In a year forecast to be volatile, and with the spectre of recession still very much on the cards, Top1000funds.com finds CIOs exploring new strategies, paring back on active equity, investing in technology and wrestling with the many disparate approaches to sustainability.
“We will get through it, even if bad things happen,” said Richard Hall, president, CEO and CIO at the University of Texas Investment Management company (UTIMCO), the $69.2 billion asset manager and of one of the largest public endowments in the US, voicing the uncertainty many investors feel heading into 2024 in a recent board meeting.
Against the backdrop of contrasting analysis from UTIMCO’s trusted advisors, amongst which JPMorgan and PIMCO predict a soft landing but BlackRock and Bridgewater Associates skew to a hard landing where high rates pitch economies into recession, Hall’s team are maintaining a neutral position – alongside modelling how much the S&P500 could potentially decline should corporate earnings take a pounding.
UTIMCO’s correlation to equity means that in a worse-case scenario if the stock market falls 20-50 per cent it could equate to an $11-24 billion decline in the value of assets under management.
“It’s a lot of money,” warned Hall, whose preparation for a recession includes ensuring UTIMCO has ongoing liquidity to make distributions; is not over its skis in terms of capital calls and commitments and has the firepower on hand to invest in opportunities.
Asking Top1000funds.com interviewees focused on the long-term to share their thoughts on the year ahead is often met with reluctance, given commentary is so quickly out of date. While gathering opinions mid-December, the Fed signalled extensive rate cuts through 2024. But Hall’s advice to “hope for the best but prepare for the worst” in a likely volatile year echoes broad CIO sentiment where others counsel on the importance of diversification and warnings that AI and ESG will continue to fuel inflation.
Exploring different strategies
With inflation still not firmly beaten, growth elusive, and allocations that worked in the past no longer as effective, asset owners will increasingly integrate different strategies to fit the new economic regime. Take Helmsley Charitable Trust, the New York-based $7 billion charitable trust, now exploring convertible bonds offering bond-like characteristics alongside an upside kicker that is less volatile than equities.
Helmsley is also hunting buyout opportunities in Japan, opening up thanks to governance reforms that are forcing Japanese companies to embrace efficiencies and accept the tough, hands-on approach these managers deploy.
In another reflection of uncertainty ahead, investors are boosting their ability to take advantage of opportunities as they arise by increasing and readying their tactical asset allocation. Like the $38 billion Iowa Public Employees Retirement System (IPERS) where CIO Sriram Lakshminarayanan said the ability to tactically invest requires a change in mindset that is rooted in constant communication with managers and their views on the market.
Although there is a growing consensus that borrowing costs will fall in 2024 (“monetary tightening is over,” declared Timo Löyttyniemi, CIO of Finland’s VER in a LinkedIn post) for now higher rates continue to impact the interplay between cash and bonds.
For the first time in years, many investors go into 2024 holding more in cash and will continue to do so as long as rates stay high. If recession comes into view and the Federal Reserve and other central banks lower rates, the environment will become better for bonds and worse for cash and asset owners will likely position to benefit from the price appreciation in bonds.
For now, higher borrowing costs will continue to impact how pension funds approach leverage in 2024 which remains more expensive than in the past and by extension, less beneficial. It’s something front-of-mind at the $71.9 billion Pennsylvania Public School Employees’ Retirement System, PSERS and Canada’s TTC Pension Plan (TTCPP), the $7.8 billion defined benefit fund for employees of Toronto’s public transport network.
Some investors spoke about paring back on active equity in 2024, arguing it is difficult to pick winners in a market dominated by the leading tech stocks. “We are hoping to implement decent-sized passive allocations by year-end,” said New York-based Geeta Kapadia, CIO of Fordham University’s $1 billion endowment. “I don’t think looking for long-only US equity managers that outperform is a great use of our time. I’d rather take active risk in private markets than in public equities or credit.”
But even if investors question the value of active equity, there is much talk of enduring and compelling US equity opportunities. Technological leaps like LLM (large language models) powering the AI revolution and the new generation of life-changing drugs will continue to offer unprecedented opportunities in public markets.
“A rising tide will lift all boats, just be invested in boats, just be invested in equity,” said Charles Van Vleet, CIO of the Textron pension fund, who will run an active stock picking strategy through 2024 but says passive allocations will also benefit from unprecedented corporate innovation.
“Who is going to reap the benefits of this productivity? It’s not going to go to labour – it’s going to go to the capital providers; to the equity investors, and it’s already priced into the market.”
Adjustments in private equity
Investors predict a mixed year ahead for private equity – an asset class Norges Bank Investment Management, investment manager of Norway’s $1.5 trillion wealth fund Government Pension Fund Global, hopes it will finally get a green light to invest in after years of petitioning the Ministry of Finance.
Higher interest rates mean a higher cost of doing business that will continue to impact portfolio companies’ performance and multiples, and may not feed into valuations until 2025-2026. Meanwhile, investors are unclear if exit strategies via IPO and M&A activity will open up in 2024.
“I have to remind our senior managers and board that returns will be more challenging going forward. Yes, private equity is the best performing asset from an absolute return perspective, but you must also look at it from a risk adjusted basis, and private equity is the most risk-taking allocation in the fund,” said Suyi Kim, global head of private equity at Canada’s CPP Investments.
Many asset owners go into 2024 overweight their allocations because of capital appreciation in the underlying programme and GPs sitting on companies because they don’t like current valuations, and don’t want to write them down. It means the year begins with many LPs choosing fewer managers with whom to re-up as well as selling assets in the secondary market. Still, one LP’s challenge will be another’s opportunity. For some, 2024 will open the door to invest with sought-after GPs for the first time and support fee negotiation.
Recruitment and talent acquisition, particularly around technology, will be a key issue through 2024. At ADIA, tech prowess can be seen in its purest form in the quantitative research and development team and the asset owner says it will continue to recruit globally respected experts in diverse areas such as machine learning, strategy development and portfolio construction through 2024.
Elsewhere Industriens, the DKK 217bn ($30.6 billion) Danish pension fund, will spend 2024 continuing to explore AI models to optimize its asset allocation, uncover anomalies in data, perform automated text analysis and put in place restraints, for example around ESG at a level impossible to replicate in Excel. Meanwhile the quest to fill CIO openings at US public pension funds including CalPERS is likely to get easier as the tide finally turns in favour of recruiters.
Will asset owners increase their allocation to China? Investors respond that strained geopolitics, complex regulation, the increasing cost of doing business not to mention the inability to forecast exits makes direct investing in private assets in China challenging.
Sustainability in 2024
This year may see the term ESG increasingly give way to more coherent themes around sustainability. Elsewhere, investors look forward to applying new tools to support sustainability in their large allocations to sovereign debt.
The investor-led ASCOR project (Assessing Sovereign Climate-Related Opportunities and Risks) has just published its first independent academic assessment of 25 countries’ climate targets and policies. The analysis offers investors data and insights spanning the extent to which emissions are declining to a country’s regulatory focus.
Adam Matthews, co-chair of ASCOR and chief responsible investment officer at Church of England Pension Board, believes it is one of the most important sustainability initiatives in years. “Investors haven’t had an academically rigorous, transparent and publicly available holistic lens through which to assess climate mitigation and adaptation in their sovereign holdings until now,” he said.
Sustainability teams will also spend 2024 wrestling with their approach to emerging markets. For many pension funds on a net zero trajectory, emerging market holdings have a disproportionate impact on their total carbon footprint, explains Mirko Cardinale, head of investment strategy at USS.
“The easiest way to reduce that footprint would be to sell carbon intensive companies in emerging markets, but this does little for the real world impact. We are keen to see real world change and that’s why we continue encouraging the highest emitting companies we invest in to reduce their carbon emissions.”
The focus for investors this year will be engagement with national issuers, but also recognising the importance of emerging markets being treated fairly in current frameworks.
“We need differentiated pathways for companies in emerging markets,” concludes Matthews.
