Few industries around the world could have more reason to bemoan their fortune in the recent past than the Irish construction sector, which recently recorded its first month of growth in over six years.

The €1.2-billion ($1.6-billion) fund that invests construction workers’ pension savings on the Emerald Isle has jumped at the opportunities presented by the eventual upturn, most notably by backing Dublin’s equally beleaguered government debt.

Pat Ferguson, chief executive of the Construction Workers Pension Scheme in Ireland, says that a 2 per cent allocation to Irish government bonds was made in 2011 with 10-year yields then at the 13 per cent mark. The scheme plans to continue holding the bonds to maturity, while creaming off a coupon around the 6 per cent mark each year. While Ferguson admits the fund was tempted to sell the bonds when yields plummeted to below 4 per cent, Ireland’s finances are now in such healthy shape that it is set to leave its international bailout program in December.

Ferguson says he would recommend Irish government bonds to overseas investors hungry for yield. “Ireland is still seen as being on the periphery, but Irish bonds have improved significantly and offer a relatively secure yield,” reckons Ferguson. Being on the ground at one of the flashpoints of the euro crisis proved vital in the fund’s decision to back its government. “We decided the risk of the Irish government defaulting was just not possible despite the pressure to do so. It simply would have made no long-term sense in view of its financing worries,” explains Ferguson.

The Irish government bond allocation falls within the considerable 31 per cent of the “member fund” – the largest, defined contribution element of the scheme – that is allocated to alternative and opportunistic investments. Ferguson justifies the significant allocation as “we have to gear ourselves for low single-digit returns over the next 10 to 15 years by remaining as diversified as possible, and by looking at new asset possibilities”.

A recent $54-million investment into an Irish small-and-medium-enterprise fund launched by BlueBay and Ireland’s National Pension Reserve Fund was the latest addition to the alternatives/opportunistic segment. This joins a number of absolute return mandates, some historic venture capital investments and a fusion mandate investing in currencies, commodities and hedge funds.

“The SME fund is very much a long-term investment of the kind we can afford to make as we have greater incomings than outgoings,” says Ferguson. He praises the scheme’s absolute return funds for carrying out their function and meeting benchmarks, albeit feeling “they have not quite been up to scratch this year so far”. The strong correlation between equity and bond markets in the past few years has fundamentally vindicated the absolute return idea, he points out.

 Building the right defined contribution mix

The fund has a 44 per cent combined equity and real estate allocation, which is a neutral position within a 35 to 55 per cent bandwidth. Some 25 per cent of the member fund is invested in low-risk bonds and cash, although the fixed interest allocation rises to 39 per cent across the scheme as a whole. This is largely because there is a bond-heavy fund for the annuities the scheme automatically grants to members on retirement.

The scheme will not be tweaking or changing its strategic allocations based on any market predictions resulting from an unwinding of quantitative easing. “Going forward, we have no immediate view of changing allocations without a clear fundamental market shift,” Ferguson says.

The defined contribution nature of the fund, together with its long-term horizon, gives it the potential to take on a “substantial element of risk”. It has recently changed the profile of its “lifestyling” asset mixes so that members up to the age of 55 are now invested in corporate rather than government bonds for their progressively increasing fixed interest allocation. “The return on long bonds wasn’t giving members fair growth,” says Ferguson.

Nonetheless, the fund is happy to keep members on an 80 to 90 per cent fixed income and cash allocation in their final years before retirement. This is done to reduce the threat of volatility eating into pension pots, as any drop in bond prices would also be reflected in cheaper annuities.

 Fencing off financials and real estate

The fund has resisted any temptation to take on added risk by dipping further into the depressed Irish real estate market, according to Ferguson. Its real estate investments amount to 7 per cent of the fund, held directly across six office and retail properties in Ireland and in two European funds. “Our Irish properties have lost substantial value over the past few years, of course, but with our long-term focus we are content to wait until the market improves,” he says. Steady rent yield is another crumb for comfort despite those valuation losses.

Interestingly, the Construction Workers’ Pension Scheme shuns financial firms in its corporate debt investments. This is done in order to “take some of the risk out of corporate bonds,” explains Ferguson.

The fund aims for a “cash plus 5 per cent” return target. “As long as our model is working, we are not unduly focused on returns though,” states Ferguson, clearly relishing the freedom that the defined contribution model offers. That also gives the fund a bit of patience with its asset managers. Ferguson argues that it would always prefer to analyse whether a manager’s strategy is sound before dropping one for performance. It relies on Accuvest for investment advice and shortlisting managers.

The Construction Workers’ Pension Scheme has returns around the 5 per cent mark so far for 2013 on top of a 8.9 per cent performance in 2012. It will clearly be looking wide across the asset allocation spectrum to keep returns at that level in the future. It would surely please Irish construction workers to see that at least something they have been building recently has had a nice orderly increase in value.

The following article is a letter from United Food and Commercial Workers’ John Marshall in response to our recent article, Walmart takes divestment blows to the body.

 

I read with interest the excellent article on the Swedish AP funds’ recent divestment from Walmart based on concerns about the company’s systematic abuses of workers’ rights in the United States. As you may know our union has been very engaged with the company on these issues and has supported the workers currently organising in the Organisation United for Respect at Walmart (OUR Walmart).

In my role with the United Food and Commercial Workers’ capital stewardship program, I am in regular communication with a number of investors and analysts about concerns related to the company’s poor labour practices. In that context I was intrigued by the quote in this article from an unnamed analyst referring to the perceived desirability among portfolio managers of holding Walmart stock, apparently due to the belief that Walmart is a good proxy for the global economy.

That perspective is very different from what I would characterise as the prevailing view among analysts, specifically that Walmart stock over the past several years has been attractive to the extent that it is a countercyclical asset and, in particular, that it is insulated from risk in the eurozone. This perceived insulation and Walmart shares’ close correlation with the defensive consumer staples sector, which has rallied over the past several years, explain most of the relatively modest gain in Walmart shares during that period.

Indeed, despite this favourable macroeconomic environment for Walmart, its stock has significantly underperformed its retail peers, including unionised retailers such as Costco and Kroger, over the past one, three, five and 10-year periods.

WMT vs PEERS

As for the impact of labour concerns on the company’s share price, we have pointed to two direct areas of concern for investors: the well documented operational problems associated with understaffing and underinvestment in training, as well as the lost sales and slowed expansion resulting from reputational harm. For a fuller discussion of these issues, please see this report we published last year.

Over the past two years, in the face of Walmart’s apparent unwillingness to reassess its hostility toward its own workforce, several large investors – including APG, PGGM, Mn Services and now the Swedish AP funds – have taken the decision to divest their Walmart shares. Prior to these divestment decisions, while these investors were engaging Walmart as owners, representatives of each of these funds travelled to the US and met personally with Walmart workers to hear their perspectives.

Although we do not advocate divestment as a strategy and view the continued engagement by other investors as critical to the long-term effort to change Walmart, the Dutch and Swedish funds have earned the gratitude of thousands of Walmart workers for simply listening to them and taking these concerns seriously. Perhaps someday Walmart’s leaders will do the same.

 

John Marshall, CFA

Senior capital markets economist

United Food and Commercial Workers

When Eugene Fama enrolled at Chicago Booth School of Business in 1960, “finance was a joke”, he says in a candid and fascinating insight into his more than 50 years as a student, academic and teacher at the university.

The essay, published by Chicago Booth’s Capital Ideas, details Fama’s own history but also a short history of finance including how the efficient-market hypothesis was born.

Fama, who is often called the “father of modern finance”, calls the Black-Scholes paper on option pricing the most important paper in economics of the twentieth century.

“No other paper has to be learned by every single economist getting a PhD and has also created an industry – the derivatives industry.”

Fama, who also got into Harvard, chose to go to Chicago because he was advised that “it was more academically oriented than Harvard”.

He is the Robert R McCormick Distinguished Service Professor of Finance, and received a MBA and PhD from the University of Chicago Booth School of Business

“I love my work,” he says in the essay. “I have no intention of stopping as long as I’m breathing – and I may even do it after that.”

To read the full essay, click here.

Two more high profile investors have punished US retailer Walmart for its anti-union stance and poor labour practices by divesting their holdings in the company. AP Funds, Sweden’s cluster of state pension funds named AP1 through to AP4 and AP6 (there is no AP5) worth a combined $140 billion, sold its equity and corporate bond holdings in the company last week. In July PGGM, the Dutch asset manager that oversees €133-billion ($174-billion) also dropped Walmart from its equity portfolio after years of cajoling failed to change the company’s labour relations policy.

PGGM’s divestment, which amounts to 0.1 per cent of the fund’s assets under management valued at around $272 million, was the culmination of a process of dialogue and disappointment, explains Saskia van den Dool at PGGM. “It is regrettable that one of the world’s largest companies takes so little interest in the concerns of its shareholders and other stakeholders. The long dialogue with Walmart had both high and low points,” she recalls. “During the highs we received positive signals that the company was considering action upon our concerns. PGGM maintained the dialogue for as long as we thought improvements were feasible, but in the end we saw no option but to divest when it became clear that the engagement did not produce the results that we aimed for.”

Similarly, AP Funds’ decision to divest follows six years of pressure dating from before the different Swedish government funds had even coordinated strategy on ethical investment via their Ethical Council, set up in 2007. “AP Funds applied pressure on Walmart via direct dialogue, issuing shareholder resolutions and by collaborating with other investors,” says Christina Kusoffsky Hillesöy, chair of the council. “Our policy is to engage with companies that violate international conventions but if we can’t improve the company, we will divest.” Both investors believe that divestment, and with it the end of any ability to affect change at Walmart, doesn’t belie any failure in their ESG strategies. “We hope our decision sends strong a message not only to Walmart and its board members, but also to other companies. We take our role as an active owner seriously and we believe that abiding by internationally accepted standards is an important corporate responsibility that ultimately contributes to the long-term success of the companies we invest in,” says van den Dool. Christy Hoffman, deputy general secretary of UNI Global Union, which represents workers from around the world through 900 affiliated unions also believes that investors have to follow the threat of divestment through. “You have to hold out divestment as the ultimate act. If you don’t divest, they won’t take you seriously.”

A series of soft blows…

Yet the impact of divestment hasn’t been felt immediately. European investors such as AP Funds and PGGM are already well known for their proactive environment, social and governance strategies. Last year PGGM voted at more than 3,100 shareholder meetings, was in dialogue with 746 companies and excluded 42 companies from investment. Most recently, the fund began a process to check the 2,800 companies in the FTSE All World Index, in which it is invested, against its own specific ESG index. Markets have factored in Walmart’s aggressive approach to labour relations ever since the retailer was dropped back in 2006, when Norway’s Government Pension Fund sold more than $400 million worth of shares citing labour issues, and Sweden’s AP2 fund became the fist in the cluster to sell its stake in the company. “Walmart will always come under pressure from unions because it provides low-paying jobs and is the biggest private employer in the world,” said one New York-based analyst who declined to be named. “But it’s hard to find such a stable company that is a better barometer of the world economy. There will always be an appetite for Walmart shares.” In contrast, he believes Walmart is more concerned with smoothing investor concerns over bribery allegations in its Mexican subsidiary. This “is more of an issue” than its poor record on labour relations, he said.

…lands an influential punch

Yet both PGGM and AP Funds are influential investors and other pension funds in the region may follow where they lead. Walmart will take years to shake off the stigma of exclusion and divestment in Walmart may add weight to other campaigns particularly those around fossil fuels, where advocacy groups are pushing investors to better climate proof their portfolios. Swedish national pension fund AP4 has just announced plans to invest in a new emerging markets-equity fund, which excludes companies with high greenhouse gas emissions and extensive reserves of fossil fuels based on a new index. “With few exceptions, carbon dioxide is now widely recognised to have a negative impact on the climate. We believe that these companies will be valued differently in the future and that greenhouse gas emissions will be associated with higher costs in the long term. Hopefully, this will also increase the pressure on companies to lower their carbon dioxide emissions,” says Mats Andersson, chief executive at AP4.

At both PGGM and AP Funds, divestment was born from the belief that better governance helps returns but also that bad governance increases risk. The funds argue that investors that passively track an index still manage to deliver on their return objectives despite exclusions which only have a marginal effect on their tracking errors. “We are long-term owners and we saw a real risk in holding Walmart,” says Sweden’s Kusoffsky Hillesöy. “We are convinced that the issues we were concerned about at Walmart will eventually have a negative effect on the company’s performance,” concludes van den Dool.

The funding crisis that hit pension funds across the world may be easing – in common with the five-year long economic crisis – but restoring healthy funding levels remains a vital priority for many investors.
The Netherlands’ €4.9-billion ($6.6-billion) UWV pension fund is one of that number. A funding ratio of 98.7 per cent at the end of August was not the lowest in the recent past, but was some way short of the 104.3 per cent that the Dutch central bank has designated as a minimum for its country’s investors.
UWV has been given until the end of August 2014 to meet the minimum as part of a recovery plan. Investment advisory committee chair, Johan de Kruijf, says the funding issue “remains troublesome” due to low interest rates and low returns on the bond-heavy portfolio. De Kruijf thinks that “if markets continue to rise, we can get on track to meeting this target”, but adds that there is also plenty of cause for concern as market volatility does not give him confidence that recent equity returns are sustainable. “Who knows what would happen if there are policy surprises or US or Chinese growth disappoints?” he asks.
While some might suggest substantially increasing the 19 per cent share that the fund invests in equities would ensure a speedier funding recovery, de Kruijf explains that this option is off the table. “You would end up running into regulatory restrictions on taking additional risk,” de Kruijf points out.
The UWV fund is sticking to the defensive asset strategy determined by its 2011 asset-liability management study. While it would have no desire to make strategic changes before a new study is completed, de Kruijf says there is an additional motivation to keep strategy changes to a minimum. “Everyone in the Netherlands is waiting for the new pension regulations to be finalised, which will likely bring a new supervision system in the next 18 months,” he says.
De Kruijf recognises that the new regulatory regime in the Netherlands is set to result in some “serious discussions” on potential investment changes. With detailed negotiations on future discount rates looking likely to set a complex artificial new rate, “it is very hard to say what the consequences of the Dutch pension reforms will be,” he says. “It looks like interest rates would be a bit higher and, by implication, there would be some room for additional risk, but on the other hand the artificial nature could present troublesome issues from a risk management perspective,” he explains. “Nonetheless, if there is room for more risk in our portfolio, it must come from the regulatory arrangements.”

Overlay play

When it comes to playing with risk levels, de Kruijf concedes that the UWV fund’s overlay strategy – worth some 10 per cent of the fund’s assets – currently gives the greatest room for flexibility. This can be achieved by changing interest rate hedging levels, although the most significant contribution of these hedges in recent times has been partially shielding the fund from declining interest rates.

De Kruijf explains that the fund’s sophisticated overlay strategy covers “the economic exposure of all elements in the portfolio”. If decreasing the level of interest rate hedging, for instance, the fund would increase holdings of futures and currency issues in order to ramp up the exposure to equities and return-seeking assets.
These overlay weightings are dynamically set on a monthly basis in relation to the performance of the portfolio relative to the market and the fund’s strategic asset allocation. A defensive position becomes automatically established if the fund is behind on both indicators, with the flipside being true if the fund runs ahead of these markers.
While enthusiastic of the benefits the overlay has brought, de Kruijf is not keen on the possibility of the UWV fund adding to its strategy with other derivatives. He reasons this would end up introducing new risks into the portfolio.

Defending the defensive

The UWV pension fund has 37 per cent invested in a low-risk fixed income-matching portfolio, with another 25 per cent invested in corporate bonds and high yield.
Keeping its defensive strategy has seen the fund continue a 60-per-cent interest rate hedge. The investor uses AllianzGI as a fiduciary manager for manager selection, but retains its investment strategy responsibilities.
Having a public sector insurer as a sponsor is a motivation for the defensive strategy, explains de Kruijf, as any financial support would be politically problematic. The ageing demographic of the fund also skews it towards risk aversion.
The biggest source of change within the static strategy currently comes within the alternatives portfolio. The UWV fund has earmarked an increase in its alternatives segment from 8 per cent to 17 per cent in its strategic allocation and has been viewing potential new assets as it seeks to reach this level. The fund has been exploring infrastructure, but is not investing just yet. “We will invest in infrastructure when we finalise the requirements and legal set-up of investment vehicles for non-real estate alternatives, including private equity,” says de Kruijf.
Unusually for Dutch investors, the fund has opted to ground its infrastructure and private equity moves in domestic law. “Using domestic law would be a better way to settle disputes if any come up,” reckons de Kruijf.
As soon as the infrastructure investments are finalised, they will join commodities (around 2 per cent of the fund) and real estate in the fund’s alternative bucket. The UWV fund is also aiming to increase its real estate exposure from 6 per cent to 10 per cent in its alternatives drive.
The fund also has a 5 to 6 per cent allocation to mortgages within its fixed income portfolio, which de Kruijf says it may increase if the Dutch government’s national mortgage bank idea is successfully implemented. Hedge funds, however, are not currently of interest to de Kruijf and UWV.
Trying out new assets and tweaking allocations as part of the alternatives drive will therefore remain the focus for the UWV fund until next year brings the deadline for both its recovery plan and pension reforms in the Netherlands.