Understanding the drivers of your portfolio risk and return, and then using that information to more dynamically adjust the portfolio, is one of the benefits of the total portfolio approach according to CPP’s Manroop Jhooty, whose total fund management team is exploring whether to include emerging factors in portfolio design.

CPP Investments has been debating what “emerging factors” it might consider alongside the macro factors such as growth and inflation that it uses in its total portfolio approach to design and implement optimal portfolios.

CPP Investments senior managing director and head of total fund management Manroop Jhooty tells Top1000funds.com that one of the advantages of the total portfolio approach (TPA) is the ability to look at emerging factors that can impact the return and risk of the portfolio. Geopolitics and climate change are two examples, with the fund using scenario-based testing to inform adjustments to the portfolio on a tactical, or even strategic, basis.

“When we think about geopolitics and climate change, one of the advantages of a TPA approach is you have the ability to factor-in emerging factors on top of the more foundational fundamental factors that can impact return and risk to your portfolio,” Jhooty says.

“Climate is one area still under development and we spend a lot of time thinking about that, getting the right data and the mechanism you want. We are thinking about transition scenarios, physical and transition risk to the future value of the fund.”

Jhooty says geopolitics is similar and the team uses scenario analysis to test different theses.

“Everyone knows the hotspots, the difficulty is ascribing risk premia to it,” he says.

“We do scenario-based testing and shock the portfolio. We look at prior geopolitical situations, run scenarios and use those to circle back and inform using judgement to adjust the portfolio on a tactical or strategic basis.”

Jhooty says the team has been debating recently what other emerging factors might be through which the portfolio should be assessed.

“How much of performance in markets is trend or momentum, or is there an emergence of a factor?” he says, pointing to AI as one possible example.

“Clearly it is a big driver of growth and a contributor to the appreciation of equity values in the US. You can argue it’s a trend but it is also structural in the way the economy is orienting itself and operating in the future, so it could be an emerging factor, potentially, because of a structural impact on the market.”

At the moment CPP looks through the lens of growth, inflation, discount rate on cash flows and risk premia which it believes are the primary drivers of valuation.

“We believe all valuation is based off cashflows, and they are a function of growth, inflation, discount rate on cash flows and risk premia of the asset. Every company and asset has a loading through that because of how we think about valuation,” he says. “We try to be as balanced [as possible] across the macro factors so we are not over exposed to one factor or another.”

Risk concerns

Right now, Jhooty says the team is thematically concerned about the impact of inflation on stock-bond correlations.

“Inflation volatility has translated into real rate volatility and the impact from a policy impulse perspective has changed stock-bond correlations and resulted in us wanting to double click,” he says. “Do we have a different regime we need to be conscious of? Arguably with inflation and the policy impulse, that relationship has changed. We are asking is it temporal or structural?”

Jhooty also says that fiscal tailwinds driving equity markets have continued to be positive for growth but are arguably not sustainable, so the team is spending time thinking about how fiscal policy might evolve and the implications of that.

“We are keeping a close eye on that in terms of a second layer of risk we are concerned about,” he says. “The market to a large extent has been narrow to a subset of names and to the US. Europe and Japan are doing well now so we are looking to understand the degree to which the narrowness will eventually revert. The US and a subset of names have been a large driver of returns.”

The benefits of TPA

Jhooty heads up the total fund management group for the C$625 billion ($457.4 billion) fund, which has two core functions: portfolio design, including target exposures, leverage and liquidity; and then implementing against those targets which includes management of balancing portfolios, financing portfolio leverage and liquidity and some tactical management.

The fund uses a total portfolio approach which allows design and implementation to be viewed through risk drivers and macro factors and then the rebalancing and management of liquidity and leverage to all sit in one team of 120 people, at the top of the house.

“Integration of the design to the execution in a single department creates a lot of synergies,” Jhooty says. “The people sourcing the exposures and the assumptions we are making with the portfolio are together.”

At the core of the TPA is bringing risk and return to the centre of the discussion and moving away from benchmarks. Instead of benchmarks, CPP employs an attribution mechanism to evaluate the portfolio choices made around risk and return.

“We look at each of those decisions and how they have performed on an ex-post basis,” Jhooty says. “Did we set the right risk targets? When we chose the right macro factors did we choose the right set? There could be a thousand portfolios to choose from that have a risk equivalency of 85:15. We made a portfolio choice at that time, so we try to extrapolate the other choices and how did our portfolio choice perform. It provides a lot of value to show the effectiveness of the process and decision, but also a mechanism to challenge your beliefs and assumptions.”

While the investment allocations may not look that different to other asset allocation approaches, Jhooty says the value comes from the ability to know where your risk and return is coming from, and the drivers. That information can then be used to more dynamically adjust the portfolio.

TPA requires a high degree of modelling the portfolio and that does create complexity and tradeoffs. But the benefits outweigh the complexity, according to TPA buffs.

“With SAA you don’t have those levers because you’re thinking in the asset space not the risk and return space, so you get a greater degree of control and ability to pivot the portfolio,” Jhooty says.

“This puts a greater emphasis on relative value. You’re not just trying to beat your benchmark in an asset class, but can look at the impact of a marginal trade in a more deliberate way. Those decisions and the dynamism from TPA are where the value comes in.”

The A$175 billion Aware Super’s CIO Damian Graham said its venture capital investment in tech unicorn Canva has been good value for money but “pretty unusual” in the scheme of things. He reflects on the asset class and the broader pension investing purpose.  

Australian pension investors tend to be cautious about venture capital investment for various reasons. One is that with only an estimated A$20 billion AUM as of mid-2023, Australia-focused venture capital, the asset class is too small and can be difficult for large pension funds to make a meaningful allocation.  However, when betting on the right horses, the return can be very attractive.  

The A$175 billion Aware Super is one of the early investors of Australian tech unicorn and graphic design platform, Canva, which is currently valued at $26 billion and touting an NYSE IPO in 2025 or 2026. The exposure was through investment manager Blackbird. 

The pension fund was returned some capital last year as Blackbird sold down its shares. While declining to confirm the specific number, Aware Super’s chief investment officer Damian Graham said the fund still holds most of its investments in Canva.   

“Value for money has been good,” Graham said of the investment at the Fiduciary Investors Symposium in Sydney earlier this month. Although he conceded that the fund has become too large to consider smaller opportunities. 

“Occasionally, you do get a very small investment idea come to you, and it’s $3 million, $5 million, $10 million or even $20 million, and the governance to own that, in a direct fashion particularly, is just not time well spent,” he said. 

Aware Super has a ‘Venture direct’ program where the fund’s internal team identifies early-stage investment opportunities. 

“That hasn’t been a huge amount of money, but we’ve found some good investments,” Graham said. “But it’s hard one because you’ve only got so much bandwidth, and most of our risk is in listed equities.” 

“So when you think about the risk of managing the portfolio, we want to make sure we get those big drivers of returns and risk right. 

“[Canva] went from a very small investment to our biggest investment at a point in time, so that’s been a fantastic outcome, but pretty unusual in the scheme of things.” 

Aware Super last year joined a list of Australian pension funds in opening an overseas office in London. The highly publicised move saw Aware executives meeting King Charles at a Buckingham Palace reception and appear in one conference alongside Chancellor Jeremy Hunt.  

Graham remained in Australia but his deputy CIO Damien Webb has relocated to oversee investment operations in the UK.  

Speaking of ways to attract investment talents in a so-called deep financial market such as the UK where there is relatively little recognition of what Australian superannuation is about, Graham said the process “doesn’t start with rem[umeration], it starts with purpose”. 

“[Managing retirement savings] are important jobs, but we’re not important people,” he said. 

“The key for me is if we have the right people for trustees to have confidence that they’ve got the program of work well set up for long term. And it’s about building a sustainable program of work to so it’s not just great returns for one year… but you’ve got to be able to do it over decades. 

“The really critical issue is… are we delivering great outcomes to members, and I’m sure most people in the super system would say we can continue to do better.” 

The State of Wisconsin Investment Board is incorporating top-down macro analysis of the drivers of stock-bond correlations into its risk management, including to assess the potential of a secular shift in the stock-bond correlation.

The need to include analysis of the macro scenarios that drive a potential shift in the stock-bond correlation are highlighted in a paper co-authored by Edouard Senechal senior portfolio manager at State of Wisconsin Investment Board, recently published in the Financial Analysts Journal.

“As a result of the paper we are working on  alternative risk analysis to better understand the macro influences in our portfolio,” Senechal told Top1000funds.com in an interview.

The paper, written in collaboration with researchers at Robeco, Empirical evidence on the stock bond correlation, shows that abrupt regime shifts in correlation can follow long periods of relative stability. And by examining data as far back as 1801 it shows that inflation, real rates and government creditworthiness are important explanatory variables of the stock bond correlation.

“The macro variable can be very stable for a long time and then can shift, that is a risk that needs to be assessed right now,” Senechal says. “Most risk models take a bottom-up lens looking at things like style and sectors . The characteristics of companies have been defining the way we look at risks. At the moment most risk models are based on bottom up data but there is a need to also act on top down macro analysis. We are changing the lens.”

Senechal points to data from the US that finds between 1970 and 1999 the average stock bond correlation was 0.35 and then was −0.29 between 2000 and 2023.

“I was at a macro conference and one of the participants made a joke about correlations. When he was asked what is your view on the level of stock bond correlation, the answer was simple. Everyone knows it’s 0.3, the only thing is to work out if it is positive or negative,” he says. “But jokes aside this is very important. For the last 30 years the correlation has been negative, but for the previous 30 years before that it was positive 0.35. This completely changes your asset allocation and policies.

“The correlation between stocks and bonds is the cornerstone of asset allocation but until recently it has received little attention because it doesn’t impact until there is a big shift.”

This has important implications for asset allocation and portfolio policies. Everything else equal, the difference between the correlations of 1970-1990 and 1999-2023 results in a 20 per cent increase in risk to a 60:40 portfolio, a corresponding drop of 20 per cent in the Sharpe ratio and a significant impact on returns.

“Most people use data from the last 20-30 years, but that is not necessarily reflective of what we will get in the next 20-30 years,” Senechal says.

The paper uses a large sample looking back to 1875 in the US and 1801 in the UK, and in examining the macro drivers.

“In the post 1950s environment central bank policies started to resemble those of the present day with a dual mandate and the objective of managing both inflation and unemployment.

“When inflation is low, as it was over the last 30 years, then they set nominal rates mainly as a function of unemployment. During downturn as in 2000 or 2008 or 2020, they cut rates and enter the QE program, when equities are selling off.

“This creates a negative correlation between stocks and bonds, which makes bonds’ hedging characteristics extremely attractive to investors.

“Therefore, inflation and real rates level are important determinants of the correlation. The question today is: are we facing a structural change in inflation after 30 years of decline. Understanding when these long-term trends change, or break is critical.”

Understanding inflation and AA implications

Senechal says the key variable right now is inflation. Referencing a Top1000funds.com interview with chief strategist at IMCO, Nich Chamie he says a structural change in globalisation could result in higher inflation.

“The rise in inflation due to COVID is disappearing now but that doesn’t mean that underneath the peak from COVID there isn’t a new problem that is caused by the decline in globalisation. The question is if we are in this environment, as IMCO says, inflation could be structurally higher and that will mean an environment of higher stock bond correlation, which will have a big impact on the risk of a diversified portfolio.”

The team at SWIB is working through the implications for the portfolio and any asset allocation shifts that may need to occur. It has already reduced leverage from 15 to 12 per cent, reflecting rates going up over the past three years, and if that continues leverage is less important and will be reduced further.

“We are doing a lot of work on developing risk models that allow us to measure what type of sensitivity we have to real rates, inflation and growth,” he says. “If the stock bond correlation keeps going in the same direction, being positive, then probably  returns on bonds will decline as investors ask for higher bond risk premia and therefore higher yields.”

PGB Pensioendiensten, pension provider for Pensioenfonds PGB (PGB), the Netherlands €32 billion industry-wide pension fund, has rewritten its sustainable investment strategy. Backstopped by a new purpose to invest in a “liveable world” it has positioned investing sustainably at the centre of its strategy rather than as an “afterthought.”

“For us, sustainability is an inseparable part of all our investments. We make an integrated assessment between return, risk, costs, and sustainability with every investment,” states the pension fund.

The recently published strategy is rooted in the results of a survey amongst its 128,000 beneficiaries that revealed 70 per cent of fund participants consider sustainable investing important.

From this, the fund has drawn up three key investment themes around climate, biodiversity and sustainable nutrition, targeting reducing the CO2 footprint of the investment portfolio by half by the end of 2030 and climate neutrality by 2050 at the latest.

Strategies include re-examining and tightening the requirements it imposes on green bonds. Like demanding an independent audit of the promised impact around energy saving or renewable energy use in a green bond.

Elsewhere, PGB has cut the carbon footprint on its listed investments further compared to the previous year and has committed to providing insight into the negative impact of its investments.

“We do this according to the EU rules based on a ‘declaration of adverse effects’, according to the Sustainable Finance Disclosure Regulation. The first report for 2024 will be in mid-2025,” it states.

In another seam, the fund has improved its collection and analysis of ESG data, allowing it to use data to inform new policy and communication with participants, regulators, and the media.

“Thanks to our improved data management, we can report more confidently on our sustainable investment and the results,” it states.

In 2023 the fund excluded government bonds and state-owned companies in 173 countries while 752 companies were excluded from investments because they do not meet the minimum sustainable investment requirements.

Since 2023 PGB has reported the ‘financed emissions’ and ‘implied temperature rise’ (ITR) per year-end in its portfolio, insofar as data was available. Financed emissions amounted to 52 tons per million euros invested for listed corporate bonds and 46 tons per million euros invested for listed shares. This produces an average of 48 tons of greenhouse gases per million euros invested, states the fund.

Investing in solutions

In another pillar, PGB seeks to strengthen sustainable entrepreneurship via ‘capital allocation’ and actively investing.

“We cannot achieve our goal with exclusions alone,” it states.

PGB rewards companies that emit fewer emissions by investing relatively more in cleaner companies against the benchmark.

“At the same time, this means that we invest less in companies that have less sustainable entrepreneurship. Research shows that this approach is not necessarily at the expense of expected returns if the country and sector distribution of the benchmark is maintained.”

In 2021, PGB joined the SDI Asset Owner Platform, the international platform that measures the contribution of investments to SDGs.

“Using this platform, we can calculate what contribution the listed equity and bond portfolios have delivered on the various SDGs. In addition, we also receive reports on the contribution of real estate funds and alternative fixed income securities”.

PGB returned 11.7 per cent in 2023  with a coverage ratio of 112 per cent. The improved funded position puts PGB in an enviable position, able to increase pensions and keep the pension premium the same.

“That is good news for all our participants and employers,” it concludes.

An increased focus on liquidity management through factors, a leaning towards public markets and robust risk management are all key to implementing HOOPP’s “maniacal focus on liquidity” that helps CIO Michael Wissell sleep at night. Amanda White spoke to the Toronto-based investment chief ahead of the Fiduciary Investors Symposium.

In comparison to its Canadian peers with huge weightings to private markets, the C$112 billion HOOPP leans slightly towards public markets, a preference consistent with its liability-driven approach and focus on member outcomes.

For instance, it has a 26 per cent allocation to public equities and 12 per cent to private equity and Wissell believes public companies are still bringing ingenuity that is worth investing in. (CPP Investments has 24 per cent public equities and 33 per cent private equities by way of comparison.)

“The innovation some of those public companies are bringing is great. It’s not either or, but public and private together that is compelling, they have different characteristics,” Wissell says. “Our relationship between private and public assets is a little bit more public oriented, which is predicated on our maniacal focus on liquidity.”

Historically HOOPP has been good at making returns in troubled markets, and Wissell is quick to point out that can only happen when there is cash available.

“We have ratios we look at and the quantum of cash available if we need it. How much is tied up and how much can you get at,” he says.

Liquidity management has developed using a series of factors to measure and manage the portfolio.

“I sleep well at night knowing tomorrow I can come up with an enormous amount of capital if I need to. We don’t think we need to, but we manage for events that can happen over time or in the near term,” he says. “We use a series of liquidity metrics, and then when something does go bump in the night you are a buyer. My crystal ball is not as clear as I’d prefer it to be, but you can build a diversified portfolio, hedge the risks you can and leave yourself liquid, because something will go bump.”

As an example, he says COVID presented enormous opportunities, and HOOPP was a buyer throughout all of 2020.

It’s Wissell’s opinion that “we do live in perilous times” but the fund is not leaning into any one thematic, rather it’s exploring themes, including AI and the impact on investments.

“AI for a large pool of capital is a tool for us to manage our corporate processes, management process, an area of investment and something our portfolio companies need to be aware of,” Wissell says. “There are a lot of touch points on that and makes it more complicated, it’s something we are spending a lot of time on.”

The investment process focuses in on understanding broad economic factors and examining its portfolio through certain factor exposures and the comfort around those, for example growth and inflation risk.

Once the risk parameters are set, for example around growth risk, the decision is made whether to get that exposure through in this case private credit or another investment that may have a better tradeoff.

“We try to build the best portfolio you can with the broad factors you are comfortable with,” Wissell says. “For example, how many nominal bonds can you own without inflation risk getting too high. This is where global diversification comes into play, and we tend to learn into the developed world economies. We have some emerging markets but that is an example of where we think we can make good returns but it’s a little bit trickier to know if you’re really getting paid for all the risks there.”

Fixed income allocation

Wissell says the team is continuing to manage the broader bond portfolio, which can be “tricky” in this inflationary environment.

“We need to be mindful of that and it’s why we have been actively adding to the real return bonds and can see that is going to pay dividends this year. It’s something I feel very strongly about,” he says. “When you can pick up 2-3 per cent real, for a plan like ours, on that portion of our investment assets it takes us a long way, because it is guaranteed return and liquid. With our remining liquidity it takes down the return pressure.”

Throughout the year HOOPP has been adding to its real return portfolio with the aim of getting the mix to 50:50 between nominal bonds and real return bonds.

“It’s a unique period of time where can manage inflation risk and lock in comparatively compelling rates for a really long time,” Wissell says.

HOOPP has invested in private credit for some years but only formalised it in the policy portfolio in 2023. It performed well for the fund last year with 9.33 per cent and Wissell says he continues to think the outlook for private credit is “constructive”.

“I’m in the camp that at this base interest rate and some of the spread tightening a bit, we will still get returns that meet our pension promise at reasonable risk,” he says. “Some of the structural changes mean it will remain compelling over the medium term. A 5 per cent allocation to that asst class, that’s a measured amount earning good returns.”

Decision making process

Wissell describes the portfolio construction as a “constant refreshing”.

“I like to think about it as if I was building the portfolio from scratch today how would we build it? And if that’s not the portfolio we have then make changes and bring people in. That’s’ how we stay fresh.”

HOOPP’s decision making process is best described as collaborative. Chief executive, Jeff Wendling, is the ex-investment chief of the fund and someone whose counsel Wissell finds important.

“On big decision he’s very much involved, he’s a phenomenal investor,” he says. “Some of the tweaks we are managing right now is with me, our asset class head experts, portfolio construction team, then on top of that there’s a risk team.

“It might seem like a lot of voices, but you want to avoid the unintended consequences. We take risk and are comfortable with markets going up and down, but don’t want to make an investment we didn’t really fully consider. This leaves you with a high degree of confidence and why HOOPP has done so well for so long.”

HOOPP has a 115 per cent funded status and a 10-year annualised return of 8.43 per cent.

Michael Wissell is one of the speakers at the Fiduciary Investors Symposium at the University of Toronto from May 29-31.

While many institutional investors find themselves overweight private markets, struggling to price and exit illiquid investments in the current market, C$11 billion University Pension Plan Ontario is aggressively building out its 20 per cent allocation to private assets.

UPP was only established in 2021 following the culmination of a decade-long process by three founding universities to amalgamate their existing pension schemes into one umbrella organization.

But the private markets team led by Peter Martin Larsen has already committed or invested CAD$900 million, most of which has gone into inflation-proof infrastructure assets.  Now their focus is turning to return-enhancing private debt and private equity with new partners in close relationships that will open the door to co-investment and direct participation down the line.

“The return enhancing element of the portfolio is gathering steam. We have been very busy adding to it and are looking to do a lot more. Our private markets target allocation is significantly higher than the current 20 per cent,” says Larsen in an interview with Top1000Funds.com.

Moreover, the current market is allowing UPP to get a foot in the door with sought-after and specialist mid-market managers by offering meaningful ticket sizes. Many asset owners lack dry power in the current environment but newcomer UPP still in the foothills of building its allocation can fill a gap as an attractive partner while other Limited Partners remain strapped for cash.

“We are in the fortunate position of expanding our exposure and are focused on making new investments, not trying to realise existing ones. It’s been great timing for us to create partnerships in this market,” he says.

Bold ticket sizes and portfolio exposure within the mid-market space also mean UPP can ensure a seat on Limited Partner Advisory Committee boards, where LP investors in a fund can take an oversight role and offers another way to cosy up to GPs.

“In addition to creating close partnerships around co-investments and achieving the long-term benefits of that approach for our members, we are also focused on governance in our fund investments. We typically target the mid-market, where we can be meaningful, and every fund investment we have done so far has included an LPAC seat. In fund investments this is one way to increase ongoing due diligence and governance and be close to our partners.”

Partnerships pay off

As he expands the portfolio, Larsen has turned his focus beyond fund investment to co-investment opportunities. He says UPP is targeting a selective, smaller group of GPs to develop strategic co-investment partnerships that will enhance returns, lower fees, and offer greater control and governance oversight, allowing UPP to align investments with its own risk tolerance and sustainability goals.

Co-investments will also allow UPP to develop shared best practice and a consistent approach to risk-return assessments including accessing opportunities at the intersection of asset classes, he continues.

“Co-investments are a critical part of our strategy. They really are the core of what we are trying to do.”

He adds: “Our focus is on finding partners for value creation and outperformance through our people who are market leaders in their fields. We are also very focused on being an attractive partner ourselves. The key words for us are in-house expertise and a cohesive approach across our four private asset classes, which enable deeper partnerships.”

The skills of UPPs diverse 12-person internal team span asset class expertise and an ability to draw on their own networks to source opportunities in funds, co-investment and direct private market investment.

“We have an amazing and experienced team who have been around the block and invested through cycles,” he says. “We have people who have invested in funds, co-investments and direct with global relationships who can originate opportunities.”

Larsen says his own move from institutional investment in Denmark to join UPP in Canada has been made easy by similarities between the two regions that include a deep institutional investment ecosystem and talent pool. “The investment approach in pension funds in Canada and Denmark are similar, inspiration in Denmark come from Canada.”

He says the skills of the team is already born fruit. Like UPP’s recent €150 million investment in offshore wind veterans Copenhagen Infrastructure Partners’ latest fund, and stake in Angel Trains, the UK rolling stock company.  “We have a team with global relationships that can originate these opportunities.”

With its focus on people and partnerships, UPP’s strategy is typical of the Canadian Maple Eight. He began by building in-house expertise focused on accessing opportunities, executing; building partnerships and monitoring the portfolio. Now he’s developing partnerships that will transition into co-investment and direct participation. He also wants to integrate sustainability and diversification, tapping long-term, secular trends that are robust in any interest rate or inflation environment.

“Coming out of COVID, diversification was one of the biggest learnings”

Sustainability is incorporated into the screening and underwriting process, overseen by the internal team.

“Besides being a key way in which we seek to invest responsibly on behalf of our members, integrating material ESG factors across all investment processes is the right commercial thing to do to avoid undue risks such as stranded assets. There must be a buyer in 15–20-years time when we may look to sell the asset.

We want to partner with GPs with a track record in responsible investing (RI) and we actively engage with GPs to influence their investment decision and management practices. ESG is integrated into our portfolio construction.”

As Larsen builds out the allocation, today’s overweight LPs is a reminder of the risk and long-term nature of private investments. He says UPP has a five-year strategy to reach its (undisclosed) target allocation and won’t rush – despite the opportunity – to ensure vintage diversification.

“We will invest for the long term and target value creation over 10-15 years. All the data shows consistent out performance from private markets over a 10-15 year period v public markets. But you need to be patient and accept and embrace the illiquidity. You don’t want to be a forced seller of private assets.”

Peter Martin Larsen will speak at the Fiduciary Investors Symposium in Toronto from May 29-31. Click here for more information.