Michael Brakebill had never visited Nashville, Tennessee before he interviewed for the role of chief investment officer at the $36.6-billion Tennessee Consolidated Retirement System (TCRS) back in 2008.

Landing the job at the defined benefit scheme for Tennessee’s public sector workers, he left his position as head of domestic equity at Texas’ Teachers Retirement System in Austin and headed east.

“Nashville was never on my list of places to move before but it’s a great spot,” he enthuses from TCRS headquarters off Nashville’s tree-lined Deaderick Street. “Texas Teachers is larger and with more exposure at $110 billion assets under management, but the mandates and performance of the two funds are remarkably similar.”

In a strategy Brakebill describes as “not pulling a single magic lever but lots of small levers”, Tennessee is in the process of distributing a new allocation, laid out in December 2012, that aims to keep risk low but seek returns from new allocations to real estate, credit strategies and emerging markets.

“We have taken risk out of the portfolio and have a lower risk stance than others,” he says. “In fact we have typically 10 to 30 per cent less risk measured in a standard deviation framework than other public sector funds.” The Tennessee system also stands out from its peers in its preference for active management, which extends almost across the entire portfolio.

“We are primarily active. It pays off with fixed income especially; our externally managed international equity allocation has also done especially well,” says Brakebill.

Run internally in Nashville, TCRS has a 37 per cent allocation to domestic North American equity that includes Canadian stocks and investments are in a “plain vanilla S&P 1500” active portfolio. International and developed equity accounts for 13 per cent of assets under management and, in a new allocation created by reducing the domestic equity portion, the fund now has 4 per cent of assets in emerging market equities too.

 Keeping in clean

Brakebill, who describes progress in emerging markets as “tough this year, but strategically we are looking forward,” says the allocation is internally managed using exchange traded funds (ETFs) purchased via a screening process according to Transparency International’s corruption index and The Economist’s democracy ranking. The fund then purchases ETFs benchmarked from selected countries in the MSCI Emerging Markets Index.

“We wanted to avoid investing in nations which might be corrupt or undemocratic,” he says. It’s a process that has screened out major economies China and Russia, both highlighted as “key offenders.”

Nonetheless, it’s a strategy Brakebill is convinced will pay off, with the portfolio concentrated in better governed markets including Turkey, South Korea and Taiwan. “We do believe that better governance means better returns,” he says.

Strategic lending

The Tennessee system is also in the process of portioning a new 5 per cent strategic lending allocation. Funded by a reduction in its treasury inflation-protected securities (TIPS) domestic fixed income portfolio, the allocation will include high yield and bank lending plus other “interesting” credit allocations such as mezzanine and direct loans. “We have nothing sizeable here yet,” says Brakebill, pictured right, who oversaw initial allocations of $150 million apiece to Beach Point Capital Management and Brigade Capital Management earlier in the year. The portfolio will be benchmarked 50 per cent to the Credit Suisse Bank Leveraged Loan Index and 50 per cent to the Barclays Capital 2 per cent Constrained High Yield Index in a deliberate departure from the Barclays Capital US Aggregate Bond Index, currently yielding just 2 per cent.Brakebill-Michael-150

Brakebill counters that Tennessee’s push into new fixed income and credit strategies outside the traditional benchmarks isn’t a direct result of the Federal Reserve’s policy on quantitative easing. “Rates are lower than they would have been, but it has also boosted asset prices, particularly equities.” Tennessee’s strategy, he says, is more a consequence of a realisation that a third of the fund’s assets were in short-duration securities of between 0 and 4 years, yielding just 1 per cent or less. “It became apparent that a third of our assets were in zero yield and not doing any good for us. We do not need the liquidity and we were scratching our heads, wondering why we were there at all,” he recalls.

Real estate and private equity

Tennessee has also increased its real estate allocation, now around 5 per cent of total assets, expanding the mandate to include an opportunistic, higher risk real estate fund. The fund decided to push a more bullish position in response to “good” long-term returns from plain vanilla investments, namely fully leased quality real estate, which performed well in the financial crisis. Real estate returned 10 per cent for the 2012 fiscal year compared to 15.5 per cent in 2011.

Brakebill says the fund will also steadily boost its private equity allocation in a portfolio first begun six years ago. So far only $300 million, around 1 per cent of total assets, is invested in private equity but this will grow to “north of $1 billion”, with target returns set at S&P500 plus 300 basis points. It’s an allocation that will demand “long-term effort” to cultivate relationships with managers, and Brakebill highlights climbing values of private assets as another concern. Recent private equity commitments were made with Bain Capital and KPS. There are no plans to allocate to hedge funds. “We already have a bunch of balls in the air and we don’t want any more. Many big US pension funds haven’t had favourable experiences with hedge funds anyway.” Since TCRS shelved an international fixed income portfolio for its “unrewarding” allocation to Japanese debt, the only currency exposure hedged is in the international equity portfolio.

In a state of support

Brakebill attributes the scheme’s rosy health at 91 per cent funded to robust financial support afforded the scheme by Tennessee State. As well as “always meeting the number” – a reference to Tennessee’s preparedness to fund contributions when economic conditions tighten – the sate has also nurtured TCRS’s growing pool of internal expertise, with the Nashville team of 30 now managing the fixed income allocations, domestic equity, private equity, real estate and a trading arm. “We have been beefing up staffing in areas to reduce the operational risks of the fund,” he says. “We are very lucky that our staffing is going up, while overall the State is cutting back on personnel,” he says. “They think highly of what we are doing at the treasury and decision-makers have shown great courage in supporting us through a difficult period.” In another development, the state is also restructuring its retirement provision. From July 2014 it will introduce a new hybrid defined contribution/defined benefit scheme for all new hires in Tennessee. It will likely mean Brakebill’s treasury team begin to manage new defined contribution assets in a fund with all the characteristics of TCRS’s low risk, stable portfolio.

 

Simply comprehending the myriad of national institutional investing systems, investor types and priorities can be an onerous task. Attempting to coordinate an international effort to promote an uncommon investment strategy choice is well and truly herculean.

That is the challenge facing Raffaele Della Croce and the rest of the team behind the Organisation for Economic Co-operation and Development’s long-term investing project as they seek to lengthen the time horizons of investors and get institutional money flowing from across the world into infrastructure gaps.

Della Croce, who leads the Paris-based organisation’s project and is pictured right, argues that an international effort is vital for the infrastructure drive to succeed. “Large investors are looking at global markets as they diversify portfolios and they are increasingly discarding any national biases,” he says. He adds that financial regulation, a major influence of investment strategy choices, is also becoming more and more internationally coordinated.

In explaining the background to the OECD’s push, Della Croce says that its enduring work on institutional investors and data collection on them had been leading it to focus on asset allocation trends. The financial crisis then struck, and a desire to help inform the global effort to restore growth in the aftermath got the organisation active.

Feedback from the market that long-term investment was lacking then spurred the OECD to launch its project in 2011. The OECD cites just 1 per cent of combined global pension fund assets of $20 trillion as being invested directly into infrastructure at the end of 2012.

Powerful allies

“Our approach is to have a holistic view of the different barriers investors face – from regulation to governance and specific issues on infrastructure investments,” says Della Croce. “We want to put all this within the context of a policy framework that can actually respond in a comprehensive way.”

The OECD project has enlisted some powerful allies in its quest, most notably the G20. While headlines were dominated by discussions on the international community’s response to the Syria crisis and pledges for collaboration on tax avoidance, the G20 leaders’ declaration formulated in St Petersburg in early September acknowledged the importance of long-term investing.

The OECD’s wide-ranging set of high-level principles on long-term investing by institutional investors also became endorsed by the G20 leaders. These principles cover everything from government incentives, regulation and tax to financial education. They are designed to help policy makers promote long-term investing, but their breadth arguably also indicates the sheer complexity of the initiative.

The principles call on governments to work on sustaining private involvement in long-term projects and consider “issuing appropriate long-term instruments” to investors. Risk mitigation, promoting pooled investment vehicles, setting appropriate investment regulation and accounting rules, plus avoiding “crowding-out private investments” also make the list of recommendations to governments.

Along with enhanced political will, finding the right risk/return profiles for various infrastructure possibilities the world over is essential, Della Croce stresses. He agrees that beyond all the specific obstacles, a mentality shift is needed to bring the long-term investing dream to fruition. “At times messages that seem easy to communicate are not being communicated clearly,” he reflects. “A big motivation for our project is that investors did not feel that what they were asking for on the policy side was being acted on.”

The world needs you

While the OECD project is calling on governments and regulators to do their part, it also wants to see asset managers and owners tackle obstacles. Asset managers can play their part by easing shortages of data, transparency and trust that currently restrict the potential of infrastructure investments, Della Croce argues.

Investors, on the other hand, need to ensure sufficient governance is in place if they are looking to invest in infrastructure or other uncommon long-term assets, he says.

Insights from the world’s largest investors have been vital for the OECD’s efforts to date. The project has worked closely with a select group of participant funds that rank among the world’s biggest, including APG and the Canadian Investment Pension Plan as active partners but also CalPERS, Norway’s Government Pension Fund Global, PGGM and AustralianSuper.

Investors discarding reluctance to share information on investments is highlighted by Della Croce as a vital step for the long-term investment agenda to take off. The OECD project has analysed specifically how Canadian and Australian funds have been able to take the lead internationally on infrastructure investing, and Della Croce thinks that more can be done to   share their know-how with the rest of the world.

“They have created a track record in infrastructure investing which is missing in many other countries,” says Della Croce. He argues that the direct investing typical of Canadian funds and open-ended fund vehicles in Australia show varied approaches can succeed. The fundamental differences between the two pension systems (Canadian pension funds being largely defined-benefit investors and their Australian counterparts defined contribution) meanwhile suggest there is potential in all kinds of markets.

Della Croce takes pride in the OECD helping asset owners to match the vociferousness of asset managers on the issue. Fundamentally, he feels investors willing to take the lead can benefit handsomely. “It is not about forcing investors into investing into assets they are not comfortable with, despite interest from the policy side in infrastructure,” Della Croce emphasises.

Della Croce’s team is set to publish a survey of large pension investors’ experiences and attitudes on long-term investing later in October. This should serve as another milestone in the lengthy process of shaping policy, which “won’t finish in a year or two”. Making sure the Australian presidency of the G20 next year furthers the agenda by the time of the leaders’ meeting in Brisbane in November 2014 is the next priority. With the OECD identifying a global infrastructure gap of $2 trillion per year from now to 2030, the success of the much-discussed long-term investing agenda is likely to be gauged for decades to come though.

A scathing report into the United Kingdom’s £275-billion ($441-billion) defined contribution pension sector by national watchdog the Office of Fair Trading that lambasts high charges and complexity could have gone further say modern, low-cost pension providers. The OFT has agreed a range of reforms to the workplace pension market after its study found millions of savers weren’t getting value for money. “We do not feel they have been sufficiently radical in their approach,” says Jamie Fiveash, director of customer solutions at B&CE, a provider of workplace pensions with more than $3 billion of defined contribution assets under management in schemes that include The People’s Pension, a super trust set up in 2011 ahead of auto-enrolment. “It should be much easier to make pension transfers from old and poorly governed legacy schemes into large scale, modern and well governed schemes.” Secondly, he argues policy makers should introduce an industry-wide charging structure to allow for informed choices. “This will ensure competition on products and service delivery rather than on obscure charging mechanisms, inevitably leading to the driving down of prices,” says Fiveash.

Morten Nilsson, chief executive of NOW: Pensions, a defined-contribution workplace pension scheme provider and UK subsidiary of Danish public pension plan ATP, adds: “To help employers select a scheme that is fit for purpose and is going to deliver on its promises to members, we support the OFT’s recommendations. The success of auto-enrolment will depend on the ability of providers to build trust and earn confidence among their members. If members don’t trust their provider and see their hard-earned pension pot being eaten up by high charges and their fund performing poorly, the motivation to stay enrolled with be sorely tested.”

The OFT’s findings, gathered from a six-month investigation into the defined contribution market, raised concerns around older schemes set up before 2001 in which savers are paying charges of 1 per cent or more. It is estimated that $48 billion is locked in these schemes run by insurance firms and trust boards. They account for around 190,000 savers, who could be losing around 20 per cent off the value of their pensions. Such charges contrast with the new wave of defined contribution providers, which include government-backed scheme, the National Employment Savings Trust (NEST), whose charges gravitate around 0.5 per cent of a saver’s pot. Auto-enrolment is expected to see 9 million extra people joining defined contribution schemes over the next five years.

Mea culpa

In response to the criticism, the Association of British Insurers (ABI), whose members offer many of the criticised schemes, has agreed to carry out an audit of the larger schemes, some of which are charging up to 2.3 per cent in annual management fees. Elsewhere, Legal and General has recently introduced caps on charges for auto enrolment workplace pensions at 0.5 per cent, a price cap that will not apply to members who want more investment choice than the default fund.

The report also highlighted a lack of competence among trustees responsible for running some schemes and raised concerns about savers in 3,000 smaller pension schemes, collectively worth about $16 billion and with 1,000 members or less, who may be at risk due to poor governance. Active member discounts (AMDs), which hike charges when an employees move jobs but don’t take their pensions, also came under fire. “We welcome the OFT proposal that all schemes, including contract-based ones, should have governance committees to help serve consumers’ interests. We have found that consumers are particularly reassured by NEST’s independent governance, which has members’ interests at heart, and the fact we are run on a not-for-profit basis,” says NEST chief executive Tim Jones.

Stand and deliver

But pension experts also believe the OFT was right to stop short of recommending a cap on charges levied by providers, and that charges will continue to fall. “There has been a slow reduction of charges through market pressure in the defined contribution world ever since 2001, when stakeholder pensions where introduced,” says Alan Morahan, principal at Punter Southall DC Consulting in London. “If the government had set a cap at 0.7 per cent, it would abate the downward movement. On the other side of the coin, a 0.3 per cent charge might be too low for schemes to be viable.”

The closure of defined benefit schemes and the introduction of auto-enrolment is expected to bring a “tsunami of money” to defined contribution schemes, warns Morahan. “Unless they get charges right, and also investment performance, administration and saver engagement, there is a danger they won’t deliver.”

The Robert F Kennedy Centre for Justice and Human Rights and Columbia University’s Earth Institute will run a series of high-level courses on sustainable investment focused on environmental, social and governance approaches as well as human and labour rights this autumn.

The Compass Sustainable Investing Certificate program, designed for long-term investors, will have a solutions-driven focus showing investors how to mitigate risk and improve returns. Looking at sustainable investing across all asset classes, the course aims to correct the misperception that sustainable investment underperforms and offer ways to invest sustainably with tools other than negative screening. It will feature keynote speakers from a stellar faculty and networking sections in a participation-driven approach over two weekends.

The course takes place over six days on October 18, 19 and 20 and December 6, 7 and 8 at Columbia University, New York City. Email kaul@rfkcenter.org, call 646-553-4753 or go to www.RFKCompassEd.com.

Recent reflections on this month’s five-year anniversary of the Lehman Brothers collapse have focused on a variety of developments since the crisis: from reform to remuneration, sovereign debt to shadow banking, and from offshore tax to the Occupy movement.

However, one significant area that has been largely overlooked has been the rise of sustainable and responsible investment among the institutional investment community.

Since the global financial crisis struck, the responsible investment industry has grown rapidly into mainstream finance. For example, in 2008 the United Nations-backed Principles for Responsible Investment (PRI) had around 350 signatories. They’ve now tripled to over 1,200 signatories, who are estimated to manage around a fifth of the world’s capital. We’ve also seen the wide adoption of stewardship codes in the United Kingdom and elsewhere, along with voluntary and compulsory regulation to encourage transparency.

Even the banking sector has been working on its sustainability. EIRIS has extracted data from its Global Sustainability Ratings to compare the environmental, social and governance (ESG) risk management score of the banking sector and found that it has risen over five years from 2.79 to 3.06. This score is based on criteria that assess how well the board and senior management address company-wide ESG risks and opportunities at over 150 of the world’s biggest banking institutions.

That analysis is good news for institutional investors – it shows that reforms have helped make the banking sector safer and more sustainable – but it also needs to be put into context. The average sustainability score for all sectors is actually 3.3, which means that the banking sector still performs worse on sustainability than many controversial sectors such as pharmaceuticals or oil and gas. That may help to explain some of the continuing flow of ethical lapses that the sector has faced in the last few years, from LIBOR fixing to money laundering.

Another anniversary this month shows that the rise in responsible investment also needs to be put into context. That it is actually part of a longer term trend, which still has some way to run.

30-years old today

Thirty years ago today, EIRIS, the organisation I work for, was formed, helping give birth to the ESG research industry in Europe.

Back in 1983, responsible investment as we know it barely existed. Thirty years ago, we had just one asset management client (the Friends Provident – now F&C – Stewardship Fund) and it was a challenge to find any corporate information on sustainability. Now we serve 150 institutional investors and research around a million sustainability data points each year across 3,000 companies spanning 46 countries.

This sort of growth has not happened only as a response to the financial crisis. The global downturn, sparked by Lehman’s collapse, has been more of a catalyst than a creator for the boom in responsible investment.

As is the case with the banks and sustainability, there is also still a long way to go when it comes to institutional investors and responsible investment. Research by the PRI in 2011 showed that despite the large number of institutions it had signed up, still only 7 per cent of the global market was subject to ESG integration by its signatories. That’s a figure I’ll be attempting to drive up following my election to the PRI’s advisory council this month.

In the next five years responsible investment needs to make even faster progress. Rising global demand for food, energy, living space and water, as well as the challenge of dealing with climate change, mean sustainability issues will only become more material to mainstream investors in the years to come.

Banks and institutional investors alike still need to show that they can manage ESG issues in a way that makes individual portfolios, and global finance as a whole, much safer for the benefit of all participants in the investment chain.

Peter Webster is chief executive of EIRIS, an ESG research agency dedicated to empowering responsible investment. For more information visit eiris.org or follow on Twitter @EIRISNews

The herd mentality of investors has been agonised over for as long as markets have been around. The dilemma is often raised of whether to participate in or shun market trends, but the DKK150-billion ($27-billion) Sampension has succeeded recently with a selective approach. It has fully embraced the institutional diversification movement by building a significant alternatives portfolio, but has been content to move in for some rich pickings as other investors fled the bonds of outcast European sovereigns.

The fund estimates it made over $180 million in 2012 by buying Italian sovereign debt instead of Danish – at a time when investors were treating government paper from Rome with disdain. Sampension calculated calmly that the market reaction was excessive, given that the country was introducing reforms it felt were genuinely beneficial in an effort to keep yields down – and the bonus returns seemed to prove the Danish fund right.

Chief investment officer Henrik Olejasz Larsen reveals that much of Sampension’s Italian debt exposure has this year been switched to another unfavoured European destination, Spain. “We have seen a rapid improvement in the economic conditions in Spain,” Larsen says.

Beyond getting extra returns or proving to be in a wise minority, Larsen explains that Sampension’s faith in the European periphery is also motivated by a desire to hedge against future interest rate rises. “Peripheral debt will hedge rising interest rates in Denmark and Germany if the situation in Europe stabilises,” Larsen argues.

A European stabilisation is indeed what Sampension expects, as was reflected in a recent decision by the fund to slightly upweight its European equity exposure. “We think there will be improvement beyond what is priced into the markets,” says Larsen. That indicates the foundations of the fund’s European enthusiasm – not a denial of the problems the continent faces, but a feeling that investors have over-reacted. “We don’t think the euro crisis is over, but there is political will to kick the can down the road and do whatever it takes to keep the currency together. There may be small surprises ahead, but we don’t see any great catastrophes,” he states.

Alternative bedrock

Sampension has also notably developed a 13 per cent alternatives allocation. Larsen says that its above-average stake in the asset class has been made possible by its large size bringing added capacity and also an unusually stable membership reducing liquidity needs. Half of the alternatives bucket is invested in real estate, with the remainder taken up by private equity, infrastructure, forestry and global macro hedge funds.

Larsen has found that Sampension’s alternatives portfolio has risk/return qualities common to more liquid assets, with the exception of private equity, which has been offering superior returns. He is confident that the broad scope of assets invested by Sampension’s alternative team gives it potential to quickly adopt promising new assets. That is something the fund will likely need to do too as it eyes a 20 per cent alternatives allocation to reflect an increased risk budget, resulting from the continued development of its new unguaranteed pension offering.

Like most Danish pension investors, Sampension is aiming to extend its infrastructure allocation, which currently amounts to a small exposure to listed infrastructure funds. It has been actively seeking unlisted funds and projects for direct investing without any success so far, as risk/return qualities have yet to appeal, says Larsen. He has pledged to intensify this effort, reflecting that “we were spoilt for choice for a long time with real estate and credit opportunities, but these are drying up now”.

Sampension has joined its fellow Danish funds in lobbying the government for greater public-private partnership opportunities. The supply of projects so far has been “disappointing” though, Larsen says. Another setback came as Sampension was part of a consortium offering to fund a real estate project on Copenhagen’s harbor front, only for the government agency in charge of the process to pull the plug due to a lack of other bids. Discussions about getting Danish institutional funds into infrastructure projects are ongoing though, and Larsen floats the possibility of national projects in the construction and maintenance of public buildings as a potential breakthrough.

Beyond infrastructure, Larsen reveals that Sampension is also looking into offering direct lending in lieu of banks. “We have been trying to find exposure by negotiating with banks, but nothing has come of this so far,” he says, although Sampension is now finalising a European senior real-estate-loan fund investment.

Sticking up for CLOs

Another way in which Sampension seemingly bucks majority thinking is in its continued enthusiasm for investing in AAA collateralised loan obligations (CLOs). Larsen thinks they offer a decent hedge against a rise in government bond yields. “CLOs’ bad reputation during the financial crisis is not reflected in our good experience of them,” he argues. In his view, solid internal processes helped Sampension avoid losses on these assets, but Larsen reckons the poor sentiment towards CLOs is fundamentally undeserved.

On the whole, Sampension has some 69 per cent invested in bonds – although Larsen explains other asset classes are becoming more significant as guaranteed-liability products become less prominent in Sampension’s offering. While the equity allocation is low across the board, a substantial recent 10 percentage point increase in equities for young unguaranteed pension savers reflects Larsen’s future market outlook. “We will see a prolonged underperformance in low-risk bonds and a lower risk for a setback in equities,” he predicts.

Another key part of Sampension’s investment strategy has been interest rate hedging. While this helped the fund to huge returns of over 20 per cent for its traditional guaranteed offering in 2011, Larsen says this position has resulted in substantial investment losses in 2013. These investment disappointments have been fully compensated for by reduced liabilities, however.

A negative result for the guaranteed product can be expected at the year-end, Larsen reckons, with a healthier 3.8 per cent result coming for the first half of the year across the unguaranteed product. He remains optimistic that as Sampension’s unguaranteed offering becomes more important, there will be plenty of chances to explore new alternatives and make more shrewd investment calls within an increased risk budget. Given the fund’s recent success in judging market overreactions, there may well be other investors casting an interested eye on its future calls.