had a clear objective for the project. In seeking to deliver world class pensions to its employees it wanted to hold itself to account and introduce a clear and objective way of comparing the impact of its schemes across multiple areas. With more than 200,000 employees globally, it wanted to make sure everything possible was being done to secure great outcomes for members and make their futures financially secure. But there was a core challenge in delivering this objective and one which plagues many multi-national companies across the globe: data.

As soon as you start to understand the scale and complexity of Ford’s global pension arrangements (over 120 schemes across 36 countries; DB, DC and hybrid arrangements; around $1 billion spent annually by the company on employee pension benefits), you begin to appreciate the scale of the challenge. It is not a simple matter of comparing investment returns across the various pension schemes and countries.

For the project to really deliver against the objectives, it needed to do far more than that, including providing the Ford team with a view of what a “typical pension outcome” is across all the in-scope countries, in order to then create an objective benchmark. In the pensions industry, data availability and quality can be incredibly variable. It resulted in a lot of head-scratching moments.

We delivered the solution using ADA, our proprietary software platform, and in conjunction with our DC consulting team. One of the key initial challenges was to agree a common way of talking about pensions. Of course, the asset classes used, currencies and norms, vary country to country, but so do to the concepts of what constitutes a pension. After combining and cleansing data from a range of internal Ford sources, with external data from OECD, UN and other third parties, we built up a consistent view of the world from which to work.

Once we had our core dataset, we worked through a process of prototyping and ideation, rapidly moving through different views of what could be delivered in order to design a solution which would be able to answer Ford’s killer questions: what aspects characterised Ford’s ‘best’ pension scheme globally; what level of returns do members in each scheme get; how do member outcomes vary compared to local norms; and how does the global spend for pensions break down across different locations.

Prior to the project, the attempt to answer any of these questions would have required a huge number of human hours of effort, pulling together data and information from HR teams around the world and using analysts to calculate key factors. As a result of the work we have done though, Ford can now use ADA to get a holistic view of all the values they need to, whenever they need it. Everything from the aggregate score for a pension scheme in their world ranking, down to core accounting data and investment value analysis, all is available at the click of a button.

Being able to calculate pension outcomes for straw-people, aka typical member scenarios across all the schemes, was a fundamental requirement. The ability to deliver this functionality added considerable value to the analysis which Ford could access. This feature of Redington’s ADA platform includes an interactive investment modeller that allows for comparisons of member outcomes based on varied asset mixes, investment criteria and local market idiosyncrasies (for example, pension income conversion factors). In using this modeller, it has also allowed Ford to see how it is performing compared with other employers enabling to pinpoint potential areas for improvement, with the ability to look at this region by region.

Top Trumps

One of the more interesting ideas that came from our discussions with Ford, was the concept of Top Trumps for pensions: you could compile a key facts card for any pension around the world, with a consistent set of comparable statistics. Much more than a fun nod to the auto industry we were operating in, the pensions data cards are an incredibly valuable quick reference tool.

As mentioned, Ford isn’t alone in the challenges it faced. Many multinationals have a rich and complex corporate history which contributes to a mesh of data and information which needs deciphering. To date, many technology approaches have failed as they have tried to eat the elephant whole, throwing every requirement they have at a project and then wondering why it hasn’t delivered value. Instead, we worked collaboratively with Ford using our in-house agile framework and focused on value first, allowing us to deliver a new version of the software each week so Ford was always able to provide feedback and shape the product they were receiving.

In terms of advice for other firms approaching similar problems, the honest conversations about what the objectives are, what killer questions they have to answer, and what success will look like are incredibly important to agree up front. Once this is agreed, use an agile approach to take small steps towards your goals, and always be willing to change course in light of new information.

Adam Jones is chief technology officer and managing director of technology at Redington.