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.

Managing costs is the central driver behind €470 Dutch civil service scheme ABP’s recent decision to switch much of its public market allocation to passive, index-led strategies, according to a spokesperson at the fund.

“Until now, ABP has been an active investor. Now we are looking more closely at costs, and we do not want to make the portfolio more complicated than necessary to achieve our goals,” said spokesperson Jos Van Dijk. ABP has been one of the few remaining Dutch funds to still pursue an active investment strategy and Van Dijk said the switch will begin this year, but won’t be completed by year-end.

ABP’s growing concerns around rising costs was visible in its (latest) annual report which flags that “asset management costs” had increased “significantly.”

The report states that total asset management costs were €5,596 million in 2021 compared to €3,548 million in 2020 writing that “despite the realised returns, costs are rising at an amount that is increasingly difficult to justify to our participants and stakeholders.”

Still, the report also notes that higher costs were mainly due to the higher returns (at the time) and notes that the alternative allocation accounts for around three quarters of asset management costs.

Van Dijk said that although passive investment will be the starting point for investment in both bonds and equities, ABP won’t rule out active investment.

“We can add forms of active investing if we have sufficient evidence in advance that, after deduction of costs, this structurally contributes more to achieving our ambition than index investing on the scale we have at ABP.”

The low-cost strategy at Europe’s largest pension fund is accompanied by sustainability and simplification priorities.

ABP stopped investing in fossil fuel producers in 2021 and its latest Sustainable and Responsible Investment Policy outlines key ambitions including carbon reduction in the equity portfolio and increased investments in the Sustainable Development Goals. In December 2022, ABP updated its Climate Policy for 2022-2030 targeting net zero greenhouse gas emissions by 2050 and 50 per cent less greenhouse gas emissions in 2030 than in 2019. Other targets include investing €30 billion in the climate transition by 2030, €10 billion of which in impact investments.

Quarterly returns

ABP has just posted its first positive returns in over a year, thanks in the main to equity. First quarter results revealed the pension fund’s assets had grown by €11 billion while the fund posted a 2.3 per cent return on investment.

Still, ABP flagged concerns about economic growth ahead, particularly inflation, warning of the possibility of disappointing returns because of weakness in the financial system.

ABP’s 40.1 per cent allocation to fixed income (government bonds, long-term government bonds, corporate bonds and emerging market bonds) returned 2.6 per cent. The 27.4 per cent allocation to equity (developed market equities and emerging market equities) returned 4.6 per cent and a 22.1 per cent allocation to alternatives (private equity, commodities, infrastructure and hedge funds) made a loss of -0.8 per cent. The hedge fund allocation is also being wound down.

ABP also has a portfolio overlay comprising interest and inflation hedge, currency hedge and cash allocation that also contributes to overall return.

“I am pleased that after a turbulent investment year in 2022, we made money again this quarter with our investments,” said Harmen van Wijnen, chair of the board of trustees in a statement.

The slight fall in interest rates means the value of the pensions that ABP must pay out increased by €6 billion. The current coverage ratio increased slightly in the first quarter from 110.9 per cent to 111.9 per cent due to the development in returns and liabilities.

Increased scrutiny on the transparency of disclosures is driving measurable improvements among some of the world’s largest asset owners, as refinements to the Global Pension Transparency Benchmark methodologies and board oversight boost attention on transparency.

The Global Pension Transparency Benchmark (GPTB), a collaboration between Top1000funds.com and CEM Benchmarking, was launched in 2021 to highlight best practice and focus asset owners on more clearly, completely and concisely disclosing what they do and how they are generating value for stakeholders.

The GPTB ranks 15 countries, and 75 underlying pension funds, on public disclosures of the key value generation elements (or factors) of cost, governance, performance and responsible investing.

Since its launch the benchmark has been a facilitator for improved transparency in the industry. The results of the third annual GPTB will be launched in June with added process refinements.

“In our experience, as benchmarks mature, the performance of leading funds drive lagging funds to improve,” says Edsart Heuberger, product manager and GPTB lead at CEM Benchmarking.

“In the third year of the Global Pension Transparency Benchmark we are noticing that the leading funds in the world have improved their transparency scores the most. These are funds that have publicly declared it is their goal to be number one. We expect more of the lagging funds to embrace transparency and improve their performance in the coming years.”

New and improved process driving transparency

The GPTB focuses on the transparency and quality of public disclosures with quality relating to the completeness, clarity, information value and comparability of disclosures.

The overall scores and rankings are measured by assessing hundreds of underlying components and analysing more than 14,000 data points.

This year the process has been refined with  additional governance measures  to ensure better data and assessment.

“We recognise that a benchmark that publicly scores funds on their transparency creates new discussion,” Heuberger says. “We wanted to provide the reviewed funds with more transparency. Fund feedback prompted us to implement more robust governance and processes to document and validate our work. We will proactively share our insights with funds prior to the publication of their 2023 transparency scores. Funds now have the option to appeal a question score if they believe they were scored incorrectly.”

“Greater transparency promotes better understanding and trust”

The scoring process follows a four-tiered system including an initial review, factor-team review, CEM team reviews including a review by the Top1000funds.com team, and an advisory board review. Following these four steps there is also the chance for a one-on-one informational meeting with the underlying funds.

If there are any issues raised with regards to the scores, the advisory board will review these. In the event that the board cannot come to consensus,an independent arbiter will be consulted. David Atkin, chief executive of the PRI and original GPTB advisory board member, will fulfill this arbiter’s role.

new advisory board members

Given that Atkin is now taking on the role of independent arbiter a new board member, Fiona Dunsire, has been appointed to the advisory board.

Dunsire spent the past 29 years at Mercer including roles as chief executive of the UK, and wealth leader Asia, ME and LatAm. She has extensive experience invaluable to the GPTB including the Mercer CFA Global Pension Index and work with the World Economic Forum which culminated in developing a benchmark to measure progress on integrating climate factors within investment processes.

“Greater transparency promotes better understanding and trust in pension systems, ultimately encouraging higher levels of engagement and long-term savings,” Dunsire says. “Even the most sophisticated pension funds can struggle to assess their progress against peers in many areas. The GPTB provides a standard for best practice and highlights opportunities for improvement, allowing all funds to learn from the leading practices and raising quality over time.”

“I am delighted to join the Advisory Board of GPTB at this time. Throughout my career I have been motivated by supporting the delivery of high quality pensions that people can trust. Greater transparency should lead to better decision making and better long term outcomes for people in their later life,” she says.

Other members of the advisory board include Keith Ambachtsheer, Lorelei Graye, Angelique Laskewitz and Neil Murphy.

The way the industry has embraced the GPTB is a positive reflection of how seriously funds take transparency, and their drive for improvement is an indicator of the power of the benchmark which reframes the transparency narrative from a narrow and negative focus on costs to a more holistic and positive concept of transparency that includes governance and strategy, value generation and sustainability.

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. Canadians have terrific reporting on governance and investment performance. The Dutch are world-class on costs. The Nordics excel in responsible investing,” CEM’s Heuberger says. “Generally, funds would gain the most by improving their external investment cost and responsible investing disclosures.”

View the scores and ranks of the 75 funds from last year’s results.