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.

The United Kingdom’s Northern Powerhouse, one of the funds to emerge in a pooling process that is combining 89 local government pension schemes (LGPS), into some eight so-called wealth funds, will prioritise infrastructure investment and low costs.

The £17.6 billion ($22.8 billion) Greater Manchester Pension Fund, GMPF, pooling with West Yorkshire Pension Fund and Merseyside Pension Fund are together shaping an investment strategy that will include a 10 per cent allocation to infrastructure within three to five years, says councillor Kieran Quinn, chair of the GMPF.

The Northern Powerhouse, named after the previous UK government’s policy to boost growth in the region and with combined assets of $45 billion as also pledged to become “the lowest cost pool in the LGPS on a like-for-like basis.”

Most of the savings will come from building direct investments in illiquid assets like private equity and infrastructure, says Manchester-born Quinn, a former postal worker elected to the board of the pension fund in 1997. Existing private equity allocations in fund of funds will move to a single fund with a focus on co-investments. Similarly, hedge fund allocations in fund of funds will move to single strategy funds

The GMPF currently has a target allocation to private equity of 5 per cent and a target allocation to infrastructure of 4 per cent. Asset allocation at the fund is split between a 61.5 per cent allocation to public equity, 23.5 per cent to bonds and cash, 10 per cent to property and 5 per cent to alternatives.

The Northern Powerhouse will also reduce the proportion of indirect property and infrastructure relative to direct property and infrastructure, says Quinn.

To date the fund’s direct local infrastructure holdings are characterised by investments anchored in the community and include house building on brownfield sites, office developments and a stake in Manchester city airport. Additional cost savings will come from moving equity and bond allocations in-house as the internal team is strengthened.

“The GMPF sees the potential from further internal resourcing,” says Quinn. Here managing assets in-house will benefit from West Yorkshire’s strong internal team which manages around $11.6 billion of listed assets.

It starts from an advantageous position of already having many of the economies of scale that other merged funds are seeking, says Quinn.

“We have been very efficient regarding our fees and issues around costs. There is more to do, but this is less fertile ground to plough. Some of the smaller funds will make more significant savings.”

 

Counterproductive to compete

He wants infrastructure investment to include co-investment with the UK’s other local authority pooled funds. Co-investment will help win the bigger deals where competition has squeezed UK pension funds out of the market, he says.

It’s a strategy the GMPF has already embarked on through collaboration with the London Pension Fund Authority, LPFA, in two direct infrastructure investments in renewables in the last year. The joint venture, which he hopes will double in size to $1.3 billion worth of investment, is currently exploring opportunities in a rail franchise scheme.

“Significant and large direct investment in the UK economy is the holy grail. Pension funds must work collectively.”

It would be counterproductive if the six or so pools competed against each other, as well as against other international pension and wealth funds, for the same trophy infrastructure projects, argues Quinn.

“We are keen to create a significant investment pool, which will enable us to compete with global wealth funds when bidding for airports, shipping ports and new railway connectivity such as HS3 high-speed rail link between Leeds, Manchester and Liverpool.”

Infrastructure investments make up only 1 per cent of the assets of UK pension funds compared to 5 per cent for Canadian pension funds.

Now Quinn is impatient for progress. Like other executive teams at the local authority pools, he is waiting for government approval. Once it comes “we will quickly implement the collective monitoring and benchmarking of legacy illiquid assets, generating improvements in governance and costs savings.”

“Progress is being slowed down because we still need formal responses to our pooling submissions,” he concludes.

The idea that diversification is the only free lunch in investing was popularised by the Nobel prize-winning economist Harry Markowitz in the 1950s and has since become a widely accepted “truth” in the investment world.

However, rather than being thought of as a free lunch (which suggests that any action that helps diversify my portfolio is a no-brainer), diversification should instead be seen as a trade-off between potential upside and possible downside.

To start with a simple example: in a world of just two assets, if an investor knows with certainty that asset A will outperform asset B over the next five years, then diversifying this portfolio (by holding less than 100 per cent of asset A) will simply reduce the investor’s five-year return.

In reality, situations where an investor has certainty in relation to the relative performance of two assets are almost non-existent. However, if one allows for even a modicum of investor skill, then biasing portfolios towards those assets with the greatest expected rewards starts to make sense.

Indeed, Warren Buffett famously said that “diversification is protection against ignorance; it makes little sense if you know what you are doing.”

Put another way, if we allow for the existence of manager skill, then diversification may be detrimental to returns by diluting high conviction positions. To the extent that one believes that manager skill exists and can be identified in advance, this is an argument for seeking managers that are willing to back strongly-held and well-researched views with meaningful positions.

‘Diworstification’

We can also call on another legendary investor to argue against the “diversification is a free lunch” line of thought.

Peter Lynch, one of the most successful equity investors of all time, coined the term “diworstification” to suggest that a business that diversifies too widely risks destroying their original business because management time, energy and resources are diverted from the original purpose of the business.

This argument can easily be extended to institutional investors: an over-diversified portfolio may place such a strain on the governance / oversight capacity of the asset owner that strategic issues are subordinated to discussions around the underlying manager portfolios. This is an argument for ensuring that manager diversification (to the extent that it is justified on fundamental risk / return grounds) is consistent with the governance resources available to the asset owner.

Having argued against excessive diversification on conviction and governance grounds, we should recognise that diversification can be a powerful tool in managing downside risk. To return to the earlier example, if we replace complete certainty with complete uncertainty, we are likely to conclude that a roughly equal mix of the two assets is a reasonable approach. In this situation of complete uncertainty, diversification reduces the impact of one of our underlying holdings experiencing large capital loss.

A trade-off

This allows us to see diversification for what it is: a trade-off between conviction positions that may deliver superior returns and control of the risk that our conviction is misplaced.

Those believing that we live in a world of extreme uncertainty will lean towards diversification, while those believing in a clearer and more understandable world will lean towards conviction. In practice, many investors will find themselves somewhere in the middle of this spectrum, needing to balance conviction with management of downside risk.

Markowitz-inspired finance theory places little weight on the issue of conviction vs uncertainty, assuming a world in which expected returns, volatilities and correlations are all that matter (and that they can be easily estimated). Investors may find a discussion on the issue of conviction and position-sizing a useful input to future decision-making.

Returning to Buffett’s earlier quote, we should perhaps be humble enough to allow diversification to “protect us from our ignorance,” but be bold enough to back our conviction where we have sufficient reason to believe that “we know what we are doing.”

In the past five years, Mass PRIM has moved from using five fund of funds to 25 direct relationships in its hedge fund portfolio, and in the process has removed any “over-diversification” and dramatically reduced fees.

Eric Nierenberg, senior investment officer, hedge funds and low volatility strategies at the Massachusetts Pension Reserves Investment Management, oversees the fund’s 9 per cent target for hedge funds, and 4 per cent portfolio completion strategies.

Although Nierenberg’s team is small – it comprises two people, including him – he outlines how determining risk diversification is a priority, and how moving from a fund of funds setup to managing direct relationship helps PRIM achieve its objectives.

“The way that we see that is to try and figure out how to help diversify the risk that’s within the overall pension fund while still achieving the attractive risk-adjusted rate of return, but most importantly, having low to zero correlation with equities, since that’s the predominant risk.

“A lot of the things we’ve done over the last couple of years in terms of restricting the hedge fund portfolio, has really been designed to try and reach those objectives,” he says.

The simple recalibration from fund of funds to direct relationships not only took the number of funds down by 90 per cent, but resulted in a savings of $40 million dollars per year,” Nierenberg says.

Change to fees and strategies

A focus on costs is a part of Mass PRIM’s approach and something Nierenberg feels strongly about. The $40 million savings on removing the fund of funds approach has grown into much larger savings.

“We really think it’s our duty to try and be as prudent on fees as we possibly can. Now, that doesn’t mean that there are investments that we won’t do because there are high fees; it simply means that if an investment is a high-fee investment it has a higher hurdle to clear in order to determine whether or not it’s something that we feel like would be prudent to do. That $40 million was just basically the first stage of the savings in the hedge fund program –as we restructured further, that number has more than doubled.”

When Mass PRIM started implementing change, it changed not only the number of managers but also the style of managers and types of strategies.

“In that first stage, in 2011, they took the low hanging fruit which was to cut off the fund of funds layer, but the overall profile of the hedge funds that they had really didn’t change that much. So if you looked at the 24 managers that were put into the portfolios in 2011 they were mega-cap hedge funds, $30 billion to $40 billion in size.

“When I joined in 2012 and we really started decomposing the portfolio, there was a tremendous amount of overlap in the positions that these funds had, so there was very high correlation among the funds, and even more worryingly, the fundamental correlation of these funds to equity markets was very high.

“We realised we really needed to make some continued changes to the portfolio, and it was at that point that we decided that if we’re going to do this, we’re going to have to focus on strategies that have that lower correlation; we need to find managers who can operate on those smaller niches that maybe the larger managers aren’t able to access.”

Great change in composition

Although the number of direct relationships with hedge funds remains the same, it’s markedly different to when the fund first established its own relationships.

“We still have about two dozen hedge fund relationships, but the composition has changed pretty dramatically. And really, the genesis of that was around two years ago we decided to make all of our new hedge fund investments in managed account format,” Nierenberg says.

“I come from a long-only equity background When I came over to the hedge fund side I was shocked at how antiquated it was that everyone’s invested in a commingled fund. And a lot of the reasons that were given to me about why it’s necessary to be invested in a commingled fund didn’t make sense to me. So the managed account format has been crucial in achieving a lot of those different objectives.

“First of all, it’s having direct control of the assets. That’s something that the board of trustees felt very pleased to have, that you can’t be gated out of an account that you fundamentally own.”

Nierenberg says that there were limits on how much Mass PRIM could be in a commingled fund. Once the board set a limit of 20 to 25 per cent of any commingled fund, given the size of the allocations made, it pushed up the minimum entry point to funds of US$1 billion and above. This had the effect of wiping out a massive part of the potential manager pool, but once the fund moved into managed accounts, it specifically targeted those managers operating in the smaller space.

“We think that’s been really beneficial because these managers have differentiated strategies which we think have higher alpha potential; and it’s not just us, there’s a number of different academics both on the mutual fund side, where it’s very well known, but also on the hedge fund side where it’s maybe not as well known, that smaller funds do tend to outperform larger ones.

“The other piece is fee reduction. With commingled funds, a lot of managers are able to give some discounts for sizeable allocations, but frankly, they’re somewhat limited. With managed accounts, really it’s a whole different ball game, especially if you’re tweaking the mandate so it looks somewhat different to the commingled fund. We’ve been able to get fee reductions on the order of 40-50 per cent, so if there’s a rack rate of 2 and 20, you’re talking in the range of 1 in 10 or 1.25 in 12.That’s really meaningful cost savings. That $40 million in cost savings in the fund-of-fund layer being removed, it’s now up over $100 million a year because of the savings from management fees.”

Manager selection

Although PRIM has had an identifiable bias to US-based managers, with a handful in the UK, Nierenberg says it is time for change.

“One of the weaknesses in our portfolio currently is not having enough managers from other part of the world.

“Finding good managers is without a doubt the bottleneck in this process. I wish I had deployed even more of our legacy commingled fund capital into more managed accounts with more new managers.

“It’s just that it’s a tough process. Alternative beta is a huge part of our diligence process. We’ve developed an internal framework that really can take a manager’s returns and decompose them into alternative beta loadings, and we’re looking for those managers that have true alpha exposure. We have a risk premia portfolio that sits in our portfolio completion strategies. That portfolio is about $700 million in size and will probably grow in the coming months, and I definitely think alternative beta and risk premias are an important part of the portfolio, but focusing on the active hedge fund piece, we need to find those funds that are willing to accept the fact that the fee structure of the industry is changing, and we’re not going to be willing or able to pay 2 in 20 or anywhere close to that going forward. Willing to accept the idea of a managed account, and really, have some unique skill that doesn’t just get captured by some kind of alternative beta. What they get in return is really a very patient, very knowledgeable organisation that’s willing to stand by them, especially if there are periods of performance that aren’t so great.”

One of the biggest thing Nierenberg advocates is to bring in a specialist if an investor plans to move to managed accounts.

“There’s a lot of different organisations out there that can help an institution set up a managed account program, and that’s one thing I’ll stress, if you’re thinking about doing it yourself – don’t. Make sure that you utilise someone else. This was advice what was given to me by Dan McDonald at Ontario Teachers; they had a managed account for probably 10 years, and he said they started off trying to do all this internally – onboarding of managers, the prime brokerage agreements, the swap agreements. He said there was so much brain damage from that process that, in hindsight, they should have just paid the few basis points or whatever it was to an outside provider who has a real skill in doing this to help them. We took that advice to heart and it was a lifesaver, because there was no way we could have done this without them.”

The next step in the hedge fund program evolution, Nierenberg says, is for Mass PRIM to fund emerging managers.

 

Investment strategy at the German pension fund Ärzte-versorgung Westfalen-Lippe, ÄVWL, the €12.3 billion ($13.7 billion) fund for doctors and their dependants, is shaped around long-term, anti-cyclical investments concentrated in real estate, infrastructure and asset-backed lending to corporates.

Based in Germany’s northern city of Münster, only 10 per cent of the fund is in listed equity. It is not only the stable cash flows associated with these assets that the fund favours; they also provide shelter from market events – none more so than its own struggling Eurozone.

More than 20 per cent of the fund’s assets are invested in real estate in an allocation that has led returns over the years.

“Real estate has always represented a cornerstone of the ÄVWL’s total investment strategy,” explains Markus Altenhoff, director of capital investments.

“Our approach within real estate is to diversify across the whole risk-return-spectrum and to cover the entire value chain. A fundamental principle of the strategy is to also identify real estate opportunities in new regions, trends, and niche segments in which we can – sometimes anti-cyclically – play a pioneering role.”

Important recent investments include the fund’s stake in a three-building office complex in Washington, D.C. of which 89 per cent of the space is leased to AA-rated federal agencies, Altenhoff explains.

“This is about an A-class asset that offers credit cash flows with incremental yield opportunities; ideal characteristics of a long-term wealth preservation tool. The rent roll will also offer a significant yield premium over the U.S. Government credit.” ÄVWL’s in-house real estate team stuck by their anti-cyclical ethos when they divested from some of the fund’s trophy London real estate holdings in response to overheating in that market; a strategy that has also fortified the portfolio from any Brexit tail-wind.

Now, growing competition for real estate assets and tougher market conditions has made value added a key theme.

“Here we identify under-valued and fairly valued markets with a substantial appreciation potential over the investment period. A stable basis of at least 70 per cent in core and core plus investments guarantees steady and sustainable cash flows,” Altenhoff says.

ÄVWL is also busy building its allocation to infrastructure with the unlisted allocation now “a significant part of the portfolio” accounting for around 15 per cent of total assets and including asset-based investment and project financing, often as part of a consortium, and a growing commitment to renewable energy.

However, it is noteworthy that the fund does not see infrastructure as an asset class in its own right. Rather its sees infrastructure investment across the portfolio in loans and mortgages, fixed income and alternatives; projects with system relevance, or those involving a certain type of regulation, explains Lutz Horstick, head of securities and loans.

“When we speak about ‘long-term’ investments, we mean ones that have a time horizon of at least 10 to 20 years. If we believe in the long-term profitability of an asset, we intentionally accept a certain degree of volatility and price fluctuations. We are ready to enter investments with more complex structures in order to profit from extra yields in terms of illiquidity premiums. This often includes arranging consortia,” he says.

Seizing opportunity

One consequence of the fund’s increased exposure to infrastructure has been a jump in US dollar exposure.

“We have sought access in particular to the US dollar credit markets, important because infrastructure and asset-based investments are to a large extent US dollar denominated. We have moved away from full currency hedging and used the US dollar as an asset class in its own right. In addition, we also keep a high share of hard currency emerging market debt. As a consequence, the US dollar exposure at the end of August 2016 was about 12 per cent of assets under management.”

It has given rise to the other reason the fund is immune to structural weakness in the Eurozone post Brexit: “ÄVWL is a net gainer of the Brexit decision so far and has profited from the US dollar appreciation which has, to a large extent, overcompensated the depreciation of a relatively moderate sterling exposure,” Horstick says.

Along with financing infrastructure, asset based lending with an anti-cyclical bent includes the fund financing ships and aircraft, seizing opportunity in two niche segments where traditional bank backers have fled the market.

“In the asset-based space we saw a widening of the spreads as a consequence of banks leaving the sector, especially in the aviation and shipping sector. ÄVWL invested a three-digit-million-Euro-amount in this sector during the last three years.”

ÄVWL manages about 60 per cent of its assets internally.

“We aim to have internal know-how for all relevant asset classes. External managers help us in asset classes where it is not worth building in depth in-house expertise and we also use external managers in areas where we have no direct access to the market or where we are regionally not present, like the US and emerging markets. We use consultants only in special niches or if we are entering a new area or asset class and do not have the necessary experience.”

The fund uses dedicated managers in private equity because it doesn’t have the resources for direct investments.

“At this point in time we are focusing on manager selection in private equity as this is the main driver for the performance within this asset class.”

Active management also lies at the heart of strategy.

“We strongly believe that active management adds value. To us it is very important to select the best strategy which fits our requirements. We see this as an essential driver for the performance of our fund,” Horstick says.