A strong belief in active management, trust in the skills and capabilities of its team, and a low-cost commercial approach has resulted in the Swedish AP4 producing its best ever performance – 16.4 per cent after expenses in 2013. Amanda White spoke to chief executive, Mats Andersson.

It’s a neat story for the SEK260 billion ($39 billion) fourth Swedish buffer fund. It’s beaten the board’s real return requirement of 4.5 per cent annually by 1.4 per cent over 10 years. Its active management approach has outperformed the benchmark index and its management expense ratio remains extremely low at 11 basis points including commission.

Chief executive of AP4 Mats Andersson has been at the helm since 2006 and has gradually reorganised and restructured the fund to be based on the core values of being professional, respectful and transparent.

“If we can live these core values and we can trust our people there is a potential to delegate and by delegating then we can be more efficient,” Andersson says.

At the cornerstone of the fund’s approach is the fact it’s a long-term investor and can withstand volatility; it advocates transparency in every investment, and if there is a choice between simple and complex investments, then simplicity is prioritised; it emphasises low cost; and has a commercial approach.

In the past five years AP4 has been one of the best performing pension funds globally, and much of that is due to its focus on the allocation process.

It allocates capital based on three time horizons – long-term (40 years), medium-term (3–5 years), and short-term (6–12 months) – with increased emphasis on the medium-term horizon.

Andersson says to meet the long term return target of 4.5 per cent real, the asset allocation needs to have a higher allocation to risky assets, which the fund interprets as 65 per cent equities and 35 per cent fixed income.

“If we have a long-term approach and measure this return over 20 years we will capture the risk premium,” he says.

This has worked, with much of the recent return attributed to a high proportion of listed equities.

“We believe in the long term there is an equity risk premium. We strongly believe there are only two assets, government bonds and equities, and the rest is a blending,” he says.

At the tactical level – in Swedish equities, global equities and global macro – the fund has had 11, six-month periods of active results, realising 50 basis points per annum above the benchmark.

The third level of allocating assets is called strategic mandates, and looks beyond the three to five year horizon.

“We try to be a long term investor and the fund invests where you need a long-term approach. For example you can’t measure private equity in three years,” he says.

AP4 also has huge position in small caps, and invests in sustainability and engagement mandates such as in low carbon, all of which measure in greater than three year periods. More like 10 years, Andersson says, adding the fund has about $10 billion invested in these strategic mandates.

“If we can do this then over time we can add 75-100 basis points. Over the past three years we’ve exceeded our targets.”

Generally the fund will back listed equities, over private equity where it only has about 1 per cent invested.

“We believe in listed equities and active management, we’re not too keen on private equity and infrastructure,” Andersson says. “We have gone our own way and will continue to do so, but not as an objective in itself.”

“Many funds have been forced to reduce risk, we are strong believers in liquid assets and we can bare volatility. Risk comes from different sources. Funds managers looking for uncorrelated and low volatility investments is just a way to play a charade.

“Everyone was so scared after 2008/09 and 2011 and were forced to sell equities and liquid assets but we think that was done at the wrong time. We can withstand volatility, and think it’s not a good measure of risk.”

About 80 per cent of AP4’s assets are managed inhouse, and by law it has to have 10 per cent managed externally.

The investment teams are organised under equities, global macro (which includes fixed income and foreign exchange), allocation, real estate, SMEs, ESG and other strategic investments. The fund’s CIO, Magnus Eriksson, is also the deputy chief executive.

The fund has a large home bias, about a third of its equities exposure is in Swedish equities compared to the MSCI of around 1 per cent. Andersson says historically over the past 20 years Swedish equities have outperformed the rest of the world, which is attributed to a unique governance approach whereby asset owners sit on a nomination committee which decides who’s on the board.

“Owners are accountable for the companies in Sweden,” he says. “In the US management hijacks the companies. Governance in many other places is management driven, not owner driven.”

While there is currently a review by the Swedish government to merge the AP funds from seven into five, Andersson says it is not clear what the strategy will be.

He does say the AP funds have been top quartile performers at lowest quartile cost, and it would be a challenging process to close a fund and restructure the assets. But for now, it’s business as usual.

 

 

 

 

The $1.3 trillion Government Pension Investment Fund of Japan will use factor investing, or smart beta, as a third way of implementing equity mandates, alongside active and passive, following a six-month research project conducted by MSCI that investigated how to best implement the growing interest in factor exposures.

 

The research project conducted by MSCI sits in the context of changes to the GPIF’s asset allocation which includes increases to global and domestic equities and a move away from its huge domestic bias across the portfolio, but particularly in fixed income.

It was thought that allocating more assets to equities required a thorough look at the implementation opportunities particularly given any limitations due to the fund’s enormous size.

In April, the fund announced it had awarded 14 active and 10 passive mandates for its domestic equity funds, and introduced some performance based fees. At that time it also decided to implement a wide range of indices. Based on the research “Effective implementation of non-capitalisation weighted index/benchmark”, conducted by MSCI, the GPIF introduced a new category alongside passive and active, called “smart beta active investments – an investment approach to effectively capture mid to long term excess returns through indexing strategy”.

Chin Ping, head of index applied research at MSCI, says the research was a six-month project that looked at the possibility of implementation of factors and covered both equities and fixed income.

“Factor investing has become more popular globally and the question many investors are asking is how to implement them. For GPIF the same is true and in particular in the context of the size of the fund. Their motivation was whether they could take advantage of moving away from cap-weighted portfolio,” he says.

MSCI concluded that the GPIF should not treat factor investing as a replacement for passive, or as an active strategy, rather it should create a third independent allocation to sit between the two.

“We concluded that factor investing is not a substitute for cap-weighted but an active mandate” he says. “But due to governance factors, and the cyclical nature of the factors, you should treat it as a third bucket, independent from active and passive and judged on its own.

“There is no way it can substitute for the passive allocation especially for large investors, you can’t have a $1 trillion factor portfolio.

“And the problem with the active bucket is that factors bring superior performance, but it raises questions about the governance framework, how do you evaluate factors on an ongoing basis?”

MSCI constructed 18 indexes based on six factors– high dividend yield, size, value, quality, momentum, low volatility – across the three regions represented by MSCI Japan, MSCI Kokusai (World ex-Japan), and MSCI emerging markets indexes.

“Our findings showed that all simulated single equity factor indexes outperformed their cap-weighted benchmarks by 30-260 basis points from November 1995 to August 2013,” the report says.

For the GPIF it is only the early phase of implementing factor investing, and the funding to do so will come from the strategic decision to decrease bonds and increase equities.

At the end of December 2013 the GPIF’s asset allocation was 55.22 per cent in domestic bonds, 10.6 per cent in international bonds, 17.2 per cent in domestic equities, 15.1 per cent in international equities and 1.77 per cent in short term assets.

This represents a significant shift from a year earlier where the fund had an allocation of 60.14 per cent to domestic bonds, 9.8 per cent international bonds, 12.9 per cent to domestic equities, 12.9 per cent to international equities and 4.25 per cent to short-term assets.

In October 2012 the Board of Audit of Japan expressed its opinion that “GPIF should consider reviewing whether their tentative policy asset mix ensures safe, efficient and reliable investment on a regular basis during the medium-term plan”.

As a response to this, and through discussion with government and the GPIF’s investment committee, the tentative policy asset mix was changed.

Domestic bonds were reduced from 67 to 60 per cent, domestic stocks increased from 11 to 12 per cent, international bonds increased from 8 to 11 per cent, and international stocks increased from 9 to 12 per cent. Short term assets remained the same at 5 per cent.

In 2013 the fund returned 9.45 per cent.

 

The new domestic equities investment managers

 

Traditional active management:

Eastspring Investments

Invesco Asset Management

Seiryu Asset Management

Natixis Asset Management

Nikko Asset Management

FIL Investments

Russell Investments Japan

JP Morgan Asset Management

DIAM Co

 

Smart beta active management:

Goldman Sachs Asset Management

Nomura Funds Research and Technologies (Dimensional Fund Advisors)

Nomura Asset Management

 

Passive:

DIAM Co

Sumitomo Mutsui Trust Bank

Mitsubishi UFJ Trust and Banking Corporation

BlackRock Japan

Mizuho

 

 

 

Customised benchmarks, absolute return strategies and long-term mandates are all being considered by the PGGM executive team as it implements the new PFZW investment framework. Amanda White spoke to Ruulke Bagijn chief investment officer of private markets and Marcel Jeucken, managing director responsible investment at PGGM about what it really means to be a long-term investor.

The €167 billion ($228 billion) Dutch pension fund manager, PGGM, is working under a new investment framework which is the result of an 18-month soul-searching review by its client PFZW, under a project called “The White Sheet of Paper”.

The investment framework has been adopted by the board and now the focus has shifted to implementing the investment framework.

It’s a work in progress, and involves both incremental and transformational change. Ruulke Bagijn chief investment officer of private markets at PGGM and Marcel Jeucken, managing director responsible investment at PGGM both sit on a working committee to determine the best way forward.

“Such a review makes you focus on what really matters,” Bagijn says.

She says at the core of the strategy is sustainability, and she identifies with the Michael Porter concept of “shared value”.

“The benefits we pay are worth more in a world worth living in,” Bagijn says. “We also can’t produce returns in a system that doesn’t work, so the sustainability of the financial system is a core part of what we look at as a long-term investor.”

PGGM’s focus will be taking on a larger role in the viability and sustainability of the world. It’s no small ambition, but it’s one that many large institutional asset owners are addressing as the debate over short-termism continues.

“Long term investing for us is providing a valuable future, providing a pension in a sustainable world. It’s working for the current generation but not at the expense of future generations. A sustainable and viable world includes saving a good pension and contributing to the economic and financial environment in which we operate and live.”

It focuses on a stable financial sector, human rights and good corporate governance with emerging investment themes as part of this including climate change, water, food security and health.

She says PGGM will intensify its efforts in focusing on long-term horizons, which leads its policy choices, including asset allocation.

In implementation terms this means better benchmarks, alternative strategies in public markets and more focused portfolios.

“As a long term investor we look at asset allocation and now wand to design a dynamic element to that. In terms of sustainability we will look at benchmarks, investing more in The Netherlands, agency issues and remuneration. We’ll look at our own behaviour and the behaviour of others, and want to continue to have a pioneering role in promoting a sustainable financial system,” she says.

“We think there needs to be courage from pension funds to create their own benchmarks and worry less about peer risk,” Bagijn says.

Customised index

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

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

PGGM has just completed the second year managing passively to this ESG customised benchmark, which accounts for about 90 per cent of its equities exposure, or about €44 billion in market-cap and smart beta strategies.

Marcel Jeucken, managing director of responsible investment at PGGM says the benchmark is not an exclusion strategy, rather it is about relative performance.

“It’s like an active benchmark, we don’t want to blindly follow an index. This ranks the relative performance of companies, and we think the worst companies are indicators of many things including management,” he says.

Jeucken chairs an internal working group that looks at many implementation issues in the context of the overall focus on sustainability, including benchmarks.

“We are looking at a number of areas and the impact they have. Benchmarks might lead to short termism and herding behaviour by passive and active managers. The benchmark provider actually has more impact on the stock than capital providers.”

“We try to figure out what we can do and what the impact will be. One option might be to not have benchmarks, rather have an absolute return target. We are investigating all options but the solution has to be workable.”

Jeucken says PGGM is also looking at long-term mandates and the impact and role of remuneration on short-termism.

“We have started the journey, looking at our role in financial markets, our behaviour, how we act and the measures we use,” he says. “Through the White Sheet of Paper Project we are focused on going back to asset ownership as the driver of what happens in financial markets – this includes who is employed, how benchmarks are set, the view of alignment and the view of incentive structures. It’s a big agenda, with difficult questions, and we’re not sure where it will lead us.”

Jaap van Dam, managing director of strategy at PGGM will contribute an article on the White Sheet of Paper project next month

Large pension funds might be invested on a truly global basis but their operating models are rarely global structures. Towers Watson argues that asset owners can benefit from a business model that can deliver organisational performance, manages talent and aligns with core missions from multiple operating locations.

Over the last decade, large pension funds and sovereign wealth funds have grown significantly and now dominate the investment industry both by size and influence. Typically, the source of their funds is locally derived from pension obligations or national assets.

But the destination of their funds is completely global in line with the range of investment opportunities becoming highly global and diverse. This has been seen in public markets and in particular alternatives and private markets.

The conclusion is clear. The asset owners must think deeply about how they operate in this global context – now more than ever before. And we suggest that to deserve the title of being a ‘truly global fund’, the asset owner must walk the talk with an effective multi-location global operating model.

The opportunity

Global corporates have been working with this globalisation dynamic for decades and have developed global operating models in response.

These models are ones that large asset owners could learn from and adapt to give them the best chance of competing for and capturing the returns they need. But what is an effective global operating model?

Simply put, this is a business model that can deliver organisational performance from multiple operating locations; a model that manages talent successfully globally; and a model that aligns with the organisation’s context, mission and culture.

In the highly competitive investment market place, research has shown that operating from multiple locations can provide a competitive edge and add substantial value.

This is especially true for asset owners in light of the successful trend towards bolstering internal teams with talent, particularly in the problematic areas of private markets. The advent of advanced operations and technology infrastructure allows an unprecedented level of global integration to occur.

However, a fund operating in multiple locations is likely to face a number of difficult challenges. We cite the principal issue as that of aligning culture, combining the best of the local and global ethos; but the issues extend into the decisions matrices used and how efficiently political capital is allocated; the effectiveness of oversight whenever the activities to be assessed are not local; and the impacts of trust and fairness which generally work best with close proximity.

Goals

In order to address these challenges funds will need a well-designed operating structure with clearly articulated core values, beliefs and norms specifically developed to support diverse global jurisdictions.

An interesting example of this is a fund tied to one region where its mission and obligation is to support that region for long-term social and economic provision. Were it to contemplate opening offices outside its region in large financial centres, its leadership would need to understand to what extent cultural values from their region could be transferred internationally and to what extent any dilution could be tolerated.

Another scenario is where an organisation’s central DNA is deeply wedded to risk management.  Were they to contemplate the move to a global operating model, this priority would have to receive the same attention everywhere. Otherwise one wrong deal at a local level as a result of poor engagement with head office would risk serious reputational damage.

While values and culture are soft and intangible, organisational design, roles, responsibilities and processes are not. Asset owners increasingly see the merits of enterprise-wide risk frameworks.

These frameworks are designed to define policies and procedures to mitigate risk from a wide and holistic perspective – investment, operational and reputational risks are covered. They are designed to accommodate the requirements of the regional regulator too.

Such frameworks also make managing people across geographic boundaries a little easier. For example, through standardised HR policies, talented staff can be moved around the globe to enhance the individual’s personal capability with the added benefit at a global level of the cross fertilisation of ideas and thinking.

Where to start?

There is no one-size-fits-all approach and an asset owner’s operating model should reflect its own comparative advantages, priorities and culture.

For organisations wanting to establish an overseas presence, setting up a representative office has usually been the first step to act as an outpost for extending the brand presence into non-domestic markets.

These can be useful for building and enhancing networks and to facilitate face-to-face interaction and whose value should not be underestimated2.  While setting up a representative office is a relatively low-cost approach and is unlikely to contradict the culture or identity of the core organisation, a typically constrained scope is likely to limit its ability to deliver significantly improved returns.

At the other end of the scale, fully fledged satellite offices are most effective at replicating the core organisation with the advantage of being semi-autonomous and providing an independent source of return.

This is premised on the satellite office being given the fullest remit to perform. However this is a costly option, with significant infrastructure and talent management demands and may run the risk of compromising the identity and culture of the original organisation. In extremis, a satellite office could become a source of unwanted competition and dilute the benefits usually associated with having a global presence.

Given the challenges at the edges of this spectrum, a blend that has the best of both approaches, may appeal.

These would include having a well-defined and documented split between home and satellite responsibilities and sufficient organisational flexibility to allow tailoring that plays to local strengths. For example different functions – such as research, deal origination, portfolio management, or direct investing – could be emphasised in certain locations depending on where it makes sense geographically.

In addition, individual asset classes – such as private markets, real assets, and hedge funds – could be prioritised in certain offices.  So while specialised, focused and competitive overseas offices may be appealing, they come with onerous governance requirements. And one can also challenge from the alignment of interests and the avoidance of duplicating efforts and resources point of view.

Once the decision is made on which approach to take when developing an overseas presence, the discussion will naturally shift towards implementation. This can be particularly difficult – in terms of costs, resources and time – if the chosen route is to establish a new office with a broad remit and significant autonomy. While speed may be attractive in the short term, the challenges around culture, alignment and monitoring could persist.

While there are a number of approaches, completing a spinout or strategically acquiring an external asset management business can offer a potential quick solution. These have been explored recently by some asset owners. One example is that of ABP with New Holland Capital.

So what is the best option when choosing a global operating model? In our view the least risky and easiest to implement approach would be to start with a representative office, review its effectiveness and if successful expand the scope of the operation while exploring a secondary location.

This method, if successful can be used as a blueprint for the establishment of a more autonomous satellite office.

The surprising mantra of success for asset owners is centred on how well they recognise their competitive edge and make sure strategy is congruent with this.

Choosing the most appropriate model for global expansion that aligns with the fund’s governance capabilities is critical; and so is implementing organisational design and an operating structure that gives it a sustainable competitive advantage.

Tej Dosanjh is a senior consultant in Investment Organisational Change at Towers Watson 

 

According to Malcolm Gladwell’s Outliers, at least 10,000 hours of practice is needed to be a success at your chosen profession. This means that a fund manager will hit their strides around age 40. But the London Business School is giving its students a leg up in that quest to find success. They have real-life stockpicking responsibilities as part of the student-run investment fund.

Ever wondered where the next generation of funds managers will come from? Well the London Business School is helping to nurture this next breed of money managers.

The first European school to have a student-run investment fund, it cultivates an environment of learning by doing. Students are taught to think like funds managers and three times a year there is a competition giving students the chance to pick the fund’s next stock.

The winner doesn’t just get the glory of beating their fellow students, but the honour of having real money allocated from the Student Investment Fund.

On Thursday June 5 the Summer Stock Picking Competition took place and the stockpicking finalists, students from the Masters in Finance and Executive MBA programs, were ready to present.

Each had five minutes to sell their best idea to the three-person judging panel of Dan Brocklebank director at Orbis, Jon Guiness an equity analyst from Fidelity Worldwide, Konstantin Leidman and investment manager from Schroders, (all three LBS recruiters, the latter two LBS alumni).

The Student Investment Fund was created in 2003, with LBS alumni Clint Coghill and James Lyle the first benefactors donating $100,000 over five years. The first stocks were Valero Energy and DFS Furniture, with Fimalac added to the fund in March 2004 after the first stock picking competition.

Emeritus professor, Elroy Dimson, who taught the school’s first Topics in Asset Management in February 2004, was integral in setting up the fund more than 10 years ago. Although he now has a role at Cambridge Judge Business School, he remains involved today.

“The aim of the fund is to help students understand security analysis and portfolio management,” Dimson says. “A secondary goal is to eventually provide scholarships.”

The fund has assets of around £400,000 and when it reaches £1 million it may start making distributions for scholarship purposes.

It is a long-only fund with a long-term horizon emphasising bottom-up portfolio construction and a fundamentally-driven research process. About 40 per cent is invested passively in the MSCI and the remainder is active equities.

The rules for the stockpicking competition are simple. Students present their best ideas with the only limitation that the stock has to be investable. There is no minimum market cap and the universe is global.

More broadly the fund is currently prohibited from investing in bonds, options, private placements, short sales, margin transactions, financial futures, and commodities.

Eddie Ramsden, who teaches a finance class in value investing, says “remarkably” the fund has outperformed.

“This is a totally student-led fund and it has outperformed. It’s outperformed by 9 per cent over the time frame,” he says.

Ramsden’s course is also instrumental in helping students to “think” like funds managers. They are asked to take the perspective of an investment fund manager who has to make real-time buy, sell and portfolio sizing decisions based upon their analyses and changes in both fundamentals and market prices.

“There is not usually the same level of familiarity with stockpicking at other schools,” he says. “We teach the basic concepts of what to look for in stockpicking. In the stockpicking competition students have the chance to express an idea in a concise way and there is a huge value in that. It’s about saying what the market view is and why your consensus differs.”

 

The competition

The 2014 Summer Stock Pitch Competition is run by the LBS Investment Management Club, whose catchcry is “walk on the buy side”, and the winner will become a member of the investment committee.

There are very different styles in the finalists’ presentations and the judges are determined to focus on the quality of the ideas and not the presentations.

There are about 30 in the room and European and American accents highlight the global nature of the student body at LBS. Of the five finalists presenting none of the students are British.

Many of the presentations get bogged down in unnecessary detail, with the judges wanting metrics of how the businesses will perform over the next 10 years, such as revenue, growth, or EBIT.

“We want to know what the competitive advantage of the business is,” Guiness says.

Depending on the stock the general feedback was that more useful information was needed in the presentations – whether it be context around the management and competitive advantage, the wider industry and its volatility, or whether the market was building in any price corrections. For one stock, Seadrill, the judges said it was a “minefield of financial engineering and it was not clear what you’re buying”.

In this case the judges struggled to make a decision but in the end decided to take two half positions, in Cairn Energy and Prosegur – allocating £35,000 or 8 per cent of the fund across the two stocks – with one of the PhD students’ executing the trades the day after the competition.

The students congregated afterwards for free beer and networking. They were pleased with themselves. For those that participated there was a sense they were one step closer (with two more hours under their belts) to their dreams of becoming fund managers; and for those that watched, a sense of pride in their colleagues and their institution that what they had witnessed was part of the future of funds management.

 

 

The student finalists in the LBS Investment Management Club Summer Stockpicking Competition

  • Johannes Arnold’s chosen stock was Folli Follie
  • Joan Esteve Manasanach’s chosen stock was CVR
  • Jeff Smith’s chosen stock was Prosegur Compania Seguridad
  • Henrik Madsen’s chosen stock was Cairn Energy
  • Alex Karam’s chosen stock was Seadrill

 

 

LBS student investment fund performance

 

The UK Law Commission has delivered its final report on how the law of fiduciary duties applies to investment intermediaries and an evaluation of whether the law works in the interests of the ultimate beneficiaries. The project was commissioned by the Department for Business, Innovation and Skills (BIS) and the Department for Work and Pensions (DWP) in March 2013.

The Law Commission’s initial consultation paper was published in October 2013 and received responses from 96 consultees, and it has now delivered its final report

The report’s terms of reference covered five things:

(1) Investigate how fiduciary duties currently apply to investment

intermediaries and those who provide advice and services to them.

(2) Clarify how far those who invest on behalf of others may take account of factors such as social and environmental impact and ethical standards.

(3) Consult relevant stakeholders.

(4) Evaluate whether fiduciary duties (as established in law or as applied in practice) are conducive to investment strategies in the best interests of the ultimate beneficiaries. We are asked to carry out this evaluation against a list of factors. In particular, do they reflect an appropriate understanding of beneficiaries’ best interests, are they sufficiently certain, and do they encourage long-term investment strategies?

(5) Identify areas where changes are needed.

 

The report can be accessed here