A long-awaited review of Sweden’s buffer funds has proposed consolidating AP1, AP3 and AP4 into two funds.

Stating that the “advantages outweigh the disadvantages,” Tord Gransbo, an adviser to Sweden’s Ministry of Finance working on the review since last October, argued that consolidation would create efficiencies and scale, effectively managing the capital in the long term for a higher net return.

The many similarities of the three Stockholm-based funds (AP2 is based in Gothenburg) include their gradual move towards comparable asset allocations, assets under management (between $44 and 47 billion each) and increased co-investment. Moreover, Gransbo noted that they employ similar numbers of staff in the same job categories and compete against each other for sought-after staff.

In other shared seams, the funds have deepened cooperation on environmental and ethical issues through the Council on Ethics.

“The high degree of similarity means that there are good opportunities to achieve economies of scale in asset management through consolidation or mandatory administrative cooperation,” states the report, in Swedish.

“The consolidation proposal has a much greater potential to improve the conditions for efficient, rational and effective management of the buffer capital and thereby contribute to a higher net return in the long term.”

Gransbo flagged the complex process around consolidation would incur considerable direct costs and significant implementation risks that could impact returns.

The report did explore the benefits of greater cooperation (rather than consolidation) between the Stockholm funds. This would create cost efficiencies and reduce the risks that come with consolidation. However, Gransbo noted that the consolidation proposal carries a significantly greater potential to improve management of the buffer capital, which would, in the long run, contribute to a higher net return.

The report did not single out any of the three funds as a candidate to be split up. The report will now be consulted on, and the all-party Pensions Group will decide the actual shape of any changes to the system.

“We will now read very carefully and analyse the proposal and will of course assist in the formal consultation process that will soon commence,” a spokesperson for AP4 said.

“It is good and natural to regularly review the management of the public pension system’s buffer capital, and we welcome the fact that “Pensionsgruppen” has started to review how the pension system can be developed and strengthened.”

In addition, the report proposes changing the structure of the AP Funds’ boards, highlighting a possible reduction in board members and the requirement of specific skills.

AP6 benefits

Grasbo said his preference is to maintain the current organizational structure of small, private equity specialist AP6.However, he suggested AP6 should be integrated into the wider buffer fund system.

“The Sixth AP Fund has not been integrated into the buffer fund system. It is high time that this happened,” he said.

AP6 chief executive officer Katarina Staaf said the review points out that the expertise of AP6 should be scaled up and that AP6 should be fully integrated to the Swedish buffer system.

“One way of doing this, according to the review, is to remove today’s legal requirement of currency hedges, to allow inflows and outflows linked to the pension system and to open for AP6 to be enabled to borrow from The Swedish National Debt Office [Riksgälden], who is the central government financial manager,” Staff said.

“All are necessary changes that we welcome.”

 

Investment strategy at Seattle City Employees’ Retirement System (SCERS), is guided by an overwhelming focus on long term assets. Hedge funds and commodities are out and cash – not a risk-free asset for a long-term investor – is kept to a minimum. Instead, perpetual equity, long term fixed income and real assets are in, accounting for a combined three quarters of the $4.1 billion portfolio.

“The takeaway is that those of us with long-lived liabilities like pension funds, benefit from being invested in long-lived assets like equities, real assets and long-dated bonds and should leave the short-lived assets like cash, intermediate bonds and hedge funds to those with short-lived liabilities,” says SCERS’ CIO Jason Malinowski in an interview with Top1000Funds.

Malinowski calls the strategy liability aware investment and dates the approach at SCERS to a board request six years ago that the investment team think more about the liabilities when assessing risk and performance. It fired the starting gun on a conceptual and analytical framework, followed by an  incrementalist approach that is still not complete.

In the intervening years events like the collapse of Silicon Valley Bank (SVB) have built on Malinowski’s faith in the strategy. He uses the travails of SVB to illustrate what can go wrong when an organisation’s assets and liabilities are structurally misaligned. In this case, SVB’s substantial holdings of long-term bonds – which suffered crippling losses when interest rates rose – and short-term deposits.

“SVB failed to balance long-lived assets and short-lived liabilities when the opportunity cost of capital increased,” he explains.

It’s the exact opposite for pensions. “For pension funds, liabilities are long term and members can’t withdraw their funds. If they invest in short term assets like hedge funds and credit they have the opposite asset liability mismatch that is exposed if the opportunity cost of capital falls.”

He says the strategy involves a shift from thinking about risk and performance of the investment portfolio to the risk and performance of the total plan. SCERS’ liabilities are discounted according to expected returns, and the team need to understand the relationship between investment performance and changes in expected returns.

“We needed to switch our focus from asset volatility to funded status volatility.”

Hedge funds and core bonds

In 2019, Malinowski eliminated hedge funds, re-allocating money to equity and infrastructure. Last year he went a step further, trimming the allocation to core bonds in favour of a new 5 per cent allocation to long term bonds.

While many CIOs enthusiastically endorse hedge funds’ uncorrelated returns, particularly when bonds and equities fell in tandem in 2022, Malinowski believes he can find enough diversification between stocks, bonds and long-term real assets to override the need for hedge funds.

“Hedge funds do not have a role in a portfolio that funds long term liabilities,” he says.

Moreover, as a liability aware investor, plummeting stocks and bonds in 2022 were not a source of alarm.

“I had a different view of what happened in 2022. We saw negative asset performance, but it was also a period when expected returns were increasing – bond yields were increasing, and earnings yields also increased. Our assets fell for sure, but our liabilities were also falling because expected returns increased, and this made the pension maths work again.”

Liability aware investment also means Seattle loses out on bold allocations to star performing assets like private credit where SCERS’ small allocation is capped, but other investors continue to flock.

But Malinowski is happy with a limited exposure. He reasons that one of the biggest risks with private credit for investors with long lived liabilities is re-investment risk. “When we get our principal and income back after 3-5 years we will have to reinvest it into new credit allocations. But this is subject to the market environment at the time which could have lower interest rates and lower credit spreads,” he says.

Background to the strategy

The strategy has similarities to LDI – like a focus on the whole plan rather than just the investment portfolio, and funded status volatility rather than asset volatility. However, LDI liabilities are discounted based on long bonds and in a liability aware portfolio, all long-term assets are attractive because they align with long term liabilities.

“Yes, we like long bonds, but we also like equities because they are perpetual, and real assets like real estate and infrastructure.”

He says the strategy does not cut fees dramatically. SCERS’ long-term fixed income allocation is in passive treasuries, but the fees from the equity and real asset allocation are still high. “With 30 per cent in private markets we do have meaningful fees. This was not an exercise in minimising fees.”

The strategy doesn’t use leverage in the bond portfolio and is straightforward to implement, something that is important because it helps weather any storms. He is mindful of liquidity and the need to pay benefits, but says SCERS’ doesn’t need huge amounts of liquidity on hand. “You need to be aware of how much liquidity you can take, but our outflows are modest. Liquidity isn’t a meaningful constraint for our portfolio.”

Malinowski fields regular enquiries from peer CIOs  interested to know more. Many of their questions centre on how he got board approval and how the fund first initiated changes in its asset liability study to switch to long-term asset classes. He finds the process useful since it tests what SCERS has put in place – and it also reassures him that SCERS hasn’t strayed too far from peers.

“I am focused on how different we are  [to other funds],” he concludes.

 

 

 

Two themes dominate strategy in CalPERS’ $72.6 billion private equity portfolio as it gets back on course after an infamous lost decade of missed performance: co-investment; and reducing the bias to buy-out.

Co-investment, favoured for its structural alpha and dramatic savings compared to traditional fund investment, now accounts for 40 per cent of the portfolio. In marked contrast to the previous two decades when CalPERS prioritised large allocations to funds, in 2023 the majority of the pension fund’s private equity commitments were in co-investment which could, predicted Anton Orlich, managing investment director of the portfolio, save the pension fund $25 billion over the next ten years.

“Each $1 billion of co investment results in a $400 million saving thanks to not paying GP management fees and profit share. One third of those savings are made on the front end of the investment, and two thirds at the back end, meaning that the saving accelerates through the portfolio,” he said, speaking in a recent board meeting.

Nor does co-investment just lower fees. Orlich told the board that it had helped CalPERS develop its brand and trust with GPs, supporting key relationships so that the pension fund can still access investments, even when managers are oversubscribed.

“There is so much emphasis on cost saving within co-investment that governance gets overlooked,” he said.

CalPERS has increased its allocation to co-investment despite a tough climate in the asset class. The lack of deal flow and exits has knocked into new co-investment opportunities. “As the level of M&A declines, there are fewer co-investment opportunities,” he said.

Another important benefit of the co-investment programme is that it has avoided the build-up of large unfunded commitments. Co-investment has increased cash demand (which jumped from $3 billion to $9 billion in 2023) because commitments go straight into the ground. But Orlich espoused the benefits of quickly putting money to work over fund investments where GPs often delay capital calls and leave LPs at risk of meeting unfunded commitments in challenging markets.

The portfolio is cash flow negative because deal activity is slow, and CalPERS is seeing very little in the way of realised gains coming back into the portfolio. However, the lack of cash flowing back is impacting CalPERS less than others.

“It affects us less because of our under allocation during the current harvesting years,” Orlich says.

He predicts CalPERS will continue to deploy more than it gets back for another four years. Only then will the fund begins harvesting returns that can pay for future investment.

Mega buyout bias comes to an end

For the last two decades, large mega buyout funds dominated CalPERS’ strategy. Over the last two fiscal years, the team have reduced the allocation to buyout from 80 per cent of the portfolio – it used to account for 91 per cent in 2020-21 – to 67 per cent, equivalent to $48.9 billion. The shift has created an opportunity to generate alpha where there is a greater return dispersion across other allocations including growth, opportunistic, credit and venture.

Moreover, within the buyout portfolio, CalPERS is shifting to more mid-market buyout opportunities where managers are less dependent on leverage to generate returns.

But the strategy means manager selection (CalPERS invests with 126 managers and 363 funds) is even more important. Key deployment themes include vintage year consistency, along with a growing ($4 billion) allocation to diverse managers where CalPERS is able to tap into enhanced diversity and return dispersion. Orlich warned that allocating to emerging managers involves even greater emphasis on manager selection because there is more upside and downside.

He is also prioritising  consistent pacing. The team successfully allocated $15.5 billion every year for the last three years. Only with consistent pacing will it possible to achieve the fund’s recently increased goal to allocate 17 per cent of the portfolio to private equity – up from 13 per cent. “Consistency in commitments is important to avoiding another lost decade,” he said.

In another theme, the team have selectively diversified the portfolio geographically over the last two fiscal years. The program is still US centric (U.S. exposure is approximately 75 per cent) but European exposure is approximately 20 per cent.

 

Staff at Ontario Teachers’ Pension Plan Board, the $247.5 billion global asset owner, come into the office at least three days a week. Although some come in four, or even five days, the investor hopes its new downtown Toronto offices will encourage people to spend more time on site.

It is also the type of premises that will help lure top talent to the pension fund, explains George Konidis, managing director, Real Estate & Workplace Transformation, OTPP, who led the dramatic renovation of the landmark building.

Since the pandemic, we have proved we can work effectively from home. And mandates that compel staff to show up more regularly at the office are often unpopular – although banks are taking a much tougher stance, stepping up enforcement of days required in the office.

Konidis believes OTPP’s new offices will boost human connection and creativity and show the office in a new light, bringing people together in a different way.

“Our new workplace experience fosters the need for collaboration, networking, mentoring and productivity,” he says.

“We have invested in our teams by providing a space that enables a successful workplace experience while also giving people the flexibility to work from anywhere.  We’re pleased with what we’ve achieved.”

Flexibility and choice

The emphasis on flexibility and choice in work styles stand out as one of the building’s key features. OTPP’s new offices have tech-enabled work seats, lounge seating, collaboration seating, meeting rooms, cafés, lounges, quiet rooms, focused workspaces and amenities to support individual needs in the workplace.

Staff can work in different workspaces to suit their individual business needs and workstyle preferences, he explains. “The aim is to further elevate well-being and productivity by providing spaces that match how people want to work and the type of work that they will be doing.”

A suite of technology tools and solutions give employees the ability to work effortlessly from anywhere in the office and the range of rooms are designed to improve meeting equity by making the experience the same for participants in person and online via new, hybrid first meeting experiences, says Konidis.

“When we made the decision to create a brand-new workspace and head office, we were looking at and planning how we could drive an elevated workplace experience. We are proud to have created a space that reflects our culture and emphasizes sustainability, inclusion and well-being and one that, we see, will motivate employees and increase productivity.”

The investment teams can use the conference level floor and meeting space “to dial-up the experience when they are hosting meetings and events,” says Konidis. “Having the ability to elevate the in-person experience, coupled with being centrally located in downtown Toronto, will certainly be beneficial.”

He adds that the new office will also help attract top talent.

“We see the in-office experience – especially when a physical space can reflect an organization’s culture and draw-in priority elements to our teams like wellness, sustainability, and amenities – playing a vital role in attracting and retaining talent.

We took the time to speak with employees and understand what they were looking for in a workspace. The outcome was an amenity-rich space with sustainability, inclusivity, wellness and flexibility embedded in its design.”

 

 

 

Alberta Investment Management Corporation, AIMCo, the $160 billion asset manager for pensions, endowments and insurance groups in Canada’s western province, is developing a total portfolio approach in private assets.

Unlike other Maple Eight investors, AIMCo’s client funds decide their own asset allocation and most of them have reached their target in private markets. Rather than continuing to plough in capital, the investment team are now thinking more about comparing opportunities across assets and anticipating future trends.

“The investment horizon for these assets is long and the ability to rebalance in the future is hampered,” warns Marlene Puffer, who joined AIMCo as CIO in 2023 from Canada’s railway pension fund CN Investment Division.

This approach ensures AIMCo taps sufficient risk but also protects against embedding too much connected risk. Puffer says cross-functional conversations and analysis from the risk team supports intelligent decision-making and avoids unintended consequences.

The team is exploring how different themes cut across different asset classes, she says. The best example is AI which manifests in every corner of the portfolio, but in private markets is encapsulated in red-hot investor demand for data centres. These buildings touch infrastructure and real estate; they hold private equity elements in the construction and development phase; and that are also a renewable energy play.

“We are having more sophisticated conversations around where we want to play in this [AI] value chain and why,” Puffer says.

“It is about making sure we don’t miss part of the value chain because of our definition of what constitutes a real estate or infrastructure investment, or the geographical focus of the portfolio.”

AI is just one example. The total fund approach will touch every point of AIMCO’s strategic direction defined by global diversification, a focus on Asia, integrating climate and new energy opportunities, and garnering more strategic input from partners so that fund investments lead to co investments and direct investment.

“Global diversification, energy and climate opportunities and strategic partnerships all sit in total portfolio management,” Puffer says.

“It is about collaboration and breaking down silos.”

A new approach to risk

The new approach is supported by AIMCO’s rebooted risk culture following losses during COVID-induced market volatility when the investor shed $2.1 billion on a strategy meant to profit from low volatility in equity markets, known as VOLTS. A review found that escalation of the risk of the strategy to senior management and the board was “incomplete” and did not come soon enough.

Now the breadth and depth of risk governance and collaboration has been overhauled, fanning a new risk culture. The investment process involves a two-step approach to analysis whereby anything new coming into the portfolio (a manager or strategy, for example) is discussed first at the investment committee level, before further scrutiny by the investment, risk, legal and sustainable investing teams.

Governance has been reviewed and refreshed. The board has oversight of the risk parameters of every underlying product, and review and set the appetite for risk tolerance and the total fund risk budget. Escalation policies are also now embedded.

New high profile hires include Kevin Bong, senior managing director, chief investment strategist and head of Singapore; and chief risk officer Suzanne Akers who joined in 2022. Puffer says the pair represents a new level of talent and leadership that is now embedded into investment teams, weighing in on due diligence.

“Deals have not been done, or we’ve added more due diligence, as a result of these people,” she says.

There is an independent risk assessment for every transaction and Akers is a voting member of the investment committee.

New C-suite hires have helped build a new culture that encourages psychological safety in all interactions, and open and challenging conversations. Team building and in-person, regular offsites despite the teams being spread around the globe is fostering strong relationships and ensuring everyone pulls towards the same strategic goals. Puffer says gatherings may thrash out strategies, or just focus on building trust and understanding of each member of the team, she says.

“We all know where we are going,” she says.

Private credit is the star of the show

AIMCo’s $7 billion private credit portfolio is another a key area of Puffer’s focus. The investor is expanding its already significant private credit talent base in London and Toronto, with new hires in New York. Maintaining the portfolio’s size, and growing it further, requires stepping up from the small-cap investments made at the beginning and developing large-cap partnerships and deal flow out of New York.

It’s difficult to scale in small cap, she explains. The typical four- to five-year tenor of a private debt deal means around 20 per cent of the portfolio is in perpetual motion.

“You have to feed the portfolio,” Puffer says.

“We are a small team, and feeding it with large-cap deals is more effective. Although it’s possible to scale through small deals, they take up as much time as a big deal and require the same level of talent and staffing.”

AIMCo is one of many investors piling into the asset class which now accounts for some $2 trillion of assets under management. The IMF recently sounded the alarm at so much debt being traded out of the public eye in its latest Global Financial Stability report.

Puffer acknowledges the risk of scaling the allocation in an environment where interest rates are more likely to fall than rise, but she is reassured by an enduring return profile that adds value and provides an alternative exposure to liability matching fixed income.

“Private credit is the star of the show,” she says.

“The sensitivity to interest rates and duration is not the only reason we are in private credit. We are also in it for the credit spread, and for a little extra because of today’s base rate. Even as rates come down, it still has value because it will be down less than our other investments in fixed income.”

Moreover, she says AIMCo has an edge because of the team’s ability to execute. Private credit is shaped around fund investments, yet with each partner the team expects significant co-investment deal flow opportunities. Cue a sophisticated internal team not only with the ability to turn deals around quickly but also a familiarity with its partners and the way they work, and knowledge of the underlying companies.

Puffer will also spend the coming months sizing opportunities in Asia via AIMCo’s new Singapore office, opened late last year. She says fund mangers are increasingly setting up shop in Singapore, enabling new partnerships out of the city state that will lead onto co-investment opportunities, particularly in renewables and diversified infrastructure.

Pioneering responsible investor Brunel Pension Partnership is using AI to improve stewardship evaluation and has spent much of the last year improving the misalignment of interests between asset owners and managers in relation to climate stewardship.

The team uses an AI-driven tool called a generative pre-trained transformer (GPT) to analyse and compare the voting guidelines of approximately 20 asset managers and owners, according to the fund’s recently published Responsible Investment and Stewardship Outcomes Report 2024.

The £30.8 billion ($38.9 billion) Brunel uses the insights to update its own voting guidelines, ensuring they are ahead of current practices and expectations.

“It’s about understanding the broader shifts in stewardship standards and ensuring our guidelines reflect these,” says Oliver Wright, responsible investment officer.

Brunel has also developed a quarterly report reconciliation tool which uses AI to assess implementation of its voting guidelines. It then uses the reports generated as a tool to engage with its service provider where it sees discrepancies.

“Given the importance of voting implementation, the ability to automatically verify this information has been invaluable,” Wright says.

“It ensures the reliability of our reports and significantly reduces the time and effort previously required for manual checks. This means that we can devote more resources to engaging with investee companies and other core stewardship activities.”

Brunel believes AI’s role in stewardship is only set to grow. As the technology advances, Wright says he expects new tools for more effective engagement with companies, improved monitoring of sustainability factors, and even predictive analytics for identifying potential governance risks to appear.

The future of stewardship will likely involve a greater integration of AI to not only streamline operational tasks but also to enhance the strategic aspects of work like focusing engagements to ensure meaningful outcomes.

“GPT has already proven to be an asset, and its ongoing development will undoubtedly open up further possibilities for enhancing our stewardship practices,” Wright says.

However, whilst AI brings substantial benefits, Wright warns of its risks. Like the potential for social bias in AI algorithms. Given that AI systems are trained on large datasets that may contain societally biased historical data, there’s a concern that these systems could replicate and even amplify existing societal biases.

Alongside this, there’s the challenge of ensuring that the fund’s reliance on AI doesn’t diminish the value of human judgement, and that data privacy and security are rigorously maintained. To mitigate these risks, the team regularly audits AI tools for bias, ensures transparency in operations, and maintains a balanced approach that combines the efficiency of AI with the nuanced understanding of experienced professionals.

Addressing misalignment

In another noteworthy trend, Brunel has spent the last year working with other asset owners to address the misalignment of interests between asset owners and managers in relation to climate stewardship.

The 2023 proxy season provided signs that some asset managers had failed to unequivocally challenge oil and gas companies that were backtracking on their climate commitments, the report says. This contrasted with the positions of large asset owners that shared the view that if climate related risks are not addressed through stewardship activities, this can translate into investment risks for their portfolios, affecting long-term beneficiary interests.

To address the discrepancy, Brunel entered “robust and constructive dialogue” with its managers, identifying how fund managers can be better supported in delivering asset owners’ climate stewardship strategies.

Brunel’s analysis of the misalignment, and conversations with other asset owners, was framed by research findings presented by independent academic, Professor Andreas Hoepner. Using the energy transition in the oil and gas industry as a test case, Professor Hoepner and his team have evaluated the voting records of select managers on oil and gas majors.

This research provided evidence of a misalignment. The full research which was released in November 2023 provided insights on misalignment trends and voting rationales. For example, only a select few asset managers publicly align their reasoning with asset owners.

Some asset managers perceive voting and ESG engagement as mutually exclusive, raising concerns about potential access loss to management if misaligned.

The review also found distinct engagement process types ranging from persistent, long-term engagement with considerable progress to “quick fix” and “jumping the bandwagon” styles, pointing to issues around consistency and a long-term approach to engagement.

The research also put forward a number of rationales for the gap, highlighting that further research is needed to explore these issues in greater detail.

These include cultural misalignment – namely the differences between UK based asset owners and non-UK based asset managers – and resource allocation misunderstanding – aka the potential misunderstanding of the importance of stewardship and voting, leading to insufficient resource allocation.

Other reasons include a misunderstanding fiduciary duty, particularly in terms of risk management related to climate change and financial conflicts of interest.

In the next phase of the project, asset owner participants will initiate one-to-one bilateral conversations with their managers on the basis of the research findings. The next phase will also look into how asset owners can articulate their views on climate stewardship.