Being a responsible investor is an integral part of fiduciary responsibility, according to Erik van Houwelingen, chair of the investment committee at the giant Dutch fund, ABP.

Speaking as part of a panel at the Fiduciary Investors Symposium at Cambridge University, he said ESG has been a part of the fund’s history, and the way it invests for a long time. But in 2014, with emerging trends globally and issues such as the treatment of workers in textile companies, the board met to examine ESG in a more fundamental way.

“We as a board looked at the way to go forward, and we went through an investigation to see if ESG investing was a by-product or truly at the heart of everything.

“At the end of 2014 we did a revision project of the ESG policy, it took us 18 months to conclude, and as a result we view responsible investing, not ESG, as a fundamental part of our fiduciary responsibility,” he said. “There is a debate in the US and UK whether it is a fiduciary responsibility. We have decided being a responsible investor is an integral part of fiduciary responsibility.”

He said there was a plethora of academic research investigating the correlation between ESG and risk profile, and the fund also did their own work, looking back and forward.

“We arrived at the conclusion, and decision, and belief, that going forward responsible investing is a part of every investment decision we make at APG and ABP. Taking that to our participants has been very challenging.”

Van Houwelingen said the call centre has been flooded with participants in disbelief saying they don’t believe that ESG and risk/return go together.

“There is work to be done and it means we need to increase engagement with plan participants to make sure they come with us on the journey.”

The €373 billion ($424 billion) fund has a specific policy on climate which outlines that by 2020 the fund will strive for a 25 per cent reduction in the carbon footprint of its liquid equities portfolios, which is about a €100 billion ($113 billion) portfolio.

The fund also has a target to double sustainable investments from €20 to €58 billion by 2020. It currently has €5 billion in renewable energy.

“We think it is more important to have clear targets to be striving for, and it’s not necessarily about the numbers.”

Meanwhile Mark Mansley, chief investment officer of the Environment Agency Pension Fund (EAPF), who sat on the panel with van Houwelingen, said the fund developed a formal climate policy in the lead up to COP21.

“We found you could reduce your climate risk with little impact on financial risk. We set a simple and high-level policy, to be part of the solution not the problem,” he said.

It focused on three areas: decarbonising the portfolio, which included reducing the exposure to oil and gas by 50 per cent and coal by 90 per cent; setting a goal of engaging with companies about what they are doing; and a positive investment target of 15 per cent.

“We are quite comfortable to go this far, probably beyond the rest of the investing community. The opportunities have to make sense financially, there has to be a sufficient risk/return, but there are lots of good opportunities in clean energy, and real estate for example.”

“Our members are not unfamiliar with climate change given it is the Environmental Agency. But as an investor we have always had to look at climate change from an investment point of view, and we have been doing it for about a decade now.”

Mansley highlighted the Aiming for A project which is asking key fossil fuel companies to meet standards.

EAPF has also been active putting forward shareholder resolutions for transparency on climate change risks and opportunities to companies’ businesses, and has had success with the BP, Shell and Statoil.

“We are starting to see some real change there; now we are asking did we aim too low?”

Mansley called on investors to encourage policy action on climate change, and the EAPF has joined with other investors calling for a price on carbon.

The price on carbon should be $100 per tonne of carbon dioxide emitted, according to Professor Chris Hope, reader in policy modelling at Cambridge University’s Judge Business School, who presented to delegates at the Fiduciary Investors Symposium at Cambridge University.

The impact of such a price is that the hidden economic costs exceed the after-tax profits for companies between 2008 and 2012, he says. Further, for coal companies, the hidden economic costs don’t just exceed their profits – it exceeds their revenues.

“We have to do something to raise the costs of climate change; regulation will have a bigger cost than a tax,” he said.

“So we should charge $100 per tonne on emissions that go into the atmosphere – if we were to do that in the UK we would end up with revenue of about £50 billion per year. This won’t destroy the economy, it would stimulate the economy.”

If the UK government were to raise this new tax revenue they could make changes in other areas – for example, decrease the rate of income tax from 20 to 15 per cent (£20 billion), reduce VAT from 20 to 16 per cent (£20 billion), protect the poor and elderly from energy price increases (£5 billion), support research and development, information campaigns (£5 billion).

However, Hope, who was the lead author on the UK’s Third Assessment Report of the Intergovernmental Panel on Climate Change, warned that revenue raised from a carbon tax should not be put it into subsidies for green investments.

“Governments are very bad at picking those winners; they should put it back into general revenues.”

Hope was also the specialist advisor to the House of Lords Select Committee on Economic Affairs Inquiry into aspects of the economics of climate change, and an advisor on the PAGE model to the Stern review on the Economics of Climate Change.

He uses an integrated assessment model for climate change policy that integrates science with economics and talks about the effects for policy makers and investors. It gives a mean estimate of the social cost of CO2.

It builds in some views of the future relating to demographics, emissions, atmospheric considerations, radiation and global climate, regional climate, direct impacts on ecosystem crops, then social and economic impacts.

The model Hope provided to the Stern review and US EAPA is called the PAGE model and divides the world into eight regions; uses 10 analysis years up to 2200; four impact sectors including sea level, economic, non-economic and discontinuity; looks at two policies and their differences; includes 112 uncertain inputs; and does 100,000 runs to calculate distributions of outputs.

“The net present value of global impacts of a business-as-usual scenario has a mean value of $400 trillion of net present value of impacts. This is why Stern says climate is the biggest market failure the world has ever seen,” he said.

“It is quite hard for investors or governments to do something with that number because it’s so large. It is better to identify what the extra impact is if you put one more tonne of this gas into the atmosphere, or the benefit if you don’t put one more tonne into the atmosphere.”

The session was chaired by Fiona Reynolds, managing director of the Principles for Responsible Investment (PRI), which has called on governments to take the COP21 seriously and has called for a price on carbon. The PRI investor statement on climate change is signed by 204 investors with $20 trillion.

In a discussion on long-term investing that framed the themes for the conference, managing director of strategy at PGGM, Jaap van Dam, urged investors to think differently about how they invest, introducing the notion that investors shouldn’t focus on the returns to individual members but the societal benefits of long-term behaviour.

Van Dam reminded the audience that the purpose of a pension fund is to turn savings into wealth, not to harvest the market return or create alpha.

“Because of our scale and knowledge, and our position in the long financial chain from the actual saver of capital to the user of capital, we can and should do things differently,” he said.

In particular he said there is a fundamental notion to connect investing with the real world, and that investors have greatly understated stewardship.

Van Dam also spoke about the OECD’s notion of productive capital, which supports infrastructure development, investment in the green economy and sustainable growth. This, he said, introduces the environment and the benefits for society at large when investing with a long horizon.

“I feel that if we do not seriously address both issues, putting our capital to work where it is needed to generate long-term wealth, then we stand to lose our license to operate in the long term.”

He said the OECD outlined the importance of long-term investing because patient capital allows investors to access illiquidity premia, lowers turnover, encourages less pro-cyclical investment strategies and therefore higher net investment rate of returns and greater stability; and, further, that engaged capital encourages active voting policies, leading to better corporate governance.

“So, logically, the OECD is not per se focusing on the returns for the individual investor, but more on the societal benefits of long-term investor behaviour.”

The theme of long-term investments and connecting with the real world was carried into the panel discussion chaired by Stephen Kotkin, John P Birkelund ‘52 Professor in History and International Affairs at Princeton University.

Investors – Roger Gray, the chief investment officer of USS, and Christian Seymour, head of Europe for IFM – sat alongside Raffaele Della Croce, lead manager on the long-term investing project at the OECD, and Sharan Burrow, general secretary at the International Trade Union Confederation (ITUC).

Delegates were reminded that they are stewards of other people’s money, and investing should be focused on creating long-term value for members and stakeholders.

In particular, Burrow urged investors to do more, and said that workers are demanding investments be directed towards patient, responsible investments.

“Long-term investment principles simply make sense. For workers, as the asset owners of pension funds, the time horizon to realise secure retirement incomes is not linked to short-term investment,” she said.

“Institutional investors, governments and financial regulators all have significant roles but asset owners – workers – demand serious change for pension fund outlays.”

Burrow said the principles of long-term investment are obvious and the ITUC has supported the development of the OECD framework and the G20 adoption. She said:

Patient capital is the antidote to speculative vulnerability and vital to the infrastructure build necessary to generate jobs and growth along with the industrial transformation vital for climate action.

Engagement is critical to monitor company commitments. Our demand for every company to have a plan for decarbonisation and jobs requires direct monitoring as does the management of other risks including the corporate governance required to avoid corruption or excessive leverage.

Productive capital requires the commitment to fund sustainable infrastructure including clean energy and carbon-neutral urban build and transport.

And we demand responsible capital that meets the test of the UN business and human rights principles. Human rights and workers’ rights are not negotiable.

“There is an urgent need for investors to more rapidly change their practice – align incentives with long-term investments, and where not large enough for direct and prolonged engagement create pooled funds to enable such. Without long-term investments and jobs – secure jobs with decent wages – the very sustainability of pension funds and potentially mutuals is also at risk,” she said.

“2016 is shaping up to be the most vulnerable year for the global economy since 2008,” Burrow said. “With more than $65 trillion invested in the global economy, the major institutional investors in OECD economies, including our pension funds, have to look to themselves for whole swathes of instability created by short-termism, unquestioning agency dependence and inadequate corporate governance oversight of the companies in which they invest.”

“Tragically, not enough has changed, with today’s average holding of shares around five months compared to more than five years in the 1980s.”

Last month conexust1f.flywheelstaging.com hosted the Fiduciary Investors Symposium on campus at King’s College, Cambridge University. The university, one of the oldest in the world at more than 800 years old, has produced people, ideas and achievements that continue to transform and benefit the world – including the establishment of the fundamentals of physics and the discovery of the structure of DNA.

It was a perfect environment for a conference that has established a reputation for challenging asset owners and managers to think differently, with an overarching mission of transforming institutional investment decision making. For three days we hosted 115 people from 15 countries debating investment strategy, opportunities and best practice, in particular the challenges of thinking and acting long term. With more than $5 trillion of asset owner money in the room, it provides a good guide to the mood of global investors.

Long-horizon investing has been a focus of many large pension funds for many years now, with a focus on the appropriate investment vehicles, risk appetites and supply chains. What, pleasingly, is clearly emerging now is that pension fund design, purpose and behaviours need to change to achieve the desires of long-horizon investing.

The business of managing pension assets should not be about alpha, or really about money management at all. The pension fund industry – and pension funds individually – are tasked with providing members with a retirement income; and as Keith Ambachtsheer says, they are tasked with turning savings into wealth.

This means what they do, and how they act, should have “everything to do with the real world”, according to Jaap van Dam, head of strategy at PGGM.

This became even more evident at the Fiduciary Investors Symposium, as investors seemed less interested in conversations around smart beta, factors and quantitative investing, and more focused on impact investing, stewardship, behavioural biases and governance.

The fundamental notion of a connection with the real world is important in this industry. Whether it’s in deciding investment strategies – with an emerging tilt away from traditional financial tools towards forward-looking, all-encompassing risk tools and less tolerance for smart beta versus a fundamental macroeconomic view – or looking at the societal benefits of long-term investor behaviours, including the environment and public needs such as affordable housing.

The pension industry should not be viewed as part of the money management industry and should not replicate the way it invests in and rewards staff – there is nothing long-term, or societally beneficial, about the behaviours of quantitatively driven hedge funds, for example.

Pension funds need to understand their mission, and work responsibly to be patient and engaged owners of capital.

 

Jay Willoughby, the new chief investment officer at The Investment Fund for Foundations (TIFF), has set himself the challenge of doubling assets under management at the $10 billion fund that invests on behalf of 750 not-for-profit endowments and foundations from across America.

Willoughby’s arrival at the helm coincides with TIFF celebrating its 25th anniversary, a milestone that he also wants to celebrate with a new era of boosted returns.

“TIFF literally has one of the coolest missions of any asset management firm. Our members are all trying to make the world a better place; by partnering with them and making returns for them, we are also trying to make the world a better place,” he says.

Willoughby joined TIFF, after nearly five years as chief investment officer at Alaska Permanent Fund, at the same time that the institution introduced a new constructed index.

This increased the equity allocation, reflecting the fund’s conviction that it needs to hold sufficient equity to propel returns, but also created a more balanced exposure with the remaining allocation, underscoring its belief that risk needs to be tempered with a range of diversifying strategies.

“We target 65 per cent in equity, 20 per cent in diversifying asset classes and 15 per cent to fixed income. The old target was 13 per cent in cash, 20 per cent in TIPS, break-evens and other things that weren’t really performing. We’re also winnowing down the exposure to commodities and REITs to zero,” says Willoughby.

Strategies at the fund include plans to increase the allocation to US energy infrastructure via master limited partnerships.

Willoughby believes this fee-collecting infrastructure for the oil and gas industry is currently undervalued due to the low oil price.

He is also looking at opportunities in China targeting China’s new and fast-growing consumer-facing businesses.

“I’m not interested in China’s old companies or the old economy,” he says, in reference to investments in China’s industrial base like steel and mining.

“I’m focused on the future, looking at companies poised to benefit from China’s consumer base and technological penetration in the country.”

Both these strategies will fit in the fund’s long-only equity allocation and will involve the hiring of new managers.

TIFF only manages its fixed income allocation in house.

Here the strategy is to ensure enough liquidity for the annual 5 per cent pay-out to members.

“The aim of the fixed income allocation is to keep the purchasing power of our clients,” he says.

Another new investment theme at the fund is seeking opportunities in biotech, and Willoughby says TIFF is also in the process of putting together a structure to better tap opportunities by shorting stocks alongside having long-only exposure.

“We want alpha on the long side and to hedge on the short side,” he says. “Right now my goal is to partner with the best managers in the equity and hedge fund space.”

TIFF is also keen to develop alternative income streams in the hedge fund portfolio.

“We have no global macro, no statistical arbitrage and no algorithmic trading either. In fact, we have very little in these new, and strategic, more statistical and less fundamental strategies and my aim is to add more diversified income streams.”

Hiring managers

TIFF currently uses around 15 managers in the long-only space and 10 managers in its diversifying portfolio.

Willoughby says he is in the process of hiring five to six new managers at the fund to fill new allocations.

It won’t amount to an increase in the overall manager head count because of the vacancies created by axing allocations to commodities and real estate investment trusts.

“Very little is actively managed in-house. Our preference is to be with the best managers rather than do it in-house, although, of course, there is nothing to say we couldn’t manage more in-house.”

The current strategy also plays to TIFF’s strengths in manager selection, which Willoughby says is fortified by the institution’s high profile and experienced board.

TIFF charges the charitable foundations whose money it invests a 20 basis-point management fee and runs a “tough but fair” negotiating process with fund managers.

The fund targets returns of 5 per cent return for its clients, but as his tenure gets under way Willoughby is aiming for much more.

“If I can add between 100 and 400 basis points per annum to that benchmark over three, four, five years we are talking about a superior return. My aim is to put in place the managers that can outperform the benchmark and achieve our clients’ goals.”

In 2014, the Ontario Teachers’ Pension Plan (OTPP), considered by many to be the best pension plan organisation in the world, paid salaries, incentives and benefits to its 1109 employees of C$300.5 million.

As chief executive, Ron Mock, got a base salary of C$498,654 and total direct compensation of C$3.78 million – which included long-term incentive payments of C$1.961 million. Neil Petroff, the executive vice president of investments, got paid C$4.48 million, including C$2.722 million of that in long-term incentives.

These sound like grand figures. And indeed they are. However, what is behind the figures is more interesting than the numbers alone.

The total investment costs of OTPP, including staff salaries was C$460 million. On assets of C$153 billion, that’s about 28 basis points.

Conversely, the $295 billion CalPERS, which is restricted in what it can pay staff due to its public sector identity, paid $159.3 million in salaries and wages in 2014 – around US$60 million less than OTPP. But it spent a massive $1.347 billion in external management in the 2014 financial year. Which means it is paying costs of about 45 basis points on external managers alone.

In a cost review, CalPERS identified that 91 per cent of total costs were from external asset management fees, and of that 87 per cent of those external fees were from private assets and hedge funds. The fund, which has a 20-year investment return of 8.5 per cent, has since been recalibrating its portfolio, including its private equity and hedge fund programs, to bring costs down.

But OTPP doesn’t need to compromise investments in potential high-alpha generating investments – 38 per cent of its portfolio is in natural resources, real assets and absolute return strategies, and the 45 per cent in equities is split between public and private markets.

It has generated an annualised rate of return of 10.2 per cent since 1990.

Why the differential?

The comparison of these two funds reveals so much about organisational design and strategy, the inputs to pay structures, and the subsequent value generated. It is naïve to consider salaries on face value.

The difference in the cost structures of these two large pension organisations is largely due to internalisation, particularly of private assets investments, which means paying high salaries to investment professionals. But as much analysis has shown, it is this exact function that is the differential in excess return between funds.

The article Is Bigger Better? Size and Performance in Pension Plan Management by Alexander Dyck and Lukasz Pomorski, shows that a significant source of excess total fund return is the large-scale implementation of private markets investment strategies by specialised in-house pension fund investment teams.

And going deeper, the major driver of success was a reduction of overall fund costs, with external funds management costs considerably greater than the differential in in-house investment staff pay.

Seemingly then, pay differential among organisations is often dependent on the active versus passive management component of a fund’s investments, the extent to which it is insourced, and the private versus public assets split.

OTPP advocates that to get upper-quartile performance, you need upper-quartile people, and to get upper-quartile people you have to pay them upper-quartile salaries. OTPP is the best-performing fund in the world, by many measures. So some attention should be paid to this argument.

Global pay practices

Keith Ambachtsheer’s new book The Future of Pension Management, has a chapter on the pay practices in the investment functions of 37 pension funds from three continents with assets of $2.2 trillion.

Ambachtsheer observes that the biggest driver of high pay is the total headcount of employees directly or indirectly involved in the investment function. And this is tied to the strategic decision by funds, mostly Canadians, to insource private market functions.

“It comes down to organisational culture and the approach to what the job is. Pension funds need to define the business model, the metrics of success and how they relate to pay. Canadians are clearly the outliers in how they pay their people. Why? It is driven by the governance model of needing to be competitive within the organisation. It doesn’t work to have smarter people on the outside. It’s a competitive environment and they want to decide whether to outsource or insource,” Ambachtsheer says.

“We now have a lot of data through CEM that shows if you internalise high cost areas, like those investments charging 2 and 20, then costs reduce by 90 per cent. That’s a 4.5 per cent competitive advantage. Then the question becomes: if the board knows that competitive advantage can exist, what should they do? This will only work if a board truly understands what the economics looks like and they have the people to make it happen.”

Wealth across the globe is more concentrated than at any other time in human history, including the Roman times, with Oxfam reporting that 62 people in the world have the same wealth as the bottom half of the population.

Pay, and what you are paying for, are very sensitive issues.

The global pension study by Ambachtsheer reveals the median of the top five executives’ average compensation was $416,000, which is around 10 per cent of the average compensation of the top five executives for major commercial financial institutions.

 

Investment management comparisons

In Australia, Macquarie Bank’s chief executive, Nicholas Moore was the highest paid executive from a listed financial services company, in 2015 he got paid A$16,495,070. And of the top 50 highest-remunerated executives from the ASX in 2015, nine worked in financial services.

The 2015 Dawson Partnership survey of investment management industry salaries in Australia found chief executive officers’ fixed component varied from A$320,000 to A$800,000 with a short-term incentive component of between 20 and 150 per cent, and a long-term component of 10 to 150 per cent. Chief investment officers’ fixed component salary varied from A$350,000 to A$700,000 with a short-term incentive component of between 50 and 30 per cent, and a long-term component of 50 to 300 per cent.

P&I recently reported that Larry Fink, chairman and chief executive of Blackrock, got paid $26 million in 2015. This was made up of a $900,000 base salary, an $8.72 million cash bonus and deferred equity of $4.095 million. The remaining $12.285 million was a long-term incentive.

But you can’t compare the salary of a chief executive of a pension fund to a broader listed company or even a financial services company, says Justine Turnbull, partner at Seyfarth Shaw and a specialist employment lawyer who has worked for listed companies and superannuation funds in Australia.

She says traditionally, super fund CEOs have been more like administrators than a typical CEO, with little need within the businesses for change and innovation, the usual domain of a CEO. Rather, super fund CEOs have been conservative.

“The CEO has no work to do in getting the money into the fund. But there are certain aspects such as managing people, technology, and a level of sales and marketing that are similar functions,” she says.

But the purpose of superannuation is investing over a long time horizon which is very different to a trading investment environment and requires a different skill set and focus.

More global comparisons

The total amounts paid to executives in Ambachtsheer’s global pension study varied significantly, as did the structure of pay including the base and variable components.

Ambachtsheer found the median top-five total pay, across the 37 funds, was $461,000 with a wider middle 50 per cent range of $362,000 to $669,000.

The median chief executive pay is split 50:50 between base salary and compensation based on organisational/personal and investment performance.

For investment professionals the split is more like 25 per cent base and 75 per cent variable.

CEM Benchmarking, which specialises in benchmarking cost and performance of investments and administration of pension funds globally, conducts an annual benchmarking of what it calls the “global leaders” group.

In 2014, CEM asked the group some ad hoc questions regarding remuneration, and specifically about bonuses paid to staff.

Of the 22 funds involved in the study, staff at 21 of the funds were eligible for bonuses, based on non-investment objectives, portfolio or asset-class performance and total fund performance.

Some of the funds – about eight – had secondary targets to meet before the total fund performance bonus was paid. This included that the total fund performance had to be positive, and if it wasn’t the bonus was deferred until the returns were positive. Others required that individual targets must be met before they could receive the total fund bonus. In some cases the individual targets were non-investment objectives related to compliance or ethical issues.

The median level of bonus a chief executive at these funds could earn was 188 per cent, and for a chief investment officer it was 90 per cent; and all of them had a cap on their bonuses.

Mike Heale, partner at CEM, says whether an organisation pays variable incentives can be cultural.

“In Sweden it is 100 per cent fixed pay, it’s in their culture. In the Netherlands it is about 80 per cent fixed pay. In the US there is a politicalisation of pay, and Canadians have about 25 per cent base and 75 per cent variable.”

[In the Netherlands, Heale says, there is the “stupid man rule” which means no public service employee can get paid more than the Prime Minister – which is around $150,000. President Obama’s salary is around $395,000].

Australian remuneration structure

In Australia, executive pay and structures at superannuation funds are also highly variable.

On the bonus front, the heads of the investment teams at AustralianSuper are able to earn performance pay up to 40 per cent of their base pay, or 60 per cent for the chief investment officer. At UniSuper the maximum performance based remuneration available to any executive officer, including the chief executive, ranges from 30 to 100 per cent of their fixed remuneration. Some Australian funds, such as Cbus, don’t pay bonuses at all.

It is the structures of pay, particularly how bonuses are constructed and benchmarked, that needs much work in the superannuation executive arena.

Importantly, observers of governance and organisational structure, such as Ambachtsheer say that the variable component of pay should be spread over at least four years.

Turnbull is in favour of long-term incentives with some deferral of a short-term incentive. This is particularly relevant, she says, in the context of superannuation business linking incentive pay to the goals of the member, and that members’ interests are met over the longer term.

“Generally in Australia there is an over-focus in the exec rem space on short termism, and we would do better in all industries including the superannuation industry to have a longer-term focus,” she says.

“The philosophical objection to bonuses falls aside when you can link performance goals for bonuses to members.”

She believes incentives play a crucial part of pay and can drive performance but the industry needs improve in terms of how hurdles are set, the time frames of incentives and how they are aligned with the member interests.

“This is a competitive environment for talent, superannuation funds need to step up,” she says. “If the remuneration structures don’t evolve we just won’t get the talent that we need. There’s non-monetary benefits in those environments and the funds are seen as nice places to work, and we shouldn’t undervalue that, but if we want to try and drive top performance there has to be an at-risk component of pay.”