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France’s Caisse des Dépôts et Consignations (CDC) has just provided fresh ammunition for critics who say the state-backed investor distorts markets by acting as the “armed wing” of the French finance ministry. On October 17, Prime Minister Jean-Marc Ayrault unveiled a new public investment bank, jointly owned by the CDC and the government, to lend to struggling small and medium-size businesses. Jean-Pierre Jouyet, the CDC’s chief executive, denied the Banque Publique d’Investissement would throw money at “lame ducks”, but there are plenty of sceptics who do not believe him.

“The Caisse’s latest initiative is not how the free market should work,” says Philippe François, a senior researcher at IFRAP, a policy think tank in Paris. “It shows once more how the CDC lacks any independence from the state.”

That view is not shared by Jouyet and his management board at the CDC, who command a funding leviathan with assets worth €478 billion ($621 billion), at the end of 2011. They argue that far from obstructing efficient capital allocation, the 196-year-old Caisse is an indispensable investor at a time when France’s GDP growth for the second quarter was precisely zero. Laurent Vigier, the CDC’s director of European and international affairs, goes further. He says the Caisse is in the vanguard of “like-minded” state-investment vehicles worldwide, which are providing welcome stability and liquidity in global markets following the 2008-9 financial crash.

“A lot of capital that fled markets when stock exchanges collapsed has never come back,” says Vigier, a board member. “Now the regulatory demands of Basel III are deterring private banks from providing credit and liquidity, so long-term investors like the CDC can help fill the gap.”

Good will and global infrastructure

To that end, the CDC set up the Long-Term Investors Club (LTIC) in 2009 to provide an international forum for state-backed funds with the same strategic mission. Today the LTIC has 15 members, including such heavyweight investors as Germany’s KfW state development bank, the Ontario Municipal Employees Retirement System, the Development Bank of Japan and the China Development Bank. The well travelled Vigier hopes more Asian members will join and identifies state-owned Australian financial institutions, such as the Queensland Investment Corporation, as ideal future LTIC members.

“With its strong institutional base, Australia is great territory for us,” says Vigier, pictured above left. “We haven’t paid the country enough attention so far.”

It is indeed curious that the CDC has taken so long to raise its international profile, given the global reach of its holdings. Take a ride on the Sydney Monorail, for instance, and your ticket fee ultimately goes back to Paris; the Monorail and Sydney’s light-rail network are operated by Veolia Transdev, a CDC subsidiary (as are the harbour ferries, in a joint venture). In India, the filthy River Ganges is being cleaned up by Egis, a CDC-owned infrastructure company, under a government contract awarded last year. Meanwhile in Germany, real-estate investor Icade – another CDC business – manages commercial properties in every major city.

Defying definition

As Vigier acknowledges, one reason the CDC is relatively unknown outside France, compared with international funds on a similar scale, is because it is so difficult to define the Caisse to a foreigner.

“We are like a cross between a sovereign wealth fund and a perpetual endowment, but we do not receive any public money,” he says.

Vigier’s claim is debatable because it depends on accepting the CDC’s own distinction between consolidated and non-consolidated assets. The CDC was originally established in 1816 to restore confidence in French public finances after the ruinous Napoleonic Wars and pay civil service pensions.

Today, the CDC still manages dozens of public-sector pension funds, but by far the most important source for its $281 billion of non-consolidated assets are government-backed tax-free personal savings accounts. Until 2009 the CDC was the monopoly deposit base for all contributions to these accounts, known as the ‘Livret A’. Following pressure from private-sector French banks, which wanted access to this lucrative business, the CDC now receives 65 per cent of total Livret A income. It then uses the money to finance long-term loans for social housing.

The distinction between public and private revenue streams becomes even more confused when breaking down the CDC’s consolidated assets of $340.6 billion, which delivered an operating profit of $10.6 billion last year. Vigier says that the CDC’s liquidity is boosted by a “permanent float” of about $40 billion – cash that pours daily into the Caisse’s coffers in its role as the monopoly deposit bank for all legal fees paid on French property transactions. The monopoly is protected by the state, as is the CDC’s immunity from France’s bankruptcy and insolvency laws.

The key test of whether the CDC is an independent fund manager or a state agent is its $96.6-billion financial-investment portfolio, which encompasses $5.72 billion in property, $46.4 billion in fixed income, $22.1 billion in equity stakes and about the same amount in other asset classes including private equity and small and medium-size enterprises.

From time to time, the Caisse is accused of acting for the government on the Paris Bourse, where it is the first or second-largest shareholder in half of the country’s 40 leading listed companies on the CAC 40 Index.

Beholden to political masters

In reality, the CDC is an investing hybrid, says Colette Neuville, president of France’s Association for the Defence of Minority Shareholders.

“The CDC is generally a responsible long-term shareholder, but it is not a normal institutional investor, because of its mission to serve what politicians decide is the public interest,” she suggests.

Dexia, the Franco-Belgian bank that collapsed in 2011, illustrates Neuville’s point. As part of the bailout cobbled together by the French and Belgian governments, the CDC agreed to take over Dexia’s municipal financing operations in France. The result: Dexia’s French businesses lost $589 million in the first half of 2012, and were the main reason why the Caisse’s profit fell by almost two-thirds for the period to $453.7 million. Vigier maintains that the CDC was morally obliged to acquire Dexia because the French parts of the bank had previously belonged to the Caisse before the ill-fated Belgian merger in 1996. Not many private fund managers would advance such an argument to justify a dud investment.

In the end, the CDC’s sheer scale and deep roots in France’s financial landscape mean it can afford the occasional flop. It does not follow, though, that the CDC is inherently stable. Its management must always pay close attention to France’s shifting political winds, as an entity under parliamentary supervision whose chief executive is appointed by the country’s president.

“Different parties of the left and right have different views about what they want the CDC to do,” observes Neuville. “Unfortunately for the CDC, it can never satisfy the government of the day entirely, because even the Caisse’s resources are limited.”

Augustin de Romanet, pictured left, the CDC’s chief executive from 2007 to 2012, had a tense relationship with former President Nicolas Sarkozy because de Romanet was close to Sarkozy’s predecessor, Jacques Chirac, whom Sarkozy detested. Sarkozy eventually dismissed de Romanet shortly before losing his own job in this year’s French presidential election.

Jean-Pierre Jouyet, de Romanet’s successor, may be more politically adept; he is a former junior minister in Sarkozy’s government but also a friend of France’s new socialist president, François Hollande.

For foreigners doing business with the CDC, the message is clear. The Caisse may invest its money for the long-term, but its chief executives will always be subject to short-term political whim.

 

The global economy is on life support and the best that can be expected for the next five to 10 years is to get out of the intensive care unit but not off the critical list. Slow growth, low interest rates, serious unemployment levels, marginalised activity in the growing informal sector, sovereignty as a defensive strategy and democratic volatility – these realities are not conducive to the management of workers’ capital for stable retirement funds in the current dominant market frame.

Whether you accept the analysis, modern portfolio theory or consider the unfunded liabilities of defined-benefit schemes or the inadequate returns to retirement benchmarks of defined-contribution schemes, the reality is we need a different future for workers’ capital. This requires us to push the reset button.

Yesterday I made the argument for leadership. The significance of pension funds cannot be underestimated, and thus the capacity to lead – rather than follow – investment activity to establish demands on governments and markets is possible if there is the will to do so.

The growth of pension funds

Assets under the management of pension fiduciaries have grown from an insignificant part of economies to huge pools of capital. Total pension fund assets now exceed national GDP in the Netherlands, Switzerland and Iceland. Across all countries in the Organisation for Economic Co-operation and Development (OECD), the average ratio of pension assets to GDP in 2009 was 67 per cent. In the United Kingdom it was 81 per cent and in Australia 82 per cent (OECD 2010). Institutional investors collectively own 73 per cent of stock issued by companies in the Fortune 1000. Pension funds alone hold the largest ownership block, with around 30 per cent.

I would also add developments in China to this mix, with the extraordinary potential for rapid growth of investment funds, with the pace and scope of the rollout of a three-tiered contribution structure of social protection.

Pension funds need to shift toward patient-capital strategies and away from short-termist behaviour characterised by high turnover of assets, allocations to speculative hedge funds and the acceptance of products that are overleveraged such that risk and hedging risk becomes a vicious cycle.

Engineering fundamental shifts

If Wall Street, the City, mainstream media and many of the governance systems in use throughout society are still operating with twentieth-century market-economy assumptions, what will it take to engineer some fundamental shifts for both sustainable investments and outcomes for workers’ capital?

Let me address this through the lens of risk and climate risk in particular. No matter how remote they might seem when viewed through prevailing short-term perspectives, the long-term ramifications of climate change, income inequality, pollution and ineffective allocation of capital are real, are staggering and are a fiduciary concern.

It has been asserted that blind reliance on outdated assumptions and resistance to change have turned the application of reasonable twentieth-century prudent fiduciary practices into a twenty-first-century “Lemming Standard”. Even if you don’t agree with this, there can be no argument that copycat investment behaviour drives the creation of additional market volatility – making bubbles and busts more severe and generating systemic risks.

Hard questions

As significant partners in the architecture of the pension funds, unions must face significant questions – hard questions that should drive significant shifts in focus if we get the answers right. As capital owners and/or trustees, labour certainly needs to look at our role in generating preventable crises and the destruction of capital for which we have a collective stewardship responsibility.

At what point did we allow our funds to become captive of the dominant market frame without question?

Have we lost a perspective of the original labour rationale for bargaining for deferred wages into retirement income and/or advocating for the legislative/regulatory guarantees for dignified retirement incomes?

What is a dignified retirement income as a percentage of salary and how do we drive that base for all people with a mix of deferred wages (employer and worker contributions), state pensions and annuities, et cetera? In Australia, for example, we set out to both ensure retirement incomes that at least meet the ambition of 65 per cent of salary at 65 and to take some or all (depending on salary base) of the burden off state funds given the demographic realities.

What is the actuarial figure of investment returns over the long term (patient capital) that will best guarantee an agreed retirement benchmark?

Can we generate an alternate framework of guaranteed returns for at least certain portfolio shares without relying in total on the ravages of the speculative market with the costs of hedging and the deepening of a failed economic model? Can we and should we disaggregate young client capital for intergenerational shift in the investment culture? Do we need to carve out the distressed group of emerging retirees and treat the threat as banks have with their demand for recapitalisation? I know that this is artificial in terms of portfolio-percentage investments, but as a communication strategy and a rationale for much greater attention to ‘patient capital’, it speaks to workers.

What would it take to get 6 per cent returns from infrastructure investment over five to 10 years if we rethink the role of the state and the private sector. Can we look at government and or multilateral institutional backing for moderate percentage returns to drive diversification into developing and emerging economies?

Through a green lens

These issues are on the radical edge of the discussion here, but let me look at some of this through the lens of low-carbon, climate-resilient projects in green-economy investments including transport, housing and energy infrastructure, et cetera – long-term projects that fit well the liability profile of pension funds with spans over 20 to 30 years.

This is something labour unions are increasingly committed to and some changes are already taking place. Current pension leaders in green investments are increasingly originating from collective agreements and/or have trade-union pension trustees: Danish ATP, US CalPERS and CalSTRS, Dutch ABP and PGGM, Swedish APs and several industry funds in Australia, to mention a few.

The recent decision by the South African Government Employees Pension Fund to invest R1 billion in green bonds is a good example.

But how do we move further and change scale? Our own calculations suggest that pension funds could raise the share of green/low-carbon assets of their portfolio from a shocking low level of 2 to 3 per cent to 5 per cent in the next three years, which would unleash some $300 billion annually in the years following. This benchmark is the base we understand is around the tipping point of market maturity.

To reach that figure, the barriers are not on the demand side; they are on the supply side, and in the lack of readily available green financial products that combine performance and security.

How to make the change

Let me suggest some distribution of roles for that to happen.

Asset managers have a responsibility to develop transparent products that can combine performance and security while ensuring transparency and traceability of investment into low-carbon projects. They need to be accountable to asset owners on the financial and ESG performance of the products they deliver.

Sadly, the transparency call is not yet the case for existing investment in high-carbon assets. Excessive product complexity, often opaque to trustees, does not help when you sit on the board of a pension fund.

The current green-bond market ($16 billion, annual issuances in the range of $1 billion to $2 billion) is a drop in the ocean of the world bond markets. A lot could be done to develop green bonds, long-term bonds, as an asset class that is attractive for pension funds.

Alternative assets, such as clean-energy infrastructure funds and other green private-equity investment funds, as well as insurance-type derivative products (traded through transparent exchanges), can also help pension funds diversify their portfolio, and manage and mitigate risks that are specific to climate-resilient low-carbon projects, if – and that is a big if – they are properly regulated and supervised by authorities.

Policymakers and regulators must ensure a stable policy environment around carbon pricing, fossil fuels subsidies and other reforms that aim at financial stability to avoid unintended consequences that inadvertently discourage pension funds from investment in green projects.

But beyond that, government guarantees, or those of multi-lateral institutions, on green products will be needed since private insurers, especially since the 2008 crisis, cannot generate the trust or the scope to fulfil that role. But despite, or maybe because of, the massive transfer of public money into bank rescues or guarantees, public-money guarantees for private projects are a delicate issue. The model needs to be designed for confidence with the right balance, the right risk and reward sharing between public and private finance, as experience with poorly designed public private partnerships tells us. This, though, is critical work and is essential to building and rebuilding economies.

Finally, we need more education and dialogue that generates initiatives between institutional investors, civil society and governments.

We have set a challenge for investment in the green economy, and in addition to the imperative for transition of investment to low-carbon infrastructure for security, we also know that jobs – good jobs – will be delivered. Along with the projected demands for 50 per cent more food, 45 per cent more energy and 30 per cent more food by 2050, demands that must be delivered within a green-economy frame – jobs, jobs and jobs – are the upside return.

Mistaken fiduciary duty

However, the shifts in attitude and design are significant, and fiduciary responsibility is significant among the challenges.

Many industry professionals also mistakenly believe that the duty of loyalty, which includes the sole-purpose test, requires fiduciaries to maximise short-term returns without regard to the longer term consequences and systemic risks generated by their behaviour. Nothing could or should be further from the truth.

In fact, governing fiduciaries are legally required to take a balanced approach that impartially balances the different short and long-term interests of fund participants as human beings. The US Supreme Court, for example, has specifically held that the fiduciary duty of loyalty extends not to the plan itself, but to the beneficiaries as individuals.

Under the duty of loyalty, fiduciaries cannot turn a blind eye to material risks and opportunities that are relevant to delivery of sustainable pension benefits to the human beings who are fund beneficiaries, especially if the fiduciaries’ own management practices amplify those risks. Risks to the interests of beneficiaries in a sustainable retirement must be recognised and, to the extent reasonably practicable, must be managed in a way consistent with the interests of both current and future retirees. All those involved in making decisions about the investment of workers’ capital must be mindful of the international legal framework in which investment decisions are being made, which includes respect of internationally recognised human and labour rights and standards.

The Asset Owners Disclosure Project (AODP), a project aimed at transparency and disclosure of high-carbon and green-economy assets held by our funds, today released a new report regarding fund trustees’ fiduciary duty that indicates significant legal risks in the event of financial losses caused by climate-change impacts, both physical and regulatory. The AODP commissioned leading global law firm, Baker & McKenzie, to study the evidence for trustee obligations over climate change, looking at developments and action since the Freshfields Report of 2009. The AODP/Baker & McKenzie report has used the Australian legislative framework as a reference point having similarities with trust law in other major pension economies.

The AODP/Baker & McKenzie report referenced the evidence available and found that understanding of climate risks was reasonably advanced, but that action taken to manage climate risk had been very limited. It concludes that this gap between understanding and action represents a clear legal risk to trustees.

Plain and simple

It is clear to us that a potential climate or carbon crash will smash portfolio values and frankly make the subprime crisis look mild. Unlike subprime, trustees have had ample warning, and members will turn to their trustees for answers and potentially legal recourse. It is clear that trustees must act on the convergence of both the demand for patient capital investments and the management of future risk as we recognise the imperative and the opportunity to participate in the transition to a low-carbon economy.

The reality is that there is some underlying value destruction already underway in high-carbon assets, and transparency and redesign of patient-capital strategies for security of retirement incomes, provision of decent work and the planet itself.

Thus, in conclusion, there are several key issues for labour as representatives of the workers’ capital funds under management and the revision of fundamentals including principles of fiduciary responsibility.

 

1. What do we have to do to reset the investment frame for significant pools of patient capital supporting the real economy and generating moderate returns over the long term?
2. The investment of workers’ capital to rebuild economies and consider investment through a jobs lens requires dialogue and design initiatives agreed between labour, employers, institutions and the state.
3. Diversification must include green-economy investment in the face of climate risk and be inclusive in design for secure investments in developing and emerging economies. As part of this design, surely it makes sense to have government guarantees back part of the imperative to meet today’s and tomorrow’s climate challenge – at least to leverage market maturity.
4. Pension funds exist for the social purpose of financing workers’ rights to secure an adequate retirement income. Happily, they also provide significant economic security. So, notwithstanding the capture of our funds in a dominant market model with obvious and ignored risk, the question should be asked as to why there is no demand for some recapitalisation given the equivalent transfers and guarantees provided for the banks.

 

Above all, greater transparency with greater simplicity and a decoupling of workers’ capital from the irresponsibility of speculative greed requires both agreed principles, a moderation of expectation and urgent leadership.

We believe we can push the reset button. Do you?

 

Success stories at pension funds are a real rarity in crisis-ravaged Europe, with deficits hampering countless major international firms.

The CHF16.9-billion ($18.1-billion) pension fund of Swiss supermarket cooperative, Migros, is firmly in the blessed minority of funds enjoying rude health. Migros Pensionskasse was even able to boost its surplus to $1.3 billion in 2011 while markets dropped.

The fund appears at first to have ridden on the back of the alternative investment boom in recent years.

Some 33 per cent of the fund is invested in bonds and as much as 29.8 per cent is allocated to real estate. These two asset classes were solid performers throughout the crisis, the latter offering Migros a stunning 13.1 per cent cumulative return in 2010 and 2011.

Christoph Ryter, head of the fund, says that domestic real estate in particular has been a major help to the fund.

Striking Swiss gold

Ryter baulks at the suggestion that the fund has followed an alternative path to riches.

“It might sound strange to anyone in the UK, for instance,” he says, “but real estate is a classic, established asset class in Switzerland”.

The latest indications from UBS are that Swiss property prices have risen 35 per cent in the past five years. The market has been helped by an influx of European Union wealth that sees the fiercely independent alpine country as a safe haven.

Is it time then to go even deeper into real estate to make it the Migros fund’s largest asset class?

Definitely not, says Ryter. “We don’t believe very much in our capability to foresee the best performing asset classes in the future, so we stick to a strict rebalancing,” he adds.

The fund is selling a small portion of its real estate holdings to make sure it doesn’t exceed the 30 per cent it earmarks for the asset class in its long-term strategy.

This strategy is also forcing the fund to go cool on its other recent good performer, bonds, which should not exceed a 40-per-cent limit. Ryter feels anyway that the bonds outlook is modest as “it is difficult to imagine that interest rates will get any lower in the future”.

Equities have been the biggest winner of efforts to get the portfolio to match its targeted long-term asset mix, with shares targeted at 30 per cent of the total. The Migros fund expanded its equity holdings in 2011 to compensate for a drop in their value since the crisis.

That came despite the equity portfolio seeing a 10.6 per cent fall in value over the year, hampered largely by an underweighting of US equities against the more troubled European and Japanese markets.

Clearly the Migros pension fund is not run on reactions to recent fortunes in asset classes. “We hope to get an anti-cyclical momentum into the portfolio,” Ryter explains.

Satellite portfolio

In addition to rebalancing its asset mix, that anti-cyclicality has been gained by a 15-per-cent commitment to satellite portfolios in each of the fund’s three main asset pools.

These consist of assets such as high-yield corporate and inflation-linked sovereign bonds, private equity, absolute-return funds and opportunistic property investments.

Naturally, not all investment calls have paid off. Currency hedges were taken out in 2010 and 2011, when a flight to the safety of the Swiss franc sent its value soaring and threatened the returns on Swiss pension funds’ overseas investments.

Ryter chuckles as he recalls that just as the Migros fund had reached the targeted hedging ratios on its equity portfolio, the Swiss National Bank introduced its famous CHF1.2-to-euro ceiling.

That move sent the value of the Swiss currency tumbling “and we missed out on a free hedge,” says Ryter.

The fund has since unwound its euro-currency hedge on equities due to the confidence it has in the Swiss National Bank’s stance keeping the franc low. It wants to leave nothing to chance though, keeping 90 per cent of its bond-currency risk hedged and significantly less than that hedged on its equity portfolio.

Staying on message

The investment approach at the Migros pension fund might look rather advanced compared to the UK and US pension funds that have seen huge equity bets lead them on to the rocks in the past decade.

That the Migros fund achieved a meager 0.1-per-cent return in 2011, well below its own benchmark, suggests it is far from immune to the international struggle for investment returns, however.

How can Migros continue to operate a healthy defined-benefit pension fund then when the schemes are becoming endangered not just in the UK and US but also in Switzerland?

A big part of the answer lies in Migros’ status as an unlisted cooperative. “There is not the same pressure to de-leverage and de-risk by getting rid of a defined-benefit scheme that exists at other big Swiss companies,” Ryter explains.

Ryter admits though that increased life expectancy is a major threat to the fund’s defined-benefit model.

He also speculates that should inflation take off in the future, the Migros fund might also need to make the switch to defined contribution.

Recent changes to the fund’s benefit promises have also helped maintain the status quo though by “making the investment demands more comfortable”, he says.

The fund now offers 70.2 per cent of a member’s final salary after 39 years of contributions, a cut from 74.1 per cent. Migros employees must now work until 64 to claim their full company pension too, giving them a year longer than previously to make retirement plans.

“It’s not a very sexy message,” says Ryter. It seems to work rather well though.

 

The investment and pension industry has created too much complexity and added too many costs, and must move towards more simplicity, executive vice president and member of the management committee of State Street, Jack Klinck, told delegates in an opening address at the Fiduciary Investors Symposium in Santa Monica.

Klinck observed four mega trends in the industry: globalisation, retirement savings, regulation and complexity.

“The industry has been good at innovating. But we’ve become too complex and added costs. I think we need to go in the direction of simplicity,” he says.

“Sophistication is elegant simplicity, not complication. There are more than 76,000 fund products around the world. We don’t need any more products.”

Klinck says for every 10 funds that are added to 401(k) offerings, the number of people making a choice decreases. In addition, there is more money invested in cash than ever before.

“So, more products are not necessarily better.”

If a product or offering cannot be explained simply to someone outside the industry, Klinck says, then the chances are it’s not going to work.

Personal behaviours – such as trust and integrity – will also be important.

“With simplicity comes more understanding, and with more understanding comes trust,” he says.

Burrow: Take the lead

Klinck’s comments about simplicity were echoed by the general secretary of the International Trade Union Confederation, Sharan Burrow, who addressed issues of the global economy and the labour market, pointing out there were more than 200 million people around the world that were unemployed.

She believes that building economies has to be income-led growth and questioned the nature of fiduciary duty if institutional investments were not building economies.

“These funds can make a difference,” she says. “You are the leaders, but not if you follow the leader.”

Beware Japanisation

Also at the conference, chief executive of Hermes, Saker Nusseibeh, chaired a session on the economic and political impacts on global markets.

All the participants in the industry need to act more cooperatively, he says, advocating a holistic approach to investments, which includes a partnership between asset owners and providers.

Nusseibeh was joined on a panel by senior general manager of risk at the $1.23-trillion Japan Post Insurance Company, Ryujiro Miki, and professor of law at Georgetown University, Chris Brummer.

Miki, whose fund invests 77 per cent in Japanese government bonds, discussed the concept of “Japanisation” with the delegates. Arguing the US and European short-term interest rates were following the same pattern as Japanese interest rates from 1987.

“Japan invented quantitative easing. We are maybe at QE10 or QE15,” he says. “But the US announcing QE3 is an indication that QE2 didn’t work.”

The Japanese government has indicated it will list Japan Post Insurance in the near-to-medium-term future, and Miki thinks this would potentially have an effect on the market more widely.

“If we build the return-seeking portfolio, then this might have an effect on global markets,” he says.