The transformational effect of artificial intelligence has already been felt across a number of industries. Its impact is now also being felt in financial markets and particularly in the function of investing within asset management.

David Wright, co-head of Quest, quantitative business strategy, at the Switzerland-based Pictet Asset Management, told the Fiduciary investors Symposium at Stanford University that current techniques being used included large language models, natural language processing, and machine learning to make predictions.

Wright quoted a recent global survey by Mercer that showed nine out of 10 investment managers were either already using AI or planned to use AI in the future as an indication of the potential uses for both quantitative and fundamental managers.

“On one side, you’ve got tools that can help be more effective, be more efficient, and focus where the investor want to spend their time,” he said.

“At the other end, you’ve got the quant space, where you’re starting to see front-to-back machine learning-based models to forecast returns.

“It comes together a little bit in the middle as well, with kind of quasi-tools. These are often natural language processing, where you want to assess sentiment, or you want to summarise documents.”

He gave the example of a Pictet team developing an in-house, large language model to summarise all the 10-K financial documents – comprehensive financial reports required by the US Securities and Exchange Commission to be filed annually by public companies – that they otherwise would have to go through by hand, bringing it down to a summary that takes only 10 to 15 minutes to read.

Quant Race

Wright says machine learning has been looked at in some capacity for 10 to 15 years on the quantitative side of the industry, with the equivalent of an arms race in the quest for data, technology, and computing speed.

With significant progress being made, there have been a lot of headlines and even academic papers over the past couple of years suggesting stock picking can be done by large language models. Wright says this is not credible yet, but machine learning is starting to really have an impact on stock picking elsewhere in the investment world.

“The reason this is possible is that the opportunity has really accelerated for quantitative investing over the last 10 years,” he said.

“There’s so much more data, there’s much faster computing speed, computer storage is much cheaper. The barriers to doing machine learning today are much lower than they ever were historically.”

Some recent applications of AI lend themselves to the more traditional stock picking fundamental managers as well.

That includes being able to make more accurate return forecasts, particularly over shorter horizons, because it can incorporate a much larger number of features or signals or data sources.

“What machine learning can allow you to do in the quant space is overcome one of the key challenges that we have, and that is the trade-off in modelling between complexity, accuracy and errors,” Wright said.

Fully Transparent

One of the key challenges with machine learning relates to transparency, with asset managers generally wary of not being able to fully understand where the returns are coming from, or where the investment positions come from

Wright says his team used some academic work focused on currency markets undertaken in the US, and wrote a paper that took that work and transported it over to the equity market.

“Where we stand today with our live models is that every single position in our portfolio, we can take it back to which features drove that, what is the interaction effect between those features, and then we can explain to our clients and attribute the performance to the features.” he said.

“It gives them a lot of comfort that we can truly understand what we’re doing. We can move from a black box to a fully transparent crystal box.”

With that growing comfort level, institutions are looking for machine learning models to help them generate pure alpha, stripped of common factor returns. They want active returns that are independent from the market regime, customisable approaches that can be implemented in different types of strategy, and transparency and interpretability.

“The alpha is getting harder and harder to come by in the market,” Wright said.

“Trading off analyst sentiment in the market now is much less effective than it ever was historically. But if you understand how an analyst forecast interacts with how close it is to the company reporting its results, there is alpha to be made from that.”

A higher interest rate environment, increasing divergence among major central banks, and geopolitical uncertainty are some of the major risks that top asset owners are bracing for in coming years.

In a discussion at the Fiduciary Investors Symposium at Stanford University, long-term investors including APG Asset Management, MFS Investment Management, CPP Investments, considered the top macroeconomic themes that will play out over the next few years and what their implications will be for investors.

“Our expectation is that we’re moving into a higher-interest rate, higher-inflationary environment. Yes, rates are likely to come down from where they are currently, but we’re unlikely to go back to where we were in the period following the global financial crisis,” said Jonathan Hubbard, managing director in MFS’ investment solutions group.

Hubbard said he believes the driving elements behind the current persistence in inflation are less well understood, given that it follows more than a decade of zero interest rate environments after the GFC. Despite central banks kicking off a monetary easing cycle, that could mean periods of rolling inflation.

Inflation is also top of mind at Canadian pension fund CPP, head of portfolio design and construction Derek Walker said, with the potential that we have entered a world where inflation is either higher or more volatile.

“The reason that is relevant for us, as it will be for asset allocators in general, is that diversification benefits that we see between fixed income and equities are very strongly driven by that,” he told the audience of pension and sovereign funds.

“In those environments where it’s primarily growth that’s driving that correlation, we see a more negative correlation. But when it’s primarily inflation and real rates increasing, then that tends to be a positive relationship. So it has big implications from a diversification standpoint.”

Policy Divergence

APG global head of fixed income Ann Marie Griffith said one of the key issues that central bank policies have largely been co-ordinated since the global financial crisis, with rates coming down to very low levels.

However, now we’re seeing dispersion. The Federal Reserve delivered a supersized 50 basis point rate cut on Wednesday, the Bank of Canada has already eased three times, the Bank of England once and, two cuts have come from the European Central Bank.

“But what we’re really seeing is these central banks reacting to facts on the ground in their particular countries or regions, instead of acting in concert. So that’s creating a bit more volatility within markets and then across markets,” Griffith said.

She pointed out that some other countries such as Japan and Brazil, are actually thinking about raising rates as they deal with issues such as weakness in their own currency, and wage and inflation pressures.

“These are very sort of unusual activities, considering where we’re coming from since the financial crisis, but definitely creating a lot more volatility and a lot more interesting opportunities in portfolios.”

Another issue that is finding resonance is re-globalisation where global trade relationships, global supply chain structure and logistics are all changing.

What started in 2017 with the Trump administration tariffs were underscored during Covid, where companies couldn’t access their supply chains in different countries; then was impacted by the Russian invasion of Ukraine; and is currently being felt through the war in the Middle East, which is impacting shipping channels.

“Put that all together, and as a COO of an organisation, does it make sense to have outsourced all of this business and manufacturing?” Hubbard said.

“So we’re starting to see some of that come back to the US. But we’re also starting to see some of those trade relationships change and I think the beneficiaries will be countries in Asia, some countries in South America.”

Strategic Allocation, Tactical Play

Asset owners are looking to deal with the volatility in different ways. As a long term investor, CPP’s first line of defence is around building a resilient and robust strategic allocation, Walker said. That also involves stressing portfolio allocation to a number of different scenarios.

 “So making sure that we are not allocating capital in assuming a very benign inflation and rate environment. We kind of put more weight on a higher rate, higher inflation environment.”

APG’s Griffith noted that there is still a very compressed spread environment, with potential for the Federal Reserve to be a little bit slower than the market has anticipated.

“We’re probably still a little bit biased to have risk on in the portfolios, but much more closer to home, and also trading up into more liquid, larger names and trying to create a little bit of extra liquidity in the portfolios to take advantage of some of the volatility that we may see in the coming months.”

Hubbard said while short-term market trends took precedence, he was advising clients to continue to focus on the long term.

“Don’t give up on diversification. I think that there’s too big of an opportunity set outside the US. Maintain that as part of your strategic assets allocation, even if it doesn’t work out this year or next. I think over the longer term, there are definitely great opportunities.”

While financial markets grapple with the impacts of this week’s interest rate decision from the US Federal Reserve, what matters more is how markets got to this point and how this will impact the next three-to-six-month window.

The Fed announced a rate cut of 50 basis points on Wednesday, lowering the target range for the federal funds rate of 4.75 to 5 per cent.

At the Top1000Funds Fiduciary Investors Symposium at Stanford University, just hours before the Fed’s decision Bridgewater Associates portfolio strategist, research group, Alex Smith tipped a cut but noted the real consequence would not be the specific decision the Fed made, but how markets had arrived in this position.

“I don’t think it matters,” Smith said.

“I guarantee they’re going to cut. Is it going to be 25 [basis points]? is it going to be 50, 37.5? I don’t know. What’s really interesting is how are we in a position where I can guarantee you they’re going to cut.”

He noted that almost 17 years ago to the day, the Fed cut 50 basis points ahead of the Global Financial Crisis, and he questioned whether it had any impact in the following months.

But looking at the situation now, the focus is on why the Fed cut, what the implications are, and what it effects it will have. “That’s the next three to six months,” Smith said.

“But then stepping back, how is that similar to and different to what we’ve experienced before? There are some similarities – old-school interest rate policy; we call it ‘monetary policy one’.

“[This is] the traditional way we learned how the Fed operated, but with a twist and that twist is what we call ‘monetary policy three’ which is what we call fiscal policy. These two things are operating at the same time and it’s going to create a pretty different backdrop for investors.”

When rates are lowered to stimulate the economy during a downturn, it typically leads to greater borrowing, and that borrowing produces spending.

“One person’s spending is another person’s income, and you get the cycle going,” Smith said.

“It leaves a residue and that residue is debt. The debt went higher and higher and higher and the debt itself was a deflationary force. That’s why inflation is going down and it reached a level in 2008 where private sector debt was very high.”

It was then that the Fed sent interest rates to zero, to no response, which Smith likened to an emergency ER doctor using a defibrillator on a patient with no effect.

A different regime

Instead, the Fed went to a different policy regime – dubbed ‘monetary policy two’ – which involved printing money to pump into the financial market instead of stimulating borrowing by lowering interest rates.

“A very different form of stimulation, it produces asset inflation – not much in the way of goods and services inflation – and it very indirectly kind of leaks into the real economy,” Smith said.

Smith posited a twofold justification for the decision to pursue this method: first, because inflation was already low; and second, because, ultimately, “they had to”.

“They were the only game in town,” he said.

“There wasn’t much in the way of fiscal stimulation, but by the end of the 2010s it became apparent you were going to need more fiscal [policy] to get additional stimulation.

“What catalysed that I don’t think anyone predicted, which was the pandemic. You had a rapid decline of economic activity and coordinated money printing and fiscal easing.”

The fall out of the Covid-19 pandemic led to multiple trillion-dollar stimuli which targeted support for consumer incomes.

“Those incomes were spent – one person’s spending is another person’s income so that was good,” Smith said.

“You got good income growth but there was a residue, the excess demand. There was too much demand and the economies that stimulated more had more inflation and that led the Fed to eventually recognise it was not transitory.

“We’ve got to tighten, move interest rates up 550 basis points, move QE [quantitative easing] to QT [quantitative tightening] and then you’ve had this effect where inflation has come down.”

While Smith notes there are other factors that have driven down inflation – like the resumption of functional and undisrupted supply chains – the economy is now in a position where inflation has come down closer to target but it’s beginning to create weakness in the labour market.

“They want to get in front of it, that’s why they’re easing today because there are the effects where this has slowed inflation, but the tightening is slowing spending in the real economy,” Smith said.

But Smith conceded the reason everyone is “obsessed” with these three monetary policy frameworks is because ‘monetary policy one’ is the goal for central banks, but elected officials prefer ‘monetary policy three’.

“So that’s a tension,” Smith said.

“It’s one thing if you want to have record deficits and the central bank’s printing money and basically handing it to you, it’s another if you’re moving in opposite directions.”

The good news

The good news, Smith said, is that this is different to the GFC. In 2008, defaults on subprime mortgage debt directly drove the crisis, but private sector credit hasn’t played a role in the economic expansion for the last few years.

“Is it like 2008? It’s not, that’s good the news,” he said.

“The big support was fiscal stimulation and very strong labour markets – now those are rolling off and the Fed has to offset it.”

“That’s mid-cycle easing. Mid-cycle easings are great for everyone in this room, if you’re an asset owner. Now there’s two flies in the ointment: we don’t know if it’s a mid-cycle easing and you don’t know until afterwards; and this could easily be wrong.”

Smith added there “is a lot of good news priced in” which has meant higher asset prices and lower forward-looking returns.

“When we look at the momentum of the conditions it looks like we’re probably more in the foothills of a bubble than the top of a downturn and you could see rich assets get richer still,” Smith said.

“We’ve all been conditioned to that; you haven’t had a prolonged drawdown in 15 years. That’s in the US where we’re generally probably more of a mid-cycle easing, much more favourable for asset holders than entering a recession with a lot depending on not how much they cut today, but how much do they cut, and do you get the [economic] response?”

The jewel in the crown of the Church Commissioners’ portfolio, the London-based asset manager for the historic assets of the Church of England, is its allocation to real assets.

Comprising a quarter of the £10.4 billion ($13.7 billion) portfolio, prized property and land investments include the Hyde Park Estate, 90 acres of prime London real estate that includes Westminster’s Connaught Village, alongside heritage properties like Fulham Palace, once the home of the Bishop of London. The Commissioners also own 82,000 acres of productive UK farmland and a similar amount of UK and international forestry.

Portfolio returns are used to support the work and specific needs of the church, alongside clergy pensions, and strategy is carefully crafted to balance patient long-term investment alongside the need to prepare for a different future overseen by Charlotte Moss (commercial property) and Joanna Loxton (land), both newly promoted into their roles.

Rather than seeking wholesale changes, Loxton and Moss aim to build a synergy in strategy across the two portfolios to ensure that everyone working in the team knows what they need to deliver.

“Our job is to create an overarching structure to ensure portfolio performance,” says Loxton.

Strong Returns in Strategic Land

Some of the highest returns in real assets have come from an allocation to strategic land (3 per cent of the entire portfolio) comprising housing and employment sites that the Commissioners bring up through the planning system before selling for development.

It’s an asset that is attracting growing investor interest since the new Labour government made housebuilding a priority, pledging to increase supply to 1.5 million new homes over five years, a level unseen for more than 50 years.

Loxton says the strategic land portfolio currently accounts for 7500 acres, targeted to deliver around 33,000 new homes (roughly 9000 will be low-cost, affordable homes in-line with the Commissioners’ pledge to address social inequality) and employment spaces.

Bringing strategic land forward through the planning system involves working with local councils, other stakeholders and consultants to demonstrate its suitability, Loxton says. Once planning is approved, in some cases the Commissioners partner with a developer to bring the site to market, while in others they sell the land with planning permission to a housebuilder to bring forward the new homes.

“In many cases we seek to take a ‘patient capital’ approach to delivery and bring sites forward under joint ventures with master developers, housebuilders and commercial developers,” Loxton says.

“We are not developers, so are looking to partner with those with the expertise to bring forward our sites comprehensively and swiftly.”

Although land is sold from the strategic land allocation, the team constantly acquires new sites, actively buying new land with long-term development prospects. Some are small sites for just 10 homes, others much larger, destined for 10,000.

Re-imagining retail

One area of the portfolio that has witnessed lower returns is retail. But Moss says a strategy to re-imagine retail across the Hyde Park Estates focused on filling space with best-in-class independent retailers is starting to reap dividends.

“Retail has been difficult, but we are seeing it come back with our independent retailers who focus on selling the right, quality stock,” she says.

“ESG-certified office and residential also does well.”

Outside London, re-imagining property has included turning old warehouse units into a theatre. Elsewhere, a mall in the north of England has introduced an NHS diagnostic centre to move the space beyond just shopping.

Although the consequences of climate change haven’t yet knocked returns in the land portfolio, Loxton says climate change is now a key risk. But integrating sustainability is far from straightforward given it raises important questions – 90 per cent of the farmland in the portfolio is highly productive, versatile land, vital in terms of UK food production, yet farming in the UK contributes to around 10 per cent of total UK emissions.

The team is grappling with questions like how to use land for food production as well as increasing carbon capture and biodiversity. Questions like the merits of taking land out of food production, or whether this will create further problems elsewhere, and the different likely emissions profile of ‘best practice’ versus ‘standard practice’ and how close they can get to net zero farming, are now front of mind.

Loxton says active stewardship involves looking at the impact of climate change in the short and long term and exploring ways to build resilience. The team work with peers and policy makers to explore innovative practices.

The Commissioners balance their active stewardship and using the power of their voice with an awareness that farmers are custodians of the land and many have farmed for generations.

“We are looking at how [our tenants] integrate sustainability measures into their businesses in a way that supports and enhances their practices – and, consequently, our landholdings,” Loxton says.

Strategy appears more straightforward in the property allocation, for now. For example, the Commissioners have introduced green leases that include clauses around reduced energy consumption in an approach that is enabled by direct ownership.

“We do have direct control over the portfolio which helps us do this,” Moss says.

Natural capital

Natural capital, the new entrant on the sustainability spectrum, is an emerging market where the team is focused on engagement and exploring opportunities and challenges. The fund has completed a natural capital baseline assessment across the portfolio and was the first asset owner to sign the taskforce on nature related frameworks.

“Natural capital is a big discussion and focus area within sustainability and one that we want to be at the forefront of,” Loxton says.

Current projects include working with a bird charity on wetland recovery and another project with the Wildlife Trust. In London, natural capital projects include working with stakeholders like Transport for London and local councillors to develop biodiversity.

Long-term strategic land and timberland have the strongest returns, although Loxton notes timberland has struggled recently because of the downturn in the housing market. This stand in stark contrast to 2020, when timberland returned 41.3 per cent partly due to the sale of a number of forests in Scotland and the US.

At Brightwell, which manages the assets of the £47 billion ($62 billion) British Telecom Pension Scheme (BTPS) one of the largest private sector DB schemes in the UK, liability-driven investment (LDI) is managed in-house, but cashflow-driven investment (CDI) for client funds is managed externally.

In contrast to many other UK pension schemes or asset managers, Brightwell believes that the credit collateralisation of LDI exposures and cashflow management is possible without all the relevant assets sitting with the same manager.

The two-pronged approach requires a sophisticated set up, technology and position level data sharing, says Wyn Francis, executive director and CIO in Brightwell’s latest newsletter.

“It is a received wisdom in the industry to combine LDI and credit under one roof for credit collateralisation and holistic cashflow management,” Francis says.

“However, this can result in manager concentration as the majority of a scheme’s portfolio sits with a single investment manager. The usual argument is that this is the only way to use credit as collateral for LDI and manage the operational requirements of cashflow management. At Brightwell, we strongly disagree with this approach.”

LDI and CDI

LDI is best described as a fancy name for a structured set of derivatives exposed to, in this case, the price of gilts. The idea is that pension funds buy these derivatives to protect them against yields going down, as this leads their liabilities to go up – when their liabilities are going up, they also have an asset that is posting them collateral. When yields fall, LDI funds receive margin but in the reverse scenario when yields rise (like they did in the UK’s gilt crisis in 2022) pension funds must post more collateral in-line with calls from their investment banks.

CDI, in contrast, matches fund income to scheme cashflows as they fall due and is an alternative to a traditional growth-and-matching investment strategy.

Since the LDI crisis, many pension funds have run their LDI and CDI allocations with one manager in a combined portfolio. The approach, Francis says, is a consequence of pension funds struggling to manage their collateral (bonds) during the LDI crisis because it was not easily accessible for their LDI managers. Some funds were unable to get cash fast enough to meet increasingly urgent collateral demands.

“One of the issues was that managing collateral was very difficult because their collateral pools were not in the same place, or the place that LDI managers needed it to be. Communication between LDI and CDI managers was challenged,” says Francis, who adds that under Brightwell’s approach, the internal team also have full cashflow visibility of the CDI assets.

Splitting up the allocation between in house and external managers brings a range of benefits. For example, the strategy allows pension fund clients to benefit by exposure to their preferred credit manager, gaining exposure to niche or best in class managers. Clients also retain the flexibility to change managers if performance drops or their requirements change.

It also avoids manager concentration, another problem during the LDI crisis when some investment managers were unable to service all their clients equally. Brightwell argues its approach reduces pension funds’ reliance on a single manager, often running many mandates to similar objectives, potentially creating operational and market risks.

Francis says Brightwell likes to build long-term relationships with managers, treating them as trusted advisors. But it also seeks to limit the number of managers it works with, to ensure a diversity in approach and portfolios.

“We like [managers] to be able to move across from public to private credit and make that value decision for us,” Francis says.

“It is unlikely that a good LDI manager is also the best-in-class credit manager. Managing LDI and credit under one roof to deliver CDI not only means potentially forgoing the returns that a credit specialist could offer and, as such, a loss of value, but also the loss of future flexibility.”

Putting the plumbing in place

Francis explains that the strategy has involved working closely with asset managers and custodians to make sure “the plumbing is in place”, including daily data on the bonds managers hold, and which ones are ring-fenced for collateral purposes.

“It requires communication with managers and the custodian whereby managers inform us of any bonds they want to sell out of, and new bonds coming into the portfolio,” Francis says.

He says Brightwell has built and uses a hybrid platform that allows it to manage LDI and CDI as one portfolio without directly managing corporate bonds.

“We believe that we are uniquely positioned as a fiduciary manager who only manages LDI, overlays and longevity risk in-house,” he says.

“We do not have proprietary funds or strategies to allocate to and as such do not compete with other asset managers. Other asset managers see us as investors and there is a mutual desire to co-operate. Close collaboration between all parties is vital for managing LDI and CDI under separate roofs.”

AP4, the SEK533.3 billion ($51 billion) Swedish buffer fund, is integrating Scope 3 emissions into its systematic equity allocation in the latest bid to improve risk and return at the pension fund, globally recognised as a role model in sustainability.

The systematic equity portfolio sits alongside a fundamental allocation which already integrates Scope 3 and supply chain risk in its deep fundamental processes. It means the latest innovation will complete Scope 3 integration across the entire SEK165 billion ($16 billion) equity portfolio apart from a (SEK 29 billion ) $2 billion allocation to emerging markets.

“We aim to be exposed to as little systematic risk as possible and want to find the green leaders of the future,” says Julia Ripa a senior analyst in the listed equities portfolio tasked with building sustainable equity strategies. “Because Scope 3 can be a large part of a company’s emissions, it is very important to integrate this risk into the portfolio and we can’t wait for ever to integrate Scope 3 – the danger of being exposed to the systematic risk of climate change is growing all the time.”

AP4 aims to achieve net zero emissions in its portfolio by 2040 and has cut emissions by 65 per cent since 2012 when it was one of the first pension funds out of the gate with the strategy. In 2023, the portfolio’s carbon dioxide emissions decreased by a further 11 per cent.

Although Scope 3 emission data is still frequently based on inaccurate estimates (in contrast to reported Scope 1 and 2 data) Ripa says the tide is turning, and the decision to integrate Scope 3 is a response to the steady improvement in emissions data from companies’ complex up- and downstream processes.

It is also born from AP4’s belief that new European reporting standards will yield better data going forward, despite fears amongst some investors that the regulatory focus on reporting could end up hindering genuine corporate change.

“EU regulation is really helping because we need reported data to improve data quality and availability. Once companies report their Scope 3 data it makes it much easier for us to select the best companies from the worst companies,” she says.

In the systematic portfolio the team continuously optimises the parameters that govern the algorithms used to select the sustainable winners of the future. If the data is poor quality, it yields noise and is often volatile; it holds too many inaccurate estimations that don’t correlate enough to reveal significant trends. “The team can end up just targeting companies on the basis of luck,” she warns.

Feeding Scope 3 data into the systematic portfolio won’t necessarily lead multiple companies falling out of the index.

“We won’t exclude all companies with high Scope 3 emissions,” she says.

Instead, the team aims to use the data to increase AP4’s weighting to the winners in each sector in the sector neutral strategy. They believe this will reflect the transition risk that the team is trying to capture more accurately compared to simply excluding the worst sectors. It is this, she says, that will ultimately lead to higher risk-adjusted returns.

“We are convinced sustainable investment will yield excess returns going forward, both by minimising sustainability risks but also by identifying winners,” she says. “In the long run, companies that are producing sustainable products and have sustainable business relationships, will be the future winners and yield excess returns.”

Ripa acknowledges that in some ways integrating Scope 3 data might not reveal significant corporate change. High emitting companies under Scope 1 and 2 like energy and utilities will still be high emitting under Scope 3.

However, she does say integrating Scope 3 will give a more holistic view of the carbon footprint of a company, something that will potentially change the way a corporate is viewed through a sustainability lens. It is possible that corporates that were clean under Scope 1 and 2 emissions will become brown when their Scope 3 data is revealed. “We will be able to fully understand company risk,” she says.

Car manufacturers which don’t have high emissions in their own manufacturing processes and have fallen out of Scope 1 and 2, but which produce a product that does have high emissions will be picked up in Scope 3, are a case in point.

Although the data from financials still has gaps, she says that Scope 3 data will also cast banks and insurance groups in a new light. For example, it can expose banks’ corporate lending book, particularly those financing fossil fuels.

“Banks have the opportunity of playing a large role within the climate transition, and we will finally be able to track their activity,” she says.

When it comes to high emitting sectors, AP4 combines Ripa’s team’s quantitative skills with the experience of the fundamental portfolio managers so that fundamental analysis is integrated into the systematic strategies.

The lack of quality, forward-looking data makes it challenging to pinpoint future leaders in these sectors, she says. A fundamental, qualitative approach is better suited to look deeply into individual companies and create a sustainability profile based on a corporate’s ability to transition and become a green leader of the future.

AP4 has continued to invest in the energy sector and in select fossil fuel companies in accordance with a belief that fossil fuels are essential for a successful transition. However, the investor has divested from thermal coal and oil groups it doesn’t believe are on a transition path.

Both the fundamental and systematic allocation seek out transitioning companies. Both portfolios also incorporate forward looking metrics, analysing how aligned companies are to the Paris Agreement and how exposed they are to rising carbon prices.

AP4’s allocation to emerging markets doesn’t sit within either the fundamental or systematic allocation, and is managed by external managers. Here the investor also aims to reduce emissions in the index, but hasn’t begun to integrate Scope 3 – although Ripa says it’s in the pipeline.

“Our approach when investing in emerging market equities is just the same. It’s about finding companies willing to transition and trying to improve, but doing so is more challenging in emerging markets. Data quality, reporting and to some extent awareness haven’t come as far as in developed market. In the end, it’s the same approach, just a few steps behind.”