Global investors should have as much as 30 per cent of their portfolios exposed to natural resources, more than double the current market average, because of a burgeoning worldwide food crisis, GMO’s Jeremy Grantham says.

The droughts afflicting farmers in the US and the subsequent spike in food commodity prices are just forerunners to the climate-change fallout that will see many food-importing developing countries struggle to feed their populations, according to Grantham.

The co-founder and chief investment strategist at Boston-based asset management firm, Grantham, Mayo, Van Otterloo and Company (GMO), warned investors in his most recent quarterly letter that long-term investors should position their portfolios for a resource-scarce world and decades of rising commodity prices.

“For any responsible investment group with a 10-year horizon or longer, one should move steadily to adopt a major holding of resource-related investments,” Grantham advises.

Not only should investors look to gain exposure to natural resources, but they should also prepare for how the rising resource prices will impact the rest of their portfolios.

“I am now also convinced that rising resource prices will worsen the prospects of the portfolio, by both squeezing profit margins and reducing overall growth,” he warns.

“If correct, this will have serious implications for longer term endowments and pension fund returns: among other factors, a lower growth for GDP in the long term may mean lower returns on all capital.”

 

Rise, natural resources
Grantham advocates allocating 30 per cent of a total portfolio to natural resource plays, with half of this allocated to what he calls a “senior or preferred component” of forestry and farms.

“My personal, somewhat arbitrary, breakdown of a targeted 30 per cent is to have 15 per cent in forestry and farms, 10 per cent in ‘stuff in the ground’ and 5 per cent in resource efficiency plays,” Grantham outlines.

His views on increasing exposure to natural resources are shared by a number of large institutional investors, which have made strong forays into this space in recent years.

The innovative Yale Endowment is one such leader, with its latest update to investors detailing a sharpened focus on natural resources.

From June last year, the endowment decided to split its real-asset allocation into two separate natural resource and real estate buckets.

The endowment is closing in on its target allocation of 9 per cent to natural resources, currently allocating 8.7 per cent to a portfolio of opportunities that includes timberland, oil and gas, and metals and mining.

Its longstanding oil and gas (begun in 1986) and timber (1996) have achieved 16.9 per cent per annum since inception, the endowment reports.

Its investment team aims to achieve a 6 per cent real return target from its natural resource holdings.

In Europe, long-term institutional investors are also looking to be early movers into agriculture.

Swedish buffer fund AP2 last year announced a $250-million joint venture with a US pension fund and financial services provider to buy farmland in the United States, Brazil and Australia.

AP2 invested the money into a newly formed company that has joint venture partner, TIAA-CREF, as its majority shareholder and administrator. TIAA-CREF already has extensive agriculture investments worth more than $2 billion, which include 400 farms, vineyards and orchards in the United States, Brazil, Australia and Eastern Europe.

 

Move for food
In his broad-ranging quarterly letter to investors, Grantham drew from analyses of climate, agriculture and water resources to make the case that the world is five years into a severe – and likely ongoing – food crisis.

He predicts these food shortages will threaten poor countries with increased malnutrition, starvation and even collapse.

“Resource squabbles and waves of food-induced migration will threaten global stability and global growth, this threat is badly underestimated by almost everybody and all institutions, with the possible exception of some military establishments,” Grantham says.

He warns that the commonly held assumption of a minimum 60-per-cent increase in food production is needed by 2050 to feed the forecast world population of 9 billion is unachievable.

Grantham highlighted water shortages, the degradation of farming land around the world and the growing cost, diminishing stores and effectiveness of fertilisers as major hindrances to sustaining food production, even at the current inadequate levels.

Recent US drought-driven spikes in grain prices Grantham predicts are just a foretaste of things to come and particularly concerning, given the widespread plantings undertaken after 2008 shortages led to food-price riots in some developing countries.

For investors, higher input costs driven by a scarcity of natural resources will impact company profit margins and economic growth, and squeeze national budgets in the developed world. In the developing world, it could lead to much more volatile political and social instability, he predicts.

Grantham advises investors look to what he calls “quality” stocks.

These companies either have a much lower resource cost as percentage of total revenues or have a higher profit-margin base to buffer against rising costs.

To read the full GMO quarterly letter, click here to visit their website.

 

The gargantuan impact of systemic risk in global financial markets has been corroborated by a consortium of industry and academics collaborating to provide independent quantitative research, insight and leadership on systemic risk.

Driven by director of MIT’s Laboratory for Financial Engineering,  Andrew Lo, senior managing director at State Street Global Markets, Jessica Donohue, and managing director for research and academic relations at Moody’s, Roger Stein, the Consortium for Systemic Risk Analytics was founded to provide a platform for institutional investors, academics and industry experts to present and discuss new research and better quantify drivers of systemic risk.

 

Collaboration across the board
Systemic risk has presented a major challenge for regulators funds managers, academics and investors who have relied on the diversification tenets of modern portfolio theory for their investment allocations.

“Systemic risk was never imagined by modern portfolio theory,” Lo says. “Modern portfolio theory is now incomplete because of the complexity in financial markets.”

Stein says much of the work involves dealing with the large volumes of incompatible data. He notes that, ironically, in some cases there can be too much information for investors and policy makers to evaluate. Much of the work that is now being done is about using new analytic techniques to rationalise and filter down information to something that is more actionable.

Donohue says in the end investors have to consider systemic risk in asset allocation and tactical asset allocation.

“We are creating relationships and my hope is that will result in relevant measures and ways of thinking that will help investors better manage the turbulent environment,” Donohue says.

The consortium will seek to foster collaboration between academic and industry to research the interrelatedness of markets and the potential sources of systemic risk.

 

Bringing people together
The aim of the consortium is to initiate bilateral conversations on these risks.

“We are driven by a sense of urgency. Systemic risk is not something that businesses are focusing on; it requires a collective effort. Contrary to popular belief, most financial services firms are not evil but are concerned about their impact on systemic risk and so are willing to share information about exposures in their portfolios,” Lo says.

An example of the work the consortium is doing is a “network map” that Stein and Lo developed to combine portfolio analytics and network analysis. The map outlines the relatedness of money market funds and the risks to them through exposures to non-US debt. In this case, Moody’s agreed as a one-off to provide the anonymised data to Lo and Stein. They then shared the results of their new analytic approach with the group, which included State Street, Moody’s academics as well as government organisations such as the Securities and Exchange Commission and the Office of the Comptroller of the Currency.

“The notion is to bring people together who wouldn’t otherwise talk to each other, and to do so in a way that expressly addresses issues of confidentiality and complexity,” Stein says.

 

More than just quants
Lo has done much research on systemic risk, including a variety of measures and the relationships among markets and different investment holdings. “There is increasing correlation,” he says. “For example, in the hedge fund industry there is no corner that is undiscovered; all are crowded trades.”

The consortium is interdisciplinary, with Lo involving various departments of MIT in the research and discussion including physics, engineering and maths.

“Although much of the discussion focuses on financial data and analytics, we also talk about the impact of things like dependence on key computer systems as being potential sources of systemic risk. It is an active debate,” Stein notes.

State Street Global Markets, the investment research and trading arm of State Street Corporation, has produced a prolific amount of research and work through State Street Associates, its collaboration with leading academics.

Some of that work includes measures of systemic risk and turbulence in conjunction with Mark Kritzman, who also teaches at MIT. Similarly, Stein’s focus has been developing approaches to extending quantitative credit measures for applications in systemic risk analysis.

Donohue says industry consortium members do not share proprietary information, but published works, such as those of Kritzman, could be applied to share insights with the group.

The consortium will have a public website and announce new members within the next month.

 

 

Institutional investors around the world have been lobbying for the right to have a say on pay, a right to have an input into the remuneration of the executives in the companies they invest in. In June the UK’s business secretary, Vince Cable, laid out new plans that will give shareholders three-yearly votes on executive pay in that country.

Speaking to the House of Commons, Cable said “…it is neither sustainable nor justifiable to see directors’ pay rising at 10 per cent a year while the performance of listed companies lags behind and many employees are having their pay cut or frozen.”

Similarly the issue of pay is rife in the investment industry: everything from paying internal pension investment staff enough to the over-pay and pay structure in funds management firms.

 

The wrong ratio
Saker Nusseibeh, chief executive of Hermes Fund Managers, believes the debate is centred on the wrong issue.

“Personally I think the remuneration structure needs to change. Quantum is the wrong issue,” he says. “The bonus structure is flawed with a short-term focus. The industry needs to tie managers into paying for what they do and a bonus is above what you do or a specific task.”

Nusseibeh is comfortable speaking out on issues in the industry. He is chair of the 300 Club,  a group of global investment professionals whose aim is to raise and respond to urgent uncomfortable and fundamental questions about the very foundations of the investment industry and investing.

The 300 Club’s mission is to raise awareness about the potential impact of current market thinking and behaviours, and to call for immediate action. Short-term behaviour and short-term bonuses is one such issue, and was highlighted extensively in the recent Kay Review.

“In the funds management business the ratio of salary to total compensation is 2:1. The ratio is wrong,” Nusseibeh says.

Other structural problems worth highlighting in the industry, he says, include longevity – or lack of it in leadership positions – and compartmentalisation, in which each actor in the financial industry is being rational in their own silo but in totality is creating irrational behaviour.

“This leads to the law of unintended consequences,” he says. “An example is with ownership of companies; we have to collectively decide what we want companies to do.

“It goes back to honesty. The financial business is not necessarily comfortable with full transparency and honesty. It is a very elitist culture and things are made more complex than they need to be so players can take a margin.”

By way of example he says: “There were enough people around before the crisis who knew what was happening to stop it. There’s asymmetry of information. We think to encourage honesty you have to lead by example.”

 

True advice
Hermes Fund Managers is owned by BT Pension Scheme and that fund remains its largest client, however the multi-boutique asset manager also, increasingly, manages money for third-party clients.

“With our third-party clients we’re prepared to be completely transparent; hopefully they’ll ask that of other funds managers,” he says. “We are a great believer in transparency of pay and we publish how much we pay everyone” *

“If you’re hiding something, like how much you’re being paid, you have to ask why,” he says

Nusseibeh sits on the BT Pension Scheme investment committee. He says the Hermes business has been built on three pillars: excellence, responsibility and innovation.

“We have to show the same care and responsibility to our third-party clients that we show to our parent. This means transparency. They have access to our internal spreadsheet, risk analysis and attribution, and our qualitative assessment of the manager. We review all of our portfolios on a continual basis, have a formal review monthly and investors have access to the minutes of the meeting. It is true advice: telling a client when we don’t agree.”

 

* According to a document called Pillar 3 Disclosures at the end of December 2011, aggregate annual remuneration of senior management who have a material impact on the risk profile of the firm is £9,381,000 in respect of the 2011 performance year. This is made up of fixed pay and variable pay. The bonus structure includes an equity participation scheme and a bonus deferral scheme.

 

US college and university endowments have gone from pioneers in the adoption of socially responsible investing (SRI) to markedly trailing the rest of the investment industry in integrating environmental social and corporate governance (ESG), new research reveals.

The Boston-based Tellus Institute, an independent not-for-profit think-tank, looked at 464 endowments and was damning in its findings, revealing that if SRI policies did exist they were limited to screenings of tobacco and so-called sin stocks and divestment from Sudan.

The endowments represented in the study have combined assets of more than $400 billion.

Researchers found endowments also displayed a weak knowledge of ESG investing strategies and were virtually absent from well known investor networks, with just one student-run fund signing up to the UN-backed Principles for Responsible Investment (PRI).

The Environmental, Social and Governance Investing by College and University Endowments in the United States: Social Responsibility, Sustainability, and Stakeholder Relations report’s lead author, Joshua Humphreys, says the research reveals endowments were stuck in a “1990s mindset” when it came to ESG investing.

“Overall, we found that the endowment community exhibits a very weak understanding of the leading ESG investing strategies, trends, nomenclature and opportunities that exist. We found that the endowment community as a whole has a very anachronistic understanding of the ESG space as if they were trapped in the 1990s,” Humphreys says.

Humphreys says this is principally because funds had failed to engage with other investors in collaborative efforts, in particular ground breaking working groups at investor networks such as the UN PRI that have focused on extending ESG integration to private market and alternative asset classes.

The level of funds reporting they utilise SRI/ESG criteria to inform their investment decisions has also steadily dropped, researchers found.

Using data collected by the National Association of College and University Business Officers (NACUBO) the report finds that 18 per cent of funds claim to integrate SRI/ESG factors into their investment processes, down from 21 per cent in 2009.

ESG AND ENDOWMENTS

Lack of collaboration with other investors has meant endowments have been left behind on ESG integration.National Association of College and University Business Officers (NACUBO) report finds that 18 per cent of funds claim to integrate SRI/ESG criteria into their investment processes, down from 21 per cent in 2009.

Researchers found a lack of transparency from endowments. According to the Sustainable Endowments Institute (SEI) survey of 277 US endowments, just 36 per cent reported they disclose their investment holdings to their entire school communities.

The SEI has issued a report card examining endowment transparency and disclosure, which found that more than half of the surveyed endowments scored a C or worse.

When it came to incorporating ESG considerations into investment decisions, Sudan-related investment policies remained the most widespread ESG investment issue on an asset-weighted basis.

Some $150 billion in assets were affected by these policies. This was followed by tobacco screens ($75.3 billion) and human rights ($15.7 billion).

Tobacco stocks were the most commonly screened stocks.

 

 

From explosion to erosion
Humphreys described this as endowments moving from “explosion to erosion” when it came to the adoption of SRI/ESG investment practices. Endowments had led the push to divest from Sudan, but activity in the SRI/ESG space had steadily diminished in recent years, Humphreys notes.

Researchers found that much of the activity and reporting around the consideration of ESG factors in investments focused on proxy voting.

However, due to the endowment model, which focuses on alternative assets as opposed to public markets, the focus on proxy voting has meant there is little ESG action taken on the majority of assets endowments hold.

When it came to proxy voting, almost 200 endowments either did not have the capacity to exercise their proxy votes because all holdings were in mutual funds or outsourced this responsibility to external investment managers.

 

Stakeholders take the wheel
The drivers for adopting ESG investment practices were also different for endowments.

While ESG integration has moved into the mainstream with investors seeing risk mitigation and/or return enhancement opportunities, endowments have typically adopted ESG investment after demands from stakeholders.

These stakeholders include students, donors, alumni and staff and faculty members.

“A lot of ESG investing activities that schools embrace is, quite frankly, not through any sanguine acknowledgement of the pertinence of ESG issues and risk analysis or investment opportunities but simply as a kind of responsive mode to the demands of stakeholders,” Humphreys says.

Cambridge Associates associate director and head of the consultant’s mission-related investing group, Jessica Matthews, says that endowments that approach the asset consultants to discuss ESG-integration are more concerned about what peers are doing than in the investment case for adopting ESG strategies.“We have certainly heard from our college and university clients on these types of issues but I would agree with what the report concluded that colleges and universities are not doing as much as some of these other groups,” Matthews says.“What really happens at the colleges and universities is that they are very driven by what their peers are doing and the question we always get, if we do get a question from this group, it’s ‘what are the other ones doing? Are we behind? Are they doing anything?We are getting pressure from our students are they getting the same pressure?’ So there is a very strong peer focus here from this group.”

Matthews says that charitable foundations drive about two-thirds of the business of the mission-related investment group at Cambridge.

The group focuses on opportunities for impact investing across asset classes.

Another reason Matthews cites for endowments trailing the industry in terms of ESG integration is that the main champions of the adoption of SRI and ESG-related investing have been students.

“The stakeholders to some degree are the students and they are a transient group, so you don’t have somebody who is a champion for doing some sort of ESG or mission-related investing.

But at foundations, this could often be the president of the foundation,” she says.

While education and university endowments have been slow to adopt ESG investment practices this is often at odds with the ground-breaking work done in this space by the same education institutions’ faculty and staff.

 

Institutional disconnect at Harvard and Yale
Both Harvard and Yale have established research organisations looking at ESG investing practices. This includes Harvard University’s Initiative for Responsible Investing through the Hauser Center for Nonprofit Organizations. Yale’s School of Management has established a Center for Corporate Governance. Yale also has a Center for Business and the Environment that seeks to provide thought leadership on sustainable investing.

Despite academic staff leading new thinking on ESG investing, there is an apparent disconnect when it comes to the performance of the university’s endowments.

Both universities have student-led advocacy groups pushing its respective endowments to do more to make their investment processes more transparent.

Launched in 2011, Responsible Investment at Harvard describes itself as a “broad coalition of students, alumni and staff”. The organisation was established to pressure the Harvard Management Company (HMC) to initiate greater ESG integration in its investment decision making for the $32 billion endowment.

It has called for the endowment to adopt a transparent policy to incorporate environmental, social and governance due diligence into all aspects of the investment portfolio, as well as set up a social choice fund to prioritise impact investment opportunities.

In an interview in the Harvard Gazette in May, HMC president and chief executive officer Jane Mendillo responded to concerns about the fund’s sustainable investing practices.

Mendillo says that as a long-term investor the fund had a responsibility to look closely at the sustainability of all investments.

“All of our investments are thoroughly vetted for their potential returns, their risks, and also for their sustainability.

Our due diligence process includes critical evaluation of issues related to environment, labour practices and corporate governance,” she told the university newspaper.

Yale University’s endowment has come under pressure to reform from The Responsible Endowment Project – a student led initiative that has called for a major overhaul of SRI/ESG investment practices at the $19.4 billion endowment.

The project has released a framework for responsible investing, arguing that Yale’s Advisory Committee on Responsible Investing, the body responsible for overseeing ethical investment practices, is no longer up to the task.

More than 80 per cent of the endowment’s assets are now held in alternative assets, according to project research released in 2009, with virtually all assets managed by external managers.

The committee’s focus on proxy voting, the project argues, means that it has little impact on oversight of the vast major investment activity.

The project’s demands for reform include full disclosure of holdings by the endowment as well as rigorous disclosure by external managers. It also advocates that the Yale endowment engage in collaborative investor networks such as the UNPRI.

However, the report’s researchers singled out the Yale institute as one of the better performing endowments, citing its allocation of $1.4 billion to clean technologies, renewables and sustainable timber.

“The case of Yale highlights how alternative asset classes such as private equity and venture capital and real assets such as timber can be particularly well suited for investments in environmental sustainability,” the report’s authors note.

The not-for-profit think tank Investor Responsibility Research Center Institute (IRRCI) funded the report.

MSCI looks at how equity investors can find European stocks that offer some protection against the current volatility buffering markets.

Zoltán Nagy and Oleg Ruban examine how the Barra Europe Equity model (EUE3) can be used to help identify stocks that are less sensitive to the unfavorable movements in troubled countries.

Using the covariance matrix of the EUE3 model, the researchers calculate the predicted betas of European stocks with respect to a given country. After repeating this separately for the five most troubled countries (Ireland, Portugal, Spain, Italy, and Greece), Nagy and Ruban look for common characteristics of the lowest beta stocks.

The results show important regional, sector and style commonalities among these securities.

To read the research click here

 

Co-head of responsible investment at the £32 billion Universities Superannuation Scheme, David Russell, says asset manager engagement with companies should move away from its “almost myopic focus on remuneration” to other issues that impact value and strategy.

His comments come on the back of the final report of the Kay Review of the UK equity markets and long-term decision making. One of the recommendations in the report was to improve the quality of engagement by investors with companies.

Russell says the challenge for the industry is in the implementation of the recommendations.

“Whilst we welcome the general thrust of Kay’s recommendations, the challenge is going to be with the implementation of the recommendations and the steps necessary to kick-start the changes needed which Kay has highlighted.

Across the board asset owners and asset managers in the UK have largely welcomed the recommendations.

Martin Gilbert, chief executive of Aberdeen Asset Management, one of the biggest managers in the UK with £182.7 billion in assets under management, said he was “very supportive of John Kay’s findings”.

“As an asset manager, we have very low turnover of about 10 per cent annually because we believe it is best to buy a good company and hold on to it as long as we can,” he said. “By being a long-term investor, it helps with engagement and corporate governance. We can engage with companies and act as proper and responsible owners of their stock.”

There were many recommendations that would have a material effect on the structure and habits of funds managers including disclosure of fees, re-thinking remuneration and a move away from quarterly reporting.

“I’m sure UK companies would like to move away from quarterly reporting but I think it would be difficult. US investors which many UK companies wish to attract to diversify their shareholder register view quarterly reporting as standard.”

The overall conclusion of the report is that short-termism is a problem in UK equity markets caused primarily by the decline of trust and the misalignment of incentives through the equity investment chain.

The review sets out principles that are designed to provide a foundation for a long-term perspective in UK equity markets and describe the directions in which regulatory policy and market practice should move.

“The epic story of Ulysses tying himself to the mast to resist the call of the sirens demonstrates the length of the history of attempts to construct devices and institutions to combat our instinctive short-termism. The central question for this review is whether capital markets in Britain today dissuade or stimulate the search for instant gratification in the corporate sector,” John Kay says in the final review report.

Some of the key recommendations of the review include:

  • Improving the quality of engagement by investors with companies
  • Increasing incentives to such engagement by encouraging asset managers to hold more concentrated portfolios judged on the basis of long-term absolute performance
  • Tackling misaligned incentives in the remuneration practices of company executives and asset managers, the disclosure of investment costs and in stock lending practices
  • Reducing the pressures for short-term decision making that arise from excessively frequent reporting of financial and investment performance, including quarterly reporting by companies and from excessive reliance on particular metrics and models for measuring performance, assessing risk and valuing assets
  • Companies should consult their major long-term investors over major board appointments
  • Asset managers should make full disclosure of all costs, including actual or estimated transactions costs, and performance fees charged to the fund
  • The Government and relevant regulators should commission an independent review of metrics and models employed in the investment chain to highlight their uses and limitations.

The review also recommends the establishment of an investors’ forum for institutional investors in UK companies.

USS’ Russell says ideas such as the investors’ forum are not new and it is uncertain of their impact.

“It remains to be seen if they will lead to this year’s increased voting and engagement activity becoming an established feature of the investment landscape,” he says.

“There also needs to be recognition that pension funds are broadening their holdings away from equities, particularly as defined benefit schemes mature. A consideration of what long term investment means for non-public equity holdings is essential in this context.”

Joanne Segars, chief executive of the National Association of Pension Funds whose members represent £800 billion says the report offers some useful, practical advances.

“Equity markets must work more effectively in the long-term interests of investors and savers, who need to be able to see that they are getting value for money.

“The NAPF is pleased to see Kay say that transaction costs and stock lending income should be set out more clearly. Boardroom pay must also become more transparent and more strongly linked to long-term performance.

“Most pension funds delegate responsibility for company engagement to an investment manager, and Kay is right that this relationship needs to be reshaped if good corporate governance is to develop further.

“Pension funds need to hold their managers accountable for delivering long-term returns, and quality stewardship should be a key factor when picking or reviewing investment managers. However, at present there are many competing priorities for trustees, and managers’ capabilities are difficult to assess.

“Our members regularly engage with companies on routine and more serious matters. This approach fits well with Kay’s suggestion of a forum to encourage collaboration among domestic and overseas investors, and it’s something funds will be keen to get involved in.

“We strongly support the FRC’s Stewardship Code and welcome the new best practice statements for asset owners. These could encourage pension funds to be more explicit in their expectations of their asset managers and more rigorous in holding them to account. We plan to incorporate the relevant parts of the statements into our Corporate Governance and Voting Policy and Guidance on the application of the Stewardship Code.”