More and more investment organisations have begun to recognise and embrace the importance of a strong culture, and to actively build one. So what is culture?

Think of the genetic code in DNA. It is a set of rules that define the development and function of living organisms. Similarly, culture is the written and unwritten organisational code that defines the way an organisation does things. It is the collective influence from shared values and beliefs on the way the organisation thinks and behaves.

For an investment organisation striving to be a long-horizon investor, what kind of organisational culture should they build?

The right people

First, let’s not lose sight of the fact that culture is unique to individual organisations. There is no such thing as the best culture model. That being said, I am hoping to offer a few ideas for long-horizon investors to adopt as part of their own genetic code.

Start with hiring the right people. The foundation of a strong long-horizon culture is people who genuinely believe in long-horizon investing and act accordingly. Extrinsic (monetary) incentives can influence behaviour but intrinsic characteristics – innate to an individual’s values, perspectives, knowledge, experiences and way of thinking – are more powerful for achieving alignment and producing desirable outcomes. The tendency to do the right thing (as opposed to just doing things right) should be a prominent prerequisite for hiring. This includes the willingness and ability to challenge the consensus position.

Once the right people are hired, the organisation needs to demonstrate long-term commitments to their growth and development. One of the challenges is that the duration of some long-horizon investments can be much longer than the tenure of the individuals involved in the initial decision to invest. That mismatch can be addressed, at least partially, by encouraging longer tenures. When it comes to assessing people, the key is to reward long-term thinking and behaviours, instead of short-term investment performance, which is inherently noisy.

Given the right people, it is important to think carefully about how to put them together to form a team. The goal, in my view, is to build cognitive diversity through composition and process. Institutional investing is all about group decision-making. Under most circumstances, cognitive diversity helps improve that decision-making.

A long-term investment journey is bound to be bumpy. When adverse performance inevitably happens, a team rich in cognitive diversity supports an environment where non-consensus views are actively solicited and the willingness to go against the crowd is encouraged. It can also lead to advantages in processing information and greater cognitive resources (skills, perspectives, knowledge, and information). All these benefits facilitate a more accurate assessment of whether an investment thesis is still valid. If it is, then staying on course becomes a straightforward decision. If, on the other hand, the assessment points to having fallen into a value trap, then the organisation should not blindly stay put.

Integrate and include

Diversity is ineffective without inclusion and integration. There is a balance to be found between promoting cultural unity and avoiding everyone thinking and acting the same. Building highly diverse teams without good integration can lead to more dissenters when times get tough, causing distractions and value-destroying decisions. Patterns of working together within a team should be set early on, and good integration can be fostered by introducing appropriate behavioural checklists.

Leaders are hugely influential in the creation and evolution of culture. Recognising that culture declines over time when left to its own devices, good leaders actively work to maintain it. They lead by the examples they set, what they choose to focus on, and what they don’t to tolerate. They seek a deliberate alignment of culture to long-term strategy and take every opportunity to advocate for the importance of a long-term approach. They engage in building peer-to-peer relationships and mutual respect with the board. In times of underperformance, this relationship should provide a buffer and enhance understanding.

Good leaders strive to build an environment where career risk is low. They have the willingness to appear to be wrong and reward genuine progress towards long-term objectives. They make sure the entire organisation is in sync regarding the benefits of investing for the long run and the expectation of a bumpy ride.

They also communicate clearly and regularly. Lim Chow Kiat, chief executive of GIC, Singapore’s sovereign wealth fund, spoke about being careful about the exact words used in communication. The fund prefers “sustainable results” to “consistent results”. Leaders will correct anyone who uses or likes the phase “the long term is but a series of short terms”. In Lim’s view, the wrong words can corrode or even corrupt the process.

Long-horizon investing is challenging. But if there is such a thing as a ‘secret sauce’, it comes from building a long-horizon culture as a competitive edge.

Liang Yin is senior investment consultant in the Thinking Ahead Group, an independent research team within Willis Towers Watson and executive to the Thinking Ahead Institute.

Boomboxes, Polaroids, floppy disks and phone books. There is an entire generation today for whom these things are mostly alien, consigned to the past, thanks to the wisdom and technology of our age. With only one of the last 35 calendar years exhibiting inflation of above 5 per cent in the US, is high inflation just another quaint phenomenon to be added to the history books? Or is it a dormant risk lying in wait?

For some observers, the runaway levels of inflation observed in the 1970s and 1980s are unequivocally a problem of the past. To this way of thinking, a combination of central bank independence, structural reductions in the strength of organised labour, decreasing reliance on fossil fuels and improvements in technology that lower consumer prices, makes inflation more easily controlled by policymakers and high levels of it unlikely.

At the other end of the spectrum are those who argue that inflation is almost inevitable as unemployment reaches secular lows in the US and the UK, reversals in demographic trends increase dependency ratios in coming decades, and central bank policy remains extremely stimulative in a historical context.

We cannot know for sure which view is accurate. Inflation is a complex phenomenon driven by many interacting forces within an economy, and some of these relationships are not well understood. Consequently, we are cautious about making bold predictions about the level or direction of inflation over time.

We do believe, however, that there is evidence that the balance of inflationary and disinflationary forces is shifting, such that there are an increasing number of plausible scenarios in which inflation could move meaningfully higher than current levels in developed economies.

Peak globalisation

Inflation and wages – and by extension the labour market – are intertwined, and for the last few decades, the increasing globalisation of the labour market has acted as a disinflationary force, as it has opened up cheaper labour markets in emerging economies. This has reduced the bargaining power of workers in developed economies and exerted downward pressure on both wages and prices.

The influence of this relationship may wane as previous sources of cheap labour in Asia, Latin America and Eastern Europe experience rising wages and standards of living, and the options for low-cost labour outsourcing diminish. Although there may be scope for further trade liberalisation to drive production costs down globally, there is perhaps a greater chance of moves in the opposite direction (deglobalisation) given the current tensions surrounding trading relationships.

Fewer workers and more retirees

Another inflation driver with a long-term trend that may be changing direction is global demographics – in particular, the proportion of the total population that is working versus the proportion not working (i.e. the dependency ratio).

There is a lively debate around how changes in the dependency ratio may influence interest rates and inflation, but a compelling argument centres on the supply and demand for goods and services. The argument is that children and retirees (the dependent population) contribute only to the demand for goods (via consumption), while the working-age population contributes to both the demand and supply of goods (via consumption and production). The dependent population, therefore, provide an inflationary impulse in the economy, while the working-age population will tend to be a disinflationary force.

United Nations population projections suggest that we are at, or close to, a turning point in the global dependency ratio. This could turn a longstanding disinflationary force into an inflationary one over time.

Cyclical pressures

In addition to the structural drivers discussed above, a further inflationary impulse arises from cyclical pressures in the current economic environment. Although cyclical drivers such as low unemployment and strong global growth can, to some extent, be offset by tightening monetary policy, cyclical forces are arguably more inflationary today than at any time since the GFC. This is particularly true in the US, where fiscal stimulus is being applied when the economy is already facing late-cycle inflationary pressures.

In counterpoint to the forces discussed above, it is worth noting that technology is likely to remain a powerful disinflationary force for decades to come, as the prospect of rapid increases in automation places downward pressure on wages and production costs. However, it is extremely difficult to assess the likely pace of technological development and its impact on inflation over time.

The discussion above illustrates that the balance of inflationary and disinflationary forces in the global economy may be changing and we would argue that inflation risks are skewed toward the upside, from a cyclical standpoint. Investors should avoid biasing allocations in a way that assumes a continuation of past trends and seek to ensure their portfolios are likely to be robust in inflationary scenarios.

We encourage inflation-sensitive investors to make a clear assessment of their inflation needs, as determined by their objectives and liabilities, and review the balance of risks within their portfolios – in particular, the extent of their exposure to higher-inflation scenarios.

Inflation-sensitive investors holding portfolios dominated by broad market equity and fixed interest bonds could consider diversifying both their growth and defensive portfolios. Within growth portfolios, real assets – both listed and unlisted – may provide some degree of inflation sensitivity. Within defensive portfolios, inflation swaps, inflation-linked bonds, shorter-duration bonds and floating-rate assets are likely to prove more robust under higher-inflation scenarios than traditional fixed interest government and corporate bonds.

President Xi Jinping, during his first visit to the US in 2012, called for a “new type of great-power relations in the 21st century”. This statement – a version of which had been uttered with far less notice by several of Xi’s predecessors – was taken to imply that China seeks recognition as a superpower on a par with the US.

For most of recorded history, China was the pre-eminent power. Back in 1784, when the first US ship landed in China, at the port of Guangzhou, carrying American-grown ginseng and some New World silver to exchange for valuable brick tea, America was a small coastal nation with a population of 3.9 million and a mostly farming economy. China then had a population of 300 million, and accounted for an estimated 40 per cent of global GDP.

History played a cunning trick, however. Not long after the founding of the US, China happened to go into prolonged decline. Its tribulations lasted the better part of a century and a half. Without that circumstance, one is hard pressed to imagine the US becoming a superpower, given the importance to US prosperity and standing of dominating East Asia. By 1979, China’s claim on global output was a minuscule 1.5 per cent, despite having nearly 1 billion people. In contrast, the US, with less than a quarter of China’s population, boasted a 27 per cent GDP share.

Stunning ascent

Then, history surprised once more. Over the ensuing four decades, China’s GDP, in dollar terms, skyrocketed from about $270 million to $12 trillion. Today, the country accounts for more than 15 per cent of nominal world output. The US share sits just above 20 per cent. Who, in 1979, had any inkling of such a turnabout? Be careful when forecasting the future.

Several factors drove China’s stunning ascent. But one key was Deng Xiaoping’s strategic reorientation away from the Soviet model, towards a de facto economic partnership with the US. The Chinese leader had observed the miraculous revival of his neighbour Japan from the ashes of the Second World War, followed by the rapid rise of South Korea and Taiwan, all of which had adopted a strategy of selling into the ravenous US market.

In 1979, Deng became the first Chinese Communist leader to visit the US, which the next year opened its markets to China, just as it had done for the East Asian tigers. Chinese industriousness proved to be stupendous; still, it is not too much of an exaggeration to say that the colossal appetites and purchasing power of the American middle class created the Chinese middle class.

The interconnections have run deep. China and the US had combined in the Second World War to defeat Japan’s attempted seizure of East Asia. And, notwithstanding China’s turn to communism and the two powers’ clash from opposite sides of the Korean War, the US initiated a rapprochement with Beijing, as a counterweight to Moscow, then fully supported China’s rise, fantasising that as that country grew rich, it would become more like America.

Delusions aside, China’s revival has taken place entirely in a US-dominated world. The current situation – with the two countries simultaneously great powers – is a first.

Modern China confounds

What happens next? One of the fundamental problems with answering that question derives from China’s rebounding history. Everything we think we know about the importance of the rule of law and secure property rights, the necessity of freedom of information, the superiority of private companies, domestic political competition as sine qua non, and much else, we formulated without having to take China’s example into account. After all, China was down.

Now, many experts have been applying the laws of social science to a resurgent China and predicting the authoritarian system’s demise. However, decade after decade, the downfall fails to occur. Perhaps China will eventually be undone by the so-called middle-income trap; that is, it will stop developing for want of high-quality institutions, and suffer social upheaval. Bad debt might cause a financial and then a political bank run. Corruption could finally stop being a lubricant and become fatally corrosive, bringing down the whole system.

As the expression goes, China at some point must cease to defy gravity. In the meantime, however, its state performs a great deal better than many experts think it should, and so does its economy.

Never has a state this opaque become this wealthy and mighty. True, we have the intriguing cases of Germany and Japan before the First World War – two authoritarian regimes that had highly dynamic economies. But both were more politically pluralist and open than today’s Communist-ruled China.

Analysts of the rise of imperial Germany and imperial Japan are still debating whether it was their authoritarian regimes, or the nature of the international system of the time, that rendered them externally aggressive. This debate has implications for gaming the behaviour of contemporary China. What is certain is that imperial Germany and imperial Japan were profoundly influenced by Great Britain’s policies and global posture. Today, China’s trajectory is intricately intertwined with that of the US.

Doubts about the US

Beijing’s ability to continue on its upward path is not the only confounding variable. The institutional stability and overall reliability of the US have come to be doubted, too. Observers have gaped as the US administration deliberately undermines its own surpassing assets – democratic government, open markets, and mutually beneficial alliances. Behind this transfixing attempted suicide lie longer-term failings in understanding and responding to China.

Investors have been put on notice by the White House’s erratic declarations of trade penalties, which address genuine issues but in self-defeating fashion, and China’s vows of retaliation. Each government is seeking to demonstrate resolve. There is much more skirmishing to come, and no end in sight to the vicious rivalry over artificial intelligence, bioengineering and other frontiers of technology. But rather than the expected deepening economic frictions, it is the unexpected or the half-forgotten – that old problem of Taiwan – that is poised to shatter everything.

China has made a point of reclaiming territories it views as historic possessions, most recently Hong Kong, and Xi personally reaffirmed Taiwan as Chinese territory and a “core interest”. The modernising People’s Liberation Army, for its part, is at last on the verge of acquiring the amphibious landing capacity necessary to seize Taiwan by force.

Such an action might seem so self-destructive, economically, as to be out of the question. But opinion polls of the island’s inhabitants have recorded a trend decisively away from Chinese identity toward a separate Taiwanese identity, the opposite of what mainland China had hoped for from stronger bilateral economic integration. About 60 per cent of the island’s residents consider themselves exclusively Taiwanese, 3 per cent say they are Chinese, and 30 per cent say they are both. For those under 40 years old, Taiwanese identity – associated with democracy, rule of law, freedom of speech and assembly – climbs towards 70 per cent. Connect this fateful evolution to Xi’s aspirations to achieve a historic reign, and to America’s paper commitment to defend Taiwan’s sovereignty, and one can see just how combustible is this flashpoint.

Can Beijing allow solidification of what, from its point of view, is a permanent separatist identity? Significant economic pressure has not chastened the Taiwanese. It seems only a matter of time before the Communist party leadership feels compelled to intervene. And if the US were to fail to reverse a mainland takeover of Taiwan, that would demolish American credibility throughout Asia, a perhaps too-tempting proposition for Beijing.

Americans and Chinese, John Pomfret’s magisterial The Beautiful Country and the Middle Kingdom states, have repeatedly been swept up into “rapturous enchantment begetting hope, followed by disenchantment, repulsion and disgust, only to return to fascination once again”. One hopes he’s right – and that relations soon re-enter the front end of that cycle. For now, the two powers are on the road to conflagration.

Pomfret concludes that the US and China are locked “in an entangling embrace that neither can quit”. Xi’s evocation, in his 2012 speech and since, of revived superpower status and rewriting of the international rules, resonates profoundly with the mainland Chinese people. So does Beijing’s forward posture in the South China Sea, which the US Pacific fleet patrols. The US administration must figure out not only the Chinese regime’s objectives and bottom line, but also how Chinese decision-makers view US objectives, and whether they consider US statements credible. Washington’s escalating confusion and ineptitude over how to handle China’s predictable, eventual refusal to accept subordinate status in a US-configured world does not inspire confidence.

As the relative power shift continues and we puzzle over the varying degrees of resilience or brittleness of the two different systems, we remain bereft of answers to the question of what their stable coexistence might look like. Moreover, even if we knew the contours of that peaceful win-win equilibrium going forward, we would still have to figure out how both sides would get there.

Business as usual is upending business as usual. Investors could play a part in a spiraling destabilisation, betting on making money from anticipated dislocation.

Britt Harris defines strategy for the year ahead at the University of Texas Investment Management Co in two words. “Total alignment” is the new mantra that will govern the $41 billion university endowment’s own internal structures, and its relationships with investment partners and external beneficiaries.

Built on the analogy of a ship set on course with all oars rowing in sync, total alignment describes Harris’s first major overhaul at the fund he joined last June as chief investment officer and chief executive. It reflects Harris’s renowned expertise in team building, developing talent and nurturing partnerships during a career that includes 10 years leading the $140 billion Teacher Retirement System of Texas (TRS) and a stint as chief executive at hedge fund giant Bridgewater Associates.

“This is a strong foundation for UTIMCO going forward that can last for years to come,” he said when presenting the total alignment strategy to the UTIMCO board.

The strategy represents a refreshed mission and more aspirational vision for the endowment, which was founded in 1996. Although UTIMCO has long had a profound mission statement, Harris says few people can remember it. Now, a raft of new and pithy acronyms sum up UTIMCO’s goals of fostering education, research and advancements in society and healthcare.

It is these goals that will inform a culture of higher purpose designed to play a key role in attracting and retaining talent. The fund has lost 37 people in the last three years, and Harris is determined to see the endowment recruit and hang on to top talent going forward.

“One of the great things that we have here is a more easily articulated higher purpose than most organisations that manage money,” he explains. “If you want to make a difference in the world with your skill set, this is where you want to be.”

Harris draws on his own managerial expertise to articulate the type of culture he wants to imbue. He counsels colleagues in preparation, being early rather than on time, coming to work with their “headlights on”, and adopting curiosity over defensiveness. And although he has only just taken the reins, he is also determined to have UTIMCO develop a succession plan, so a senior team that reflects the values of the fund will be ready and able to take the helm.

“Every great organisation has a succession plan,” he says. “One of the reasons I could leave where I was without disruption was because we had done a good job preparing for succession.”

In sync on the inside

Successful investment organisations are also built on strong internal teams that all work in sync, and here is where Harris has spotted another gap in UTIMCO’s armour.

“We have a lot of really talented people who are highly motivated, superstars in their own right,” he says. “But the teams themselves are still relatively young. One of our challenges is how we mature these teams.”

To help, he has brought in expertise from the outside. New recruits include deputy chief investment officer Rich Hall, previously head of private equity at Harvard Management Co., and managing director Scott Slayton, who joins UTIMCO from Jamison Capital Partners.

Harris is also targeting reform of the endowment’s internal processes to build teams from the inside. He wants UTIMCO’s 94 staff to get to know one another better; he’s just ordered ping-pong and pool tables to encourage people out from behind their desks and into communal areas at the fund’s Austin, Texas headquarters. He says strategy will concentrate on putting people in positions that play to their natural skills and innate qualities, where they can excel via “natural ability” rather than “brute force”. He also calls for management to think “not about what is best for my unit, or best for me, but what is best for the fund”.

Collaborative partnerships

Total alignment also applies to UTIMCO’s external relationships. In another shakeup that bears the hallmarks of Harris’s strategy at TRS, he aims to transform UTIMCO’s relationships with managers from adversarial clashes into strong, collaborative partnerships based on sustainable fee structures and status for UTIMCO as a preferred client at the front of the queue for the best deals. Harris proved his ability to change the dynamics between asset owners and managers when TRS remoulded its relationships with hedge fund managers using a new 1-and-30 fee model. He took the new deal to 23 of the fund’s managers and 18 accepted it.

The fund will be reviewing the compensation of all managers that have underperformed and for which UTIMCO is paying more than 50 basis points.

“They are not all going to be fired; they are going to be reviewed,” Harris says.

He also wants to create a premier list of about 30 top managers across asset classes that can be drawn upon as and when needed. This way, the fund will no longer be looking for managers all the time.

He also wants to build more strategic partnerships in the public and private markets.

“I’ve done this in the past and it produces outsized returns on an absolute and risk-adjusted basis,” he says, adding that co-investment and strategic partnerships are also important conduits for bringing new information into the fund.

“It’s not going to happen in a day or two or a month or two, but it is already [starting],” he says. “We will be well served by this framework. Total alignment is our first priority.”

Long-term investors know sharemarkets are overvalued but they are struggling to work out when, or if, a crash will come. By looking back through recent capital markets history, Keith Ambachtsheer, professor of finance at the University of Toronto’s Rotman School of Management and a frequent adviser to pension funds and governments, throws a ray of light on what the future holds and how long the good times, and the bad, might last.

In the latest Ambachtsheer Letter, he argues that even with an uncomfortable downturn, long-term equity investors will still come out ahead. But he warns to batten down because a difficult bout could last for 10 years.

His analysis applies to investors with 30-year horizons, free from short-term drawdown risks. Examples include sovereign wealth funds and the likes of the giant $C337.1 billion ($265.5 billion) Canada Pension Plan Investment Board or the $NZ38.4 billion ($28.1 billion) New Zealand Super Fund, plus the raft of pension funds that now put conditions on how much they pay out.

“A large part of the institutional world is now managing truly long-term money,” Ambachtsheer says.

By constructing multi-decade scenarios for capital markets, Ambachtsheer looks ahead to share and bond return prospects and their implications on strategy for long-term investors. He frames his research on the Gordon model for long-term equity investment. The formula, developed by academic Myron Gordon, who was also based at Toronto University before he died in 2010, is a renowned method for calculating the fair value of shares.

Ups and downs

To help construct his future scenarios, Ambachtsheer looks back at how capital markets have behaved since WWII. The ’50s and ’60s brought steady economic growth and modest inflation. The ‘Scary ’70s’ followed, with energy wars and accelerating price and wage inflation, which led to 20 years of steady economic growth and modest inflation in the ’80s and ’90s. Excessive optimism at the turn of the century led to the ‘double bubble blues decade’ with its dot.com bubble followed mid-decade by the housing finance bubble – leading to the global financial crisis. Since then, concerted global monetary action has set the stage for the current, optimistic mature capitalism era, now 8 years old.

With this context in mind, Ambachtsheer sees three possible scenarios playing out in the decades ahead – which one will come true is difficult to predict.

“We know how something will happen and the consequences, but I can’t give the probability,” he says.

Mature capitalism scenario

First, mature capitalism could continue. In this scenario, robust productivity and profit growth remain, accompanied by less of a boom-bust cycle, thanks to a lack of correlation across geographical and economic sectors, continued subdued inflation, continued low nominal and real interest rates by historical standards, and relatively high equity prices. How long mature capitalism would last is difficult to gauge. Some optimist-driven periods have lasted 20 years but that isn’t cast-iron reassurance, Ambachtsheer says. Looking back before WWII, the Roaring ’20s era lasted only a decade before the nasty, capital value-destroying Dirty ’30s.

The bubble scenario

A second scenario suggests another bubble decade. Investors would once again buy into a high-tech narrative, as they did in the ’90s, this time led by Apple, Amazon, Google, Facebook, Tesla, Bitcoin and their younger brothers, sisters and cousins. Share prices would once again levitate into materially over-valued territory. As happened in the first decade of the 2000s, the return of equity prices to economically justified levels would be ugly, leading to financial distress for many equity investors, while yields on high-quality bonds would fall once again.

Scary ’70s redux

Ambachtsheer’s third scenario is a replay of the Scary ’70s. After ultimately futile negotiations, a new global trade war would erupt, leading to faltering economic growth and rising inflation across the world. At the same time, the climate change targets of the Paris Accord would be breached, damaging food production, water supplies, and the viability of living in low-level coastal areas and high-pollution urban areas. Financial markets would react negatively, with falling share prices and rising nominal and real interest rates.

A downturn could last a while, Ambachtsheer warns. History suggests it may take as long as a decade for things to return to normal.

In two recent cases, it’s been 10 years, he says. “The crisis in the ’70s resolved in the ’80s and the crisis in the late ’90s resolved with the financial crisis in 2008-09.”

Forecasts based on scenarios

Ambachtsheer turns these narratives into long-term return forecasts, applying the Gordon model to various projections that capture the S&P income yield and shares’ productivity and profit growth. In the bubble scenario, the dynamics create a timing opportunity even for long-term investors: selling shares at bubble prices and buying them back later at ‘normal’ prices.

In the Scary ’70s scenario, share prices continue to be bid down, price and wage inflation accelerate and nominal and real interest rates rise, squeezing the equity risk premium. But in all three scenarios, even these two most gloomy forecasts, the Gordon model ultimately calculates that long-term investors with no exposure to drawdown risk can expect a long-term positive equity risk premium.

“Long-term equity investors with a 30-year-plus timeframe will end up ahead, even if there is a bad decade,” he says. However, Ambachtsheer warns that the projected equity risk premium is “well below” the average post-WWII experience.

He is upbeat about governments’ ability to navigate downturns. Successful monetary and fiscal policies since WWII include the Volcker intervention in the early 1980s and the intervention to contain the global financial crisis in 2008-09.

“We’ve learnt how to take the sharp edges off bad outcomes,” he says.

The challenge for long-term investors would be to “keep calm and carry on” as these pessimistic scenarios play out, avoiding getting caught up in panic selling and keeping track of the Gordon model for its clues what share prices suggest for the direction of the economy.

“When moving into bubble land, pull back until prices are more sensible,” he says. And investors with shorter time horizons must question how much they need in bonds to protect against drawdown risk.

The DKK269.6 billion ($44.5 billion) Danish pension fund Pensionskassernes Administration A/S (PKA), which administers four Danish labour market schemes in the social and healthcare sectors, has rapidly increased its allocation to renewable energy in recent years.

It has piled into wind parks in Denmark and across Europe in search of long-term, fixed returns uncorrelated to financial markets, while also steadily divesting from fossil fuels. In the middle of last year, PKA divested from five Canadian oil companies, bringing the total number of fossil fuel-related firms it has excluded from its investment universe in the last two years to 53.

“We have already done a great deal in offshore wind and we are going to build out this part of the portfolio more,” chief executive Peter Damgaard Jensen says. “We are also going to do more in onshore wind.”

PKA does invest in some renewable assets via funds; for example, it is a regular investor with Macquarie, a manager that has put about $20 billion into renewable energy since 2010. But the fund also has about $2 billion to $3 billion in various direct renewable investments and it is this part of the portfolio that will grow most in coming years, Damgaard Jensen says.

The focus will be on acting alongside other institutional investors and local and European utilities such as Denmark’s Ørsted, formerly DONG Energy. Most recently, PKA bought a 50 per cent stake in the UK’s Walney Extension Offshore Wind Farm with Danish pension fund PFA. Walney Extension will be the world’s largest offshore wind farm when commissioned in the second half of 2018.

One reason for the push to invest directly is a desire to cut costs. Damgaard Jensen estimates investing directly saves about a quarter, or even a third, on a wind project over the long term.

Going direct has involved recruiting a team of 10, which he says will grow to between 15 and 20 over the next three years. It is an expansion the pension fund has paid for by switching most of its equity to passive strategies. PKA gets involved in projects only once a tender is won, and Damgaard Jensen tries to ensure that other partners bear all the construction risk.

“We try to structure the deal to ensure construction risk is under the utility, because they have the expertise,” he says.

On ungeared wind projects, he expects a return of 5 per cent to 8 per cent.

Once a project is up and running, operational and political risk still need navigating; wind power is intermittent and the government subsidies that underpin wind farm investment can change.

“We diversify the risk by investing in different countries, all with stable political systems,” Damgaard Jensen says. He navigates market risk – the chance of electricity prices falling – by deliberately factoring low power prices into investment returns.

“We are very conservative about long-term electricity prices,” he says.

PKA maintains a willingness to sell its wind farms when the price is right. In 2016, the fund made a return of nearly DKK1 billion ($165 million) on the sale of its stake in the Butendiek German offshore wind farm to a consortium led by Japan’s ITOCHU group. PKA bought the wind farm in 2013, when it was at the planning stage, and achieved an annual return of about 25 per cent for its members.

Other alternatives

Wind farms and other renewable energy sources make up a large portion of PKA’s 10 per cent allocation to infrastructure. This sits in an alternatives portfolio that now accounts for 30 per cent of AUM. That is a bigger alternatives allocation than at ATP, PFA, Danica or Sampension – Denmark’s other top-five funds.

The alternatives portfolio is run by PKA’s dedicated alternative investment arm, PKA AIP, and has been steadily built-up ever since the financial crisis.

“In 2008, we learnt that having too much in equity made us vulnerable in a financial crisis,” Damgaard Jensen explains. “We are not expecting another 2008, but there will be another crisis of some kind in years to come and alternatives give us the diversification we need.”

In addition to renewables, the alternatives allocation includes a 10 per cent to 12 per cent investment to real estate, and a 7 per cent to 8 per cent allocation to private equity, in co-investments and fund investment. The rest is in forestry and absolute return strategies, targeting uncorrelated returns.

In the real-estate allocation, there is a heavy home bias, where PKA has built up an expertise over the last 25 years.

The fund aims to invest DKK2 billion to DKK3 billion in Danish real estate every year. New aspects of the strategy include investing in projects a “little earlier” and large-scale developments. Rather than just a single building, the pension fund is now targeting whole areas, like the ongoing redevelopment of the former Carlsberg brewery site in the west of the Danish capital, and Enghave Brygge district in Copenhagen’s Sydhavn area.

“It takes three to four years to build up whole new areas,” Damgaard Jensen says.

The absolute return portfolio is managed internally but the strategies are developed and honed with support from managers. It includes hedging strategies such as catastrophe bonds but also long/ short hedge fund strategies structured to perform well in a downturn.

“We will know if we’ve got it right when we see some headwinds,” Damgaard Jensen says. “We work with banks and product managers to develop a product that fits us.”

The allocation is run by a team of five to seven, in a dynamic setting where staff are given the freedom to craft and establish the strategies themselves.

“I believe this makes it interesting and is a reason to stay with PKA. It is intellectually attractive and an opportunity for some of our younger employees,” Damgaard Jensen says. The fierce competition for talent in Denmark’s pension sector leads to regular movement of staff between rival firms.