Evolving portfolio construction techniques that include more attention to liquidity management, diversification and resilience are needed in a macro environment that has more complexity and volatility delegates at the Fiduciary Investors Symposium at Stanford University heard. Investors from CalSTRS, CPP Investments and MFS share their approach.

Evolving portfolio construction techniques that include more attention to liquidity management, diversification and resilience are needed in a macro environment that has more complexity and volatility.

Delegates at the Fiduciary Investors Symposium at Stanford University heard that inflation, geopolitical risk, and climate are contributors to a more complex environment that has a broader range of outcomes, dictating an evolving approach to portfolio construction.

Derek Walker, head of portfolio design and construction at CPP Investments and Geraldine Jimenez, senior investment director at CalSTRS both said that liquidity management was top of mind.

For CalSTRS it was focused on the funded status and the maturity of the plan and a larger allocation to private markets than ever before.

For CPP the focus on liquidity is to ensure “as much capital is put to work as possible”.

“Our focus on liquidity is quite intense, not because of cashflow needs but because we want to allocate as much as we can to active programs and that they are allocated as efficiently as possible,” Walker says.

The panel, which also included Benoit Anne (pictured), managing director of fixed income solutions at MFS, participated in a conversation about diversification that was anchored around liquidity and equity bond correlations.

CPP Investments has built its investment strategy on “three big planks” with one of those constructing resilient portfolios.

“Correlations are such a crucial part of diversification and something we have been trying to augment, in terms of, for example, adding inflation sensitive assets.”

Similarly, CalSTRS has added inflation-sensitive assets, a risk-mitigating strategy, and private credit.

With investors looking for a strategy to truly provide diversification, MFS’s Anne proffered the return of fixed income as an alternative to alternatives.

“I’m really excited about the comeback of fixed income as an interesting asset class after years of risking falling into oblivion,” he told delegates, pointing to duration risk in particular.

He said the analysis of macro regimes was a very important pillar of the investment process and was ecstatic to be moving away from the era of quantitative easing. Monetary policy, he said, was “back as a powerful policy tool” going forward.

“We are moving away from the fear of the Fed that was very toxic and painful for most investors for the past few quarters,” he said.

“Thank god we are exiting this long era of QE, which came with a lot of collateral damage and distortions and we are now facing the luxury of some sort of normalisation, the old normal. It is very good news, we are embracing the shift away from QE.”

Anne said there was definitely a shift to more complexity and higher uncertainty which was a favourable environment for fixed income.

“I think public fixed income provides one way to manage that complexity after the repricing because fixed income is back as a volatility management tool and return generator.”

 

Bridgewater Associates co-chief investment officer Greg Jensen said government policy has steadily increased in influence over the economy and portfolio construction over the past 20 years and now outstrips the importance of private sector incentives. The pace of deglobalisation is a key trend for institutional investors to keep abreast of, he says, as the US races towards another presidential election cycle.

Government policy has surpassed private sector incentives as a major factor influencing financial markets and portfolio outcomes, said Greg Jensen, co-chief investment officer at Bridgewater Associates.

Jensen, who leads portfolio construction at the storied hedge fund alongside Karen Karniol-Tambour and Bob Prince, told the Fiduciary Investors Symposium at Stanford University last week that investors need to pay more attention to geopolitics and public policy now than at any time in the past two decades of market cycles.

“This is a very time where politics matter a lot, with a lot of cross cutting ways,” he said. “If you turn back the clock 20 years … largely, in most of the West, the politics weren’t that important, the private sector was the more dominant driver of the economy.

“[But] today, with the geopolitics and the degree of government [intervention] … fiscal and monetary policy are as important drivers oif the economy as the private sector and the incentives of capitalism.”

Jensen listed climate policy and the energy transition as an example of a policy area in which the decisions of world governments would have an outsized influence over investments. Initiatives aimed at reducing wealth inequality was another.

The Connecticut-based investment chief estimated that government policy had grown from representing a 30 per cent influence over the global economy, with the private sector accounting for 70 per cent, to a 60/40 split in government’s favour.

Asked whether the outcome of next year’s US presidential election mattered to investors, Jensen said the “rate of deglobalisation” was one of the important trends that could be impacted. Republican frontrunner and former President Donald Trump was a vocal opponent of globalism and the US economy’s seeming reliance on foreign manufacturing.

In order to protect portfolios against the geopolitical risk, Jensen suggested CIOs consider an equation that analyses “ the effects of globalisation, and then reverse those things”. He said the pace with which deglobalisation was taking hold in the global economy was having an enormous impact on portfolios, referencing trade between the US and China, which took decades to build up gradually but “fell off a cliff” amid more recent diplomatic tensions.

Those trade tensions meant that “marginal dollars” are now flowing out of China to more expensive markets from the perspective of productivity, although Jensen added the labour cost gap between China and the rest of the world has reduced as living standards in the world’s most populous nation have risen.

“We’re trying we’re trying to measure those flows, trying to measure the economic quantities that are coming out of China, where they’ll go and how those things are going to be affected. And, that’s a huge area of work.”

Jensen admitted that Bridgewater had made a number of missteps that dragged on investment performance in the second half of 2022. Inflation in the US fell more dramatically than the firm and its analysts had predicted, while the downturn in economic activity was more muted.

But he stood behind the thesis that many economic indicators are “unsustainable”, even though the original call from Bridgewater may have been eight or nine months early.

“The big picture is that the profit margin picture for companies is getting worse,” Jensen said. “Corporations and households, particularly in the US have extended their duration to such a degree that debts are very long duration, [which] means the tightening plays out over a longer period of time than it would otherwise. Those things have slowed down the cycle, but I don’t think it’s ended the basic shape of the cycle. And so I do think you’re going to see weaker growth.”

Jensen said Bridgewater’s famed research process, which now incorporates elements of generative AI in the form of virtual investment associate, had input all the data relating to the misguided bets of last year and would factor them into future predictions.

“The great thing about markets is you have two outcomes,” he said. “You could be right, which is kind of cool. Or you could be wrong, and you get to learn, which is also kind of cool.”

 More than $4 trillion a year in investment is needed over the next 30 years to meet the goal of net zero by 2050, asset owners have been told. Arun Majumdar, dean of Stanford University’s school of sustainability describes it as the “defining challenge and opportunity of the 21st century” for investors. But Greg Jackson, chief executive of renewables pioneer Octopus Energy, says it is only feasible if a revolutionary new global energy grid is established.  

More than $4 trillion a year in investment is needed over the next 30 years to meet the goal of net zero by 2050, asset owners have been told.

The figure, an estimate of the International Energy Agency, was described by Arun Majumdar, inaugural dean of the Stanford Doerr School of Sustainability, as the “defining challenge and opportunity of the 21st century”, with a critical role to be played by private capital.

“All the major nations, fortune 500 companies have made commitments but no-one knows how to get there,” Majumdar told the Top1000funds.com Fiduciary Investors Symposium at Stanford University in California last week.

Majumdar, a former vice-president of energy at Google, said the scale of the challenge was vast but the commercial opportunities for investors were beginning to stack up. “We have never seen solar and wind this good and cheap in human history,” he said.

But Greg Jackson, chief executive of London-headquartered Octopus Energy – which has 5.3 million customers via its retail arm – said “incumbent thinking” was thwarting progress on net zero and investment in renewables.

“If anyone should understand exponential growth its investors,” Jackson told the symposium. “The only thing holding us back is actions of governments, companies and their investors.”

He joked that he was going to “ban the words ‘energy transition’” in his company, urging that a more wholesale shift in consumer and investor behaviour was required.

“We need to build an entirely new, upgraded global energy system,” he said.

Majumdar concurred, describing the approach as “powerful” and noting that the electricity grid used in most nations had not advanced much technologically since “Edison and Tesla”, a reference to 19th century inventors Thomas Edison and Nikola Tesla.

At the same time, Majumdar, who had just returned to the Stanford campus from a tour of Asia, including the G20 summit in India, said it was important that business and activists acknowledged that different regions must set their own timelines and commitments.

He gave the example of Indonesia, which he said would “love to transition” because its food production was already being adversely affected by climate change-related heat waves, but was also still opening and operating coal power stations years away from ammortization.

On the flipside, Jackson said there were signs of swift progress in the developed world, with the number of EV charging stations in the UK growing tenfold in a 12-month period.

In response to a question from the floor from an executive at a US pension scheme, who complained that some interpretations of the fiduciary duty precluded impact investing in renewable energy, Jackson reminded delegates to the symposium of their political clout, as the stewards of almost $8 trillion in investor capital.

“Talk to your governments – if you’re being forced to invest in the wrong things, they [will] listen to you.”

Investors face challenges finding opportunities among companies that don’t have a clearly defined transition pathway. But it can made more effective by a focus on the tangible investments being made by those companies, rather than listening too closely to pledges and targets that exist only on paper.

Investors that want to address the low carbon transition as a potential investment theme should build an investment process that helps them focus on tangible investments being made by companies, not just pledges made on paper, the Fiduciary Investors Symposium at Stanford University has heard.

Affirmative Investment Management sustainable credit specialist George Barnard told the symposium the first pillar of a research process for doing that is deep company-level expertise. The second pillar is a systems or whole-economy approach; and the third is “making sure that all of this is integrated into the investment process”.

Barnard said a deep research approach involves integrating often overlapping areas of investment expertise.

“The first and most familiar to us as investors is company-level expertise,” he said.

“This is an understanding of the company. Rather than from a fundamental credit perspective [it’s understanding it] from a transition perspective. We need to understand the plans, the targets…beyond just are they targeting X percent emissions reductions?”

Barnard said one of the hurdles to the low-carbon transition is scepticism about timeframes being unrealistic, or targets set and pledges made insincerely.

“We’ve seen a lot of net-zero pledges which functionally aren’t really worth the paper they’re written on,” he said.

But if that’s the elephant in the room of the transition debate, the key to solving it is to eat that elephant one bite at a time.

“One of the problems is that we’re dealing with a very large problem and we’re not breaking it down.

“When you look at transition as a theme, and it’s just this massive economy-wide problem, it’s very hard to engage with. It’s very hard to identify a company and say, you know, yes, this is a good candidate for the low carbon transition.

“So we also need to understand the tangible investments, the capital being deployed [and] the R&D going on in the background that will actually get that company to those targets.”

Barnard said some companies, industries and sectors have relatively clear transition paths but for others it’s less clear and considerably more challenging.

As an example, the production of aluminium can use renewable energy as an input to the manufacturing process, But on the other hand, it uses anodes that decay and release CO2 into the atmosphere.

“We know there’s a solution, in anodes which don’t degrade and therefore don’t release CO2 into the environment [but] we don’t know how to make them,” he said.

Barnard said engaging with companies in “in a constructive and robust way with respect to their transition plans” is key to identifying opportunities and investment targets and supplying the capital those entities need to make the transition.

“That requires an understanding of what those risks and opportunities are, it requires an understanding of what the potential future solutions are going to be, and whether they’re realistic, and in what timeframes. And that’s really the idea behind transition analysis.”

Barnard said a core component of any company analysis is the tangible investments being made and committed to, which can’t be rolled back or reneged on.

“We like to see robust targets and strategies, but they’re not as good as seeing that this car company is building a dedicated EV plant like they’re not going to not going to knock it down in five years, that it’s locked in,” he said.

“We like to see JVs with battery producers to build huge amounts of capacity. That’s the kind of thing that allows us to be confident in the longevity of that particular strategy.

“There is always uncertainty, and we have seen companies roll back on commitments, but we aim to be as confident as we can with the information that we have at the time.”

Affinity approaches transition finance from a fixed-income perspective, because that’s its background as a manager, but Barnard stresses that the strategy need not necessarily be restricted to bonds. The genesis of the strategy was to consider what a 2050 economy looks like, and a realisation there are hard-to-abate sectors in the economy that re not receiving the investment they needed to effect a transition.

“We were looking at portfolios and thinking, there’s a need to address here,” he said.

“But when we were building that strategy to address that need, it wasn’t from the perspective of let’s go into a new asset class. It was [that] we do this, and we want to support our clients to generate the most impact they can, and to provide innovative new solutions to generate that impact. And that’s really where the strategy stemmed from.”

Barnard said the strategy has started to shift into private asset classes but is moving slowly as it gathers and assesses the quality of the data it needs to support its deep-research approach

“You’ve got to work out, okay, how do I digest this new type of data, this new availability of data?” he said.

“What levers can I pull to increase the availability of that? And so that process is ongoing, but it will, [and] there are there are challenges to solve that.”

A foundation stone of the transition to renewable energy is paradoxically a major contributor to the problem it’s helping to solve. How asset owners think about investing in a solution that is also part of the problem is a challenging and complex task.

Semiconductors are integral to the transition to renewable energy and the development of AI. But investors face a paradox when semiconductor production itself has such a large environmental footprint.

The energy transition and the growth of AI is inconceivable without semiconductors, Pictet Asset Management senior portfolio manager Luciano Diana told the Top1000funds.com Fiduciary Investors Symposium at Stanford University.

Diana said the question facing investors is whether semiconductors are a very simple enabler of the energy transition, or whether they a growing environmental problem, “and the answer is both, actually”.

“We do have a paradox, because they are crucial for the green transition,” he said.

“They enable electrification, decarbonisation and energy efficiency. At the same time, they have an environmental footprint which is growing very rapidly in-line with our data economy.”

That footprint includes the use of large quantities of water, and (perhaps ironically) energy consumption.

“Should an investor like me, a responsible investor, allocate capital to this important and growing industry? Should I avoid it altogether? It’s a very complex topic,” Diana said.

Diana said calculating the footprint of semiconductor manufacturing is complex and bedevilled by incomplete data and, in any case, only tells part of the total story. But the energy transition can’t happen without increased semiconductor production so Pictet applies two conceptual frameworks to its investment decisions. The first is the concept of planetary boundaries, originally developed by the Stockholm Resilience Centre.

“It comprises nine dimensions [including] climate change, biodiversity, freshwater, chemical pollution,” Diana said.

“These are all interconnected, it’s really crucial to understand this. And each dimension has a boundary that shouldn’t be crossed if we want to avoid nonlinear and irreversible change.”

(The Stockholm Resilience Centre reported earlier this month the six of the nine boundaries have already been crossed.)

The second conceptual framework is lifecycle analysis, which is an estimate of energy, water and raw material-related emissions that are associated with a product’s lifecycle. And the lifecycle analysis gives rise to the concept of a company’s “handprint”.

Diana said a company generates a handprint when it offers its customers a solution that has a lower footprint than business as usual. It is a positive environmental measure, and the bigger the better, and there’s theoretically no limit to a company’s handprint.

“This is the opposite concept to that of the footprint, where with the footprint we want to reduce it down to zero as much as possible,” he said.

“Here, we want to maximize it. And because it’s a difference between a baseline and a counterfactual scenario, measuring a handprint inherently is complex and cannot be done very precisely.”

This approach can, and does, give rise to scenarios whre an investor commits capital to a company it knows has a large and often growing environmental footprint, but for the sake of the role the company plays in reducing the footprints of others.

Diana says the aim is to identify and invest in companies that “only want to minimize their own footprint, but they also at the same time want to maximize their handprint on the rest of the economy”.

Semiconductors are a good example of this approach, and there are others. And while there’s been significant focus on the production of semiconductors, particularly as a result of heightened public interest in renewable energy and AI, Diana says it’s important to keep the environmental issues in perspective for two reasons.

“The first reason is that the emissions from semiconductor manufacturing alone are around 100 million tons of CO2 equivalent per year,” Diana said.

“That’s 0.2 per cent of the global total. But more importantly, this footprint of an industry doesn’t tell the whole story about the environmental impact that it has on the rest of the economy. It’s important and essential I should say to also look at the handprint.”

After a slow and steady research and development phase, the “big bang” moment of last year’s ChatGPT launch will kick off a slew of innovations that could rival the internet for their profitable application to investible businesses, says tech equity analyst Owen Hyde of Jennison Associates.

After a slow and steady research and development phase, Owen Hyde of Jennison Associates expected a slew of investible artificial intelligence innovations to come to market.

The New York-based tech equity analyst told the Fiduciary Investors Symposium at Stanford University on Wednesday that the launch of Microsoft-backed OpenAI’s ChatGPT tool in November last year was a “big bang” moment for institutional capital to begin flowing to artificial intelligence ventures.

“The question is how fast we go from R&D to production,” Hyde said. “I think it can be as big [as the internet] because it’s a new platform, in the same way the internet was a new platform you can build on top of.

“There’s fundamentally new capabilities that you can have when you’re able to generate text or generate images, and I’m not smart enough to be able to guess what all those applications are going to be. But I know we’ve seen some interesting stuff early on.”

Hyde, who was previously an analyst at JPMorgan, said the AI sector was on the cusp of a major innovation as “multimodal” applications – i.e. tools that can take multiple inputs and generate multiple outputs – begin to launch to the public, possibly before the end of 2023.

“Right now, we can see a handful of pretty clear opportunities in the app space but we think we’re also going to find out that there’s stuff that we haven’t thought of yet. And that’s where I am getting really excited because there’s opportunities.”

He anticipated that enterprise-facing AI applications would be the first serious investible proposition, singling out existing software providers who are able to help clients boost productivity by harnessing AI technology would be obvious early winners. But he said there were also plausible consumer use cases in the near to medium term, including personal assistants who might answer questions or assist with administrative tasks such as booking travel, although he added there may be a “behavioral” hurdle to consumer take-up of AI tools.

However he said the sector faced considerable regulatory risk, given its nascent status and government concerns about AI-generated misinformation or “hallucinations”.

“I worry about something happening that creates an issue for the whole industry and gives it a bad name,” he said. “And that regulation has to come in after the fact and goes over the top.”

He dismissed concerns that AI may replace many human jobs, which may create populist obstacles to its rollout, saying any serious discussion of replacement technologies for existing parts of the workforce were at least five years’ away.

And, even if it were to replace some menial tasks, Hyde suggested some economists and investors may welcome that development anyway.

“Employment growth may slow … but that’s somewhat healthy,” he said. “That might be a deflationary force in what has been a very inflationary environment.”