Page 4 – Top1000funds.com

This is the fourth part in a series of six columns from WTW’s Thinking Ahead Institute exploring a new risk management framework for investment professionals, or what it calls ‘risk 2.0’. See other parts of the series here.

In this thought piece, we turn back in time – not to imagine how outcomes might have been different under a risk 2.0 framework, but to deepen our understanding of what this new mindset reveals. Because of path dependency, it is likely that a world trained in risk 2.0 would have even evolved along entirely different trajectories. So, rather than asking “what if?”, we ask “what can we learn?”

Our inquiry is guided by two questions:

What new insights emerge when past crises are reinterpreted through the risk 2.0 mindset?
How do these insights help us recognise the limitations of risk 1.0 and better prepare for the risks of the present and future?

Historical examples of significant market falls allow us to consider whether there are flaws in risk 1.0 thinking that resulted in the nature, likelihood and/or severity of these events being underestimated.

We applied a set of diagnostic criteria that exposed where traditional frameworks systematically fell short. These criteria were chosen because they highlight distinct but interlinked failures across assumptions, models, and system-level understanding:

Crash recorded – describes the event which provides context for the testing framework that follows
Risk 1.0 assumption violated – identifies the core theoretical assumptions that failed under stress (e.g., normal distributions, stable correlations, etc). It also highlights how simplifications embedded in risk 1.0 created blind spots under extreme conditions
Unexplained by risk 1.0 – captures dynamics that risk 1.0 models could not account for (e.g., nonlinear feedback loops or contagion effects)
Model blindness – reflects the inability of risk 1.0 models to adapt to emergent realities, leading to misplaced confidence in flawed measures. Demonstrates the disconnect between reductionist models and complex adaptive market behaviour
VaR inadequacy – shows how VaR underestimated clustering, fat-tailed events, and compounding systemic pressures
Neglect of systemic risk – exposes the absence of system-wide awareness in risk 1.0 (inter-market connectivity, liquidity spirals, contagion, etc)

[click to enlarge] Example 1 | black monday, 19 Oct 1987

Seen through a risk 2.0 lens, Black Monday exposed the fragility of risk 1.0 foundations. The Dow Jones fell 22.6% in a single day – a 20-plus-sigma event that defied assumptions of normality and stable correlations. What appeared as an isolated market shock was in fact a system-wide feedback loop: portfolio insurance and dynamic hedging amplified losses as automated selling cascaded across markets and borders.

Gaussian-based VaR models failed to anticipate extreme tail risks or the clustering of volatility that followed. Model blindness was exposed by confidence in reductionist models that ignored how collective actions could drive instability. Beneath it all lay a neglect of systemic risk: liquidity vanished, margin calls spiralled, and inter-market connectivity turned local stress into global contagion. Black Monday stands as an early warning of how complex dynamics can overwhelm static models – and why risk 2.0 demands adaptive, system-aware thinking.

Through a risk 2.0 lens, the dot-com collapse reveals how belief in rational pricing masked deep behavioural and systemic distortions. By October 2002, the Nasdaq had fallen around 77%, exposing how risk 1.0 models equated low beta with low risk and ignored valuation extremes. Market exuberance became self-reinforcing, driven by momentum, narratives, and a collective faith in technological transformation.

Traditional mean-variance frameworks failed to capture how capital is concentrated in overvalued assets, nor how investor behaviour amplifies instability. Volatility regimes shifted abruptly, invalidating assumptions of stable risk premia, while VaR models ignored emerging tail risks.

The crash revealed feedback loops between capital loss, investor sentiment, and liquidity withdrawal – dynamics under-appreciated by risk 1.0.

Example 3 | great financial crisis, 2007-2009

Viewed through a risk 2.0 lens, the Global Financial Crisis epitomises the collapse of risk 1.0 assumptions. Between October 2007 and March 2009, the Dow Jones fell roughly 53%, as beliefs in stable correlations and the independence of credit risks unravelled. Bonds once deemed risk-free became central nodes of systemic contagion.

Traditional models could not explain the freezing of credit markets or the cascading counterparty failures. The Gaussian copula framework missed correlation spikes and nonlinear stress dynamics. VaR, built on historical data, underestimated the magnitude and persistence of losses.

At the system level, “too big to fail” institutions turned from stabilisers to amplifiers, exposing the fragility of tightly coupled markets. Liquidity spirals and regulatory blind spots deepened contagion. The GFC became the germinal moment for the modern notion of systemic risk.

The COVID-19 shock was unlike anything risk 1.0 could imagine. In just four trading days, the Dow fell around 26% – including a 13% single-day drop on 16 March. No model built on historical financial data contained a pandemic scenario, and assumptions of stable correlations and sector diversification collapsed.

The simultaneous decline of risk assets worldwide reflected an economy in sudden global shutdown. Risk 1.0 models could not link epidemiological dynamics to market stress, nor capture the speed at which liquidity evaporated. Jump risk, flash-crash behaviour and asymmetric liquidity were all overlooked.

Like in other events considered, VaR frameworks underestimated both the magnitude and clustering of volatility, while systemic blind spots emerged as liquidity froze. Only massive central bank intervention prevented a broader financial seizure.

Seen through a risk 2.0 lens, the COVID crisis highlights how financial systems are deeply entangled with environmental, social, and real-world shocks.

Example 5 | UK LDI/gilt crisis, Sept-Oct 2022

The UK gilt crisis of 2022 revealed how even safe assets can become sources of systemic instability. Within six days, long-dated gilt yields rose about 1.5 percentage points, triggering margin calls and forced selling across LDI portfolios. Assumptions of stable rates, low volatility, and gilts as inherently low-risk assets collapsed almost overnight.

Traditional risk models failed to capture how rapid yield spikes could trigger collateral spirals and feedback loops between leveraged pension funds and the broader gilt market. Stress tests were anchored in mild historical scenarios, overlooking the extreme rate shocks of 2022.

The episode exposed the deep interconnections within the pension and LDI ecosystem – linkages under-recognised by risk 1.0. Only the Bank of England’s emergency gilt purchases prevented a full-scale liquidity crisis.

What can we learn?

Revisiting these crises through a risk 2.0 lens is not about judging the past, but about refreshing our field of vision. Each episode exposes how risk 1.0’s linear, model-centric view missed the adaptive, interconnected nature of real markets.

Risk 2.0 invites us to see and think in systems, shaped by behaviour, feedback, and design. Its strength lies less in prediction and more in awareness – the ability to recognise fragility before it becomes failure.

Andrea Caloisi is a researcher at the Thinking Ahead Institute at WTW.

Global markets have faced several defining moments in 2025. From the DeepSeek-driven reassessment of the US’ AI leadership to the Liberation Day tariffs which plunged global trades into uncertainties, these episodes have tested asset owners’ theses around geopolitical stability, the dominance of the tech sector, and geographical diversification.

Top1000funds.com has always been committed to going beyond the headlines and uncovering the fundamental shifts in how asset owners construct their portfolios and run their organisations. This year our readers continued to engage with in-depth Investor Profiles showcasing the thinking of global CIOs.

We now have readers at asset owners from 108 countries, with combined assets of $45 trillion, and we are also pleased to say that in 2025 we significantly increased our pageviews and our user base with our readers spending more time on our site.

Advocating for better practices

This year marks the end of the Global Pension Transparency Benchmark, which Top1000funds.com conducted in partnership with CEM Benchmarking annually over the past five years.

The GPTB measures and ranks the transparency of 75 asset owners from 15 countries, based on the factors of costs, governance, performance and responsible investment.

We’re incredibly proud of the project’s impact across the pension industry. Some topline figures: 92 per cent of funds improved their total transparency scores; all 15 countries in 2025 achieved better scores than they did five years ago; and Norway’s Government Pension Fund Global earned a perfect transparency score of 100, two years in a row.

But for leaders of transparency, the journey doesn’t stop here, you can read about how the GPFG and Canada’s CPP Investments will seek continuous improvements from here.

We continue with other key knowledge-sharing initiatives including the Asset Owner Directory and the Research Hub.

The Asset Owner Directory is an interactive tool to give readers an insight into the world of global asset owners. It includes key information for the largest asset owners around the world, such as key personnel, asset allocation and performance, and also includes an archive of all the stories that have been written by Top1000funds.com allowing readers to better understand the strategy, governance and investment decisions of these important asset owners.

The research hub links our events and our content with our Fiduciary Investors Symposium event series built on a close association with academia. For nearly 15 years we have been hosting the events on leading university campuses, giving delegates an immersive educational experience and challenging them to think bigger.

Now we have developed this research hub, which brings investors the academic papers written by the university professors who have been such an integral part of our programs. The research hub allows you to search academic papers and related Top1000funds.com content by the name of an academic or university, or by subject.

I have the pleasure of speaking with you – our global allocators and managers – every day and we know that despite the volatility and uncertainties, there’s never been a more exciting time to be an investor. The job of protecting members’ capital as a fiduciary has also never been more important.

Thank you for being a reader, a delegate, a sponsor or a speaker, for engaging with our content and for generously sharing your knowledge.

We’re going to do it all again next year and kick off our event calendar with the Fiduciary Investors Symposium in Singapore from March 24-25, 2026.

Hope to see you there.

Until then, happy holidays.

Produced in partnership with Scientific Infra & Private Assets

Global asset owners are expanding into infrastructure debt in a bid to lock in long-duration income, but the surge of money is also triggering questions about how to quantify risk in an illiquid and inherently opaque market.

The trend sits at the centre of a broader rotation from public to private markets as investors hunt for new sources of alpha and diversification. Infrastructure assets under management grew at a 19.7 per cent compound annual rate over the decade to 2024, with infrastructure debt expanding even faster at 23.1 per cent.

The shift is now visible in the growing number and size of mandates.

In September 2025, Dutch pension giant APG announced its first infrastructure debt allocation, awarding €425 million to an impact-focused mandate to Schroders Capital, and in May 2025, UK workplace scheme NEST seeded a new Europe-focused infrastructure debt fund run by IFM – in which it holds a stake – with an initial commitment of about €530 million.

Infrastructure debt has outperformed corporate and liquid bond peers at similar durations (yielding 4.9–5.1 per cent), with lower volatility (4.5–5 per cent) and with higher risk-return ratios (up to 0.98), according to data provider Scientific Infra & Private Assets (SIPA).

It is these type of risk-return characteristics that make private assets well suited to generating reliable income, according to NEST Invest chief executive Mark Fawcett.

“Private credit, infrastructure, etc – if you go to the right part of that asset class, you can generate the income [and] generate a superior pension income,” he said at the recent Fiduciary Investors Symposium at the University of Oxford.

Behind the veil of private infrastructure credit

However, the challenge of measuring risk and return becomes particularly pronounced within private market sub-sectors such as infrastructure debt.

Most infrastructure credit is project finance and so assessed by ratings agencies. It pushes investors towards an imperfect workaround: taking a listed bond proxy and adding an illiquidity premium.

“There is no like-for-like listed market for infrastructure credit – you just don’t have public bonds formed from wind farms,” says Abhishek Gupta, head of product at Scientific Infra & Private Assets (SIPA), the commercial arm of the EDHEC Infrastructure & Private Assets Research Institute.

Investment grade infrastructure debt and corporate bonds have a long-term monthly return correlation of 0.8-0.9 given shared macro drivers such as interest rates and credit cycles, but there are also periods when their performance decouples. For example, in the non-investment-grade segment, the 12-month rolling return correlation between infrastructure debt and corporate bonds turned negative between mid-2018 and late-2021, illustrating periods of decoupled performance despite exposure to shared macroeconomic drivers.

Another issue with benchmarking is the illiquidity premium itself, which is usually treated as a static number rather than a dynamic variable.

“This illiquidity premia also changes over time during the market cycles depending how active the market is,” Gupta says.

It can lead to fundamental risks, despite infrastructure debt consistently demonstrating overall low default probabilities.

“If you don’t assess the risk properly, you can’t estimate spreads in this market as effectively. That’s a problem if you’re not valuing infrastructure credit on your books fairly to the market.”

An assessment of private debt ratings using InfraMetrics® classifications compared against public credit ratings (such as S&P) for the same issuing entities where both private and public instruments exist, shows a consistent alignment over time.

On average, 13 per cent of private debt instruments classified as investment-grade by public agencies were assigned a non-investment-grade label by InfraMetrics® over the past five years.

Notably, in 2023 and 2024, alignment between the two rating approaches reached 100 per cent, coinciding with an observed decline in overall credit risk following the pandemic period.

A heterogeneous asset class

Between 2019 and 2023, the average one-year probability of default (PD) for infrastructure debt declined, stabilising around 1 to 1.3 per cent, while recovery rates have consistently remained above 75 per cent, according to SIPA. Yields are attractive at 4-5 per cent compared to riskier private infrastructure equity at 6-8 per cent.

But the distribution of risk is lumpy depending on lifecycle, leverage, and sector, according to Riazul Islam, senior quantitative researcher at SIPA.

“Assessing infrastructure credit risk requires a granular and forward-looking approach that captures both project-specific characteristics and broader macroeconomic conditions. The InfraMetrics® model incorporates time-varying factors such as the debt service coverage ratio (DSCR), leverage, cash flow available for debt service (CFADS), firm age, and benchmark interest rates (e.g., the risk-free rate). These inputs allow for dynamic recalibration of credit risk as both firm-level fundamentals and external environments evolve. This factor-based framework enables nuanced, data-driven evaluation of creditworthiness and supports informed decisions on restructuring scenarios or credit classification adjustments over time.”

Globally, energy and water resources have shown the highest average probability of default, reflecting commodity cycles, resource constraints, and higher operational volatility (1.91 per cent), while network utilities with monopoly-like models posted the lowest (0.19 per cent).

Young firms (0-5 years) were most vulnerable, with default probabilities around 1.8 per cent – often due to construction risks and lack of operational history – with mature stage firms dropping to just 0.6 per cent.

Accurate data is the key to finding new investment opportunities, accurately valuing existing investments, and to underpin capital market assumptions, Islam says.

“Infrastructure debt can be managed not as an illiquid, opaque niche, but as a mainstream credit allocation with measurable risk and return characteristics.”

More granular, project-level data is allowing investors to distinguish between fundamentally different sources of risk across lifecycle stages, sectors and capital structures, rather than treating infrastructure debt as a homogenous allocation.

Defence was once treated by many asset owners as a near-automatic exclusion but the sector’s resurgence since Russia’s full-scale invasion of Ukraine in 2022 has exposed a blunt reality for fiduciaries: the harder the screen, the greater the risk of missing returns.

Defence companies are only about 2.5 per cent of the MSCI World index, yet performance has been hard to ignore. The MSCI Aerospace & Defence index surged 49.25 per cent in the year to November 28, 2025 as the Russia-Ukraine war and a less reliable US ally prompted a surge in investment across the sector.

“There’s a slow acceptance – an openness now for everyone to allow them back in your portfolio,” says Aston Chan, chief investment officer, head of investment solutions at sustainability investment solutions and data provider Impact Cubed, which has been advising asset owners on the issue.

“It’s no longer Europe versus Russia. It has become Europe versus Russia without having the US as a reliable partner.”

Yet investing in the sector is anything but straightforward. Depending on cultural norms, geography and interpretations of fiduciary duty, one asset owner may frame defence investments as protecting democracy, while another sees it as a reputational risk amid accusations of profiteering from war.

Nordic investors embrace ‘total defence’ and revisit exclusions

Asset owners closest to the Russia conflict have been amongst the quickest to change their approach to investing in the defence sector. Their longstanding proximity to the Russian border has created the Nordic concept of “total defence” or “comprehensive security”.

It refers to a whole-of-society resilience mindset across military defence, civil preparedness, supply chains, cyber, information security and critical infrastructure.

Earlier this year, the €65.7 billion ($77.1 billion) Ilmarinen Mutual Pension – based in Finland which shares a 1300-plus kilometre border with Russia – incorporated this approach in revised principles for responsible investment.

“When the illegal invasion of Russia to Ukraine happened in 2022 we saw this geopolitical change and started to analyse what it means,” Karoliina Lindroos, head of responsible investments, Ilmarinen Mutual Pension, said at the Fiduciary Investors Symposium at the University of Oxford.

Its previous policy excluded many “dual use” companies that didn’t operate purely in the defence sector. For example, Finnish satellite-imagery company ICEYE initially began commercialising synthetic aperture radar (SAR) imagery to monitor hazardous Arctic conditions, but in 2022 began providing Ukraine with access to its capabilities.

Funds with a hard-line exclusion on defence can miss out on a key source of innovation outside of the much-heralded tech sector and with it, potentially higher returns as new technology diffuses across the economy.

“We thought that this type of binary policy may not serve us as well as it served us in the past, and we need more nuance. But at the same time, we needed to find the balance… could we get exposure to defence sector companies but at the same time, how do we consider the human rights risks that are inherently present in this sector?”

The fund now has a more flexible approach – with enhanced oversight – including the ability to invest in companies that manufacture “controversial weapons” if they are headquartered in NATO countries. The €66.7 billion ($78.3 billion) Finnish pension fund Varma also made a similar change regarding potential investments in controversial weapons.

It is one of the most common changes and largely focused on companies involved in the nuclear sector, according to Impact Cubed’s Chan, as opposed to companies making weapons banned under common international treaties such as anti-personnel landmines, cluster munitions, chemical weapons or biological weapons.

“In my experience, it’s largely cultural,” Chan says.

“A number of asset owners in France have excluded alcohol, but not nuclear weapons, and that’s saying something in a place that produces great wine. The French asset owners as a group never have – and in my opinion probably never will – consider nuclear controversial. Germany does. So depending on when my train crosses the border, the mandate changes.”

Israel–Palestine pushes screens in the opposite direction

But even as the Russia-Ukraine conflict has opened the door for a more inclusive approach to defence companies, the Israel-Palestine conflict has placed pressure in the opposite direction, with more investors taking a hard-line.

The Israel-Palestine conflict was a key driver behind the Avon Pension Fund’s recent re-evaluation of its defence sector investments – a hotbed issue among its members who tend to work at local unitary councils, universities, academies, town and parish councils, housing associations and charities.

Committee members of the £6 billion ($8 billion) local government scheme voted 8 to 2 in favour of the approach after a months-long member consultation led to a formal member survey. The result was lineball, with 42 per cent supporting divestment, 47 per cent favouring remaining invested, and 11 per cent unsure.

After the meeting, councillor Toby Simon – who also serves as chair of the Avon Pension Fund Committee – said committee members recognised it was a difficult and sensitive issue.

“The fund takes all member views seriously and, in reaching a decision, the committee has balanced those views with its wider fiduciary duty, legal advice, financial considerations, and the wider regulatory context with the evolution of pooling,” he said of the decision by the fund, which is one of ten within the Brunel Pension Partnership.

The Israel-Palestine conflict similarly prompted a defence sector review by the Sydney University of its endowment’s investments following campus protests related to the Middle East conflict. Unlike the Avon Pension Fund, Sydney University announced in November 2025 that it would divest from the sector in principle.

Norway’s NOK 878 billion ($87 billion) Kommunal Landspensjonskasse (KLP) – which serves employees at local municipalities and workers at health enterprises – in June excluded US industrials group Oshkosh Corporation and Germany’s ThyssenKrupp for selling weapons including armoured personnel carriers, warships and submarines to the Israeli military.

Karolina Malisauskaite, analyst – responsible investments, at Norway’s KLP said the exclusion was made under its existing criteria which prevents investments in companies that sell weapons to countries in conflict where there is a high risk of the end user violating international humanitarian law.

“In June, a UN special group of experts that were working came up with a press release listing companies that were involved in selling weapons to Israel, and there was documented evidence that those weapons were used in Gaza,” she said at the Fiduciary Investors Symposium at the University of Oxford.

“They came out saying companies selling weapons to Israel are risking being complicit in the war crimes and human rights violations.”

It raises another key risk for investors in the sector: defence companies largely have one customer – government – and they cannot control how any state ultimately deploys its weapons. When those systems are implicated in a conflict zone, the reputational fallout can quickly rebound on the fund.

When returns meet responsibility: the case for defence in a democracy

While the humanitarian aspect of war, and the close relationship that defence companies play, cannot be underestimated. the fiduciary rationale to invest in the high-performing defence sector is a drive underpinned by legislation in many countries.

“The main thing for the last 15 years is that nothing has performed better than tech,” Chan says. “But now, in the last year, I would say that the only thing that’s performed comparably or even better than tech in some places, is defence stocks.

“So if you were sitting on an investment committee in Europe and said, ‘We’re not touching the best performing assets,’ that’s an increasingly difficult position to defend, and opens you up to tough questions around societal resilience and fiduciary responsibility.”

In addition, aerospace and defence shares typically exhibit low correlation with the broader business cycle, meaning their exclusion would marginally increase overall equity risk, according to a paper prepared by the Avon Pension Fund. Unlike fossil fuel producers, defence companies do not face the same long-term risk of assets becoming “stranded” as economies decarbonise.

An increasing number of European asset owners are pairing this investment case with a broader social purpose. Some argue ESG can only be underpinned by democracy itself – and investments in the defence sector as part of protecting it.

Danish pension funds AkademikerPension, PensionDanmark and AP Pension joined forces in December 2025 to back ETNA, a newly formed defence-focused private markets fund. They framed the move as an act of social responsibility in the current security climate and an opportunity to deliver strong long-term returns for members.

Rikke Berg Jacobsen, head of ESG at AkademikerPension, said the decision followed an earlier softening of its approach to companies associated with European nuclear weapons programs (although ETNA cannot invest in nuclear weapons).

“We consider it our societal responsibility to provide capital support for the rebuilding of Danish and European defence,” she told Top1000funds.

“We can fulfil this responsibility in several ways. For example, we can invest in the large publicly listed dual-use and defence companies (the policy change created greater scope for doing so), we can support the Danish defence directly through public–private partnerships and we can invest in smaller, non-listed defence and resilience companies.

“It is in relation to the latter that ETNA is focused and given the rapid technological development within the defence sector, we actually believe this is where our members’ capital can have the greatest impact per krone invested.”

ETNA will focus on buyout and growth equity investments in European SMEs that contribute to strengthening Europe’s defence capabilities and resilience. Several other fund managers have explored launching defence-focused funds, particularly in defence-related infrastructure which does not attract as much risk of reputational damage for asset owners.

The investment opportunities are only likely to increase after NATO’s recent commitment to invest 5 per cent of Gross Domestic Product (GDP) annually on core defence requirements and defence- and security-related spending by 2035.

But as NATO members rearm and private capital is invited in, asset owners will be judged not just on whether they invest, but on how: the conditions they set, the transparency they demand, and the boundaries they are willing to defend – to members, regulators and themselves.

Alaska Permanent Fund Corporation (APFC), the sovereign wealth fund set up in 1977 to channel state royalties earned from the mining and oil industries into financial investments for future generations, has one-fifth of its $89 billion portfolio in private equity.

For the last 15 years, the fund has steadily pushed into private markets of which private equity is now central to its long-term growth and diversification. Yet Allen Waldrop, deputy chief investment officer, private markets, tells Top1000funds the current 18 per cent target allocation and annual deployment of $1.5 billion is likely to edge down in the next cycle given the size of APFC’s allocation to private markets.

Still, any significant move will be complicated by the fact that moving in and out of private markets is challenging.

Extracting from legacy GPs

Although APFC only actively invests with around 50 GPs across private equity and venture, the fund still has over 125 managers on the books. That includes GPs APFC has decided it is not going to re-invest with but which still run legacy funds committed to back in 2010 or 2015, explains Waldrop, speaking from Sacramento, where he oversees a team of six based in Anchorage, Juneau and Boston.

“We have managers that we have stopped investing with, but they don’t go away. There is legacy stuff hanging on in the portfolio. It’s hard to get them off the books.”

Old investments made in funds years ago contribute to unrealised gains. Of APFC’s $11 billion in unrealised gains reported in 2023, almost $6.3 billion (57 per cent) was from the private equity portfolio.

These funds also have a long life, and are still captured in the manager count, because GPs now extend the life span of funds through continuation vehicles. Managers have become frequent users of CVs given the challenges around traditional exits like IPOs or M&A, and CVs, explains Waldrop, allow managers to create a separate entity that they can sell and bring in third-party investors.

“CVs are not inherently good or bad – they can be useful tools in the right situation. But they can also be abused and used for the wrong reasons which means we have to look closely at what the manager is actually doing,” says Waldrop who brackets CVs with other criteria in fund documents like NAV loans that have also crept into the small print and are now commonplace.

“A fund might have borrowed in the past via subscription lines, but they are now borrowing money against the existing portfolio in a NAV loan with longer terms. Most agreements hadn’t contemplated this ten years ago,” he says.

A way out via the secondaries

APFC is prepared to sell in the secondaries market rather than invest in a continuation vehicle. Although Waldrop says he uses the secondaries market to trim the portfolio or raise cash, it’s not his preferred approach.

“We aren’t active sellers in the secondary market in terms of using it as a tool to manage the portfolio. But when we are presented with an opportunity to roll our interest in a continuation vehicle or take liquidity, we tend to take liquidity. We will only roll or invest after looking at what the transaction is, who the manager is and whether we like the company. We’ve taken opportunities to get liquidity through secondaries, but we are not really active sellers or buyers.”

He is even less enthusiastic about buying in the secondaries.

The abundance of capital in the market, and the presence of investors able to draw on tools APFC doesn’t have, like leverage or the ability to fashion highly structured transactions with deferred payments that ensure a particular return at a higher price, put APFC out of the bidding.

“We have a high return expectation for secondaries, and our cost of capital is different,” he says.

The arrival of interval funds with periodic liquidity, active buyers in the secondaries off the back of retail investors arriving in the space, is another reason to be wary.

“We’ve noticed the advent of interval funds that are aggressively buying secondaries.”

Managing the managers

Stuck with a large stable of managers, APFC evaluates its managers by rating them according to different categories in a focused strategy that Waldrop says prioritises the best.

“Good terms don’t save you from a bad investment. Our approach is to get in with the best managers – and then get the best terms we can.”

It’s an approach that APFC has particularly honed in venture where a wholly opportunistic strategy is shaped around openings with the best managers rather than trying to fill an allocation.

“We have some great managers in the portfolio now. If we can expand it we will, but we will only do it if we can access the best managers. We don’t see a need to just put money into venture.”

He believes writing smaller cheques in private equity also helps drive outperformance in an environment where fund sizes are creeping ever higher. Not so long ago, a $500 million fund was considered large. Now fund sizes stretch to $25-billion plus.

“Once fund sizes go beyond $15 billion it can be more difficult to outperform,” he says.

Writing smaller cheques also keeps investments simpler and more transparent given the many components that now characterise large funds.

“Generally speaking, we don’t need to make really large commitments so we can be more selective and find managers in the lower and mid-market that will outperform and who we can invest with on their third, fourth and fifth fund.”

Even though APFC avoids the competition of mega funds by carving a niche lower down the rung, he says competition to invest with the best managers remains fierce because the best GPs remain over-subscribed.

“There are numerous cases where we are targeting over-subscribed funds and trying to get a reasonable allocation. Those folks can drive terms,” he says, adding that fees haven’t moved in favour of LPs. Sure, there has been a slight decrease in management fees and other things that count as expenses, but only around the edges.

Private equity doesn’t allocate based on what is happening today

Another inherent challenge of the allocation is the fact that commitments are sometimes made long before the money is put to work. It means that the investment landscape has often changed by the time the money is finally drawn down.

It’s encapsulated in the shift in sentiment in the European buyout portfolio, for example. APFC focuses on mid-market and lower mid-market buyout opportunities in European growth equity where private equity funds poured targeting European companies on the basis they would expand into the US or Asia. Only that growth trajectory for these companies has changed because of de-globalisation.

“Tariffs make expanding into the US more complicated for European companies, which can no longer rely on expansion into China and other Asian markets either. It’s also one of the effects of deglobalization. Companies are having to rethink the landscape, and we are seeing more companies expand to be pan-European or regional,” he concludes.

The board of CalPERS has approved a momentous structural change that gives the $556 billion fund a single reference portfolio for judging performance, delegated authority to investment staff to construct the portfolio, and a simplified measure of success.

The fund’s chief investment officer, Stephen Gilmore, has been behind the fund’s shift to this approach which he says can add 50 to 60 basis points to portfolio returns.

In a long and detailed interview, Top1000funds.com editor Amanda White spoke to Gilmore about how a TPA mindset can add value, simplify accountability and open new opportunities for investments.

For the related and detailed story on the fund’s approach click on this story

How CalPERS aims to add 50-60 bps using TPA