Climate risk has certain features that stretch the imaginations and toolkits of investors, meaning a new framework that includes systems thinking is necessary to branch out from the narrow measurement and management of risk predicated on modern portfolio theory. Amanda White speaks to author of Net Zero in the Balance, Roger Urwin.

Net Zero in the Balance: A guide to transformational thinking, produced by the CFA’s research and policy centre and authored by WTW’s Roger Urwin, seeks to influence the industry in climate investing, a discipline that is still in its infancy.

“This paper is an attempt to build a guide to the whole framework of net zero which hasn’t really been described before. It’s a long paper and is meant to be the coherent whole,” Urwin tells Top1000funds.com in an interview.

“We are still in the creation of a net zero investment proposition, so there is not anything completely set in stone, and we have to adapt from here.”

The new framework emphasises systems thinking, which really means two things: thinking about the whole and its interconnections with the past; and a pattern that is changing all the time. It has a particular application to finance, which both impacts and is impacted by society, technology, the legal system, ethics, politics and consumers. And now, climate.

“We don’t want to over-complicate something that could be simple, but investment has quite naturally taken up system thinking but in a relatively unstructured way,” Urwin says. “Now net zero is a challenge to be integrated into finance.”

Historically, the investment industry has grown up thinking narrowly about its taxonomies according to Urwin, with Modern Portfolio Theory (MPT) in particular making some significantly narrow assumptions.

“This means industry thinking has grown up with a narrowness that is unhelpful now,” he says.

“The environment is part of our ecosystem. The climate system itself has its own ecosystem which is covered by specialist scientists and their disciplines are important for the industry to understand and embrace.”

Thinking deeper about the problems

Thirty years ago, Urwin started the investment business at Watson Wyatt, now WTW, which has grown into a business of more than 1000 employees. More recently he started working directly with clients in a more creative way, with deeper thinking at the core of his challenge to investors, scrutinising how and why processes and behaviours exist.

Similarly, the frame of the CFA paper posits that tackling complexity requires thinking that is inclusive of different perspectives and challenges norms.

“We need to think deeper about the problems,” Urwin says. “The industry has a lot of auto pilot in it. You can lead the horse to water, but it isn’t necessarily going to drink.”

The paper emphasises the need to breakdown the problem into “useable chunks” and suggests a new framework combining an investment model and systems model that will encourage conversations that are more grounded.

“This subject is really stretching,” Urwin says. “We are trying to coach people into…an understanding of the problem deeper than we have.”

Urwin says one of the problems is the industry wants wisdom, packaged up nicely in a bow.

“It’s the question of ‘what I should do on Monday?’,” he says. “Essentially the approach to climate everyone should be taking is to establish its materiality: is it impacting risk and return in my portfolio? Then climate risk management becomes an extension of normal risk.”

But while it is an extension of more commonly recognised investment risks, the features of climate risk present challenges to investors that their imaginations and toolkits have not previously tackled.

Urwin has an acronym to explain the complexity, SUPINE: systemic, uncertain, pervasive, interconnected, non-linear, endogenous.

“The action is the investment industry has to be better at integrating climate risk as a risk to be managed,” he says.

Challenges: Benchmarks, incentives, time frames

In addition to challenging the industry’s historical norms around behaviours and thinking, other industry structures present challenges for climate risk integration.

“There are problems in our frameworks in the system which get in the way of interacting with sustainability and climate in particular,” Urwin says, naming benchmarks, incentives and time horizons.

In essence he says benchmarks are backward facing; incentives are not integrated; and time horizons are relatively short and not balanced.

“The challenge is it is not joined up, and there are multiple goals. Under MPT there was only one goal, it was all about alpha, and that’s how the incentives and benchmarks were set up,” Urwin says.

But climate risk can’t be viewed through the lens of MPT because there are different risks entering the system in different time frames.

“We understand risk at a three-year horizon but when we look out 10 to 20 years we haven’t got the quality of the telescope,” he says.

Risk can be viewed through a stochastic lens which is engrained in finance, and uncertainty risk which, by definition, is the lack of quantification.

“At one end you have radical uncertainty, and unknown unknowns. Climate risk is more in that area,” he says.

The good news is twofold: this problem is ripe for the smart minds in the industry attracted to the intellectual challenge of new finance; and climate science can give meaningful insights for finance to adopt, most notably the integrated assessment model, for which Yale’s William Nordhaus won the Nobel Prize [See The spirit of green, an online video interview by Amanda White with Professor Nordhaus].

“I’m very clear it is an opportunity, and this is captured substantially in what people are trying to build into portfolios, like climate solutions as part of a net zero plan and financing them is a very important part of net-zero investing,” Urwin says. “Every time you have to be reminded whether the risk-return proposition is suitable for your portfolio, and a lot of the climate solutions are early innovation finance which has been more difficult for mainstream investors to commit to.”

Strategies for success

In addition to framing the issues of climate more broadly through systems thinking and developing transformational change within organisations, Urwin advocates universal ownership, stewardship and the total portfolio approach as strategies for success.

“TPA is a whole approach, so it fits neatly into the climate challenge,” he says.

Similarly, universal ownership or 3D-investing is a relevant framework for looking at each investment in terms of risk, return and real-world impact.

“The returns we need can only come from a system that works,” Urwin says. “The financial system is supported by the environmental and social system and if that doesn’t work it produces poorer returns as a result.

“This links to stewardship and moving the system to fully recognise externalities and doing what is possible to limit damaging climate change.”

An environment of increased macro volatility and geopolitical risk means investors should question assumptions, move towards more narrative-based scenario thinking and build resilience says Richard Tomlinson, chief investment officer of LPPI.

A healthy level of scepticism goes a long way in investing, and Richard Tomlinson chief investment officer of the £26 billion ($34 billion) LPPI, has it in spades.

In an environment he believes will become more volatile, and the impact of geopolitical uncertainty is untested, he’s “sceptical that everyone will play nice” and rates will come down.

In this context he’s encouraging his team to more explicitly acknowledge that investing is based on assumptions, and to look at uncertainty in views and forecasts, noting there is not one single reductive model.

“Don’t assume central banks can always come to the rescue with monetary stimulus, don’t assume the current (stable) plumbing of the world economy and world order will continue indefinitely, don’t assume rates and inflation will drop back to the levels of 2008 to early 2020’s,” he says in an interview with Top1000funds.com.

“Move away from point forecasts as these can be deeply misleading unless you are very careful with full disclose of all assumptions, methodology and all confidence intervals.”

Instead, he advocates for more narrative-based scenario thinking that is more dynamic and inclusive.

“Assume rates and inflation may be higher going forward and more volatile, don’t assume the rules-based order will continue indefinitely, assume that a big dislocation in markets will happen at some point but the cause could be any number of drivers,” he says.

With more dispersion and potential risk, it is more important than ever to invest carefully and be more dynamic in thinking and behaviours, and building resilience in portfolios is part of that.

“Investors need to try to be as aware as possible of the structural drivers of investment returns, like falling and stable inflation, low interest rates, tight credit spreads,” Tomlinson says. “And if any asset has relied on something being way above trend or structurally different to what is likely going forward, be careful.”

To this end Tomlinson suggests avoiding any asset that is reliant on “free money” or ultra-low rates and abundant financing, making him cautious on venture capital and any asset where the time-cost of money really matters.

“It drives you more towards investments with clear fundamentals,” he says. “That’s not to say more speculative investments can’t perform but time is now being priced more aggressively. Edward Chancellor’s excellent book The Price of Time is really helpful in framing this debate.”

He views the world as a bit more complicated than in the past, where allocators could invest globally and it didn’t really matter what you bought because everything went up.

“That’s not the case anymore. There is more dispersion and potential risk, we are seeing it in equities now,” he says.

“There is another layer of diligence going on for thinking about how the world might play out over the next few years. The risk profile of putting capital to work means the probability of something bad happening is high, it could be the geopolitics piece, but also some of the climate scenarios and physical risk in certain regions of the world is elevated.”

Building resilience

Tomlinson says building resilience in portfolios essentially means not building a portfolio for a single base case and embracing uncertainty.

“You do have to make some trade-offs but do it knowingly,” he says.

“Build a portfolio to perform in several higher-probability central cases and survive plausible negative ones. Narrative-based scenario analysis can help with this. The ‘what if’ questions and then some war-gaming of scenarios and the team making decisions to test thinking and reaction functions. My current view is don’t bet the farm on long rates falling right back down. But also don’t bet the farm against it!”

To this end, portfolio construction is key in terms of strategic asset allocation, but so is looking at underlying asset characteristics such as factor risks and cyclical exposure.

“We are more thoughtful on how we weight individual strategies within the buckets,” Tomlinson says.

LPPI doesn’t follow a full total portfolio approach, because underlying clients set an SAA, but its thinking is along similar lines in terms of a total portfolio view to achieve goals, rather than individual benchmark outperformance.

While the aim is to build a portfolio to survive in a range of scenarios, LPPI does tend to have more growth-orientated portfolios, leaning into inflation-linked assets, and is relatively underweight emerging markets. This is not based on a view of emerging markets per se, but rather, on an anchoring to the mandate of generating returns linked to long-dated UK liabilities.

And in areas like infrastructure and real estate there is a clear home bias because execution is more efficient with a team on the ground.

Tomlinson says this “structural alpha” or added value from execution is a natural advantage for LPPI, with its ability to fully originate and manage direct assets.

“Within our investment team alone, we have over 15 people focused on direct infrastructure and more on infrastructure funds, both investment due diligence and operational due diligence,” he says. “This allows us to manage exposure to infrastructure very effectively – driving alignments up, costs down and being able to be very specific about what we do and don’t want to do.”

The investment team has grown from 15 to over 70 in the time Tomlinson has worked at LPPI and he has focused on moving from generalists to specialist investment staff.

“Our people have deep experience and can push back hard on managers,” he says. “We have given them the environment and framework and they are very technical specialists and fanatics at what they do.”

Importantly there is strong governance around that, so the specialists get to flex their edge but it’s wrapped in solid operational due diligence.

“My job is to give them the environment to do that and step in if needed. We have a super solid underwriting process,” he says. “Any investment you make, there is risk and uncertainty. Do everything you can to make sure the initial decision is good and then make sure you have solid lines of defence.”

What’s next

Time horizons and connectivity underlie the challenges ahead for Tomlinson.

He’s moving the team to cooperate more as one portfolio, rather than silos, and to marry the top-down and bottom-up views and activities.

“We are trying to get people to think broadly, and out of the view of competing for capital. That is the bit that we are looking at to build,” he says.

Generally, the fund looks to invest over 15 to 20 years, but time horizons are on Tomlinson’s mind at the moment.

“We have strong views on what the world look like in five to 10 years, it’s more about geopolitics, demographics, and the supply side of economy and a potential collision between climate and demographics. There will be more change in the next decade than there has been in a long time,” he says.

But the challenging part is how to make those views actionable.

“That’s what I’m wrestling with, trying to make that more practical beyond not investing in a few areas,” he says, adding the ESG time horizon is one example.

“ESG in the now is a lot about compliance and reporting,” he says.

“But over a longer time-horizon it feeds into investment strategy, investing in the transition or ignoring it, physical risks and geographies. The mid horizon stuff is a bit more complicated. How do we think about the framing for the next five years, that’s the bit we are wrestling with.”

Most institutional investors continue to steer well clear of cryptocurrencies. The prospect of fraud and theft, wild volatility and more high-profile failures like crypto exchange FTX raise too many red flags to invest in crypto, blockchain, and the wider digital asset ecosystem.

But Abdiel Santiago, CEO and chief investment officer of the Fondo de Ahorro de Panama, Panama’s $1.5 billion sovereign wealth fund, is one of many CIOs watching the market develop from the sidelines.

Investment strategy at the young sovereign fund is still cautious and conservative. The fund began allocating to cash, fixed income and a little equity when it was set up six years ago and has only recently started to develop an allocation to private equity and infrastructure. Santiago is also exploring opportunities in core and opportunistic private debt with the fund’s investment managers although he says the asset class remains too frothy to invest in right now.

But he believes long-term investors are well positioned to embrace new opportunities in digital assets as the market develops, and signs of its evolution are evident. For example, the market capitalisation of Bitcoin already accounts for about 3 per cent of the S&P500: add in all the other cryptocurrencies and that reaches about 5 per cent.

Maturation is also visible in the emergence of Bitcoin and Ethereum exchange-traded funds which Santiago believes could provide a good entry point for more institutional investment. A range of ETFs has been approved in the last year and a half in the US, Europe and Australia, and he reflects that these products provide a more reliable wrapper, regulatory clarity, and have helped reduce the mystery around digital assets that could signpost wider adoption.

“ETFs are providing a sanitised method of investing in cryptocurrencies,” he says.

Some pension funds have already stepped into the market, such as the State of Wisconsin’s Investment Board which manages $156 billion in assets for the Wisconsin Retirement System. Elsewhere, $143 million State of Michigan Retirement System has invested in Bitcoin ETFs. Last May, Jersey City mayor Steven Fulop wrote on X that he planned to allocate part of the city’s pension to ETFs.

Correlation risks

Exactly how an allocation to digital assets would fit alongside other assets investors hold remains a key unknown. Bitcoin and Ethereum fell more sharply than equities, commodities and fixed income when markets crashed at the beginning of the pandemic; and Bitcoin shattered the idea that it was an inflation hedge when it plummeted as inflation soared around the world in 2022.

However, Santiago suggests that although the diversification benefits aren’t present today, that doesn’t mean digital assets are not an investable asset class and that they will not be a source of diversification in the future. Only time, data, and analysis will tell.

“It is still too early to see how digital assets will offer diversification in a portfolio in the future,” he says.

“Exploration of the basic correlation between bitcoin, the biggest cryptocurrency, and gold, averages around 0.5 to 0.6 in a positive correlation. Gold goes up and Bitcoin also goes up. Similarly, when the S&P500 goes up, Bitcoin also spikes. Although analysis of Bitcoin against a bond index sees less correlation, there is not enough history in the data to say if digital assets do or don’t act as a ballast against risk assets.”

He adds that it is similarly unclear whether digital assets will even grow as an opportunity set.

“It may be that it doesn’t grow, but just remains the same size for a long time.”

Regulatory clarity

What is clear, however, is the need for regulation. Santiago argues that a strategic shift toward clearer and more consistent regulatory frameworks would protect early investors and support sector growth.

“The stability of blockchain investments and, by extension, digital assets, significantly hinges on future regulatory clarity,” he says.

He describes the current landscape as “regulation through enforcement” whereby regulation is unclear but punishments and penalties are meted out for misdemeanours. For example, little viable regulatory progress ensued the collapse of FTX.

“The industry would benefit from and is asking for a regulatory regime in which serious players can operate,” Santiago says. “We are really looking for a catalyst that would allow people to start moving away from this punitive approach.”

Santiago is no more wary of the risk in digital assets than he is of the risk inherent in any other asset class. He traces much of the risk to the sector’s “bad birth” and thinks it is probable digital assets hold more headline than fundamental risk.

However, he says post-trade and custody concerns are particularly pressing for investors because of unknowns around how the assets would be held or protected.

“It would be about getting comfortable around the custody angle for institutions like us,” he says. Positively, he notes emerging solutions like cold storage, taking the investment offline and putting it with a reputable bank.

“It comes down to risk measurement,” Santiago says.

“Just because something is riskier doesn’t make it a bad investment.”

But he observes that many investors struggle to understand digital assets. The idea that their investment sits on a computer server is a difficult concept to grasp.

“For good reasons, investors want to see the asset they invest in,” he says.

“Even if it just a computer, we need to know there is something standing behind it.”

For this reason, he suggests the most compelling opportunities in digital assets will lie in blockchain technology and the real-world applications it offers, such as collecting and securing patient data; supporting money transfers; and logistics and supply chain management, for example.

“When we can see applications utilising this infrastructure for real applications in the real world our level of comfort develops,” he says.

Despite transparency in blockchain infrastructure, from an ESG perspective, cryptocurrencies are also problematic. Cryptocurrencies have uses for nefarious actors in evading sanctions and taxes and Santiago concludes the race to secure power for mining means owning power infrastructure is becoming as valuable as the cryptocurrencies themselves.

“This isn’t just mining,” he says.

“It’s a strategic bet on the future of power.”

 

 

At CalPERS, the largest pension fund in the US, the rationale for investing in the energy transition is as compelling as it was for technology investors in the early 1990s. The $500 billion pension fund for California’s public sector workers has pledged to invest $100 billion (up from $50 billion) in climate solutions by 2030, convinced the sector can generate alpha and help reduce emissions in the portfolio.

“If you go back 30 years and asked an asset allocator if they should have overweighted technology, the answer today would be that would be a good idea. We are at a similar point now as we were in the early 1990s, and we want to position the portfolio,” says Peter Cashion, managing investment director, sustainable investments at CalPERS on a Top1000funds.com webinar in partnership with Pictet Asset Management.

Pension funds like CalPERS’ growing commitment to the transition is reflected in a recent paper by Pictet Asset Management and the Institute of International Finance.

Although more investor capital is flowing into the transition, the authors also flag the yawning shortfall. Moreover, financing the energy transition is gobbling up most institutional capital, leaving sectors like agriculture and transport struggling to finance change.

“In order to meet 2050 net zero goals an additional $8 trillion needs to mobilize annually,” says Emre Tiftik, director of sustainable research at the IIF. “For each one dollar invested in fossil fuels we currently invest one dollar in clean energy and this needs to grow from 1:1 to 1:7.”

It’s not only the lack of capital that signposts the risks ahead, it’s also the source. Tiftik adds that if governments continue to finance the transition at current levels it will add an additional $200 trillion to global sovereign debt by 2050.

“This is not reflected in governments long term projections.”

Active investment

Tiftik argues that active investment is a helpful tool for investors seeking to pick winners in the early years of the transition. A strategy endorsed by Pictet Asset Management (Pictet AM) where stock picking begins by using the SDGs to measure the extent to which a company is aligned to the transition.

“We have an internally developed tool that assesses SDG alignment for all companies in the benchmark index MSCI ACWI” says Yuko Takano, senior investment manager of Pictet AM’s Positive Change strategy also speaking on the webinar. “It’s possible to see that higher-aligned companies have higher returns,” she said, explaining that alignment refers to corporate “leaders” – businesses that are already aligned with net zero and benefit from a green discount in their capital costs.

Pictet AM’s Positive Change team also buckets companies into “improvers” and “opportunities” categories. Opportunity stocks have the lowest level of alignment to the SDGs and lower valuations, and the team engages and nudges management in the direction of change. Investors should seek to hold a mix of opportunity and improver stocks because these companies represent a valuation opportunity.

Takano describes a bottom-up stock picking process based on fundamental research. The team particularly hunts for proof of sustainable business models that can profit in the new economy. Another element of research includes robust analysis of company financials.

“Transitioning takes a lot of capital,” she said. If the company has a weak balance sheet or high levels of leverage, it will be screened out.

“Being an active manager allows us to probe and question, and try to get more insights,” she says.

CalPERS is also developing a more active approach to climate investment, weaving in climate risk and scenario analysis into portfolio construction. For example, the team believes it is possible to generate outperformance by investing in companies that are climate aware and have efficient energy and water usage.

“Companies that are resource efficient [have a] lower cost structure and are more profitable. Companies focused on this have significantly outperformed in the last five years,” says Cashion, adding that strategy at the pension fund is shaped around partnering with managers that lead in the space. “It comes down to material knowledge asymmetry. Us as investors having knowledge that the market hasn’t factored into decision making.”

In another approach, in July CalPERS invested $5 billion in a climate transition benchmark put together with FTSE. The platform underweights high emitters without a transition plan and overweights high emitters with a transition plan and is sector neutral.

In public equity the team are looking at active managers with a view to working with a handful in a concentrated portfolio where the manager takes active bets on which companies will outperform because of the transition.

CalPERS augments its approach with a bespoke taxonomy that defines the three key areas it will invest. One is around mitigation and investing in renewables for example, where the pension fund has seen most deal flow. Another is shaped around adaptation, focused on investments at the forefront of innovation like heat resistance crops or reinforced infrastructure. The third classification is investing in companies prepared to transition like high emitters with credible decarbonization plans.

“We are investing in high emitters today with a clear path on how to reduce emissions over time. This supports decarbonisation of the whole economy, not just in our portfolio and this is where the largest capital investments are needed,” explains Cashion.

In private markets, CalPERS has already or will invest $5 billion, mostly focused on infrastructure and private equity. In private equity the deal sizes are smaller, but the number of investment opportunities is significant and offers diversification benefits. CalPERS is also opening up to new managers in this space.

“We are now looking at more mid-market asset managers; more niche or those that have a dedicated climate strategy.”

Other points in the report

The Pictet AM-IIF report also details the impact of carbon pricing, an essential element in the transition. The IIF’s Tiftik says carbon prices will cause energy prices to increase by as much as three times over the next 30 years with implications for economic activity and labour markets, and potentially reducing political will around the transition.

Although carbon prices will drive up energy prices, the impact on inflation will be limited because the transition will lead to output losses with significant implications, particularly socially.

He also flags that the inefficient use of capital in the green revolution could lead to bubbles. All revolutions have a habit of creating bubbles because of asset misallocation.

“We are worried about this and need to monitor it closely,” he concludes.

Published in partnership with Pictet Asset Management

New Zealand Super’s new chief executive Jo Townsend inherits an organisation with a strong culture but facing some challenges posed by rapid growth. An internal project aims to reduce complexity and focus on simplicity for a fund already rated by WTW as operating at global best practice levels.

New chief executive of New Zealand Super, Jo Townsend, is aware of the fine balancing act her role requires: managing organisational change, as an aftermath of growth, in an organisation that has grown up with an embedded and very particular culture.

At 20 years old New Zealand Super is a young organisation, and for 10 of those years the partnership of Adrian Orr and Matt Whineray was the backbone of the organisation, growing a culture and investment process from the ground up.

With a great legacy to work with, including record five-year returns, Townsend inherits an organisation of 200+ staff (with 55 appointments made in 2023 alone) and assets of $79 billion with all the complexity of fast-paced growth and capital market headwinds.

“As a new CEO one observation of the organisation is it has grown quickly in the last five years in headcount, and complexity can be a function of rapid growth in an organisation,” she says in an interview with Top1000funds.com.

“I understand the importance of culture and it is a key area of focus in the organisation. As a new CEO top of mind is how to maintain that through a period of change.”

Townsend, who started as CEO in April this year, is taking a considered approach to understanding the organisation, involving staff in the evolution but also bringing a new perspective.

“I am looking at processes with a fresh set of eyes. I’m asking everyone ‘why do we do it that way?’ And having good chats about what the change challenge is in the organisation, and getting people to think about ‘how and why’, not ‘what we need to…’.”

While she says it is still early days there is a common realisation and acceptance there needs to be change to be successful.

An internal project, with the grand Oscars-like name of Guardians of the Future, focuses on key initiatives for continuous improvement.

“It is internal language we use when talk about continuous improvement and what we need to do to be able to be successful over the next 20 as we have for last 20 years,” Townsend says.

Key areas of focus include reducing complexity and focusing on simplicity; strengthening the investment approach through evolving the total portfolio approach and sustainability; and maximising the organisation and focusing on culture and a learning mindset.

The successful evolution of these three key elements of the organisation – culture, technology and the total portfolio approach – were also reflected as areas of improvement in the fund’s recent independent review, as required by law, with the fund receiving a WTW Global Best Practice rating.

The review was very complimentary in its report, including an acknowledgment that New Zealand Super is operating at global best practice in its activities, a state it has maintained for the past five years, and that WTW has the view the “investment process is completely exceptional among the asset owner community”.

But it also said a focus on new leadership, improving system design, maintaining a strong culture in a more complex organisation, and undergoing a technology transition, were all factors that can make the organisation more resilient.

CIO hire

One of the principal challenges for the organisation is filling the vacant CIO position, following Stephen Gilmore’s defection to CalPERS. Chair of the fund, John Williamson, has only been in the role since February this year, so how the three key individuals, all new to their roles, interact will be crucial to the future of the culture.

Townsend says there has been a huge amount of interest both internally and externally in the CIO position, but she is taking her time with the process.

“I want to make sure we are doing the most thorough process we can,” she says. “We are trying to conclude as soon as possible but we won’t rush.”

One of the consequences of the CIO vacancy is a 12-month delay in the usual five-year review of the reference portfolio.

“We will do a full review of how we do that strategic setting of our risk appetite and objectives and how to achieve that through our total portfolio approach,” she says.

Townsend says one of the WTW recommendations was to incorporate more horizon-scanning of systemic risks in the lead up to the review of the reference portfolio.

“We have a long lead time in that reference portfolio review, and will start with some of that scenario planning,” she says.

“We take that on board and are working with the asset allocation team and economics team to work out the best way to produce that information for board.”

Technology transition

For a couple of years the fund has been conducting a strategic project, dually supported by the technology and investment teams, to build and strengthen investment data.

“We are migrating away from legacy systems and putting a Snowflake database in,” Townsend says.

“This is a big investment data program, that will be foundational and extremely important to deliver. We are hoping to move out of project phase into BAU in mid next year.”

Click to enlarge

As part of this, staff are being upskilled in certain areas of technological ability, including Python.

Overall Townsend says the WTW reviews have been beneficial to the fund as a guidepost or health check that it is heading in the right direction.

The last review in 2019 also provided recommendations including a review of beliefs; a review of the compensation structure; making greater use of a risk factor framework and allocating more resources to focus on responsible investment; and greater use of stress testing. All of these have been addressed by NZ Super in the time between reviews, with various responses by the fund. A review of investment beliefs and a remuneration review were both completed in 2020.

Townsend says she entered the CEO role knowing this process, which is a co-creation with WTW and sharing of views and drafts going back and forth, was underway.

“It’s been a very useful process. WTW could get a full picture with the co-creation, and it was helpful for me in getting up to speed as new CEO,” she says.

“The process overall was extremely valuable, and there have been strong levels of involvement from Treasury which was fantastic. Overall, the process has added benefit to the Guardians, giving assurance to the government that the path we are on is solid and robust.”

More innovation originates from the US than in Europe, says Timo Löyttyniemi CEO of the €21.6 billion Finnish State Pension Fund (VER), and while Europe has made several attempts to respond to the dominance of US tech giants, the US venture capital market is stronger, and most IPOs take place in the US.

But although European innovation has not been as attractive an investments as US tech Löyttyniemi argues in a recent post on the fund’s website, that could change.

In the US most patents are registered by start-up companies, and fostering a European growth market for start-ups is one way of promoting innovation he says, suggesting a five-point plan to boost European innovation.

Information and communications

For innovation and venture capital investments to be attractive, they must be profitable. According to the latest statistics from Invest Europe, European venture capital funds have outperformed US funds over the past 10 years, returning over 20 per cent per annum.

In the preceding period, it was the other way round.

“Sound profits attract investors. Information about healthy profits should be actively distributed and made readily available. The 2021 and 2022 venture funds are likely to prove disappointing, but if interest rates fall, the investment environment will offer improved opportunities for innovation and its financing.”

Investment products readily available

Löyttyniemi  says that investing in venture capital funds is often a difficult decision for European investors.

“Newly established funds are initially small. For an institutional investor, analysing these funds is an arduous and time-consuming task.”

For this reason he advises creating fund of funds, allowing investors to be collectively involved in the start-up sector.

“In Finland, such a solution is offered by the Finnish Industry Investment’s fund of growth funds. Its counterpart at a European level is the European Investment Fund.”

He says that BlackRock’s purchase of Preqin could offer investors new opportunities. BlackRock has typically operated as an asset manager focused on the public equity and fixed income markets. Now it is making a foray into the illiquid markets where Preqin has been a leading information provider.

“Hopefully, the acquisition will generate easy and cost-efficient investment products for the unlisted market.”

A single strong technology exchange

Löyttyniemi argues that Europe needs a strong European ‘Nasdaq’ where growth companies can list. In a report published in June, McKinsey highlighted the wide gap that exists between US and European exchanges. The stock exchanges differ both in terms of the number of technology companies going public and valuation levels.

“We could create a perception of a single exchange even if it were a combination of many,” he says. “The important thing is to establish a highly visible and prominent marketplace whose star companies become the talk of the town.”

The challenge Europe faces is where to set up this exchange. Pre-Brexit, London would have been the obvious choice but the location is not obvious today.

A single strong technology index

A strong stock exchange creates a strong, easy-to-follow index that allows investors to make investment decisions based on that benchmark index.

“If there are too many indices, there will be no sufficiently strong benchmark that would generate sound investment products. A strong stock exchange equals a strong index. It is also possible to create a robust virtual index based on several technology exchanges and local ‘Nasdaq’ exchanges. This would be the second-best option if a single strong exchange fails to materialise.”

“Nasdaq is a household concept. So is Silicon Valley. Where are Europe’s innovations?” he asks.

Information marketing

The efforts to create a European Capital Markets Union (CMU) is a long-standing project. The problem is that the proposed solutions are limited and isolated without an overriding idea of how the European capital market should be created.

One solution, he says, is the ‘innovation market.” Innovation market infrastructure is a chain of layers which consist of stock exchange, market, benchmark indices and investment products by which investors are attracted to invest.

Europe possesses huge potential in terms of knowledge and skills, he concludes.

“This fact can be used to create a roadmap for the kind of progress outlined above to increase the attractiveness of European growth companies from an institutional investor perspective at the various stages of development.

“When there is a good and functioning market for innovations, it will drive workers and researchers to innovate. A pre-condition for a sound market is a multi-tiered, highly functional capital market infrastructure.”