The Asia Pacific region is home to more than half the world’s population, four of the largest economies (China, Japan, India and South Korea) and Asian innovation is at the forefront of green finance and technology. The list of reasons to invest in APAC is compelling and institutional investors in the region are increasingly tapping the opportunities.

Among its benefits the region provides unparalleled diversification due to a diverse and dynamic mix of emerging and developed economies, in a landscape where Christy Tan, managing director, investment strategist, at Franklin Templeton says countries are divided by a ‘Wallace line.’

This, she says, is in marked contrast to North America or Europe which are characterised by more homogenised markets and similarities in demand for products, lifestyles, technology and even infrastructure.

“There is a huge difference in the way that opportunities and challenges present themselves across APAC even though these countries are geographically close,” she says.

Local monetary policy, specific trade flows within the region and domestic consumption patterns influence APAC equity markets in unique ways, she continues. It’s manifest in APAC equity sector weightings differing from those in the US and providing opportunities in sectors underweighted in the US like financials, consumer discretionary sectors and manufacturing.

Diversification is also evident in the different levels of income, volatility, efficiency – and ultimately returns – across the region.

“If you are looking to improve return expectations, we see most opportunities in India, Taiwan, Japan and the Philippines. If you are trying to reduce valuation multiples in the portfolio, South Korea and China are undervalued,” she says.

Elsewhere, different countries are emerging as global leaders in specific sectors like cashless payment innovation in China.

At the NZ$77.1 billion New Zealand Superannuation Fund, a passive reference portfolio split 80:20 between equities and bonds guides the Auckland-based sovereign investor’s risk-on approach. A total portfolio strategy eschews any country-level approach apart from an overweight to New Zealand where acting CIO Alex Bacchus counts the largest investments in private forestry and agriculture alongside a sizeable allocation to public markets.

However, NZ Super does run an active return strategy that strategically tilts to take positions at a country and regional level across equities, rates, currency and credit based on the team’s views of long-term fair value.

In Asia, this most recently manifest in an overweight to the Japanese yen (reduced since the yen has strengthened) that was also long Japanese equities. The strategy also played into improved governance amongst Japanese corporates where Bacchus notes regulation is pushing companies to return more money to shareholders.

“We don’t try and forecast what is going to happen in the next few months, but take positions based on our long-term view of valuations,” he says.

Michael Hasenstab, executive vice president and chief investment officer for Templeton Global Macro, also flags currency opportunities in Japan as an example of the region’s diversification. Although he is wary of Japanese fixed income because of potential upward pressure on bond yields, he argues the yen continues to stand out from a structural perspective.

“We expect the Japanese yen to potentially benefit as corporate behaviour and the labor market shift to more productive structures, reflation takes hold, monetary policy normalizes, and reshoring takes advantage of Japan’s strategic and comparative advantages.”

Another example is Thailand’s $34 billion Government Pension Fund which runs an active, top-down investment strategy that also avoids allocating to any specific country. But Man Juttijudata, senior director, strategic and tactical asset allocation who is responsible for GPF’s active investment strategy, says the region’s diversification benefits play an increasingly important role.

For example, he recently parred down the allocation to Thai equity in favour of a wider emerging market allocation.

“We try to reduce our home bias. We first stepped outside Thailand with our allocation to developed markets, but we found we still had a large domestic allocation so allocated more to emerging markets. We only have a very small allocation to Thai equity today.”

Juttijudata adds that GPF is innately comfortable stepping into India or frontier markets like Vietnam and is planning to increase private equity investment in Thailand and the Philippines.

“We are Thai, we are already risky,” he reflects. Still, he is mindful of the challenges in the region, particularly the lack of regulation around infrastructure, and most of GPF’s public and direct real estate and infrastructure investment is either in Europe or Australia.

Attractive income streams

Fixed income provides the same diversification benefits as equity or a particular currency exposure. Australia is a favourite allocation for investment grade sovereign investors on one hand. On the other, those same investors can tap into duration and yield advantages in other countries – albeit with an eye on the oftentimes lack of liquidity and the need for more hedging instruments.

Hasenstab believes that the region’s low debt levels relative to developed markets where debt burdens rose during the pandemic also make a compelling reason to invest. China and India have relatively high fiscal balances, but many other emerging Asian countries have significantly smaller deficits or possibly even surpluses – for example, the IMF projects small fiscal surpluses for Korea from next year.

This provides an opportunity for investors seeking to diversify away from markets where fundamentals may mean more shaky returns for bonds, or where there are concerns about potential supply of bonds into the markets because of large deficits, he says.

On a cautionary note, NZ Super’s Bacchus warns that economies in APAC are not immune from developed market sovereign debt and the global debt imbalance.

“Many of these countries are tied to the US dollar, and debt levels in the West can influence what happens in Asia,” he says. “It hasn’t been an issue yet, but at some point it might be.”

GDP, growth and trade

Perhaps the other standout reason to invest in APAC is the region’s growth. Although Chinese growth remains challenged, Australia, South Korea and Indonesia have demonstrated consistently high growth rates whilst countries including Singapore, Philippines and India stand out for their high variability in GDP growth.

The region is significantly more vibrant than the mature western economies, argues Hasenstab who points to IMF expectations that Asian growth will hit 5.0 per cent in 2025 compared to 2.2 per cent for the US and 1.2 per cent for the EU.

Positively, NZ Super’s Bacchus also observes the pickup in Indian growth versus China, noting how emerging market indices have now rebalanced with more exposure to India than China.

“Equity returns in China have been low compared to India which is doing amazingly well.”

Index investors are mindful of the fact APAC has a reasonably small market cap relative to its GDP, potentially limiting opportunities. However, Bacchus counters a GDP-weighted portfolio approach can face issues relating to access and liquidity, and that globalization means economies and countries will always interact to some extent.

Tan says the region’s “healthy” consumption levels make APAC economies less reliant on exports for growth. And APAC is also benefiting from reshoring and friendshoring strategies, as well as “China plus one” where some supply risk is diversified away from China. Hasenstab argues the integration of supply chains leads to greater exports, but also “drives fixed investments in facilities as well.”

He cites Malaysia as an example of being well positioned to benefit from reshoring trends in another nod to the region’s extraordinary variety. “Malaysia is marketing itself as a neutral player geopolitically, hoping to continue to attract investment both from China and from the western-aligned bloc,” he concludes.

Published in partnership with Franklin Templeton Investments

Texas Teachers records the highest quarterly return in its 85-year history – 333 basis points of alpha – with US and Indian equities fuelling the excess return. Known for its active management the fund has made a number of recent changes to the portfolio including removing China and reducing allocations to private equity.

The Teacher Retirement System of Texas (TRS) the $203.7 billion Austin-based pension fund  posted the highest alpha in its 85-year history in the second quarter of 2024, ending the quarter with a 1-year return of 9 per cent and +333 basis points of excess returns.

“Morale is quite high,” said chief investment officer Jase Auby, speaking during the fund’s mid-September investment committee meeting.

The strong one-year market returns at the pension fund have been supported by US equities, the largest asset class in the fund and accounting for 21.2 per cent of the return. Returns in Indian equities have also driven performance.

“India continues to outperform and is the top performing major equity market for the past year and all the 2020s,” said Auby.

He added that in contrast to India, China has performed badly in recent years.

TRS only has a half weighting to China in its emerging market benchmark and the fund’s new asset allocation removes China in totality. Although the public equity benchmark allocation is zero, TRS’s active strategies are able to make out-of-benchmark allocations to China although these exposures are small.

Auby said it is still unclear whether the US will enter a recession. One indicator that suggests it could is unemployment levels. The Sahm Rule, highly predictive of recession, was triggered last month by nonfarm payrolls. However, he countered that one of the reasons recession has been forestalled so far is the strength of the US consumer, indicative in strong retail sales.

“The US consumer continues to spend with surplus funds got through covid to power the economy,” he said.

New strategic asset allocation

The TRS board recently approved a new strategic asset allocation at the fund that aims to increase resilience to potential financial market shifts. Headline changes in the new SAA, conducted every five years, include lowering the target to private equity to 12 per cent from 14 per cent.

TRS will also shift some allocations in the global equity and stable value portfolios within its diversification framework, as well as reduce the allocation to the risk parity portfolio.

Elsewhere the fund has created a new 6 per cent allocation to inflation-linked bonds within the government bonds sleeve to both reduce duration and sensitivity to inflation. The asset allocation to nominal government bonds will be cut from 16 per cent to 10 per cent.

An eye on corporate earnings

Auby explained how corporate earnings –  a company’s net income after tax  – and often referred to as the bottom line, offer one of the most important indications of stock market growth or decline ahead.

The reason that the US stock market continues to outperform all other regions is strong corporate earnings. Although earnings declined during the pandemic the market is now predicting double digit earnings for US corporates at this time. He said that European indices have underperformed because corporate earnings are lower compared to other regions.

US outperformance is due to America’s booming tech sector, and the fact the US has the highest concentration of tech companies reporting strong earnings compared to any other region.

“Nvidia contributed 2.1 per cent of the total 10 per cent earnings growth over the last year for the S&P 500,” he said, referencing the star performer whose earnings analysts now view with as much importance as economic data.

TRS incorporates earnings into its equity strategy in a number of different ways.

In depth fundamental research finds companies set to beat earnings growth to tap excess alpha. Other strategies include quality analysis that brackets companies according to the quality of their earnings in different buckets.

“If you invest in the quality factor you are investing in the best and it gives you the highest return,” said Auby. “Quality is a statistical measure of earnings stability, strength of balance sheet and those higher profit margins; three things shown over time to outperform market.”

Natural capital holds more risk and opportunity than climate change, but where do investors start? Top1000funds.com takes a deep dive exploring the investors that are making inroads to nature-proofing their portfolios.

Natural capital, the store of the world’s natural resources spanning soil to flora, fauna and minerals underpins the global economy providing the world’s food, medicines and built environment. Investors are waking up to the systemic risk and opportunity in its rapid depletion that has the potential to be even bigger than catastrophic climate change. But many struggle with where to start nature-proofing their portfolios.

Getting started

Don’t view natural capital as an asset class, says Brian Kernohan, chief sustainability officer at Manulife Investment Management. The global asset manager, which traces its first investment in timber and agriculture back 40 years, approaches nature on a spectrum that places climate investments alongside traditional inflation-proof real assets and less familiar investments in the circular economy.

“Don’t think about that spectrum as defined buckets, think of it as a wide range of opportunities. A spectrum gives the ability to be creative and build strategies in a blended approach,” he says, using investments like wooden buildings that combine real estate and the circular economy as an example.

The other essential ingredient to getting started is stewardship.

“Investing in nature involves active management to conserve the asset and ensure it persists,” he explains.

Some asset owners are grasping with the concept of a spectrum and blending approach. They are steeling for a wave of nature-related investment products to hit public markets and are exploring bespoke mandates with managers. Examples of other points on the spectrum they are comfortable with include low risk blue and green bonds issued by development banks.

But they struggle to conceive how they can integrate and scale nature investments outside obvious real assets.

Take AP7, the SEK1.3 trillion Swedish buffer fund, which recently got the green light to invest more in illiquid assets. Johan Florén, head of ESG says the fund will develop its allocation to nature in this corner of the portfolio rather than its SEK1.2 trillion equity holdings.

“Illiquids have the best opportunities if you want to contribute,” he says.

Manulife Investment Management’s Kernohan believes one solution lies in supply chain analysis. It’s an area Brightwell, asset manager for the £46.9 billion BT Pension Scheme which has just begun exploring how to integrate nature as part of its thinking on climate and net zero goals also believes is a significant part of the puzzle.

“Supply chains could potentially unlock 80-90 per cent of the nature risk within a portfolio as well as shine light on other sustainability issues such as modern slavery and climate emissions,” says Emma Douglas, who leads on Brightwell’s sustainable investment and stewardship activities.

But accessing corporate supply chain data is a huge task. Douglas believes many corporates still don’t have full transparency of their own supply chains and have only just got to grips with climate reporting; progress in private equity is even slower.

Investors also need systemic processes to analyse supply chain risk.

But the wheels of change are starting to turn. In 2023, AP7 reported on biodiversity across its portfolio for the first time using the Taskforce on Nature-related Financial Disclosures (TNFD) disclosure recommendations, pulling what data it could from the 3,000 companies in its portfolio in a top-down approach that revealed high risk in every sector. Florén is also ploughing his energy into corporate engagement via investor-led group Nature 100+ to push companies to report in line with the recommendations.

He is convinced that although TNFD reporting is still voluntary it will trickle down into corporate reporting standards and is likely to be incorporated into EU legislation in the future. Kernohan also believes companies will increasingly use natural capital accounting methods alongside financial accounting to understand the impact and dependencies on nature.

He says the need to measure nature in the same way that investors have come to measure emissions is perhaps the most important lesson the industry has garnered from climate investment.

“We know we can’t manage what we can’t measure. Climate and carbon have taught us we need an accounting system of the thing we are trying to manage,” says Kernohan.

A different playbook to climate

But commentators also stress important differences between nature and climate investment.

Integrating climate into investment strategies involves reducing one key global metric (carbon) but biodiversity risk is local and involves multiple metrics.

For this reason, and in another distinction from climate, Douglas believes investors in nature should not jump to attach targets before deepening their understanding.

“The metric and target approach investors have adopted to reduce portfolio emissions needs to be adapted to nature but shouldn’t be the first port of call,” she says.

Too narrow targets set too early on could just create more problems, she continues, particularly if investors don’t collaborate with academics. For example, optimising on one (tree planting) could trigger negative consequences (forest monocultures with a negative externality for the local ecosystem) elsewhere.

“If you destroy an existing habitat by planting trees, are you adding to anything?” she asks. Targets can encourage divestment and put a strait jacket on progress, and she also questions investors’ ability to achieve some of the targets they set. “Is it even possible to have a portfolio that is free from modern slavery?”

Putting a price on nature

But for all the distinctions between nature and climate investment, just as in climate, investors will never integrate nature into their portfolios at scale if it equates to lower returns.

The problem is that biodiversity loss is still taken for granted. Valuing nature to a point where the market prices it into a risk adjusted return, coming up with a value proposition for flora and fauna or peat land for example, still feels years away.

Rather than wait for the world to try and solve this complex problem, Kernohan suggests investors put capital to work in one tangible project at a time. This way they can tick off low hanging fruit and find opportunities with real and immediate impact.

Witness how mangrove wetlands on a coastline provide protection from storm surges and hurricanes, he suggests. “You can value mangroves that come with their own biodiversity as a trade off against the catastrophic loss caused by a hurricane. What is the price we incurred by not having nature protect us?”

He is also encouraged by progress in the carbon market where a forest can now be managed for wood and paper outputs, or as a carbon store. “Three years ago, carbon wasn’t valued highly enough to compete as an investment, but this has now changed,” he says.

In another example, the UK government’s high-profile dispute with global investors about the value of water suggests that pricing nature is finally climbing the political agenda.

Investors including C$133 billion Ontario Municipal Employees Retirement System (OMERS) and £75 billion British Universities Superannuation Scheme (USS) cut their losses in troubled UK water utility Thames Water because of demands from Britain’s regulatory authority, OfWat, that they reduce their returns below the cost of capital.

It’s a similar story in Sweden, where Florén argues investors can’t make enough profit because Swedish regulation decrees water infrastructure can only be self-financing. Meanwhile, waste and over-consumption increase because water is cheap.

“The population is not used to paying for water,” he says. “When things are free there is too little investment and over consumption. If there is no financial interest, problems are difficult to solve, and this is also visible in the tragedy of the commons.”

Regulatory risk

The issue reveals how regulatory risk is now a key risk for investors in natural capital. USS recently said its losses in Thames water have shaped its approach to other regulated utilities, calling on the government to recognise the need for investment, and strike a fair balance between risk and returns over the long term.

Moreover, because the concept of investing in nature is new, regulatory frameworks are bound to evolve and change. As the EV sector shows, regulatory course corrections are inherent at the intersection of government and new sectors and concepts, says Manulife Investment Management’s Kernohan.

“Investors will have to consider the risks that the government introduces in the way they manage the regulation,” he says.

Yet in a Catch-22, regulation is also essential: the market won’t find a value for nature without it.

In some ways the regulatory landscape is starting to evolve. AP7’s Florén welcomes the EU ETS, the world’s first carbon market, and notices a new regulatory impetus coming out of Europe from tree planting to river restoration.

Other investors agree.

“If governments send the right signal, the market will respond,” says Douglas, who stresses regulators should incentivise not punish.

Regulation, says Kernohan, could involve policymakers taking stock of natural capital at a government level to understand if it is increasing or decreasing.

“Perhaps they could do it in the same way as they measure GDP,” he concludes, reflecting on what the future could look like.

“Governments could create a metric that is an indicator of natural capital wealth and allows it to track natural capital. Natural capital underpins economies, but it has become an externality and an input to growth whereby nature actually declines at the expense of a single financial metric, GDP.”

London-based AustralianSuper deputy CIO Damian Moloney oversees the global expansion plans of Australia’s largest superannuation fund. While a global presence has clear benefits for the fund and its members, Moloney’s advice to others contemplating the same is to plan extensively and build early.

When AustralianSuper opened its first offshore office in Beijing in 2012 it had A$46 billion in assets, cashflows of A$8 billion a year and 39 investment staff.

Fast forward to 2024 and around half of the fund’s A$341 billion ($228 billion) is invested offshore, it has offices in London, New York and Beijing, and is growing exponentially.

Part of the genesis of the offshore expansion is the pace of growth of the fund. Fuelled by Australia’s mandated superannuation system (11.5 per cent inflows per year, regardless of investment returns or new membership) the fund is projected to grow to A$700 billion by 2030 and $1 trillion not long after. It is expected that 70 per cent of new flows will be invested offshore.

Deputy chief investment officer Damian Moloney, who joined the fund in 2018, heads the strategic direction, governance, oversight and enablement of the fund’s global investments program from London.

Moloney explains how the offshore strategy has evolved, with the success of the operations refocussing strategy from the initial expectation that the international offices would simply manage in region assets.

“Because we have been successful in recruiting the right people and teams, and the AUM is much bigger, we decided to manage outside the region. So that platform can be leveraged to manage offshore across the board, that’s what we are doing in London,” he tells Top1000funds.com in an interview.

The 150 people in the London office, about half of whom are in investments, is expected to triple by 2030. The fund also recently committed to doubling the assets it invests in the UK in that timeframe, to around A$26 billion.

The London office manages real assets where it has made some significant investments including a 74 per cent interest in the King’s Cross Estate, which it calls home. From London it also manages fixed income, global equities and private credit where it has invested around A$4 billion – including a £375 million ($488 million) subordinated facility to support Heathrow Airport during the pandemic – although the fund’s head of private credit, Nick Ward, recently relocated from Melbourne to New York.

The new-ish head of international equities and private equity, Mark Hargreaves, who was appointed last year, is also based in London overseeing expected growth of global equities from A$69 billion to A$255 billion, and private equity from A$14 billion to A$55 billion in the next four years.

About 30 per cent of the fund’s assets are invested in North America, where a team of 60 is headed by new head of Americas, Mikaël Limpalaër who will oversee the expected doubling of the team within two years. Most of the assets managed from New York are unlisted.

At the same time the fund’s Australian investments have doubled in the past five years and by 2030 the expectation is they will exceed A$260 billion, which is the equivalent of about 9 per cent of the country’s forecasted GDP. Pushing assets offshore is a natural diversification, and opportunity.

It has been, and continues to be, a huge undertaking for Moloney to build the teams and the infrastructure (the London office numbered six when he arrived). The experience has made him acutely aware of what is required for a successful global business build, and his advice to others is to plan extensively and build early.

“One big learning is we didn’t design the build early enough,” he says. “We should have worked harder and better on technology, the architecture and have the systems and structures in place earlier. Invest in that upfront is what I’d say.

“Clarity around plans is important: what do you want to do and where do you want to do it? Building from the top down is easier than the bottom up. And recruit for the future, making sure when those people arrive they are suitably delegated.”

A new 10-year plan is about a year away from being finalised, but already he says having people on the ground in the key financial centres is paying dividends for manager relationships and access.

“We are particularly seeing this in private equity with Terry [Charalambous] going to New York there has been a substantial uptick in the relationships as he is on the ground,” Moloney says, adding there have been notable improvements in access to GPs, co-investment and deal flow.

On the asset management side, the fund is also now more easily able to have representatives on the boards of various investee companies and to work directly with management and non-executives on the ground.

“You have to be present to be part of the conversation,” Moloney says. “When I came here we were about $150 billion. Now we are over $350 billion and are a lot more interesting now.”

Global decision making

Of a senior team of eight people, half are now offshore. And Moloney admits there is an internal discussion about the shifting centre of gravity at the fund.

“We are transitioning from Melbourne-based decision-making to more global, and having delegated decision making within region,” he says.

“It’s iterative. If most of your team and investments is offshore, you should be offshore, but there is no hard and fast rule”.

He adds that the bulk of the investment support remains in Australia.

“The support to run the investment portfolio is in Australia and that will be the case, they are experienced and mature at what they do,” he says.

The fund has global portfolio management systems and other technologies that all teams globally are hooked into.

“It is a bit of an effort with decision-making, coordinating the three offices, but we just work it out as we go,” he says.

Some delegated authority is in Australia, and some offshore, such as private markets; but mostly internal approvals go to chief investment officer Mark Delaney in Melbourne and, if needed, to the investment committee.

“Performance was good and the portfolio looked good and worked well, so we didn’t want to disrupt the delegation too much,” Moloney says. “We just work through the time zones.”

Continued internalisation

Generally speaking, the fund’s investment strategy is focused on long-term investment themes including digitisation and the energy transition.

Just this month it made a A$2.2 billion investment in US data centre, DataBank adding to its A$60 billion real assets portfolio that includes digital infrastructure across Australia, EMEA and South America. Last year it made a A$2.5 billion investment in DigitalBridge Group for a significant minority stake in Vantage, which at the time was the fund’s largest infrastructure investment in Europe.

Philippa Kelly, chair of the investment committee, says growing the investment team outside Australia an anticipated fourfold over the next decade is part of the fund’s internalisation strategy.

“This reflects our long-term approach to internalisation, and that, wherever possible, investments should be managed by those with local insights and proximity to the deals and target assets,” Kelly says in the fund’s latest annual report.

“We expect that more than 75 per cent of the portfolio will be managed internally by 2030.”

The good news for members is an expectation that by building these teams out the fund expects to “save more than $1.3 billion per year by the end of the decade”.

Moloney says he expects about another two to three years of work to build out the capabilities in the London and New York offices to support that internalisation effort.

“We expect to extract some real efficiencies as we internalise, we reduce external costs, and we can maximise what we have and expect to deliver some of that benefit to members,” he says.

In addition, Moloney says the investment committee and board is keenly focused on how to hold the internal team accountable to the same standards as external managers.

A recent $A1.1 billion equity and credit write-off connected to venture capital investment in Pluralsight attracted front page news in Australia.

After the write-down the fund took a very close look at what happened and what could have been done differently, Moloney says.

He also welcomes the growing public scrutiny of funds investing more directly into private markets.

“I think personally, as a member as well, scrutiny on funds in this area… could do with ongoing focus and I don’t think we should shy away from it.”

He says the fund needs to deliver on its promise to deliver an outcome for members that is better than just passively investing the money, and to be accountable for that.

“So I think it is actually a good thing that we get constant scrutiny, it just needs to be balanced across the sector,” he says

“Not every model is the same, and capabilities are being built differently, but the ultimate test of it all is the performance numbers.

“There will always be issues in a portfolio, we are so big now with so many assets and geographies, I don’t mind the scrutiny personally. I think it is a good thing. And our members should expect that. It’s all part of being a good business and doing a good job, being open to scrutiny and being up for the challenge.”

AustralianSuper’s balanced fund 10-year performance was 8.07 per cent and one-year to June 30 was 8.46 per cent.

Disclaimer: Amanda White is a member of AustralianSuper

 

Damian Moloney is a speaker at the Fiduciary Investors Symposium to be held at Oxford University from November 19-21. The event is for asset owners, for the program and registration click here.

 

 

The fundamentals that underpin timberland, and their strategic role on the path to net zero, will reward consistent investment in productive natural capital. Aleksi Ehtee, timberland team lead at the Church Commissioners for England explains why forestry is a real opportunity for patient capital to tap into favourable long-term supply-demand dynamics while generating positive financial, environmental and social value.

This year has seen relatively muted timber prices across major markets, as reduced economic activity has applied drag on the demand for wood-based products, and construction starts have stalled owing largely to affordability.

For several reasons, however, this short-term downturn is expected to see a reversal supported by deep-rooted market fundamentals. Investors that have been involved in timberland for some time are used to waiting for end values to mature. Patience also tends to pay off.

For example, temporary price fluctuations may impact cash yields, typically with limited impact on capital values, while timber can be kept ‘on the stump’ until there are stronger signals to sell. Similar defensive strategies to ride out downward pressure may also see investors benefiting from the optionality to participate in voluntary carbon credit markets where credit pricing and markets are favourable, and diversifying risk exposure through the introduction of complementary land uses.

Like many institutions with decades-long hold periods, however, it is the dynamics and the structural resilience of the sector that make sustainable forestry especially attractive to the Church Commissioners for England. That the idiosyncrasies of the asset class allow for a degree of ‘tactical’ yield protection is valuable. But it is the fundamentals that underpin timberland and the timber commodity, and their strategic role on the path to net zero, that will really reward consistent investment in productive natural capital.

Consider socio-demographic trends. On one level, the UN estimates that the world’s population is expected to increase by nearly 2 billion to 9.7 billion in 2050, which will expand the base demand for raw materials, including timber, over time. Layer on top of that the positive correlation exhibited between net GDP per capita and the consumption of wood-based products; as well as the observation that developed and developing economies are using timber more resourcefully to replace non-renewable materials such as plastics. Factor in that the constrained net supply of timber is decreasing globally, and sustainable forestry begins to look relatively undervalued at a global scale.

The proposition that more people equals greater demand would hold water for most commodities, so what else makes timberland a worthy addition to portfolios with longer time horizons? Demand quality is one differentiator.

International timber markets are deepening with the steady increase of timber used in construction and the adoption of cross-laminated timber as an alternative to steel and concrete in the built environment. Markets are also broadening thanks to the push for increased use of sustainable materials, which is supporting demand for wood fibre (in the form of paper and cardboard) as a viable replacement for plastics in consumer industries. New applications are rapidly emerging for wood-derived products, ranging from bio-based plastics and renewable chemicals to eco-friendly battery energy storage technologies.

For the aforementioned reasons, World Bank forecasts predict a quadrupling of demand for timber by 2050, while other more conservative estimates from public bodies such as the UK Forestry Commission and the Softwood Council still suggest a three-fold increase over a similar period.

Our trees continue to grow, regardless of financial market conditions

Of course, there are further factors at play that will push prices upwards over a longer period. Timber supply, particularly that of lumber-grade timber, is not expected to keep up with demand. Around half of all institutional-quality timberland is concentrated in the US, with Europe, Latin America and Australasia representing the other half.

Increasing supply has its limitations – not least the time it takes for newly planted trees to mature. Another factor is certification. End users, as well as investors themselves, are increasingly wanting to procure sustainably managed and FSC or PEFC accredited stock as part of responsible supply chain practices.

Then there is competitive tension between the price of timber and the carbon stored therein.

Timber – be it standing or locked up in the built environment – uniquely benefits from dual purposes. Forests can be used as either an offset – to essentially act as a ‘sink’ in the carbon cycle – or as a perpetual source of commercial timber supply.

Moreover, capital directed toward conservation may reduce commercial timber production from natural managed forests. If increasing value is placed on carbon and biodiversity, this could further limit timber supply going forward – while potentially providing asset owners alternative income opportunities.

As responsible investors, our 88,000-acre sustainable timberland portfolio is a cornerstone of our contribution to people and the planet.

We’re proud to have planted 11 million trees in the past five years alone, and the fact that our sustainably managed forests combine renewable resource production and carbon sequestration, with caring for our environment and rural communities.

For the Church Commissioners for England, forestry is a real opportunity for patient capital to tap into favourable long-term supply-demand dynamics while generating positive financial, environmental and social value. All the while, our trees continue to grow – regardless of financial market conditions.

Aleksi Ehtee is timberland team lead at the Church Commissioners for England.

PFA, Denmark’s largest pension provider, is switching more of its portfolio into equities. The strategy is a direct reflection of the increasing comfort with risk of the beneficiaries in its defined contribution offering, which accounts for around two thirds of the $100 billion portfolio.

“We can see that more of our clients have moved from the middle of the road to running more risk,” CIO Kasper Lorenzen tells Top1000funds.com, explaining that beneficiaries tap into life cycle products based on two underlying feeder funds titled towards either equity or more stable, income-based returns.

“Danes have got used to having more equities in their pension fund and become more familiar with the volatility and drawdowns that come with equity. Our balance between equity and fixed income is changing because people are ready for it, especially younger people.”

In a reflection of the shifting dynamics amongst beneficiaries, Lorenzen has spent most of this year developing PFA’s market-based pension product, PFA Plus.

He believes the growing appetite for equity investment is a consequence of savers’ better understanding of  DC and the way it works during the last 18 years. He observes that people are more involved in investment, especially since COVID, although he is also mindful that enthusiasm for equities might also have something to do with markets performing well.

“We have to be careful about this,” he says.

Passive with a caveat

PFA hunts for returns through three value drivers. First of which comes traditional asset management centred around choosing the right securities across equity and fixed income risk.

However, recent analysis revealed the team has a strong track record managing fixed income risk and security selection but found that active fundamental stock picking was more difficult.

“We were less successful at this element,” says Lorenzen. “We looked back and realised that active fixed income rather than equity was the real value driver.”

The second value driver is private markets where PFA has gradually substituted traditional asset classes for private market exposure like swapping fixed income for real estate over the last decade.

A third element involves risk management, turning the conversation to Lorenzen’s belief that the word passive no longer reflects the complexity and decision making behind index investment.

Yes, the the DKK 220 billion ($32 billion) equity allocation has a passive backbone and PFA is no longer deciding to own one company over another.

But the team must still decide which index to use, mindful of too much emerging market exposure all the while ensuring a home bias in Danish equities for example; run top/down overlays, lever up or down, add geographical sector tilts (they run underweights when it comes to China mostly due to risk/return rather than ESG or  sustainability) and layer on derivative positions.

Elsewhere the team has to integrate net zero targets, voting and concentration limits on some of the largest exposures in the book which requires a degree of research.

This raft of tweaking and adjustments can mean the investor may not actually invest in 20 per cent of the index, picking up a tracking error the team also has to decide they are comfortable with.

“This kind of risk management has been the key value driver for us for the past five years,” says Lorenzen. “Let’s call it passive but we refuse to say we are passive. We run overlays; we are active in derivatives and active in private. We are passive with a caveat.”

A new liquid markets team

Lorenzen’s investment strategy has been accompanied by an overhaul of the investment office. The old asset management division has gone, replaced instead with a smaller investment division wholly focused on managing the assets of the pension fund rather than selling additional funds to other investors.

“PFA Asset Management used to run 8-10 equity processes overseen by portfolio managers. The team now run 1-2 processes,” he says.

The headcount has been reduced from 150 to around 100 of which 35 sit in the front office overseeing liquid and private markets.

“It makes things easier; we are much more focused. Being competitive in Denmark’s pension market is enough of a challenge. Being consistent and good at this is what matters to us.”

Lorenzen has also created a liquid markets team (something he also did while chief investment officer at ATP) encompassing FX, credit and equity so that instead of specific asset class teams, decision making is now top down. It meant some of PFA’s traditional equity investors were let go so that the team could be strengthened with global macro, top down skills.

“Let’s face it, even for specific equities it’s still about Fed rate cycles, growth and discounting of long dated cash flows,”

Key risks ahead

The larger allocation to equity will open the door to additional risk that is already front of mind. Namely, concentration risk in the equity book where the US accounts for around 70 per cent of the market cap and big tech, particularly companies involved in AI, dominate.

“We have sizeable exposure to specific names and exposures that are much bigger compared to other, very large private market exposures,” he says.

Managing this risk is another example of the active decision making that now accompanies passive investment. It calls into question beliefs in the benchmark; investors must decide if they can justify the valuations and concentration or if they would do better to run overlays or change the benchmark to bring the portfolio around a different anchor.

PFA isn’t approaching the problem with these strategies yet.

“To be honest, right now we are comfortable with it and we buy into this idea of the winner takes all in AI,” Lorenzen says. “Companies have put themselves in a good position and grown and taken advantage of their position in AI.”

Still, he recognises that at some point there will be a reset focused on the main beneficiaries of AI. It will move from companies building the hardware to those building the software and applying software in their processes.

“We saw this at the beginning of the century around the dot.com boom when the profits moved from the likes of Intel and hardware producers to other institutions that captured that productivity boost. That is something we are aware of here too.”

PFA’s larger equity exposure will also open the door to more climate risk where he says investors deploying capital to the transition face increased uncertainties around the technology and governments’ ability to build the infrastructure around which market forces will be able to respond.

Until this happens, he believes private investors are going to be reluctant to deploy more, particularly after repricing in more traditional asset classes.

“We are still involved, some of our investments have done fine, in others we’ve learnt lessons, Northvolt being one of them.”

Positively, he concludes that government financing of the transtion could spark new interest in traditional real assets like inflation linked bonds which could offer a reasonable return.