Investors always have to face uncertainty and risk, but for the next couple of years, political factors will play an important role in markets, creating more random change and making it more difficult to predict market movements, according to Li Keping, senior adviser to China Investment Corporation (CIC), and former chief investment officer, who was speaking at the International Forum for Sovereign Wealth Funds in Auckland.
In the past year CIC has made a number of organisational and investment changes due to the current investment environment, including improving its asset allocation framework.
Keping says CIC has delegated more decision-making power to lower level, single portfolio managers both in-house and externally.
“We have given them more room if they have the ability,” he says.
It has built out its capability in private equity, both internally and in its network to co-invest and go direct.
“We ask ourselves, ‘what we can do?’ We are very focused on what our competitive advantages and potential advantages are,” he says. “We think cross-border ability is one of our potential advantages.
“In this investment environment we have relatively high equity beta risk; how do we deal with potential drawdown risk? We have to think about correlation as a whole portfolio.”
Gordon Fyfe, chief executive and chief investment officer of bcIMC, who was on the panel alongside Keping, says having patient, long-term capital is an advantage.
“In public equities, why would any of us own equities? We don’t need the liquidity; why aren’t we looking for opportunities to invest higher up the capital stack and take advantage of that? So even in low return environment there are ways to get returns,” Fyfe says.
He also says there are more exciting opportunities in distressed.
“You can get some good assets by acquiring the debt. This is not easy, and there is a lot of work understanding the sectors and assets. But if your organisation is geared to look for these opportunities, they do sum up and make a difference.
He also says investors should be paying more attention to private markets fees.
“Paying 3-5 per cent per year might be okay when returns are 25 per cent, but when they are 9-12 per cent it makes a big difference. Look at ways not to pay these fees,” he says.
“For example, start a new fund with experienced people who you can back and negotiate better terms. Or you can co-invest.”
New Zealand Super and PSP, the fund Fyfe used to head, co-invested in a forest in New Zealand, and bcIMC has co-invested with GIC on infrastructure and real estate.
“One of the reasons I like coming to these forums is meeting people we can potentially co-invest with. We don’t need GPs. One of the competitive advantages we have is we have a large balance sheet, and economies of scale allow us to build big internal teams. We also have very long-term time periods; we never have to sell an asset unless it’s at our choosing.
“For any of us here – because we don’t have to sell in a shock – bad is good, because we don’t have to sell, it’s just an accounting adjustment. We need to take advantage of distress and hopefully find some good assets. We should start looking at debt and leverage; your liability is an asset. When rates move up you’ll be well positioned.”
Also speaking on a panel discussing investment risks and returns in the current environment was Massimiliano Castelli, managing director and head of strategy, global sovereign markets, UBS Asset Management.
“I spend most of his time advising clients on asset allocation. So what’s the strategic approach for sovereign wealth funds to respond to the current environment?”
There are four possibilities: increase risk; increase illiquid asset classes and more direct investing (seeing a long of that); become more tactical; and implement alternative portfolio construction techniques.
The third and fourth on the list require broader change, and a move away from asset allocation and to something completely new.
“Becoming more tactical sounds easy, but it is difficult to implement, but there are excellent opportunities,” he says. “Implementing alternative portfolio construction techniques, you become more like a hedge fund and use what’s available to you, not just asset allocation. This will require organisational change.”
According to Chiew Kit Tham, managing director of total portfolio strategy at GIC, the risk/reward of buy and hold has deteriorated over time.
“We are worried about the long term. Most globally diversified investors will experience a decline in returns compared to what they are used to. So what can we do about that?
“Most long-term investors might be tempted to pare down risk; they could also dial up risk, but more interesting is to rotate, shift risks around, and expand risks.”
He also says other options for investors in this environment would be to expand bottom-up alphas and keep dry powder.
“We like the characteristics of bottom-up alphas; we want to take advantage of alphas that take advantage of market stress and access to deals,” he says, noting there are two types of bottom up alphas – volatility and market timing.
“If you do alpha properly, and choose the right managers, it will give you a lift,” he says. “Investors should make use of the strengths they have that others may not be able to access.”
