PensionDanmark’s decision to invest in naval patrol ships flags a new source of complexity bearing down on ESG and sustainability-minded European pension funds. Many cap investment in the defence sector and exclude defence stocks because they fall foul of ESG filters, but as war drags on in Europe, the continent’s institutional investors will increasingly have to review the ethics of investing in defence.

PensionDanmark’s decision has been many years in the making and isn’t new territory for the $49 billion labour market fund. It is already an experienced investor in ships and the multifunctional patrol vessels, still in the design phase, will sit in its sizeable infrastructure allocation alongside flagship green investments like its stake in ten wind energy projects on islands around the world.

PensionDanmark is providing the finance to a newly formed consortium, Danske Patruljeskibe K/S, comprising defence group Terma and ship designers Odense Maritime Technology (OMT.) The trio’s first customer is the Danish Ministry of Defense Acquisition and Logistics Organization (DALO). Once this order has rolled off the production line, they hope to begin building military vessels for other country’s navies too.

“The risk primarily lies in the fact that it is a new type of ship that we are developing together with our experienced partners Terma and OMT,” says a spokesperson for PensionDanmark from the fund’s Copenhagen offices.

“PensionDanmark’s investment policy, including our principles for responsible investing, is discussed and approved every year by the board and has broad support. There has been a shift in the general perception of defence investments after Russia’s invasion of Ukraine.”

The fund has been first out of the gate amongst European peers to identify opportunity in geopolitical risk and the ongoing war in Europe. Most other European pension funds are only just beginning to have a complex and soul-searching conversation on the ethics of investing in defence with their stakeholders and society.

But pressure is building. Like the former Dutch Minister for Defence Kajsa Ollongren urging the country’s pension funds to invest more in the sector earlier this year. Her comments followed 2022 calls from a majority in the Netherland’s House of Representatives on pension funds to invest more in defence groups due to the war in Ukraine.

In the UK, the Investment Association, a trade body for investment managers and pension schemes, is also on the case, recently writing that “investing in good, high-quality, well run defence companies is compatible with ESG considerations.”

Meanwhile defence firms, confident that by the EU’s taxonomy won’t impose restrictions on financing their sector, are upping the ante and lobbying hard to get into pension funds’ portfolios.

“The geopolitical backdrop is changing, and different nations are in different positions,” reflects Richard Tomlinson, CIO of the United Kingdom’s £26.3 billion Local Pensions Partnership Investments, LPPI. “Understandably, there is more political support for this kind of thing in the Nordics than in the UK, given geographical proximity to Russia. That said, it’s not inconceivable to think that the UK government could do the same and actively encourage pension funds to invest more in the military in the future.”

For now, any conversation about defence at LPPI remain confined to navigating geopolitical risk in the portfolio. The investment team, alive to growing geopolitical risk for a while, have run “wargaming” workshops to plan for different scenarios and how they might respond in each. These have included an escalation in the conflict in Ukraine or rising tension between China and Taiwan.

Investing through an impact lens

One way pension funds could approach their traditional reluctance to invest in defence is by looking through an impact lens. In this context, investment in some defence assets could even sit in the social infrastructure bucket, reflects Tomlinson. “Viewed through this lens, it’s not that big a leap to go from investing in hospitals and social housing to ensuring the sustainability of liberal democracy via supporting critical defence infrastructure.”

PensionDanmark certainly has no qualms about investing in companies that contribute to “the defence of Denmark and NATO allies” so long as these companies aren’t involved in controversial weapon production and respect treaties prohibiting chemical weapons, cluster munitions and anti-personal mines.

The vessels will strengthen the capabilities of the Danish navy in domestic waters and prepare the fleet for future complexities at sea, extols the fund. “We believe our investment will make a significant contribution to society in supporting the future-proofing of Denmark’s navy and thus national security.”

But like many ESG and impact investments, investing in defence scores well in one area, preserving liberal democracy and national security, but less so in others, for example, climate. War ships and planes kick out huge amounts of emissions that will be difficult to square with net zero ambitions.

For some investors, the obvious starting point is clear government guidance. Daan Spaargaren, senior responsible investment strategist at PME says the Dutch pension fund for 1500 employers in the metal and high-tech sector that serves 630,000 beneficiaries, is willing to discuss the issues at stake. But he also wants policy guidance on which areas of the defence industry needs most investment, and where pension funds should funnel capital.

Moreover, he believes it is incumbent on the government to procure from these defence companies.  “If governments want investors to support a national defence industry, then the government should guarantee procurement so these companies can invest and expand.”

Spaargaren is aware of the potential returns in the sector where PME already invests, mostly in listed defence stocks and bonds. “The defence sector is flourishing and returns high,” he says in a nod to how the rearmament of Europe, as well as wider military spending among the US and its Asia-Pacific allies, is an increasingly important macro theme.

UK pension funds wrestling with the issue should reflect that in some respects they could already be active investors in the sector, suggests Tomlinson. At one end of the spectrum, some UK pension funds may be investors in military housing group Annington Homes via private equity group Terra Firma, for example. Further up the scale, others will hold stakes in BAE Systems which supports the UK’s strategic nuclear deterrent Trident.

Investing in more conventional, listed defence stocks to financing a country’s critical defence capabilities should be seen on a spectrum but the leap may not be that big.

Many pension funds also have existing investments in dual use technologies such as AI, facial recognition and secure communications, he continues. These technologies, with both military and civilian applications, also sit on the spectrum.

The recent spike in ransomware attacks on UK NHS hospitals has highlighted the critical role of this kind of technology in fighting cyber attacks. It offers another example that makes it possible to trace a line between UK pension fund investment in cyber security today – to financing war ships PensionDanmark-style tomorrow. “At what point does social infrastructure that enables our national institutions to combat cyber risks and broader asymmetric warfare extend to funding warships?” he asks.

As the debate grows in the Netherlands, Spaargaren notes that a few pension funds are seeking to loosen exclusion policies and invest in nuclear. He says PME has no desire to unpick its own policies, and questions if funnelling more capital into nuclear would actually support the Netherlands defence strategy anyway.

Moreover, he believes that investing in nuclear and any other controversial weapon would cross a line for PME beneficiaries, where some are already uncomfortable investing in defence.

“Investing in military capability will come down to an investor’s investment beliefs and their stakeholder group,” concludes Tomlinson. “Some investors will have clear fiduciary responsibility to principles that preclude this type of investment and will be very clear about what they can and can’t do. Others may be more able to align with government policy, if one emerged.”

In the meantime, governments’ attempt to convince Europe’s pension funds that the defence sector is green and sustainable has only just begun.

The proportion of female board members overseeing listed Swedish companies has edged downwards in the past year, back to 2022 levels. Only around 35.5 per cent of current board members on companies listed on NASDAQ Stockholm, the region’s biggest stock exchange, are female, according to SEK425bn (€37.9bn) Swiss buffer fund AP2’s Female Representation Index 2024.

“We have seen steady growth in the proportion of female board members since we introduced the Female Index in 2003,”says Eva Halvarsson, CEO of AP2.

“Unfortunately, the increase has levelled off in recent years and this year it is decreasing somewhat. The companies have some way to go to reach the goal of 40 per cent women on the boards.”

AP2 wants its listed holdings have at least 40 per cent of each gender represented on the board by 2030, and actively influences its portfolio companies to have a strategy for diversity, equity and inclusion (DEI).

“Diversity is an important issue for the fund and is one of five focus areas within sustainability. The fund’s starting point is that companies that work with diversity, equity and inclusion not only take sustainability issues very seriously but are also more competitive and thus create better value,” says Halvarsson.

Of the 356 companies examined in AP2’s Female Representation Index 2024, the number of female board chairpersons decreased from 34 to 32 – corresponding to just 9 per cent of listed companies having a female chairperson. The number of women CEOs also fell to 42 from 45, equivalent to 11.8 per cent of companies with a female CEO.

Nomination committees help

The survey revealed that companies with nomination committees have a higher proportion of women on the board than companies without a nomination committee. Companies whose nomination committees have female representation also have an average of five percentage points higher proportion of female board members compared to all-male nomination committees. At the same time, half of all nomination committees lack a female representative.

Positively, the proportion of women in listed companies working on management teams has increased, up from 26.4 per cent to 28.8 per cent. The number of women in management roles is at the highest level since the survey started in 2003 and signposts a rich base to recruit for more senior roles down the line.

“It is gratifying that our Female Index shows that the proportion of women in management continues to increase, which is an important factor for there to be a good recruitment base for female board members in the future,” says Halvarsson.

The largest proportion of female board members is found  in the finance and telecom and media industries. Materials industries and consumer discretionary sectors are at the bottom, with less than 30 per cent women.

The survey found most women in management positions in real estate, healthcare and services industries, while the lowest proportion is found in sectors including energy, where only one in five people in management roles  are women.

AP2 compiles its Female Representation Index internally. The 2024 survey included 356 primary and secondary listed companies on Nasdaq OMX Stockholm. In addition, the survey records the proportion of women who have graduated from study programmes that constitute the traditional recruitment base for management groups and boards.

Diversity, equity and inclusion are integrated into AP2’s investment strategy.  The buffer fund has developed a multi-factor index for internally managed foreign equities and corporate bonds that integrates various ESG factors including equality and the percentage of women in the company. The index is expected to generate higher returns at lower risk, while taking sustainability aspects into account.

“There are indications that the factor of the proportion of women in the company, from a global perspective, has contributed to a positive return in the Fund’s multi-factor index for foreign equities. The effect has been stronger in developed markets compared with emerging markets,” says the fund.

In the Fund’s model for analysis and evaluation of private equity companies’ sustainability practices, these practices are assessed on the basis of 25 assessment points that include diversity and inclusion.

AP2 also engages through dialogue with companies concerning selection processes for boards and management teams.

 

The United Nations Joint Staff Pension Fund (UNJSPF) recently reduced the allocation to equity in its $92.5 billion portfolio by 10 per cent in what Pedro Guazo, representative of the secretary-general (RSG) for the investment of the UNJSPF assets, describes as a conservative strategic allocation in response to the overvaluation in tech.

Behind the defensive exterior, the fund is stepping into new allocations in venture, impact, and private credit as well as developing more sophisticated strategies in an increased allocation to fixed income.

It speaks to a state of confidence after sharp losses in 2022 at the pension fund that is still in an accumulation phase; supported by a funded ratio of 111 per cent and boasts a large and growing investment team who all have skin in the game as beneficiaries.

“We are in a strong position compared to peers,” reflects Guazo who has led investment since 2020. He oversees six-seven different asset classes in a primarily dollar denominated portfolio and tells Top1000funds.com in an interview from the pension fund’s New York offices that strategy avoids any financial engineering or unnecessary complexity.

“We only invest in things we understand,” he says.

The active equity allocation now accounts for 43 per cent of AUM and is divided into four teams (North America, Europe, Asia Pacific, and Global Emerging Markets) that follows a disciplined investment process centred on equity screening, fundamental analysis, and frequent dialogue with corporate management teams.

Although the portfolio has been reduced he remains wary of key risks, particularly economic slowdown in China even though the portfolio has little direct exposure to China.

“If China doesn’t grow as expected, it will impact global demand for everything” Guazo says.

“We follow the US and Chinese economies closely because what they do has the most impact on our portfolio.”

The capital and profits – he says the fund sold at a fortuitous time – take out of the stock market has been ploughed into fixed income, favoured for its protection of capital and liquidity.

“With interest rates at this level, it makes sense to be in fixed income and our analysis shows that the risk return proposition is higher than other asset classes,” Guazo says.

“Interest rates may still be in the same ballpark for the next two-to-three years, and we are comfortable having an allocation to fixed income because it is paying off.”

New allocations to sub asset classes within fixed income include high yield corporate bonds that bring additional yield at very little risk compared to public equity. The fund has launched the allocation with passive exposure to understand how the benchmark is composed but will switch to active in time.

Similarly, implementation is with managers first, in a strategy that allows the team to learn, follow decision-making and understand the information on hand, before bringing the portfolio in house.

“We seek to manage everything internally, but there are times like in high yield when we don’t have the internal knowledge, we partner with external managers, give them a mandate consistent with the Fund’s objectives and learn while we invest,” Guazo says.

“We follow every decision and see what information they are using so that we can bring the allocation in house.”

Around 82 per cent of the portfolio is managed internally, and Guazo is convinced it is the key reason why UNJSPF has some of the lowest costs in the business. Total investment costs are 33 basis points compared to a medium amongst peers calculated by CEM Benchmarking of 45 basis points. “We always try to manage internally because it’s more cost efficient, as shown in the cost peer comparison analysis,” he says.

His conviction that active, in-house management pays is also reinforced by UNJSPF’s monthly report on every asset in the portfolio and the performance over different time frames. It offers comparisons against the benchmark and reveals the outperformance of internal management against the benchmark.

“It’s better than an x ray,” he says.

“It’s our MRI.”

Impact investment

In another new seam, UNJSPF is also exploring impact investment across all public and private asset classes. Impact themes are aligned to the SDGs and range from biodiversity and the transition to social housing or female empowerment. Investments include labelled bonds issued by development banks which Guazo likes because they include impact measuring and reporting criteria.

“We will never sacrifice return or modify our risk metrics for any investment and one day, hopefully, the whole portfolio will be invested with impact,” he says.

For now, he is particularly focused on combining impact with a venture allocation, another new foray for the fund that will sit in the private equity envelope. “We’ve been in private equity for 13 years but have always focused mainly on large buyouts,” he says.

The Fund hasn’t adopted a target to venture, preferring not to have to fill an allocation. “Of course, the ticket size in venture will be much smaller than what we are used to in private equity where we typically invest at least $120-$150 million.”

Private markets

He has no plans to build out allocations to private equity (8.3 per cent) real estate (7.5%) or beef up a smaller allocation to real assets that comprises infrastructure but also timber, agriculture, and commodities. For now the team remain chiefly occupied committing capital from distributions and diversifying risk to ensure different vintages across the fund investments which account for the whole private markets allocation.

Guazo has no ambition to do more private markets in house. Mostly because the pension fund would never be able to hire the size of the team required.

“In-house investment in private markets is very labour intensive and you need a lot of flexibility to hire the right people, particularly around compensation,” he says.

“We can’t attract this group of people to work for us internally because we are working on UN contracts. We have good compensation, but nothing comparable to the large pension funds or GPs.”

Returns in real estate have slightly trailed the benchmark for the last couple of years. One reason is that the fund uses a US-centric benchmark, and the underlying portfolio has a large exposure in Asia and Europe which has performed poorly given the strength in the US dollar. But he sees opportunity in new areas that also combine impact like affordable housing in the US.

“It provides good solid returns and protects against inflation,” he says.

 

Published in partnership with Pictet Asset Management

The artificial intelligence revolution is still in its infancy, but already there is scarcely a business in existence not touched by digitalisation and the application of technology in its operations, in one form or another. What we’ve seen so far is just the tip of the A-iceberg.

AI’s implications are far-reaching: from producers of the rare earths needed to manufacture semiconductors, which then go into every data centre; to hyperscalers that deliver cloud services to businesses and consumers; to software application developers; and to businesses that use those applications to better deliver goods and services to consumers.

As an investment strategy, an investible universe that incorporates all traditional businesses trying to exploit technology, including AI, to modernise or streamline their operations is simply too broad.

Hundreds of thousands, if not millions, of businesses “could be seen as ‘digital companies’, if you take the loosest definition”, says Pictet Asset Management’s (Pictet AM) senior investment manager, active thematic global equities, John Gladwyn.

Conversely, a number of focused investment strategies have been developed to cash in on the development of AI as either a revolutionary (or at least, a very rapidly evolutionary) technology that will change the world in ways we can’t even guess at, let alone invest in with certainty.

Somewhere in between is an approach that recognises AI as an accelerant to the already healthy growth of digital technologies. Gladwyn says a distinction must be made between companies and businesses adopting technology to streamline existing processes to drive efficiency gains, and businesses that have technology, including AI, at their core.

“Because we invest in…digital-first companies, that leaves us with an investment universe of about 250 companies,” Gladwyn says.

For example, he says, “Walmart was primarily a supermarket operating company, and then it has adopted the walmart.com website and [become an] e-commerce business because it had to, because that’s where the market went”.

“Amazon.com started as an e-commerce platform,” he says. “And that’s where we draw the line: between those that are at their core digital businesses, versus the pre-existing, let’s say legacy businesses.”

CalPERS deputy chief investment officer, capital markets and operations, Dan Bienvenue says the fund considers technology and AI “through lots of lenses”.

Like any large organisation that deals in making sense out of large volumes of information and data, CalPERS has to consider the impact of AI on its own business. As an investor, CalPERS invests in AI-linked opportunities directly – the chip makers, the cloud providers, the software developers and so on. Some of this it does itself, and some it does through external managers.

The derivative opportunities

Bienvenue says there are also “derivative” opportunities – businesses that will use AI to streamline their processes and systems and, in some cases, to reimagine their businesses operations from top to bottom.

“Similar to the rise of cloud years ago, the rise of the Internet years before that, like home computing – all of that stuff – I actually think that the bigger implications are going to the indirect ones, the derivative ones,” Bienvenue says.

“It’s not so much the AI itself, it’s the way that AI leverages how they do their business. There will be a number of disruptors and disrupteds, and that’s actually arguably as big or bigger a theme in terms of the implications for our portfolio.”

Bienvenue says there will even be second, third, fourth and fifth-derivative implications of AI “exactly the way that there have been for past big technological steps forward”.

“I would put AI in a similar category, and specifically generative AI is another technological step function forward. That’s going to have lots of second and third and fifth order derivatives as a result.”

AI investment opportunities are a subset of the broader technology universe, but Border to Coast Pensions head of equities Will Ballard says “equally, the benefits of AI can reach further than the technology universe itself”.

“The technology sector can cover everything from AI [to] software and services, to hardware manufacturers and semiconductor equipment,” he says.

Ballard says “every company is different and our role as investors is to be able to distinguish between them, understand their competitive advantage, what they could be worth, and determine whether they are an attractive investment or not”.

“Just like there is an opportunity within the automotive supply chain, from the suppliers to the manufacturers and then the distributors, all the way through to the taxi operators or logistics providers, understanding their position within their business landscape, their bargaining power with their suppliers, the barriers to entry to other competitors, and the demand from their customers is essential,” he says.

Chipmaker Nvidia, for example, is “in an exceptionally attractive position, being the sole supplier of leading-edge hardware necessary for the ongoing AI revolution”, Ballard says.

Meanwhile, however, Google is in competition with Amazon and Microsoft and others in cloud services.

A traditional business that might use AI to improve its own operations or to disrupt its competitors must be understood in the context of its own particular industry, Ballard says.

“Just like we must understand the sustainability of Nvidia’s dominance, so we must understand the competitive advantage and persistence an early adopter of AI might have within a more traditional setting,” he says.

Catering to business, catering to consumers

Pictet AM’s Gladwyn says that on top of identifying technology-native businesses, it also organises potential investment targets into two further groups: those set up to cater to business customers, such as Microsoft; and those set up to cater to consumers, such as Amazon.

“And then we have the bottom layer of enabling technologies, which would be more semiconductors, for instance, that are critical enablers on which everything else depends,” he says.

Gladwyn says the trends that AI serves to accelerate are already established.

“The big trends for the strategy have been cloud migration – movement of workloads into the cloud – and digital transformation,” he says. “AI is an accelerant to both.”

John Gladwyn

“It’s one of the reasons why this investment cycle has been so far benign – what we have seen in our universe is that the winners have just remained winners.”

It’s a strategy that deliberately ignores the potential gains that might come from companies that do successfully transform themselves.

“For every one that does it, there are many more that do not,” Gladwyn says.

“You can spend so much time micro-analysing 10 companies that claim they’re on a transformational journey, but ROI on that time is just not as good as focusing on technology-centric companies.”

Gladwyn says Pictet AM classifies technology-centric companies into four broad categories, in a kind of conceptual stack.

“You have software at the top; you then have the large language model [LLM], which is kind of the intelligence layer,” he says.

“Below that you have the cloud infrastructure, which itself is built on hardware, including of course Nvidia’s GPUs.”

Gladwyn says the attraction for investors is that all of those layers will change over time, but the timing and pace of that change will vary, layer by layer.

“Because things change, it gives you the opportunity to try and get ahead of that,” he says.

“But what’s so interesting to us is that there is a big difference between when the different layers of the technology stack experience change. Before you run the railways, you have to build the railroads. We’re now building the railroads. Nvidia is benefiting before a software company is benefiting, because you can’t have one without the other.

“The value-added part is trying to differentiate which areas benefit and when.”

This is the “impossible question that we are all grappling with”, says Border to Coast’s Ballard.

“The first assumption is that data-heavy sectors such as insurance or finance might be quick to benefit,” he says.

Will Ballard

“What we are seeing is that there are signs that the impact is much wider than that. Just like with the advent of the internet, the scale and impact on our lives of AI is going to be tremendous. It is likely that it touches everything we do, there is no sector that is not going to be impacted.”

Ballard says even sectors considered unlikely to benefit, such as mining which might seem tied more closely to commodity prices, “could experience changes to how they go about everything from the geological surveys at the start of a project all the way through to the way they sell and distribute the final processed product”.

Pictet AM’s digital strategy generally holds between 35 and 50 stocks, and currently the investment portfolio is at the lower end of that range.

Gladwyn says that as a public-equity investor Pictet AM’ s digital strategy is “quite excited” about the current cycle. Big, publicly listed companies like Google and Microsoft are likely to be the biggest beneficiaries “because they have the talent, the data, the infrastructure and the money to actually take advantage of this technology”.

“This cycle is fairly different from previous cycles, in which the beneficiaries have been the smaller, more nimble private companies,” he says.

“The characteristics of the companies we invest in are growth businesses. They will have above average top-line growth. These companies are also highly profitable. In the past the earnings per share (EPS) growth of this group of companies has outperformed quite nicely the top line growth of either the MSCI World or MSCI IT Index.

“We believe this combination of structural growth and strong financials is highly attractive to end investors.”

The lessons of history

Academic and researcher Professor Ajay Agrawal says figuring out a potential path for the take-up, impact and investment opportunities of technology and AI might be easier if it can be compared to earlier technological revolutions, such as the invention of electricity. Agrawal says both AI and electricity are “general purpose technologies”.

As University of Toronto Rotman School of Management Geoffrey Taber Chair in Entrepreneurship and Innovation, Agrawal says the take-up of electricity by manufacturers was initially low; after roughly 20 years after electricity was invented, only around 3 per cent of factories were using it and when they were if was for marginal gains, such as replacing gas lamps with electric lamps.

Part of the reason was the sheer weight of investment that had been made in traditional processes, including steam engines.

Agrawal says that gradually, more entrepreneurial factory owners, and those building new factories from the ground up, began to adopt electricity in preference to steam. It revolutionised the design and construction of factories. No longer were the massive columns needed that supported the driveshafts of the massive steam engines and took up factory-floor space. Now, every machine in a factory could have its own power supply and motor, vastly reducing the amount of time lost when one steam engine driving multiple machines broke down.

Changes in design and construction in turn revolutionised manufacturing processes and streamlined production. Before long, factories powered by steam were no longer economically viable.

Applying a technology like AI to a company’s existing processes, but leaving the processes essentially unaltered, could be quick and generate profit gains in order of 20 per cent, Agrawal says. Designing processes and systems from scratch, and putting the new technology at the core, takes longer but the gains could be in the order of 500, 600 or even 700 per cent.

Gold mines and rabbit holes

Ballard says the key to keep on top of the fast-changing opportunities that a breaking technology wave like AI might deliver is to “stay informed and be open-minded”.

“Our fund managers and analysts are always talking to CEOs, industry experts, academics across all different sectors try to get a better understanding of what trends they are seeing and what they are thinking of doing,” he says.

“The main point we stress is that we recognise that we don’t know all the answers, so we approach these big, transformative questions with an open and eager mind. We recognise that there is no such thing as certainty, and so informed, critical, probabilistic thinking is crucial to good decision making.”

CalPERS’ Dan Bienvenue says, to use a baseball analogy, AI is in about the third inning. It will develop quickly, often in unexpected directions. Investors will find themselves going down rabbit holes as some developments play out productively and some do not. Bienvenue says that’s inevitable.

“In order to find the gold mines, you have to go down some of the rabbit holes,” he says.

“Ex-ante, those can’t be differentiated. You try to differentiate and you work with smart people that can try to differentiate, but the only way to avoid every rabbit hole is to avoid the gold mines also.”

Bienvenue says in addition to company-specific or industry-wide impact of new technology on portfolios and investment returns, there will be broad economic implications that will touch all areas of an investor’s portfolio.

“Again, I’m the equity guy, but I think they are also exciting,” he says.

“There will be both a multiplier effect of just the money that’s being spent on AI – and there’s a lot of money being spent – and some of that is being spent in unproductive places; we can just all acknowledge that not every dollar invested will be productive.

“There’s not only that implication that I think is probably a per cent or two [added] to GDP, but then there’s this whole big productivity side [and] we haven’t even seen all the places that it’s going to manifest itself. That also is going to drive economic growth.

“Through the lens of the investment outcomes, that becomes self-reinforcing. I would call it a virtuous cycle. I’m the eternal optimist, and I’m very optimistic about these impacts on a go-forward basis.”

CalPERS’ sustainable investment strategy is predicated on a belief it can generate outperformance by investing in climate solutions – with $100 billion to be allocated by 2030. Peter Cashion, managing investment director for sustainable investments tells Amanda White why, and how, it looks for climate alpha opportunities.

CalPERS has been energetic in the implementation of its new climate action plan, developed under the leadership of Peter Cashion last November. Among other things, the plan includes deploying $100 billion to climate solutions by 2030 – just over 20 per cent of CalPERS’ $469 billion AUM – with the aim of both generating alpha and reducing the carbon intensity of the portfolio.

When the plan was devised, the fund already had $47 billion in climate solutions and the team under Cashion is hard at work to more than double that commitment, with nine new private investments made in recent weeks.

Reporting to the CIO – now Stephen Gilmore, who started at the fund this week – Cashion and his team have worked each asset class to develop a sustainable investment plan towards 2030.

“It’s not a fixed number for each asset class, but a range,” Cashion told Top1000funds.com in an interview.

“We see investment opportunities across the spectrum with the most tangible in infrastructure, private and public equities.”

Already CalPERS has worked with FTSE to develop a customised climate transition index, that evaluates the risks and opportunities of the global energy transition, and it has committed $5 billion in its public equity investments to this scalable alternative to a market-cap index.

It has also announced its first wave of private investment, with $1.1 billion in private equity and infrastructure committed across nine deals, and a further $3.6 billion across 19 deals in advanced pipeline.

Investments to date include supply chain optimisation, an energy company, a lithium-ion producer, electric boats, wind turbines and fossil-fuel-free logistics.

“In a number of opportunities we are seeing more in private equity, particularly in co-investment where we are very active,” Cashion says, adding that while infrastructure deals are fewer in number, they are much bigger in scale.

Infrastructure deals make up about $900 million of the recently committed $1.1 billion, so it’s a big portion of committed investment already.

“We will see opportunities in private credit and fixed income, but they haven’t matured or transpired as much yet as they have on the equities side,” Cashion says.

“The equity coming in is good, but to have the leverage to generate returns you need debt, so that’s why we see impending opportunity in fixed income and private credit, and we are actively having calls with fund managers.”

Cashion says one of the key differentiators for CalPERS’ climate plan is it is driven by the notion it can generate alpha and outperform by investing in climate.

He explains there are a number of reasons the fund sees investing in climate as a thematic that can generate outsized performance.

First is the size and scale of the transition opportunity set that is not only large but growing. It has also identified the theme of resource efficiency with companies more attuned to using less energy experiencing lower costs and so higher valuations. And the inclusion of both physical and transition climate risks as an area of focus means in both portfolio and security selection risk management is more robust.

“Taking in the combination of those three factors it’s a recipe for higher performance, particularly over time as these effects roll out,” he says.

While the fund hasn’t put a precise number or expectation on the alpha that it can generate from these investments, it has clear tracking of climate solution investment performance and will benchmark that against the asset class benchmark.

The nine recent investments were a combination of flagship funds and dedicated climate funds, and Cashion, who was previously the global head of climate finance and chief investment officer in the financial institutions group at the World Bank’s International Finance Corporation (IFC), says “we welcome both”.

“An investment through the flagship fund is indicative this is not a niche do-gooder pursuit, this is generally good business,” he says.

“But we also want to identify the exclusive climate-focused funds in private equity, infrastructure or private credit.”

CalPERS also plans to coinvest in climate solutions alongside the asset classes.

“This is not a carve out for sustainable investment, but we will jointly implement it with the asset classes,” he says.

“Once my team is built out we will have a joint process with one of my team sitting alongside the asset classes and I will jointly approve it. This is a more scalable model and with the urgency of the transition needed and the opportunity set it is better to play at scale.”

In fact, it’s the opportunity CalPERS presents to invest at scale that attracted Cashion personally from a 30-year career at the IFC to make the move to CalPERS.

“I made the move because I saw the potential and the scale. We are doing something big and new at scale,” he said adding that CalPERS is looking to recruit a further 10 people to the sustainable investing team, effectively doubling the size.

And while the team has made some quick progress since setting the strategy in November, Cashion is cognisant it won’t be a straight line.

“We have an additional $53 billion in incremental investment to make, we can’t just divide that by 6.5 years [to get to 2030] and that’s what we do each year,” he says. “The pace of the opportunity set may be uneven and that could be an obstacle.”

As a result of its climate investment ambition, and the $100 billion commitment, the fund has set an emissions reduction target for 2030.

It had already committed to a net zero 2050 target but one of the advantages of the new sustainable investment strategy work is to define a 2030 target of 50 per cent.

The emissions intensity of every portfolio at CalPERS has been mapped by the internal team taking into account any asset allocation shifts.

“An interesting component of that is the $100 billion investment,” Cashion says.

“Without that we wouldn’t reduce by 50 per cent. The $100 billion is driven by the fact we think we’ll make more money that way, but it also reduces emissions.”

The investment universe for climate solutions at CalPERS has been grouped into three buckets: mitigation, adaptation and transition. Cashion says he is aware that transition investments may come through buying into higher emitters, such as steel, that will mean an uptick on the emissions footprint of the portfolio.

“We are comfortable with that because we don’t just want to impact our own portfolio but the broader economy. We want to lean into these,” he says.

Another objective of the focus on climate investments is also to build more resilience into the portfolio and the fund will recruit specialists across both public and private markets to fully integrate ESG analysis into the portfolio.

Climate scenarios will also be incorporated into the fund’s capital market assumptions and asset-liability management process with climate scenario stress testing included in the top-down portfolio view.

“This is still an evolving science and we are developing that muscle from the top down and also within specific asset classes and sectors so we will look at the firm, asset and macro total fund exposure level,” Cashion says.

Key to that will also be more analysis and expectation of fund managers’ ESG integration capabilities and the internal sustainable investment team will give providers recommendations to work towards.

Peter Cashion will speak at the Fiduciary Investors Symposium at Stanford University from September 17-19. For more information click here.

Singapore’s state investor Temasek has a cautious outlook on China, despite having 19 per cent of its $389 billion portfolio invested in the country.

Temasek has been one of the big beneficiaries of China’s growth. But in recent years its allocation has struggled and underperformance in the country’s capital markets has dragged on overall performance in the portfolio, the value of which rose just 2 per cent on the year to March.

Speaking during the investors 2024 Review, the investment team said that despite a pro-growth stance from Chinese policy makers and an encouraging approach to foreign investment, structural demand challenges in China’s economy continue to weigh.

“We need to see a little bit more progress on that front before we can invest at a much faster pace,” said Chia Song Hwee, deputy chief executive officer.

Rather than companies focused on export that might be impacted by geopolitical risk, sectors of interest include Chinese companies that are tapping into domestic consumption. Other  examples include biotech, import substitution, robotics and the EV value chain.

While enthusiasm for China remains muted, Temasek will allocate more capital to developed markets like the US in the next 12-18 months.

The team did not give an exact breakdown of exposure to US assets but the Americas region constitutes 22 per cent of its portfolio. The US will continue to be the largest destination of capital outside Singapore, but Temasek will also increase its focus on India, Japan and south-east Asia, markets that have benefited as global investors seek to cut their exposure to China as growth slows and geopolitical tensions rise.

The size of the portfolio makes being nimble challenging. The team said that when they try to adjust the portfolio, the results aren’t immediately visible. “When we say “turn”, it will actually take quite a bit of time for us to make that shift,” said chief financial officer Png Chin Yee.

Temasek’s allocation to private assets is now over half the portfolio (52 per cent), up from 20 per cent in 2004.  The shift is a consequence of easier market access to unlisted assets and the ability to work with private companies, rather than a specific target to unlisted assets. Investment is made according to returns objectives and the opportunity in key themes. The increased exposure means the investor now reports unlisted assets at mark to market value, more in line with our peers.

Risk in real estate

Temasek has invested most in the credit side of real estate where it has found the best risk-adjusted returns that include a significant amount of downside protection through equity subordination. Assets include multifamily, other forms of living, data centres, logistics and hospitality.

The team said that data centres and logistics are still benefiting from secular tailwinds but warned that energy consumption in data centres is an increasing risk.

Owners are under pressure to integrate newer technologies and switch to more renewable sources. Temasek’s portfolio companies include  STT, Singtel, and Keppel and the team said the hype around data centres, along with AI and private credit, were front of mind.

“We have to have the discipline on valuing the opportunity and taking the appropriate risk measures when we invest, or not,” said Chai Song Hwee

Strength in partnership

Temasek is a renown early stage investor, but it is prepared to stay invested once companies go public to tap future appreciation. A good example is Adyen, the payments company, which Temasek invested in back in 2014 and still holds since it went public in 2018.

Partnerships in green investments include its stake in Pentagreen, a sustainable infrastructure debt financing platform set up with HSBC that focuses on lending to companies that struggle to tap traditional finance.

Temasek has also been active with the Monetary Authority of Singapore. Under the FAST-P initiative, Financing Asia’s Transition Partnership, a blended finance approach seeks to combine the private and public sector as well as philanthropy to catalyse financing for sustainable and transition finance in the region.