The Callan Investment Institute explores portfolio construction using risk factors in its latest paper. The research finds that while building purely factor-based portfolios is challenging and largely impractical for most asset owners, using factors to understand traditionally constructed portfolios can be very useful.

The paper, from the research arm of Callan Associates, looks at ways that key elements of factor-based methodologies can be integrated in multiple ways into traditional asset-allocation structures to enhance portfolio construction, illuminate sources of risk and inform manager structure.

Click on the title to read Risk Factors as Building Blocks for Portfolio Diversification.

For the past five years David Neal has been integrating the vision of “one team, one portfolio” into the culture of the investment team at the $77-billion Future Fund. This has now been set in stone – well, porcelain – with coffee cups bearing the moniker used by staff throughout the organisation.

The slogan is not a frivolous mantra but a reality among the investment team, and an overriding philosophy driving the culture and the investment decision-making at the Future Fund.

The investment team is driven by nine principles that all feed into the complex, multi-layered and reciprocal process. And its internal team is deliberately small, and strategic, with assets managed by external managers.

David Neal, the fund’s chief investment officer since inception and an engineer by training, puts a lot of emphasis on documenting the process via a diagram that shows the multiple inputs into decision-making.

 

Size and culture matters

“When you are managing a large amount of money, there’s a tendency to just grow and grow because it’s always easy to justify an extra person. Being clear about how our beliefs, comparative advantages and required culture influence the right team size and process is therefore critical,”
says Neal.

The fact decisions are made by an interactive team, means that size is clearly something he takes very seriously. Not just size per se, but the impact it has on the fund’s culture. Adding extra functions and people comes at a cost, he says.

“Our right size is not much bigger than it is now,” he says. “It is not just about size and cost, but the point at which the culture could degrade more rapidly with extra people.”

The fund is trying to remain as small as possible internally while allowing its asset size to grow as large as possible.

And while the investment process is supported by investment models, there is a recognition of their limitations, and the emphasis on qualitative inputs into the portfolio construction. The teams get together frequently to discuss ideas and everyone feeds into decision-making. The managing director and chief investment officer have right of veto, but Neal rarely uses that right.

Communication discussion forums, including macro and market forums, and senior-investment and full-investment team meetings feed into the decision-making process, highlighting the benefits of a small team in such a process.

The Future Fund sits in a peer group that includes the $158-billion Canadian Pension Plan Investment Board (CPPIB) and $15-billion NZ Super, both of which approach the management of assets in a single total portfolio. However, the difference in the approach taken by these two funds highlights a view taken by Neal, that the right size is a function of the business strategy driving the fund.

The CPPIB, for example, hires more than 600 employees and manages all assets in house. This differs to NZ Super and the Future Fund, whose teams focus on strategy and outsource asset management.

“We look at our own comparative value add in each area, what does it mean for process, and what team structure do you need. What we require is strategic thinkers, as most of the money management is outsourced.”

“We look at our own comparative value add in each area, what does it mean for process, and what team structure do you need. What we require is strategic thinkers, as most of the money management is outsourced.”

 

Total management costs

Last financial year the fund paid about $444 million in total management costs, which includes all fund-management fees, core custody and portfolio administration, and the costs of the board and the agency. About $153 million of that was investment-manager base fees, with a further $218 million in performance fees paid to managers, highlighting an important bias in the investment thinking towards rewarding alpha.The internal investment staff were collectively paid $21 million, and have a performance bonus which is aligned to both the three-year rolling return of the investment and annual plans. (It pays its chair $182,530 and board members
receive $91,280).

 

The mechanics of decision-making

There is a global trend among large funds to bring asset management in house, ostensibly as a cost-saving exercise. But not only is the Future Fund required by law to keep an external manager between its agency and the money, Neal doesn’t necessarily believe it would be more effective to fulfilling the fund’s strategic aim.

“I’m sure we could put a business case together to manage money in house,” he says. “CPPIB is a very high quality organisation and they are working very hard to add value. If success is defined as beating the benchmark in each sector then added together to beat a portfolio benchmark, then this is rational. But for us, every person added makes it harder to create an efficient total portfolio targeted on our ultimate real return objective. It would be difficult to have seamless ideas and true competition for capital across sectors with 600 people, you feed teams like that with transactions. We have very different objectives.”

It makes sense for Neal to document the investment decision-making process in a detailed linear model, complicated by important feedback loops. The foundation inputs of beliefs and the mandate interpretation feed into portfolio construction from the top down. That also gets fed with scenario planning and macro environment analysis such as strategic themes and sector risk and opportunity analysis. Qualitative and quantitative risk-and-return assessment are also inputs.

What is clear at the Future Fund is that the culture and the process are interdependent.

“The process requires that we are checking on the strength of our culture,” he says. “And it is what I spend most of my time doing. The culture reinforces the process and vice versa.”

 

One team, one-portfolio

One of the key differences Neal highlights is the Future Fund’s one-portfolio approach. What this means is that everyone in the organisation has input into the portfolio as a whole, and in this way it is much more akin to the approach of NZ Super, which also has a small strategically based team.

It is no coincidence that the inaugural general manager of the Future Fund, Paul Costello, formerly worked at NZ Super.

The Future Fund does have a target allocation, or medium-term allocation, which in the 2010/11 annual report was 39 per cent in equities, 15 per cent in tangibles, 16 per cent in debt, 20 per cent in alternatives and 10 per cent in cash.

However, the actual allocation can vary a great deal from this target, which is different again to the long-term strategic asset allocation, which is not even really seen as a benchmark, more of a guide to the typical nature of the portfolio over time. This raises questions of how the performance of the team can be assessed if there is no benchmark to measure their active decisions against.
“We should be confident and competent enough to be evaluated without the use of a benchmark, we don’t need to curl up in bed sucking the corner of a benchmark,” Neal says.

Instead there is a concentration on meeting long-term goals via a commitment to teamwork and the nine investment principles, and a focus on the cultural values of integrity, innovation and “joined-upness”.

Long-term Strategic Asset Allocation Target asset allocation
(as of June 30, 2012)

 

 

Current asset allocation
(as of March 31, 2012)

 


The team functions by focusing on collaboration, looking for better ways to ways to communicate, which includes “being candid without getting personal”.

The fund has had some recent high-profile leadership changes but Neal takes this in his stride.

“With the CEO and chair changes, we have had a strong alignment. With all of the flavours of the board we’ve had, our overall investment beliefs, principles and strategy implementation, have consistently been bought into. There really hasn’t been a change. Personally, I don’t worry about it,” he says.

 

Continuous communication, continual development

While there is a one-portfolio approach, the investment team is still structured into the specialist sector teams of listed equities, private equity, property, infrastructure, debt and alternatives, strategy and environmental, social and corporate governance (ESG).

There is a focus on continuous communication and continual development so the entire team is brought along for the ride, whatever that might be. And while the “annual” portfolio reviews are conducted almost monthly the team, particularly the strategy team, is cognisant of focusing on the long-term – even as the short-term noise gets louder.

Neal says there is a lot of peer review in the investment team, stressing that the joined-up process only works if the specialists inform other specialists and vice versa.

He says the sector teams do their own analysis, guided by the strategy teamwork, and then filter up their ideas through their own research.

Those ideas arrive at a review committee, either a manager-review committee or an asset-review committee, consisting of about nine senior people.

That committee pulls apart the idea, tests its consistency with the strategic direction and whether in itself it is an opportunity. Passing that test, it then goes to the investment committee, which includes the sector heads, the managing director, the chief investment officer and head of strategy, whose job it is to build the portfolio and approve the investments.

 

Responding to change

While it seems like a reasonably bureaucratic process, Neal says it doesn’t necessarily take a long time to make a decision.

“We are open to the fact that things change, and so the portfolio and views change. It would be a very unusual world in which forward-looking risk and returns don’t change. But the things that populate the portfolio – the building blocks – don’t necessarily need to change when markets change quickly.”

The close relationship that the fund has with managers is also a lever to move the portfolio rapidly if it is appropriate.

“We have a close relationship with managers and I hope if the world changes, we have them already in place to be opportunistic either in the existing mandate or a new one. The committee owns that decision, the strategic decision, so we can do that rapidly at short notice,” he says.

Neal points to an example when the US credit rating was downgraded, and the fund took the view that the market had not sufficiently priced the likelihood that the US government was running out of fiscal stimulus bullets.

“We gathered the investment committee quickly, within a day of the strategy team forming the view, and made a decision to decrease our equity weight a few percent. We weren’t trying to make money from short-term trades, but it was a medium-term-outlook decision,” Neal says.

The investment committee has been granted decision-making approval within a range of plus or minus 3 per cent around the big headline allocations and within a sector have full discretion if the decision is to use an approved manger.

“For example, when the bank-loans market sold off in the credit crisis, we appointed a range of credit managers to build a substantial exposure for us. As the crisis developed, we had the discretion to move quickly and efficiently by expanding the mandates of those existing managers, for example, into securitised debt as it looked cheap.”

Neal describes the way that manager relationships are handled as “very deep and frequent”. Where the fund had 15 managers in June 2008, it now has 87.
“They’re important eyes and ears on the market, and they contribute to where the strategy should evolve. We have a bias to use an existing manager.”

“They’re important eyes and ears on the market, and they contribute to where the strategy should evolve. We have a bias to use an existing manager.”

The fund rarely uses consulting services, and Neal says the services they purchase are more about research and narrowing the field.

“It is a pretty small part of the overall approach.”

Neal says there is a trend to increase allocations to infrastructure, property and private equity, but it takes time to build and at some point will slow.

“It is taking us much longer to buy than we thought,” he says. “Three years ago we thought we’d be further along the line.”

The debt component of the fund also sets the portfolio apart, demonstrating that there is diversification as well as diversity. There is an overweight to high yield, which gives diversity to the corporate risk alongside its listed-equity and private-equity allocations.

This is a perfect example of the benefits of the one-portfolio approach. While the overall equity-like risk allocation has not altered, there is a recognition of the multi-dimensional nature of risk, and so where the risk is coming from, or being allocated to, has altered.

Future Fund principles of investment philosophy
Principle 1: Our portfolio management is focused on the specific objectives and risk definitions of the fund

Principle 2: We manage a single, total portfolio

Principle 3: We act as a single team, running an integrated process

Principle 4: We manage our portfolio dynamically

Principle 5: We aim to construct a diversified portfolio that is, as far as possible, robust to an uncertain future

Principle 6: We seek a relatively small number of relatively large relationships

Principle 7: We value flexibility and nimble decision-making

Principle 8: We manage for a net of costs return

Principle 9: While growing our investment team as large as necessary, we aim to keep it as small as possible

 

The seriousness with which the Danish pension fund ATP takes hedging paid off last year, with the fund recording its best ever return. A combination of the hedging activity and a deliberate move to substantially reduce its risk meant the fund weathered the European storm despite the fall-off in interest rates.

The 579-billion-Danish kroner ($98.4-billion) fund is managed in two distinct portfolios, a hedging portfolio and an investment or return-seeking portfolio.

The investment portfolio is divided into a beta and alpha portfolio, with about 97 per cent of the risk in the beta portfolio managed according to five underlying risk factors.

But it is the hedging portfolio that remains the main focus and indeed the main driver of the fund’s ability to pay its beneficiaries. The role of the hedging portfolio is to hedge, as precisely as possible, the interest-rate exposure of the fund’s pension liabilities, which last year was adversely effected by the fall in interest rates.

Chief investment officer of ATP, Henrik Jepsen says 2011 really demonstrated the importance of hedging against risks.

“There was a very substantial fall in interest rates in 2011, which meant being hedged was extremely important,” he says. “We made a total return of 26 per cent and the bulk of that came from hedging activity.”

Last year the total pre-tax return was $21.18 billion, with the hedging portfolio contributing about $18.3 billion, enabling it to pay its pension promise as well as add $679 million to its bonus reserves after tax.

The investment portfolio also contributed in a reliable way, with the fund realising returns regardless of what financial markets were doing.
“Effective risk diversification proved its value in our investment portfolio again in 2011,” Jepsen says. “And noticeably we made positive returns in all four quarters of the year despite the big differences in conditions – quarter one was optimistic, quarter two more wobbly, quarter three saw an extreme flight to quality and quarter four rebounded somewhat.”

Last year four of the five risk classes within the investment portfolio contributed to returns, with equities the obvious anomaly. The investment portfolio gave a return of $3.2 billion.


Hedging in Denmark

However, while the fund outperformed, particularly given wider market volatility, changes in the guarantee benefits – due to declines in interest rates – negatively affected hedging activities by $17.5 billion. The changes in the guaranteed benefit were higher than the return on the hedge (after tax) because Danish interest rates fell more than German interest rates as Denmark experienced flight to quality during the autumn, he says.

This meant that overall the results for 2011 came in at $441.6 million – lower than the performance target of the hedging and investment activity for that year.

In the context of the five-year performance target, however, the fund was above its target.

ATP has changed the way it quantifies the market value of its future pensions. Until 2011 the Danish swap rate was used to calculate pension liabilities but that changed last year.

“We have now changed the discount rate so it is a mix of Danish and German interest rates, which reflect the way we actually can hedge the liabilities and will result in a more stable hedging result. It means the hedging portfolio and value of liabilities will move more in sync.”


Dynamic risk allocation

Another example of how seriously risk is taken is that the $52.5-billion investment portfolio is driven by dynamic risk allocations.

At the end of March this year, the beta portfolio had an asset allocation (and risk allocation) as follows: commodities 3 per cent (11 per cent risk allocation), inflation 16 per cent (24 per cent), equity 15 per cent (42 per cent), credit 15 per cent (8 per cent) and interest rates 52 per cent (15 per cent).

The investment portfolio’s risk allocations have been stable for the past five years and, while there isn’t a benchmark per se, the fund has a long-term risk allocation, which includes 35 per cent in equities, 20 per cent in government bonds, 10 per cent in credit, 25 per cent in inflation-linked assets and 10 per cent in commodities.

“The long-term risk allocation was determined on the basis of a qualitative and quantitative study including data for the last century,” Jepsen says. While the fund can diverge from this risk allocation, he says it must always be within the limits of effective diversification.

In addition to diversification paying off, Jepsen says the fund had a focus on tail risk protection and reduced the absolute portfolio risk markedly during the second quarter.

“We are now using about half of our risk budget,” he says. “We kept the same relative-risk allocation, but did the risk reduction in a balanced way. We don’t bet on markets but have a risk-based decision model.”


Certain and small

Jepsen says the fund sold a lot of exposure in all five risk classes including equities, index-linked bonds and its oil exposure.

And, given the volatility in Europe, Jepsen says the focus will remain on defence, rather than offence, in the fund reaching its performance target.

“We lack visibility about the deleveraging process and the debt crisis so it is hard to be offensive. It is not any easier this year, as we see a lot of different equilibria depending on how the euro situation turns out. The biggest mistake to make would be to move to risker assets because safer assets are yielding so low,” he says. “We have stayed liquid and taken risk off the table.”

While the fund doesn’t use asset-class descriptions, by way of demonstrating the fund’s current risk tolerance Jepsen says if, conceptually, the fund was invested in equities, then about 20 per cent of the money would be in equities right now.

He says ATP has consistently taken a risk approach to the volatility in markets. Among other things the fund sold almost all its exposure to peripheral governments long before the crisis evolved.

“We look at tail risks rather than the most likely expected outcome,” he says. “We are not putting money on what we think will happen but rather making sure that the portfolio will perform well no matter the economic outcome.”

Jepsen is not afraid of losing short-term opportunities.

“It is much more important to avoid a black hole than miss a small rally,” he says.

Given the size of the fund, its investment team is quite small.

In the investment department, it only employs 20 people to manage strategy and implementation of fixed income, hedging, Danish equities and tail-risk management.

The specialised investment areas such as real estate, private equity, venture and alpha have been put into wholly owned subsidiaries owned by the fund, but not based at the headquarters.

“It means there is a smaller organisation here and management can focus on the broader issues,” he says.

Jepsen is responsible for the broader team, including the actuarial team, which together numbers about 80.

In recently released research, Dominic O’Kane, affiliated professor of finance at EDHEC Business School, challenges the assumptions about the operation of the eurozone sovereign-linked credit default swaps (CDS) market.

The European Parliament decided to permanently ban so-called “naked” CDS in October 2011 on the back of claims that their speculative use caused or accelerated the rapid decline in 2010-11 bond prices of eurozone periphery countries.

O’Kane performed theoretical and empirical analysis of the relationship between the price of eurozone sovereign-linked CDS and the same sovereign bond market during the debt crisis of 2009 -2011. Read the paper here: The Link between Eurozone Sovereign Debt and CDS Prices.

The complexity of sustainable investing could be a step too far for many asset owners with current governance not up to the complexity of embedding environmental, social and governance (ESG) factors into decision-making, according to head of Towers Watson Roger Urwin.

The comments come as the global asset consultant is set to release the results of Project Telos, a collaborative project spearheaded by Urwin and done in conjunction with Oxford University.

Also partnering on the project were 22 investment management partners and eight chief investment officers. The global CIO group included Mohammed El Erian of Pimco, Jim O’Neil from Goldman Sachs Asset Management, Adrian Orr from New Zealand Super and Jaap van Dam from PGGM Investments.

 

Streamlining complexity

Urwin says that the Project Telos aims to provide a road map to sustainable investing as a way of streamlining the challenging complexity of integrating sustainability considerations into asset owner decision-making.

“Telos is trying to help organisations to take on a new strategy when often the governance they would have to move to that new approach would be super-stretched by this type of change,” Urwin says.

“The governance of asset owners across the world is not strong. I didn’t say weak and that is important. Because in some respects to be too negative about asset-owner governance is to lose track of the difficulties that asset owners have in managing complex funds in the fast-moving financial markets of today.”

Having been at the coal face of fund governance, working with some of the world’s biggest asset owners on improving their decision-making processes, Urwin says that sustainability demands funds ask big questions beyond traditional investment approaches.

It also brings into the spotlight what he describes as the “governance gap” between the existing levels of fund governance and the demands of managing an increasingly complex investment landscape.

Clarifying a “worldview” and a set of beliefs around investment at the board level is crucial to starting down the path of sustainable investment.

Urwin says that sustainable investing has become more justifiable than ever from a “finance first” point of view.

For Towers Watson this involves a definition of sustainable investing that encompasses long-term investing that is efficient – as measured by return per unit of risk.

Sustainable investing also entails intergenerational fairness: “We measure that by the terms of the deal for present, current participants being as good as the returns enjoyed by future participants of a fund,” Urwin notes.

While the detailed findings of Project Telos have not yet been released publically, Urwin says the project aims to provide road map covering key areas from drawing up sustainable investing mandates to managing risk exposures to ESG factors.

“It is a cute phrase, but funds don’t have the bandwidth to deal with sustainable investing at the moment,” he says.

“That is why Towers Watson is helping funds to embed sustainable investing within the investment process, and a change management process around road maps is the best shot at the task.”

 

 

Transformational change

The work done in Project Telos involves thinking about “transformational changes” and positioning portfolios with a view to how these changes will affect investment performance over the medium to long term.

Towers Watson identifies three transformational changes involving slowing growth in developing economies; the changing demography and the declining work force in developed countries and China; and resource scarcity and the pressure it will put on natural capital.

According to Urwin, traditional investment approaches look to gradually plan for the future on a year-by-year basis, while sustainable investing demands fiduciaries form a view that takes into consideration some of the key risks that can have a material effect on portfolios.

It is an approach that attempts to position a portfolio both for today’s conditions and simultaneously for what the future may hold, Urwin explains.

Starting with a clearly defined set of investment beliefs and worldview, a fund could take the step of committing to the UN-backed Principles of Responsible Investment (PRI) as part of starting the process of embracing sustainability.

Urwin describes this process as “emblematic” and “only one piece of the whole”. Asset owners also have to roll up their sleeves and get down to the nitty gritty of looking at their manager line-up and how to construct mandates that reward a long-term focus.

This would involve an integrated assessment to look at sustainability practices.

“Sustainability encompasses ESG exposures, it’s a portfolio assessment, it’s a process assessment but it also encompasses the economics of the relationship, the fees in the relationship, the benchmarks used,” Urwin says.

Part of this process is a “de-emphasis” on the role of cap-weighted benchmarks as a measure of performance, with a greater focus put on absolute returns over long periods of time.

Using the navigation principle of triangulation as an analogy, Urwin says that an emphasis on outcomes is a way of “getting a fix on a manager from two lines of sight”.

Moving from a relative benchmark to incorporating absolute-return objectives requires substantial governance work, according to Urwin.

“Benchmarks drive portfolios; bad benchmarks drive bad portfolios. This principle is being applied here. So the driving force behind portfolio construction is an outcome more than a relative-to-benchmark position – that type of point is a key part of the sustainability conversation,” he says.

Another clear signpost on the road map is funds thinking about their exposures to certain sustainability themes.

As part of this, traditional notions of asset allocation are expanded to include so-called smart-beta, in which investors use both specific mandates and asset-allocation decisions to capture exposures to a variety of ESG-related themes.

Urwin points to ESG-weighted indices as an example of a fast-growing selection of investment tools to measure and give exposure to ESG factors.

Finally, the road map also encourages an expanded role for the notion of ownership responsibility, encompassing asset owners as not just investors, but advocates for a broader range of issues.

“Asset owners and asset managers as their agents must have a much more developed view of their ownership responsibility, particularly in respect to the major causes of our time,” Urwin says.

“So, examples will include the oversight of the banking sector and their externalities, oversight of companies with environmental responsibilities and influence on important societal questions such as corporate pay.”

Urwin says that Project Telos has grappled with the question of fiduciary obligation, explaining that the road map is underpinned by an “enlightened view” of what constitutes fiduciary duty.

He says members now expect their fiduciaries to address issues such as executive compensation or environmental concerns.

With total portfolio costs of only 15.3 basis points, the $43-billion United Nations Joint Staff Pension Fund is one of the most efficiently run pension funds in the world – not bad for a fund that has investments in 41 countries and 23 currencies. This year it embarked on an operations overhaul to bring even more efficiency to its investment management.

The fund claims to be the world’s most globally diversified pension fund: not only are its investments in 41 countries and 23 currencies, it serves 23 different member organisations scattered all over the globe.

This year it joined the twenty-first century with an investment-operations overhaul designed to bring further stability to its investment approach as markets continue to be volatile.

“Underneath the mess in markets, we built an infrastructure we think every fund should have. Basically we retired our fax machine,” says Suzanne Bishopric, director of investments at the United Nations Joint Staff Pension Fund (UNJSPF).

 

Of the world and in the world

The fund now has an integrated trade-order-management system, which is fully integrated with SWIFT and matched with an independent master record keeper

In the past the fund followed its own UN-accounting standards – not those standards adhered to throughout the world.

“We are now using accounting standards, followed throughout the world, that are robust. This has allowed us to do a lot of other good stuff like monitor brokers. We know within a minute if a trade has been executed. It gives us great monitoring power and the risks of mistakes are less.”

The fund is monitoring any distinction in transaction-execution costs in a quarterly report and Bishopric says it’s starting to pay off.

United Nations Joint Staff Pension Fund: Ajit Singh, deputy director for risk; Suzanne Bishopric, director, investments; Toru Shindo, deputy director, investments.

“We have learnt that you don’t have to reinvent the wheel. There are standardised products out there and if you take a modular approach to it then you don’t disrupt your operations. We started with the payments side, then our trade-order-management system, so we can keep brokers honest. The trade-matching and affirmation software keeps settlements safer and this is important for us because we’re global,” she says.

It isn’t a joke that the fund has “retired its fax machine”; until this digital technology was introduced it was still using faxed orders.

“We would send a fax to Brazil and get a reply the next day. Now we are as close to the state of the art as any fund; we’ve leapfrogged some intermediate technology,” she says. “We went from a green field to state of the art. But there is an advantage to being a latecomer: we can see what is tried and true and what the industry standards are.”

Measuring up

Bishopric says the fund’s 58 staff recognised they needed these standards to improve their performance and put in a lot of effort to make it happen.

About 90 per cent of the fund’s assets are managed in-house, except for private equity and real estate.

It recently engaged CEM Benchmarking to do a cost-benchmarking study, which revealed its costs were “off the charts on the low side”, according to Bishopric.

The total investment costs of managing the portfolio were 15.7 basis points, which is an outlier in terms of global funds, it is “dangerously low”, she says.

The fund’s global peers typically operate within the range of 40 to 80 basis points.

Compared with other funds the UNJSPF saves money because of its internal trading and it also has a very low allocation to alternatives, currently less than 1 per cent, and similarly less than 5 per cent to real estate.

At the end of March 2012, the fund’s asset allocation was 60.7 per cent equities, 28.8 per cent bonds, 4.5 per cent real estate, 5.2 per cent short-term investments and 0.8 per cent alternatives.

However, there is a plan to increase the alternatives allocation, which Bishopric says is being done methodically and judiciously, adding about 1 per cent per year.

The fund’s biggest alternative investment is with the World Bank Group’s Intenational Finance Corporation’s African, Latin American and Caribbean Fund (IFC ALAC), which is a private equity investment.

“The philosophy is the investment has to resonate with our organisation,” she says. “We have a number of restrictions, such as tobacco and defence, reflecting the ethics of the UN.”

One reason the fund invested with the IFC fund is that it is managed consistently with principles of responsible investment (PRI).

“We can then learn private equity their way first, through a beneficial approach, before going to the private markets.”

The World Bank green bonds are another investment and an example of the fund investing according to PRI, she says. There are also other screens in their equity investments, such as worker safety.

The fund recently tested its new system in a disaster-recovery test, during which everyone in the investments team worked from home. Bishopric was in Montreal at the time and the deputy director for risk, Ajit Singh, was in Geneva.

“We managed to do our trades,” she says. “It was extremely beneficial and I highly recommend everyone do that. As Treasurer of the UN, I lived through 9/11 and having systems helped us enormously then.”

Operating reforms will save costs, she says but insists the point of pension investment management is to manage returns, not costs, the net return is the important place to focus

Having said that the fund did have a negative return last year partly due to a huge weight in Europe. It has investments in 41 countries, with North America dominating, followed by about 25 per cent of assets in Europe.

“There is uncertainty to what will happen in the eurozone,” she says.

“A set of irrevocable exchange rates poses some serious constraints. If you have an irrevocable exchange rate then greater flexibility will be required from other economic factors, such as labour or interest rates. There is a single currency but not the same creditworthiness.”

UNJSPF has liabilities in Europe, so “we do need to have some exposure there,” she says.

At the moment all the assets are managed in New York, but Bishopric says budgets not withstanding, it would be ideal to have an office in a different time zone.

However, she acknowledges that satellite offices are a risk and need to be well staffed, and have the same risk management and oversight as any office.

“You can’t start a second office on the cheap,” she says. “Operating infrastructure is a missing thing in fast-growing funds.”

UNJSPF also implemented RiskMetrics this year and now every portfolio manager has access to the risk parameters of portfolios.

“We analyse the portfolio risk at least weekly. Because we manage money in-house, the fund can benefit from delving deeper into the components of risk.

“We can look at every stock and it’s attribution to risk,” she says. “We can find outliers in every portfolio and remove them. We did that in the first quarter when we wanted to dial down risk.”

Bishopric is slightly optimistic: she says the value-oriented managers are seeing great valuations not seen since 2008.