The $7.6 billion Employees Retirement System of Rhode Island, (ERSRI), is cutting its allocation to hedge funds. In a “back to basics” strategy, the fund will slash its hedge fund allocation by $500 million over the next two years, reducing the allocation to 6.5 per cent of assets under management, down from 15 per cent. It will reallocate funds to more “traditional” strategies for growth and stability, consisting mainly of low fee index funds. The fund’s hedge fund exposure is currently about $1.1 billion.

“Most hedge funds aim to produce positive returns that have low correlation to the movements of the global equity markets,” says general treasurer Seth Magaziner, a native Rhode Islander whose role heading up the state’s treasury department includes overseeing investment strategy at the pension fund.

“While some of our hedge funds have delivered on this mandate; too many have not. In recent years, too many hedge funds have shown low correlation to the market when the market has been strong, but high correlation in times of market decline. At the end of the day, absolute return strategies need to generate positive returns and provide legitimate protection from market risk in order to justify their fee structure.” With this in mind, the fund will only keep the hedge fund allocations which show adequate non-correlation to the market to protect the fund from volatility, and a strong enough performance to justify fees.

New strategy

Cutting management fees is a key motivation behind the latest strategy at the fund which serves 60,000 active and retired public sector workers in America’s smallest state, and where none of the active allocations are managed in-house. Rhode Island frequently monitors its returns net of fees and compares the figure to peers, as well as the fund’s index fund performance, the fund’s benchmark, and a hypothetical 60/40 stock to bond ratio fund, explains Evan England, a spokesman for treasurer Magaziner. The overall hedge-fund portfolio has posted a return of 4.85 per cent after fees since its launch in 2011, but many of the individual funds within the allocation haven’t met expectations. More than half the gains of the hedge fund allocation have been swallowed by the high fees.

Reducing the hedge fund allocation is part of wider changes to Rhode Island’s asset allocation following a comprehensive review of the fund’s target allocation. The process included modelling potential portfolios against potential market conditions. The new allocation portions 55 per cent of the fund’s assets to growth. Along with low-fee index funds, the growth bucket will include a 15 per cent allocation to private equity – more than double the previous allocation of 7 per cent.

About 39 per cent of the fund will be in stabilising assets divided between volatility, crisis and inflation protection strategies and include allocations to fixed income, real estate and momentum, among others. Six per cent of the fund will be in income strategies. The new strategy comes on the heels of lagging returns. As of June 2016 the fund posted a one-year loss of 0.3 per cent, a five-year return of 5.8 per cent, and a 10-year return of 4.8 per cent versus a 7.5 per cent assumed rate of return.

Magaziner was only sworn in as general treasurer in January 2015, joining from environmental, social and governance (ESG)-focused asset manager Trillium Asset Management. As well as being quick to push on manager fees, he is also championing greater transparency. His “transparent treasury” policy now asks the fund’s 100-odd managers to publish their fees, but also their performance and expenses on a regular basis.

“If you are managing public funds, the public has a right to know how you are performing and what you are charging for that performance. Not a single one of our managers left us when we initiated this policy, and we have seen no evidence that it has limited our options when we have been searching for new managers to invest with.

“Since we announced this policy, other public pension funds, including large public plans in New York and California, have followed suit. I believe that the type of transparency we have championed will soon be the norm,” Magaziner adds.

Say-on-pay

It’s the kind of collaboration he would like to see in other areas too.

“Rhode Island is a small state with a relatively small pension fund. While we work to be thought leaders on issues facing pension funds globally, it often makes sense for us to team up with our larger peers to attempt to drive change.” One area he believes collaboration will begin to bring real change is corporate governance in investee companies.

Rhode Island is already a vocal shareholder, most recently voting against management-backed pay proposals at US giants Facebook and eBay in “say-on-pay” proposals where companies ask shareholders what they think on executive pay packages.

“When the companies we invest in award excessive pay packages to executives, it comes at the expense of the pension fund and the public employees we serve,” he said.

“Our say-on-pay effort reflects our position that executive compensation should be transparent and based on performance.”

So far this year the fund has voted “no” on executive compensation plans at 75 companies. It sends a letter to all companies that received “no” votes to inform them of the fund’s opposition and offering to open dialogue on how best to progress on “the important issue.”

 

Anyone browsing the popular investment press recently would be forgiven for thinking that diversity has become the latest buzzword in the investment industry and that by demonstrating diversity, organisations may increase the probability of generating superior investment returns.

Copious volumes of research are regularly published supporting the assertion that financial benefits accrue to companies that value diversity in its many forms. McKinsey & Company has published analysis suggesting that ethnically diverse companies in the top quartile for diversity are 35 per cent more likely to outperform, and gender diverse companies are 15 per cent more likely to outperform.

Interest in understanding and measuring the benefits of diversity in a tangible way is growing quickly. According to a study published by the UK-based Criterion Institute, in 2015 only a quarter of investors placed importance on gender diversity, whereas in 2016, a total of 51 per cent of investors agreed.

The speed of change in this attitude is both surprising and welcome. Diversity has long been an important part of our manager research process, based on a belief that more diverse teams with shared values make better decisions.

Mercer’s approach to researching and rating investment managers and their strategies is underpinned by our assessment of four key factors, the most important of which is idea generation. In assessing this, we consider how effective a manager is in generating value-adding investment ideas, which is central to the ability to generate superior returns for investors.

This is an intentionally broad perspective which ranges across the entire spectrum of opportunities, including those in particular asset classes, countries, sectors or specific strategies.

In all cases though, a common thread we observe in assessing the quality of a firm’s investment outcomes is the need to assess the quality of the organisation and team that is implementing the investment process.

Cognitive diversity

Of course a group of people who look different from one another are diverse in terms of identity. However, of greater importance for an investment process is cognitive diversity. Our research process is focused on identifying and avoiding the phenomenon of “groupthink”, which we regard as the natural enemy of good decision-making.

Groupthink is a phenomenon that occurs when the desire for group consensus overrides an individual’s underlying preference to present alternatives, critique a position, or express an unpopular opinion. In this situation, the desire for group cohesion effectively overrides good decision-making and creative problem solving.

Diversity as a characteristic of a team is only beneficial to the extent that it helps drive imaginative and creative solutions and reduces the likelihood of groupthink.

There are circumstances other than a perceived lack of diversity of a team that can foster a culture of groupthink. For this reason we are wary when we observe a team with a dominant group leader or a low level of challenge within the group, regardless of any surface-level diversity.

The operating environment for a team can also discourage positive decision-making.

For example, a team that is subjected to pressure from poor performance or from funds outflow or other business pressures may be more vulnerable to groupthink.

Mercer’s onsite meetings with management teams are central to our investigation of the existence of constructive challenge in decision-making. In meetings we investigate the way a team reaches its decisions and also how it manages the mistakes it has made.

In discussing an organisation’s resourcing, it is as insightful to explore a leader’s attitude to diversity. We are focused on uncovering the illusion of unanimity, where in reality team members are hesitant or reluctant to disagree.

The freedom to disagree with consensus views must be valued by the team and a discussion of how a team works through dissenting views is useful.

Having established a good track record, any team is at risk of becoming complacent, believing in its own wisdom at the expense of other ideas. To counter this effect, many successful teams adopt an approach that invites a devil’s advocate to question the logic of a widely-held belief.

Self-perpetuating cycle of homogeneity

The exploration of staff turnover and the reasons behind recent departures can be informative in understanding team dynamics and the value a team places on diversity. The need to fill vacancies can also shine a light on a manager’s attitude to diversity.

Often we are told that a team which does not appear to be diverse is so because individuals with different backgrounds or experience do not apply to fill positions in a team. This creates a self-perpetuating cycle of homogeneity which is unlikely to be beneficial to investors in the longer term.

An understanding of alignment and remuneration is also important in appraising the team’s approach to decision-making.

A team that is remunerated as a whole rather than as individuals contributing independently may react to challenge or debate differently and this can impact the way the team accepts and manages dissent.

Returning to the increasing publicity of the importance of diversity in organisations, it is very apparent that the most visible dimension of diversity being discussed in the investment market and in the media is that of gender diversity.

Studies highlighting and exploring the dramatic deficit of women in senior roles in the investment industry, and in portfolio management in particular, are raising many pertinent questions about the roadblocks to improving gender diversity and how these may be dismantled.

Many of these questions are the same ones we ask managers during our review process. However, the recent sharpening of the focus on gender diversity is only one aspect of the diversity narrative that we explore in our interactions with teams of investment managers.

We believe that successful investment teams can come in many shapes and sizes. But we firmly believe that, other things being equal, a diverse team with shared values is more likely to outperform their less-diverse peers.

Clare Armstrong is a principal at Mercer.

For a fund that prides itself on approaching new investments “methodically and without haste” Norges Bank Real Estate Management, the unlisted real estate arm of Norway’s NOK 7167 billion ($871 billion) Government Pension Fund Global (GPFG), has built up a sizeable portfolio in a short amount of time.

The ministry of finance only gave the green light for the fund to invest in real estate in 2010.

Three years later it had broadened that mandate to allow investment in property outside Europe, and it made an inaugural investment in the US in the first quarter of 2013.

Now the fund is busy looking for opportunities in Asia since setting up shop in Tokyo in October last year.

At the end of 2015, unlisted real estate accounted for some $21.9 billion under management – 2.4 per cent of the total fund – as GPFG fast becomes one of the world’s best known landlords.

“Our strategy is to invest in a limited number of major cities with various common characteristics. We look for cities expected to see continued population, employment and economic growth and we believe cities that attract intellectual and financial capital will also have the greatest potential for economic growth and increased trade.

There should also be constraints on the development of new real estate, whether regulatory, such as height restrictions or annual construction limits, or topographical limits such as coastlines or mountains, as this will favour long-term growth in rents,” said fund spokeswoman Line Aaltvedt in an interview from GPFG’s Oslo headquarters.

About 62 per cent of the real estate allocation is in office property, with investment spanning locations on New York’s Times Square to Paris’s Champs-Elysees. The fund has a stake in Berlin’s emerging technology sector; Munich’s fast-growing business services, media and manufacturing sites and London’s Oxford Street – in a deal closed two weeks after Brexit.

“In Europe, we are concentrating on large real estate markets such as London, Paris, Berlin and Munich. Our investments in the US span four major cities: New York, Boston, Washington, DC and San Francisco,” she says.

Despite the office bias, diversity is an essential pillar. The portfolio is spread across 13 countries with the greatest exposure in the US (48.9 per cent) followed by the UK (26.3 per cent) and France (11 per cent.)

Diversified assets include logistics facilities near ports and transport hubs, tapping into global supply chains. Logistics account for 24.4 per cent of the real estate portfolio split between the US and Europe. European investments totalled 240 logistics properties across 11 countries at the end of last year, compared to 390 properties in the US.

“Our aim is to build a global, but concentrated portfolio, in a limited number of cities around the world,” she says.

“We try to avoid making too many major investments in any one year, as this reduces the risk of investing excessively in a period when the market subsequently turns out to have been overpriced.”

Scouting for opportunities

In all, the fund has some 3,100 tenants in different industries in Europe and the US. Net rental income amounted to $841 million in 2015.

With only 2.4 per cent of fund assets invested in property to date, but a mandate to increase that to 5 per cent, GPFG is scouting for more opportunities.

It means pushing into a market at a time many critics believe prices are poised to fall. Competition for assets has increased, as global investors seek real estate’s stable, inflation-adjusted cash flows while interest rates are so low. Yet Aaltvedt counters the fund will only increase its allocation when the right opportunities arise.

“We currently have a mandate to invest up to 5 per cent of the fund in real estate, but there is no deadline for reaching this percentage,” she says.

The allocation will grow with a corresponding decrease in bond holdings. According to the mandate from the ministry of finance, the fund should be invested 60 per cent in equities, 35 per cent in fixed income and up to 5 per cent in real estate.

The portfolio, which has returned 6.9 per cent since inception, depends on high values, strong rental income and low vacancy levels.

Investments in offices and retail in the UK and the US, and investments in European logistics, have performed best since inception. In contrast, investments in offices and retail in Germany and France have performed less well.

At the end of 2015, 93.5 per cent of the portfolio was let, and 1 per cent of the portfolio was under development. The ministry of finance mandate requires the fund target a net return on the real estate portfolio that matches, or exceeds, returns on MSCI’s Investment Property Databank (IPD) Global Property Benchmark, excluding Norway.

GPFG invests mostly alongside partners in order to benefit from local knowledge and expertise, explains Aaltvedt. The fund had 10 investment partners at the end of the year.

“Investing with partners gives us better access to new investment opportunities and better information on which to base investment decisions,” she says.

“We have started making investments alone. We have wholly-owned assets in several of the European cities, and although we will continue to invest with partners, we also expect to do more transactions without partners.”

“At of the end of last month we had 135 employees working for us. When the fund began investing in 2010, the real estate department had just three employees,” she concludes.

 

Photo credit: Times Square:CoStar

The $1.3 trillion Government Pension Investment Fund of Japan has a 100-year timeframe but that doesn’t mean all of its assets are long term.

“We are happy for active managers to trade on a short-term cycle, and passive managers to focus on sustainability over the long term of the company,” executive managing director and chief investment officer, Hiromichi Mizuno says.

“You can’t force all investors to have the same horizon. If as a whole it works, I am happy. I agree the sum of investors as a whole have a long term perspective, but you can’t dictate that all investors behave the same way.”

The GPIF is managed externally and around 20 per cent of the portfolio is managed by active managers and 80 per cent passive.

“The direction we are trying to make clear is that active and passive managers can have different roles and different time horizons,” Mizuno says.

“We are encouraging passive managers to engage with companies with a long time horizon in mind. On the other hand, if active managers say they think three months is the best timeframe to produce alpha then I won’t discourage it. The mismatch might be difficult to manage but we are trying to make the rules as clear as possible.”

This month the GPIF established a new division in its public market investment department, called “stewardship and ESG”.

Its investment principles outline that the fund will continue to maximise medium- to long-term equity investment returns for the benefit of pension beneficiaries by fulfilling stewardship responsibilities. And it believes that it is appropriate and essential for GPIF as a pension fund to increase long-term investment returns for pension beneficiaries by fostering sustainable growth and worth of companies in which it invests.

The fund accepted Japan’s Stewardship Code in May 2014 and became a signatory of PRI (principles for responsible investment) in September 2015.

Mizuno’s comments were made as part of a panel discussion at the PRI in Person conference in Singapore last month. Mizuno is a member of PRI asset owner advisory committee.

Commenting on climate risk and fiduciary duty, he said that “I don’t see a point in beneficiaries getting a full pension but they can’t step outside”.

The fund is looking at how to interpret this into daily investment activities, including looking at a proposal for environmental, social and governance (ESG) indices.

“Climate change is a long-term issue but we need to take it into our daily investment practice, ESG indices/positive screen companies is one way to do that.”

Bold proposition

To overcome the problems associated with short term reporting, Mizuno made a bold proposition to the audience.

“I propose that every asset owner only reports 50-year rolling performance number,” he said.

The session, which was chaired by the chair of PRI, Martin Skancke, also heard about the challenges of reporting long-term numbers.

Paul Smith, chief executive of the CFA Institute, says keeping focused on the long term is hard.

“With a 100-year time horizon you’re not around to reap the benefit, so behaviourally it is difficult, but also hard from a metric point of view. Also difficult where there’s a trust issue in the industry, hard to conduct long term investing in that environment,” he says.

Scancke says the Norwegian Sovereign Wealth Fund’s working definition of long-term is the capacity to hold an asset and not be forced to sell it; the ability to be contrarian and can sell or buy and rebalance when others aren’t.

Smith says the problem the industry is trying to resolve is that ESG issues, especially the environment, require a long-term focus.

“As the joke runs, the long-term is a series of short-term events, not as simple as saying the long-term is good and the short-term is bad, but about needs; finance industry structure needs to change to fit those needs,” he says.

“If we believe those challenges exist, then how do we enable that to happen?”

Chief finance and chief risk officer of APG, Angelien Kemna, says that APG and PPGM have collaborated on metrics to measure sustainability impact and keep returns focused first.

 

 

The $188.8 billion California State Teachers Retirement System, CalSTRS, will decide next April whether or not to divest from non-US thermal coal. The giant US fund only has a small exposure to emerging market coal, but the decision, which would follow on from the fund divesting from US thermal coal, and investing in a low carbon index strategy earlier this year, isn’t straightforward.

“We are conducting a deep dive into our non-US thermal coal holdings, but you have to consider the human issues as well as the climate issues in emerging market coal. In countries like India, there are so many people without electricity that without coal they will burn wood and dung, which is often worse than coal. There are two sides to the argument,” observes chief investment officer, Christopher Ailman, speaking from the fund’s Sacramento headquarters.

The decision to jettison US coal assets was easier, consistent with both the fund’s fiduciary duty and the changing regulatory landscape in the US.

Divestment in the US was limited to CalSTRS passively-held equity index portfolio and fixed income securities; active managers had mostly chosen not to own US coal in recent years.

CalSTRS further pushed its low carbon strategy this year when it committed up to $2.5 billion to low-carbon strategies in US, non-US developed and emerging equity markets.

The passively managed portfolio will be invested in an index designed to have significantly lower exposure to carbon emissions than the broad market, and a nearly complete reduction in exposure to fossil fuel reserves.

The MSCI ACWI low-carbon target passive index portfolio will be internally managed with implementation phased in, beginning with US equity, followed by developed markets and then, eventually, emerging markets.

Hedge funds for risk mitigation

The fund, which invests assets for nearly 896,000 active and retired school employees, is also in the process of introducing more risk mitigation into the portfolio through hedge fund strategies.

A new allocation to ‘risk mitigating strategies’ (RMS), will specifically target “less correlation to global growth,” smoothing volatility as the fund matures.

“We are a mature fund and we pay out more in benefits than what we receive in contributions. It means we care a great deal about the downside. We can’t ignore the low interest rate environment we’re in today, so we have to recognise that fixed income does not serve our purpose,” says Ailman.

The allocation will comprise four different strategies because “there is not one security you can buy to mitigate risk; you need to buy a basket.”

The components include long treasury bonds; trend following strategies; global macro and systemic risk premia.

In all, between 50 to 55 per cent of the allocation will be allocated to hedge funds. The whole strategy will account for 9 per cent of fund assets and the money will come out of fixed income and the global equity allocations, he says.

The bid to reduce risk comes as CalSTRS continues to be battered by volatility in a portfolio characterised by a 56.6 per cent allocation to global equity, as of the end of August 2016. The fund returned 1.4 per cent last year, due particularly to a poor performance in stocks.

The best performances came from real estate and fixed income which returned 11.1 per cent and 5.7 per cent respectively. Private equity, which currently accounts for 8.3 per cent of assets under management, also disappointed, returning 2.9 per cent, 1.7 per cent below CalSTRS custom internal benchmark.

“We think long-term, and the economy ebbs and flows. The US has been so strong for the last five years, it is not surprising there has been a pause,” says Ailman.

He also points to the funds three-year and five-year net returns at 7.8 per cent and 7.7 per cent respectively; CalSTRS has a target average return of 7.5 per cent over time.

Fee crackdown

Enduring investment themes include continuing to strengthen the fund’s internal teams, although Ailman says allocations to emerging markets, some private equity, and real estate will remain with managers.

Around 60 per cent of assets are currently internally managed. He is also keeping a keen eye on fees. CalSTRS says its fees come in at 30.8 basis points, meaning for every $100 it invests, it costs around 31 cents.

“The value-add has to exceed the fees you pay. Outperformance is inconsistent, hard to find and not easily repeatable. I’ve been in this business for 30 years and I thought fees would have come down by now, but Wall Street has just gotten cleverer at introducing new products that have a higher fee. Investors are focused on the net result and are willing to pay the fees if they are achieving a superior return net of fees. The problem is they pay first and wait; it’s not fun.”

Ailman plays down the outcome of the US presidential election on the pension fund, stressing again CalSTRS’s long-term outlook. Although he does ponder on one of the longest election processes in the world.

“Friends in Canada have pointed out that they held their country’s election, and reorganised their government, in less time than what we took to just run the primaries.”

Looking back over her 10-year career at France’s €36.3 billion ($41 billion) Fonds de Réserve pour les Retraites (FRR), chief investment officer Salwa Boussoukaya-Nasr observes that despite steady innovation, all change at the public fund has come against a backdrop of enduring continuity.

Boussoukaya-Nasr was appointed chief investment officer in 2012 at the fund which was created in 2001 to build reserves for the country’s public pension system. The reforms under her watch include introducing strategic hedging options, investment in a wider selection of asset classes, and most recently de-carbonising the passive equity portfolio.

“Since I joined we have gone through many changes but we still have the same goals, and much of the same team,” she says.

FRR is split between performance and hedging assets – 48.9 per cent versus 51.1 per cent respectively – and returned 3.08 per cent net of charges last year.

The largest allocation in the performance bucket is to developed market equities, with the rest in emerging market debt and equity and high yield euro and dollar bonds. In the year ahead she believes small cap European stocks, high yield and emerging debt and equity will be the star performers.

“Emerging markets were disappointing, but they are now doing well,” she says.

Hedging assets include French treasury bonds as well as euro and dollar-denominated investment grade corporate bonds. Eurozone and US corporate bonds together account for more than 45.6 per cent of the hedging component.

FRR is required by law to use external managers across the portfolio and active management strategies also dominate.

At the end of last year around 53 per cent of total net assets and 59 per cent of equity investments were actively managed.

Boussoukaya-Nasr believes these active mandates have helped shield the fund from enduring structural weakness in the Eurozone and Brexit fallout.

Here, additional hedging through option strategies ahead of the UK referendum, also dampened the impact of post-Brexit volatility.

Now she believes active strategies will position the portfolio for new trends, particularly slower UK growth and a “normalisation” of US and Eurozone valuations as Eurozone earnings improve.

FRR increased its exposure to the Eurozone with allocations to the region’s investments rising from 41 per cent in 2012 to 49 per cent in 2015. She also favours active management in US investment grade credit.

“Credit is a good place to find active returns above the benchmark.”

Growing Eurozone optimism

At the heart of FRR’s building Eurozone optimism lies a sizeable stake in the French economy.

Investment includes listed shares in French small- and mid-cap companies, debt and private equity and French real estate, with particular focus on long-term illiquid unlisted assets, after the French government granted the fund permission to invest beyond 2024.

Although the strategy is actively encouraged by the government, Boussoukaya-Nasr believes it is mutually beneficial both for the fund and the wider French economy.

“France is an obvious place for us to focus. We have a micro economic impact where we help companies develop and create jobs. It’s important because companies lack capital to the extent that many promising companies go abroad to the US for financing or go to public markets too early because they can’t find the capital. It’s challenging but interesting and we have the money and time to invest. We are also investing where there are less actors, so there is more opportunity and we can find attractive premiums.”

More than two thirds of the passive equity allocation in Europe, North America and Asia Pacific, excluding Japan, is now in low carbon strategies using MSCI Low Carbon Leaders indices that FRR worked with MSCI, AP4 and Amundi to help develop.

“We think that in the long-term, stranded assets will penalise equity valuations,” she says.

The indices exclude 20 per cent of the highest emitting companies, with a maximum 30 per cent – by weight – exclusion of companies by sector. They also exclude the largest owners of fossil fuel reserves with the objective of cutting both the carbon footprint and fossil fuel reserves of companies in the index by 50 per cent, compared to the relevant parent index. The most challenging aspect of the strategy so far has been minimising the tracking error compared to the performance of the standard indices in Asia.

“We have had a higher tracking error in Asia that has made it difficult to achieve the objectives of the low carbon leader in Asia so far – it has been very volatile but we began less than a year ago,” she says.

De-carbonisation

Boussoukaya-Nasr has also begun to de-carbonise the smart beta allocations which she admits is a “challenge without changing the characteristics of smart beta.”

“We gave our managers a maximum tracking error target that they have applied to their in-house processes. From what we have seen so far it’s encouraging.”

Smart beta strategies at the fund focus on value, small cap and low volatility factors in the Eurozone and North America, and represent 24 per cent of FRR’s allocation to developed-country equity and 42 per cent of its total passive equity mandates. There is a fixed weight between the different smart beta strategies.

“Some of the strategies behave better than others, but all have cycles,” she says.

In contrast, de-carbonising the bond portfolio is still a way off.

“Working to reduce CO2 and divesting from the worse emitters in equities makes sense because the valuation of those companies will fall. But in bonds the link is less obvious because as long as a company doesn’t default – even if there is a higher financing cost and the spread increases – there is still a return from investing in a company with high carbon emissions.”

She also questions the “ownership” ethos of a bond investor.

“If you have equity in a company, you are an owner of a part of that company and responsible for emissions, but bond holders are not owners. As an equity owner the emission belongs to you; as a bond holder you’re responsible for financing emitting activities.”

The fund is also working to combine active strategies with its de-carbonisation ambitions, considering reducing exposure to coal by divesting from companies that use mostly coal as a primary source of their energy.