Despite concerns about the US sustaining its economic growth and stock market returns, global investors continue to pour money into the world’s largest economy.  

Foreign capital now accounts for some 40 per cent of all investments into US equities, Temasek CEO Dilhan Pillay told a Bloomberg conference in Singapore last week, underscoring foreign investors’ enduring confidence in US outperformance. 

“The question I think we grapple with is, where do we rotate our capital into?” Pillay said. 

“The choice in the US is one thing, but the choice outside of the US is even worse to some extent in terms of volume and your investable space. 

“If you look at the promising markets in terms of equity performance… you look at India, you look at China, look at Europe in the last 12 months or so, the absorption capacity [for capital] is not there for rotation out [of the US] in significant levels.” 

When choices for geographical diversification are limited, Pillay said investors look at rotating into alternative asset classes, which come with currency risk considerations  

He said Temasek was looking to introduce more uncorrelated returns to equities and will increase its allocation to core-plus infrastructure as a result. Temasek does not allocate to fixed income or commodities, which might be used by other investors to achieve the same goal. These assets were likely to still be US dollar-denominated, however. 

As a result, the weakness in the US dollar becomes a huge problem for a non-US dollar-denominated investor because it eats into returns, Pillay said.  

The ICE dollar index, which measures the US dollar’s strength against a basket of six other currencies including the Euro, Japanese yen and the British pound, has dropped 8.5 per cent since the beginning of this year.  

“I’ll just give you one statistic: between 2002 and 2012, if you were Singaporean and invested US stocks, the S&P went up 30 per cent and the US dollar depreciated against the Sing[apore] dollar by 33 per cent, so you have minus 15 per cent in your returns,” he said. 

Hedging costs have also risen as that’s what the majority of foreign investors outside of the US now have to do, Pillay said. It’s come to the point where the fund has to look for a “natural hedge”.  

“It means I’ve got to be looking for things that give me, on a net basis, the return I expect for the risk associated. So some US dollar-denominated assets will not give me a net return that will justify my allocation of capital,” he said. Around 37 per cent of Temasek’s assets is US dollar-denominated according to its annual disclosures.  

But neither Pillay nor Singapore’s other sovereign giant GIC believe the US dollar’s status is being fundamentally challenged. GIC chief executive Lim Chow Kiat said at the same conference that a scenario of complete de-dollarisation whereby the US dollar ceases to be the reserve currency is unlikely to happen. 

“We don’t see that. There aren’t clear alternatives [to the US dollar],” Lim said. 

“If you have a very high exposure to a particular currency or country adjusting it down 10 per cent is not unusual. 

“I would say that there are enough levers for investors and other participants to adjust their [currency] position without causing a big problem.” 

Both funds are still deeply committed to the US market. This July, Temasek chief investment officer Rohit Sipahimalani reiterated the fund plans to invest an additional $30 billion in the US before 2030 and said it is “well ahead of that pace”.  

Similarly GIC boosted its US equities allocation in the year to March 2025 despite reservations around high valuations and the ability for companies to meet earnings expectations. The country remains the biggest recipient of its capital.  

“US exceptionalism, for the time being, doesn’t look as though it’s going to be at risk,” Temasek’s Pillay said. “But you do have things that could cause a little bit of fraying.” 

“It might be that the structural issues we face in the United States are issues that have to be thought about in your risk analysis, but the rotation [of capital out of the country] is not easy, and that’s the reality.” 

An alternative, more technical, title for this thought piece would be ‘risk has an upward-sloping term premium’. We will argue that the future is riskier not (only) because it is uncertain, but because the quantum of risk increases with time. We start by asserting that the future is unknowable [1].

Talking about the term premium of risk will therefore be tricky. Risk 1.0 gets around the problem by assuming an unchanging world so that, in each future period, we will get a new pick from the same underlying distribution. In this framing, risk does not have a term structure or, at least, not one of any interest. Once we ‘know’ (have made our assumption about) the distribution, risk through time is easy to derive mathematically. We could then push harder and talk about ‘time diversification’, which is spreading our risk budget more evenly across our investing lifetime. If there is no term structure to risk, this makes perfect sense.

Risk 2.0 assumes a complex adaptive system, and therefore we know that the underlying distribution is changing and will continue to change. Therefore, if we use a risk 1.0 model, we should introduce error bands around the output to reflect the mismatch between the assumed distribution and reality. The further into the future we wish to make projections, the wider these error bands should be, as there is more time for reality to diverge from the starting assumptions. It is also important to recognise that the increased uncertainty around the shape of the distribution as the projection horizon increases is additional to, and different from, the “widening funnel of doubt” (which is generated by “known” parameters and is part of the risk 1.0 mindset).

In addition, a complex adaptive system will exhibit ‘path dependency’. The state it goes to in the next time step is not a random and independent pick from the distribution, as per risk 1.0. Instead, the pick is from a constrained subset of the distribution, because the next possible state is dependent on the path taken through the previous states.

Now this could be interpreted as increasing the accuracy of our risk forecasting (reducing the variance of possible outcomes in the next period). However, first, we would need to be confident in our ability to determine the strength of the path dependency and to isolate the appropriate subset. And, second, we would need to be confident that the system was not about to enter a phase transition [2] and jump to another new distribution.

Finally, the transition probabilities themselves are dependent on the previous path of the system (not just the current state) and as the projection horizon increases the number of potential paths increases and therefore the degree of predictability of the system decreases. On balance, we would suggest that a further widening of the error bands is probably appropriate.

What we can know about the future

We know that systems grow in size and/or complexity unless actively constrained [3]. Bigger and more complex systems require greater amounts of energy and resources for information processing, maintenance and growth. They are also more likely to exceed carrying capacity thresholds, making them unsustainable over the longer term. In short, systemic risk rises as systems get bigger – particularly so when the system approaches resource or energy limits.

We also know that almost all politicians are committed to finding policies to promote economic growth. And we know that asset prices are underpinned by an assumption of continued growth. We further know that we face a number of problems that could affect future growth prospects:

  • Falling fertility rates
  • Toxicity
  • Deforestation
  • Biodiversity loss
  • Climate change
  • Planetary boundaries
  • Carrying capacity.

So, if growth continues into the future, we can posit that systemic risk will rise exponentially alongside it. If growth stops (or at least slows significantly), we should expect a downward repricing of risky assets. In either case, therefore, we can expect an upward-sloping term structure for risk. Risk in the future is very likely to be higher than it is today.

Investment time horizon

The extent to which a rising term structure for risk matters will depend on the investment time horizon. The longer the horizon, the more it matters. This is partly due to the upward slope, and partly due to the higher chance of occurrence (noting that these are not independent). To illustrate, consider a 20-year-old starting a defined contribution pension account. The ‘pensions deal’, historically, has been to double the real purchasing power of contributions. Early contributions are small and late contributions tend to be large, so the average contribution is invested for about 20 years, and we can double it if we earn an average annual return of 3.5% above inflation. But note that we need to earn that return for 40 years, over the whole period of contributions.

Now, a doubling through investment returns implies a close-to-doubling in the size of the economy [4]. And we need to do this twice for the 20-year-old’s investment journey [5]. So, by the year 2065, we would need a global economy 3- to 3.5-times bigger than our current economy. If our current size of economy has produced the list of issues noted above, and breached 7 of the 9 planetary boundaries, how likely is it that we can continue to grow without triggering systemic risk? We are back to the unknowability of the future (in terms of details, timings and possible surprises).

What we have sought to do here is to set the global economy within and dependent on functioning planetary systems, and to explore the need for investment returns, the dependence on growth to achieve them, and the limits to growth on a finite planet. It is our conclusion that the term structure of risk is upward sloping into the future.

Tim Hodgson is co-founder and head of research of the Thinking Ahead Institute at WTW, an innovation network of asset owners and asset managers committed to mobilising capital for a sustainable future.

[1] The technical description would be ‘radical uncertainty’, a term popularised by John Kay and Mervyn King in their 2020 book Radical Uncertainty: Decision-Making for an Unknowable Future. Radical uncertainty differs from Knightian uncertainty as it is unresolvable – no amount of new information makes the uncertainty go away

[2] An alternative term is ‘punctuated equilibria’, yet another characteristic of complex adaptive systems. A ‘Minsky moment’ is a prime example of a phase transition / punctuated equilibrium

[3] See Systemic risk | deepening our understanding, Thinking Ahead Institute, July 2023

[4] From Thomas Piketty’s Capital in the Twenty-First Century, 2013, we learn that investment returns (r) are higher than economic growth (g), so the economy does not need to double to support a doubling in investment value

[5] More likely three times, as the trend is to maintain a reasonable weighting in growth assets during the retirement phase

CalPERS made history last week after it became the first US pension fund to adopt a total portfolio approach (TPA). The change, approved by the board after months of internal deliberation, is another mark of chief investment officer Stephen Gilmore, who before joining CalPERS was the investment head at NZ Super – one of the most prominent TPA adopters alongside Canada’s CPP Investments and Australia’s Future Fund.

Yet some US public pension funds doubt if yet another acronym to label something they should already be doing is entirely necessary. Like Ben Cotton, chief investment officer of $80 billion Pennsylvania Public School Employees Retirement System, founded in 1917 and one of America’s oldest pension funds.

“It’s interesting that we need a new acronym to help us focus on what should be common sense,” Cotton tells Top1000funds.com in an interview from PSERS’ Harrisburg office. He joined the fund in 2023 from overseeing retirement benefits in the motor industry, recruited as a safe and experienced pair of hands to shore up internal controls and governance after PSERS had reported an inflated investment performance in 2021.

“A lot of allocators have made the mistake of being too siloed and segmented, whereby rather than make decisions in the context of what is best for the whole portfolio, they make decisions focusing more on each different allocation. I have tried to approach investments more holistically my whole career, and adding an acronym doesn’t make it a new strategy.”

Cotton views TPA as allocating in accordance with the opportunities in front of him, and says PSERS has allocation targets with embedded leeway that already allow a conscious decision to overweight or underweight. Moreover, the board have always delegated to the investment team on rebalancing decisions and asset allocation adjustments within the context of the strategic asset allocation.

“We [always] ask ourselves if we are making decisions that complement the whole portfolio or if we are making decisions that just maximise a silo in isolation. The former is the better way to go,” he says.

PSERS is close to its target asset allocation, apart from a slight overweight to cash and underweight to long-duration fixed income. Positioning away from the long-term strategic asset allocation requires high conviction and in today’s climate, he argues that conviction is thin on the ground. “You need a high conviction to stray off your long-term plan, so in the current environment we’ve got closer to our targets as a result.”

He points to the recent decision to axe PSERS’ remaining 5 per cent allocation to leverage as a typical example of the investment team’s ability to adjust to an ever-evolving market environment.

“When cash is close to zero and the cost of leverage is zero, over the long run the risk premium you pick up with a modest amount of leverage is additive. But once you hit the point where the cost of leverage is as high as the risk premium you pick up, it starts to introduce undue uncertainty, not only in return expectations, but also liquidity needs.”

The decision to drop the hedging strategy also shows Cotton’s holistic approach in action.

For the last 14 years, PSERS has hedged around 70 per cent of its FX exposure to developed markets in a “winning” trade that has both reduced volatility in the portfolio and enhanced returns. But the Trump administration’s reshoring policies have turned the tide on the strategy: a cheaper dollar, he explains, makes it easier to onshore assets and ensure goods made locally in the US are more competitive with those from abroad. “On balance, we decided we’d rather not have that currency hedge,” he reflects.

He adds that removing the currency hedge has not increased volatility in the equity portfolio and is a strategy other funds are now also adopting. “Most of our peers in the public space were not hedging to start with, and of the few who did, we know of one that recently went to zero just prior to us.”

The value of liquidity at the fund, which is only 64 per cent funded, has also informed his decision to axe the strategy.

Paying out on hedges and settling on derivative positions should the currency move the wrong way requires cash and creates transaction costs, he explains. “In a period when we are concerned about our liquidity profile, we want to keep surprises at bay.”

It leads him to reflect how the funded status informs other decision-making too – namely forcing a level of risk and a larger appetite and tolerance of uncertainty. A strong funded ratio gives investors more freedom in how they approach the market, but pension funds with large deficits are compelled to take a minimum level of risk.

“Our funded ratio limits our options and opportunity to de-risk in light of uncertainty because de-risking exposes us to inflation at the same time as we are paying out cash to meet our liabilities,” he explains.

Keeping private markets within target

Liquidity has also played into Cotton’s firm cap on PSERS’ 30 per cent allocation to private markets which he says would have ballooned overweight if historical pacing models had been maintained.

The allocation, comprising private equity, real estate and infrastructure, was 8 per cent overweight when he joined but moderating pacing, combined with a more selective manager approach and selling off older assets, has kept the allocation in check.

“If we had blindly followed our pacing model in private markets based on historical experience, we would be significantly overallocated,” he says, adding that the team also struck it lucky when it came to re-investing money garnered from selling private assets in the secondary market.

“We sold certain private assets into the secondary market on average close to par and at a good clearing price. It helped us beef up liquidity and freshen our private markets book. We were also able to reinvest the proceeds into the April drawdown, so when we put the money back in the market, it was a fortunate time to be deploying into equity markets.”

Although private markets account for an ever-increasing portion of the investable market, his outlook for alternatives remains cautious because of the cost of capital and stop-start distributions. “The cost of capital is much higher, so to make it work, investors want to buy private assets at a lower price. We are seeing things improve, but distributions are still challenged, and activity is a lot slower than historically.”

He is also mindful of fees – even though PSERS rarely pays 2:20. “Our fee load is closer to 1:11 across private markets. This is not just because we are strong negotiators but mostly because we take advantage of our scale and lean into relationships.”

Rebuilding the trust

Rebuilding the trust and connection between PSERS’ investment staff and the board has been a key focus since he joined.

His efforts have focused on increasing transparency and reporting, particularly around investment management fees, and improving the context in which the investment team provide information to the board. Cotton says that information in and of itself does not amount to transparency – information needs to be presented to the board in context.

“It’s about providing the information that helps answer [their] questions.”

In a benefit that now reverberates throughout the entire fund, trustees have begun to delegate decisions to the investment team, increasing efficiency.

“Up until recently, we had to bring approval for every GP commitment to the board, even when we were re-committing to long-term relationships. Now our policy provides for delegation approval for mandating certain existing relationships to the investment team, and it has started helping us be more efficient on investment decisions,” he says.

Asset owners are witnessing a sea-change in data management and analytics as artificial intelligence opens doors to more efficient processing of investment information. But despite the promise, some may be wary of experimenting with the new technology due to the potentially negative consequences of failures on budget and culture.  

This tension was recently explored at the Top1000funds.com Fiduciary Investors Symposium. Jon Webster, senior managing director and chief operating officer at the C$777 billion ($554 billion) CPP Investments encouraged his allocator peers to first shift their mindset to one of “continuous exploration” when it comes to AI.  

He challenged the view that AI experimentation is inherently expensive to implement, at least for an organisation of the size of CPP Investments. It subscribes to the enterprise version of ChatGPT and uses DealCloud as its CRM software, whose combined fee is less than C$5 million a year against a C$2 billion annual operating budget and a C$10.5 billion investment budget.  

“I don’t think you should be afraid of the cost aspect of it. In fact, I’d lean very heavily into that,” Webster told the Fiduciary Investors Symposium at Oxford University.  

“To the experimentation point, it’s not that you should experiment. You literally have no choice but to experiment, because what the models can do tomorrow is just not the same as they were able to do yesterday.” 

To understand what AI can do for a fund, one needs to first understand what constraints it will remove, Webster said. He proposes that an organisation which is formed around investing is essentially “an information-processing supply chain” – it takes structured and unstructured data and turns them into investing ideas. 

The limitations, in turn, are “scarcity of expertise”, “high degrees of specialisation”, and “limited information processing capacity”, which is an intrinsic part of being a human.  

“Lots of those constraints are about what we prize deeply, as in ourselves, our own intelligence,” he said. 

“The thing we’re looking at inside CPP Investments is, how will our organisation get changed by this [technology]? How will work legitimately get redesigned? And are the constraints around which our organisational structure was formed, as valid as they were?” 

The C$26 billion ($18.5 billion) OPTrust has also been on a journey in the past six years to more comprehensively implement AI in its investment process. It started with using AI to determine risk on/off positions but now has a regime model of four macro quadrants upon which it makes asset rotation decisions, thanks to more accuracy in risk factor predictions enabled by large language models.  

“I don’t think we think about it from a perspective of, because this is a new technology, we have to chase it,” said Jacky Chen, managing director of completion portfolio strategies, total portfolio management at OPTrust.  

“It’s a very natural progression that as we think about our investment approach, we naturally gravitate ourselves towards that kind of decision making.” 

The most important principle of AI implementation at OPTrust is that a “human is always in the loop”, Chen said, but he acknowledged that the technology becoming a more prominent part of the investment process means portfolio managers also need to change their old behaviours.  

“As an example, when AI doesn’t know what to do when you ask it to build a risk indicator, it will immediately assume that risk equals to 0.5 times the fear index plus 0.5 times maybe the gold price. And they draw this beautiful chart,” Chen said. 

“[But] would you be able to make decisions on that? I think the traditional, more fundamental managers need to start understanding how to vet that and look into that [underlying model].” 

Conversely, quant portfolio managers need to be more market-driven, instead of treating market events as “noise” and focusing purely on their data sets as they traditionally have been.  

“The cycle is moving way faster now. If you don’t do that, you’re not able to very effectively manage your model,” Chen said. 

CPP Investments’ Webster said for asset owners, using AI is not about making faster but better investment decisions, “unless fast is your competitive edge”. 

“For many of us, it isn’t,” he said. 

“You’ve got to do something different with the technology, otherwise, it’s all a bit pointless.” 

Despite headlines of exponential escalation in the cyber attacks on governments and corporations, an expert says the core threats have remained largely unchanged in the past decade with only subtle shifts emerging today.  

Speaking at the Fiduciary Investors Symposium, former founding chief executive of the UK government’s National Cyber Security Centre, Ciaran Martin, said Western economies still persistently face the four types of cyber threat they’ve been dealing with for a long time: espionage from China; disruption from Russia; hacktivism from Iran; and political interference from North Korea.  

“The cyber security industry loves to say the threats are going up exponentially, and hackers are getting increasingly sophisticated and so forth. We say that all the time, every day, it’s not essentially true,” said Martin, who is now professor of practice in the management of public organisations at the Blavatnik School of Government, University of Oxford. 

What changed is these attacks’ efficacy and their ability to “inflict pain” on corporate or state victims. 

“[For example], the North Koreans have become very sophisticated cyber criminals… they account for a large part of the 20 per cent of unrecovered crypto heists,” he said.  

“They’ve stolen $3 billion this year alone, mostly from bridges because they’re innovating. That’s how they get past sanctions, and they’re very good at cashing it out before it can be traced and recovered.” 

Cyber criminals have also become better at squeezing companies to maximise disruption. Martin recalled the Jaguar Land Rover cyber attack in the UK in August, which forced the car manufacturer to cease all production for weeks and order staff to stay at home.  

The nation’s Cyber Monitoring Centre estimated that the incident led to a £1.9 billion ($2.5 billion) financial hit to the British economy. 

“They [the cyber criminals] really know how to inflict pain,” Martin said. 

“AI has not transformed cyber threats, not yet, and maybe it won’t. But it’s making it a bit cheaper and a bit more efficient to be a cyber criminal… the business model of criminals has got really good and that’s very worrying.” 

For financial institutions, there are three cyber security considerations to keep in mind: newer forms of assets such as crypto tend to be more vulnerable than traditional finance such as banking; sensitive information in the sector has more value and is therefore more monetisable; and the disruption of services to clients or transactions can carry greater consequences.  

Financial institutions can manage these risks by getting better at determining which types of data breaches matter the most.  

“At the moment, in terms of the way public policy is framed and the way public discourse is framed, it’s just ‘here’s a large number of data breaches’, whereas actually it’s just your name and your email,” Martin said. 

“If you go to the General Counsel and ask what’s our legal obligations, there’s only one: personal customer data. So if you take a legalistic approach to what your duties are, you’ll prioritise personal data.” 

While cyber attacks have rarely directly resulted in the loss of human lives, there are cases where that is a very plausible outcome. The Five Eyes – an intelligence alliance consisting of Australia, Canada, New Zealand, the UK and the US – has warned that the Chinese government has infiltrated critical infrastructure which could be used to their advantage if there is a significant escalation of tensions, Martin said. 

Martin also rejected suggestions that the superior power of quantum computing will dismantle cryptography as society knows it.  

But the risk lies in considerations such as which country gets there first – getting to that point three or five years ahead of international competitors would give a country a great advantage geopolitically. 

“It’s almost mathematically and engineeringly impossible to have something that can just break all of the modern cryptography and RSA algorithms without being able to write similar things that are equally secure,” he said.  

“There’s a lot of work in secret about quantum-resistant cryptography, and there has been for many, many years. Most people would say that when the quantum world comes in with this mind-boggling ability to calculate at scale, the security will be there.” 

Asset allocators are seeking new ways to optimise portfolios beyond using the historic mean variance tools in the face of higher and more volatile inflation expectations.  

At the Fiduciary Investors Symposium at Oxford University, a panel of top UK and US fund investment heads said breaking away from established practices – such as moving from strategic asset allocation to a total portfolio approach – is often a challenging task, but a new context demands modern investment frameworks.  

Elizabeth Fernando, chief investment officer of the £55 billion NEST said investors haven’t invested in an environment of high inflation, interest rates and bond yields for a long time.  

“One of the things that worries me is – if we’re building portfolios using historic mean variance optimisation tools – we’re in a very different regime to the one we’ve been in for the last 20 years,” she told the symposium.  

“If you’re relying on backwards-looking models, I would be concerned that you’re anchoring to the wrong things.” 

NEST, which is the biggest defined contribution fund in the UK, instead employs a form of TPA through which it looks for “incremental assets” that can improve the probability of meeting its various portfolio-level objectives. 

“What matters in terms of risk is very different between those, so it brings a very nice clarity to your decision making – it becomes very obvious when something no longer fits there,” Fernando said. 

“[It also helps with] decisions that previously would have been quite difficult to make because it’s risky against an SAA or reference portfolio.” 

Joe McDonnell, chief investment officer of Border to Coast, which is one of the Local Government Pension Scheme pools, said if forward-looking inflation leans towards the higher end of 3 per cent rather than 2 per cent, then investors would have a significant problem.  

“If you have 3 per cent inflation, there is one asset class that will save you and that’s commodities – nothing else does. Commodities is a difficult asset class for most of the asset owners, and I don’t see them holding 15 to 20 per cent in commodities,” he said.  

McDonnell suggested that asset allocators examine the level of inflation beta they have in their portfolios.  

“What you really want is an asset class that actually ticks along quite nicely, but if there is an inflation problem, it has a positive beta around that,” he said.  

“If we do have a 3 per cent [inflation], the correlation benefits or diversification benefits of bonds/equities breaks down, and does not recover. If you don’t hold a broad set of commodities, you have a problem, which means the majority of us will have a problem. So we need inflation controlled.” 

David Veal, chief investment officer of the Employees Retirement System of Texas echoed that there is a “fiduciary case” for investing in gold even though the fund traditionally hasn’t had an allocation. While it doesn’t generate income, the price increase of gold has been strong.  

The fund is also looking to real assets to as a line of defence in a high inflationary environment, working with many European managers to explore infrastructure opportunities.  

Border to Coast’s McDonnell added that UK private markets will benefit from the government’s push to invest more locally but a lot of the capital would likely come from the domestic listed markets, which have suffered a long period of underperformance. 

“Obviously you have the flow to passive management, active management clearly hasn’t worked. What you’re basically going to see is institutional investors who are investing UK will jump over the public market and more focused on the private market,” he said. 

“Not saying that’s a good thing. I’m just saying that’s what’s going to happen.”