Asset owners collaborating to influence labour rights in investee companies have another string to their bow with the release of the Committee on Workers’ Capital report examining large fund manager voting performance.

The report, designed in part to help investors hold fund managers to account, looked at 13 resolutions in the 2023 proxy voting season examining the number of supported resolutions, as well as the consistency and transparency of behaviour in manager proxy voting. For example only three of the asset managers examined, Blackrock, LGIM and UBS Asset Management, actually disclosed their proxy voting rationale.

One clear result was the disparity in the behaviours of the US versus non-US fund managers, with the report acknowledging the drivers of that behaviour including the regulatory differences.

The largest five asset managers, all headquartered in the US – Blackrock, Vanguard, Fidelity, SSgA, JP Morgan – demonstrated low support for proxy votes related to fundamental labour rights in 2023. But the non-US cohort that was examined – Amundi, LGIM, UBS, DWS Group, SUMI Trust – voted in support of the proxy votes most of the time.

Hugues Letourneau, associate director of the CWC said the large shareholdings these firms have in the S&P500 meant it was essential for asset owners to engage their managers on labour rights. And he said the influence of managers is increasing, demonstrated by the AUM of the largest fund managers growing by 150 per cent in the 10 years since 2013, compared with pension assets in OECD markets which has grown by 46 per cent in that time.

“We do think when a large shareholder votes against a resolution it makes it easier for a company to turn around and say ‘our top 10 shareholders don’t care about this’,” he said. “It makes it easier to sweep it away. We want asset owners to share this report with managers and ask them what they are doing on the key issues we raise in the report.”

One of the resolutions examined was the freedom of association resolution at Amazon.com, co-filed by Canadian pension fund BCI, marking the first time a Canadian pension fund has filed a labour rights resolution according to Letourneau. About 20 per cent of Amazon is owned by Vanguard, BlackRock, SSgA, Fidelity Investments, and JP Morgan Asset Management.

In this case two asset managers, Blackrock and JP Morgan AM, demonstrated uneven and confusing shareholder engagement escalation pathways. They disclosed that they had been engaging with Amazon on social issues since January 2022 and yet they didn’t vote on that resolution.

The Amazon case also demonstrated an example of split voting with JP Morgan AM voting differently depending on its funds. In the case of both Amazon.com and Netflix shareholder resolutions the JP Morgan Large Cap Growth Fund voted against both resolutions, and the JP Morgan Sustainable Leaders Fund voted for both resolutions. Letourneau said this demonstrates the important role of ESG teams within fund managers to coordinate messaging and voting positions.

Letourneau is also the founder of the CWC Asset Manager Accountability Initiative, convening asset owners from around the world to engage with global asset managers on investment stewardship practices.

In the past two years it has brought groups of 15 asset owners from around the world to directly engage together with fund managers, including Macquarie, UBS, SSgA and Blackrock, in structured clients meetings. It has a scheduled meeting to discuss labour rights with Blackrock this February.

Investing outside Canada can bring important benefits to client portfolios, but the $73.3 billion pension fund for Ontario’s public sector workers, IMCO, also believes that this should be balanced by careful considerations including an overwhelming bias to developed markets – and staying mindful that forecasts of GDP growth rates are not a good enough reason alone to venture outside Canada.

So outlines president and CEO Bert Clark in a recent posting on LinkedIn where he describes a global investment environment characterised by higher geopolitical risk, deglobalisation and the growing importance of ESG.

Around 65 per cent of IMCO assets are invested outside Canada most of which is in developed markets (approximately 93 per cent) thereby avoiding heightened currency, ESG and geopolitical risk inherent in some jurisdictions leaving just 7 per cent of assets under management in emerging economies.

Clark argues that large Canadian pension funds significantly increased the amount they invested outside of Canada in recent decades, driven by the elimination of federal tax restrictions, and the belief that large parts of the world were converging towards free markets and democracy. Tectonic shifts like the fall of the Berlin Wall in 1989, China joining the WTO and economic and monetary union in Europe signposted the way.

“In retrospect, it is hard to believe that so much progress occurred in such a short period of time. The sad postscript to the era that was thought to be the end of history is well known to us today. In recent years, globalization has waned, and geopolitical tensions and risk have risen,” he argues pointing to Brexit, US tariffs on Chinese exports and Russia’s invasion of Ukraine as examples.

In today’s context, he argues Canadian investors need to have a well-considered approach to where and why they are pursuing geographic diversification. A quick return to the optimistic years at the turn of the millennium seems unlikely today.

The need to invest outside Canada

Still, the benefits of investing outside Canada are compelling. Particularly because of the relatively small size and concentration of Canadian capital markets. The total market capitalization of the MSCI All-Country World Index (MSCI ACWI) is US$82 trillion while the market capitalization of the Toronto Stock Exchange (TSX) is only about 3 per cent of that of MSCI ACWI.

Meanwhile, financials and energy account for approximately 50 per cent of the S&P TSX index. The 10 largest companies in the TSX represent more than 35 per cent of the index but the top 10 companies in MSCI ACWI (which include behemoths like Apple and Microsoft) represent only 18 per cent of that index.

“An investor that only invests in Canadian public equity is investing in a very narrow subset of global equities, with a high concentration in financials and energy and a high concentration in a small number of companies,” he explains.

In addition, some important public debt market investment opportunities in Canada have been getting smaller.

One of the most important advantages of geographic diversification is the access it provides to private assets. For example, the nine largest Canadian pensions have reported investments of over $400-billion in private equity and $100-billion in private credit. The Canadian private equity and credit opportunity set simply would not have accommodated this level of investment. The Canadian government still owns assets like airports, ports, power utilities, roads and bridges that Canadian investors have been able to snap up overseas because of privatization programmes in other jurisdictions.

Clark warns that the correlation between economic growth and equity market returns is not strong enough to be the sole driver of investment decisions – especially in emerging markets. For example, from 2003-2021, Chinese GDP grew at an annualized rate of 8.55 per cent vs. 1.95 per cent in the US, but equity market price returns (based on MSCI indices) in the two countries were essentially the same over that period.

“Higher GDP growth did not result in higher equity returns.”

Many factors other than GDP growth drive equity market returns, including relative central bank policy, valuations, tax policy, competition policy, foreign investment and currency restrictions, the size and efficiency of domestic pools of capital, location of revenue source, international tax treaties, labour policy, geopolitical risk and ESG considerations.

Where to invest?

In answering the question where to invest outside Canada, investors should consider whether they have any real advantage investing in the jurisdictions they are contemplating.

Real investment advantages include things like operational leverage (the ability to leverage centralized risk, legal, HR, IT, back and middle office capabilities), relevant sectoral expertise, the ability to leverage scale (by making large commitments to best-in-class partners to reduce fees, for example) and the ability to invest directly and effectively oversee investments in the geographies being contemplated.

Just as only a very few companies can operate effectively in many jurisdictions, most investors can only leverage real investment advantages in select geographies.

Not having the ability to leverage any real advantage in a geography doesn’t mean it should be entirely excluded from an investor’s portfolio. But, because the opportunities for outperformance are less, it should mean investing less in those places and more in jurisdictions where they can leverage their advantages.

“This is why IMCO tends to focus its investments outside Canada in select jurisdictions, including the US, Europe and Australia. These are places where we are able to leverage our investment advantages, particularly our ability to partner with best-in-class investors, invest directly alongside our partners in private assets and participate in energy transition investments,” he says.

Investors should also be mindful of the impacts of foreign currency movements because these can have material impacts on investment risks and returns. Longer term foreign currency losses can sometimes be material (the Argentine Peso has declined by 97 per cent vs. the USD over the past 10 years) and in the near-term, movements in exchange rates can create material investment gains and losses that need to be planned for.

Near-term currency gains and losses for most developed market currencies can be efficiently mitigated through straightforward currency hedging transactions. But, emerging market currencies are more difficult to efficiently hedge.

Even in jurisdictions where hedging is more feasible, hedging currency requires access to liquidity to post as collateral. Investors who invest in foreign markets and hedge the related currencies will need to consider the liquidity requirements of doing so, which may mean owning more liquid low return assets like government bonds.

Today, investors who pursue geographic diversification also need to consider their ability to do so in a way that is consistent with their ESG beliefs. In some countries, particularly in frontier and emerging Markets, the laws and practices relating to environmental, labour, corporate disclosure, corruption and corporate governance make that more difficult.

Investors also need to consider the political risks associated with investing in some countries.

For example, Clark says the geopolitical risks associated with investing in some countries like Russia and China are much higher today than they have been in recent decades. Investors need to consider whether these geopolitical risks are ones they are willing to accept and are adequately compensated to take.

“IMCO does not invest in Russia and restricts investments in China almost exclusively to public equities and to a very small percentage (2 per cent) of the total assets we manage,” he concludes.

University of Texas Investment Management Co (UTIMCO), the $69.2 billion asset manager and one of the largest public endowments in the US, is hoping for a soft economic landing but planning for a recession. That means honing a playbook that ensures the investor has ongoing liquidity to make distributions; is not over its skis in terms of capital calls and commitments and has the firepower on hand to invest in opportunities.

In a worse-case scenario, given UTIMCO’s correlation to equity, if the stock market declines 20-50 per cent that could equate to an $11-24 billion decline in the value of assets under management. “It’s a lot of money,” said Richard Hall (pictured), president, CEO and CIO in a recent board meeting at the fund’s Austin headquarters.

Against the backdrop of contrasting analysis from UTIMCO’s trusted advisors – JPMorgan and PIMCO, for example, predict a soft landing but analysis from BlackRock and Bridgewater Associates is skewed to a hard landing – the investor is maintaining a neutral position but modelling how much the S&P could potentially decline should corporate earnings take a pounding.

“We will get through it, even if bad things happen next year,” he said.

Rebalancing in action

In an example of UTIMCO’s determination to invest in opportunities (and classic rebalancing strategy) Hall detailed how the fund pocketed a $2.3 billion gain out of the sharp fall in equity markets at the end of 2022.

UTIMCO steadily bought around $2 billion of stocks, continuing to buy even though the market’s continued fall exposed losses on earlier purchases. At the bottom, that collective purchase program had lost a negative P&L of about $200 million, he said.

The subsequent rally provided a $450 million total uplift on that basket of purchases which the team have gradually unwound overtime to maintain its neutral position.

“We sit today with a $238 million gain from having done that,” he said, underscoring the importance of staying neutral when clear market signals are absent and demonstrative of classic rebalancing and buying assets as they get cheaper in the belief that markets recover.

Under the hood of UTIMCO’s rolling asset allocation the team have introduced modest changes. For example, UTIMCO has bought down bonds by 3 per cent and is slowly adding real estate and infrastructure. “That stability doesn’t mean not doing anything. We rebalance month to month, selling expensive assets,” he reiterated.

In another corner of the portfolio, Hall has an eye on the interplay between cash and bonds. If rates stay higher for longer the fund will continue to hold cash. But if recession comes into view and the Federal Reserve begins to lower rates, the environment will become better for bonds and worse for cash and UTIMCO will position to benefit from the price appreciation in bonds.

Hall said that the recent performance in the equity market could hold clues as to what lies ahead. Struggling fundamentals in many smaller companies could be “the canary in the coalmine,” flashing trouble ahead.

Still, the team shared that the recent outperformance in the equity market (driven in the main by 10 stocks) underscores the importance of fundamentals; reaffirming that corporate sales, growth and margins bring the best returns – and that investors in a cap weighted index will do well as long as large companies pull returns higher. “What the market did was reward fundamentals,” said Hall. “Fundamentals matter and companies with better fundamentals appreciate more in value, most of the time.”

Looking into recent returns

Hall said that UTIMCO’s returns have been knocked by legacy portfolios in emerging markets and poor returns in natural resources, where although oil and gas did well, metals and mining worked against the portfolio. In contrast, public equity supported the portfolio once it reverted to solid trend.

“Long-term we try to run the portfolio at 100 basis points of alpha,” he said.

The bulk of UTIMCO’s assets are in an endowment funds portfolio which returned 6.7 per cent.

Public equities, one of UTIMCO’s biggest portfolios, experienced strong returns in developed markets and good returns in emerging markets. Private equity performed “slightly negatively” because although buyouts and private credit did well, venture and emerging markets allocations dragged.

In private markets, Hall predicts tougher times ahead for venture capital as companies seek to raise cash against the backdrop of lower valuations. In contrast, he said buyouts will remain stable.

Turning to hedge funds, he said managers are finding good spread opportunities between companies they are long and companies they are short. In real estate, UTIMCO is long-term bearish on office, more bullish on industrial and multi-family with a focus on US growth markets.

Still, as a contrarian investor, the team has begun to explore opportunities in office which might just be the right point in the cycle to go back in.

 

At this time of year our industry sees a plethora of outlooks covering the world through an investment lens, zooming in on inflation, interest rates, geopolitics and markets. Here I take the less common lens that zooms out on the big picture issues which, through the power of inter-connection, increasingly shape our investment world.

In the ever-evolving landscape of the global stage, the year 2024 holds promise, challenge, and a myriad of unforeseen events. F. Scott Fitzgerald’s notion of intelligence, the ability to hold two opposing ideas and function, resonates as we anticipate both the expected and the unexpected.

As we delve into the coming year, three key focal points emerge, each demanding our attention and thinking ahead: the ascent of systems thinking, the critical understanding of tipping points, and the growing nexus between an increasingly polarised society and new technology that is fostering a destructive post-truth zeitgeist.

Systems thinking: beyond the parts to the whole

The call for more profound systems thinking marks a paradigm shift in how we approach complex challenges. Peter Senge’s wisdom encapsulates this approach: seeing wholes instead of parts, understanding interrelationships rather than isolated entities, and working with patterns of change rather than static snapshots. In this era, success for the investment organisation hinges on comprehending and navigating the broader systems within which we operate.

As we embrace this holistic mindset, a shift in culture and learning becomes imperative. It’s about moving from zero-sum mentalities to positive-sum perspectives, going broader instead of deeper, and fostering collaboration that transcends individual success. The acronym VUCA — Volatility, Uncertainty, Complexity, and Ambiguity — becomes a guiding principle for cultivating vision, understanding, collaboration and adaptability in an ever-changing world.

Expanding our gaze to encompass earth and social systems is crucial. Anthropogenic changes have elevated the significance of earth systems, while increased interconnectedness has underscored the importance of social systems. Understanding these interconnected systems is paramount, as their intricacies hold the key to addressing the increasingly complex business and geo-political challenges.

Tipping points in climate and social dynamics

Tipping points, the moment where change becomes unstoppable, demand our attention. In climate systems, the Global Tipping Points report to COP28 warns that harmful tipping points pose grave threats to our planet’s life-support systems. And they put forward social tipping points as possible defences. We should remember that some tipping points can be positive.

The scientists’ lens is based on data and analysis and a passion to discover truths. This is one segment of our society that deserves respect for its judgements. Look out in 2024 for more influence from climate scientists. Investors need to show more imagination to gauge the power of breaches to Earth system boundaries and understand their effects on the resilience of our financial system.

At the same time, Malcolm Gladwell’s concept of social tipping points underscores the transformative power of ideas and trends once they reach a critical mass. The Global Tipping Points report advances the potential in positive tipping points like the electric vehicle transition shaped by a combination of social, financial, governance and technological forces. The pin-up here is Norway where these factors were aligned – last year 90 per cent of new cars sales there were electric. Marshalling these multiple influences is pivotal for shaping resilient societies and resilient financial markets.

Post-truth realities and navigating the misinformation era

The fusion of technology and human influence has given rise to post-truth landscapes, where appeals to emotion and personal beliefs often outweigh the trust in objective facts. We still have significant climate change scepticism despite the overwhelming weight of scientific evidence.  This erosion of trust in institutional truth-telling is fuelled by new media technologies amplified by AI and an over-promotional culture. Distinguishing truth from untruth becomes an increasingly complex task, exacerbated by the rise of deep fakes and misinformation.

Truth-seeking though remains a powerful force through the human values of humility and curiosity and the aptitude for critical thinking. This lens is what is needed to build the accurate belief about reality that is the essential foundation for any good outcome.

While much of the world still strives for truth, the fusion of different values, misaligned social media and the impact of technology threatens to pull us in the opposite direction. Vigilance is paramount, especially in the context of significant 2024 elections, where the spectre of deep fakes looms in a world where our AI guardrails seem too flimsy to protect the integrity of the system.

Navigating 2024: conclusions and actions

As we navigate the complexities of 2024, the interconnectedness of systems becomes evident. To thrive in this intricate web, embracing systems thinking, recognizing tipping points, and confronting post-truth realities are essential.

And applying systems thinking tells us that collective action across these areas is a multiplier to good outcomes. Being joined-up across people, organisations, countries, and thinking has never been more important.

By putting forward the right vision, understanding, collaboration and adaptability, we can foster a future where the test of our mettle lies not only in expecting the unexpected but also in shaping it.

 

In recent years, Iceland’s Lifeyrissjodur Verzlunarmanna, LV, has significantly boosted the passive allocation in its global equity portfolio.

The strategy, explains CIO Arne Vagn Olsen in an interview with Top1000Funds from the fund’s wintry headquarters, just south of Reykjavík, is a consequence of successful fee negotiations with the likes of index managers BlackRock, Vanguard and StateStreet and deciding to drop active managers because they struggled to outperform. Almost 80 per cent of the global equity allocation is now passive.

“Given the size of the fund and the size of our mandates, we have been able to negotiate and reduce equity management fees to a level we feel comfortable with. Our growing fund size and the increase in overseas investment has given us leverage in fee negotiations.”

LV is certainly growing. The €8 billion pension fund, still open and a hybrid of DC and DB is Iceland’s second largest; it was set up in 1956 and with 180,000 members (around half of the population) will be the largest pension fund in the country in the next decade.

Moreover, LV’s global allocation (45 per cent of AUM to global public and private markets) is significantly larger than peer funds which typically allocate around 35 per cent of their assets outside Iceland.

“The combined assets of Iceland’s pension sector is twice the size of Iceland’s GDP so it’s important for us to invest outside of Iceland to reduce systematic risk in our portfolio,” he explains.

Increasing fixed income

Olsen is also planning to increase the allocation to overseas fixed income, currently around 5 per cent of total assets. The strategy is being driven by forecast increases in volatility over the coming years because of inflation uncertainty and the impact of AI and ESG as well as higher bond yields, he says.

“Nobody really understands the impact of ESG legislation on markets,” he warns.

The boosted allocation is likely to be actively managed and focused on investment grade developed markets, but he also plans to add a high yield allocation and other instruments outside typical investment grade. “We are in the process of analysing and simulating the potential impact on the portfolio from a risk and return perspective. Nothing is decided yet.”

Although it will most likely be actively  managed, he plans to tap the same fee benefits in fixed income as he has in equity. “We don’t have the same amount of leverage to put pressure on our managers in fixed income. But part of the allocation shift will include fee negotiations and our aim is to try and get the same results as we have in equity.”

Managing inflation risk

One of Olsen’s biggest challenges is navigating Iceland’s inflation, currently running at 8 per cent. Although the fund invests in inflation-linked assets (around 35 per cent of the portfolio is inflation-linked whereby the value of the investment rises with inflation) it is unable to hedge inflation risk in its liabilities – beneficiary payments are pegged to inflation and have risen exponentially.

“Our liabilities are growing with inflation and the risk is that we may have to cut benefits if our assets can no longer cover our liabilities. Our ability to neutralise this risk is limited because we don’t have the tools.”

In contrast to the United Kingdom’s BTPS or Denmark’s ATP, LV can’t use derivatives to hedge its liabilities because its size dwarfs the market capitalization of Iceland’s banks, creating too much counterparty risk on the other side of any swap.

“We wouldn’t feel comfortable taking counterparty risk with a local bank to hedge all our liabilities,” he says, observing that ever since Iceland’s banking crisis in 2008 and the sweeping regulation in its aftermath, the banking sector has curtailed business abroad and has much stricter rules around reserves. In contrast, the country’s pension industry is growing, and increasingly international.

One solution could be investing more in inflation linked infrastructure opportunities in Iceland. However, this would require policy makers providing more support to encourage investors into the space.

In other changes, Olsen is considering using more of LV’s tactical asset allocation to ensure the investor is nimble and takes advantage of opportunities. “Tactical asset management will be more important than it used to be,” he predicts. Around 5-10 per cent of the portfolio is currently managed tactically.

LV has also rewritten its rules around rebalancing.

“If you don’t rebalance regularly, it’s not really a strategic asset allocation,” he says. “We will rebalance more regularly, but it will also come down to volatility. We need to be prepared to change our decision around our allocations if the market conditions change and we do believe we are heading into unchartered territory in the coming years.”

 

A recent investment by APG, the €517 billion Dutch asset manager, in a Woman’s Livelihood Bond that provides access to capital for women entrepreneurs in Asia and Africa provides a compelling alternative to emerging market corporate and sovereign debt or DFI issuance.

The strategy also offers a window into how APG’s responsible investment strategy has evolved to incorporate impact – in this case advancing SDG 5 and 13, a nexus of gender equity and climate action respectively. APG began integrating the SDGs in 2015 following requests from its major client pension fund ABP whose beneficiaries work in the government and education sectors. and targets 20 per cent of its AUM in the SDGs.

Singapore-based IIX, Impact Investment Exchange, manages and oversees the loan disbursements to portfolio companies – the underlying borrowers – and is a corporate issuer itself. But APG’s $30 million investment is lower risk than typical emerging market corporate debt because it has developed market government-backed guarantees.

The underlying corporates have similar default probabilities of emerging market corporates, but with the prospect of much higher debt recovery rates, due to the participation of DFIs.

“IIX secured a government-backed partial guarantee from the Swedish International Development Cooperation Agency (Sida), as well as support from the U.S. International Development Finance Corporation (DFC). That lowers the risk for investors compared to other emerging market corporates,” explains APG senior credit analyst and sustainability lead, Joshua Linder.

The investment also has relatively low volatility and little correlation with highly liquid credit investments in public markets. The bond priced with an annual coupon of 7.25 per cent.

In another facet of the strategy, it is easier to direct impact in this kind of structure compared to broad-brush emerging market investments.

“During our due diligence, we profiled each of the portfolio companies to ensure that the expected end beneficiaries align with client impact priorities. We also reviewed IIX’s historical track record for impact reporting, which includes surveys with representative samples of end beneficiaries. The detailed impact reporting – both from a quantitative and qualitative perspective – gives us further confidence,” says Linder.

Monitoring impact is one of the most complex challenges for impact investors. But APG responsible investment credit analyst, Lee Anne Hagel is impressed with IIX’s track record when it comes to reporting.

“As investors in this bond, it is crucial that we have transparency – detailed information on the activities our investment is funding and what is achieved in concrete terms. IIX uses pre-determined financial and social metrics, collects input from the end beneficiaries, and proactively verifies the impact data. In addition to annual financial reporting, we will also receive semi-annual impact reports on the individual borrowers we are lending to and on our investment as a whole,” she says.

Sustainability and digitisation are overarching themes shaping APG’s investment strategy, visible in a Sustainable Development Investment (SDI) Asset Owner Platform, driven by AI technology. The platform, launched in 2020, is designed to deliver on the SDGs and support positive outcomes. It has been created by investors for investors, and is shaped around innovation and cooperation.

Developed together with PGGM, the platform sifts through reams of structured and unstructured data to gauge the extent to which companies’ products and activities meet the SDGs.

The platform scores companies’ products and services rather than corporate conduct, the traditional ESG lens. Enthusiasts argue that SDG scores are better at integrating impact. For example, research shows that some companies with poor SDG scores can secure good ESG scores and ESG ratings can struggle to reflect positive impacts.

Meanwhile other investors like Bridgewater are increasingly incorporating risk, return and impact in a three dimensional model.