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.

I’ve always been frustrated by interviewing consultants and the lack of conviction they have about their decisions.

“What would your ideal model portfolio look like?” I constantly ask.

“It depends on the client” is the predictable and consistent answer.

That may be valid, even true, but it speaks to a wider problem.

Consultants are hired to give advice. But most consultants don’t seem to want to put their hand on their hearts and back that advice or stand for it. Advice with conviction, which may at times include saying they got it wrong, would surely be more sought-after than peer-group or bland advice.

Consultants have been picked on in the media for the past couple of weeks, with the New York Times column Dealbook and the Financial Times article Billions of dollars wasted on investment advice both picking up on research by Oxford University’s Said Business School, Picking winners? Investment consultants’ recommendations of fund managers.

The research analysed what drives consultants’ recommendations of institutional funds, what impact these recommendations have on flows, and how much value they add to plan sponsors.

“We find that consultants’ recommendations of funds are driven largely by soft factors, rather than the funds’ past performance, and that their recommendations have a very significant effect on fund flows, but we find no evidence that these recommendations add value to plan sponsors,” the report says.

According to Andrew Ross Sorkin’s article in Dealbook: “Ultimately, Mr Jones wrote, the lesson of his research ‘would be to require investment consultants to provide the same high level of disclosure as that which is provided by fund managers on their performance, or the same level of disclosure provided by research analysts on their stock recommendations.'”

Adding cost

One of the key points to pick up on in this conversation, is that not only do consultants not add value, at least according to this research, but they do add cost.

Ron Bird and Jack Gray have written a lot about the agency problems in the investment industry and are due to publish a paper in Rotman International Journal of Pension Management entitled Principles, Principals and Agents.

The authors surveyed the chief executives of pension funds in Australia and subsequently non-Australian funds, with the responses revealing “the depth and complexity of the agency ecosystem in which the superannuation system is enmeshed; a system that imposes substantial costs on members’ retirement benefits”.

(Interestingly there is a footnote which explains that both authors have been and continue to be agents – consultants, investment managers and advisors.)

The paper seeks to better understand the structure, role, influence and costs of agents in superannuation and asked questions of the chief executives such as who are the agents and what do they do, how do agents justify their decisions and actions, and what are their supposed benefits to members.

It looks at trustee/directors, asset consultants, internal investment staff and external investment managers.

While the research found that the costs of consultants (10 basis points) was small compared to other agents, it worryingly reported agents’ costs have increased much more than funds under management and have doubled relative to agents’ reported influence.

The high level of relatively negative views about agents suggests that the superannuation system is far from optimally structured in members’ best interests, the paper concludes.

In many jurisdictions, pension funds as institutions are a relatively new phenomenon. In Australia for instance, the system is only 20 years old, and it is common for agents, or outsourced partners, to be used by the funds as they “grew up”.

Ill equipped

In fact funds have relied on consultants as they have evolved as institutions for good reason: they can’t make decisions themselves.

It is remarkable to learn how many large investors have very poor decision-making processes.

For the most part, the sophistication of the internal decision-making, governance structure and resources is not commensurate with the asset size of large institutional investors.

There are exceptions – such as the Canadian Pension Plan, the Australian Future Fund and New Zealand Super – but on the whole pension funds are not equipped to make decisions.

As funds take responsibility and ownership of this, create the functions and fill them with the resources necessary to make good decisions, the role of agents will diminish.

A review of the number and role of agents should be on the radar of all funds as they evolve into institutions.

At the United Nations-backed Principles for Responsible Investment conference Cape Town on October 1, general secretary of the International Trade Union Confederation Sharan Burrow delivered a speech entitled Push the Reset Button – a Line Between Speculation and Investment. She discussed the stability of the global economy, the necessity for investors to shift to long-term thinking and the crucial role of pension funds in truly sustainable investment. At the heart of Burrows’ speech is the centrality of workers’ capital – the money that funds the industry that feeds us – and the respect that deserves.

Read the full report here.

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.