Funds around the world improved their scores on responsible investment disclosure by more than on any of the three other factors assessed in the 2023 Global Pension Transparency Benchmark.

The GPTB measures the transparency of disclosures of 15 pension systems across the value-generating measures of cost, governance, performance and responsible investment. Scores of all four factors improved this year compared to last year.

Responsible investment disclosures showed the most improvement, with the average score improving by 20 per cent, from an average score of 49 to 59 year-on-year.

This was followed by the governance factor, which achieved the highest average score this year of 65 out of a possible 100, an improvement of 11 per cent for the year. The gain was driven by 92 per cent of funds improving their governance disclosure.

Average scores for performance disclosures declined slightly, from 64 to 62 year on year.

Cost scores improved from an average of 48 to 51; however, with the stark improvement of the responsible investment factor, cost disclosures now rate as the lowest average score of all the four factors. Only 45 per cent of funds improved their public reporting on costs.

CEM Benchmarking product lead for transparency benchmarking Edsart Heuberger says that funds would generally gain the most by improving their external investment cost and responsible investing disclosures.

In terms of individual fund scores, the Dutch fund Stichting Pensioenfonds Zorg en Welzijn topped the list for cost. In the governance factor, three funds ranked equal first, all achieving the extraordinary result of full marks in their scores: Australia’s AustralianSuper, and Canada’s CDPQ and CPP Investments.

Norway’s Government Pension Fund Global was the best fund for transparency of disclosures related to performance and also took equal top spot with Dutch fund bpfBOUW for responsible investment.

In last year’s review it was noted that governance scores were most closely correlated with the overall score, and that perhaps it was the case that as good governance produces positive results, it creates greater incentive (or perhaps less disincentive) to be transparent with stakeholders.

CEM observes this year that responsible investing disclosures showed an equal correlation with governance and that good governance allows funds to move beyond simply managing assets and towards addressing wider environmental and social issues.

Cost factor

The average country cost factor score was 51 but there was huge variation between individual funds, with scores ranging from 7 to 93. Heuberger says as the dispersion in scores suggest, cost disclosures varied considerably in completeness, and he urges funds to pay more attention to this factor.

CEM’s asset-owner performance database clearly shows that net returns are materially impacted by investment management costs, with about 75 per cent of gross returns above benchmarks going to pay related investment expenses.

But paying more does not necessarily get you more: CEM says cost-effective investment management strategies generally outperform high-cost approaches over the long-term. Costs matter, and they should be understood, managed, and disclosed.

Barriers to comparing costs around the globe include differences in tax treatment, organisation/plan types, and accounting and regulatory standards, which all mean it is difficult to find common ground for assessment.

“Cost reporting seems to be the area where funds flounder a little bit,” Heuberger says.  “It takes considerable effort internally, and also requires external managers to report to you. It could take five to 10 years to see the change required.”

Governance factor

The average country score for governance was 71 out of a possible 100. This represented an increase of seven from last year’s average score of 64, and makes it the best rated of the four factors.

The governance factor was one of the standout results in this year’s GPTB, with three funds ranked equal first and all three achieving the extraordinary result of full marks: AustralianSuper, CDPQ and CPP Investments all scored 100.

The biggest Canadian public funds continued to be the leaders in governance disclosures, consistent with their reputation of excellent governance. All five Canadian funds included in the benchmark featured in the top 10 funds for governance disclosures, and were all in the top 10 funds overall.

 Performance factor

The overall average score for performance was 62, a slight decline from 64 last year. Average country scores ranged from 21 to 95.

The US and Canadian funds lead the way, with an average country score of 87 and 89 respectively.

These funds typically had extensive and good quality reporting across all performance components.

 

Responsible investing factor

Funds were scored based on 54 questions across three major components. The average country score was 49 out of 100 up from 42 in last year’s review, marking the biggest relative improvement among any of the four factors.

Improvements to disclosures were seen across all components and most countries, however this factor still has the greatest dispersion of scores reflecting that countries are at different stages of implementing responsible investing within their investing framework. Average country scores ranged from 0 to 94.

The Netherlands stole Sweden’s crown in this factor with a score of 77, besting the Swedish funds by a single point. Both countries had improved disclosures over the past year. The Nordic countries – Sweden, Denmark, Finland, and Norway – continued to do very well as a region on responsible investing, with all countries receiving scores well above average.

CEM’s Heuberger notes that funds were more likely to provide quantification of their responsible investing initiatives and this year, and that more funds went a step further and provided context by laying out longer-term goals.

“Several funds started producing stand-alone reports focused exclusively on responsible investing which provided comprehensive, holistic overviews of their programs,” he said.

While overall in the past three years there has been positive momentum in the advancement of transparency across all the factors, there is still room for improvement.

“Leading countries excel in different areas,” Heuberger said.

“Canadians have terrific reporting on governance and investment performance. The Dutch are world-class on costs. The Nordics excel in responsible investing.

“Generally, funds would gain the most by improving their external investment cost and responsible investing disclosures.”

 For all the scores and rankings by country, fund and factor click here

Is chasing the Canadian model of a large allocation to illiquid assets appropriate for every pension fund? It’s a question that the £34 billion multi-client asset owner Railpen has been investigating in research that examined the right target allocation to illiquid assets in the context of risk tolerance, flexibility and liquidity management.

“This is something we have wrestled with for a while,” head of investment strategy and research John Greaves says.

“Parking the strategic merits of investing in illiquid assets, we wanted to investigate our client’s liquidity capacity, or risk tolerance related to their allocation to illiquid assets, across private equity, private debt, infrastructure, real estate and other alternative illiquid assets.”

According to Greaves the most important thing in setting the limits on long-term illiquid asset allocation is the “portfolio steerability” which includes understanding the clients’ need for flexibility.

“Every investor has a tolerance for the portfolio to drift over time away from a strategic asset allocation,” he says.

“Illiquid asset classes tend to have smoothed and lagged asset valuations which can amplify this effect.”

Led by Lukas Vaiciulis, research by the strategy team – which will publish a working paper later this year – resulted in a framework that focused on scenario planning and the uncertainty inherent in illiquid investments.

Greaves says the allocation to illiquid assets has typically been approached by investors in a heuristic manner, with allocations determined by what “feels right”. A research literature review didn’t reveal much quantifiable research and yet it is one of the most important decisions that investors make.

“It is something you can plan for and think about what happens and what you would do under different scenarios,” Greaves says. “I was really keen we approach this in an open-minded way. I asked the team to tell me why we can’t do the Canadian model.”

Railpen’s scenario planning focused on the problem of over-allocation and the inability to get back to target in a reasonable timeframe or to deploy in favourable market conditions.

“We looked at the allocation drift and what the options were to rebalance, including secondary market transactions” Greaves said, in an interview in the fund’s Liverpool Street, London, office.

The impact on short-term liquidity management was also considered. “Typically, short-term liquidity risk is managed by maintaining a prudent level of cash-like assets against an extremely stressed cashflow scenario. However, the issues come when you need to recapitalise. What assets are you selling? What if the stress gets worse over the following months? We found these issues interacted with the illiquid assets, but it was only limiting at very high levels of illiquid assets given our cashflow profile and liquid asset mix.”

Uncertainty and lagged performance

The Railpen modelling also looked at the uncertainty of returns and cashflows and the impact of lagged returns and smoothing.

“We wanted to have a framework where we recognise the uncertainty with illiquid asset cashflows and can test different allocations against our risk appetite and make sure we are able to do what is needed for our clients in certain environments,” Greaves says.

A framework was developed that tested a number of scenarios including changing the strategic allocation without undermining the investment case of the investments.

“Investors allocate to long-term illiquid investments because it is bringing something to the overall portfolio, like additional return or diversification, and we need to hold the assets for a reasonable period of time to realise those benefits, it takes time to play out,” Greaves says.

“From a portfolio construction perspective, if you need to sell at the wrong time, it might undermine the reason for the investment in the first place. I think it is a common myth that you can just sell certain direct investments when you need to. There is typically an investment thesis that plays out over many years and of course large costs to buy and sell,” he says. “We want to try and avoid having to sell assets before we would like to or being unable to deploy in favourable market conditions, where possible.”

Testing the portfolio against various scenarios while being able to maintain investment discipline resulted in an allocation to illiquid assets for defined benefit (DB) schemes open to new members of around 30-40 per cent, much smaller than the allocations seen by the Canadian funds which in many cases is 60-70 per cent of the portfolio. This highlights the importance of recognising and understanding client-unique objectives, constraints, and opportunity sets in choosing the right investment strategy.

“We found when we go above a 40 per cent allocation to illiquid assets, we start to see a lot of drift, forced sales and big changes in the amount we can deploy each year, particularly in a scenario where the target changes” Greaves says.

The open DB pension schemes that Railpen manages are slightly cashflow-negative which also impacts the illiquid allocation.

“Cashflow positive funds can go higher,” Greaves says.

Flexibility, agility and change in processes

The research also looked at allowing for the target allocation to change through time. Flexibility is important if the belief is the right strategy for an open DB fund can change over time in response to market conditions and funding.

“We do think flexibility is important and we wanted to test the ability to change our mind in the future,” Greaves says.

“The results were somewhat non-contentious, but the exercise gave us some quantitative rigour and gave us some confidence. If the board says our mandate will never change then that’s different. Some funds like sovereign wealth funds perhaps have a more stable mandate.”

Railpen found the illiquid asset mix was also very important. “If we have more in direct, cashflow generative assets like infrastructure, or shorter-duration assets like private credit, then we could push it higher,” Greaves says. “Like anything in investing you look at your risk tolerance, investment beliefs, and where you can add value. This research helped us find our sweet spot at this time.”

The exercise resulted in the fund changing its approach to private asset allocations, reinforcing the idea of being proactive, adjusting pacing quite frequently.

“While private assets are a long-term investment it is not a set and forget,” Greaves says.

One of the practical changes in the process is the strategy team now regularly meets with the illiquid teams to talk about pacing.

The research was also a useful tool to talk to the board about the importance of flexibility and demonstrate different scenarios including one example which was reducing the illiquid assets from 40 to 20 per cent over five years.

“They got comfort that we demonstrated we can move from a relatively high allocation to something much lower in a short period of time through the cashflow profile of the assets, even in a shock or stressed environment” Greaves says.

Now the fund looks at its illiquid allocations in the context of the role the asset plays, the exit and the execution, in a dynamic approach. All Railpen investments are modelled with a cashflow profile and exit periods under different scenarios, with those assumptions kept up to date.

“In illiquid assets, the execution is so important,” Greaves says. “We are trying to think about the exit upfront and keeping the analysis up to date.”

The exercise also showed the importance of maintaining good market relationships with external managers, trying to maintain a good pace of investment with the best managers where possible. The impact on internal teams was also a consideration.

“Institutional investing is much more than just a good strategy. It’s the whole institutional investing ecosystem on how you deliver on that well”, he says.

“By thinking about these decisions through the lens of the overall institutional investment process, we believe it allows schemes like ours to better respond to client needs.”

 This article makes the case that energy is the metaphorical lifeblood of any system, and is therefore the fundamental systemic risk. This insight should inform how we go about our net-zero investing.

As my entry point, let me ask and answer a question: what is energy for? Removing humans from the frame momentarily, this leaves us free to observe that energy comes from the sun; that plants convert the sun’s energy via photosynthesis into sugars; that some animals eat the plants; and that other animals eat animals.

It follows that the plants need to replace what has been eaten. If there is any energy left over, the plant can think about growth – either making itself bigger, or by making copies of itself. From this, we can see that energy has two uses – maintenance, or the repair of damage, and growth, or the making of new things.

When something is new there is very little maintenance to do, allowing almost all the energy to be expended on growth. If it is also small, the rate of growth can be spectacular (low-base effect). Over time, parts wear out and need to be replaced so a larger and larger proportion of energy is spent on maintenance, and less is available for growth. In addition, the “thing” is now bigger and so the rate of growth falls, and eventually stops. Biological growth for an individual entity has a stopping rule; when all the incoming energy is required for maintenance, growth stops.

As we have removed humans for the time being, the “thing” above will be biological, but the principles also transfer to mechanical things. It takes energy to create a machine, and more energy to maintain it.

Returning to our human-free world, we can now start to think about systemic risk. Our thing will seek to replicate itself and grow its population. In isolation, a population can grow up to the limits of available energy. So the population of a bacterium in a petri dish will grow exponentially and then crash to zero when the food runs out. The population of rabbits on an island will rise and fall as it adjusts to the availability of grass. But populations rarely exist in isolation. Instead, we typically observe multiple populations existing simultaneously in an ecosystem, which introduces the complexity of different types of relationships – from symbiotic to predator-prey. These ecosystems can evolve to an equilibrium state, which will be within the limit of available energy, and the rates of extraction and rates of replacement will be equal (a prey species will have enough offspring to replace those being eaten).

Evolving towards equilibrium does not mean systemic risk is absent – just ask the dinosaurs. Even excluding external shocks posed by meteors, a new species could arrive over the hill and find that it is perfectly suited to this new environment. At best, the existing species will have to concede some ground to accommodate the new arrival. At worst, the newcomer outcompetes one of the existing components and sets off a cascade of consequences. Or, perhaps, the climate changes with a similar wide range of possible effects.

We can now re-introduce humans and let them do their thing. They build societies and economies (the ‘system’) some of which, over time, collapse. This thought piece would suggest that the collapsed historical systems out-grew their ability to maintain themselves.

One more thought before we get to our present context. When systems grow, they also increase in complexity. As the number of components grows, the number of possible connections between them explodes. Niches tend to get smaller, and specialisms deeper. There is now a need for energy to also support significant information processing. As we have discussed above, the availability of energy is a systemic risk. I see it as the fundamental systemic risk. And we increase that risk every time we grow our system. I suggest a hypothesis: human systems will always be associated with rising systemic risk. We apply our ingenuity to overcome system constraints. This leads some to believe that human ingenuity will always be able to overcome the next presenting problem. The other side of that trade is that, if we fail on any one occasion, then systemic risk may not show much mercy.

Our present context is illustrated by the graphic. It was created by Johan Rockström as part of his seminal work on planetary boundaries. This version contains 2022 data. The planetary boundaries are indicated by the dotted line. The colour green signifies activity within the boundary. The colour orange highlights activity beyond the boundary. The way we are running our system is – according to the scientists – literally unsustainable.

Climate change has captured the majority of the public attention, and emissions are in breach of their planetary boundary (and so our climate is warming and will continue to do so under present conditions). But the biodiversity problem is even worse – the label ‘E/MSY’ (extinctions per million-specie-years) shows it so much further beyond its planetary boundary. We should expect most ecosystems to change.

The chart also shows that we have big problems with plastics (‘novel entities’) and how we produce our food (‘land-system change’ and ‘biogeochemical flows’). If you believe the scientists have done good work and placed the boundaries in the correct places, then it is hard to think of any better visualisation for systemic risk. We are running our system too aggressively.

So, how might our current context of systemic risk and breached planetary boundaries play out? There are broadly two pathways – to deliberately manage the risk down through time, or to continue as we are and expect the system to reduce the risk in its own way at some stage through a collapse.

Hopefully the first option is obviously preferrable, but the difficulties of bringing it about are equally obvious. Global governance, and stronger national governance, would help.

However, the landing place I am aiming for is net-zero investing.

If it is true that a system will always try to grow unless constrained, then it follows that it will lap up any energy that is available, irrespective of its carbon content. This means that trying to reduce fossil fuel energy will be pushing against the ‘natural order of things’.

It further means that addressing systemic risk, and the breached planetary boundaries, will require the deliberate imposition of constraints – in order to change the shape of the system, and how (or whether) it can grow.

It is my belief that net-zero investing will need to incorporate this idea of constraints, so that it can succeed with the net-zero part of its mission.

Tim Hodgson is co-founder of the Thinking Ahead Institute at WTW, an innovation network of asset owners and asset managers committed to mobilising capital for a sustainable future.   

In a recent paper researchers from Singapore’s GIC, FTSE Russell and asset management group GMO explain why investors should integrate green revenues into their portfolio construction, arguing that the sustainability metric Weighted Average Green Revenue (WAGR) is a useful tool for investors looking to assess and integrate green opportunities.

Investors know that transitioning to a net-zero economy requires solutions that enable the economy to decarbonise like renewable energy, electric vehicles, and recycling technologies. The green economy is growing faster than broader equity markets, with a compound annual growth rate of around 13 per cent over the last decade while companies providing climate and environmental solutions have been outperforming the market since the early 2000s. Yet how best to measure portfolio exposure to climate-related investment opportunities remains an enduring challenge.

Focusing on specific themes such as renewable energy infrastructure is narrow and risks overlooking other critical segments of the green economy, such as long-range transportation, technology and resources. Comparability is further limited by varying definitions and methodologies for what constitutes a ‘green asset’.

“It needs an overarching metric applied consistently across asset classes, to compare the performance among asset classes and aggregate the results up to the portfolio level,” write the authors.

Additionally, the way asset owners disclose green investment exposure is often binary—a company or investment is tagged as green or not. This approach focuses on pure plays and does not consider the nuanced nature of a company’s business model, whereby some business lines are green, and others less so. It also fails to capture companies’ transition progress.

The right tools

The best and most comprehensive metrics to measure portfolio exposure to green solutions comprise green revenue, green capex, green patents and avoided emissions, states the report. Of all these, green revenue is easier to interpret; directly links to companies’ cash flows and real-world impact, and the data is more readily available and comparable.

WAGR calculates the green revenue percentage (GR per cent) of a portfolio by applying company GR per cent to the portfolio weight of each company. Investors can set portfolio-level targets of climate solutions using WAGR, such as a minimum level, an improvement relative to the benchmark, or to track specific WAGR pathways such as decarbonisation trajectories.

The calculation of WAGR is straightforward and easy to implement. It is also highly comparable across equity portfolios and indices given most of them use market capitalisation to determine stock weight. This makes it easier to compare portfolio performance against benchmarks. In addition, it echoes the method recommended by the Technical Expert Group (TEG) on Sustainable Finance for measuring alignment of equity investment with the EU Taxonomy.

The modular nature of the underlying green revenues data allows investors to measure portfolio exposures to individual climate solutions. WAGR can be broken down into different technologies across sectors, subsectors and micro sectors providing flexibility for investors seeking investment opportunities in specific sectors, states the paper.

Moreover, by using the Weighted Average Green Revenue (WAGR) to measure and analyse portfolio exposure to climate solutions investors can build on the portfolio weighting methodology used in carbon metrics such as Weighted Average Carbon Intensity (WACI), already widely adopted.

Green revenues

Green revenue companies by market capitalisation are diverse across industries, although they tend to be clustered in certain large sectors, such as technology and industrial goods and services. Several industries have higher WAGR particularly the automotive sector (36 per cent) and utilities (29 per cent), driven by demand for electric vehicles and renewable energy generation.

Growth in the auto industry’s green revenue weighted market cap is a more recent trend, having increased by over 350 per cent between 2019 and 2020. While climate solutions are often thought of as solely focused on renewable energy and electric vehicles, in reality, they represent a diverse set of activities spanning multiple points up and down value chains. For instance, energy management and efficiency have constituted at least a third of the green economy since 2016, driven by building and industry energy efficiency measures.

A portfolio can use WAGR to target an increase in its exposure to climate solutions and the broader green economy.

Using WAGR, the researchers analyse portfolio exposure to climate solutions, including size, growth, industries, green sectors, regions, and the level of ‘greenness.’

Potential investor applications of WAGR include climate reporting against frameworks such as the Task Force on Climate-related Financial Disclosures (TCFD), target setting, thematic investing and corporate engagement. However, investors should acknowledge the constraints and trade-offs when building portfolios with a significantly greater WAGR, such as sector and country concentration, volatility and the size of the universe.

The transition to a green economy is still in its early stages, resulting in relatively low WAGR for market capitalisation based indices. In 2022, the WAGR of the FTSE All-World Index was less than 8%. To achieve portfolios that resemble an index but have a significantly greater WAGR, large positioning deviations are necessary.

“We also find these portfolios have concentrated exposures to certain countries and industries. For example, a portfolio with 50% WAGR has a 14% overweight on China and an 18% underweight on the United States,” write the authors.

The researchers note other challenges like a lack of disclosures based on green revenues. In addition, climate-related disclosures in private markets, including green revenue data, continue to be in short supply, limiting access to comparable data across different asset classes for investors.

However, by raising greater awareness of the value of WAGR to assess and integrate green opportunities into portfolio construction the authors hope to encourage greater disclosures. In conjunction with other sustainability metrics, WAGR can be a useful tool to calibrate and measure exposure to climate solutions in a portfolio management context, they conclude.

 

 

 

New rules that could allow pension fund beneficiaries in South Africa to access their savings ahead of retirement hold important implications for South Africa’s largest pension fund the R2.3 trillion ($0.12 trillion) Government Employees’ Pension Fund, GEPF, and it’s ability to invest in illiquid assets.

Reforms currently going through the legislative process under the Revenue Laws Amendment Bill will enable South Africans to access up to a third of their net retirement savings early, while ringfencing the remainder for retirement over the long-term.

The rationale behind the so-called ‘two-pot’ system is that it will actually encourage members to preserve their pension by making it more flexible to accommodate the unforeseen financial pressures many face in their working life, stalling a trend that sees workers resign from their job to access their retirement fund.

“Instead of waiting until they retire or resign, the regulation will allow people to access annual withdrawal amounts if they choose. The industry is really grappling with these proposals,” explains Sifiso Sibiya, head of investments at GEPF. “It is existential for the entire retirement funds industry and will have an impact on how investment strategies are executed once regulations are finalised within the next six months. If you have to increase the amount of liquidity available there will be less assets for long term investment.”

His chief concern is how the fund will ensure sufficient liquidity on hand to pay beneficiaries seeking an early payout and the implications for long-term investment.

He is also mindful of the amount of liquidity GEPF will need to make available, warning getting it wrong could trigger “a market event.”

Sibiya also predicts that the implications will be keenly felt in GEPF’s administrative department where colleagues will need to deal with new pressures around cash flow management, ensuring the fund can absorb the volume of payments expected, as well as keep track of what has been paid out, accounting for money already withdrawn.

As soon as the legislation is passed, he says the investment team will start putting contingencies in place.

Monitoring the PIC

For now, he continues to spend most of his time focused on governance and enhanced monitoring of GEPF’s primary asset manager the government-owned Public Investment Corporation. The PIC is responsible for investing around R2-trillion on behalf of the GEPF, but the relationship came under strain due to political interference at the PIC during Jacob Zuma’s presidency.

In 2021 GEPF revised its mandate with the PIC, drawing up new conditions that included stipulations around consequence management that leave the PIC liable in the event of inappropriate investment decisions; better disclosure of the PIC’s investment decision making processes and ESG integration, and scrutiny of its fee model in the unlisted portfolio.

Now, mandate compliance and monitoring performance around benchmarks is a crucial element of Sibiya’s role. “We are transitioning into a new mandate [with the PIC] that governs our processes and there are more eyes on what we are doing to enhance the effectiveness of our oversight,” says Sibiya.

Tightening GEPF’s organizational capabilities and oversight structures has involved doubling the internal oversight team to six where the focus is ensuring the PIC implements GEPF’s strategy to the letter.

“Research indicates that at least 80 per cent of investment outcome is attributed to asset allocation and we are intent on ensuring our asset allocations are adhered to in order to achieve our set objectives,” he says, continuing “we have added capacity to the team to enhance our effectiveness when it comes to governance around the application of our strategic asset allocation.”

GEPF sets its asset allocation based on an asset liability model and PIC is responsible for implementation and selecting the securities.

Elsewhere, GEPF continues to fill its target 15 per cent allocation to global equity (and a little fixed income) recently increased from 10 per cent. Mandated to managers including JP Morgan, Goldmans and BlackRock, Sibiya says the allocation is bringing important diversification benefits, particularly acting as a buffer against rand volatility and allowing GEPF to tap into dollar returns, and other geographies, at a time growth in South Africa remains challenged.

“The rand is a volatile, emerging market currency and is expected to devalue over the medium to long term based on purchase power parity measures. As a result when South African investors allocate overseas, the currency depreciation translates into an additional return that may act as a buffer, especially if local assets underperform.” Still, he says GEPF won’t push its global allocation beyond 15 per cent of AUM. “This is our targeted allocation and is not expected to change.”

In another seam of the portfolio GEPF targets 5 per cent in unlisted African investments. Of this, it manages a tiny 1 per cent allocation to private equity across Africa internally and the rest is mandated to PIC which in turn allocates to external managers.

Spread across 50-odd countries Africa’s unlisted market is attracting flows from global investors, drawn to new opportunities like infrastructure as high inflation and interest rates impact their portfolios at home. Investing in Africa also holds compelling SDG and ESG opportunities. US public pension funds (where a government initiative aims to foster trade and investment between Africa and the US) have invested in private equity funds run by African Development Partners, for example.

Does GEPF’s experience offer insights for these investors? Above all, Sibiya counsels on the importance of hard currency revenues wherever possible to protect against a currency squeeze impacting returns.

“African currencies are generally volatile despite some being pegged to hard currencies and sharp devaluations can catch you by surprise. Assets may perform in local currency, but when they are converted into dollars it becomes something different and they may underperform. Measures can be put in place to mitigate against currency risk on portfolio returns like structuring portfolio companies with business models that generate hard currency revenues.”

Korea Investment Corporation (KIC), the country’s $169.3 billion sovereign wealth fund, is increasing its allocation to private assets and accelerating the expansion of the portfolio faster than initially planned.

“KIC plans to raise its allocation to alternative assets to 25 per cent by 2025 from 22.8 per cent ($38.7 billion) at the end of 2022 to enhance its returns while better responding to market volatility amid macroeconomic and geopolitical uncertainties,” confirmed a spokesperson for the fund that was set up in 2005 with $1 billion seed investment.

The move reflects an acknowledgement that the benefits of diversifying into equities and fixed income “are becoming less apparent.” Strategy at KIC is increasingly focused on exploring new investment strategies and expanding alternative investments, diversifying across asset classes to build a long-term investment portfolio that is less susceptible to market volatility.

Despite a “proactive risk hedging” programme and the fast-growing allocation to alternatives (alternatives where 17 per cent of AUM in 2021) sharp falls in bonds and equities meant the fund suffered a -14.36 per cent loss in 2022.

The fixed income allocation (31.6 per cent of AUM) and equity (38.3 per cent of AUM) make up the bulk of KIC’s “traditional” portfolio and has seen an annualized return of 4.06 per cent since 2004.

In contrast, since its launch in 2009 the combined alternatives portfolio of private equity (9.5 per cent) real estate and infrastructure (9.7 per cent) and hedge funds (3.3 per cent) has achieved an annualized investment return of 8.23 per cent.

KIC will focus particularly on investment opportunities in private credit markets, and the spokesperson told Top1000Funds.com the investor will access opportunities both directly and through external fund managers. KIC began making direct private equity investments in 2010 and co-investments with GPs in 2011.

KIC had previously aimed to raise its alternatives target to 25 per cent by 2027.

The decision follows other leaps forward in its approach to alternatives that include last year’s acquisition of private debt manager Golub Capital. In a nod to “the sharp growth of the private debt market where loans to blue-chip companies can generate stable cash flows” KIC strengthened its partnership with Golub by becoming a shareholder.

Elsewhere, KIC opened a new San Francisco office in 2021 to better hunt opportunities for its  venture investment programme KIC Venture Growth (KVG) that seeks “secure high-growth potential opportunities” that will “expand our portfolio.” The KVG fund aims to deal with industry paradigm shifts and identify excellent tech assets early on.

KIC is also setting up an Indian office, following in the footsteps of other investors including Canada’s Ontario Teachers’ Pension Plan (OTTP) and Singapore’s Temasek. CDPQ opened a Delhi office in 2016.

Hedge funds

KIC begun investing in hedge funds in 2010 and runs a diversified strategy using multiple approaches. Going forward, a particular focus will be on absolute return strategies that take advantage of arbitrage opportunities such as equity L/S, event-driven and fixed-income arbitrage, seeking to tap the impact of rising interest rates, increased market volatility and other changes in the financial environment.

Asset allocation decisions are based on KIC’s long term strategic asset allocation; strategic tilting, and tactical decisions. Going forward, KIC plans to strengthen the role and function of asset allocation in consideration of financial market conditions, the characteristics of each asset class and its investment horizon to achieve its investment objective.

“We hold an asset allocation forum every quarter to integrate top-down and bottom-up views from various investment departments and formulate a house view to ensure a reliable asset allocation process,” states its annual report.

The investor has also strengthened its risk management processes, particularly macroeconomic research capabilities as well as re-examined its investment processes to build a system that can withstand future “black swan” events.

Recruitment

KIC’s expansion into private markets has called for an overhaul of its recruitment practices. Nurturing talent across its 300-plus employees is now a central seam to strategy. “The world’s top financial institutions are all trying to secure and retain the best people. It’s a war for talent,” states the report.

KIC went through six recruitment rounds in 2022 and is giving staff more opportunities to study abroad, actively developing overseas investment training programs in collaboration with top global managers. Management philosophy now includes a commitment to “happiness management” by creating a workplace of “respect, consideration and fun and generating positive synergy among employees.”

In April 2022 KIC launched the International Finance Academy, an educational program that nurtures overseas investment specialists and supports the development of Korea’s finance industry. The fund has also revamped its compensation system “because we know that if KIC wants to grow excellent talent, they need excellent compensation.”

Domestic finance industry

Another critical component of strategy involves developing the domestic finance industry. KIC has strengthened its partnerships with domestic financial institutions by making commitments with two asset managers for overseas equity mandates.

“By entrusting domestic managers with more assets and continuing to diversify our strategies, we will actively help Korea’s financial institutions hone their overseas investment capabilities and become more globally competitive.”

It’s a similar story in hedge funds.  Last year KIC supported the overseas hedge fund investments of domestic financial institutions by participating in more joint ventures with them. “With our diverse hedge fund investing experience, and through showcasing our management capabilities, we are helping lead the development of the domestic finance industry.”