Having a breakfast meeting with Cliff Asness is a wake-up call. He will let you know if you’re late – something he holds in very little regard. He admits he has to constantly remind himself that just because he’s 20 minutes early to everything that others are not automatically then 20 minutes late.

Asness is open, he’s entertaining, even funny. And he also possesses the rare combination, at least in this industry, of intellectual genius and social libertarianism. It’s very engaging and you quickly get the feeling that you’re only scratching the surface of his intellect as he changes from political activist to quantitative mathematician to social philosopher.

Social justice is also good business

Having two sets of twins is an almost perfect justice for a man who revels in the competitive game of statistics – he’s clearly an overachiever. But while he boasts about the competitive achievements particular to quantitative investment managers, his intellectual reach doesn’t stop there. His social and political interests include gay marriage and tax.

“I believe in all forms of small government, not just economic. Gay marriage is something I just believe in,” he says. “I believe in treating people equally under the law, economically and socially. It’s my overall life philosophy.”

He takes this issue of fairness to work with him, and questions the industry in its approach to clients.

“Too many funds charge alpha prices for what is really beta,” he says. “Our firm charges fair fees for strategies that deliver beta-like returns.”

While this is in line with his intellectually honest approach, it’s also good business.

“Acting like this will build a business with more long-term value. You want to be honest with people, they’ll know when you’re being honest and they’ll pay 2:20 when it’s appropriate.”

Asness seems to have an idea every minute or so and is happy to express them.

He believes alpha exists, including some at AQR, but not nearly in the quantity the industry claims, and stresses that to utilise it you don’t just need to believe in it, but find it before the fact and net of fees.

However, he is passionate about the trend being advanced by his firm and others to tailor fees to the risks and rewards of the strategies a client chooses.

“In the active management world a lot of strategies are smart beta, but for a long time have been sold at alpha prices,” he says, using value and momentum as examples. “The good thing is this trend is bringing the veil back, and saying this is what we know and can invest in.”

 Smart, without the beta

And this trend to smart beta, is kind of the industry playing catch-up with some of the ideas AQR has been touting for some time – one of the manager’s ongoing themes is the existence of beta, hedge fund beta, and alpha, and the fees applicable depending on the outcome. He sees it as a client-friendly trend; if something is called a style premium then the fees will be different to an active fee.

Style premiums are increasingly being used as a tilt on beta by many offerings.

AQR has taken this idea and run with it. Its latest offering, that currently just has investments of the partners of the firm, combines the four factors of value, momentum, carry and defensive across seven asset types (industries, stocks, countries, bond markets, currencies, commodities and short term rates), producing a combination of roughly 25 different long-short strategies.

Asness says it’s smart without the beta, a concentrated version of the tilt without the benchmark.

“One of the advantages of quant strategies is you can do many things at the same time,” he says. “It is important to have them all in the one place, if you do each tilt separately it’s not efficient. A single smart beta can’t be as consistent as four smart betas in seven places.”

AQR continues to be innovative, taking the same themes Asness has been talking about for decades and reinventing new products. It will soon launch a long-only version of its quantitative stock selection product, which will have value, momentum and growth tilts.

“We’re doing something traditional, as many investors still need this structure, but our fees will be lower than the long-short ‘smart without the beta’ version,” he says.

From spending time with Asness, you can also assume certain things about the other co-founders of his firm. For instance, AQR could not be the success it is if David Kabiller did not have skills that complement the acute personality and thinking of Asness. Turning ideas into a money-making reality requires a partnership. Asness is one side of that coin.

 

Emerging market investing and sustainable investing easily rank as two of the most substantiated of the many investment trends of the past decade. However, the two styles of investing are far from natural bedfellows. Christian Ragnartz, as chief investment officer of the $17-billion-plus Swedish pension fund AP7 – which has 13 per cent of its equities invested in emerging markets – knows all about the pitfalls. “Environmental, social and governance (ESG) challenges remain huge in some emerging markets as some are very non-transparent,” he says.

As a gauge of the issue, Brazil and South Africa are the best performers in Transparency International’s 2012 Corruption Perception Index from the popular BRICS grouping. They both rank a modest sixty-nineth place, level with Macedonia but behind Lesotho and Romania. That is not to assume that all emerging market companies neglect sustainability norms, that developed market firms are immune from environmental, human rights or governance breaches or indeed that all established markets are better. Italy, for instance, is ranked behind Brazil and South Africa on the 2012 Corruption Perception Index.

So, how can funds continue to persuade a skeptical public of their sustainable investing credentials while taking advantage of the emerging market boom?

Ragnartz concedes that while sustainable investing considerations were a factor AP7 discussed “at some length” when defining its emerging market strategy in 2007, there was not a “huge impact” on its initial investment choices. Part of the reason for this, he says, is that the lack of transparency made it more difficult for AP7’s sustainable investing experts to perform their usual filtering work.

He explains that “the scarcer information and restrictions on press actually made it hard for our consultants that help us screen these markets to objectively verify violations to international norms”. Enough information has been gathered though, Ragnartz adds, to blacklist some emerging market firms.

From little things…

AP7, if not among the emerging market pioneers, was among the first wave of investors interested in the region, shifting exposure from around 2 per cent of equities in 2007 to the 13 per cent today. The dramatic pace of flows of institutional investment into the developing markets certainly shows little sign of relenting. According to a 2012 Mercer survey, the number of European pension funds with emerging market debt allocations increased more than fivefold from 2010 to 2012, making it the most common alternatives asset class among continental European funds.

Enhanced investor interest has helped to focus sustainability experts’ attention on the emerging world. Alka Banerjee, vice president of global equity indices at S&P Dow Jones Indices, says it is simply a case of major investors with large exposures to emerging markets trying to ensure that their portfolios maintain consistent sustainable criteria.

This has created real pressure in the markets, with the largest inflows of investment, says Banerjee, resulting in a “large and concerted push by governments, exchanges and companies to set high standards and try to emulate them”.

According to Mike Lombardo, a sustainability analyst at Calvert Investments, South Africa and Brazil provide examples of practices improving to such an extent that they are models which some of the developed can look up to.

Lombardo, who has spent time exploring corporate disclosure in South Africa for a United States Forum for Sustainable and Responsible Investment (US SIF) project, says that the ESG requirements of the Johannesburg Stock Exchange for listed companies are “world class”, with a new integrated reporting requirement boosting disclosure standards further in 2011. The presence of a burgeoning environmental technology industry in China along with stricter environmental legislation is another development that challenges popular perceptions.

Ragnartz agrees that “the situation is better these days as the emerging markets have matured.”

On the one hand, the tricky task of assessing emerging market firms against sustainability criteria has become easier with the experience gathered at AP7, he says. He echoes Banerjee in adding that the companies have also put more resources to handling these factors due to stakeholder demand.

Approaching disclosure

Despite the progress, those involved in promoting sustainability in emerging markets agree that there is room for improvement in many places. Discrepancies between emerging markets is a frequent concern. Differing attitudes are certainly indicated by the experience of the Carbon Disclosure Project (CDP). It has gained a markedly lower response rate from Russian and Chinese companies than South African firms in its attempt to gauge corporate climate change policies.

Emma Hunt-Jones of Towers Watson says that while transparency, corruption and environmental damage might seem the most pressing emerging market concerns, coming to terms with unfamiliar governance and ownership structures is often a greater investor priority. Emerging market companies with elements of family or state ownership can be a “red alert” for investors, she says. Jessica Robinson of the Association of Sustainable and Responsible Investment in Asia adds that those investing in real estate in the region tend to become cagey on government involvement in projects due to fears of corruption. And, there are investors who have become more trusting of the positive virtues of unfamiliar practices such as family ownership, Hunt-Jones says.

Among all these challenges, investors who are able to be proactive and get the data they need for sustainability in an emerging market gain a distinct advantage, according to Hunt-Jones. Lombardo adds that getting the full picture means investors’ sustainability analysts need to make an honest appraisal of the drawbacks. Understanding the cultural context and weak structural issues in a given market, such as corruption or lax enforcement of the law, is vital, he says.

Going local without turning native

The history of sustainable investing has shown that the largest funds are those most likely to take a lead on policy engagement and most comfortable in divesting from particular countries or sectors, Hunt-Jones points out. For instance, major US retirement funds such as the Kansas Public Employees Retirement System have been instrumental – along with asset managers such as Calvert Investments – in the Conflict Risk Network. This grouping has persuaded companies to avoid indirectly supporting violence in Syria and Sudan.

CalPERS’ policy of blacklisting certain markets in the past has proved more controversial. Hunt-Jones points out though that a decade after it pulled investments from Malaysia, the country is now considered to be one of the stronger emerging markets on sustainability.

Robinson says a choice to exclude certain companies might not have the desired impact: a company omitted due to poor transparency could still have strong sustainable practices.

Whichever way it is formed, sustained engagement in emerging markets is a resource-sapping job for even the biggest institutional investors, with air miles and specialist knowledge usually needed in plentiful quantities.

There are other options, though, for reducing the sustainability risk of emerging market investments that smaller funds might naturally find more appealing. One is looking beyond emerging market equities or bonds to focus on corporations in domestic or established markets with operations in emerging markets or other exposure there. Another is investing in the socially responsible emerging market funds that many asset managers, who might have extensive sustainability screening capabilities, now offer.

AP7 was prepared to take on the ESG risk, says Ragnartz, via its emerging market investments as it made an effort at the same time to boost sustainability screening for these markets. For him, the biggest sustainability concerns have moved away from the established emerging markets onto “frontier markets”. Only time will tell if companies in these markets will be able look to those that came of age at the start of the century as beacons on the pathway to sustainability.

 

A Chinese proverb says “women hold up half the sky” and, while Australia may have been among one of the first nations to implement universal suffrage, glass ceilings can still be a hazard for professional women in this day and age. See what Future Fund chair David Gonski has to say on equal representation on super fund boards.

It’s difficult to ignore the clamour around infrastructure investment, the asset class of the moment. Lloyds TSB and the London Pensions Fund Authority recently joined founder members of the Pensions Infrastructure Platform, PIP, a government initiative to encourage pension funds to invest more in infrastructure. The Universities Superannuation Pension Scheme, USS, just increased its allocation to infrastructure debt with a second deal in less than six months providing long-term inflation-linked financing to a UK water company. A survey from Prequin finds that 78 per cent of UK schemes plan more infrastructure investment over the next 12 months and local authority schemes are about to be given greater freedom to invest in infrastructure at a time banks, stalwart lenders to the sector, are restrained from lending long-term by new capital requirements.

Infrastructure makes perfect sense for UK schemes struggling to manage growing liabilities and in search of new long-term, inflation-linked income on account of poor bond yields. UK schemes have lagged behind their counterparts in Canada, Australia and Europe. Foreign funds are now stoking local enthusiasm as they continue to buy prime UK assets: Canada’s £160-billion ($242-billion) Caisse de dépôt et placement du Québec is close to buying a stake in the $3-billion London Array wind park off the coast of Kent in southeast England. Classic asset classes aren’t behaving properly and infrastructure is a tangible, uncorrelated investment offering capital appreciation. It may tick all the boxes but I can’t help thinking that UK pension funds aren’t going to ride to the rescue of the cash-strapped government that wants institutional investors to do the job it no longer can.

Long term, but not too long

Greenfield infrastructure is a bridge too far for most schemes. On one hand the UK’s large mature defined-contribution schemes need a cash yield from day one to meet their monthly pension obligations, which is difficult with greenfield. On the other, the flagship, job-creating type of infrastructure the UK government really wants pension funds to finance, like the proposed new rail service, High Speed 2, which will link the UK’s major cities, are just too risky.

It is eighteen years since the Queen opened the Channel Tunnel between the UK and France, but operating company Eurotunnel is only recently profitable. The project ended up costing nearly twice what it was supposed to and left a trail of bust investors in its wake. When London bid for the 2012 Olympics in 2003, the price tag was $6 billion; by 2007 that had jumped to $10.6 billion. In China it takes two years to build a railway but in the UK complicated planning laws mean it could take 20. In short, running infrastructure assets is the easy bit. The idea of contractors and project sponsors shouldering construction risk doesn’t assuage UK schemes just yet. The real risk comes in the construction phase and few have the appetite or experience to venture here.

The minefield of public opinion

Even if UK pension funds get to the post financing the construction of new infrastructure, they’ll be very choosy which assets to pick. Post-Fukushima, few UK funds will want the political hot potato of nuclear power, a no-go without government and power-price guarantees anyway. “The government needs to convince pension funds nuclear is an investible asset class,” says Marcus Ayre, head of infrastructure at First State. Hospitals, where services are being reorganised and pruned because of financial constraints, carry a health warning. Trustees may even find toll-road projects too political, unpopular in the UK because drivers believe they already pay for the roads through other taxes. Nor is equity investment into schools or prisons proving particularly attractive just yet. For sure, the bigger schemes are venturing into new areas, like the $16.6-billion Greater Manchester Pension Fund (GMPF), shifting away from pure real-estate investment to a broader infrastructure play focused on community assets, investing in social housing and the refurbishment of Manchester’s St Peter’s Square. But smaller schemes lack the size or resources to invest directly in projects that demand management similar time and oversight.

Governments and greenfield

Would government guarantees de-risk greenfield assets enough to make them less speculative? Duncan Hale, head of infrastructure research at Towers Watson, doubts it: “Guarantees aren’t a magic bullet for trustees progressing up the knowledge curve,” he says. Besides, the government is unlikely to offer guarantees anyway. How can it persuade taxpayers to subsidise infrastructure but not get the benefit from any winnings at a time when the chances of taxpayers receiving any of the $98.2 billion they pumped into Royal Bank of Scotland and Lloyds look more remote than ever?

It leaves most funds constrained to brownfield investment, but the market is already crowded here, with full prices paid for the safest assets with the most stable cash flows. Fixed income, investment-grade infrastructure may be the cheapest and safest way to buy into the infrastructure story, but it offers returns that may not be enough to meet schemes’ underlying liabilities. The UK’s utilities, looking for debt and equity investment, are a better bet. They’re not greenfield, they have stable cash flows and are backed by a regulatory regime that lends financial certainty to investors. Will schemes move up the risk curve with equity stakes? Some will, but most won’t because they only want low leverage and stable cash flows. It’s one of the reasons why the PIP came about in the first place – to get away from these kinds of private equity structures.

At only $1.5 billion, the PIP hasn’t had that many takers and that kind of money doesn’t go far anyway. Most UK schemes are too small to invest meaningfully in infrastructure and it’s an asset that only suits those with long-term liabilities – schemes planning a buyout won’t venture into infrastructure. The idea of savers in the community also being investors in the community is compelling, as is investing in something that you can touch, that you use everyday. UK pension funds have been involved in infrastructure investment for years but until more get properly comfy with the risk, the asset class can’t really take off.

Finnish pension investor Ilmarinen is exploring whether to send a representative to South America as it intensifies its emerging market operations. Timo Ritakallio, who heads investment at the €29-billion ($39-billion) fund, says it is looking to access “more and more emerging market opportunities”.

In January Ilmarinen sent a senior portfolio manager to run a “one-man office” in Shanghai for a year, with a view to maintaining a permanent presence and potentially investing directly in China. “It is working well and we are already looking at the South American market to see if it would be possible to set up a similar system there,” Ritakallio says. “Our first reflections on the Chinese project are that it is extremely useful to have our own person there to procure information for us.”

Given Finland’s strong economic links to Russia, Ritakallio explained that a knowledge advantage in China and South America would bolster Ilmarinen’s position as a leading emerging markets investor.

Some 18 per cent of Ilmarinen’s equities were invested in emerging markets at the end of September 2012, an increase from 16 per cent at the end of 2010.

That represents a holding for Ilmarinen of over $2.6 billion in emerging market equities.

Finnish challenge

Equities are the fund’s largest asset class at 41.2 per cent of the overall portfolio, a fraction larger than Ilmarinen’s bond holdings as of September 2012. While the performance of equity markets has been spectacular of late, Ritakallio says Ilmarinen has missed out on the full benefits of the recent upturn in sentiment on global markets.

Ilmarinen’s 2012 investment return was 7.5 per cent, he reveals. While that is good news for the already healthy funding position of Ilmarinen, it did not allow it to make any substantial progress towards its target of being Finland’s top-returning pension investor – in 2011 it had the fifth-best return figures.

The pension fund’s investment choices were possibly a tad more cautious and patriotic than they needed to be, reflects Ritakallio.

For one thing, Ilmarinen started 2012 underweight on equities, a position it has since changed to neutral. It also made a serious effort to concentrate its bond portfolio on “risk-free” holdings to avoid the fallout from the euro crisis, debt that has delivered slim yields. “Maybe we were a bit too worried about the situation in the eurozone,” Ritakallio admits.

Some 37 per cent of Ilmarinen’s equities are held in Finland, a position Ritakallio describes as “a challenge” as Finnish share indexes have underperformed European ones by around 20 per cent over the past two years.

Domestic equity exposure has been steadily declining since 2010 to make way for an increased appetite for US and Japanese shares, along with emerging market equities.

Ilmarinen wants to combine its tradition as a strong supporter of Finnish companies with its enthusiasm for emerging markets by focusing its domestic equity picks on corporates trading with that part of the world, Ritakallio explains. A strong emerging markets profile will also help US and European companies’ chances of being picked by Ilmarinen.

Standing firm

Ritakallio expresses confidence in Ilmarinen’s broad asset strategy to perform in the future, especially with the improved worldwide investor outlook.

“We expect the equity market to be volatile in the coming years but we have quite a positive view”, Ritakallio adds.

The fund’s diversification activities have seen it take strong positions on real estate (11.7 per cent of the portfolio) and alternatives (6.5 per cent). Both offered steady returns of 3.8 per cent and 5.8 per cent, respectively, in the first nine months of 2012.

Infrastructure is currently an investment focus at Ilmarinen but the fund is keen to route these stakes through the existing asset structure. For instance, Ilmarinen backed a new infrastructure fund from Swedish private equity managers, EQT. That kind of vehicle offers an “optimal solution” for Ilmarinen, which has 4.5 per cent of its assets in private equity, Ritakallio says, a position it aims to boost to 6 per cent in 2015. Some $650 million per year will need to go into private equity to meet that goal – a prospect that might just have managers lining the streets of Helsinki.

Ilmarinen has also experimented with direct investment in infrastructure projects, taking a stake in the E18 highway, a road and ferry route connecting Craigavon in Northern Ireland to St Petersburg in Russia through Scotland, Norway, Sweden and Finland.

Making major equity investments in infrastructure companies is another channel that Ilmarinen has taken to gain exposure in the asset class.

As a large investor in a relatively small market, Ilmarinen’s engagement activities carry a lot of clout in Finland. As a top-three share holder in a number of Finnish companies, Ritakallio says he is satisfied the fund gets a good say in remuneration and board appointment decisions.

Taking its responsible investment approach to China could be difficult though, Ritakallio concedes. Nonetheless, Ilmarinen will give it a good go if it decides to invest directly there, with Ritakallio saying “as a responsible investor we want to be responsible everywhere”.

Jo Townsend, the chief investment officer at REST Industry Super, says the fund is not only investing according to a long-term horizon, but is also willing to depart from the pack when making investment decisions.

“Our fundamental investment belief is that it is possible to add value through active investment management, and we do that through both the use of active investment managers and changes to asset allocation.”

Townsend says the widely stated belief that you can’t add value through active management and, moreover, that they are waste of fees, is contestable.

“We can actually demonstrate that the use of active investment managers has added real value for our members over long-term time horizons after the payment of active investment fees.”

REST uses internal reporting that shows they have been able to add value over asset class benchmarks consistently by using active investment managers. For example, Australian shares asset class is plus 3 per cent per annum and the overseas shares asset class is plus 2 per cent per annum, both over 10 years after all fees. (See table below.)

“These outcomes reflect both the use of active investment managers and our active approach to asset allocation,” says Townsend, adding that the core strategy is the only investment option to which REST applies its active approach to asset allocation.

REST will also make changes to asset allocation that, at times, can be quite different to the activities of other funds in the industry, Townsend says.

A classic example is the tech bubble of the late 1990s-early 2000s when REST had a substantially underweight position in overseas equities – around 8 per cent compared to about 20 per cent in the industry.

A whole other class

In 2008, this led to the establishment of a new asset class to place the structured securities – the “credit opportunities” sector, which sits in the growth alternatives asset class. Townsend says the call has paid off for REST members.

“Our initial allocation was 4 per cent of total FUM and today the allocation is 6.5 per cent,” she says. “…Those assets have been some of our best performing over the past four years or so.”

It all relates to a longer term focus that Townsend identifies as a true differentiator for the fund, which is one of the largest super funds by membership – more than 1.9 million members, and funds under management just about eclipsing $23 billion.

Allocating assets

REST believes bond prices are extremely stretched and that there’s potential for an interest-rate rise to lead to capital losses in those markets. It’s a view that shapes REST’s investment philosophy.

“REST has viewed bonds as being an expensive asset class for quite some time and is defensively positioned,” says Townsend. “Further down the track, we see that there is the potential for inflation to return in view of the extraordinary extent of expansionary monetary policy being practiced right around the globe – which is effectively helping to keep bond yields so low.”

A prime focus for the fund, meanwhile, is real assets, which Townsend says REST is in constant search of, namely direct property and infrastructure investments. More specifically, they are looking for core properties with high levels of income and relatively stable income profiles with moderate levels of capital gain.

Approximately 90 per cent of funds under management and 98 per cent of REST’s membership base, are invested in the fund’s Core Strategy, a mix of shares and bonds, property, infrastructure, alternative assets and cash – 25 per cent defensive and 75 per cent growth.

Fund manager performance

The fund reviews each asset class on an annual basis, which also entails a look at its manager line-up. Currently the fund employs 42 external investment managers across 11 different asset classes.

Townsend says that REST will not terminate a manager because of short-term underperformance, however.

“We will always look to make sure that we understand what is going on with a manager’s performance. There might be very good reasons that a manager is underperforming.

“An absolute reason to terminate a manager would be if they’re not investing in accordance with their philosophy and the reasons they were put into the portfolio.”