Global pension funds are increasingly looking to private assets to build resilience, stress testing various scenarios to manage the liquidity risks that come with increasing private market allocations.

In a panel discussion at Conexus Financial’s Fiduciary Investors’ Symposium held in Singapore, Anne-Marie Fink, chief investment officer, private markets and funds alpha at the State of Wisconsin Investment Board, said SWIB has the advantage over many other US pension plans that its liabilities fluctuate with its assets, with the amount it pays out based on a five-year return with a base level that it cannot go below.

That “gives us a certain amount more flexibility relative to somebody who has got to pay X amount regardless of what’s going on in the markets,” Fink said, in a discussion chaired by Amanda White, director of international at Conexus Financial.

SWIB manages around US$143 billion in assets. The fund has roughly 28% private assets and is debating internally to increase that allocation to 35% or even 40%, Fink said. The fund’s liquidity allowed it to increase its allocation from 20% during 2021.

“Our teams have been really talking to all of our GPs and essentially saying, ‘we have liquidity, and if you have other partners that maybe are over their skis on their private assets, we can provide liquidity.’”

The fund’s hedge fund strategy is “portable alpha” with virtually no beta in its portfolio, Fink said, along with some passive allocations. This is sensitive to the cash rate, so now that the cost of capital has risen, the fund is now “pruning” its portfolio and looking for ways to increase return per dollar committed, potentially using leverage and accepting some extra volatility.

Also on the panel was John Greaves, head of investment strategy and research at Railpen in the United Kingdom, which manages about $50 billion of assets and administers several pension schemes including the UK’s Railways Pension Scheme.

Improved resilience versus governance and liquidity costs

Adding the appropriate amount of liquidity is an important consideration for Railpen, Greaves said, with illiquid assets like real assets potentially improving macro resilience, but at a governance cost and a liquidity cost.

The fund has pensions to pay, so it cannot ignore short-term risk outcomes, he said, and “liquidity risk is one of those reasons where you can become unstuck in the short term.”

“Funding liquidity risk” came to the fore last year in the UK, he said, proving it is critical for funds to think through, and stress test, their expected short term cash flows.

“That was really challenged in the UK in September and October last year with the volatility in the UK Government Bond Market,” Greaves said. “So that was a really good reminder to think what what might happen, what your risk models might say is impossible, and think through the unexpected. But that aside, it’s usually managed very prudently.”

“Market liquidity risk” is also a critical consideration, being the amount of illiquid assets a fund considers appropriate, Greaves said. These assets may take “many months or years to sell, sometimes you have some control, sometimes you don’t,” he said. 

Managing relationships is critical

The fund balances and differentiates among these assets where some assets may be very illiquid, while others may have strong secondary markets or provide significant income. Managing relationships with general partners is critical, and investing one year but not the next can stress these relationships.

“It was mentioned earlier that you want to avoid the bottom quartile managers,” Greaves said. “You better believe that you need to be investing almost every year to kind of do that, and to maintain those relationships in the top quartile managers. That’s just the way it is.”

Stress testing also involves looking at the possibility that illiquid assets may suddenly become cash flow negative, and “you’re not getting that return of capital because your general partners aren’t exiting because the environment isn’t favourable to do that,” Greaves said. 

The fund needs to limit exposure to illiquid assets at about 40%, he said, noting this approach differs from some Canadian schemes that have much higher levels of illiquidity.

“That model, I think, relies on being fairly proactive on secondary sales and exiting assets, and that is a very resource-intensive and quite a different investment process, so it wasn’t a good fit for us,” Greaves said.

Ding Li, senior vice president, total portfolio policy and allocation, economics and investment strategy, at Singapore sovereign wealth fund GIC, said taking a total return perspective, and looking at the total fund outcome, is also critical.

“For the long-term investor, especially for those kinds of pension plans which have some kind of payout liability, I think the total return is actually the focus for the investment outcome rather than alpha only,” Li said. “Because even if you pick out the right Alpha, if you don’t really capture good market beta, then your total outcome still does not meet your client’s objective.”

Muslim consumers comprise a young and enormous population, and there is a growing opportunity for startups that cater to their needs, argues one of Asia’s most impressive venture capitalists, Thomas Tsao.

Tsao, one of Asia’s most well-known venture capitalists, has been increasingly involved with “TaqwaTech” startups, which build products to serve muslim consumers. He co-founded Gobi partners in 2002–a regional platform that supports entrepreneurs from early stage to growth stage–with 13 offices and locations around Asia.

Tsao has invested in nearly 350 companies in Asia including Aerodyne, Airwallex, Animoca, AutoX, Carsome, GoGoX, Kumu, Prenetics, Sandbox VR, Sastaticket.pk and WeLab.

Speaking at Conexus Financial’s Fiduciary Investment Symposium in Singapore, Tsao said Gobi in its early days had a significant focus on the innovation going on in China along with its massive market.

“It’s a huge opportunity, and look at it now, but what’s a bigger opportunity than that?” he said. “It’s focusing on Muslim consumers, and it’s a $2 billion population opportunity. So that’s something we’re very, very excited about.”

Some of Gobi’s TaqwaTech investments include Durioo, which is “trying to become the Disney for Muslim children…creating animation around Muslim values for a younger audience,” Tsao said.

Ratings for Muslim-friendliness

Another, Tripfez, caters to Muslim travellers by providing a rating system for hotels based on Muslim-friendliness, he said, noting hotels in Muslim countries typically provide prayer mats and an arrow pointing in the direction of Mecca, among other Muslim needs. These are often not provided by hotels outside Muslim countries.

The pace of innovation is accelerating, Tsao said, with technological developments allowing emerging markets to learn from each other and the paths of other nations and build tech ecosystems much more quickly than their forbears in Silicon Valley or even China.

Another of Gobi’s investments is Carsome, a South-East Asian e-commerce platform for buying and selling cars. While some high-end cars can be bought online, the majority of brands are sold through auto dealerships, which Carsome wants to disrupt, Tsao said.

“If you talk about it from an ESG standpoint, a car manufacturer should never build a car until it actually has an order,” Tsao said. “But in order to do that, you need perfect information and you need a lot of traffic and we see that as a real breakthrough that’s going to come in and will then also tie into the next big phase of mobility, which will be autonomous driving.”

In the future, consumers will be able to buy an electric vehicle with autonomous facilities, and rent that car to an autonomous network during the times it isn’t being used, so it can pick up passengers from Grab or Uber and generate money for the owner, he said.

Early-stage VC not affected as much

While large tech platforms have seen massive corrections in the past year, Tsao said the early stage universe – where venture capitalists write cheques for $500,000 up to around $25 million – has not been affected as much.

He said “one of the most interesting investment opportunities in China today” is in China’s Greater Bay Area, a megalopolis that will combine Hong Kong, Guangdong and Macao into a super-economic zone of around 70 million people.

“I think this is going to be one of the most interesting opportunities and there’s a lot of tech sectors that people are going to be investing into,” Tsao said. “And again, for all of those who are doubling down on China, you should be looking at the Greater Bay Area.”

A future of rising uncertainty demands investors fundamentally re-think the way they assess risk when building resilient portfolios, argued a panel of experts from MSCI and Singapore sovereign wealth fund GIC.

A joint research paper focussed on building balanced portfolios in a dramatically changed market environment. Its authors outlined five forward-looking scenarios future markets could face, and argued investors should assess the resilience of their portfolios against these scenarios, rather than relying on backward-looking assessments of risk such as mean-variance optimisation.

The paper, Building balanced portfolios for the long run: A new framework for incorporating macro resilience into asset allocation, was co-authored by Grace Qiu and Ding Li, both senior vice presidents, total portfolio policy & allocation, economics and investment strategy, at GIC, and Peter Shepard, managing director and head of analytics research and product development at MSCI.

All three authors spoke with Amanda White, director of international at Conexus Financial, in a panel discussion at Conexus Financial’s Fiduciary Investors Symposium held in Singapore.

The paper argues investors face two major shifts in the investment environment. The first is that private assets have gradually moved from peripheral alternatives to lie at the core of many asset allocations.

The second, more sudden development is the period of heightened macro uncertainty markets are now facing, with higher inflation and interest rates adding to the challenge of secular forces such as climate change, geopolitical tensions and de-globalisation.

Private assets: higher returns, lower risk

Grace Qiu said private assets promise higher returns and lower risk, but they can be hard to evaluate and incorporate into the asset allocation process alongside public markets. Investors need a measure that can be consistently applied across public and private markets.

“We all know that simple statistical-based volatility or drawdown measures will potentially understate private market risk due to accounting smoothing or lagged valuation phenomena,” Qiu said. “Using a public market proxy can be a dirty and quick fix, but it lacks fundamental linkage to private markets, and therefore can be quite difficult to communicate to your private market colleagues and receive buy-in.”

Macro-economic risks that could dominate the coming decades include supply-driven inflation, a less-credible central bank, rising real rates and slowing productivity growth, the paper argues. It uses five potential macro scenarios to test a framework for allocations that is more resilient against long-term risks, at the cost of shorter-term volatility.

Peter Shepard said investors have largely been limited by “two ways of approaching risk,” one being very statistical and short-horizon, and the other a purely qualitative approach to the long-term.

“That’s really unsatisfying,” Shepard said, noting investors either operate “like a casino with known rules, or you give up on a more data-driven process altogether.”

The paper presents a middle ground that models the long horizon and then allows investors to apply judgement to the more uncertain components, he said.

A lot can be predicated about the long term

Investors have long assumed that it is difficult to forecast for the short term, and even harder to forecast for the long term, Shepard said. But the team realised there is actually a lot that can be predicted about the long term.

“It’s hard to say how much it will rain next week, it’s harder to say how much it will rain a year from next week, but it’s actually easiest to say how much it will rain next year,” Shepard said.

Cash flow shocks and discount rate shocks are painful on a short term horizon because prices drop, but “discount rate shocks are less and less painful” on a long horizon because expected returns go up, he said.

Conversely, trend growth shocks to the trajectory of markets are among the biggest risks facing long term investors, Shepard said, unlike macro volatility which is less of a systemic risk and more of a “bump in the road.” These risks cannot be managed by looking in the rear view mirror, he said.

Ding Li said mean-variance optimisation has been key in past decades for portfolio construction because it provides a useful perspective, but it is not the optimal choice for long term investors.

The study shows, for example, that with a ten year horizon, bonds are resilient to only one scenario–a demand shock–but not for other scenarios. Infrastructure, on the other hand, shows balanced resilience across different scenarios. But mean-variance approach will tell investors that bonds are a very good all-round diversifier based on the past 20 years of negative correlation between equities and bonds.

“Our portfolio does show relatively better resilience across different scenarios, but the cost is, if you’re focussed on a short-term volatility risk profile, our portfolio has higher volatility than a traditional mean-variance portfolio,” Li said.