In 2015 the second Swedish National Pension Fund (AP2), with about SEK300 billion ($37 billion) in assets, completed an internalisation of $6 billion in external mandates, introduced new risk systems, formalised its environmental, corporate and social governance strategy, and implemented a change of custodian, moving $31 billion in assets.

“I am really proud of the organisation,” Eva Halvarsson, chief executive of AP2, says.

“We felt we were evolved enough to do that. When the fund was set up in 2001 we wouldn’t have been. But we now have competence and knowledge and built up new systems, so we felt ready.”

With total costs now at 17 basis points, the plan is to reduce that further to 14 basis points.

The main vehicle for achieving that is in-house asset management, and in the past three years more than $6 billion has been shifted from external mandates to the internal investment team, including in emerging market fixed income and global credit. The fund now manages around 83 per cent of assets in-house.

The team is lean, with 65 staff in total, around 35 of who are in investments.

Internally the team manages: Swedish equities, credit, emerging markets bonds, Swedish bonds, and developed market bonds. There is a large quant division, so more assets managed in-house does not necessarily translate to needing more staff.

The fund still has a number of external mandates with development market equities specialists such as Generation and AQR.

“We have four values and one of them is constant improvement, so we look at costs but it’s not a purpose on its own. We have chosen the portfolio we think is the best,” Halvarsson says.

AP2 has government restrictions around where it is allowed to invest. With the main investment requirement that the fund invests 30 per cent in bonds, and not more than 5 per cent in unlisted assets, with the exception of real estate and real assets such as timber and agriculture.

The fund’s asset allocation is 44 per cent equities, 31 per cent fixed income and 25 per cent alternatives. The equities allocation is split between Swedish equities (10 per cent), global equities (24 per cent), and emerging markets (10 per cent). Within fixed income there is a 6 per cent allocation to emerging markets. The alternatives allocation is split between real estate (12 per cent), private equity (5 per cent), alternative credit (2 per cent), alternative risk premium (3 per cent), and Chinese Series A equities (2 per cent).

Halvarsson admits that the mandated 30 per cent in bonds, which naturally means lower returns, creates a bipolar portfolio, with the fund needing to take risk in other parts of the portfolio.

“I look back and see three trends in the way we work with the portfolio. There’s been a move from developed markets to emerging markets; a move from listed to unlisted (real assets); and fund investments to direct investments and joint ventures,” she says.

AP2 is keen on real assets, and under different rules Halvarsson says the fund would invest in infrastructure. “It suits us,” she says.

“We continue to increase investments in real assets, it suits our objectives. In a globalised world it is so hard to find uncorrelated but real assets.”

The fund takes a 30-year time horizon and believes in active management, and in 2015 produced about 1 per cent of active return.

 

Knowledge-sharing and common values

Halvarsson says it was a positive and necessary challenge to develop the organisation further – and bringing the assets in-house helped with that.

In addition to the internalisation process, in 2015 the fund also introduced new risk systems, formalised its environmental, corporate and social governance strategy, and implemented a change of custodian moving $31 billion in assets.

The new risk system is a combination of Risk Metrics and Barra One, which not only allows a portfolio view of risk but also enables environmental, corporate and social governance analyses of the portfolio.

The fund is also tendering for a new performance system, and is developing its own business system which includes knowledge sharing.

“This has been a magnificent way to increase cooperation in the organisation – we have common values and we work with our values as part of [our] daily work. With competence, systems and a willingness to cooperate and improve, all this has tightened the team,” she says.

Halvarsson has been chief executive of AP2 for 10 years, and she says this is “one of the greatest things I’ve done.”

“I’m privileged to be working with very talented people, everyone is better at what they do than me,” she says of her staff.

 

Sustainability a key driver

“The integration of sustainability is part of our daily life, so I forget to mention it,” she says.

“Ten to 15 years ago, a financial analyst would say if it isn’t in our spreadsheets it can’t exist. But now we look at things you can’t put numbers on. What is the best possible information that you have before making a decision – and we use all types of information before investing in the future.

“Sustainability turned into a hygiene factor, everyone is talking about it but not knowing what they’re doing. Asset owners, governments, consumers and companies, who does what and what are the expectations, it’s a mess,” she says.

But Halvarsson is clear on the role of her fund, and other asset owners.

“Every time I talk about it, I want to mention it is not up to AP2 to put a price on carbon,” she says. “We have a very important role as a catalyst, but the expectations are that asset owners are sitting on money and should transform the economy.”

“The financial industry has a very important part to play, and we have to learn more or else we can’t make the right decisions. But we are looking at it from financial risk perspective, and we are not a political instrument.”

Halvarsson sat on a panel on sustainable investments at the 2015 World Climate Summit in Paris, which added further weight to her belief that the finance industry needs greater knowledge and competency around sustainability issues to achieve better financial outcomes.

The framework for AP2’s sustainability program is anchored in the international conventions that Sweden has signed, such as labour conventions.

In 2015 it reduced its risk to climate by limiting investments in power companies whose profits derive primarily from coal-powered generation of electricity, and has consequently divested from 28 power companies.

When the fund divests it is done from a financial risk perspective, a view that assets are not priced correctly, and is not a moral decision, Halvarsson says.

The vision is to make environmental, corporate and social governance an integral part of all analytical and investment processes. And the fund connects actions to the United Nations sustainability development goals, and in this way can visualise that what they are doing is connected to a bigger perspective.

AP2 has been investing in green bonds since 2008, and was one of the first in the world to do that. Now it has decided to make it part of the strategic asset allocation, of 1 per cent, for benchmark purposes, which Halvarsson also says signals it is an important part of the portfolio.

“I hope it will increase over time, green bonds have performed in line with other bonds,” she says.

 

Diversity as a competitive advantage

In 2003, AP2 developed a female index, measuring the percentage of female employees at companies listed on the Swedish stock exchange.

“We want to ensure the companies we invest in have the best talents and use all the possible recruitment. It puts the facts on the table,” she says.

“Gender diversity drives better governance and better company returns, we are totally convinced of that.”

The index focuses on female board representation and leadership roles.

“The number of women in management is showing steady but slow growth, it’s now about 20 per cent. But women on boards is more volatile.”

Halvarsson says quotas are being talked about more seriously than ever before. After the annual general meetings this year, if there is not 40 per cent of women on boards then there is a discussion about enforcing quotas.

While last year 50 per cent of all new board appointments were women, it will still take 44 years before management is 50:50 because of the slow pace of change.

“My view is if we reach 30 per cent, then it will become easier, because it starts reinforcing itself. We need some self-recognition here, it will be stupid not to avoid a law on this, it’s about competency. We need more understanding around this competency driver and that it can be seen more as a competitive advantage.”

“In our Myers Briggs testing, the chief investment officer and I don’t have one figure in common. That’s good for us, we need to work together.”

“It is about the same thing – values. We recruit and retain and develop people and have to work with the whole spectrum. Younger employees see it differently, and I don’t want an organisation that’s conservative, with old values. We cooperate with other asset owners on sustainability, so how can we do it on gender and diversity?”

 

“We view ourselves as a pension delivery organisation, while a lot of other funds see themselves as asset managers. Asset managers generally measure risk in terms of market volatility or drawdown in capital, but our mantra is to deliver on a pension promise,” says Jim Keohane, president and chief executive of Healthcare of Ontario Pension Plan, HOOPP.

“We define risk as based on factors that may impede our ability to write that cheque 25 years from now, which would include additional factors such as changes in the purchasing power of our assets, caused by changes in interest rates and inflation. We don’t benchmark ourselves against returns, we aren’t this type of organisation. Measuring against returns does not give a full picture of whether or not you have succeeded.”

Success, for Keohane who has been at HOOPP since 1999, is better measured by the glowing funded status at HOOPP, up to 122 per cent from 114 per cent in 2014, despite all of last year’s economic uncertainty.

HOOPP is a C$63.9 billion ($50 billion) Canadian fund is a multi-employer defined benefit plan, serving 309,000 working and retired healthcare workers.

Its liability driven investment, LDI, comprises two investment portfolios: a liability hedge portfolio, designed to hedge the major risks that would impact HOOPP’s pension obligations – namely inflation and interest rates – and holding assets which perform in a manner similar to its liabilities, and a return seeking portfolio designed to earn incremental returns and bring diversification benefits.

Real estate over infrastructure

Within this structure, strategies at the fund are as noteworthy for what they include, as what they don’t – like the absence of any allocation to infrastructure in the liability hedging portfolio.

“Sure, infrastructure has long-dated and inflation hedging characteristics similar to real estate, but infrastructure also has sovereign risk and regulatory risk. We have invested in infrastructure in the past,” Keohane says.

He prefers real estate, with its high correlation to inflation. The 12.5 per cent allocation returned 8 per cent last year, despite a currency hedge.

The absence of infrastructure is not only informed by the risk of governments acting against stakeholders, but also by Keohane’s belief in the value of liquidity and always having enough on hand to be in a position to buy at points of distressed selling.

“Liquidity can be valuable at various points in time. For example, in January if you had liquidity you could take advantage of this,” he says referring to the sharp fall and subsequent rise in asset prices six months ago. “Liquidity is a trade-off. If you are going to consider tying it up in illiquid assets you have got to be sure you are getting a premium for this. The pricing of infrastructure today doesn’t hold sufficient risk premia: private equity can if you are in the right deals.”

Other current themes at the fund include absolute return strategies in the foreign exchange forward market where HOOPP is exploiting odd pricing anomalies. Keohane also plans to increase the fund’s allocation to real-return bonds relative to nominal bonds. He also sees opportunities in credit, structured credit and credit derivatives, where uncertainty around new financial regulation within the Dodd-Frank Act has left opportunities.

“The spreads here are wide, relative to what we’d expect and are not relative to the credit fundamentals. There is an absence of ownership, a sense of being in no-man’s-land. Some of these things are priced favourably against the risk.”

Opportunities as well as challenges

Confused credit markets, and banks exiting traditional business because of capital charges, are some of the areas where new regulation brings opportunities. But it is also raising challenges, particularly for HOOPP’s heavy derivative use and dependency on banks’ ability to act as a counterparty.

The trend among banks to exit high balance sheet usage, low margin businesses is starting to reduce liquidity in the repo market, with banks “shedding repos off their balance sheets.”

Although HOOPP can address this through central clearing, it involves the fund changing its model and sets it on a challenging road.

“Dodd Frank creates problems for us as a derivative user in terms of how we do deals and exit them. Central banks understand the challenges but the regulators are marching on.”

HOOPP’s strategy relies on in-house management and cutting edge technology in an organization where of the 600 staff, 250 reside in the IT department, with Keohane having a 60-strong investment team.

HOOPP’s investment costs are about 20 basis points, while total costs at the fund are 30 basis points.

“There is no way we could keep this low if we were outsourcing. Many of our strategies involve the efficient management of our balance sheet, but the outsourcing model doesn’t allow this. With an in-house model, we can also dial risk up, and down, and we can move money across asset classes; and if you’re outsourced this is more difficult and expensive to do.”

“If you outsource to another party they won’t tailor what they do to you. They tell you what the service is and you can either give them money, or take it away.”

 

Investors should not rely on investment theory because the complex and connected risks in the real world cannot fully be accounted for, says Tim Unger, head of advisory portfolio group at Willis Towers Watson in Australia.

For example modern portfolio theory, for which Eugene Fama won a Nobel Prize, factors in the exogenous risk of changes to underlying fundamentals, but only explains about 20 per cent of the realised market volatility, Unger says.

The theory does not account for endogenous risk, such as the random behaviour of investors who are acting on incomplete information.

According to the theory of rational beliefs by Stanford’s Mordecai Kurz, investors make judgement calls about what will happen to the price of securities based on past and present data, but because not every investor will have access to the same information, and this will cause some to overestimate the price and others to underestimate. Based on these rational beliefs investors will take actions, and this in turn causes things to be more volatile than they otherwise should be. Kurz’s research shows once you take this into account, 95 per cent of market volatility can be explained.

“Turns out that we need more than just one theory,” Unger says.

“The world is complex and there is no single overriding theory that does a good job of describing the real world that we live in. It’s just much more complex and changes more quickly than we expect. We can however use and draw on a number of theories to help us get a better understanding of the world, rational belief being one, but there are others.”

Because no one investment theory is sufficient, Unger said institutional investors should be taking actions to account for this, including developing stronger and deeper investment beliefs; allocating more to alternatives as equity markets will always have bad periods; and either being truly long-term or truly short-term, as a portfolio cannot simultaneously capture the benefits of both.

“In all of this, good beliefs are critical … And by having a better mental map of how those [investment theories] can impact security prices and asset classes, you can actually reflect those in your portfolios and generate better outcomes.”

Stronger and deeper investment beliefs

According to Unger, in an ideal world there is a hierarchy of beliefs, starting at the board and running down to those implementing the portfolio.

The board sets the high-level views and beliefs that frame the organisation and the investment portfolio. However, as there is no settled theory on the more detailed aspects of financial markets, the closer you get to those implementing the actual portfolio, the deeper and richer those beliefs need to become to help in the navigation of decisions.

“Embedded in every single investment decision you make is a set of beliefs. And so what we are arguing for, is that judgement and beliefs need to become a bigger part of the investment process, and those beliefs need to be richer and deeper.”

Another suggestion on how to achieve a better performing portfolio was for asset owners to use those fund managers who had sophisticated mental maps and were already capitalising on a deeper understanding.

“Those managers that can do that are clearly worth paying fees for because they generate excess returns. But other ways you can exploit better understanding is either through thematic investing or through dynamic asset allocation (DAA).”

What thematic and dynamic asset allocation require from an investor is the ability to identify where markets have mispriced and then the patience to wait for those to be realised.

“I’m not going to suggest that any of these are easy – none of them are – but they are all doable, that’s the important part.”

Allocate to alternatives, even if it is difficult

Recently Willis Towers Watson has increased its emphasis for investors not to rely on risk premia that are macro sensitive, as most portfolios are too reliant on credit and equity market risk.

“While Australia has led that charge in terms of increasing allocation to alternative assets, more recently they’ve slowed down and the rest of the world has actually overtaken them.

“The question is, why is that? Have they reached the point where they have the right allocation to alternative assets? Or are there factors that are limiting greater uptake of diversity?”

A straw poll of the delegates at the consultants Ideas Exchange in Sydney revealed that headline fees were not the constraint; rather it was a desire not to increase complexities in portfolios.

“But the fact that there isn’t greater conviction in the equity risk premia is also interesting. I think what it says is there is still appetite to take on greater diversity, it’s just that there are things that are making it harder to do; [that] there are higher hurdles to get new assets in your portfolio and that marries with our experience.”

Exploiting endogenous risk

Unger added asset owners need to have a truly long-term view.

“It’s too difficult and it’s too unrealistic to expect that we can build portfolios to do well in the short-term and the long-term,” Unger said.

“We have to adopt a portfolio that will do better over the long-term, partially because while we may well have a belief in mean reversion, we just don’t know when that is going to apply.

“Most of the changes in markets in the short-term are not due to changes in the fundamentals, it’s due to noise, so the best way to outperform with stock selection or asset allocation is to have a truly long-term view.”

However, it was possible to outperform by being truly short-term by exploiting endogenous risk that dominates the financial system, but which is largely noise when looked at from the longer term perspective.

Unger suggested some strategies that exploit endogenous risk were non-price weighing schemes and smart beta.

“There are also some very short-term oriented strategies that seem to do that, but I would argue they are probably not as easy to do as the longer term fundamental stuff, but still doable.”

Barry Kenneth joined the UK’s Pension Protection Fund, PPF, as chief investment officer three years ago from Morgan Stanley, where he headed up the bank’s fixed income and pension coverage. It was a role which involved navigating new banking regulation introduced in the wake of the financial crisis, in an experience that leaves the PPF in competent hands today.

The £22.6 billion ($33 billion) lifeboat fund is positioning itself ahead of costly regulation coming pension funds’ way, around the use of derivatives on which the PPF relies upon in its liability driven investment (LDI) strategy.

European pension funds have been exempt from the mandatory central clearing of derivatives until 2017. Next year new rules to bolster markets against systemic risk, mean over-the-counter derivatives will be processed through centralised clearing houses, requiring banks to hold increased capital against these instruments, reducing their availability and increasing costs.

“We are assessing potentially changing our portfolio in advance of central clearing obligations,” says Kenneth.

The PPF takes on defined benefit schemes left stranded if their corporate sponsor collapses. Funded by a levy on eligible schemes, its strategy is one of caution and focus, balanced between generating enough of a return to pay its 200,000 members, yet not place too big a risk on its levy payers.

Kenneth’s plan for reducing the reliance on inflation and interest rate swaps, and better proof the portfolio from the looming cost of derivative strategies, is a hybrid portfolio that will ultimately account for 12.5 per cent of the fund’s assets and “does two jobs.” Hybrid assets will have the hedging and inflation-proof characteristics of the LDI portfolio but also income-generating qualities.

So far investments include renewable energy, index-linked private placements and rental properties. Kenneth’s “proactive” approach to finding assets favours co-investment, allowing the PPF to bid on bigger projects where the competition is less fierce. A flagship deal in 2014 saw the PPF team up with M&G Real Estate to buy Manchester office blocks valued at £300 million-plus ($439 million) bringing both stable cash flows and an interest rate hedge.

The PPF previously targeted a 70 per cent allocation to cash and bonds to match liabilities, with the remainder in risk assets aiming for a LIBOR-plus 1.8 per cent outperformance target. By 2017 the fund will have a strategic 58 per cent allocation to cash and bonds, comprising UK gilts and annuity contracts, global government bonds and global aggregate bonds; including emerging market debt, a 22.5 per cent allocation to alternatives comprising private equity, infrastructure, timber and absolute return strategies, a 7 per cent allocation to public equity, with the remainder in the hybrid portfolio.

The fund’s small 7 per cent equity allocation is designed to counter the large equity allocations held by many of the schemes, some significantly underfunded, that it protects.

The flexible risk budget ranges from 3.5 to 5 per cent but with the current “headwinds” in the global economy Kenneth’s risk appetite currently hovers around the bottom end of the range. “We are looking for pockets that will deliver value in a challenging environment. We have been allocating more of the portfolio to idiosyncratic risk that is not aligned to the broader market.”

Internal and external ‘added value’

The fund is continuing to move more management in-house. The liability side of the balance sheet, namely derivatives and government bonds, will be the first portfolio to be brought in-house.

“If anybody knows what our liabilities look like and how to hedge them, we should,” he says.

Other assets will be brought in-house gradually over time, although this will never amount to the entire portfolio – only the parts of it where he sees real value.

“We are not being driven by a time scale and we are not going to build up massive teams,” he says.

Kenneth believes that both external managers and his 14-strong internal team can add alpha through their decisions.

The external managers add value against their benchmark and the internal team add value through manager selection and benchmarking.

“In portfolio construction we think about our true investment benchmark – our liabilities – not the asset based indices. Since we hedge our liabilities, this is equivalent to looking at the total return. The manager may deliver alpha, but if the index falls by more than the alpha, that is not going to add value to the fund.

“We also think in risk factors, and we have given out risk factor mandates especially in our hybrid portfolio, where we are focussed on obtaining credit, duration, inflation and illiquidity characteristics in physical assets, as opposed to constraining the managers based on asset class name,” Kenneth says.

The PPF has evolved and thrived from small beginnings in 2005. In its latest phase, it is acquiring assets that provide long-term cash flows and have less reliance on financial instruments, showing its continued ability to adapt to changing market conditions and financial regulation.

Private equity funds have long been characterised by high fees. Even as the number of asset managers (general partners or GPs) offering PE funds increased steadily over the past few decades, competition for the attention of limited partners (LPs) did not lead to an immediate shift in the cost of mandating specialist managers to buy and sell private companies.

Recently however, as reported on top1000funds.com in the article Investor pressure on fees, years of pressure from asset owners has led to a seemingly ineluctable trend towards fewer and lower private equity management fees.

The fact that increasing competition did not immediately lead to lower costs, when these were high to begin with, is an interesting puzzle.

Economists would see a case of strong information asymmetry between buyers and sellers, combined with a case of “type pooling” – in a market where some managers are capable of delivering a high quality service at a fair price (type A) but most are not (type B), both types of manager can tend to “pool” together and offer the same low quality product at a high price. Competition fails. This common phenomenon (think “finding a good plumber”) is the result of information asymmetry: clients cannot tell beforehand which service providers are of type A or type B.

Fee levels are only a consequence, or a symptom, of information asymmetry between GPs and LPs.

High fees had been acceptable to LPs thanks to high reported returns. But as the recent decisions by CalPERS or NYCERS to pull out of hedge funds altogether illustrate, lower returns in recent years have made fee levels much harder to justify in alternative strategies.

Reported excess returns in hedge funds or private real estate are lower in part because they are better measured: valuation methodologies and available data have improved sufficiently to allow quasi-market valuations to be reported.

Hence, out-performance measurement has become more accurate, and also lower because a greater proportion of hedge fund or private real estate performance can now be understood as a combination of market betas.

The evolution of asset pricing techniques and data availability has led to more accurate risk-adjusted performance measurement, and to a re-evaluation of the benefits received by LPs from delegating investment decisions to a hedge fund, or private real estate manager.

In other areas of the alternative universe, private asset valuation remains a source of significant information asymmetry between GPs and LPs.

For very illiquid and thinly traded assets, such as infrastructure, investment returns continue for the most part to be reported on the basis of quarterly or annual appraisals, which leads to a number of well-known issues: stale pricing, return smoothing and the impossibility to estimate the true diversification contribution of such assets in the absence of reliable measures of co-variance.

When assets are valued by discounting 25 years of future cash flows, the choice of cash flow scenario and discount factors explains most of the reported performance. In the absence of robust cash flow forecasting and discounting techniques grounded in financial theory, the entire reporting exercise amounts to a set of ad hoc and often opaque assumptions.

Nor is this news to asset owners.

In a new EDHEC Infrastructure Institute/Global Infrastructure Hub survey of institutional investors’ perceptions and expectations of infrastructure investment, less than half of respondents declare trusting the valuation reported by private infrastructure asset managers. A quarter declared not knowing whether or not they can trust them, and a little more than a quarter bluntly reports not trusting reported NAVs in infrastructure PE funds.

Today, in the infrastructure and other very illiquid asset classes, reported returns are also somewhat lower because new investments are being made at higher prices, and the pressure from LPs to lower fees is on.

But bludgeoning service providers into charging lower fees (sometimes with the help of the regulator), without asking them to provide better service, does not solve the market failure identified above.

 

Are asset owners condemned?

Those who pull out of delegated investments can either abandon an asset class altogether (no more hedge funds!) or try and internalise the skill set.

But in both cases this creates opportunity costs from lower diversification with – and within – the asset class (you cannot replace 20 asset managers with one internal team). In the latter case it also creates direct costs.

Furthermore, private investment teams operating within asset owners still mostly report the same stale NAVs and IRRs, while those who will stick with private asset managers who can only charge low fees (because the regulator said so) may now be faced with 100 per cent of type Bs.

So are asset owners condemned to maneuvering between the Scylla of DIY private investing and the Charybdis of opaque and expensive delegated investment in private assets?

There are solutions to minimise the effect of information asymmetry in market dynamics. To avoid the pooling of manager types, market participants can create “sorting devices” or “revelation mechanisms” to facilitate the processing of information from uninformed to informed participants.

In economics, this problem is typically modelled as a “market with adverse selection and competitive search”, where some agents post terms of trade (term sheets) and others aim to screen the other side of the trade by agent type.

In such models, the informed side of the trade (here the asset manager) can move first and signal to the market what terms they can offer, or the uninformed side (asset owners) can move first and request bids for a discriminating “menu” of potential products or investment solutions, which includes items that only type A managers can deliver, prompting type Bs to exit this segment of the market.

Hence, beyond the debate on fees, the need to better discriminate between private asset managers should lead asset owners to require better reporting, better valuation techniques and better risk-adjusted performance measurement.

Their next battle will logically be to improve the valuation framework of private assets and move away from reporting single IRRs and towards a fully-fledged factor decomposition of returns. In fact, CalPERS did keep one hedge fund manager on its books, the only one that could offer a hedge fund strategy defined in terms of alternative betas.

Still, it should be noted that solutions to problems of information asymmetry always involve the uninformed side paying an “information rent” to the informed side for revealing its type.

In other words, asset owners should not expect to get type A managers on the cheap. It remains in their best interest to try and discriminate between them and the rest, because it can lead to the cheapest outcome for a given level of risk-adjusted performance.

Finally, given the recent trend on fee levels in private equity, it is also in the best interest of type A managers to signal very clearly that they can deliver better measured out-performance by adopting more transparent and useful performance reporting standards, and valuation methodologies that are better adapted the nature of the information available about private assets.

Frederic Blanc-Brude is the director of EDHEC Infrastructure Institute-Singapore and EDHEC Business School Asia-Pacific

When Anne Stausboll started her role as chief executive at CalPERS it was a tumultuous environment, or what she calls a “perfect storm”. It was January 2009, the markets were in crisis, there was a state budget crisis in California, and CalPERS was facing ethical issues relating to the fund and former employees.

“My focus was on restoring trust and credibility to the organisation, and making it transparent and open,” she says.

Where historically the culture at CalPERS had been built around its size, and the large size of its portfolio; Stausboll has been focused on rebranding CalPERS around a public service organisation.

“We are here to serve others who have served California,” she says. “This has brought the organisation together, and it is very unifying to brand around that.”

CalPERS is a big business, and the role of CEO is immense. CalPERS administers retirement benefits for more than 1.8 million California public sector workers and oversees an investment portfolio of approximately $300 billion. CalPERS also purchases health care for nearly 1.4 million members.

And this means Stausboll oversees around 2,700 employees and an annual budget of $1.8 billion.

“When I started my job as chief executive in 2009, CalPERS had been here for 75 odd years,” she says. “One thing that struck me about the organisational structure was we didn’t have a financial office. That was quite a gap.”

She sees it as one of her greatest achievements; that there is now a well-established and well-functioning financial office, that also oversees risk management, and is integrated with the actuarial office and investment office.

“It took a few years to do that, and we needed to get regulatory approval. But that strengthened our financial and fiscal policies, and CAPR and treasury management were all strengthened,” she says. “This was a big shift and we are a leader in the US on our asset liability program, and the CFO and that office organises that. The financial office, actuarial office and investment office are all integrated, whereas before they were separate; so now the thinking is integrated giving us a holistic view of assets and liabilities.”

The benefits of size – 100 managers by 2020

During the seven years of Stausboll’s leadership, the CalPERS portfolio has grown from $181 billion at the end of June 2009 – a year where the market value of assets declined by 24.8 per cent – to more than $300 billion today.

Only a month after Stausboll was appointed as CEO, Joseph Dear* was appointed chief investment officer. The two became a formidable team focusing the portfolio clearly on the long term and what it means to be a long-horizon investor. This focus, as well as an emphasis on risk management, steered the portfolio out of the crisis.

Both Stausboll and Dear also had many years of experience working in large governmental bodies, with Stausboll holding various roles within CalPERS before becoming CEO, including serving as deputy general counsel, chief operating investment officer and interim chief investment officer, and previously chief deputy to the California State Treasurer. Dear also had many years of experience in governmental bodies, including executive director of Washington State Investment Board and assistant secretary of the US Labor Department, where he led the occupational safety and health administration.

This experience translated to a well-functioning organisation, almost despite its enormous lay board, as both Dear and Stausboll could communicate complex investment and business decisions in an effective way.

In addition to focusing on the long-term, the investment office has been focused on negotiating fees with external managers, and there has been a continued focus on costs.

“There are challenges of having a large portfolio, but there are advantages through being cost effective,” Stausboll says. “Reducing management fees goes to streamlining the portfolio, and we have a priority to make the portfolio less complicated.”

The fund’s decision to exit hedge funds in September 2014 is one example of that, and Stausboll says the focus is now on reducing the number of external managers in private equity and real estate, but also in equities. It is also decreasing the number of consultants and advisers it uses.

“We had more than 300 managers, and now we are down to 159. Our target is 100 by 2020,” she says. “That restructure has resulted in the past five years of a saving of $135 million not including profit sharing fees. We are a public organisation and want to use in-house as much as possible.”

While Stausboll admits that recruitment is difficult – with “internal staff pay an ongoing conversation” – once staff join CalPERS, “they enjoy it because of the strong mission and culture”.

Committed to sustainability

At the cornerstone of that mission, now, is sustainability. And Stausboll has been a driving force behind that. She is deeply committed to sustainable investment, and serves as chair of the Ceres board, the US’s largest coalition of investors, environmental groups, and non-profit organisations advocating for sustainable business practices.

She will continue on the Ceres board when she retires from her role at CalPERS at the end of June.

Stausboll is also a member of the advisory council for the United Nations Environment Programme (UNEP) Financial Initiative, which supports the regulatory and associated market innovations needed to align the financial system with the long-term success, resilience, and sustainability of the real economy. And she was a member of the working group that drafted the United Nations Principles for Responsible Investment and she served on the UNPRI governing board from 2006 through 2009.

Three years ago, the CalPERS board embarked on a project to deliver its first ever investment beliefs, and sustainability was at the core of that process.

“I’m very pleased with the development and clarity the investment beliefs brought, they are an anchor for the fund. The process to arrive at that was almost as important as the beliefs, because it helped relieve some tensions. It gave us clarity around ESG and integration,” Stausboll says.

“One of the exciting things that has happened in ESG is it is now not viewed separately from risk and return. But barriers remain, there is a lack of data around ESG issues, and we need reporting standards.”

Stausboll, and CalPERS, is supportive of the Sustainability Accounting Standards Board (SASB), which was formed to set market standards for disclosure of material sustainability information to investors.

“We think it is important that we get mandatory disclosure of ESG factors,” Stausboll says.

Last year CalPERS made the bold move of requiring all its managers to identify and articulate ESG in their investment processes.

Another barrier to ESG progress, she says, is the short-term nature of the industry, and in particular the short-term incentives in the industry, including in remuneration.

“It is important to include sustainability factors in compensation and incentive measures, and encourage managers and asset owners to look at their own compensation and set it in terms of the long term. That is hard to do. And three to five years is not necessarily long term when we are thinking about long term sustainability issues,” she says.

She urges asset owners and other organisations to partner on critical issues, with shared ideology, to leverage resources and impact.

“We are in collaboration, but investors aren’t necessarily natural collaborators. It is important to keep building this. The current proxy season momentum on issues is because of the collaboration,” she says.

Stausboll is the eighth CEO of CalPERS, and the first woman to head the pension fund.

“Women[‘s] representation in the financial industry is low, and gets lower the further [you go] up the ranks. But what I think is exciting is the heightened awareness around the positive difference gender diversity, and other diversity can make. This is a positive time for women,” she says.

 

*Joe Dear died in 2014 at the age of 62.

conexust1f.flywheelstaging.com remembers him, and the contributions he made to the industry.