California Public Employees’ Retirement System’s CIO Ben Meng is preparing for a market dislocation by ensuring the $354 billion pension fund has enough dry powder on hand to take advantage of a drawdown.

Speaking during the fund’s June board meeting, Meng stressed the importance of sufficient liquidity ahead of the “probability of a large drawdown” in a session that included expert commentary on the importance of the pension fund’s 28 per cent fixed income allocation.

In the second of a new series of education sessions for CalPERS 13-strong board that includes three new members, the CFA Institute’s Jeffrey Bailey explained bonds’ low risk, liquidity and counter-deflationary benefits in a detailed analysis that served to highlight the predicament facing America’s largest pension fund.

Despite bonds’ solutions to today’s challenging markets, grindingly low yields (set to go lower still following the Federal Reserve recent signalling of cuts later in the year) mean buying them won’t close the fund’s 71 per cent funded gap or meet its 7 per cent hurdle rate.

“In the absence of high interest rates, buying bonds isn’t an option,” said Meng.

Drawdown around the corner

Drawdowns typically follow in the wake of recessions and come every ten years in a pattern characterised by six or seven “good” years followed by “two or three” bad years, said Meng who was deputy CIO at China’s $3.2 trillion State Administration of Foreign Exchange before returning to CalPERS as CIO in January where he served seven years from 2008. That tenure turned into a front-row seat to the financial crisis sending the fund plunging 24 per cent.

“Most people are implying that the next drawdown is near; it’s coming,” he said.

Meng said his priorities are making sure CalPERS can pay all its bills – the pension fund paid out $22.9 billion FY2017-18 in pension benefit payments – and ensuring it has the dry powder on hand to take advantage of opportunities via a “proactive and comprehensive” liquidity management action plan, something Meng turned his hand to on “the first day” he started back at CalPERS.

The investment team have also set up a “real time scenario analysis” and plan to update CalPERS’ investment policies and guidelines to facilitate a response.

“The policies and guidelines are for normal times, not for times of crisis,” said Meng.

Low for long

Low bond yields have forced pension funds to hunt for higher risk assets outside bonds, particularly private equity, said Bailey, an allocation CalPERS is aiming to develop in an expanded strategy.

“The yields are just too low. If you went back to the 1990s, the standard asset mix was 60/40, everybody would talk about 60/40. And today no one talks about 60/40. It just doesn’t generate the expected return that people like to plug into their calculations.”

Low fixed income returns aside, in a prospect vice chair of CalPERS board Theresa Taylor referred to as “scary” for the fund’s 1.9m beneficiaries, Meng said that based on capital market assumptions (CMAs) for the next 10 years the pension fund is expected to return 6.1 per cent on average, below its 7 per cent target.

According to the pension fund’s new strategic asset allocation adopted in July last year, assets are split between global equity (50 per cent) fixed income (28 per cent) real assets (13 per cent) private equity (8 per cent) liquidity (1 per cent)

Bailey also warned the board about fixed income benchmarks, stressing the importance of monitoring the appropriateness of the benchmark for any individual investment manager given that managers, assigned a particular niche of the market to operate in, tend to gravitate towards more risk inside their investment mandates.

Over the long run, higher yielding assets hopefully produce higher returns, however that doesn’t necessarily mean the benchmark is appropriate for that particular manager, he cautioned.

“If you had taken more risk than the benchmark, should you be scored in a positive way? One of the big questions that I think staff have when they deal with investment managers is how they keep an eye on the investment guidelines associated with that manager. Not always easy.”

For CalPERS board member Margaret Brown, setting the right benchmarks for internal staff to avoid “riskier bets” is also a concern.

“We have benchmarks for our investment staff and they earn bonuses based on surpassing benchmarks. I want to make sure that when we set those benchmarks, we’re taking risk into account,” she said.

Dry powder

Bailey also referred to the deflationary hedge benefits of high-quality bonds.

“If there ever was deflation, fixed income would be the place to be,” he said, noting that after a decade of economic growth the prospect of deflation has faded to the back of investors’ minds, yet the risk is evident in the negative government bond yields in Japan and some European economies.

Liquidity management is another key reason to own fixed income, he said. High quality bonds can be bought and sold at almost no cost making it a low-cost way to manage liquidity and its fungibility makes it easy to sell if needed to rebalance equity positions.

“If there was a significant equity market drawdown it would be easy to sell high quality fixed income and invest back into equities.”

Taking lower risk is always going to result in lower returns. But taking higher risk doesn’t necessarily mean higher returns, he said, concluding with a warning that the next downturn will reveal where higher risk strategies have worked.

“I think the ramifications of taking higher risks are only going to be clear on the next major downturn. At that point, we’ll find out how those strategies have worked.”

 

 

The United Kingdom’s £31.4 billion ($39 billion) Pension Insurance Corporation, an insurance company specialising in securing the liabilities of defined benefit pension schemes, is growing its infrastructure allocation to renewables and student housing and pushing into new markets in the Ireland and Spain.

The fast-growing £6 billion ($7.5 billion) direct allocation to infrastructure already includes a large allocation to wind assets like its debt financing for the UK’s giant Walney offshore wind farm. But Allen Twyning head of debt origination at the PIC says more renewable deals are in the offing.

“We are aware of a significant renewables pipeline in the coming years. This is an area of growth as well as student housing. A few years ago, institutions didn’t really look at student housing, but this has changed now.”

PIC typically invests in long-dated – typically 30-40 years to match its liabilities – investment grade infrastructure debt, conservatively structured with high quality cash flows and security of the asset.

“We structure in protection. For example, we could prevent dividends being paid if something went wrong,” he says. Returns-wise, the allocation targets Gilts plus150-200bps. “We look for 1.5 to 2per cent above what you can get on a government bond; it’s not a huge return but it is very low risk because these are investment grade cash flows.”

The PIC doesn’t invest in infrastructure equity due to its higher risk and volatility profile and aims for deals that match its risk-return objectives, typically around £50-100 million ($62-$125 million). Moreover, Twyning also believes that in many ways infrastructure is more secure, and better quality, than corporate debt nowadays.

“Corporate’s ratings traditionally drift downwards over time so it is harder to lend long-term to them. Take for example Ford Motor company. It was AAA throughout the 1970s and then slowly drifted downwards, eventually being restructured in 2009.”

That is not to say there aren’t risks in the allocation. PIC does take construction risk which it navigates via project finance structures like embedded credit protection with cash or bonds put aside in case the contractor gets into difficulties. Something particularly on the radar in the UK’s construction sector given high profile, late cycle credit challenges for developers like Carillion and Interserve that have hit institutional investors in projects like the Royal Liverpool Hospital.

“The contractor is there to deliver a building at a certain price and the credit risk is on them. We do a deep dive into the credit quality of all our counter parties in projects and ensure we are very confident the counterparty will be around for at least the next four to five years: you invest in a project over 20-30 years and construction risk occurs in years one to four,” he says.

Competition for UK assets is fierce, namely because less infrastructure has come to the market in recent years than what the UK government had promised. PIC manages to swoop on the best deals in the tough market because of its in-house capabilities and strong relationships with sponsors, says Twyning.

On one hand, big institutional deals come the PIC’s way via partner banks seeking to raise large amount of debt via a club of investor.

“Housing associations will have advisors and arrangers who come to us,” he says.

On the other, deals are increasingly sourced on the project finance side via PIC’s growing relationships with sponsors.

“We are getting to know the sponsors. For example, we have done eight transactions with UPP in the student accommodation space. We have that relationship and talk to them directly.” PIC has now financed around £500 million of UPP student-accommodation projects.

Breaking into new German and French markets is a challenge because of the easy availability of bank finance in Europe, he says.

“There are lots of good projects in Europe, but we are priced out. We haven’t got involved in European infrastructure because we can’t compete in terms of pricing with the banks. Banks in the UK pulled back, but in France and Germany projects are well banked and we can’t compete with what those institutions can offer.”

In contrast, Spain offers some exciting opportunities where the PIC it can compete.

“Spanish Solar assets are of great interest due to the new more stable regulatory environment and more attractive returns.”

Where it invests overseas, PIC cross currency swaps, swapping its euro cash flows for sterling cash flows as soon as it buys the assets to ensure its cash flows match its liabilities.

The UK’s new LGPS megafunds, keen to invest in more infrastructure, promise to hot up the competition for assets further.

One of the challenges for local authority pension funds to date has been the ability to make meaningful investments without large in-house teams and scale.

“From a credit perspective infrastructure is expensive. Each deal involves lots of work,” he says.

Moreover, without the ability to structure deals in-house, high fees can quickly erode gains.  “The big insurance companies in the UK, and funds like USS are our biggest competitors. The new LGPS funds could be competitors too,” he says.

PIC runs an in-house team of five which Twyning hopes to build out to seven in the coming months. The fund doesn’t use any external managers but does have technical advisors that bring expertise on elements of projects like, for example, how realistic a construction program is or the costs to replace a contractor should it go wrong.

In the student housing space, this outside support could involve in- depth advice on long-term demand for student housing.  Where Twyning and his team are expert is getting the debt right and the structuring – ensuring the debt is structured in line with the rating, the credit quality of the counterparties and the long-term market for the asset.

“For the more technical parts we will have a third party – for example we aren’t experts in wind projection so will use specialists. My job is to get the debt structure we are comfortable with,” he concludes.

With the US-China trade war turning into what looks to be a grave and possibly permanent collapse in relations between the two super powers, institutional investors will reap their biggest gains from dislocation, according to Stephen Kotkin, professor of history and international affairs at Princeton.

The China investment challenge has always been to capture the aspirational middleclass. But while it is a great play for institutional investors, it’s limited in how many people have been able to pull it off, he said at a roundtable sponsored by Deerpath Capital Management.

“You have the aspirational middleclass on the one side of the investment and then hedging against massive dislocation on the other side,” he said.

“The big money that’s going to be made in China is going to be made from the dislocation, that’s the real big money.”

Speaking on the impact of a deepening trade war on asset prices, the Princeton historian said “That’s the one [geopolitical risk] we’re talking about today. Because the destructive potential is so vast, you can’t put a price on it.”

Kotkin warned that the trade war is part of a larger strategy by the US to destabilise the Chinese communist regime, adding that the belated confrontation with China will continue well after any trade deal is signed. “This is permanent now,” he said.

A burning issue for the US is the universally-held view that China would integrate into the US-led global order and look more like a developed democracy.

The academic said this is wishful thinking as China has no intention of opening up its political system.

However, he noted the panic this realisation has caused, prompting the Trump administration to demand a reset of the US-China relationship.

“The Trump administration achieved a total transformation of the conversation in the US by turning China into an adversary that must be confronted,” he said.

“He’s done it in his clumsy way and he’s not fully aware… but he’s done it.”

A suicide mission!

Kotkin, a renowned specialist in communist regimes, pointed out that Trump has decided to test the resilience of the Chinese communist regime.

“This is why the market doesn’t understand what to do. It hasn’t really understood Trump from the beginning and the risk that Trump could cause a meaningful shock.”

“On the other hand, who’s to say that China is really as strong as we think it is,” he argued, adding that despite breath-taking economic innovation, Beijing doesn’t act confidently.”

Investors at the roundtable were keen to hear more from Kotkin about how the fractious relationship between the world’s two biggest economies will play out and how robust the communist regime truly is.

In his view, the China challenge will remain even if the current regime collapses, since it would inevitably be replaced by a nationalist, potentially xenophobic right-wing authoritarian regime.

“Every time communism has tried to liberalise and open up, it’s liquidated itself.  Those people who expected the Chinese communist regime to fully liberalise and to transform itself into a democracy or rule of order didn’t study communist history.”

Critically, he added, Xi Jinping won’t allow communism to be destroyed as it was in the Soviet Union.

“We’re looking for them to open things up politically and legally and if they do so they’ve destroyed themselves, it’s a suicide mission. So, the likelihood of that happening is low in my opinion.”

Kotkin also told the investors that the west can’t rise to the China challenge by crying foul or by punishing; it can only rise up to the task by competing effectively and responsibly.

“We don’t see that right now; we see the opposite on almost all fronts. Trump is confrontational but not competitive.”

Gary Gabriel, the CIO of State Super, asked about the chances of the two countries forging a good trade deal. Like his peers, Gabriel was keen to know the inside story – whether the two super powers are trying to get more favourable terms or whether they plan to overturn the current order.

Although China is a clear beneficiary of the US–led international order, Kotkin conceded it is hard to tell.

“There’s arguments inside US intelligence agencies on this point, there’s no consensus and that’s because inside China, there’s also no consensus on this question. They’re debating it themselves but the answers are very different.

“There are a large interest groups pushing to overturn and there are large interest groups pushing for the deal. So that’s why it tugs back and forth.”

Out of options

The Princeton scholar’s bottom line is that China’s power has to be accommodated in some fashion and that is problematic for the US because it will have to offer concessions.

Yet, on issues like Taiwan – and any moves towards formal independence –there’s no middle ground, he said.

“It’s unlikely the US will walk away from the South China Sea.”

Notably, at the worst possible time, mainland China has introduced the possibility of an extradition law for Hong Kong which means that anybody arrested in there can be extradited to Beijing.

What adds to investor turmoil, Kotkin warned, is that the China watchers, on both sides of the fence, don’t know the answer because the actors themselves don’t know the answers.

For Kotkin, the far bigger problem is that efforts to manage the prolonged stand-off are not working. To the US, China looks like the big malefactor and to China the US looks like the bully.

Richard Batey senior manager, macro strategy, investments, at AustralianSuper and Nader Naeimi, head of dynamic markets and senior portfolio management at AMP Capital, were keen to know if punishing China with a trade war would raise the risk of a serious political conflict. Both noted China’s heightened power in south-east Asia.

Kotkin spoke of the arrogance displayed by the Chinese authorities but said Beijing failed to back that up with the confidence required for a serious military confrontation.

“That tells you that there are limits to how confrontational the Chinese are going to get vis-à-vis the US. So, the Chinese have some options but those are not the same options as a confident power would have.”

Participants then discussed how much China had to lose by risking serious conflict – especially given China’s success – which set it apart from Russia and Iran.

A direct conflict would increase the risk of the regime collapsing, argued David Macri, CIO, at Australian Ethical. Consequently, given the US muscle, his feeling is that a deal is likely on terms favourable to the US”

Tim Macready, CIO of Christian Super, remarked that despite President Xi’s move to consolidate the power and lengthen his own political lifespan, there comes a date when that ends either because of internal forces or his death.

Mark Burgess, chair of HESTA’s investment committee, weighed into the debate by saying investors needed to consider that the damaged relationship between US-China has become a populist theme.

In his view, the now bipartisan issue could become so embedded in the US-Chinese psyche that politicians on all sides will play this theme for a long time.

Noting that all populists tend to find a thread of something that resonates, he likened this to opening pandora’s box.

“If I was the Chinese, I’d be worried about this because it gives enough momentum inside the system for them to effectively become a replacement, say, for Russia.”

Returning to an earlier theme, Kotkin said geopolitics, generally speaking, has very little importance for investors.

“However, he added, when great powers confront each other that’s not day-to day politics. “That’s world-shattering potential, although not world shattering inevitable.

The historian then steered the conversation back to Beijing’s long-term political strategy.

In the event of a trade deal, he went on to say, the big question for investors is whether they can trust that deal to hold for two years, five years, 10 years, 20 years.

“The problem is the uncertainty over this relationship is now semi-permanent. Even though there are calculations that can help reduce risks  in the short term, it is really hard for long term investors; it’s a different environment entirely.”

Deerpath Capital founder, James Kirby, from picked up this point, arguing that the direct effect of further trade tariffs or prolonged conflict will be negative which raises some interesting decisions on what discount rate to use when evaluating new projects. A higher cost of capital, in turn, has the effect of reducing investments,’ Kirby said.

“I   think that’s a real issue today and it’s going to continue until people feel like this high level of geopolitical uncertainty has been somewhat resolved.”

His comments were echoed by Mark Walker, CIO of UK’s Coal Pension Trustee Services, who also raised the topic of the strength of the US dollar versus the renminbi.

“Is this entire part of the world going to end up trading in renminbi,” queried Walker.  Is it a financial weapon or not?”

Kotkin downplayed this by underlining the depth of the US capital markets. He expects more trade in Chinese currency, especially bilaterally, but no change of the international financial system as a result.

Brendan Hallet, from New South Wales Treasury Corporation, expects financial market volatility to pick up as political uncertainty grows and becomes more mainstream,

The roundtable concluded that geopolitics is very hard to build into investment portfolios and it doesn’t matter until it does and at which stage it is too late.

 

The output of a decision-making process is more than just a decision, which is even more good reason to work hard at getting that process right.

Good decision making is central to good investment. So investment organisations naturally pay a lot of attention to the business of making choices. This article is about the output of that process. Which might seem like a short subject: the output of the decision-making process is, surely, a decision.

Well, yes. But it’s more than that.

Suppose an investment committee is considering hiring money manager X, or adopting strategy Y. The decision they make may appear simple: do it or don’t do it. Allocate 5 per cent or 3 per cent or nothing. But the way the decision was reached has knock-on effects, too.

Perhaps the committee was one of those that makes decisions based on the HiPPO principle – that’s where decisions boil down to the “highest paid person’s opinion”. (That’s a common way to make decisions, even though it’s not common to admit that’s what’s happening.)

Two years on, and perhaps there are some performance wobbles (as there nearly always are at some point). Does the group stick with the original decision, or does it bail? That probably depends on personalities and relationships, on whether the original hippo is still around, on whether the others in the room felt committed to the decision when it was made. So the process that was followed has an impact years later.

Or perhaps the committee followed the other common practice of requiring a consensus. Consensus is a good thing when it’s achieved authentically, but if every decision needs to be a consensus decision, it can be difficult to fully explore all possibilities. The awkward questions might not get asked. Perhaps it’s only when the performance wobbles happen that those awkward questions come up – two years later than they should have.

Then there are the decisions that are susceptible to being criticised with the benefit of hindsight, the sort of decisions that worry the lawyers. Suppose, for example, that a portfolio management team decides to disinvest from companies with poor environmental records because of the downside risk this creates. Or that a defined contribution plan decides to move significantly away from the peer group average asset allocation in its default strategy, in order to increase the probability of meeting the plan’s objectives.

Even if these decisions are based on prudent and rigorous analysis, it’s still possible that they will lead to losses. If that happens, it’s not enough simply to have made a sound decision, you also need to be able to demonstrate that you did so. So the process itself, and the documentation of that process, is a critical output.

There’s a danger, of course, that concerns about hindsight-driven criticism will constrain decisions. At its worst, this can mean fiduciaries fail to take actions that are in participants’ best interests. Fiduciaries must avoid the temptation to hide in the herd, and sometimes that means having the courage of your convictions. But it would be foolhardy to ignore the possibility of somebody challenging a decision at some point in the future. The existence of a paper trail can offer valuable protection.

Finally, few investment decisions are standalone decisions. Most groups do not come together to make one decision only. So the way each decision is made feeds back into the group dynamics, and shapes how the next discussion will go. An open conversation creates the conditions for a better decision next time, as the group becomes comfortable with one another. Groups tend to become more cohesive and effective over time. Occasionally, this can go too far, creating the possibility of group think – that’s when it’s time to bring in the outsider view, or to consider shaking up the team (uncomfortable as that may be).

So that’s just a few of the ways in which the output of a decision-making process is more than just a decision. Which is even more good reason to work hard at getting that process right.

 

Bob Collie is head of research at the Thinking Ahead Group, an independent research team at Willis Towers Watson and executive to the Thinking Ahead Institute.

 

The Oxford Sustainable Finance Programme at the University of Oxford has established a new research theme on The Future of Engagement, that will look at how to achieve greater success in engagement. Director of the program, Ben Caldecott, explains how emerging technologies, changing client preferences, new regulatory landscapes, and evolving economic geographies create new opportunities for more effective engagement and forms of active ownership.

 

Investors, from the largest institutions such as pension funds, insurers and sovereign wealth funds to the smallest millennial retail saver, are increasingly concerned with ensuring their investments across different asset classes have smaller environmental footprints and that these become better aligned with different environmental thresholds.

Effective engagement and active ownership are arguably one of the very few ways investors in large listed equities markets can have any positive (or negative) impact on the real economy. It is, therefore, incredibly important for improving the environmental performance of companies and assets.
Yet there are pervasive collective action problems in effectively executing concerted and coordinated engagement strategies with other like-minded investors. Further, investor influence on companies and their environmental footprints differs enormously by asset class, sector, and geography, as well as by the size and reputation of the investors in question. These differences are often glossed over.

These are familiar problems and some progress has been made to improve engagement. But much more needs to be done and done quickly in order to secure the implementation of the Paris Agreement and the Sustainable Development Goals.

To secure a step change in the efficacy of investor engagement for securing lasting sustainability outcomes, the Oxford Sustainable Finance Programme at the University of Oxford has established a new research theme on The Future of Engagement.

Fortunately, emerging technologies, changing client preferences, new regulatory landscapes, and evolving economic geographies create new opportunities for more effective engagement and forms of active ownership.

 

As part of the project we will looking at some of these topics: 

Engagement in asset classes beyond listed equities

There are many opportunities for effective change to be driven by investors through their holdings in different asset classes. We are interested in some of the following questions: how does the form and function of engagement differ by asset class? How should investors prioritise engagement in different asset classes and how might this differ by the type of institution? How could coordinated engagements across asset classes (‘full spectrum engagement’) work, and how could it help to achieve desired outcomes more quickly?

Measuring engagement performance

There is a distinct lack of research in this area, so fundamental questions can be explored to provide new insights, including questioning who should be doing the measurement, with what public/proprietary data, and whether measurement should focus on engagement outcomes or processes. The focus on measurement can also link to broader questions of whether and how engagement is incentivised and encouraged throughout the investment system. 

Fintech innovation

New fintech products and services are disrupting incumbents. Examples include the OpenInvest web platform which facilitates manager selection, PensionBee which allows the amalgamation of pension pots (potentially giving a louder voice to retail investors), and technologies which facilitate virtual AGMs (with the power to redefine corporate-investor communication and engagement spaces and practices). How can fintech change existing engagement practices and open up new approaches to engagement in the near future? Can fintech be used to track voting patterns, fund manager performance on engagement, and engagement outcomes? Can fintech be used to reduce climate-related information asymmetries between market actors, and how this data can inform corporate engagement? How can fintech redefine the geographies of corporate engagement?

Regulatory reform

There is significant momentum gathering behind sustainable financial regulation and policy reform in Europe and in other jurisdictions. We will explore how these reforms might affect the scale and scope of shareholder engagements throughout the investment system and across different geographies.

New markets

Much of the dialogue and academic research on engagement is focused on listed equities in the US, Canada, Europe, Japan, and Australia. How do engagement questions/issues differ geographically, particularly in emerging economies?

Behaviour and game theory

Novel insights into engagement strategies and effectiveness can be gathered through the application of behavioural finance and game theory. Can we secure new insights through behavioural experiments? Can game theory be used to optimize engagement strategies over the long term?

Newly available data

Developments in artificial intelligence, when combined with new and existing datasets, augur ultra-transparency that will upend the current information asymmetries that exist between companies and their investors, and between financial institutions and their regulators. This has huge potential to help align the financial system with environmental sustainability. New data can contribute to and further shape shareholder engagement practices and processes. Could this potentially drive more timely and targeted engagements?

‘Place-based’ engagement

Instead of engaging with boards and management on topics related to process, governance, or incentives at a parent company-level, could parallel engagement strategies become much more targeted and localised? For example, focusing on achieving specific sustainability outcomes in specific places and industries in a defined time period, taking account of local context and local levers of influence available to investors and investor coalitions

Theoretical, technological, regulatory, and practical changes can shape active ownership for the better and The Future of Engagement project will systematically explore these issues and identify specific ways to achieve greater success much more quickly. We need to achieve a step change in the quality and efficacy of engagement across asset classes, sectors, and geographies. This is essential if finance is going to work for both people and planet.

 

Dr Ben Caldecott is founding director of the Oxford Sustainable Finance Programme and an associate professor at the University of Oxford, as well as co-chair of the Global Research Alliance for Sustainable Finance and Investment.

Resources in the investment value chain have to shift away from financial analysis and securities trading towards stewardship and engagement according to Luba Nikulina, global head of manager research at Willis Towers Watson.

Speaking at the 8th Sustainable Finance Forum run by Oxford University Smith School of Enterprise and the Environment, Nikulina said there were a number of asset managers “doing good things” but there was too much greenwashing as sustainability has “became very fashionable”.

Nikulina and her team of 100 analysts review 30,000 asset management products to come up with 500-700 recommendations.

“There has been a lot of activity as everything related to sustainability is very fashionable. There are some firms that do some good things, but in reality in my team “green washing” is becoming a very frequently used term as we see managers using sustainability as an opportunity to package something for higher fees.”

She said the level and allocation of resources in the investment value chain needed to be reallocated to where it can and should make the difference.

Willis Towers Watson recently conducted some research on large passive managers to assess their capabilities in engagement. Nikulina said the resources they have dedicated to governance and engagement have increased in absolute terms, but in terms of assets under management the resources haven’t increased in line with that.

“The level of skill is also not good enough,” she said.

This is in the context of a speech given at the same conference by Professor John Kay who said that “stewardship is the main function of a large asset manager and we need to encourage them to get more resources to do that”.

Nikulina said that setting the tone at the top of the investment value chain was a powerful move forward and encouraged asset owners to engage more with their stakeholders including companies, managers, and consultants.

“But the problem with this part of the value chain is it is incredibly under-resourced. There are some very passionate asset owner champions promoting the cause, but there are very few of them. It is not the lack of willingness but the lack of resources, experience and expertise. It will come with time but it will take time.”

Feedback that Nikulina’s team have had from companies is that when there is engagement it focuses too much on issues effecting short term financial results, such as executive pay.

“Engagement is missing on longer term topics like strategy, culture and the way businesses are run which are not likely to lead to short term financial impacts but are arguably more important. This leads to the question of how we do engagement and on what,” she said.

Measuring impact of engagement is also an area that needs more work.

Nikulina’s team has been engaging with asset managers on their engagement practices in a bid to help measure their impact.

“Measurement is difficult. It is hard to measure without counterfactual evidence and say would have happened if you didn’t engage. For my team the only way to do sensible measurement is to shift our resources and engage with asset managers, and see what stands behind the success stories and the failures, and engage with them on the action plan,” she says. “The only way to achieve success is to have regular engagement and monitor progress – we now rate managers on that and if we haven’t seen progress then we downgrade the managers’ rating.”

In terms of measurement, Nikulina encouraged those entities that do engagement to carefully measure their progress.

“If you can’t measure yourself how do you know if you are making progress and effectively communicate with your stakeholders,” she said. “In reality for engagement to be successful it has to be done by everyone. We need a shift in mindset.”