Fiona Reynolds, managing director at the Principles for Responsible Investment (PRI) discusses why it’s in everyone’s interests for more investor voices to be heard between now and November before the world’s nations converge at COP21 in Paris.

 

The announcement that the G7 leading industrial nations have agreed to cut greenhouse gases by phasing out the use of fossil fuels by 2100 has been welcomed by climate campaigners and policymakers as an historic move.

In a 17-page communique issued after the summit under the slogan Think Ahead, Act Together, the leaders also agreed to back IPCC recommendations, to reduce global greenhouse gas emissions at the upper end of a range of 40 to 70 per cent by 2050, using 2010 as the baseline.

The G7 also announced that they were committed to raising $100 billion in annual climate financing by 2020 from public and private sources.

While announcement of the goals to cut carbon emissions and be carbon free by 2100 is non-binding, for long term institutional investors it is a signal among many that climate and carbon risks can’t be ignored.

Institutional investors must not let the 85-year window for eliminating fossil fuels blind us to the fact that action is needed now.

As Christiana Figueres, executive secretary of the United Nations Framework Convention on Climate Change, noted at last year’s PRI in Person in Montreal, we cannot let Paris become another Copenhagen.

If we lose this year’s opportunity at COP 21 to get an agreement on climate change, we may never get another one.

We also need to be mindful that the commitment of these seven industrialised nations isn’t the only thing that needs to happen in order to prevent a temperature increase past 2°C and the volatile effects of climate change that the scenarios forecast will come with it.

Combined, the United States, France, Canada, Germany, Japan, and Great Britain emit roughly the same amount of carbon per year as China does, according to data from the World Bank.

That’s why, regardless of the G7’s commitment, efforts to slow then stabilise emissions growth in in China and India — another major emitter — will be essential to transitioning to a low carbon world.

An historic agreement reached last year between China and the US to cooperate on emission reduction was another development in bringing a closer alignment between the world’s two biggest polluters President Obama pledged to cut US greenhouse gas emissions 26-28 per cent below 2005 levels by 2025 while President Xi announced targets to peak carbon dioxide emissions around 2030—with the intention to peak sooner—and to increase China’s non-fossil fuel share of energy to around 20 percent by 2030.

Policymakers are feeling increased pressure to act on climate change.

Financial regulators have begun to think through the potential impact of stranded assets. Finance ministers are being questioned over the extensive cost of fossil fuel subsidies following IMF reports that pre-tax consumer and produce subsidies totalled $541 billion in 2013.

And economic studies continue to point to the transformational opportunities offered by carbon and other environmental taxes that price negative externalities.

Several sovereign wealth funds are becoming increasingly sensitive not just to the financial risks posed by exposure to fossil fuel investments, but also to the potential behind offered by increased exposure to clean energy, clean technology and seeking sustainability innovations up and down supply chains.

Slowly but increasingly central bankers, finance ministers, regulators and some long-term investors are beginning to understand that incorporating measures designed to tackle climate change into their thinking is a core part of their collective responsibility to ensure a stable and robust global financial system.

But more still needs to be done.

Investor voices must be louder in supporting basic reform measures like carbon pricing and in challenging the political and corporate roadblocks still in place.

Governments and policy makers must be both urged and then actively supported in putting in place the new global frameworks and resisting the intense lobby efforts in support of the status quo.

Recently, the PRI, in collaboration with the IIGCC, Asia Investors Group on Climate Change, Investor Group on Climate Change and Investor Network on Climate Risk coordinated correspondence to G7 finance ministers, calling on them to support:

  1. A long-term global emissions reduction goal in the Paris agreement;
  2. The submission of short to medium-term national emissions pledges and country level action plans.

The letter was signed by more than 100 asset owners and investment managers including CalPERS, CalSTRS, Calvert Investments, AustralianSuper, Boston Common Asset Management, Harvard Management Company, the University of California, Robeco, and the Wellcome Trust and LAPF to name a few.

PRI will continue working with international climate groups to put pressure on policymakers to take decisive action on climate in the run-up to COP 21 in Paris.

As set out in our guidance paper The case for investor engagement in policy investors have a key role to play to commit, construct, clarify, collaborate and communicate on key policy issues.

It’s in all our interests for more investor voices to be heard between now and November before the world’s nations converge at COP21 in Paris.

 

 

Martin Skancke, chair of PRI advisory council and chair of the expert group on investments in coal and petroleum companies, appointed by the Norwegian Ministry of Finance will be among the panellists talking about climate change and institutional investors at the Fiduciary Investors Symposium at Chicago Booth School of Business from October 18-20.

The $2 trillion Australian superannuation industry continues to evolve, with the move to collective defined contribution the latest product innovation for pension funds. While the industry is largely defined contribution, it hasn’t been good at providing retirement income products. Now, a number of Australian funds that have had both defined benefit and defined contribution plan members, including UniSuper and Telstra Super, are looking to their Dutch and British contemporaries and introducing collective defined contribution. David Rowley reports.

Telstra Super is to explore the potential to create a collective defined contribution scheme as a way of avoiding sequencing risk for its members.

Chris Davies, chief executive of Telstra Super, says the A$17.5 billion fund has the scale to tailor its own pooled investment vehicle that would smooth investment outcomes.

He believes the fund may not have to rely on an external product provider to create the Comprehensive Income Product for Retirement as recommended in the Financial System Inquiry.

“We have got a dedicated product manager and our own in-house administration, so we can design systems,” said Davies. “Funds with scale can do that, or like other funds we may leverage off a third-party arrangement, whether it is Mercer Lifetime Plus or another.”

The only other Australian superannuation fund that has announced its intention to create a collective DC scheme is UniSuper – a project that its chair Chris Cuffe publicly mooted six years ago and for which a decision is expected this year.

Davies said that similar to UniSuper, Telstra Super had members who were used to the idea of pooled investment risk through Telstra’s defined benefit fund – which was closed to new members 15 years ago, but still has 5,400 active members.

“If you got the core competency around defined benefit and you have a core of members who have been through defined benefit then you have the culture, you have the ingredients to do something like a collective defined contribution arrangement.”

Davies is watching what other funds achieve in the space and the moves being made by the UK government to set up a legal and tax framework conducive to allowing collective defined contribution before proceeding.

He is also hoping that the Coalition Government’s long promised liberalisation of tax and legal restrictions on post-retirement product development will ease the way for CDC.

Davies says Telstra Super is committed to offering a sophisticated level of advice, communication and products for its members. To this effect, its submission to the Financial System Inquiry argued against the proposal for a narrow band of approved funds for accumulation on the grounds, that this would lead to a no-frills, low fee approach unlikely to offer the range of engagement and tailored outcomes that Telstra Super is trying to achieve for its members.

The two largest institutional investors in the Netherlands, PGGM and APG, have responded to the European Commission’s investment plan, urging the commission to call on institutional investors to collaborate on the investment proposal. However they also warn that institutional investors are not just a “subsidising entity” and the Juncker Plan is best executed as a partnership.

In a paper entitled “We need to talk”, director of group strategy and policy at APG, Tjerk Kroes, and chief investment management of PGGM, Eloy Lindeijer, are dubious about the relationship between government and investors in the past, saying that whenever governments see the need for large investments they tend to look at large institutional investors to supply the funds.

While this is only natural, they say: “…institutional investors have not been created to fill the gaps in government budgets they are here for a reason of their own.”

“In the case of APG and PGGM, our mandate is to invest pension savings in the best interest of our clients’ pension plans. Consequently APG and PGGM can participate in the Juncker Plan, ie invest in Europe, if and only if the actual risk-return profiles of the investment projects are at least as attractive as the best alternatives.”

The funds’ both currently invest around 50 per cent of their assets in Europe.

“In other words,” the authors say, “we do not feel entitled to take on the role of a subsidising entity, liberally supplying funds that have been entrusted to us by our clients’ participants.”

However they say that there may be scope for cooperation between the Commission and institutional investors, in particular on getting the “framework right”.

“Institutional investors have extensive market knowledge, concerning for instance securitisation and infrastructure investments. They also have extensive market experience, for instance where investment project selection is concerned, or investment structuring or project monitoring. We feel that not only the general regulatory framework, but also the actual set up of the Juncker Plan could benefit from market insights. In short, the actual execution of the Juncker Plan should ideally be organised as a partnership between the public and private sector.”

Commenting on the endorsement of the Juncker Plan and the European Commission’s green paper on the capital markets union, the investors say the measure of success for the capital markets union will be the extent to which it can raise actual investment in the real economy.

Eduard van Geldren, chief investment officer of APG, echoed these comments, calling for the European Commission to seek deeper private sector investment in its plans.

Broadly, he says, APG welcomes the ambition of broad and far-reaching policy objectives.

The European Commission’s investment plan emphasises environmentally-sustainable projects, expansion of renewable energy and resource efficiency.

This is aligned with APG which is actively seeking to invest in solutions for sustainable development issues and the fund has made a commitment to double renewable investments from 2014 to 2017.

Andrew Ang believes factor investing is a more efficient way to organise a portfolio as it allows liquid and illiquid strategies to be managed across the portfolio. It also has the added benefit of honing managers on value creation. He’s been working with a handful of investors while Professor of Finance at Columbia University on implementing factor investing, and the motivation to join Blackrock was the opportunity to springboard the practical implementation of these beliefs and transform the way assets are managed.

 

Ang says that his ambition is to see factor investing implemented across the industry more generally and oversee how funds managers can organise themselves and the management of assets to meet investor needs.

Already a few  investors, such as the Canadian Pension Plan Investment Board, the Singapore GIC, Norway’s sovereign wealth fund, and Japan’s GPIF, take a total portfolio view using factor investing. But Ang says there are missing tools in the industry to enable this to be more widespread, and part of his job will be to develop those platforms.

“It is obvious the benefits of organising a top down approach and treating liquid and illiquid investments in the same framework: more intelligent diversification and you can rebalance the factor exposures. It is more efficient to organise a portfolio that way and it is theoretically correct,” he says.

But re-orienting a portfolio along factor lines takes time, requires consultation and technology tools.

“The pulpit I have for factor evangelism at Blackrock is far wider than my reach as an academic,” he says, commenting on Blackrock’s scale, talent access and ability to innovate.

“It’s a huge opportunity to help transform how assets are managed,” he says.

Basically he sees smart beta and factor investing as versions of the same thing, with the main difference in the delivery.

“There are some differences in sophistication, whether you use leverage, shorting, and how you put it together in portfolio construction via weighting or security selection,” he says. “Smart beta is often a delivery vehicle, usually long-only, concentrating on different weighting schemes, factor investing is far broader.”

Choosing which factors, or vehicles, investors use is a very specific investor question, Ang says.

“Academia has discovered hundreds of factors. Pick only a few, understand they will have losses at some point, and implement them in a way appropriate for your fund where you can stay the course. Play to your comparative advantages on your ability to trade, whether you are best at making low versus high frequency decisions, and how skilful you are in dynamically constructing portfolios.”

In addition to being an ambassador for factor investing and a conduit for the industry at large Ang will be involved internally at Blackrock in the development of factor funds, re-organising the manager along factor lines and the development of a technology platform to help investors allocate to different factors.

While as managing director and head of the factor-based strategies group, Ang will report day-to-day to the global head of multi-asset strategies, Ken Kroner, he sees his role as much larger than just developing smart beta products for Blackrock.

“I will lead the design of accessible, scalable and cheap factor funds across asset classes and geographies and develop technology to help investors allocate optimally to those factors, and hopefully, eventually, see the whole portfolio through factors.”

It’s the technology that Ang is particularly passionate about, viewing it as a missing tool which will allow investors to facilitate factor implementation. While he sees Blackrock has having a competitive advantage in the development of such a platform, because of its risk analysis tools, he says there is a missing link in the ability to use forward-looking tools.

“Investors have good tools to see the factor risks in the portfolio they currently hold. They also want a tool that looks at what factors they ought to have, a forward-looking tool and I want to help them meet that gap,” he says.

In an age where driver-less cars are being invented he says finance is often behind when it comes to technology.

“You can go online and interact with websites and see the immediate results of our choices. But there is no tool today where you can allocate towards different factors and see the consequence of those decisions on the whole range of liquid and illiquid assets in an interactive, geographically-driven package,” he says.

He says investors don’t think of illiquid investments as bundles of factors but they are and should be considered in the overall portfolio as such. Private equity is not an asset class, he says, it is a bundle of stocks and bonds.

Factor investing is a better way to construct a portfolio, he says, all the way from the top-down portfolio to the benchmarks you give your active managers.

“This is transformative, that is one of the reasons I joined Blackrock. We can touch thousands of investors,” he says.

Ultimately, he says if investors outsource investment management they want to have funds managers spend most of the time on activities that add value. Factor investing hones the activity of a manager to decisions of compensated risk that consistently deliver higher returns, he says.

“In the long run primary benefit of factor investing is higher risk adjusted returns.”

Ang, who is the Ann F. Kaplan Professor of Business, at Columbia Business School, has been at Columbia for 15 years and was chair of the finance and economics division. As a professor he has had extensive experience consulting and advising large institutional investors, most regularly with the Norwegian sovereign wealth fund, but he’s had limited commercial experience working full-time for a commercial institution.

“I’m very proud of the work I’ve done at Columbia and the research I’ve done,” he says.

Ang’s approach to harvesting factor risk premiums is outlined in his recent book, Asset Management: A Systematic Approach to Factor Investing.

 

 

Andrew Ang will speak on factor investing at the Fiduciary Investors Symposium, Chicago Booth School of Business from October 18-20.

It is called the “CalPERS’ Effect” but it could easily be called the asset owner effect, or the institutional investor effect, or the power of engagement effect.

Wilshire, which is a consultant to the $300 billion Californian fund CalPERS, has provided an update on its study measuring the effect of engagement on a targeted list of companies called the Focus List.

The study puts a tangible measurement on the power of improving stock returns by institutional investor engagement.

“The evidence is… clear that many corporate assets are poorly managed and that resources spent on identifying and rectifying those cases can create substantial opportunity and premium returns for active shareholders,” the report says.

Many institutional investors engage with companies on issues ranging from to basic governance structures and decision making to complex environmental impacts and supply chain problems.

Norges Bank Investment Management for example, which manages the assets of the 6.9 trillion Kroner ($894 billion) Norwegian Government Pension Fund Global, held 2,641 meetings with companies in 2014, and raised environmental, social and governance issues at 623 of those.

The giant Dutch pension fund manager PGGM engaged in dialogue with 510 companies last year, and says it got results from those with 21 related to the environment, 32 related to social factors, and 80 related to corporate governance.

But there are few studies that tangibly measure the impact of engagement in the same way that the Wilshire study demonstrates. The study looks directly at the financial performance of the stocks on the focus list and the impact, on the stock returns, of the CalPERS’ engagement.

Wilshire the fund’s consultant published a report on the CalPERS Effect for some years but a recent update shows that CalPERS’ good governance campaign has added value to the share prices of targeted companies.

It measures the impact of engagement on 188 companies over the time period of 1999 to 2013, by examining stock returns before and after the “initiative” event. The number of companies on the list in any one year ranges from four to 11.

The report acknowledges it is difficult to isolate the contribution of CalPERS engagement as the stock returns can be influenced by many factors. It deals with this by extending the measurement period to five years in the belief that any other announcement pertaining to the company will have less effect over a longer time period.

Wilshire compares the daily return of each engaged company to the Russell 1000 and to the appropriate sector index of the Russell 1000, and compounds the return differences through time.

The study does not account for rebalancing and assumes that there is an equal dollar investment in each company over time. However despite this, Wilshire believes the results of this study demonstrate CalPERS’ approach to improving portfolio returns by engaging management of poorly performing companies to rethink governance and strategy continues to work.

For the three years prior to the initiative date, the engaged companies have produced returns that averaged 38.91 per cent below the Russell 1000 index, and 36.13 per cent below the appropriate Russell 1000 sector index.

For the first five years after the initiative date, targeted companies collectively produced stock returns of 12.27 per cent above the Russell 1000 index and 8.90 per cent above the appropriate sector index on a cumulative basis.

Wilshire says the analysis shows the steady erosion in shareholder value by companies prior to being placed on CalPERS’ focus List. It also demonstrates the end of that erosion subsequent to CalPERS initial contact.

Within one year the 188 companies on the focus list outperformed by 1.61 per cent and by the fifth year the cumulative excess return was 12.27 per cent. That’s a big turn around.

Wilshire says that CalPERS’ approach to improving portfolio returns by engaging the management of poorly performing companies to rethink governance and strategy continues to work.

In a tribute to the strategy, Wilshire says: “most investment resources in the industry continue to be focused on identifying small misvaluations in publicly traded stocks. This is, perhaps, unfortunate since investors are not earning a satisfactory return on the manager fees and brokerage costs they pay, given the evidence showing that the public stock markets are fairly efficiently priced.

“However the evidence is equally clear, that many corporate assets are poorly managed and that resources spent on identifying and rectifying those cases can create substantial opportunity and premium returns for active shareholders.

“CalPERS has been active corporate governance investor for many years and the continued success of the engagement process is proof that good corporate governance can improve shareholder returns.”

Factor-investing has not yet won the right to be the endurable and dominating asset allocation method, according to new research, which shows that industry or sector-based allocation still has its merits. In particular the study shows that industry-based investing offers defensive opportunities as it delivers better risk-return trade-offs for long-only portfolios during recessions and bear periods.

In the paper, Factor-based versus industry-based asset allocation: The contest, Marie Briere and Ariane Szafarz, explore the two methods looking at performance including costs and robustness.

Conceding that “applied to equities, factor investing is probably the most serious contender to the classical sector-based approach to asset allocation”, the conduct “a contest” between the two styles that addresses two questions:

1) Are the excess returns of factor investing offset by higher risks, and if so, are factor-specific risks eliminable by means of factor diversification?

2) How does factor investing perform during crisis times?

In the study, the results show that factor investing is the best strategy when short sales are permitted. Most academic studies, the authors say, draw conclusions on portfolio management with unrestricted short selling, which is a considerable limitation, since benchmark restrictions and implementation costs make long-short factor investing difficult to implement in practice.

In addition transaction costs are neglected which they say presumably, plays in favour of factor investing compared to the more passive style of sector investing.

They also point out that transactions are especially numerous for rebalancing the two momentum factors, quoting a study by Robert Novy-Marx and Mihail Velikov that estimates that the momentum factor turns over around 25 per cent per year, which implies a monthly trading cost of almost 50 bps.

“Further work could investigate whether our results are robust to incorporating transaction costs. Factor investing is not only a transaction-intensive style, it also a good performer when short selling is permitted. But short sales imply additional expenses, such as borrowing costs. Accounting for all the costs could actually make passive strategies more competitive,” the authors say.

“The emergence of dedicated indices and funds has made factor investing more accessible to… investors. However, not all identified factors are investable in this way, and the available factor investment vehicles concentrate on long-only portfolios. Therefore, a major challenge for the advocates of factor investing is the practical implementation of the investment rules they recommend.

“Our study suggests that there is no overall winner, but we do find circumstantial evidence of superiority for each style. Factor investing is clearly the best strategy when short sales are permitted. It also outperforms sector-based allocation during expansion and bull periods. In contrast, sector investing offers defensive opportunities for asset managers since it delivers better risk-return trade-offs for long-only portfolios during recessions and bear periods.

“Factor investing keeps its promises, but it still has a long way to go before it can oust sector investing.”