The global head of sustainable investing at Canada’s Ontario Teachers’ Pension Plan (OTPP), Anna Murray, said she had finally come to terms with the anti-ESG sentiment that is floating around in certain investment circles.  

In the world’s most important capital market, the US, responsible investment has become a politically charged topic. The nation’s market regulator, the Securities and Exchange Commission (SEC), last month stayed the implementation of its climate-related disclosures by public companies in the face of multiple legal challenges from attorneys general of several Republican-led states. 

Speaking just across the border at the Fiduciary Investors Symposium held at the University of Toronto this week, Murray conceded that she has spent the last number of years feeling “defensive” against the anti-ESG sentiment, but now, she “very much welcomes it”. 

“I think it’s a blessing in disguise, in that it’s made all of us very focused on removing the labels and [recognising] what we’re really talking about [around sustainability] as a set of growing and material risks that is just fundamental to our fiduciary duty,” she told the symposium.  

“One of the challenges I think that we are experiencing – if I could call us collectively as an industry – is around emissions intensity, and the absolute focus on that as the sole measure of progress. 

“While it’s a very important measure, of course, I think we can all recognize that perhaps it’s an imperfect measure, it is backward looking. 

“[I am] hoping to see the discussion starts to evolve more to include the ability to identify and capture these investment opportunities, as opposed to just focusing on the emissions portfolio reduction.” 

It is a sentiment echoed by Hendrik du Toit, founder and chief executive of international asset manager Ninety One, who said that ESG considerations have become an integral part of modern investing.  

“[The ESG team] are not the people in the corner next to the compliance team. They’re actually embedded in the investment teams, and they are in the leaderships of the firm,” du Toit said. 

Despite all the negative narratives around ESG, du Toit said the area is still witnessing an unprecedented level of international collaboration. 

“It’s very significant that the US government and the Chinese government, which don’t really talk a lot, have their climate channel absolutely open… which is not often publicized,” he said. 

“There are things happening that we should celebrate as well.” 

However, not one to mince words, du Toit said the asset management industry has done “a pretty abysmal” job in quantifying the transition risk, and it’s disappointing to see the world’s inability to even mobilise 1 per cent of its capital per annum to finance the transition.  

“We as an industry are collectively incredibly stupid sometimes,” he said. “We had a decade or five years of literally free money – what did we do with that? We threw it at tech we don’t really need to use. 

“What can we do as asset managers, besides pricing securities, is we can actually mobilise capital to invest behind the most important investment opportunity of our generation. 

“All we try to do is encourage the companies we invest in to maximise their value by recognising the transition risk – ie developing real world plans to protect the equity value, and contribute to a world which is livable. It’s really as simple as that.” 

L-R: David Bell, Anna Murray, Jane Ambachtsheer and Hendrik du Toit

With C$750 billion in assets under management, BNP Paribas Asset Management has committed 50 per cent of them to 10 net zero objectives, spanning across equity and credit corporate investments and some private assets.  

The firm’s global head of sustainability Jane Ambachtsheer said the anti-ESG move is evidence of impact.  

“A lot of the pushback we’re seeing today in the market is actually… because we’re pushing in uncomfortable places,” she said. 

“I think a lot of people are waiting for rates to come down and then we’ll see clean energy investment deployment pick up and become more attractive.” 

While pension and sovereign funds have positioned themselves well in private markets to harvest clean energy opportunities, Ambachtsheer said “the big question will be on the public [market] side”. And the performance there hasn’t really been glowing, as the S&P Clean Energy index was down 15.63 per cent on an annualised total return basis in the past three years.  

“A lot of people are looking at that and pointing to that as a proof point that sustainable investing has had its run the last three or four years, and now we’re moving on to something else,” Ambachtsheer said. 

“That’s not our perspective. Investing in clean technology and renewables is one piece of an overall broad diversified approach to thinking about the transition, and looking for the right kind of pricing and opportunities is an important element of that. 

“On the stewardship side, we voted against 1000 management resolutions last year because we weren’t happy with what the companies were reporting on climate.  

“So there are certain things that you can just measure year over year and report on, and I think understanding what investors want to achieve around net zero and helping them align with that is really a big part of our commitment.” 

The $96 billion New Jersey Division of Investment is expanding its emerging manager programme beyond private equity to include real estate and private credit.

Investments with minority and women-owned private equity fund managers already comprise 18.7 per cent of the total market value of the pension fund’s $11 billion private equity programme.

Now New Jersey will allocate more to experienced spinout teams and return-generating seed investments, in line with its commitment to improve DEI in America’s $70 trillion asset management industry of which only 1 per cent is managed by people from under-represented groups.

“The chance to build long term relationships, and being there at the beginning, investing in the first fund and seeing how the team evolves, is really rewarding,” says Dana Johns, New Jersey’s head of private equity and chair of the Private Equity Women Investor Network, a passionate advocate of next generation investment managers who has spent much of her career understanding the risks and opportunity of the sector.

New Jersey launched its emerging manager programme in private equity in 2022, kicking off in the asset class with the largest universe of emerging managers, most new fund creation, and more managers with a historic track record. Alongside deepening DEI in the portfolio, the programme has supported diversification by enhancing exposure to lower middle market opportunities which have historically outperformed relative to larger funds.

Rolling the programme out to other asset classes will allow the fund to enhance exposure to unique and niche opportunities from which it is typically excluded because of size, track record, and assets under management constraints.

Getting into the portfolio

Emerging managers seeking a place in New Jersey’s portfolio need more than a deep understanding of their investment strategy and an experienced track record of exits and distributions. Some of the most probing questions Johns asks centre around how new managers are building and running their business.

Finding a partner, raising, and deploying capital (often raising for a second fund as soon as the first has closed) and building a team is an arduous task.

Johns likes to know if the team spun out together or if they have come together for the first time to launch a fund. The latter, she says, poses more of a risk.

“If two individuals are coming together for the first time, institutional investors need to understand their prior investment experience and how they came together. LPs elevate business risk when underwriting a first time fund manager. Sometimes emerging managers ability to manage the business is more of a risk for LPs than the investment strategy itself,” she says.

Johns says the skills set and deep level of experience she looks for make the term emerging manager inappropriate. “I prefer the term Next Generation rather than emerging managers because these are investment professionals who have been doing the job for a long time but have decided to go it on their own.”

Size matters

New Jersey’s program is centred around a platform of Separately Managed Accounts that allows the investor to target small investment sizes. Emerging manager fund sizes are typically between $100 million to $1 billion and New Jersey prefers not to account for more than 20 per cent of any one fund. “We write cheques of upto $25 million that overtime will grow to 12-14 commitments to these managers.”

Size is also an issue around graduation. She says managers will only graduate to the main portfolio if, and when, they can scale to absorb larger cheques of between $100 million to $200 million. “Not all managers will move into the larger portfolio because some of them might not be able to scale,” Johns says.

A $200 million fund is not the right fit for a large LP seeking to allocate $1-2 billion a year, she continues. “These managers need to be smart about who they talk to and smart about building their network, “she advises. “They should approach the LPs that are the right size and a better fit for smaller managers. This is why we built our platform.”

Engagement

New managers can expect close contact with her team. New Jersey is closely involved with the managers on its platform, particularly via the LPAC seat. Mentorship, advice and “direct impact” will include sharing broad industry knowledge; whether to use credit lines, or how new managers should diversify the LP base for their next fund.

“We can introduce emerging managers to other LPs focused on building their emerging manager programme,” she says.

Johns treads a sensitive line when it comes to negotiating fees and counsels against “going in and pushing new managers down.” They have invariably sunk all their resources, including their own net worth, into their new fund. She says for many of these managers, every 2:20 is vital to long-term success.

But that is not to say it’s not possible to draw other LP benefits from taking the risk of supporting new partners build their portfolio. This could include first refusal on opportunities to upscale commitments, access rights to financial statements, or opportunities to build a co-investment sleeve where there are zero fees, zero carry, and size fee breaks.

“There are different ways to approach fees, and it is important managers are set up for success. We take the opportunity to minimise fees as much as possible while not putting the manager in a situation that could be detrimental to the fund.”

Challenges for emerging managers

Unlike some asset owners that are overweight private markets New Jersey was under allocated across most private markets. It means the fund has been able to allocate capital to emerging managers “at a full pace” across venture, growth and buyout within private equity.

But she acknowledges that today’s challenging market is making it harder for emerging managers. It has triggered a flight to quality with fewer, large funds absorbing a bigger portion of available private equity allocations and increased competition for investment dollars.

“There is a big knot in the system right now where LPs are constrained. They need dollars back before they can reallocate to new opportunities.”

In other trends, LPs are seeking to consolidate the number of general partner relationships to reduce risk and keep portfolios efficient.

But Johns also notices that ever-larger GPs could serve to increase the number of experienced spin outs and opportunity for LPs with an emerging manager programme.

And New Jersey has previously voiced concerns at the ever-growing size of external manager private equity and debt funds, flagging the risk of allocating to asset gatherers, where managers harvest lucrative management fees but are slow to invest because they are hampered by executing and deploying billions of dollars.

Despite her oftentimes pessimism at the level of DEI in the asset management industry, Johns passion remains undimmed. The satisfaction of seeing a new manager roll out successive funds and generate success for themselves and their LPs drives her on.

New Jersey is holding an emerging managers virtual symposium on June 26.

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.