Ten years after the global financial crisis, global growth is sluggish, inflation is hovering near record lows, and unprecedented experiments in global monetary stimulus have created the risk of asset bubbles. Put simply, current debt levels are unsustainably high and can’t be propped up forever.

That is the bleak assessment by Satyajit Das. He warns that with debt in many countries having reached three to four times gross domestic product (GDP), levels typically unseen since the Second World War, the ability of some sovereign issuers to keep paying back their debts is uncertain.

Das is an Australian-based former banker and corporate treasurer turned academic and author. His most recent book is The Age of Stagnation: Why perpetual growth is unattainable and the global economy is in peril.

Some of his earlier writings, from 2005 and 2006, proved prescient about the risks in derivatives that became more widely apparent in 2007. Given this past form, many investors are now listening carefully to Das’s fears about the global economy being over-leveraged.

To put his concerns about the build-up of debt into context, more than 20 countries now carry debt-to-GDP ratios above 200 per cent, with global debt having grown by $57 trillion, or 17 per cent of world GDP, since the GFC.

Unsurprisingly, Das says, there is uncertainty over these numbers’ short- and longer-term impact on traditional financial markets and lending practices.

What’s arguably contributed to the financial markets’ highly distorted view of economic reality, Das adds, is the longstanding fixation with using debt to buy existing assets, rather than to invest in productive businesses.

He explains: “Somewhere along the line, the world became one big carry trade. Here in Australia, people can buy anything they like with borrowed money, and everyone looks rich on paper. But finding a buyer down the track to realise the gain is becoming increasingly problematic.”

Post-war model ‘broken’

What we’ve been left with, Das says, is a world that continues to deny that the post-war economic model is fundamentally broken.

“While most [chief investment officers] continue to target historical returns of 6 per cent to 8 per cent, or 4 per cent above inflation, it’s less likely that markets will resume delivering these outcomes at some future stage,” Das says. “Similarly, chasing higher yields without understanding the higher risks is like trying to pick up a gold coin in front of a speeding train.”

He says the key problem confronting institutional investors today is that there are many more unknown unknowns than at any time in recent history. As a result, investment chiefs now find themselves trapped in a world where they’re incapable of grappling with fundamental financial problems they’ve collectively created over the last three decades.

“CIOs are playing musical chairs, and when the music stops again, it will do so in a far more radical way than it did during the GFC,” he predicts. “Most growth generated over the last 30 years is due to excessive debt, financial imbalances, and a cycle of entitlement that appears impossible for policymakers to roll back; while companies have been more concerned about financial engineering than real engineering.”

What bothers Das just as much as the mounting debt levels is that the worldwide growth in equity prices since 2009 remains hugely uneven. For example, in the US, the S&P 500 has tripled since the nadir of the GFC; while here in Australia, the ASX All Ordinaries Index still trades about 16 per cent below its peak of 6873 points on November 1, 2007. Japanese equities are lagging even more, with the Nikkei Index trading slightly down from where it was back in 2000.

Das suspects growth and inflation will remain low and volatility variable, with sudden and unpredictable “melt-ups and meltdowns”. Within this environment, he urges CIOs to get better at tapping into the brains trust behind central bank policy.

Mandated traps

Unlike superannuation and pension funds, which are locked into particular ways of investing, courtesy of their mandates, family offices have successfully learnt from their past mistakes, Das says, to emerge amongst today’s best investors. What they’ve understood, he explains, is that returns require getting close to real income streams.

As a result, what they’ve successfully done since 2008-09 is switch their previous 80 per cent exposure to public assets into private assets.

“The trouble is, CIOs, et al, can’t do that because their mandates simply don’t allow them to,” he says. “They’re fundamentally flawed because within this bi-polar macroeconomic environment, normal investing rules don’t apply.”

While dealing with the prevailing macroeconomic dynamics isn’t easy, Das recommends CIOs get better at capitalising on whatever conditions the market throws at them. While there’s no such thing as magic pudding, he says the onus is on CIOs to move away from public markets and renegotiate their investment decision rationale.

Within an environment where indices don’t make sense, he recommends moving more towards absolute returns and income than capital gains.

“Assuming that CIOs’ hands remain tied and they don’t loosen their mandates, their focus should be on things they can do smarter and learning what they can live with,” Das says. “The alternative is to admit this is an uncertainty that you simply can’t manage and return money to investors.”

While few fund managers are considering such a bold move, a growing number do share many of Das’s concerns about global debt levels and the challenges they pose to the outlook for fixed income markets.

Focus on absolute returns

Apollo Advisors head of yield product development Seth Ruthen says that to be successful in the new environment – characterised by fiscal policy exhaustion, low growth, low inflation, low GDP and low interest rates – managers need to think about different types of risks than they are used to and develop strategies diametrically opposed to those that worked a decade ago.

Ruthen urges institutional investors to seek out managers who can create multi-dimensional opportunities beyond duration, credit quality and volatility.

“That also means moving into unconstrained environments more likely to deliver absolute returns,” he says.

Similarly, Brandywine Global portfolio manager and head of high yield, Brian Kloss, argues that an unconstrained holistic approach should help generate both absolute returns and a stable level of income, while reducing correlations to lower volatility.

In addition to looking beyond the traditional asset allocation approach, Kloss suggests investors look broadly across fixed income markets and sectors to create a multi-asset class fixed income portfolio.

“This return stream should originate from differentiated sources of alpha across multiple fixed income asset classes, including currencies, sovereign bonds, investment grade and below-investment-grade credit, structured credit and bank loans,” Kloss says.

Rethink the investment process

Beyond urging a move towards absolute returns and income, Das also recommends CIOs take steps to get on the right side of future M&A activity and lower their exposures to sectors that will ultimately be killed off by disruption or regulation.

“Instead of overestimating future upside from either emerging markets or geopolitical risk, a much bigger issue confronting CIOs is how to be rewarded for funds under management, especially when ETFs are killing them on the fees [and sometimes on the performance] front.”

To create an environment where CIOs are considerably closer to free cash flow, Das recommends rethinking the investment process and the ability to preserve capital while also generating income and future capital growth. It’s also important, he adds, that CIOs get better at developing strategies around what a protracted low-growth and low-inflation environment is going to offer.

But given there’s little room for rates to go much lower, Ruthen says expanding the opportunity set to include things beyond what’s easily accessible or index-oriented – plus having the discretion to respond quickly across asset classes – has surpassed duration as the most important factor for managing risk.

“That means being able to buy debt off other people’s balance sheets, creating debt within the right parameters, using illiquidity in a prudent manner and getting paid for it in the right way,” Ruthen says. “If CIOs don’t have the skillset to reorient the business around new opportunities, they’re at a real disadvantage.”

 

Jaap van Dam, principal director of investment strategy at PGGM, one of the world’s largest asset owners known for its commitment to long-horizon investing, was once asked what he called “the million-dollar question”: Can we be reasonably certain that we will be rewarded for being a long-horizon investor?

As van Dam rightly put it, the answer to this question will determine whether long-horizon investing will take off among asset owners. Because, if there’s no reward, then why bother?

I would propose that the answer is a resounding yes. And that response is supported by the work we have done at the Thinking Ahead Institute, in particular within the long-horizon investing working group.

In our paper, The search for a long term premium, we conclude that a sizeable net long-term premium of 0.5 per cent to 1.5 per cent a year – depending on investors’ size and governance arrangements – can be exploited by investors with the appropriate mindset and skillsets. (See Long-horizon premium: up to 1.5%).

Hunting for evidence of long-term premia is easier said than done. In an ideal world, we would run a regression of net returns against time horizons. Sadly, to our knowledge the data to run such a regression does not exist due to a number of obstacles, such as the difficulty in accurately measuring investors’ the time horizons.

As a result, we used an indirect approach, based on the belief that long-horizon investing offers both return opportunities and the chance to reduce drag on returns. This led to the identification of eight building blocks of long-horizon value. Each is practical to implement, albeit with changes to the investment process. Together, they provide evidence of a sizeable premium from long-horizon investing. Some provide return opportunities and others create chances to lower costs.

Liquidity provision and other opportunities

Let’s start with return opportunities. The first relates to a study that examined more than 2000 highly intensive engagements with over 600 US public firms between 1999 and 2009. The study showed that engagements with investee companies generate, on average, positive abnormal returns of 2.3 per cent over the year following the initial engagement – clear evidence of the benefits of being active owners to encourage investee companies to take long-term approaches.

The next two return opportunities relate to liquidity. When investors are willing to pay for liquidity – in other words, sell assets below fair value – someone on the other side of the trade gets paid. One study suggests that long-horizon investors have the potential to earn additional returns of 1 per cent a year at the expense of shorter-horizon investors by providing liquidity when it is needed most.

Another aspect of liquidity involves the illiquidity risk premium, which is well established as a source of return for long-horizon investors. When investors accept illiquidity, they accept greater uncertainty because they are less able to liquidate the asset. The longer the capital is tied up, the more return investors expect by way of compensation. Academic studies point to a range of 0.5 per cent to 2 per cent a year for this particular premium – and even higher returns might be available to very long-horizon investors.

A fourth return opportunity for long-horizon investors comes from exploiting various mispricing effects via smart betas. Decades of data suggest that this can add more than 1.5 per cent a year, relative to the cap-weighted index.

Finally, understanding the long horizon can help funds take advantage of thematic investing. Many hold a belief that education, renewable energy, ageing, technology and other themes are key value drivers for investors. However, lack of consistency in implementation has prevented researchers from finding empirical evidence that a thematic approach works. Even so, belief in thematic investing is strong: 93 per cent of attendees at the 2016 Thinking Ahead Institute New York roundtable believed that it was possible to enhance portfolio value by investing thematically.

Lower turnover and other potential savings

Now let’s examine how a long horizon can help reduce drags on returns.

A study of more than 400 US plan sponsor ‘round-trip’ decisions (the firing and replacement of managers) between 1996 and 2003 compared post-hiring returns with those the fired managers probably would have delivered. It suggested that by replacing their investment managers, the plan sponsors gave up a cumulative 1.0 per cent, on average, in the three years following the change – a dear cost they paid for buying high and selling low that can be mitigated by a long-horizon mindset.

Open-ended fund structures, despite the flexibility they provide, might not be fit-for-purpose for long-horizon investors, who do not require nearly as much liquidity as short-horizon shareholders and can, therefore, take advantage of closed-ended opportunities. In open-ended structures, long-horizon shareholders essentially subsidise their short-horizon peers’ liquidity needs. One study found that liquidity-driven trading in response to flows (in particular redemptions) reduced returns in US open-ended mutual funds by 1.5 per cent to 2.0 per cent a year from 1985-90.

Last but not least, long-horizon investors can save on transaction costs by avoiding unnecessary turnover.

An advantage for larger funds

Capturing the benefits of a long horizon will probably require investors to expand their skillset and make a major shift in mindset. In many cases, it will entail incremental spending; for example, expanding investment expertise in active ownership by hiring a specialist or increasing the number of trustee meetings to strengthen belief in long-horizon investing.

The potential benefits of this additional spending are in many cases enhanced returns. In The Search for a Long-Term Premium, we examine two hypothetical pension schemes to develop a reasonable estimate of the potential long-term premium in practice.

The smaller fund focuses its long-horizon efforts on avoiding costs and mistakes. It reduces manager turnover, avoids chasing performance and forced sales, and moves part of its passive exposure into smart beta strategies. The rationale is: If you don’t have the resources to win big, at least don’t lose. The net benefit of these efforts is potentially an increase in investment returns of about 0.5 per cent a year.

The larger fund has the governance and financial resources to consider all available options for capturing premia. It introduces long-horizon return-seeking strategies while reducing its exposure to mistakes and costs. The net uplift to returns is potentially about 1.5 per cent a year.

In the investment world, where there are few universal truths, it would be hubristic to conclude that we have proven the existence of the long-term premium. We are, however, reasonably certain that the potential return enhancements of long-horizon investing substantially outweigh the cost of addressing its challenges.

If such a premium exists, however, why are institutional investors not exploiting it already? Our next challenge is to understand the potential obstacles and, finally, present a range of practical solutions to allow investors to build a long-term orientation and access that premium.

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

 

EDHEC Infrastructure Institute is releasing 384 indices covering private infrastructure equity and debt investments. We hope these results will help dissipate the confusion created by #fakeinfra.

Almost every day, asset owners are presented with new opportunities to invest in ‘infrastructure’. The appeal is always the same: yield, stability, a degree of portfolio diversification, perhaps even inflation hedging.

But that infrastructure label has been stuck on more than one tin. A serving of infrastructure can now come in many forms: from private equity funds with various horizons and mandates, to ETFs and other funds of publicly traded equities, to green bonds or infrastructure real-estate investment trusts. Many investment products may have a new infrastructure look but it is possible that they have nothing new or special to offer – just confusing repackaging.

‘Listed infrastructure’ is #fakeinfra

Listed infrastructure is a case in point. Our recent study of the (absence of) unique characteristics among 22 listed infrastructure proxies is published in a peer-reviewed journal. A key finding stands out: there is no such thing as a listed infrastructure asset class.

This study highlights the importance of discussing the existence of new asset classes in a total portfolio context. Using mechanical stock filters or industry-provided thematic indices, we conducted 176 mean-variance spanning tests – both before and after the global financial crisis – in global, US and UK markets, and found zero evidence that focusing on ‘listed infrastructure’ creates any new and persistent diversification benefits for already well-diversified investors.

It’s #fakeinfra. It’s presented to investors as an opportunity to gain exposure to something new or rare, but has, in fact, always been available; that is, it is already spanned by existing capital-market and other instruments. Today, a listed infrastructure fund is just an active equity fund with a narrow industrial focus. It is an alpha-driven product, often mislabelled as a new form of beta. It is not what investors need to better understand the potential role in their portfolio of infrastructure and real-asset investing.

#Fakeinfra looms beyond the listed equity space as well. Reporting and valuation in private equity make it difficult for investors to find the products they need. Ill-defined terminology makes this problem worse. (Is it helpful to talk of ‘core’ and ‘core+’ infrastructure assets? Unlike real estate, infrastructure is no store of value; it needs to be used to have value.)

Real results, real assets

Now, thanks to an EDHEC initiative with industry support, the growth of #fakeinfra, listed or not, may begin to abate.

The 384 indices we’re releasing – in two series of 192 indices each – show the risk-adjusted performance of hundreds of private European infrastructure equity and debt investments, going back to 2000.

Thanks to the largest database of infrastructure investment information in the world and a unique asset pricing technology designed to estimate the performance of private, highly illiquid assets such as infrastructure debt and equity, EDHEC can produce the risk-adjusted performance metrics investors and regulators need to understand private infrastructure debt and equity as asset classes.

The news is good. We find that investing in private infrastructure assets can indeed generate out-performance, diversification or better duration hedging. It can have lower value-at-risk than major market benchmarks (suggesting a better prudential treatment under Solvency-II, for example) and its Sharpe ratio can be higher than that of indices typically used as market references.

Our indices also show that while individual investments can be quite volatile, most of this volatility is project-specific; in other words, in larger, more balanced, portfolios it is diversified away. As a result, the Sharpe ratio of the infrastructure broad market index is attractive.

Today, these indices are not directly investible. However, tomorrow they will grant investors and managers access to infrastructure investment on a well-diversified basis that will make all the difference between an attractive investment opportunity and a few highly concentrated bets, which may or may not turn out well.

In a world where proper metrics have become possible and better infrastructure investment products can be imagined, #fakeinfra can become a thing of the past, and real asset investing can begin to enter adult life.

Frederic Blanc-Brude is director of the EDHEC Infrastructure Institute.

 

A G20 group, chaired by Michael Bloomberg, has released its final recommendations for company disclosure of corporate climate risk, shifting the onus for reporting from the sustainability department to the boardroom.

The Financial Stability Board (FSB) Task Force on Climate-related Financial Disclosures (TCFD) calls for increased governance that will bring climate change onto the board agenda.

The 32-member task force, which includes Jane Ambachtsheer of Mercer and Eloy Lindeijer of PGGM, calls for climate-related information to be integrated into the mainstream financial reports of companies. This would make climate risk a key corporate agenda item and would allow information to be accessed in a consistent and comparable way.

The TCFD structured its report around four areas: governance, strategy, risk management, and metrics and targets. The group’s other recommendations include disclosures that would help investors understand how their investee companies assess climate-related risks and opportunities.

Investors and the companies in which they invest need to consider their long-term strategies and the efficient allocation of capital, the TCFD states.

“Organisations that invest in activities that may not be viable in the longer term may be less resilient [during] the transition to a lower-carbon economy; and their investors will likely experience lower returns,” the report states. “Compounding the effect on longer-term returns is the risk that present valuations do not adequately factor in climate-related risks because of insufficient information. As such, long-term investors need adequate information on how organisations are preparing for a lower-carbon economy.”

The TCFD was launched by Michael Bloomberg and Mark Carney, chair of the FSB, at the COP21 climate conference in 2015.

The climate research provider institutional investors use, CDP, has committed to adopting and implementing the report’s recommendations across all sectors. In 2016, nearly 6000 companies disclosed environmental data through CDP.

CDP says addressing climate risk is a path to outperformance, with companies on its “climate A list” outperforming the market by 6 per cent over four years. Jane Stevensen, engagement director at the research provider, says mainstreaming corporate climate risk information is a key recommendation of the report.

“Despite broad recognition that issues related to climate change represent major risks to companies around the world, disclosure about those risks has been lacking. Making this a board responsibility will change that,” she says.

The recommendations will be fully incorporated into CDP’s platforms for the disclosure cycle of 2018, so businesses disclosing through the research provider can be assured they are adhering to the TCFD’s guidelines.

CDP will continue to work with investors and companies to ensure market adoption of the TCFD recommendations and support mandating disclosure over time.

“We are strong advocates of mandating and enforcing universal company disclosure to obtain consistent, comparable and high-quality information [from] companies who resist voluntary norms,” Stevensen says. “We believe policy intervention is necessary to drive the cultural behaviours and action required. This should be taken into account by the governments of the G20 as they consider how to respond to the TCFD’s recommendations.”

Chair of the the Institutional Investor Group on Climate Change (IIGC), and chief executive of PKA, Peter Damgaard Jensen, said greater climate-related financial disclosure is crucial to secure more complete, meaningful, reliable and consistent data across all companies and sectors.

“Given their importance at the top of the investment supply chain, large asset owners and asset managers also recognise they have an important role to play in driving the swift and widespread adoption of this framework,” he said.

IIGCC is a forum representing 138 large investors across 11 countries with more than $21 trillion in assets.

A premium for long-horizon investing has been quantified for the first time. A study from the Thinking Ahead Institute’s long-horizon investing working group puts a figure on the value add of eight building blocks of long-horizon investing and highlights the importance of governance in harvesting that premium.

The group’s study report, The search for a long-term premium, states that there is a net premium available by accessing return opportunities and limiting the drag on returns. The five strategies that provide opportunities for long-horizon investors are active ownership and investing in long-term oriented companies, liquidity provision, capturing systematic mispricing, illiquidity premium and thematic investing. The three that lead to lower costs are avoiding buying high and selling low, avoiding forced sales, and lowering transaction costs.

The report argues that depending on an investor’s size and governance arrangements, a premium of between 0.5 per cent and 1.5 per cent a year is available via these building blocks.

Tim Hodgson, head of the Thinking Ahead Group 2.0 at Willis Towers Watson and co-author of the report, says the premium exists but is hard to achieve.

“The key reason investors are not harvesting the long-term premium is because their governance is not up to it,” Hodgson says. “It requires a change in mindset and skill set.”

Worth the costs

For most investors, there will be some incremental governance costs required to implement these eight strategies. The group identified these costs as 15 basis points for a smaller asset owner and about 8 basis points for larger owners. However, the return gain for these actions is larger – estimated at 65 basis points for smaller asset owners and 161 basis points for larger owners.

“Asset owners will need to spend money, but it’s more than worth it,” Hodgson says. “This paper needs to survive public scrutiny so we have been cautious in our assumptions. If it becomes generally accepted there’s a long-term premium, then any investor with a fiduciary duty will have to consider it.”

The paper outlines the actions and costs of two funds – a small fund and a large one – in harvesting the eight building blocks of long-term value creation.
The smaller fund’s focus was on avoiding costs and mistakes; for example, by reducing manager turnover, avoiding chasing performance and forced sales, and moving some of the passive exposure to smart beta.

The example of the larger fund shows the advantage of having the governance and financial resources to consider all available options for capturing the premiums, including active ownership, investments in thematic exposures and setting aside cash to exploit forced selling.

The paper raises a number of questions regarding how investors would access the building blocks of value creation, and the working group will release a second paper outlining what investors require to implement them. This second paper will also include an examination of the beliefs needed to adopt this strategy.

Hodgson says some of the negatives that have a drag on returns, such as high turnover of managers and excessive costs, are explained in part by behavioural aspects.

The group deliberately does not define what “long horizon” or “long term” is, but it does attempt to say what it is not.

“It’s not having a minimum holding period, it’s not buy and hold; you’re allowed to sell,” Hodgson explains. “My personal definition is a long ‘look-up’ window, so for any decision an investor is making today, they should ask, ‘How will this pan out in 10 years?’ ”

The paper can be accessed here

The-search-for-a-long-term-premium

Sampension, the DKK290 billion ($43.5 billion) Danish labour market pension fund, is re-negotiating terms with its alternative managers in a push for more investment control. It is a strategy encapsulated in the fund’s forestry allocation, where slim returns are pushing chief investment officer Henrik Larsen to reconsider costs and manager relationships, in a process he has already applied to other alternative allocations.

Most timberland funds tend to be closed-end funds with a forced turnover and high transaction costs, Larsen says.

“We are now looking for structures that are more open-ended and give us some control over the portfolio. We give up control if we choose a traditional closed-end fund,” he says.

It underscores a trend at the fund to commit larger sums to alternative investments more tailor-made to fit the portfolio, as Larsen seeks to get closer to the investment process and have more influence.

“We are changing the way with work with funds in the alternative space. Increasingly, we put up the term sheet and discuss issues around structures and segregated accounts, looking at where we can have more influence, concentrate the risk and commit more capital. We’ve done this in US real estate and European commercial real estate debt already. We are now looking to do it in timberland, high-yield bonds and leveraged loans. We want two things: more influence on the investment and more control over our costs.”

Sampension offers three main products. One is a closed, defined benefit fund with a low risk capacity, where strategy is oriented towards fixed income, with only 7 per cent invested in listed equity. Another is a smaller fund that reinsures Danish municipalities’ statutory-linked pension obligations for civil servants, again in low-risk strategies structured to hedge against inflation with allocations to inflation-linked bonds and commodities. But it is Sampension’s third offering – a fast-growing unguaranteed lifecycle fund – that has the most risk capacity and has become, in Larson’s words, its flagship fund.

“This is a lifecycle product, so we invest more aggressively for the younger members and conservatively for those who are older and in receipt of a pension,” he says. “Our strategy is a reflection of the risk appetite and age composition of our members.”

In the lifecycle fund, assets are divided between: listed equity (36 per cent); bonds with low credit risk, including euro-denominated government bonds and other investment-grade and covered bonds (32 per cent); illiquid assets including real estate, timber, private equity and infrastructure (22 per cent); and riskier, high-yield bonds (10 per cent).

Illiquid tilts

Rock-bottom bond yields and the risk of capital losses from rising interest rates have led Larsen to oversee a tilt in the allocation away from bonds toward more illiquid assets. He’s found a particularly rich seam in Danish social housing.

“Danish rental housing under rent control is illiquid, but the cash flows are very secure. Rental income is lower than free-market levels but there are long waiting lists for flats and a very low risk of any lapse in rental income. It is a good substitution for bond risk if you can live with the illiquidity.”

It’s an illiquid exposure that Larsen plans to build going forward.

“We have no problem coping with more illiquid exposures in our portfolio. The only problem is finding suitable assets; this is what has kept us from building up this exposure even more.”

This leads the conversation back to forestry, where Sampension has built up a sizeable allocation in the US, begun in 2002, and emerging markets. However, he warns that this allocation is not always as straightforward as it seems.

“We don’t hold any Danish forestry assets because it is too expensive, and forestry isn’t as low risk as housing because the risk varies according to different geographies,” he says.

The forestry allocation has also disappointed since the financial crisis because of the ensuing slump in the housing market, its knock-on effect on timber demand, and the broader slump in commodity values.

“Forestry has seen a fairly dismal return for the last 10 years but it is a good structural asset to hold and returns will be higher going forward.”

Equity

Sampension’s unguaranteed fund has three distinct elements to its listed equity allocation. Three-quarters of the portfolio is in a low-cost, global core allocation that is indexed, or running close to the index allowing for some tracking error. Rather than being cap-weighted, the portfolio has factor tilts towards value, low volatility and small-cap shares.

“These are all traditional factors that we hope will give us extra return,” Larsen says.

A second, active equity allocation within the fund is focused on emerging markets and Danish equities, where Larsen doesn’t believe an index strategy would work.

“Emerging markets and the local Danish market are both very concentrated markets with a few large issues; neither of these markets has a very liquid futures market either.”

Of the listed equity allocation, 10 per cent is invested in Danish companies, far beyond any allocation to the Danish listed market in a cap-weighted portfolio.

Smaller but riskier is the third part of the fund’s listed equity allocation. It’s invested in an active neutral hedge fund. Larsen likes this strategy because it makes it easy to ensure money is spent only on active managers who deliver alpha.

“The idea is to separate our core index-linked exposure from a pure alpha exposure for more control. It makes it easier to measure costs, and the value of active management, if you are in a market-neutral equity hedge fund, rather than a blended traditional mandate.”

He adds that it is an allocation he would like to build.

“When we made the decision in 2009 to split our equity allocation into pure beta index-linked and pure alpha, we envisaged that by now the alpha part would be larger. We have been conservative because we haven’t yet been convinced of the capabilities of the alpha products out there. We would take on a larger part if we could find more talent.”

Costs     

With a large, internally managed fixed income allocation and a large, low-cost equity allocation, Larsen is able to keep a tight lid on management costs. Fees at the fund, including indirect costs from carried interest and transaction fees, come in at 43 basis points, on aggregate.

“Investing more in illiquid assets and alternatives will have a tendency to make our investment costs go up; however, we are negotiating for lower fees in these assets. We are also doing more internally, and making more direct investments and co-investments where we can aggressively negotiate on fees…We are open to offers from potential asset managers and this gives us leeway in negotiating fees.”

He observes that managers are still essential when it comes to ensuring diversification, namely by investing further afield in different asset classes and geographies.

“Diversification means external management,” he asserts.

Moreover, searching for direct and co-investment opportunities internally is demanding. Sampension has increased its internal headcount to 30, most of whom are focused on alternatives, particularly real estate. The fund uses six managers in listed equity, four of which run the active allocations, one the index portfolio and one the hedge fund. In alternatives, Sampension invests in more than 100 funds but some managers handle more than one of those funds.