As interest rates have fallen globally, the search for income has been a prominent narrative driving investment decisions. This has meant income-oriented assets have been “bid up” by the market, compared to other sectors, and are relatively fully priced in Mercer’s view.

In recent years there has been a flurry of “income” type funds enter the market, targeted primarily at the wealth sector or smaller institutional investors.  These can take various forms, but a common theme is an emphasis on yield-rich assets and an almost complete avoidance of lower yielding assets such as sovereign bonds. Such funds come with their own risks – the narrow pursuit of income in today’s low yield environment can offer as much downside to the unwary as the narrow pursuit of capital growth.

Types of income funds

Income products tend to fall into three categories:

Equity-focussed funds which invest primarily in stable dividend-paying companies but may have flexibility to invest a portion in fixed interest securities. Given they are concentrated in equities, for the most part these funds offer limited downside protection, albeit the defensive stock bias provides some insulation

Bond-focussed funds which are fully invested in corporate-issued fixed interest and cash. To bolster income, an allocation may be made to sub-investment grade or unrated securities

Diversified funds which are exposed to sectors as above but add or amplify asset classes with income-producing characteristics, such as listed property or infrastructure.

A dollar is a dollar

When considering such funds, it is useful to have regard to a wider context: A dollar of return is a dollar of return whether it comes from income or capital gain. Indeed, in countries where there is little or no taxation of capital gains, maximising dividends may not be the most tax-effective manner to generate returns

Investment returns are generally enhanced by tilting exposure toward those assets or sectors which offer better value or growth prospects relative to others

(As previously stated as interest rates have fallen globally, the search for income has been a prominent narrative driving investment decisions. This has meant income-oriented assets have been “bid up” by the market, compared to other sectors, and are relatively fully priced in Mercer’s view.)

The income component of an investment should aim to be sustainable but, equally, investors have to be mindful of the capital component of the total return. Valuation is important which entails not paying too much for the assets that are generating income.

‘Benign’ market environment

Income-oriented funds tend to have exposure to assets which have a relatively high correlation to the movement of interest rates, including a tilt to sectors seen as “bond proxies” such as utilities, property and banks. The fairly benign market environment we have been through over the past six years – low interest rates with moderate credit spreads and volatility – has provided a solid tailwind for income-type funds.

A low interest rate environment may well continue into the medium-term; however, that is only one scenario. A concentration on allocations to yield-rich asset classes may prove problematic in certain market conditions, such as a “flight to quality” where credit spreads widen and equity markets fall (to take one example, overseas higher yielding bonds lost around a quarter of their value in the period August-October 2008).

If valuations are stretched and begin to reverse, the prospect of investors incurring capital losses may become a reality. And in an individual sense, those who are near or at retirement are particularly sensitive to a drop in the value of their savings – they may not have the required investing time frame to recoup any losses.

There is also a risk that company dividend streams prove unsustainable, due to either pay-out ratios being too high, or insufficient revenue growth. An active manager can help by taking all the above factors into account and avoiding the riskiest parts of the market, but balanced attention to growth, as well as income, will limit the scale of the challenge.

The above discussion is not to say that an investor allocation to income-generative assets is unjustified. Especially where there is a view that interest rates will be “lower for longer” or for investors that have very clearly defined cash flow requirements – and limited need for significant upside from capital growth.

However, it raises the question as to to what extent investors should make use of income-oriented funds and whether now, in particular, is a good time to do so. A fund with more-diversified factor exposures helps reduce the likelihood of being severely impacted by a correction in any one segment of the market.

Being pragmatic

From a pragmatic perspective, it cannot be denied that a sizeable portion of investors, particularly in the endowment and wealth sectors, have a bias to receiving a steady stream of income arising from their portfolio. Human behaviour is such that regular pay-outs fill a need for “tangible” evidence of a return on investment, and there is a general aversion to drawing down on principal.

It is also true that income-paying assets fulfil a need of providing cash to cover grants, or spending requirements, in a relatively simple manner (even if the selling of units in a product can fulfil a practical need for liquidity with modest cost implications). The challenge for advisers and fiduciaries is to help ensure natural or embedded tendencies do not unduly compromise long-term investment goals.

Given the primary focus of income funds is to provide yield as opposed to an efficient portfolio in total return terms, and given the strong returns of yield-rich asset classes in recent years, caution should be exercised in allowing income-themes to dominate investment allocations.

A focus on yield should not be to the detriment of effective portfolio diversification. Ultimately, a well-constructed suite of different asset exposures should offer superior long-term outcomes to a fund dominated by corporate bonds and high-yielding shares.

David Scobie is a principal at Mercer in New Zealand

Britain’s vote on June 23, 2016 to leave the European Union (EU) has been salutary, exposing the political, economic, and cultural divide between the Davos elites (to use shorthand) and the majority population. This gap has widened not just in the United Kingdom, of course, and this was not the first such vote. (When the EU-Brussels has been put to national votes, it has tended to be repudiated, only to be subjected to re-votes or just ignored.) A squeaker remain vote in the UK would have enabled the Davos elites to continue papering over the divide. So whatever the mendacity and irresponsibility of the “leavers”, or the ultimate outcome of any Brexit process, balloting was a victory for democracy.

The vote did not appreciably increase the risk of an unravelling of the EU, which was already high. Europe today is a remarkably prosperous and peaceful place, with degrees of cross-border cooperation that are stunning by any historical standard. And this followed the most horrible wars in recorded history and required decades of painstaking effort and painful compromise. All this has been undermined, though, not by the 52-48 vote in the UK but by the integration process itself.

Europe’s deep, and perhaps insurmountable challenges, are rooted in a shift from the European Economic Community, a zone of free trade in goods, to the European Union. Aspirations for such a leap can be appreciated, but it has proved fateful in practice. Monetary union came first not because it was most desired, but because it was the least difficult. Political union lagged not because it was less desired, but because it was too difficult (cultural union, still more so). But as some critics warned at the time, and has become evident to many more people since, is that monetary union without fiscal, and ultimately political union, does not advance prosperity and peace.

Either fiscal-political union happens or monetary union ends

Amid the manifest devastation of the economies of southern member countries by the single currency, the so-called five presidents of the EU – of the Commission, Council, Central Bank, group of finance ministers, and Parliament – issued a report back in 2015 on advancing financial, fiscal and political union. Their summons died on arrival. But either fiscal-political union happens (good luck) or the monetary union ends – or the EU continues to serve as a mechanism for creating mass unemployment, because of the vast differences in the economic makeup of euro member countries.

This self-inflicted predicament is a much bigger threat to Europe than any posed by Russia, even if one holds a jaundiced view of Kremlin intentions and behavior. (The possible impact of Brexit on NATO is beyond the scope of this essay.)

Europe’s fundamental structural dilemma is often obscured by passionate ideological tilting. In left-wing critiques, the EU is increasingly identified with “neoliberalism,” an epithet taken to mean wrongheaded liberalisation of every aspect of the economy, from capital (finance) to labor (immigration), which is viewed as advantaging the few and disadvantaging the middle and working classes. At the same time, much of the actual work of the various European bodies involves extensive regulation to “harmonise” laws, practices, and institutions across borders – which produces absurd rules governing minutia, and fodder for right-wing critiques. In both guises – hyper-liberalisation/hyper-regulation – Europe is more easily bashed than loved.

NAFTA a bit like the old EEC

But this is not a matter of better public relations. The North American Free Trade Agreement, or NAFTA, resembles the old European Economic Community. But if NAFTA had been “deepened” to include a supranational court, housed, say, in Mexico City, whose rulings were mandatory for every United States jurisdiction. And then if every single citizen of Mexico possessed the right, not by flouting the law but precisely according to the law, to settle in the US and draw upon US government benefits, then Americans would better understand much of the popular mood in Europe. The refugee crisis resulting from the catastrophes in Libya and especially Syria added combustible Islamic terrorist fears to the mix, but the underlying principle of unlimited migration was already politically problematic.

Transnationalism has built-in limits. Nationalism often gets a bad name, but it is, by definition, majoritarian and therefore compatible with democracy. Transnational sentiments remain decidedly minoritarian and therefore, in important ways, incompatible with democracy. To put the matter another way, transnationalism can succeed if it is made compatible with strong national sentiment. (Most hardnosed analyses of the creation of the EU, by the way, have proven that countries joined only because the union was seen to further national self-interest.)

The EU has every incentive to punish Britain for its nationalist leave vote as a deterrent, but even beyond business people, large numbers of European passport holders, not least EU elites, want continued, unfettered access to London. Large numbers of influential UK passport holders do not want to lose openness to Europe either. Still, no state has ever been granted full access to the EU while refusing to be governed by all its rules, including open EU borders, a key factor in the leave vote. Negotiations should, perhaps, be held in a Kabuki theater.

Still, if Brexit takes place in some form – which remains to be seen – it would have little or no appreciable effect on Europe’s fundamental structural dilemma. Europe’s status quo is detrimental and ultimately untenable, but its replacement could take different forms. Upheaval remains an option.

Euro not ‘one for all and all for one’ 

To point out that right-wing populists have no viable economic program to solve the deep problems from which they gain votes is not a persuasive argument for holding onto the euro. If the euro is so dear, for economic as well as symbolic reasons, a stable way out could be via introduction of a northern euro, which only select countries would join.  The current euro would then become a de facto southern euro, and its uncertain prospects would be independent of the survival of the euro (in a sustainable, northern guise). Just such a northern-southern double currency was the original plan of some European dreamers in the second half of the 19th century. Instead, Germany unified in a series of wars and introduced the mark.

The Brexit vote’s most immediate consequence, for better or worse, has been to scuttle the “small government” austerity of the Tory government. More long-term, it seems to have placed in question the survival of the United Kingdom. In fact, Scotland, Wales, and Northern Ireland have been developing different political cultures from that of England. If the UK is worth saving, and if it can be saved, it will be. If not, the Brexit vote would have at most accelerated something that would have happened anyway.

Powerful underlying interests have a way of asserting themselves through the cut and thrust of events and the predictable political opportunists. It is possible to imagine a face-saving salvation of Britain’s EU association and of Britain itself. It is harder to imagine survival of the EU over the long term. 

Stephen Kotkin is an adviser to conexust1f.flywheelstaging.com 

He is the Birkelund Professor in History and International Affairs at Princeton University, where he has taught since 1989. He is also a fellow at the Hoover Institution at Stanford University. He is the author of Stalin, vol. I: Paradoxes of Power, among other books. For several years he was the book reviewer for the New York Times Sunday Business section (2006-2009), and today writes reviews for the Wall Street Journal and TLS. Kotkin earned a PhD from University of California Berkeley (1988).

Creating a low-carbon index was a practical way for the New York State Common Retirement Fund, the third largest pension fund in the United States with $178 billion in assets, to put its beliefs into action.

Vicki Fuller, chief investment officer of the fund, says that environmental, social and governance (ESG) considerations are integral to the investment philosophy of the fund.

“We live by them, they are firmly mentioned in our investment philosophy as a source of return and risk, this is not new for us,” she says.

“It is not new for us to be invested in renewables, solar, wind, and active managers who execute sustainable strategies.”

Now $2 billion of US equities is passively tracked to this low-emission index, which excludes or reduces investments in companies that are large contributors to carbon emissions, like the coal mining industry; and increases investments in companies that are low emitters.

The portfolio is managed by the international equities portfolio management team internally, which also manages the rest of the US passive portfolio.

In total the fund has around $50 billion in US equities, and over time plans to increase the amount in this index.

Other investors have also established low-carbon indexes to use internally.

In 2013 PGGM developed an index in house, which measures the 2800 companies in the FTSE All World Index for their environmental and social policy and good governance.

The index re-ranks the companies based on these criteria, which also include a minimum threshold. As a consequence of this, about 200 companies that don’t make it into the index have been sold by PGGM, which amounts to about 1 per cent of the portfolio.

At New York Common, the low emission index, which was created in partnership with Goldman Sachs Asset Management (GSAM), is modelled after the fund’s existing indices, which are passive investments in US companies with returns that match broad market performance.

 

Climate change one of the biggest risks

The low emission index eliminates or underweights stocks in some of the worst greenhouse gas emitters, based on independent emissions data reported to the carbon disclosure project, and will reduce the emissions profile within the index by up to 70 per cent.

Fuller says the focus of a long-term investor is on the strategies that manage risk, and that climate change is one of the biggest risks facing global investors across multiple sectors.

“By shifting our capital to companies with lower emissions and comparable returns, we are sending the message that our investment dollars will follow businesses with strong environmental practices,” she says.

“Environmental, social and governance is an important part of our long term strategies. Businesses which focus on the health of their companies are better to invest in. We want companies to generate long term returns into perpetuity; if there are issues causing them to be unattractive with long term returns, we want to know about it,” she says.

The fund participated in the landmark Mercer study, Investing in a Time of Climate Change, which identified the impacts that various scenarios of climate change could have on global investors. That report showed that New York Common had significant exposure to climate policy action, with almost 60 per cent of its allocation to public and private equities.

One of the recommendations of the report was re-allocating a portion of passive equity holdings into low-carbon alternatives.

“Mercer showed us how vulnerable our portfolio was,” Fuller says.

“We have a large exposure to developed countries and if there was aggressive mitigation we would be vulnerable.”

GSAM, which is one of the fund’s strategic partners, helped measure the carbon footprint of the global equities exposure.

 

Reducing its carbon footprint

“Our carbon footprint was 15 per cent less than the benchmark, with 75 per cent US equities and 25 per cent non-US equities in the portfolio. It set us on a quest to see what we could find,” says Fuller.

The low-carbon index was an outcome of a number of conversations with GSAM that centred around reducing the carbon footprint, which was largely determined by a subset of companies.

“Could we create a parallel index that didn’t take significant tracking error, was not different from a sector and industry perspective, but that had a lower or zero exposure to high carbon companies? We have been working on this a long time.”

Importantly, she says the focus is not just on fossil fuel companies, but on materials and industrials that also have a significant carbon footprint.

“This is why we were looking for a holistic approach. For us the approach we are taking is about the shared responsibility, it’s a problem across all industries.”

The index, Fuller says, is firmly within 25 basis points tracking error.

“That is gratifying for us because of the volatility relative to fossil fuels. We hope to increase investments in that index. We have $50 billion in US equities, about $2 billion is in the index, which is a meaningful number.”

The fund is now conducting research to determine the efficacy in applying this methodology to non-US developed equities markets. About 13 per cent of the portfolio is in non-US equities.

Engagement remains an important part of the success of the strategy to decrease the carbon footprint.

“It is very important to our success for companies to report. It is early days, but it will continue to be a big initiative to engage companies to report data to companies like the Carbon Disclosure Project.”

In addition to the low emission index, the fund recently committed an additional $1.5 billion to its sustainable investment program, bringing the total commitment to sustainable investments to more than $5 billion. Investments in this program include a wind farm in New York state and alternative energy production across the globe.

In an announcing the index, the New York State Comptroller, Thomas P DiNapoli said: “Low-carbon, sustainable investments are key to our future. Our pension fund has long supported climate aware strategies, and this expansion of our commitment offers a sensible solution that will protect the fund’s investments. It’s an approach to low-carbon investment that we can expand across all asset classes, and help spur the kind of innovation and ideas that will assist in the transition to a low-carbon economy.”

Norges Bank Investment Management would like to see an increase in the number of company listings and in a new research paper suggests more flexibility from exchanges and index providers could facilitate this.

The paper, The listings ecosystem – aligning incentives , examines the decline in the number of company listings and the concern this presents for investors.

It says that unintended consequences of regulations, lower capital needs, expansion of alternative funding sources, and changing market structure have been suggested as possible causes for this systematic decline.

The paper, which reflects Norges Bank Investment Management’s views, provides a framework that attempts to address this decline and proposes possible remedies that could be taken by the various stakeholders to encourage more listings.

The paper argues that at its core, the listing ecosystem needs to establish a new equilibrium to address the evolving conflicts of interest between founders, early investors, underwriters and future shareholders.

It proposes some practical steps that could be taken by brokers, exchanges and index providers.

One of the key findings is that given the demand from investors to access smaller and start-up companies, that exchanges develop new solutions in the form of new listing classes or alternative trading platforms, to enable smaller firms to go public at an earlier stage of their life cycle.

NBIM welcomes the idea of junior or secondary exchanges that aim to reduce barriers of entry for smaller firms. And that eligibility criteria, like trading liquidity and reporting frequency, could be relaxed at the early stages of new company’s listed life cycle.

It suggests that index providers could also be more relaxed and revisit their rules for inclusion.

“I’ve had easier weeks,” says Antony Barker, managing director and chief pensions’ officer of the £9.7 billion ($12.8 billion) Santander UK Group Pension Scheme, the defined benefit scheme for employees of the UK arm of the Spanish-owned bank, speaking the week after Brexit. But there was no suggestion that Barker was anything but prepared and poised to benefit from the UK’s decision to leave the European Union.

“The immediate impact of Brexit on the asset portfolio has been largely positive – gilt yields have depressed dramatically, but fortunately we increased our hedge ratios significantly and synthetically during the preceding weeks. Equities have recovered most of their initial losses, and as many of our mandates are global, unconstrained approaches, active management and a weakening in Sterling will have enhanced returns. Our real estate portfolio is tilted away from prime office accommodation and the private markets exposure is largely US dollar denominated. The themes in the portfolio were global ones, so the referendum result changes very little.”

It’s a robust position and “can-do” attitude, grounded in reforms that Barker introduced four years ago, when the fund shook off the stigma of being “a legacy HR problem” to become “a key business division of the bank,” innovating, demonstrating value for money and good governance.

The conservative investment portfolio of passive equity, index-linked gilts, and other conventional bonds was swept away for a more diverse risk-on investment strategy, combined with a reduction in overall risk by hedging the fund’s liabilities.

“We see two types of risk: unrewarded and rewarded,” Barker says. “We divide the opportunity set into economic or rewarded risk, and duration risk, which includes longevity and inflation and which is unrewarded, so hedged out at the best possible price. We identify the underlying investment thesis and then establish the best rewarded asset class to gain the exposure. It’s true that you can’t get more return without taking risks, but simply taking more risk doesn’t guarantee greater returns.”

Last year physical assets such as property and alternative investments were the portfolio’s best performing, with the $1.5 billion property portfolio posting gains in excess of 20 per cent net of acquisition costs and duties.

And it’s private markets where Barker has brought most transformation. Here investments are driven by individual stock selection considerations rather than macro level economics, he says.

The portfolio comprises global growth investments that Barker expects to double, or more, in value over a five-to seven-year period, even if economies and markets are stagnant. He focusses on smaller to mid-market opportunities and avoids speculative, highly geared or structured investments.

All direct acquisitions in private markets are driven by a theme or the “next big idea.” It could be in technology and digitisation; the ageing world or urbanisation and new consumer classes emerging in developing markets.

That’s entertainment

The fund has explored an entertainment theme with the acquisition of the Manchester Arena and The Brewery; another entertainment venue in London.

Barker likes the African middle class story, where changing consumer habits and technology take-up are creating opportunities in food distribution and mobile. In addition an energy theme doesn’t just stop with renewable generation, but includes energy consumption and transmission investments.

“A number of the strategies that we have in South America are looking at distribution of US-generated shale gas over a wider sphere.” Cybersecurity and handling big data is another theme.

“We recently invested in the leading company tracking epidemic diseases such as Ebola, which sells on their research to governments and insurance companies,” he says

And Barker believes Santander has the edge over other investors when it comes to off-market acquisitions.

“The reputation of pension funds is very much one of jilting people at the altar; we talk a good game, we have lots of meetings, but then we fail to come up with the goods at the right time. In off-market transactions, people want deal certainty.”

It’s something Santander can offer with cash in the bank and an ability to execute deals quickly.

“We have a longer time horizon than most, and having worked out how much cash we need to pay benefits over the next few years we can take on more complex projects and find extra value in ‘hairy deals’ needing true active management to extract that value.”

And he is quite prepared to put the work in to transform assets into a finished product. In today’s low return environment, improving the assets and then selling them on is proving a winning strategy.

Commercial property – so hot right now

“As the commercial property sector has been seen as increasingly hot, we have taken the opportunity to sell lower quality holdings at a very full price through a pro-active sales strategy, reinvesting the proceeds in new assets with demonstrable embedded value.”

Barker is a strong advocate of collaboration and shared services, linking up with other pension schemes in a variety of operating models, designed to enhance governance and execution and allow mutual participation in the best ideas.

It’s a strategy illustrated in Santander’s stake in Hermes’ infrastructure vehicle seeded by the $36.5 billion BT Pension Scheme.

Under this partnership, the Hermes fund has developed a number of renewable energy investments, as well as acquiring port sites. Most recently, Santander’s segregated account program supported Hermes’ successful bids for Eurostar and AB Ports.

And Barker is equally happy to collaborate with managers. In both private equity and the hedge fund space, Santander takes stakes in the managers so that the fund gets returns, both from a pay-off on its own investments and also from the broader success of the manager’s business through the cycle.

“In return for our investment, we enjoy a share of revenues in both the underlying fund managers and the selection business, doubling our return on the market beta exposure alone,” he says.

In private equity, the fund has worked with managers to create a low-fee fund of co-investments and a fixed fee non-discretionary account, where the manager brings due diligence, specific research and execution to ideas generated by either Santander or third parties. He also encourages more collaboration across the manager roster; for example the real estate managers work with private equity managers.

“This has reaped dividends in making ideas better, investments more profitable and execution more feasible. While good advice is always worthwhile, money paid away in fees is money that could go to pay pensions,” he says.

“The experience of pension funds generally over the past 20 years has not been good, and yet the appetite for change and innovation has been curiously limited, constrained perhaps by consultant and asset manager vested interests. If you always do what you’ve always done you’ll always get the same result.”

Canada’s Alberta Investment Management Corporation, (AIMCo), the C$90.2 billion ($69.4 billion) fund that invests on behalf of 26 pension, endowment and government funds, has more than three quarters of its assets in public markets, most managed internally.

This includes money market and fixed income allocations and a diversified mortgage portfolio, but the most sizeable chunk lies in a $27 billion sophisticated equity portfolio that combines passive low cost strategies with complex hedge fund allocations.

Internally managed equity investments include quantitative and passive strategies which currently invest in 45 countries around the world. Smart beta is one such allocation, and with it AIMCo aims to add 100-150 basis points every year.

“It’s been successful. I like smart beta,” says chief investment officer Dale MacMaster, in an interview from the fund’s Edmonton headquarters.

“We want to access beta as cheaply as possible.”

The smart beta ethos of breaking down returns into factors, and buying components like value or momentum, while isolating the remaining alpha is something he is now applying to an internally managed portable alpha strategy.

“We are adding more leverage to our own hedge fund strategies by customising the portable alpha allocation to a greater degree than before.”

Portable alpha combines leveraged exposure to an index with investments in a high-returning asset, or strategy uncorrelated to that index. The former provides the beta, the latter is supposed to deliver outperformance, or alpha. In a strategy that has evolved in recent years, MacMaster explains that a recent development is to create a global alpha pool that is then allocated across AIMCo’s beta exposure.

“We can have, say, Canadian beta and then receive alpha from a global alpha pool that has a diversified mix of exposures. It’s all about finding the most cost effective way to deliver alpha and beta.”

“I don’t want to pay exorbitant fees for straightforward hedge fund strategies that can easily be replicated. We try to be smarter in how we use hedge funds. A lot of what they can do we can do internally. Take a hedge fund that only trades volatility across every asset class – we can’t replicate exactly what they do, but there are strategies within that fund that we can execute on in-house, [on] a smaller scale, across a handful of assets.”

 

Many approaches to using hedge funds

MacMaster, who took over as chief investment officer in January 2015 and whose 17-year career at the fund includes its 2008 transition to the Crown Corporation, from Alberta Treasury Board and Finance, is, however, prepared to pay for enhanced strategies with high-conviction managers that promise to add a further 200-250 basis points.

These include long-only and hedge fund strategies with AIMCo using seven to eight hedge funds running uncorrelated strategies that bring real diversification and a deeper expertise than the in-house teams, while remaining cost effective.

“You have to acknowledge that you simply can’t do everything in-house. Currently you are seeing many pension funds divesting of their hedge fund holdings. There are many approaches to using hedge funds. We don’t look for especially high hedge fund returns; instead we look for diversified, uncorrelated alpha of modest returns, say between 6-8 per cent, on a basket of hedge funds overlaid with equity market beta.”

MacMaster uses hedge funds that specialise in leveraged credit, volatility and other diversified strategies.

“One of our hedge funds does nothing but buy positions of other hedge funds at a discounted rate in the secondary market,” he reveals.

“It’s probably easier to negotiate deals with new hedge funds that don’t have such a strong record. Most of our funds have long successful track records. If a fund has a 15-20 year record of shooting the lights out, it is difficult to negotiate fees downward. Some of our best managers have limited capacity for new money.”

AIMCo’s $19.4 billion private investment portfolio includes real estate, infrastructure, private equity and timber, where the fund is in the process of rotating land in timber to agriculture to maximise value.

The $10.4 billion real estate fund is still Canada focused with around 90 per cent of the portfolio in direct real estate with the pension fund only investing in funds when it needs the expertise or scale.

“We will invest with funds in specialist areas like, say, a total rehabilitation of a property in a geography where we have limited direct experience. We can’t do that so we find the guys that can.”

In a higher risk, higher return strategy, foreign real estate is increasingly focused on development opportunities rather than core, income producing real estate, he says.

 

In-house expertise

AIMCo used to only invest in private equity with funds, but once it built an in-house expertise and “hired the right people,” the portfolio evolved to combine fund investments, co-investment and directs.

Now the allocation is evolving again with MacMaster overseeing a strategy to target middle market private equity funds.

“There is fierce competition to invest in the large private equity funds – the biggest are turning away money. We can afford to fund the middle market funds and we can be the lead investor. The smaller funds do get the good investments too. There is a far greater choice in certain geographies and sectors.”

Private investments have also grown since AIMCo opened a London office. MacMaster says he has been amazed by the number of contacts and transactions that have come AIMCo’s way by people “attracted to our shop.”

Like so many other asset managers, AIMCo is benefiting from regulatory changes at banks.

“We have looked at opportunities in private debt and loan, collateralised loan obligations (CLOs) and trade finance. Some of these ideas are still being incubated,” he says.

“One challenge is that banks’ existing client relationships typically straddle numerous asset classes and can impinge on a pension fund’s specific investments. If you step in, you must make sure there is an alignment of interest, and that they have skin in the game.”

Sharing the risk is important and he prides himself on AIMCo’s deep relationship with a handful of partner banks.

“It takes time to structure things.”

“Canada has a very good reputation for pension management. Canadian funds have a very strong governance model with a blue-chip board operating at arms-length from government overseers,” he says.

“It was initially difficult to get the government’s attention that reform was important, but now AIMCo is a very successful story and I am proud to have been a part of it.”