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Hershel Harper received an early education in finance when he used to read Business Week in High School. The 43-year old now at the helm of the $27-billion South Carolina Retirement Systems, investing on behalf of South Carolina’s 350,000 public sector workers, says he knew back then he wanted to manage money: “I really am one of the most blessed people; I am doing what I always wanted to do.”

As the new fiscal year begins Harper, promoted internally to chief investment officer of the South Carolina Retirement System Investment Commission (RSIC) a year ago, is overseeing two shifts in strategy at the fund, both designed to simplify investment and pare down the number of managers it uses. South Carolina’s equity allocation, comprising 31 per cent to public equity and a 9 per cent to private equity, hasn’t really changed over the past year. However the US and non-US equity assets are being combined to track a single global equity benchmark, the MSCI ACWI, instead of separate active allocations to US small and large-cap stocks, non-US developed and emerging markets equity. “We are moving to a global benchmark for a straightforward approach to manage and track our largest factor exposure. I expect our global equity allocation to become increasingly more benchmark-centric, with large portions of the allocation to modest tracking error strategies, or to be passive,” says Harper.

Trimming the hedge funds

In another effort to simplify its domestic equity portfolio, South Carolina is in the process of dropping a $3.9-billion portable alpha hedge-fund allocation.

Enthusiasm for portable alpha, a strategy that allows exposure to an index providing beta returns, as well as investments in uncorrelated sources of alpha, has chilled at the fund. “Portable alpha has been successful overall, however the volatility in the short term is no longer a risk we wish to maintain.We are simplifying our implementation for alpha and beta,” says Harper. Dropping the program is also part of a broader strategy to shave South Carolina’s $5.5-billion hedge fund allocation from 20 per cent to an 8-per-cent policy target of assets under management. (There is a 15-per-cent maximum allocation to hedge funds across the plan.) Part of the reorganisation of its hedge funds includes creating a smaller, dedicated hedge fund portfolio investing only in funds that have a low correlation to other asset classes including global macro, market-neutral or managed-futures strategies. Harper is also looking to better integrate hedge fund investments across the entire portfolio. “Hedge funds aren’t so much an asset class as they are an implementation strategy,” he explains.

The potential in house

Despite the potential to manage a simplified equity allocation in house, any move to boost South Carolina’s internal team of three has stalled for now. RSIC is still weighing up the cost of technology and recruiting its own expertise rather than continuing to pay outside managers, says Harper. “Managing more of the portfolio internally will save millions of dollars, which could remain in the Trust rather than paying manager fees to firms in New York or London, but we must weigh those benefits against the potential of increasing operational risk,” he says. Any move to manage funds inhouse would start with US equities, he adds. The only internal asset management is for short duration securities (3 per cent) and the cash allocation (2 per cent).

Inhouse management would provide a saving that could help plug the fund’s $15-billion deficit, another factor increasingly weighing on investment strategy. “We are only responsible for managing the asset component but we are aware of, and understand, our liabilities,” says Harper. The deficit makes holding liquid assets now more of a priority and was one of the reasons behind reducing the hedge fund allocation. Each month South Carolina pays out more in retirement benefits than it receives in contributions, amounting to about a $1-billion shortfall every year. “This gap has to be filled by the Trust and it is our job to make sure there is enough liquidity on hand to meet the benefit payments,” says Harper. It means South Carolina holds more cash than other public funds; a “cash drag” he says he is “prepared to live with in order to mitigate the risk of not meeting a benefit payment.”

Taking on risk, mitigating volatility

Neither does Harper believe a liability-driven investment strategy is necessarily the answer. South Carolina still looks at strategy from a performance perspective, locked into a legislature-set 7.5-per-cent assumed rate of return. Nor could the fund – only 60 per cent funded – perfectly use the strategy that matches assets to liabilities anyway. “We have fewer assets than liabilities, so a pure asset-liability matching strategy doesn’t make sense for us,” he says. “In a zero-rate environment, we must take on a reasonable level of risk in order to meet or exceed that mandate. We try to do that with a strategy that simultaneously includes elements of mitigation against volatility. Our primary goal is the soundness of the plan to ensure the payment of earned benefits. All of our decisions revolve around that fact.”

South Carolina’s 8-per-cent real-asset allocation is divided between real estate (5 per cent) and commodities (3 per cent). Harper sees opportunity in real estate on the debt side, lending on underperforming “good assets in good markets”. Target markets include the UK, Germany and Ireland but also peripheral Europe. “We have $1 billion in the ground, but we are underweight; our target is 5 per cent of assets,” he says. The fund’s private equity strategy, begun in 2007, has borne fruit with an estimated 14-per-cent return in the fiscal year that includes lag, although he believes the greatest bounty is still to come. “We have capital in the ground but we’re still feeling the J-curve affect,” he says. South Carolina also co-invests in private equity, portioning some funds to its private equity managers but also investing directly in the same projects. “We have several co-investments right now,” he says. “Some haven’t worked out but others have been very successful.” Harper would like to push co-investment to account for a third of South Carolina’s private equity portfolio, although he will need a budget and additional staff to do so.

Elsewhere, the fund has a 19-per-cent allocation to diversified credit comprising a mix of high-yield bank loans, structured products, emerging market debt and private debt, and a 15-per-cent allocation to fixed income. Here the allocation is divided between core fixed income, managed by Blackrock and Pimco and recently scaled down to 7 per cent from 10 per cent, and global fixed income. An allocation to opportunistic investments includes low-beta hedge funds and risk-parity strategies.

Harper believes one of the biggest dilemmas for US public pension funds in today’s low-rate environment is balancing venturing out onto the risk spectrum with staying comfortable, in turn risking increased contributions or cut benefits. South Carolina “pushed double-digit returns” last fiscal year, coming in 150 basis points ahead of the benchmark. It’s not surprising he is confident he’s got the strategy right. “We can achieve 7.5 per cent with high confidence and without taking undue risk.”

While commodities are a controversial and problematic asset class to some investors, for others they are an ideal diversifier looking more attractive than ever. A mini-revival in commodity investing among US pension funds suggests the asset class may be enjoying a resurgence. The Los Angeles Fire and Police Pension System, Municipal Retirement System of Michigan and Arizona State Retirement System have all recently upped their commodity holdings.

Don Steinbrugge, (pictured right) managing partner of Virginia-based Agecroft Partners and investment advisory committee member of the $461-million City of Richmond Retirement System, says renewed interest in commodities is part of wider investment trends. “Investors are using commodities as part of a real asset bucket including such things as real estate, as an inflation hedge and also to diversify the portfolio”, he says. “Real assets stand to benefit from increased inflation, should that ensue from the world’s budget deficit troubles.”

That argument is acknowledged by the Ontario Teachers Pension Plan (OTPP), one of the earliest funds to have placed its faith in commodity investing, which is currently investing 5 per cent of its $129-billion portfolio in the asset class. Spokesperson Deborah Allan says in addition to functioning as a hedge against “unexpected” inflation, it believes that “commodities typically have low correlation to other asset classes”.

David Hemming, commodities portfolio manager for Hermes, says many pension funds are moving towards strategic asset allocations of between 2 to 4 per cent after dipping their toes in the asset class with less than that. A 2012 Mercer survey found European funds that invest in commodities indeed allocate around 3 per cent on average – a mere 8.9 per cent of European and 2.1 per cent of UK funds reported having commodity investments at the time of the survey though.

Tough times

The continued reluctance from many pension funds to invest in commodities perhaps stems from a relationship with investors has been best characterised as up and down. Money initially flocked into commodities in post-crisis diversification efforts, but sentiment then appeared to turn with some investors – most notably Illinois Teachers Retirement System – dropping investments. Returns at funds using the asset class have not always made other investors envious either, with CalPERS losing 7.2 per cent on its commodity exposure over the five years to January 2013. The Dow Jones UBS Commodity Index provides graphic evidence of a sluggish few years – the index has failed to come close to its mid-2008 peak and started 2013 at roughly the same level it started 2004.

OTPP has shrugged off a below-benchmark minus-1.2-per cent performance over the past four years in its commodity portfolio with a faith in the asset class’s ability to perform over longer time horizons, according to Allan.

Should other investors be equally optimistic? That may depend on whether they accept the reasoning for commodities’ key selling points misfiring in the recent past.

“Unfortunately we haven’t seen commodity returns keep pace with equity returns since 2008,” concedes Hemming, although he characterises this as a small period. “We saw asset classes come down across the board after the extreme events of 2008 and 2009,” says the manager, who argues a high growth and high inflation environment is one in which commodities would really flourish. “That is what you would expect to see at the tail end of an economic recovery,” he adds, “as you would expect equities to rally first and then commodities to follow through as the expectations of higher growth and inflation are realised.” He argues that the presence of this ideal environment in China in recent years has buoyed commodity markets there.

Hemming (pictured right) adds that the historically low correlations between commodities and other asset classes also broke down during the financial crisis and remained prevalent after with “risk-on risk-off taking hold against the backdrop of central bank interventions”. Steinbrugge feels there is ample evidence of commodities defying equity cycles though, saying that commodity-trading advisers have enjoyed negative correlation to equity-down markets over the past 15 years.

High volatility in commodities has proven another stumbling block, and was cited as a reason by the Illinois fund to ditch its commodities exposure in 2012. Hemming says there is no doubt that commodity volatility “can be a turn off for some investors and trustees”, although he argues that “with the funding levels of some pension schemes, commodity volatility could be a necessary ingredient in closing that gap”.

Steinbrugge also reasons that as a key diversifier, commodities can actually reduce a fund’s overall volatility. That is particularly the case in the US with pension funds typically running 60 to 70-per-cent equity allocations, he says, and that another flipside to the volatility is that “you don’t need much in commodity investments to get the benefits to the portfolio’s risk and return side”.

On top of sluggish returns, uncertain correlation and high volatility, even the supposed inflation-hedging properties of commodities have attracted doubts from some investors. Anton van Nunen, director of strategic pension management at Syntrus Achmea, says in his experience as an investor he has not found a “strong relationship between general inflation and commodity prices”. Hemming argues, though, that on a historical basis, spikes in energy or food prices have been clearly behind most “surprise inflation” events. Allan states that OTPP is confident too in the ability of commodity prices to “hedge against inflation over long-term investment horizons”, while acknowledging that imbalances in supply and demand can have a distorting short-term impact.

Answering the green lobby

Even if investors are sure of commodities’ investment appeal, there are further doubts about their credentials for sustainability. Commodity futures in particular have come under fire from the sustainable investing world. Murat Ünal, founder of German investment consultancy Funds@Work, says futures in so-called soft commodities – primary food products – are subject to harmful speculative investments, with liquidity often rushing to given areas to push up prices.

That argument has its opponents but “even the largest players in Germany are very hesitant to look at soft commodities” as a consequence, according to Ünal (pictured right). He reckons that the reputational risk is too great for investors to be attracted to a sub-asset class, while the potential destabilisation of soft commodity markets can in any case have a knock-on effect on emerging-market equity returns via food inflation.

Legislation that effectively prioritises bond investing has also played a major part in making commodity investing usually “well below 1 per cent” among German pension investors though, he adds.

Simon Fox, director of commodity research at Mercer UK, says that investing in farm land, a commodity allocation can actually boost a fund’s sustainability credentials by playing a part in boosting global food production. Ünal agrees this can be a case, but purely in long-term commodity investments, rather than futures. He would like to see more done in social entrepreneurship funds to facilitate this.

The place for commodities

A period of performance problems arguably presents a huge opportunity for investors. “It’s better to invest in commodities when they’re not performing rather than getting involved after they have performed,” Hemming says. Talk of an end to a commodities “super cycle” as Chinese growth slows is, however, off the mark, he argues: metal prices look sustainable and energy prices remain low in the US, while agricultural prices can swing up at anytime as they are heavily dependent on weather-influenced annual crops. Should energy prices go even lower, he suggests, they would also be able to buoy other commodities by propelling economic growth.

OTPP made commodity investing part of its alpha-seeking “tactical allocation” bucket earlier this year. It invests to the Stand and Poor’s Goldman Sachs Commodity Index benchmark, which has a 70-per cent energy tilt. Allan justifies this by arguing that energy “has historically been the best hedge against unexpected inflation”.

Across the institutional investing world, a trend towards active commodity investing has been noticed as funds shy away from the volatility of indices. “The case for a passive allocation to commodities has always been relatively weak compared to other alternative asset classes,” Fox says. As a result he thinks “there is much more interest in illiquid plays in assets such as timberland and farm land”.

The expertise of an active manager can also count in the complex asset class. Negative roll yields – the dreaded ‘contango’ – remain a challenge that can only be mitigated with skill, Hemming says. While there are active managers looking to generate alpha from commodities such as OTPP, Hermes and others focus on risk-reducing beta strategies.

The Los Angeles Fire and Police Pension System reportedly decided to split a commodity-derivate portfolio in order to carry out both an enhanced-index strategy and an “active-constrained” approach when deciding to enter the asset class.

Steinbrugge adds that commodity exposure is also being picked up in global macro and hedge funds strategies. Clearly the ways into the asset class are every bit as divergent as the views on it but there is no doubting the faith commodities proponents place in its value as part of a sophisticated asset strategy.

Al Gore, former US vice president and co-founder with investment banker David Blood, of Generation Investment Management, said sustainable capitalism is not an argument that pension funds should sacrifice value in return for values.

Rather it is consistent with the core fiduciary relationship to match liabilities.

“It’s what it’s all about,” he says.

Gore defends capitalism, saying it is at the base of every successful economy: it efficiently allocates resources, it is congruent with freedom, and importantly it is the one system that unlocks the future of individuals with incentives that unlock ingenuity. However, he is despondent at how capitalism is being pursued.

“No wonder with those virtues that everything’s going great in the world’s economy,” he says ironically. “If capitalism has all these strengths and is hegemonic in organising economic activities, why do we have these problems?”

“In the US for sure a public pension crisis is pending, California, Rhode Island, go right down the list. The conspiracy of the present against the future is bigger than I imagined,” he says. “If we are trying to predict into the future such a narrow slice of information we ignore the possibility of ruining civilisation as we know it, there’s something wrong with the way we’re pursuing capitalism.”

In an interview with Top1000funds.com he notes the distribution of income is not measured, and rising inequality is not measured in the assessment of the economy.

“We’ve made our choice for capitalism – now the focus is on how we pursue capitalism. The concept of sustainable capitalism is not an argument that pension funds should sacrifice value in return for values. Rather they should start from a premise that it should be best practice because you’ll get better returns over time.”

He says a wider scope of information assessment and processing is crucial to sustainable capitalism.

“As vice president in the White House for eight years, every morning for an hour I got a review of the military information, from many sources. What we see with our eyes is not all that is there, we can organise ourselves to include more information,” he says. “We are used to focusing on quarterly reports, number metrics are all important but only a narrow source of the value spectrum. If companies ignore the people associated with their supply chains or environmental impact then there is brand damage, that information is directly relevant to the value of the equity assessment.”

(As an aside Apple Inc, of which Gore is a long-time board member recently hired former head of the US Environmental Protection Agency, Lisa Jackson to head up its environmental effort.)

Gore believes there is a governance crisis in the world today.

“Democracy having become accepted as the best form of government has been failing to meet the test of leadership required in 21^st century,” he says.

“The US has been the de facto leader but in the last decade the quality of US governance led to a crisis of confidence in the US leadership. The world is relatively rudderless.”

Specifically, he says that US public pension funds have taken some immense risks by allocating large percentages of their portfolios to high risk assets, because governance structures reward them for doing so.

It is within investors’ power to change this.

Gore’s partner at Generation Investment Management, David Blood, says long-term asset owners have a critical role to play, and must first assess what is in their best interests.

“What will they support to realise more value?” he asks. “It is a challenge to get them together and get them to listen. Investors are uncomfortable in the conversation around sustainability. What has frustrated us is we always thought it gets a better sense of the company.”

Gore quotes the psychologist, Abraham Maslow who says if the only tool you have is a hammer then every problem looks like a nail.

“The same is true if the only thing you use to assess a company is a price tag.”

In its seminal paper, Sustainable Capitalism, Generation outlined mandated integrated reporting as one of five recommendations to move towards sustainable capitalism.

“Financial statements are one perspective in the value of the business. You need to look at the sources of capital – physical, intellectual, and social capital – and only one of those is on the balance sheet,” he says. “Other forms of capital don’t come equipped with a price tag. It doesn’t mean quantitative analysis can’t be incorporated but you have to use different systems.”

Gore urges pension funds to start asking corporations questions, saying it will “have a profound effect” on the behaviour of companies.

“Pension funds can be the most important driver of the new phenomenon, by asking questions, and engagement. When pension funds are evaluating what to invest in, start asking questions, it will have a profound effect,” he says.

“But I want to repeat a central point. This is not social engineering or getting pension funds to take on social policy or government reform. But you should do it because it improves your performance, and matches your vision with a wider spectrum of what reality really is.”

Five recommendations of Generation Investment Management’s Sustainable Capitalism white paper

Identify and incorporate risks from stranded assets
Mandate integrated reporting
End the default practice of issuing quarterly earnings guidance
Align compensation structures with long term sustainable performance
Encourage long term investing with loyalty driven securities

If investors were to focus on one aspect of the five recommendations, Blood says that identifying and incorporating risks of stranded assets would be the first choice.

“The most relative commercial issue in portfolios is to mobilise capital to low carbon,” Blood says.

The second would be around incentive structures.

“If incentive structures are short term and rewards are reinforced by short term performance then the ability to see the long term is damaged,” Gore says. “I’ve only been in the asset management business for 12 years but I have learnt that people will do what you pay them to do.”

Photo: Kasey Baker/Wikimedia Commons

Designing and implementing concentrated, long-horizon investment mandates would support longer term thinking, align pension organisation’s goals with its stakeholders, and reduce transaction costs.

This was one of the recommendations of a two-day workshop in Toronto last month, attended by a delegation of 80 pension fund executives from around the globe.

Aimed at uncovering the meaning and application of a 2012 Generation Investment Management white paper, Sustainable Capitalism, the workshop was co-hosted by the Rotman International Centre for Pension Management and the Generation Foundation.

It specifically wanted the funds to explore the practical implementation of the white paper’s recommended action plans, which were:

Identify and incorporate risks from stranded assets;
Mandate integrated reporting;
End the default practice of issuing quarterly earnings guidance;
Align compensation structures with long-term sustainable performance; and
Encourage long-term investing with loyalty-driven securities.

The participants were broken into small groups and asked to think about what micro actions their pension organisations might take internally, and what collective macro action they would join in a larger industry, national or international collaboration.

The participants recommended that their own organisations design and implement concentrated, long horizon investment mandates, and ensure that they have the necessary resources to successfully implement them.

They also said they wanted to develop a “model investment mandate” through an organisation like ICPM that could be widely shared and reported on by investors.

The participants, that included representatives from funds such as the Washington State Investment Board, Ontario Teachers’ Pension Plan, the Canadian Pension Plan Investment Board, PGGM and APG, thought that a model mandate would force the development of new performance measures and incentive compensation schemes and challenge the dysfunctional inertia that continues to exist in many pension organisations.

Commenting on the investor recommendations Keith Ambachtsheer, director of Rotman ICPM and Rob Bauer, associate director of Rotman ICPM programs, said such mandates would be a radical departure from the traditional Keynesian “beauty contest” style of active management, and also from the broadly-diversified “formula” of passive management.

The key concept, they said, was the broad adoption of “concentrated long-term investment mandates” that require investor engagement.

The funds agreed that they would commence and advocate the adoption of integrated reporting of their own organisation’s results and for assessing the long horizon prospects of investments.

They would also focus on yearly results in one-on-one meetings between investors and corporate management, in a bid to end the focus on short term earnings.

Ambachtsheer says the next step in the process, to facilitate change and to really have a profound effect in the bid to make sustainable capitalism mainstream, is collaboration.

“We need to take an activist approach to the conversations with a collaborative model. Investors as a group should make four or five choices about how to change behaviour and all get behind it,” he says.

ICPM has written papers in the past on successful models of collaboration concluding they need to have clarity, common interest, an executive function and a budget, and the ability to track success and adjust plans accordingly.

Ambachtsheer uses asset management incentive structures as an example of potential change via collaboration.

“If asset owners insisted on new structures then managers would do it because they wouldn’t have a job,” he says. “If they think in the short term they will get away with it they’ll do it, it’s easier, more exciting and they get feedback immediately. If enough of an investor base changes their expectations it will create demand.”

Transport for London, the organisation behind the network of buses, underground or “tube” trains, trams and bicycles that keep the United Kingdom’s capital city on the move, has a reputation for its generous employee benefits. But of all the staff perks on offer, including 30 days holiday a year and subsidised travel expenses, membership of the gold-plated, defined benefit Transport for London Pension Fund (TfL), is the biggest. Investment strategy at the thriving £6.9-billion ($10.5-billion) scheme, grown from $7.6 billion in 2010, has recently shifted with the fund nurturing a growing $1.5-billion alternatives portfolio comprising hedge funds, infrastructure, real estate and private equity in its bid to diversify and improve the scheme’s risk-adjusted returns over the medium to long term.

Strategy shift

The shift in strategy comes despite equities being TfL’s best performing asset this year. United States small cap and global equity mandates have led the field, says Padmesh Shukla, investment officer at TfL (pictured right), based in London’s Borough of Westminster. “Listed real estate has also seen a strong performance, and bonds and emerging market currencies fared well, but for the recent market pullback,” he says. The fund runs a large foreign exchange overlay program to hedge currency risk in the equity portfolio and active management has also helped boost returns, with 60 per cent of the equity portfolio actively managed. Active investment mandates include global unconstrained, US small cap, Japan, emerging markets and Asia, lists Shukla. “These markets are generally under-researched and have of late seen dispersions widen, making active management more optimal.” Passive investments are in markets widely regarded as efficient such as Europe, North America and the UK.

The current portfolio is split between equities (55 per cent), bonds (25 per cent), all actively managed bar a “very small holding” for rebalancing purposes, and alternative investments (20 per cent). The expanding allocation to alternatives will increase to 25 per cent over the course of 2013, primarily funded from equities. Additional allocation will be made to unlisted real estate, one or two new hedge fund strategies, “possibly” renewable energy and private equity, says Shukla.

Private equity

It’s a private equity allocation that is supported by the scheme’s “negligible” liquidity requirements, he explains. “Private equity is a way for us to extract illiquidity premium and earn higher returns, but at the same time try to reduce the market-to-market volatility of public markets,” he says. “Our private equity allocation is driven by a strong fundamental understanding of less efficient segments in the market and less desire to time the markets.” Going forward, the scheme will likely increase its allocation via a separate account format, investing in primaries, secondary and co-investments, diversified “but not overly” by sectors, managers, vintages and regions. Unlike the scheme’s hedge fund program – where it makes direct investments – in private equity, fund of funds is TfL’s preferred approach to better access more specialist and small-to-mid-size managers outside the known big names.

The fund also lacks the resources to build its own private equity specialists. TfL has an internal team of seven covering investments, accounting, finance and compliance, although it is in the process of beefing up its investment and compliance capabilities. “We aren’t FSA-authorised; all investments are done through external managers,” says Shukla.

Hedge fund portions

TfL’s hedge fund allocation is portioned to commodities, structured and distressed credit, emerging market currencies, reinsurance and global macro trends.

“Hedge funds in the distress and event driven space have performed well, both in absolute and risk-adjusted terms,” says Shukla. Over the last year new allocations have gone to Arrowgrass Capital Partners, Och Ziff Capital Management and the world’s largest hedge fund, Bridgewater Associates and its Global Macro Systematic Hedge Fund. Over half of the 4 per cent infrastructure allocation is invested in mature PPP projects predominately in the UK and with limited construction risk in an allocation managed by Semperian PPP Investment Partners.

TfL does run an LDI program, but only plans to expand its strategy to hedge out inflation and interest rate risk if “real rates go up; we believe the current levels are very low.” Although investments are also made in liability-matching proxies such as infrastructure and real estate, the fund’s long maturity profile – it boasts 83,000 members comprising 23,000 contributing members, 18,000 deferred pensioners and 42,000 dependants – means it is still cash positive. “We expect to remain cash positive for a significant period of time – an important consideration in both hedging and investment decisions,” says Shukla. Nor is the scheme weighed down by a huge deficit, with a funding level of 91 per cent compared to 73 per cent at the last triennial valuation in March 2009. “The aim is for a 100-per-cent funding level by 2020 and staging-post targets between now and then,” says Shukla.

The wrath of the European sovereign debt crisis may have left its mark on Italy in more ways than one, with both its financial and political scenes regularly sliding into crisis mode for the past year or two. However, the nation’s largest private pension investor, the €7.75-billion ($10.1-billion) Cometa fund, has firmly kept on track through the testing times though.

Maurizio Agazzi, Cometa’s director, says that whatever happens in the world outside of its Milan office, “we must not forget our mission” as a long-term investor. On being asked about any investment positions, Cometa may have taken in the heat of Italy’s crisis, Agazzi simply says, “Our asset management is based on investment plans that are long term, with no speculative choices made.”

Although Cometa is a bond-heavy investor, the fund appears to have avoided a blow from its country’s sovereign debt woes by having a global outlook. Its largest two sub funds, Reddito and Monetario Plus – which make up the vast majority of total assets among Cometa’s four funds – are dominated by mandates investing to global benchmarks, such as JPM Global and Barclays Capital Global. Cometa’s biggest sovereign debt mandate is meanwhile well diversified across the continent, with a $1.3-billion-plus investment in the Barclays Capital Euro Treasury index.

As Agazzi reels off more sets of indices, it becomes clear that identifying the right benchmark is a major focus of Cometa’s investment strategy. While Cometa wants to define what its external managers invest towards, Agazzi explains that the fund also believes in giving its managers plenty of freedom to make tactical calls and granting them full investment autonomy. “A close partnership with managers must be based on choosing the strategies best suited to achieving pension objectives”, he argues. This notion of partnership leads to Cometa keeping a close eye on its external managers – a major set of mandate awards in 2010 inspired Cometa to launch a new code of standards for managers. This built a desire to keep a tight watch on managers into the fund’s control mechanisms and has led to the fund routinely hauling managers in for meetings.

Few equities

Cometa has fewer benchmarking decisions to make in the equity space, simply because exposure to the asset class is limited. Just 15 per cent of the $5.4-billion Reddito fund is invested in equities, while the $3-billion Monetario Plus fund is 100-per-cent bond invested. International diversification defines the equity strategy at the Reddito sub fund, with 50 per cent invested in non-European stocks, a third in a European and the remainder in Italian equity mandates. Only in the small Crescita fund (with $520 million assets) do equities take a noticeably chunky share of the portfolio at 40 per cent.

The low overall equity allocation is a possible consequence of Italy’s risk-averse pension fund-investment legislation. Agazzi explains that, “Italy has a strict regulation on how second-pillar pension funds have to invest their assets, with a lot of qualitative and quantitative constraints.” One of these constraints is that Italian funds have faced limits on investments in non-OECD nations, something that appears to have held them away from the trend to emerging market investments. Cometa’s entire government bond portfolio is invested in OECD countries, Agazzi says.

You would perhaps expect an investor of Cometa’s size to relish a long-touted change in Italy’s pension investments regulations. Agazzi is wary though of the impact of a sudden liberalisation. “I do feel it is important for laws to preserve that distinction between investments for pension purposes innate in the second pillar system,” he says, “and merely speculative investment.”

Controlled enthusiasm

Alternative asset classes have traditionally been difficult for Cometa and other Italian investors to access due to their regulations. A dose of cautious interest seems to pervade Cometa’s attitude towards alternatives. It designated a strategic allocation to both private equity and real estate back in 2010, but Agazzi says it is yet to implement the moves into these asset classes pending further consideration.

Diversification was the mantra behind its 2010 mandate awards – reported to be one of the largest mandate hires in Europe that year. Agazzi explains that a full mix of passive and active mandates was sought in the big hire, together with a range of value-at-risk limits and capital protection objectives. Different risk profiles are evident in that several of Cometa’s largest mandates are invested to hedged or inflation-linked benchmarks. Extending the duration on the fund’s assets is another possible step to further diversification under consideration, Agazzi adds.

While some deem the Italian institutional investing environment as restrictive, clearly Cometa has found no shortage of ways to diversify.

With total assets growing by over $2.6 billion in the last two years, Cometa has managed to navigate a tough time in Italian economic history in some style. Being a defined contribution investor has perhaps shielded it from any funding pressures that could have resulted from tumultuous movements in government bond yield and equity markets in Italy. The Reddito fund has averaged returns of over 4 per cent between 2009 and 2011 though, figures that might make some investment managers in other pension markets envious.

Ventures on the risk spectrum