PFZW, the €266 billion scheme for healthcare workers in the Netherlands, has kept a lid on costs and expenses for another year. The country’s second largest pension fund reports its costs fell in 2022 to 0.42 per cent, comfortably below its target of no more than 0.50 per cent of assets. Over the past five years, the average cost of asset management at PFZW expressed as a percentage of the average invested capital amounts to 0.49 per cent.

PFZW has tightened its commitment to low costs in recently honed investment beliefs where it states low costs are “the starting point” of its investment strategy and stipulates that high costs are “only acceptable if they are in the interest of the participants”. Asset management costs, under a bright spotlight in the Netherlands, come via the fund’s third-party service providers and investments in fund of funds, as well as its sizeable allocation to private assets.

PFZW follows the Recommendation on Implementation Costs of the Pension Federation when presenting its costs, distinguishing between pension management, asset management and transaction costs. The pension fund reports that although its management fee increased from 0.22 per cent (€583 million) to 0.27 per cent (€644 million) compared to 2021, the performance-related fee fell from 0.53 per cent (€1.3 billion) in 2021 to 0.15 per cent (€363 million)in 2022. Last year private equity managers accounted to two thirds of PFZW’s fee payments and pushed asset management costs above target.

Five aspects of the investment policy influence the amount of asset management costs. These comprise investment mix, scale, the degree of active or passive management and internal or external management, plus if an investment is direct or indirect.

Although PFZW says it takes costs into account when deciding on the investment mix, it states that adjusting the investment mix for the sake of cost reduction is not an end in itself. “The aim is to reduce asset management costs while maintaining the target return.”

Expensive private markets

The report notes that the pension fund’s economies of scale make it possible to negotiate lower costs for services from external asset managers. In addition, the larger share of direct and co-investments contributed to lower costs within private markets compared to peers.

Investments in private markets accounted for approximately 30 per cent of the investment mix in 2022, up from 22 per cent in 2021. The division between private markets and public markets in the investment mix is ​​influenced, among other things, by the returns achieved.

Although private markets are responsible for 86 per cent (2021: 91 per cent) of all PFZW’s costs, PFZW believes that the return expectations of private investments outweigh the higher costs. With an average net annual return of 8.3 per cent over the period 2008 to 2022, PFZW’s private market investments delivered a higher return than the Liquid Benchmark of PFZW’s public market investments, which yielded an average net return of 6.2 per cent.

Scale advantages

The scale of PFZW offers advantages and the report notes that comparisons with other Dutch pension funds with less invested capital reveal the extent of those scale advantages. Another way to lower costs includes expanding direct investments, and PFZW reports that its share of direct investments, such as projects with one or more co-investors, has expanded in recent years within private markets.

The share of indirect investments by PFZW, such as participations in investment funds within the private markets, has correspondingly fallen in recent years. Investments in mutual fund structures are often more expensive and PFZW avoids them where possible.

Transaction costs

PFZW strives to limit transaction costs when it comes to rebalancing the portfolio according to its strategic investment mix. Transaction costs amounted to €241 million in 2022, 0.10 per cent of the average invested capital, on a par with 2021 levels.

However, within fixed-income, transaction costs spiked mainly due to higher spreads in 2022. The pension fund distinguishes three categories within its transaction costs: entry and exit costs in investment funds; purchase and sale costs for direct investments in investment titles and acquisition costs.

In 2022, PFZW achieved a historically poor return of -22.6 per cent on its investments, thanks in the main to a sharp rise in interest rates hitting fixed income. However, because the value of liabilities decreases when interest rates rise, the funding ratio improved. Despite the negative return, PFZW reports it is financially better off than a year ago.

PFZW targets 20 per cent of its investments contribute to the United Nations Sustainable Development Goals (SDGs) by 2025. Via so-called 3D investment, it allocates according to risk and risk as well as impact. “In doing so, we seek a balance between good results and a sustainable world. A good pension requires a world in which life is pleasant,” says the report.

As the Australian superannuation funds evolve and get bigger they face a question of whether to copy the organisational structures of their bigger, more sophisticated Canadian counterparts, or find their own way that more adequately befits some of their unique features and better serves members. Amanda White looks at the Australian superannuation market evolution and what it can learn from Canada.

The Canadian pension fund market, with its concentration of large, sophisticated, governance-first, internal investment-driven funds, has been a pinup for other markets as their own pension systems mature.

In Australia, a raft of regulatory and market forces has resulted in fast-paced consolidation of superannuation funds and a vastly changing market. It is only natural that as the funds mature they look to their Canadian counterparts for clues on what happens next.

The number of superannuation funds in Australia has fallen from 185 in 2014 to 97 in 2022 and, like the Canadian market, assets are now concentrated in only a handful of very large funds. Five funds in Australia have assets of more than $100 billion, compared to only two funds five years ago, and they make up 34 per cent of the A$3.4 trillion market. More than half of the superannuation system’s assets overall reside in just 16 funds, each with assets of more than $50 billion.

As the Australian marketplace goes through these changes at a rapid pace, it gives pause to ask whether big is necessarily better, whether members are better off, and whether these funds have the essential organisational structures and technologies necessary for success.

New research by Geoff Warren and Scott Lawrence, Do Superannuation Fund Members Benefit from Large Fund Size? importantly puts the fund members at the centre of the conversation. The paper looks at the advantages, disadvantages and challenges of Australian superannuation funds operating at large size. Their conclusion: it is not fund size per se that matters, but how size is used.

The authors are keen for the Australian conversation to shift away from the “size is good” mantra towards a keener focus on ensuring members benefit from increasing concentration. The paper suggests particular attention needs to be paid to whether the boards and management at the large and growing funds are establishing the capabilities to succeed at size.

“Implementing effectively at scale is the key,” Geoff Warren, research director at The Conexus Institute, says in an interview with Top1000funds.com.

Big is better, Canadian-style

It is commonly accepted that there is a size pay-off when it comes to institutional investment.

The consolidation of 89 local government funds in the UK into eight pools is a recent example of success, with the pools driving hundreds of millions of pounds in cost savings, access to better investment opportunities, and better returns. One fund alone, the London Pension Partnership has saved £113 in costs million since inception in 2016.

Toronto-based CEM Benchmarking has long researched the benefits of scale among pension fund clients, with analysis of its database of large asset owner cost and performance data revealing larger funds add value over smaller ones. CEM says the advantages of scale most prominently manifest in the ability to implement private asset strategies internally, resulting in lower fees.

Instead of going through fund of funds or even co-investments, having large internal teams means funds can go direct, which not only decreases costs but increases the chance of higher returns. CEM says that the median costs of internal management for private equity is 25 bps, while externally it is 165 bps.

Internalisation also gives teams more flexibility. Typically, the governance structure of funds with large internal teams have more delegated authority to make decisions allowing for more flexibility with allocations and faster decision making in response to markets.

The Canadian funds do all of these things. They are not just big, they are also sophisticated. They have supreme governance models with clear delegated authority. They have large, highly-paid internal teams with the best technology in place for trading, portfolio analytics, risk management and portfolio completion. And importantly, they invest a significant portion of their assets in direct private markets. Investments are managed with a total portfolio approach, and a key factor in their success is how the funds allocate nimbly right across the capital structure.

Ontario Teachers’ Pension Plan, for example, has generated a total-fund net return of 9.6 per cent a year since the plan’s founding in 1990. It has always been actively managed, with more than 80 per cent of assets in-house. And the governance structure, and the delegated authority, means it has an ability to be agile. (See OTPP: Positioning the fund for the next decade)

CPP Investments, known for its total portfolio approach is conducting a study on its best organisational and investment design as it approaches $1 trillion of assets.
Chief investment strategist at CPP Investments Geoff Rubin who is leading the project says funds of enormous scale will require a new cross-disciplinary approach, and innovative incentive and rewards schemes to foster the organisational culture needed as it looks to move beyond a total portfolio approach to a “one-fund” approach. (See $1 trillion funds need new incentives and investment styles)

With the large internal teams, access to direct deals and complicated organisational structures with big budgets, payrolls and technology spends, also comes larger executive compensation packages that require well thought out incentive plans and can cause complicated communication issues with stakeholders. (See OTPP makes paying well pay off)
Funds need to grapple with all these issues as they mature their organisational design.

Australia’s unique challenges

The Australian funds, it seems, are trying to replicate the Canadian model, according to the Conexus Institute’s Warren.

But there are a couple of peculiarities in the Australian market that will prevent them from being successful in exactly the same way.

The defined contribution structure and the Your Future Your Super (YFYS) legislation, and its resulting performance test, both impact liquidity and constrain the ability of Australian super funds to invest in private assets the same way the Canadians have.
Australian funds, like the Canadians, were early investors in infrastructure but have much lower allocations to private equity and in total average around 30 per cent in private markets, compared to above 50 per cent for the Canadians.

As defined contribution funds, the Australian funds also have much higher member-servicing requirements.

“With DB funds you have one client; in DC you have hundreds of thousands, and you have to interface with them,” Warren says. “The Australian funds are the most expensive funds in the world and there is a reason for that.”

The Australian funds are the most expensive funds in the world and there is a reason for that.

Warren and Lawrence’s paper outlines how large size can bring efficiencies in administration and the delivery of member services to achieve economies of scale that may reduce costs as percentage of AUM, and deliver economies of scope that can lead to better services.

But it also points out that while larger funds can be beneficial for customisation – most relevant in retirement – size does not necessarily help deliver a personalised experience.

“We view enhanced capacity to deliver customised retirement income strategies as a significant advantage of large size, as funds move to meet their obligations under the Retirement Income Covenant,” the Warren and Lawrence paper says.

“Properly catering for the diverse needs of retired members will require a large shift in product structures at superannuation funds. Significant changes will be needed in the investment capabilities of funds, and the ability to dovetail them with drawdown strategies and longevity risk pooling where it is utilised. Funds of large scale will be most able to assemble the governance structures and resources to fulfil this transition.”

Building effective teams, going offshore

The paper says that to be effective, Australian funds need to develop an investment program that leverages the advantages of size. A key element of that is the capability to operate effectively in private markets.

Many large leading funds around the world have set up multiple offices. CPP Investments alone has nine locations. Canadian funds, and large Dutch funds, have offices in NYC, London, San Francisco, Singapore, Hong Kong, Mumbai, Luxembourg, Sao Paulo and Sydney.

Australian funds are starting to set up overseas offices and invest in their own structures, with AustralianSuper, the country’s largest fund, located in Melbourne, Shanghai, London and New York.

But still, the Australian funds are disadvantaged by their Australian head office locations that come packaged with a difficult time zone and a weaker dollar. The Australian funds are also competing against well-established brands in the guise of their asset-owner peers, and investment managers.

“There is an implementation challenge of taking an Australian fund overseas and maintaining the culture and competing for talent in a market for people who are good at what they do who may not buy into the purpose,” Warren says.

“There are challenges of salary, cost and coordination.”

Size also speaks to the complication of adding complexity to investments and organisational structure which may not translate to better outcomes.

“It is surprising that when you get bigger you might not get economies of scale as much as you think,” Warren says.

“As you get larger you add in more stuff like operating across all jurisdictions, back-office, regulatory regimes, as well as new teams. It’s a new layer of operations and complexity but doesn’t necessarily mean better results.”

Australian funds have the competitive advantage of a mandated system where fund flows are regular, guaranteed and large. But a danger as the portfolio gets bigger is a need to “fill it up”, but that comes with its own complexity, not the least of which is the ability of additional investments to add value.

Many of the larger funds globally, like CalPERS, gave up on hedge funds years ago because the value added at the total portfolio from those allocations was minimal.

“The degree of difficulty is high, and my gut feel is some Australian super funds will do well and one will stuff it up eventually, but the big thing will be how the management handles it,” Warren says, adding governance will be key.

“All stuff-ups have a governance issue behind them somewhere,” he says.

The paper’s authors acknowledge that the degree of difficulty in what the Australian super funds are trying to do is high: they are growing very quickly and transforming themselves from a cottage industry into professional, global investment organisations.

Warren says there’s a high chance funds will make mistakes.

“My sense is governance and culture is critical. Not only do you have to have the governance structure around it to make sure it works and people have the right responsibilities and accountability, but [also] that the culture is encouraging an approach where everyone is in it together to generate the best returns for members and they don’t break into silos.”

Warren says that as the Australian funds get larger there is a big opportunity to do something well.

Deploying large asset amounts, retaining flexibility and resilience requires bespoke operating models. With their unique challenges, Australian funds have the opportunity to create their own way, borrowing from their more-established markets, but tailoring for their own challenges.

The key, says Warren, is to implement effectively.

“Members might be better served if industry participants such as policy makers, regulators and the funds themselves start to ask whether operating models are being configured to succeed at scale, rather than pushing for size for its own sake.”

For more information on the structure of the Canadian and Australian markets and to learn about the individual funds visit the Global Pension Transparency Benchmark and the Asset Owner Directory.

Disclaimer: Amanda White is a member of The Conexus Institute’s advisory board.

Switching out of equities into fixed income contributed to Brazil’s Fundação dos Economiários Federais, FUNCEF, healthy 2022 returns. According to it’s latest annual report, the $19.1 billion pension fund for Caixa bank employees returned 11.28 per cent in 2022 against a target return of 10.70 per cent and added $1.8 billion to the portfolio.

“The 2022 balance sheet points to the Foundation’s solidity in a period when pension funds dealt with a scenario of high inflation and large fluctuations in the Stock Exchange,” states the report.

FUNCEF, which was founded in 1977 and is Brazil’s third biggest pension fund with 140,000 participants, allocates to variable income (equity), fixed income and real estate investments.

Much of its 2022 results come from a successful allocation to fixed income. In the first quarter of the year, the pension fund took advantage of a window of opportunity to sell equity and buy fixed income assets with a beneficial spread, reducing the risk of the portfolio.

“Despite the challenging scenario, at a favourable moment in the first quarter of the year, FUNCEF took advantage of the appreciation of the Stock Exchange to make gains and migrate resources to fixed income which presented good opportunities in the wake of the current high interest rate cycle,” says the report.

FUNCEF also added short duration treasury bills (with a maturity of up to five years) as part of a liquidity strategy.

“The idea is to have the flexibility to take advantage of any drop in variable income to buy back selected assets with good appreciation potential,” says the report.

Active management

Throughout 2022, falls in the stock exchange created favourable windows for equity investment in certain sectors of the economy, continues the report. Seeking to capture these opportunities, FUNCEF reduced the position in its internally managed passive strategy which replicates the performance of the IBrX 100 and tracks Brazil’s 100 most traded securities.

FUNCEF increased its allocation to stock picking which rose from 22 per cent to 45 per cent of the total equity allocation.

“Based on analysis of the fundamentals of the companies, the strategy of management sought to select stocks with a return potential greater than the IBrX 100 in the medium and long term. In 2022, the excess gain reached 1.7 percentage points.”

The strategy also required a boosted internal team.

“The result is directly related to the investment in qualification and analysis capacity of the team which works to obtain consistent returns within the best practices from the market.”

Real estate

For the first time in two years, FUNCEF’s real estate allocation outperformed, returning 13.66 per cent and surpassing the Real Estate Funds Index-IFIX, Brazil’s  main national indicator of the sector, driven by the revaluation of assets and divestment. Divestment will continue in the coming year as FUNCEF plans for the sale of 94 assets by 2025, mainly land, commercial buildings and hotels.

The report cites a surplus at the pension fund for the third time in five years, and states that the pension fund paid a record amount of benefits ($1.1 billion.) FUNCEF reported higher returns than the average profitability of 120 Brazilian pension funds, according to a survey by consultancy Aditus.

FUNCEF manages three pension plans. The biggest, the Reg/Replan, is a defined benefit (DB) scheme. The bulk of the portfolio is invested domestically although taps international exposure via its allocation to Brazilian stocks like Vale, Petrobras and the world’s largest meat producer, JBS.

FUNCEF cites its key values as transparency, ethics, participatory management, equity, professionalism, commitment and sustainability. The focus of its activities is to guarantee benefit payments. FUNCEF was the first pension fund to adhere to Brazil’s Stewardship Code, bringing together a set of principles and governance recommendations for institutional investors.

The £23.1 billion Local Pensions Partnership Investments is amongst the oldest of the eight UK pension pools and differs to its peers in two important ways, one philosophical and one structural.

Back in 2014 – before then-Chancellor of the Exchequer, George Osborne, advocated for the pooling of the 89 local government UK pension funds – Lancashire County Council and the London Pensions Fund Authority began discussions having self-identified the benefits of pooling and owning in-house asset management capability. In 2016 LPPI was formed.

“This is a coalition of the willing,” says Chris Rule, chief executive of the fund since 2020 who joined as the inaugural CIO in 2016.

“It was designed by these two funds from the ground up, they wanted to do it. It’s why we are seeing the cost savings at greater magnitude than some of our peers and why we have been able to rapidly consolidate assets.”

The philosophical buy-in and self-direction was important but according to Rule the real benefit of pooling came from the governance structure, different to other pools, where 100 per cent of the assets were pooled.

“If you are sub-divided then you don’t really create scale. We have a curated menu of options to fulfil individual strategic asset allocations so from 2016, 100 per cent of assets were pooled. We were fully delegated to manage the assets as a fiduciary from the beginning, similar an outsourced CIO.”

“It has meant the clients have benefited from the full-time dedicated resources in LPPI across their portfolio since day one,” he says.

Managing the total portfolio

This full delegation has led to cost savings and access to different types of investments, but most importantly, according to Rule, the management of the total portfolio.

“Throughout my career I have worked in various investment houses and one of the short-comings of a typical asset owner is they have small portions allocated to different agents and no-one knows what the other is doing. You can get duplication and over diversification that way,” Rule, whose career included SEB and Old Mutual, says.

“Because we can manage the whole portfolio we don’t have to have the hyper diversification in a typical asset owner portfolio, and we can take skews in the portfolio.”

The process is similar to other large institutional investors that use a total portfolio approach, including New Zealand Super, with a reference portfolio and a policy portfolio and active decisions made relative to that.

“We are not trying to be too cute and tactical,” Rule says.

“The total portfolio is not about tactical overlays but about how we can set the mandates for ourselves and the managers we work with.”

The total portfolio view allows CIO Richard Tomlinson and his team to be more flexible in mandate construction and Rule says the fund has fewer concentration limits than if it didn’t have that total portfolio look through.

“We would rather work with managers and have high-conviction mandates uniformly than have managers with a largely diversified mandate,” he says.

“It also gives the chance to analyse where there are pockets of concentrated risks.”

Top-down total portfolio concerns include geopolitical risk, ESG and responsible investment risks and how they may manifest, inflation, and how investable China is.

Internal manager performance

At the total portfolio level the fund measures the ability to outperform the policy portfolio and according to Rule it has outperformed on all time frames.

“When we do peer analysis we look good relatively and are top of the pile over five years. When we look at the individual asset classes we can see alpha consistently across those portfolios,” he says.

LPPI has seven separate funds: global equities, fixed income, diversifying strategies, infrastructure, credit, private equity and real estate.

Global equities is the largest allocation at around 43 per cent of the pooled assets and is managed with a mix of internal and external management.

The internal global equities team at LPPI in particular is an outperformer and since inception internal global equities has returned 14.2 per cent versus the 11 per cent benchmark.

The internal team, which manages around half of the equity portfolio, features at the top of the global equities roster which also includes external mandates with Magellan, First Eagle, Wellington and Baron, with Bailie Gifford also appointed in December 2022. Its three year performance is 15.4 per cent.

“We aim to outperform by 200 bps a year and we are doing about 300 bps,” Rule says.

“We are in the top decile of managers in that space, and over five years we are even stronger.”

The investment and risk team numbers about half of a total 132 employees and while there are no immediate plans to hire or build new teams, over the medium term it is likely the platform will bring more inhouse. Most of what it currently does is through external managers.

“Part of our business planning to see where to take the business next and engage with clients to see where their asset allocation might shift to,” he says, adding the internal team has explored incubating some equity ideas with allocations of £1 million or less.

“One of the things we want to do is to give analysts career progression, and we will give them a small slice of the portfolio and let them have some portfolio management discretion. Our current equity internal team started in 2014 with about £40 million and now manages more than £5 billion.”

Impact on costs

In the year to March 2022, LPPI saved £39.1 million in costs, up from £28.2 million the year before, and bringing the total costs saved since inception to £113 million. The increased cost savings has resulted in a revised total cost savings by 2035 of £500 million, up from the initial estimate of £468 million.

The savings have come through pooling, and a focus on direct investments and internally-managed portfolios.

“A big chunk of the savings is internal management,” Rule says. For example, investing in infrastructure has contributed almost a third of our total cost savings.

“A typical infrastructure fund is 150 bps or more once you have taken into account management fees and carry. We can invest in private infrastructure for around 30bps all in,” Rule says.

“That is a very significant saving, but requires us to have the skills to do that. We have always said we should only directly invest where we have the skills to do that and an interest in investing there. There is no point doing it for a short-term holding, or where we can save a few basis points of fees and lose more in poor performance.”

The other area where LPPI has been quite thoughtful, and where Rule’s expertise has come to the fore, is negotiating third-party mandates in fees and structure.

For example the bulk of the real estate investing is direct with an external partner who does much of the sourcing and makes management decisions, but LPPI has the final say.
In infrastructure LPPI is also the designated alternative investment fund manager for GLIL Infrastructure.

The future power of pooling

As Rule and his team look to the future the focus is on collaboration.

“The model we have built is scalable and attractive,” he says.

“We need to take a step back and look at the characteristics of the model we have and how that fits with others.”

In 2020 LPPI alongside LCIV and LPFA, with combined £57 billion in assets under management, launched The London Fund, a London-focused investment fund investing in Greater London in affordable housing, community regeneration projects and infrastructure including digital infrastructure and clean energy.

“Collaboration across pools, like we did for the London Fund, will be the focus for the next 12 months,” Rule says.

“We will continue to have conversations about collaboration more broadly and the benefits of creating greater scale within the larger network. And we will look at the risks associated with bringing in more funds into the pool.”

The inevitable move to more modern food production will create investment opportunities as the food industry moves to revolutionise but also reduce its own environmental impact. PGIM thematic research group director Jakob Wilhelmus outlines the risks and opportunities inherent in this mega theme.

The industry of food production has received a lot of attention due to food price inflation, but not enough attention has been paid to the food system itself is at a critical point, with technology and production systems not updated since the 1960s.

Jakob Wilhelmus, PGIM’s thematic research group director, says the two main challenges in the food chain right now are due to the outdated production systems, that helped meet past challenges, but produced a devastating impact on the environment .

“Going forward, agriculture not only needs to adapt to climate change, but also has to reduce its own environmental impact,” Wilhelmus says. “This will bring great change to the food system and will create investment opportunities across the food value chain.”

 

PGIM’s latest thematic research focuses on food and looks at the modern history of food production and consumption.

In the 1960s, food underwent “The Green Revolution’, Wilhelmus says. “It was really the starting point of modern agriculture. And similar to our current situation, food demand was growing exponentially and there was little hope that the food production and the food system that was in place back then would be able to meet demand, to the point where the idea of widespread starvation was a real concern. And the breakthrough that really changed that was crop science.”

In response, scientists started developing more efficient seating crop varieties, particularly wheat and rice and that really led to an explosion in overall production, which together with the use of fertilisers and pesticides, was large enough to meet the challenges of that time, he says.

Changing menus

Over the next 30 years, food demand is set to increase by 60 per cent by 2050. As the population grows, there will be demand for more food. However, as the population in different regions becomes more affluent, there will be a growth in different types of food – in particular more meat and convenience food – coming particularly from sub-Saharan Africa and South Asia.

This is something he calls the “globalisation” of food, and has implications highlighted in the research for cold storage and transportation.

“The distance from where we grow our food to where it is consumed, is becoming ever larger, but at the same time, more and more of that food is reliant on a consistent cold chain,” says Wilhelmus.

“Packaging is one of the many other trends that are also very much driven by both the convergence of diets and growing affluence. More and more of the food that is shipped, needs packaging, but also more and more of the convenience food that we desire needs packaging, it needs innovative ways of packaging. So packaging is another big trend.”

Meat no more?

Although Western diets are looking beyond animal based meat – Wilhelmus says this is not a trend that is threatening the meat industry.

“To put it a little bit into context, the global meat market is around $1.7 trillion, and is still set to grow by 14 per cent by 2030. In comparison to alternative meat, which is less than 1 per cent of [the global meat industry] and growth rates are at best flat, if not declining.”

The impact agriculture has on the environment is immense. Agriculture alone is responsible for 30 per cent of all greenhouse gas emissions, and 70 per cent of freshwater use. Wilhelmus believes investors should think about the food system as being very similar to where  the energy sector was a few decades ago.

“We cannot live without it, but its environmental impact is devastating. And so the only solution is to invest in the technology and innovation that will allow us to grow productivity and reduce these negative externalities.”

Putting your money where your mouth is

On the supply side of food production innovation and technology are key. According to Wilhelmus, the most attractive investment opportunities are around increasing production and becoming more sustainable.

Climate change and how it is affecting different regions is today’s big challenge – so adapting seeds to specific groups, specific regions and their climate challenges will allow farmers to increase crop yields and meet demand.

However, the replacement of traditional fertilisers and pesticides by so called biologicals is only a matter of time, Wilhelmus says.

Being a large player in a small pond comes with many challenges and advantages.

Folketrygdfondet, the asset manager of Norway’s Government Pension Fund Norway’s NOK330 billion ($31.4 billion) allocation to domestic and Nordic fixed income and equities, is restricted by the requirement of an 85 per cent allocation to domestic assets.

Consequently the fund has about 10 per cent of the free float on the Oslo Stock exchange which means it has the advantage of knowing its investee companies very well and through active ownership has an ability to influence them. But it also creates challenges for rebalancing and when changes to the benchmark occur.

The fund is looking to shift the domestic restriction and increase its ability to invest in other jurisdictions and is currently waiting on two possible changes in strategy.

Folketrygdfondet, distinct from its high-profile sibling Norges Bank Investment Management, investment manager of the giant sovereign wealth fund’s global allocation, invests 85 per cent of its assets in Norway and 15 per cent in the Nordics. It is waiting to hear back on an application made to the Ministry of Finance back in 2019 on whether it can increase its equity and credit allocations to investments in Finland, Sweden and Denmark.

“We’d like to have an enhanced universe,” says Kjetil Houg, CEO of Folketrygfondet in an interview with Top1000funds.com. “Our share in Norway has grown overtime and we have reached our limits,” he says. “We are still waiting for a final response from the Ministry.”

At the moment, Folketrygdfondet’s expertise is primarily in listed markets, although the manager can invest in unlisted shares if a company’s board has expressed an intention to apply for a listing on the stock exchange.

“We have an edge in listed markets, but we are also asked to look for opportunities in private equity,” says Houg who describes a close relationship between the investment unit and the Ministry of Finance shaped around daily contact focused on practical and fundamental discussions.

“Politicians acknowledge the work we do is important to Norway,” he says. “Our investments have a stabilizing effect on the market, and we are counter cyclical, buying when others are selling.”

Liquidity issues

Only managing the fund’s large active allocations to the Norwegian market is increasingly challenging.

“We have almost 10 per cent of the free float on the Oslo Stock exchange,” continues Houg. “That means we will typically have a 10 per cent stake in a free float company.”

The challenge manifests particularly when Folketrygdfondet rebalances back to its classic 60:40 (equity/fixed income) portfolio boundaries.

“We bump into liquidity issues quite often,” explains Houg. This becomes more of an issue if the market moves against the portfolio whilst the rebalancing is in process, increasing the difference.

“In 2021 we had a particular difficult time, selling a lot of equities to bring the portfolio back into balance,” he says. “The Ministry of Finance expects 60:40 over time and we have to bring the allocation back to basics.”

Having such a large domestic allocation is also challenging during changes in the benchmark index. Index revisions happen twice year, and oftentimes cause the same liquidity headache by triggering overweight and underweight positions and the need to adjust the portfolio.

Folketrygdfondet’s diversified, bespoke, benchmark comprises around 150-200 names in both equity and credit. Some of the positions are held for years and holdings in blue chip stocks will be large. The active strategy aims to beat the benchmark, but one way the fund navigates the risk of being such a large investor is via its strict adherence to the benchmark with a maximum tracking error of 3 per cent.

“Relative to other investors we are always looking at our benchmark. In contrast to more actively managed funds that have more idiosyncratic risk, we have more market risk in a diversified benchmark. This is very important in terms of how we manage our risk.”

The fixed income allocation taps a variety of listed and liquid sources spanning different segments of the universe from investment grade to high yield; a special liquid allocation and stock lending. “It is not risk free. We have quite a lot of risk embedded here,” he says.

Credit and equity strategy is wholly shaped around a team approach and ethos.

“We don’t have any strong egos; everyone is making the same product. The managing director has ultimate responsibility, but decision-making is also bottom up and calibrated at team level.” In equity, nine portfolio managers specialise across specific sectors and all managers sit in the same room and discuss ideas across departments.

Alongside liquidity risk, most other key risks fall under an all-encompassing ESG umbrella that spans everything from money laundering issues with banks in the region to taxation in the fish farming industry.

“All our ESG issues are considered financial items,” he says.

The team seeks to underweight companies with ESG issues, he continues. “Typically, when we have experienced a loss, it is because we are on the wrong foot in terms of being under or overweight. We always try and close that gap and have introduced stop losses in some of these positions.”

Ownership

Ownership responsibility is another consequence of being the largest player in a small market.

“We get to know companies much better than other investors. It also gives them a chance to see into our decision-making processes so that they understand how we operate as an investor.”

Members of Folketrygdfondet’s investment team currently sit on 16 corporate nomination committees, nominating members to investee companies’ boards in a process that involves meeting different board candidates and bringing names to the committee.

“The aim is to ensure the best possible board of directors for a company,” he says.

Folketrygdfondet is a smaller player in Sweden but is just as vocal when it comes to board makeup. The asset manager is  using its ownership stake in Swedish corporates to boost board independence from corporate management.

“Swedish rules allow CEOs to also be board members, but we are voting according to the Norwegian code of conduct where the CEO and chairperson should be independent from the management of the company,” he says.

Folketrygdfondet may also end up running a new asset management unit and Houg and the team are currently carrying out analysis, coming up with suggestions on how a new and expanded mandate may look, and are due to report to politicians in mid-September.

“It’s very exciting. If it ends up being our responsibility, we would like to build something that lasts with purpose and the possibility to establish a modern investment unit with digital solutions,” says Houg.