Startlingly few institutional investors have allocations to life sciences. An informal poll of 85 asset owners from 20 countries responsible for a combined $9 trillion assets under management gathered at the Fiduciary Investors’ Symposium at Harvard University, found only a tiny handful active in the sector. The few included Lakeview Capital Management, a single-family office with a 17 per cent allocation to biotech, and France’s €33 billion ($36 billion) Fonds de Réserve pour les Retraites (FRR) which has allocated around €80 million to a private equity venture capital fund focused on biotech.

The ensuing discussion of the risk that accompanies life sciences investment helps put the figure in context. It is volatile, requires sector specialism and long-term commitments out to 15 years, calling for “a different perception of returns,” Chris Winiarz, chief investment officer, Lakeview Capital Management told delegates.

Yet allocating to biotech makes an important contribution to society – investing in the sector can help change lives. None more so than in gene therapy, the cutting-edge corner of biomedicine that works on one-time cures for some of the world’s cruellest diseases.

It’s a “sweet spot” of healthcare investment, said Debra Netschert, health sciences equity portfolio manager and research analyst, Jennison, who said its ability to “fix the machinery of our body” is transformational for sufferers.

Netschert told delegates that the sector is fast growing, and “multiple companies” in the field make following its evolution “hard work.”

The product cycles and investment horizons are long, and treating humans requires a particular kind of “thoughtfulness.”

Fellow panellist Nick Leschley, chief executive, Bluebird Bio which develops pioneering gene therapies for severe genetic diseases and cancers, told delegates that the technology “is starting to work” and that “kids are alive that shouldn’t be.”

He also warned of the unknowns in the sector, particularly around regulation and timeline. “Expectation and patience are of fundamental importance,” he warned.

Costs
One of the biggest unknowns is how the cost of gene therapy and its accompanying pricing model will evolve.

It involves developing a system that allows everyone to access gene therapy, but also recognises that treatments cost “hundreds of thousands of dollars” and can’t be handed out for free.

He predicted gene therapy will disrupt pricing models with challenging ramifications “as big as the science.”

He told delegates that companies in the sector need “enough to fund innovation, but not be egregious.”

Rather than “extort the system” because of the transforming significance of gene therapy cures, he said the system needs a different model that supports continued growth and rewards innovation, but which is also balanced.

“We all need to be responsible in engaging in this dialogue,” he told delegates.

One way to evaluate its worth is by assessing “the value to the system” of one-time cures, whereby “patients live a full life” and can contribute to society once again.

He suggested that payments could be spread over patients’ lifetimes whereby they “pay a certain amount each year for life,” only paying if the treatment works.

The idea “should be thrown out there” so that the system “is forced to consider it,” leading to a “thoughtful” collaborative dialogue, he said. Moreover, any roll out of gene therapy is complicated by different healthcare systems around the world, like the US’s insurance-based system or the German model where “everyone is covered,” said Leschley.

Valuing biotech
Valuing biotech companies is just as challenging. Positively, it is relatively easy to see if therapies are working, said Netschert.

“When you give a gene therapy you see its effects quickly. Things in the blood tell you if it’s working.”

This leads to spikes in company valuations early on, but she warned investors to be careful of “delusions of grandeur” and to guard against thinking that things will “happen quickly.” Investment requires patience, knowledge and understanding of the manufacturing process and management team.

“A large part of the valuation is the management team,” she says. “Really great mangers can do great things with an average asset, and bad managers can destroy a great asset.”

She also advised investors in the sector to be nimble, warning against paying for over-valued assets, but playing with the size of their positions and being thoughtful about risk. “If you are holding something long duration, you can adjust the size over time,” she said.

Long-term
Leschley told delegates that investors had to prepare for backward steps in this cutting-edge, entrepreneurial sector.

He said management teams “fell down but got back up stronger” driven by a passionate culture and mindset particular to biomedicine.

“This is all we care about – there is no other disease area for us,” he said. He also told investors to prepare for the long-term.

“I am not going to calm you down over near-term anxiety. I talk long-term.”

Moreover, he added that companies that raise too much money too fast “lose their hunger” and that a “lack of footing and lack of comfort” is important for innovation.

Sentiments echoed by Winiarz, who told delegates that it was vital companies understand that they have access to permanent capital.

“You have to imagine what a company will look like in ten years-time,” he said, concluding: “We don’t have Bloomberg terminals.”

CalPERS is conducting searches for outside partners to run its new Pillar III private equity program focused on venture capital investment in life sciences, technology and healthcare.

The giant pension fund is on the hunt for “a team of talented individuals” aligned to CalPERS’ mission, said Marcie Frost, chief executive at the $370 billion pension fund, speaking at the Fiduciary Investors’ Symposium at Harvard University, describing the fund’s search for the right team as “patient” and “thoughtful,” rather than rushing to meet a “deadline.”

The focus on life sciences, biotechnology and healthcare comes as the fund seeks to increase its $30 billion private equity allocation, a vital contributor to a 7 per cent return target.

Healthcare and life sciences also offers new investment opportunities following “challenging access” to Silicon Valley. Something Frost attributed to tech companies’ concern that public scrutiny and public record requests at the pension fund infringed their intellectual property.

“We are a public institution and we incubate our ideas very publicly,” she said.

Healthcare also offers an important investment seam as CalPERS struggles to recover ground after a lost decade of private equity investment.

Despite the pension fund being at the forefront of the asset class in the 1980s alongside first-mover peers like $139 billion Washington State (now boasting a 22 per cent private equity allocation) and $77. 3 billion Oregon Public Employee Retirement Fund (with a similarly chunky 17.5 per cent allocation) CalPERS didn’t keep pace and its allocation has dwindled to 8 per cent. Something Frost attributed to the consequences of “a decade” of not participating in fund raising with GPs and “inconsistent” capital provision.

Now the pension fund’s “belief in the investment thesis” behind life sciences and biotech, a desire to hold companies long-term and secure income streams to match liabilities, plus a conviction that growth will be “more pronounced in VC than buyouts,” means it can position as a “a reliable and strategic partner,” she said.

“I am excited about the opportunity. We are a 70 per cent funded system and we need to take more risk and be opportunistic. There are opportunities if we get the structure and teams we need.”

Yet CalPERS complex governance structure poses a challenge. Frost said the CalPERS board needs to “send the same message” that the pension fund is a trusted partner and reliable source of capital to the financial sector.

Something that was recently jeopardised when private equity teams talking to the fund had their names leaked to the public, she said.

Alongside its search for new partners, the pension fund is also seeking to improve its “important” relationships with existing private equity partners, said Frost.

“We want to get out of the penalty box with some of our GPs so they start bringing us their best ideas,” she said.

She also noted that CalPERS must navigate building its private equity allocation without paying a “market wage.”

Only when the model is proven, and had an impact on returns, will the focus turn to other parts of strategy like “paying market” or bringing it in-house.

“We have to have the experience before we move in this direction,” she said. Frost added that CalPERS’ CIO Ben Meng will “look at every strategy” in the portfolio over the next 18 months.

“You will see a lot of removal from the portfolio,” she said. CalPERS currently runs 70 per cent of its assets in house, with large passive allocations.

Opportunities

Once the team is installed it won’t be short of investment opportunities, said co-panellists Benjamin Davis, chief executive, Octopus Ventures, and Moty Avisar, co-founder, Surgical Theatre, an Israeli company that has developed pioneering virtual reality surgical technology.

The increased spending on healthcare per capita (forecast to rise from 10 per cent of GDP in the US to 20 per cent by 2050) reflects the size of the problem, yet society is doing little to solve it.

“It is a similar situation to climate change and global warming. There is a big problem, but nobody is tackling it,” said Davis.

Octopus is structured around specialist teams which “meet thousands” of companies around the world in search of unique people and products that “solve problems.” AI and robotics whereby “machines do the jobs people can’t” is one fast-growing area of innovation, he said.

Octopus is also keen on “taboo areas” like mental health and femtech, the category of healthcare that uses technology to focus on women’s health.

Innovations to meet growing longevity with wellness products is another opportunity. Here new products for the elderly include virtual reality glasses for dementia sufferers, sensory digital touch-tables and even robotic animals.

“Trust me, they work well. People engage with them and they are less maintenance than real animals,” he said.

Virtual reality

Virtual reality surgery will see patients becoming consumers, offering them the ability to better understand their own surgery, predicted Avisar.

It will also mean surgery improves “in terms of outcome and planning,” and higher retention rates for surgeons.

“When a patient comes to see a surgeon, only half stay with that surgeon,” he said. Engaging patients will become centre stage, allowing more people to “avoid illness” by better knowledge of their own health.

“The technology is now there for the patient to feel part of decision making,” he said.

Despite a 10-year bull market both for European equities and bonds, the outlook for European pension savers remains bleak. Whereas returns have improved in recent years, the Better Finance study, Pension savings: the real return, once again shows that most long-term pension savings products did not, on average, return anything close to those of capital markets.

It’s well and good for policy makers to insist on saving earlier and for longer, but when all is said and done, pension funds simply too often underperform capital markets, and this is, by and large, is due to excessive fees and commissions.

The global pensions gap is currently estimated at $70 trillion and forecasted to mushroom to $400 trillion by 2050: this is by far the biggest financial issue facing EU citizens, their children, and grandchildren. Pension adequacy, defined as a sufficient amount of pension income which during retirement allows for the same standard of living as during working life, is at risk.

With government pensions on the decline, and occupational ones covering only a minority of citizens and pension needs, public authorities are asking EU citizens to save more and earlier for retirement. The Organisation for Economic Co-operation and Development (OECD) stated that “in light of the challenges facing pension systems, the only long-term solution for achieving higher retirement income is to contribute more and for longer periods.”

Whereas this may be sound advice, it ignores a key reason why too many pensions fail to provide beneficiaries with an adequate replacement income. In fact, saving “more and for longer periods” won’t address the issue by itself since even saving 10 per cent of activity income for 30 years will only provide about 12 per cent of activity income through retirement. Our research unmistakeably shows that compounded returns are the main, if often ignored, driver for pension adequacy.

In 2019, for the seventh year in a row, we embarked on the Herculean task of gathering data on private pensions in 17 EU member states. Our research covers 87 per cent of the EU population, plotting the real net returns of long-term retirement savings in Europe. It helps EU citizens and public supervisors see the real net performance and costs of those long-term “retail” investment products that form the backbone of the European pension system.
Over the years these reports on the state of long-term pension saving in Europe have illustrated that the tendency to blame poor returns on the performance of capital markets holds no water.

Despite the fact that the long bull run enjoyed by markets from 2010 to 2017 slowed down in 2018, market returns for the last 19 years nevertheless remain impressive: overall, a direct balanced (50 per cent in European equities / 50 per cent in European bonds) investment from a European saver in capital markets at the eve of the 20th century, would have returned a hefty +117 per cent in nominal terms (gross of fees and taxes) and +54 per cent in real terms (adjusted by inflation.) This translates to an annual average real return of +2.29 per cent (+4.17 per cent annual nominal return).

The long-term performance of the actual savings products for many EU citizens has very little in common with the performance of capital markets. Returns for most pension products remain well below +2.29 per cent and some even venture into negative territory. Our research covers a wide range of investment styles and asset allocations, yet a simple European capital markets benchmark overperforms the vast majority of pension products on all investment horizons.

This is mainly due to the fact that most EU citizens invest less, and less directly, in capital market products (such as equities, bonds and low-cost ETFs), but are instead pushed into more “packaged” and fee-laden products (such as life insurance contracts and pension products). The EC itself points to the fact that among “reasons for not saving long-term are the often-poor performance of financial intermediaries to deliver reasonable return and costs of intermediation”.

One could be forgiven for thinking that insurance and pension products would provide similar returns to a mixed portfolio of equities and bonds, since those are the main underlying investment components of the “packaged” products in question. But using this logic to compute returns for retail investor portfolios implies a “leap of faith.” It ignores realities such as fees and commissions charged on retail products, portfolio turnover rates and risks.

Whereas fees are clearly the main culprit behind decades of disappointing returns, other factors also play a part in the ongoing destruction of EU citizens’ savings. The mid-term outlook for European pension savings is anything but rosy, with interest rates having reached rock bottom, making it impossible for European bond markets to continue to provide the extraordinary returns of the last decades. Since European pension funds are currently primarily invested in bonds, a further blow to returns seems inevitable.

In 2015, pension plans from the 15 EU member states then covered by the Better Finance study, had an average allocation of 50 per cent in debt securities, while equities on average represented less than a third of the allocation.

The Polish Country Case from the 2019 Pensions Report presents a good case in point. The difference in asset allocation between Polish pension pillars II and III clearly illustrates how an asset allocation favouring equity pays off in the long run. In Poland, government bonds account for 67 per cent of the asset allocation for employee pension plans (pillar II), compared to just 40 per cent on average for individual savings and retirement accounts (pillar III), with an average of 50 per cent invested in shares. The results speak for themselves: pillar II had a six-year annualised real net return of 2.13 per cent whereas the more equity-oriented Pillar III, at 5.22 per cent, boasted a real net return of 2.45 times that of pillar II. Extrapolating from these returns indicates that a Polish person saving 15 per cent of his or her monthly income over 35 years, would obtain a 28 per cent replacement income at retirement.

Asset allocation clearly has a strong impact on returns, but inflation, though conveniently ignored, also plays an important role in destroying the value of long-term savings. That and the heavy, and increasing, tax burden on savers. No wonder then that pensions and investments remain ranked at the bottom of all consumer products covered by the EU Consumer Scoreboard. With an ageing population, the EU can ill afford to continue down this road and needs to look into solutions to diffuse this ticking time bomb that is European pensions.

Axel Kleinlein is president of Better Finance (also called the European Federation of Investors and Financial Services Users) which is a European Commission-backed public interest organisation which promotes training, research and information on investment, savings and personal finance.

Two of the United Kingdom’s largest pension funds have launched a guide to cyber risk for asset owners, something the World Economic Forum places in its top 10 global risks for 2019. The report by RPMI Railpen, investment manager for the £30 billion ($38 billion) pension fund for the UK’s railway workers and £8 billion ($10 billion) National Employment Savings Trust, NEST, the DC workplace pension scheme, highlights key cyber dangers asset owners should watch, and rules of engagement with investee companies and reticent asset managers.

It’s the latest initiative to underscore how responsible investment, in this case engagement, is increasingly an arena for cooperation and helping hands rather than competition.

“Today’s publication provides a toolkit for pension scheme trustees. Companies should be ready for questions from investors, and pension funds need to start raising the topic with their managers,” said Richard Williams, chief investment officer of RMPI Railpen.

The practical guide even extends an invitation to other pension funds to meet a corporate and go through engagement steps alongside NEST or Railpen. Engaging on cyber security is daunting for trustees without specialist technology expertise, and new UK regulations introduced in October have hastened pressure to integrate ESG, said Jocelyn Brown, senior investment manager, sustainable ownership at Railpen and co-author of the report.

Now DB and DC schemes’ statements of investment principles (SIPs) must include policies on financially material considerations including ESG, as well as outlining how they will steward investments and the extent to which non-financial matters, such as members’ ethical views, are considered when planning investments.

“So far, we have had interest from two other pension funds to join us in a collaborative meeting with a corporate. This is a chance to raise some of the topics in the report,” said Brown. “Cyber risk is rising up the agenda and we wanted to work with colleagues to put together a tool kit with practical areas where pension funds can integrate cyber into their investment approach.”

Keyboard

The approach underscores the importance of engagement. Corporates can only mitigate cyber risk with first-rate governance, argues Brown whose active engagement with companies on cyber risk runs alongside Railpen managing two thirds of its equity allocation in-house. It means investors need to ensure that corporate boards are set up to understand the risks, challenge approaches and approve strategies, she argues. Investors should also use their voting rights to express a view on how the board is performing – possibly voting against the board.

Other strategies could include urging boards to use remuneration to force staff to tackle cyber risk. For example, investor pressure following the 2017 hack at Equifax, the credit reporting agency which exposed the personal data of nearly 150 million people, led to the company adopting an enhanced clawback policy. It gives the compensation committee discretion to recoup incentive compensation from current and former employees if cyber risk is neglected.

Data

Investors should not be thwarted from engaging on cyber risk by the lack of data. Admittedly, investors’ ability to scrutinise cyber risk and vote on “anything tangible” is hampered by the absence of good quality reporting and policy information, notes the report. According to the PRI there are no minimum standards of regular public disclosure on cyber security practices from large cap listed companies that investors can use to inform basic engagement and investment analysis. Moreover, companies fear that disclosure can lead to more hacks, acting as a disincentive to boost cyber security reporting “too much.” The advice: demand “a level of disclosure” that is not “counterproductive” based around best practice, cyber awareness at the company – and board level responsibility.

A lack of data also makes it difficult for investors to carry out pre-investment due diligence on cyber risk. Here the report flags helpful tools like cyber governance indices which rank companies worldwide by the strength of their defences and cyber governance. Third party ESG data and research from providers such as MSCI also contains assessments of cyber security and data privacy practices and controversies, notes the report.

Managers

Another piece of the puzzle involves persuading external managers to engage with investee companies, argues Brown.

“Managers will come to us seeking our views on what topics we consider material, and cyber risk is rising up managers’ priority list because of its financial materiality and the feedback they are seeing from clients like us.”

Railpen also engages alongside its external managers to check they are up to speed.

“We like to engage alongside our asset managers because even where we score them highly for ESG this gives us a chance to monitor them and check under the hood to see how they engage in practice.”

Persuading passive managers to act is more challenging.

“There is no coverage on cyber security by three of the largest index managers in their 2018 sustainability or stewardship reports,” she said.

It is forcing pension funds to lead the way. Research by report co-author and index investor Nest reveals companies most at risk include those holding large amounts of data, companies that have recently undergone a merger or acquisition, those with old legacy systems and global supply chains.

Governance and culture considerations among the largest 100 asset owners need to be improved according to the Willis Towers Watson Thinking Ahead Institute second Asset Owner 100 study.

According to the report the purpose, mission and vision of these funds needs re-setting, which suggests strategy and culture should change. Funds, it says, have to build a more coherent view of their core stakeholders and their needs.

It also points out that while the relative strength of asset owners compared with asset managers is set to rise – through building bigger teams with stronger leadership and streamlining of governance including delegation, partners and process – the operating model, including strengthened governance and leadership, remains a challenge.

These largest 100 asset owners account for 35 per cent of total asset owner capital with combined assets of $19 trillion.

The top 20 funds account for $10.5 trillion or more than half of the largest 100.

The report also makes the point that asset owners are “too important to fail in their mission. They carry a massive burden for the wealth and well-being of billions”.

As a result, the report says, they have no real choice but to take seriously their financial stakes and real world responsibilities and to lead from the front and address the big issues.

However only a small portion of the 100 largest asset owners were identified as being universal owners. The Thinking Ahead Institute uses a definition of universal ownership set out by Roger Urwin in a 2011 Rotman International Pensions Management Journal, Pension funds as universal owners, which says “for universal owners, overall economic performance will influence the future value of their portfolios more than the performance of individual companies or sectors. This suggests that universal owners will support the goals of sustainable growth and well-functioning financial markets. A universal owner will also view these goals holistically and seek ways to reduce the company level externalities that produce economy-wide efficiency losses”.

The top five universal owners listed in the report were Government Pension Investment Fund Japan, Government Pension Fund Norway, ABP, CalPERS and PGGM.

In the Asset Owner 100 study, the TAG says; “We see universal owners as well-placed to play a more influential role in safeguarding the financial system and contributing positively to some of the big societal issues, including climate change and other environmental issues”.

 

For the full list of the largest 100 asset owners click here

I chat with Gideon, CIO & global head of portfolio management at Rosenberg Equities, on data playgrounds, hubris and the exciting future for quantitative investing.

Nothing on this podcast is to be considered investment advice or a recommendation. No investment decision or activity should be undertaken without first seeking qualified and professional advice.