Page 41 – Top1000funds.com

Key Takeaways

The US Inflation Reduction Act (IRA), which marked its first anniversary in August, is driving investment in clean energy with a broad range of tax incentives.
A total of 280 clean energy projects have been announced across 44 US states in the IRA’s first year, representing $282 billion of investment.
Companies discussing the IRA along with hydrogen fuel and infrastructure on earnings calls indicated a strong potential to invest, with 70% of mentions including a target or projecting numbers.

When the Biden administration marked the first anniversary of the Inflation Reduction Act (IRA) in mid-August this year, it rolled out some big numbers to demonstrate the impact of the legislation. In response to the act’s clean-energy and climate provisions, companies had announced more than $110 billion in new clean-energy manufacturing investments since the IRA became law, according to the White House. That includes over $70 billion in the electric vehicle (EV) supply chain and about $10 billion in solar manufacturing.¹

The IRA has been surrounded by big claims—and intense criticism—from the start. When he signed the bill into law in 2022, President Biden hailed it as “the biggest step forward on climate ever.”² To spur investment, the IRA relies on a package of tax incentives intended to accelerate the deployment of clean energy as well as clean vehicles, buildings and manufacturing.³ These include tax credits for investment in renewable energy projects and facilities that generate clean electricity. The law provides tax breaks for the manufacturing of components for solar and wind energy, inverters,⁴ battery components and critical minerals. It also sets out production tax credits for renewable and clean electricity as well as power from qualified nuclear facilities.

Republicans have leveled a wide range of criticisms at the law, which passed both houses of Congress in party-line votes.⁵ Senate Republican Leader Mitch McConnell, for example, has called the IRA a “reckless taxing and spending spree” that will have “no meaningful impact on the world’s climate.”⁶ Other critics charge that the IRA benefits foreign companies in countries such as China.⁷ In particular, the law’s incentives for the purchase of EVs have faced pushback, and not just from Republicans. Sen. Joe Manchin, a Democrat who co-sponsored the IRA but has criticized the administration’s implementation of the law, said he would oppose a rush to mass adoption of EVs while China controls the supply of critical minerals required for their production.⁸

One year from the launch of the IRA, we drilled down into the data to understand the investment response underlying the official optimism. What we found was that—so far at least—the reality is living up to or even exceeding expectations. Analysis based on public announcements tracked by the American Clean Power Association (ACP), Climate Power and E2 show that 280 clean energy projects were announced across 44 US states in the IRA’s first year.⁹ These projects represent $282 billion in investment and are expected to create nearly 175,000 jobs. To find out which companies are talking about the IRA and what future projects they may be considering, we also examined earnings calls using Natural Language Processing. Solar energy was the clean-energy topic most often mentioned in combination with the IRA on these calls, followed by carbon capture and storage, and batteries and energy storage.¹⁰

The evidence of the IRA’s impact is mounting, but if the law is to achieve the goals set out by its supporters, challenges will have to be overcome. These include delays in connecting renewable energy projects to the grid and the potential for rising project costs, which could in turn push up the IRA’s final price tag. Estimating the total bill for the IRA is difficult because most of the spending under the law comes in the form of uncapped tax breaks, meaning the cost will increase as more companies and households take advantage of the incentives. Initial cost estimates tended to range between $370 billion, a figure cited regularly by the White House,¹¹ to $391 billion, calculated by the Congressional Budget Office.¹²

Made in America

The IRA’s potential to boost US development and production of clean-energy technology critical to the sustainable energy transition has been widely touted since its inception. The law provides the most supportive regulatory environment in clean-tech history, potentially driving results including the first large-scale deployment of green hydrogen and carbon capture, according to Goldman Sachs Global Investment Research (GIR).¹³ The IRA’s incentives could potentially help the US gain a larger share of the global clean-tech market, where China now dominates the manufacturing and trade of most technologies.¹⁴

Significant progress has been made in the IRA’s first year. A recent report from ACP, for example, estimates that the clean energy projects announced through July 31, 2023, will add 184,850 megawatts of new clean energy capacity.¹⁵ The IRA’s support for manufacturing and job creation is also translating into concrete projects. Of the $282 billion of announced investment, just under $27 billion is earmarked for the construction or expansion of 83 manufacturing facilities devoted to utility-scale clean energy across four main sectors, as shown in the table below. The projects include offshore wind facilities in New York, a battery plant in Kentucky and solar development from Washington to Florida.¹⁶

While many of these announced projects will take time to come online, and the capital expenditure to complete them will be spread over months or years, the construction of new facilities is already being reflected in US macroeconomic data. Private fixed investment in manufacturing facilities has surged since April 2022. It was propelled in part by the IRA and another piece of legislation, the CHIPS and Science Act, which provides funding and incentives to support semiconductor research and production.¹⁷

NEXT BIG THING

The IRA’s tax credits are deliberately broad to encourage investment across a range of clean-energy solutions. Its investment tax credit for energy property, for example, covers projects in the following areas: fuel cell, solar, geothermal, small wind, energy storage, biogas, microgrid controllers, and combined heat and power properties.¹⁸ The base credit amount is 6% of qualified investment, though this can be increased by meeting requirements for wages and apprenticeships and for using domestic steel, iron and manufactured products. Similar incentives are built into most of the law’s tax provisions.

The scope of the IRA’s clean-energy incentives has encouraged companies to announce a wide variety of investments in the first year, with more set to come in the years ahead. An analysis of company earnings calls in the year through August 14, 2023, shows that the law has sparked a widespread discussion of clean-energy topics, signaling the potential for future investment. Using Natural Language Processing¹⁹ to scan 27,794 calls held between July 2022 and mid-August 2023, we identified three areas of significant interest: carbon capture, utilization and sequestration (CCUS); batteries and energy storage; and hydrogen fuel and infrastructure.²⁰ These findings are consistent with previous Goldman Sachs research, which found that the IRA would be most transformative for products including utility-scale battery storage and green hydrogen, while accelerating investment in longer-term carbon capture projects.²¹

Three sectors have been most vocal in discussing the IRA and clean-energy topics: energy, industrials and materials. Energy companies have led the conversation when it comes to CCUS. The IRA’s support for the decarbonization of power generation includes extending and expanding an existing CCUS tax credit to include direct air capture and lowering the threshold for some facilities to benefit.²²

Materials and industrial companies are the most vocal on batteries and energy storage, which are supported by the IRA’s production tax credit for domestic manufacturing of battery components as well as clean-vehicle and clean-energy incentives. Earnings calls in all three sectors have touched on hydrogen fuel and infrastructure, an area supported by numerous provisions in the IRA, including a hydrogen production tax credit. Mentions of hydrogen in our analysis also had the highest degree of certainty regarding potential investment, with 70% including a target or project numbers, while CCUS came in at 51% and batteries and energy storage at 43%.²³

Coast to Coast

Job creation and economic expansion have been central themes of the rollout of the IRA.²⁴Our analysis shows that the announced investment linked to the IRA is spread broadly across the US, with the South attracting the largest number of projects and the Northeast in line for the largest investment. The following table provides a regional breakdown of announced projects and investment and the tally of jobs they are expected to create.

This regional distribution of announced projects translated into $225 billion of investment planned in Republican congressional districts as of July 25, compared with $38 billion in Democratic districts.²⁵ The jobs count so far also tilts in favor of Republican districts, which were in line for 96,216 new jobs, compared with 64,418 in Democratic districts.

Bang for the Buck

A recent study published in the Brookings Papers on Economic Activity series estimates the total budgetary effects of the IRA’s climate provisions (tax credits and direct expenditures) at $900 billion through 2031.²⁶ It concludes that the climate measures in the IRA will remain cost-effective even with this higher price tag.

This conclusion is based on a comparison of the cost of abating carbon dioxide (CO₂) emissions with the “social cost of carbon,” defined as the economic costs, or damages, of emitting one additional ton of CO₂ into the atmosphere. Even at the high end of estimated budgetary effects of the IRA’s climate provisions—$1.2 trillion through 2031—the law’s tax credits enable the reduction of CO₂ emissions at $83 per metric ton for the power sector, according to the study. That is far less than the damage caused by the emission of additional CO₂—about $200 per ton.²⁷And that’s before benefits including improved air quality are taken into account.

Challenges Still Remain

For all the progress made during the IRA’s first year, challenges still remain. One of these is the potential for rising project costs. The authors of the Brookings study show that macroeconomic conditions led by higher interest rates and materials costs could hamper clean energy investment. In fact, the study cautions that “macroeconomic conditions may have larger impacts on IRA investments than IRA investments have on macroeconomic conditions.”²⁸ A recent report from the US Department of Energy, for example, cited inflation along with supply chain constraints, geopolitical uncertainty and warranty provisions as factors hampering “the profitability of western wind turbine manufacturers across their land-based and offshore portfolios in 2022.”²⁹

The growing backlog of renewable power projects seeking to connect to the electric grid also presents a potential hurdle for the expansion of clean energy. A recent study led by Lawrence Berkeley National Laboratory (Berkeley Lab) shows renewable power projects are spending longer in so-called interconnection queues, a term that refers to the impact studies developers must complete before a project can connect to the system.³⁰ The study shows that nearly 2,000 gigawatts of renewable energy and storage capacity was waiting in these queues at the end of 2022, a 40% increase from a year earlier. Entering an interconnection queue is just one step in the development process, but the data nevertheless provides “a general indicator for mid-term trends in developer interest,” according to the study.

Two main issues are causing these delays, according to Berkeley Lab: grid capacity and the design of interconnection evaluation processes. Some progress has been made toward removing these obstacles. The Federal Energy Regulatory Commission has approved reforms to speed up the interconnection evaluation process, and the Infrastructure Investment and Jobs Act contains provisions to support the addition of transmissions lines to the grid.³¹

Reducing Carbon Emissions

The reduction of greenhouse gas (GHG) emissions is a central goal of the IRA, and recent research indicates that it could have a significant impact in this area. A study published in the journal Science, for example, found that the law’s provisions could lead to a reduction in GHG emissions of between 43% and 48% from 2005 levels by 2035.³² Without the IRA, the decline would have been in the range of 27% to 35%. The law may have its greatest effect in the power sector because its incentives “amplify trends already underway and lower decarbonization costs,” according to the study.

The US has set a target for reducing GHG emissions by between 50% and 52% below 2005 levels by 2030.³³ While the IRA’s projected impact falls short of this level, the Science study shows that the law helps to narrow the “implementation gap” in reaching the official target by at least 50%.³⁴One unknown is the IRA’s potential to spur other federal agencies as well as state and local governments and companies to increase their own climate ambitions, which “may be key to closing the 2030 implementation gap,” according to the study.

Implications for Investors

The IRA’s support for jobs, especially in manufacturing, should support economic growth and consumption, in turn supporting the US equity and credit markets. If four out of five projects already announced finish on time and create the expected number of jobs, this could lead to about 65,000 new jobs, mostly in manufacturing, by the end of 2024, with 50,000 coming in 2024 itself. For context, 106,000 manufacturing jobs were created overall in the US over the past 12 months.³⁵ If job creation continues at this pace, the IRA and the CHIPS and Science Act could spur the creation of half a million manufacturing jobs over the coming decade, pushing the total to 13.5 million—a level last seen in 2008.

In our view, the materials, industrial, energy and utility sectors stand to benefit the most from this boost to manufacturing, though companies will vary widely in their exposure to the IRA. As a result, active stock-picking will be the best way to take advantage of the long-term opportunities created by the IRA in public markets. On the private side, we expect the law to open up an abundance of pure-play opportunities across the spectrum of clean-energy technology, as the law’s tax incentives make the development of new technologies more profitable.

Impact Beyond Borders

For all the investment the IRA is spurring in the US, its ultimate impact could be much greater. The law has already prompted responses around the world, including from the European Union (EU). In February 2023, EU policy makers responded to the IRA with a Green Deal Industrial Plan to increase the competitiveness of Europe’s net-zero emission industry and speed the transition to climate neutrality. The plan foresees investment in strategic net zero sectors, including through tax benefits.³⁶ India’s government has launched a range of initiatives to spur development of renewable energy technologies under its Production-Linked Incentive Scheme.³⁷ In the race to shape the future of clean energy, we believe this competition among countries can only accelerate global progress toward critical climate goals while expanding opportunities for investors.

Important Information

¹ Reuters, “ChatGPT sets record for fastest-growing user base – analyst note.” As of February 2, 2023.

² MIT Technology Review, “ChatGPT is about to revolutionize the economy. We need to decide what that looks like.” As of March 25, 2023.

³ World Economic Forum, “The pace of US interest rate hikes is faster than at any time in recent history. Is this creating a risk of recession?” As of October 12, 2022

⁴ Goldman Sachs Global Investment Research, “First to the Finish: Early Hikers and the Rate Cut Outlook.” As of July 27, 2023.

⁵ Bureau of Labor Statistics, Bloomberg, HFRI. Analysis from 1990-2022.

⁶ Defined as inflation less than 2%.

⁷ Defined as inflation greater than 4%.

⁸ Goldman Sachs Prime Services, Prime Insights, May 2023.

⁹ MSCI, See additional disclosures.

¹⁰ Goldman Sachs Asset Management XIG Hedge Fund Database. As of 2022.

¹¹ The other three criteria as part of the XIG process are Governance, Infrastructure, and Process.

Glossary

Alpha refers to returns in excess of the benchmark return.

Carry is the return obtained by holding an investment for a given period.

Price-to-earnings multiple is the ratio of an asset’s price to earnings.

Price-to-equity is the ratio of the price per share to the book value per share.

S&P 500 index is the Standard & Poor’s 500 Composite Stock Prices Index of 500 stocks, an unmanaged index of common stock prices.

Risk Considerations

All investing involves risk, including loss of principal.

Alternative investments are suitable only for sophisticated investors for whom such investments do not constitute a complete investment program and who fully understand and are willing to assume the risks involved in Alternative Investments. Alternative Investments by their nature, involve a substantial degree of risk, including the risk of total loss of an investor’s capital.

Alternative Investments often engage in leverage and other investment practices that are extremely speculative and involve a high degree of risk. Such practices may increase the volatility of performance and the risk of investment loss, including the loss of the entire amount that is invested. There may be conflicts of interest relating to the Alternative Investment and its service providers, including Goldman Sachs and its affiliates. Similarly, interests in an Alternative Investment are highly illiquid and generally are not transferable without the consent of the sponsor, and applicable securities and tax laws will limit transfers.

Investors should also consider some of the potential risks of alternative investments:

· Alternative Strategies. Alternative strategies often engage in leverage and other investment practices that are speculative and involve a high degree of risk. Such practices may increase the volatility of performance and the risk of investment loss, including the entire amount that is invested.

· Manager experience. Manager risk includes those that exist within a manager’s organization, investment process or supporting systems and infrastructure. There is also a potential for fund-level risks that arise from the way in which a manager constructs and manages the fund.

· Leverage. Leverage increases a fund’s sensitivity to market movements. Funds that use leverage can be expected to be more “volatile” than other funds that do not use leverage. This means if the investments a fund buys decrease in market value, the value of the fund’s shares will decrease by even more.

· Counter-party risk. Alternative strategies often make significant use of over- the- counter (OTC) derivatives and therefore are subject to the risk that counter-parties will not perform their obligations under such contracts.

· Liquidity risk. Alternatives strategies may make investments that are illiquid or that may become less liquid in response to market developments. At times, a fund may be unable to sell certain of its illiquid investments without a substantial drop in price, if at all.

· Valuation risk. There is risk that the values used by alternative strategies to price investments may be different from those used by other investors to price the same investments.

Alternative Investments – Hedge funds and other private investment funds (collectively, “Alternative Investments”) are subject to less regulation than other types of pooled investment vehicles such as mutual funds. Alternative Investments may impose significant fees, including incentive fees that are based upon a percentage of the realized and unrealized gains and an individual’s net returns may differ significantly from actual returns. Such fees may offset all or a significant portion of such Alternative Investment’s trading profits. Alternative Investments are not required to provide periodic pricing or valuation information. Investors may have limited rights with respect to their investments, including limited voting rights and participation in the management of such Alternative Investments.

The above are not an exhaustive list of potential risks. There may be additional risks that are not currently foreseen or considered.

Conflicts of Interest
There may be conflicts of interest relating to the Alternative Investment and its service providers, including Goldman Sachs and its affiliates. These activities and interests include potential multiple advisory, transactional and other interests in securities and instruments that may be purchased or sold by the Alternative Investment. These are considerations of which investors should be aware and additional information relating to these conflicts is set forth in the offering materials for the Alternative Investment.

General Disclosures

This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities.

THIS MATERIAL DOES NOT CONSTITUTE AN OFFER OR SOLICITATION IN ANY JURISDICTION WHERE OR TO ANY PERSON TO WHOM IT WOULD BE UNAUTHORIZED OR UNLAWFUL TO DO SO.

Prospective investors should inform themselves as to any applicable legal requirements and taxation and exchange control regulations in the countries of their citizenship, residence or domicile which might be relevant.

Economic and market forecasts presented herein reflect a series of assumptions and judgments as of the date of this presentation and are subject to change without notice. These forecasts do not take into account the specific investment objectives, restrictions, tax and financial situation or other needs of any specific client. Actual data will vary and may not be reflected here. These forecasts are subject to high levels of uncertainty that may affect actual performance. Accordingly, these forecasts should be viewed as merely representative of a broad range of possible outcomes. These forecasts are estimated, based on assumptions, and are subject to significant revision and may change materially as economic and market conditions change. Goldman Sachs has no obligation to provide updates or changes to these forecasts. Case studies and examples are for illustrative purposes only.

This information discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice. This material has been prepared by Goldman Sachs Asset Management and is not financial research nor a product of Goldman Sachs Global Investment Research (GIR). It was not prepared in compliance with applicable provisions of law designed to promote the independence of financial analysis and is not subject to a prohibition on trading following the distribution of financial research. The views and opinions expressed may differ from those of Goldman Sachs Global Investment Research or other departments or divisions of Goldman Sachs and its affiliates. Investors are urged to consult with their financial advisors before buying or selling any securities. This information may not be current and Goldman Sachs Asset Management has no obligation to provide any updates or changes.

THESE MATERIALS ARE PROVIDED SOLELY ON THE BASIS THAT THEY WILL NOT CONSTITUTE INVESTMENT ADVICE AND WILL NOT FORM A PRIMARY BASIS FOR ANY PERSON’S OR PLAN’S INVESTMENT DECISIONS, AND GOLDMAN SACHS IS NOT A FIDUCIARY WITH RESPECT TO ANY PERSON OR PLAN BY REASON OF PROVIDING THE MATERIAL OR CONTENT HEREIN. PLAN FIDUCIARIES SHOULD CONSIDER THEIR OWN CIRCUMSTANCES IN ASSESSING ANY POTENTIAL INVESTMENT COURSE OF ACTION.

The views expressed herein are as of the date of the publication and subject to change in the future. Individual portfolio management teams for Goldman Sachs Asset Management may have views and opinions and/or make investment decisions that, in certain instances, may not always be consistent with the views and opinions expressed herein.

Views and opinions expressed are for informational purposes only and do not constitute a recommendation by Goldman Sachs Asset Management to buy, sell, or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change, they should not be construed as investment advice.

This material is provided for informational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities. This material is not intended to be used as a general guide to investing, or as a source of any specific investment recommendations, and makes no implied or express recommendations concerning the manner in which any client’s account should or would be handled, as appropriate investment strategies depend upon the client’s investment objectives.

Although certain information has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness or fairness. We have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources.

Any reference to a specific company or security does not constitute a recommendation to buy, sell, hold or directly invest in the company or its securities. Nothing in this document should be construed to constitute allocation advice or recommendations.

The opinions expressed in this white paper are those of the authors, and not necessarily of Goldman Sachs. Any investments or returns discussed in this paper do not represent any Goldman Sachs product. This white paper makes no implied or express recommendations concerning how a client’s account should be managed. This white paper is not intended to be used as a general guide to investing or as a source of any specific investment recommendations.

Examples are for illustrative purposes only and are not actual results. If any assumptions used do not prove to be true, results may vary substantially.

Neither MSCI nor any other party involved in or related to compiling, computing, or creating the MSCI data makes any express or implied warranties or representations with respect to such data (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability, or fitness for a particular purpose with respect to any of such data. Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in or related to compiling, computing or creating the data have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages. No further distribution or dissemination of the MSCI data is permitted without MSCI’s express written consent.

Past performance does not guarantee future results, which may vary. The value of investments and the income derived from investments will fluctuate and can go down as well as up. A loss of principal may occur.

‘Albourne ®’ is a registered trade mark of Albourne Partners Limited (“Albourne”). Albourne owns all proprietary rights in the Albourne indices and data presented here (“Albourne Information”). Albourne does not approve of or endorse this material or guarantee its accuracy or completeness, nor does Albourne make any warranty, express or implied, as to the results to be obtained therefrom, and to the maximum extent allowed by law, Albourne shall have no liability or responsibility for injury or damage arising in connection with the use of, or reliance upon, any Albourne Information.

United Kingdom: In the United Kingdom, this material is a financial promotion and has been approved by Goldman Sachs Asset Management International, which is authorized and regulated in the United Kingdom by the Financial Conduct Authority.

European Economic Area (EEA): This material is a financial promotion disseminated by Goldman Sachs Bank Europe SE, including through its authorised branches (“GSBE”). GSBE is a credit institution incorporated in Germany and, within the Single Supervisory Mechanism established between those Member States of the European Union whose official currency is the Euro, subject to direct prudential supervision by the European Central Bank and in other respects supervised by German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufischt, BaFin) and Deutsche Bundesbank.

Switzerland: For Qualified Investor use only – Not for distribution to general public. This is marketing material. This document is provided to you by Goldman Sachs Bank AG, Zürich. Any future contractual relationships will be entered into with affiliates of Goldman Sachs Bank AG, which are domiciled outside of Switzerland. We would like to remind you that foreign (Non-Swiss) legal and regulatory systems may not provide the same level of protection in relation to client confidentiality and data protection as offered to you by Swiss law.

Asia excluding Japan: Please note that neither Goldman Sachs Asset Management (Hong Kong) Limited (“GSAMHK”) or Goldman Sachs Asset Management (Singapore) Pte. Ltd. (Company Number: 201329851H ) (“GSAMS”) nor any other entities involved in the Goldman Sachs Asset Management business that provide this material and information maintain any licenses, authorizations or registrations in Asia (other than Japan), except that it conducts businesses (subject to applicable local regulations) in and from the following jurisdictions: Hong Kong, Singapore, Malaysia, India and China. This material has been issued for use in or from Hong Kong by Goldman Sachs Asset Management (Hong Kong) Limited, in or from Singapore by Goldman Sachs Asset Management (Singapore) Pte. Ltd. (Company Number: 201329851H) and in or from Malaysia by Goldman Sachs (Malaysia) Sdn Berhad (880767W).

Hong Kong: This material has been issued or approved for use in or from Hong Kong by Goldman Sachs Asset Management (Hong Kong) Limited, a licensed entity regulated by the Securities and Futures Commission of Hong Kong (SFC). This material has not been reviewed by the SFC.

Singapore: Investment involves risk. Prospective investors should seek independent advice. This advertisement or publication material has not been reviewed by the Monetary Authority of Singapore. This material has been issued or approved for use in or from Singapore by Goldman Sachs Asset Management (Singapore) Pte. Ltd. (Company Number: 201329851H).

Australia: This material is distributed by Goldman Sachs Asset Management Australia Pty Ltd ABN 41 006 099 681, AFSL 228948 (‘GSAMA’) and is intended for viewing only by wholesale clients for the purposes of section 761G of the Corporations Act 2001 (Cth). This document may not be distributed to retail clients in Australia (as that term is defined in the Corporations Act 2001 (Cth)) or to the general public. This document may not be reproduced or distributed to any person without the prior consent of GSAMA. To the extent that this document contains any statement which may be considered to be financial product advice in Australia under the Corporations Act 2001 (Cth), that advice is intended to be given to the intended recipient of this document only, being a wholesale client for the purposes of the Corporations Act 2001 (Cth). Any advice provided in this document is provided by either of the following entities. They are exempt from the requirement to hold an Australian financial services licence under the Corporations Act of Australia and therefore do not hold any Australian Financial Services Licences, and are regulated under their respective laws applicable to their jurisdictions, which differ from Australian laws. Any financial services given to any person by these entities by distributing this document in Australia are provided to such persons pursuant to the respective ASIC Class Orders and ASIC Instrument mentioned below.

· Goldman Sachs Asset Management, LP (GSAMLP), Goldman Sachs & Co. LLC (GSCo), pursuant ASIC Class Order 03/1100; regulated by the US Securities and Exchange Commission under US laws.

· Goldman Sachs Asset Management International (GSAMI), Goldman Sachs International (GSI), pursuant to ASIC Class Order 03/1099; regulated by the Financial Conduct Authority; GSI is also authorized by the Prudential Regulation Authority, and both entities are under UK laws.

· Goldman Sachs Asset Management (Singapore) Pte. Ltd. (GSAMS), pursuant to ASIC Class Order 03/1102; regulated by the Monetary Authority of Singapore under Singaporean laws

· Goldman Sachs Asset Management (Hong Kong) Limited (GSAMHK), pursuant to ASIC Class Order 03/1103 and Goldman Sachs (Asia) LLC (GSALLC), pursuant to ASIC Instrument 04/0250; regulated by the Securities and Futures Commission of Hong Kong under Hong Kong laws.

No offer to acquire any interest in a fund or a financial product is being made to you in this document. If the interests or financial products do become available in the future, the offer may be arranged by GSAMA in accordance with section 911A(2)(b) of the Corporations Act. GSAMA holds Australian Financial Services Licence No. 228948. Any offer will only be made in circumstances where disclosure is not required under Part 6D.2 of the Corporations Act or a product disclosure statement is not required to be given under Part 7.9 of the Corporations Act (as relevant).

New Zealand: This material is distributed in New Zealand by Goldman Sachs Asset Management Australia Pty Ltd ABN 41 006 099 681, AFSL 228948 (’GSAMA’) and is intended for viewing only by wholesale clients in Australia for the purposes of section 761G of the Corporations Act 2001 (Cth) and to clients who either fall within any or all of the categories of investors set out in section 3(2) or sub-section 5(2CC) of the Securities Act 1978, fall within the definition of a wholesale client for the purposes of the Financial Service Providers (Registration and Dispute Resolution) Act 2008 (FSPA) and the Financial Advisers Act 2008 (FAA),and fall within the definition of a wholesale investor under one of clause 37, clause 38, clause 39 or clause 40 of Schedule 1 of the Financial Markets Conduct Act 2013 (FMCA) of New Zealand (collectively, a “NZ Wholesale Investor”). GSAMA is not a registered financial service provider under the FSPA. GSAMA does not have a place of business in New Zealand. In New Zealand, this document, and any access to it, is intended only for a person who has first satisfied GSAMA that the person is a NZ Wholesale Investor. This document is intended for viewing only by the intended recipient. This document may not be reproduced or distributed to any person in whole or in part without the prior written consent of GSAMA.

Canada: This presentation has been communicated in Canada by GSAM LP, which is registered as a portfolio manager under securities legislation in all provinces of Canada and as a commodity trading manager under the commodity futures legislation of Ontario and as a derivatives adviser under the derivatives legislation of Quebec. GSAM LP is not registered to provide investment advisory or portfolio management services in respect of exchange-traded futures or options contracts in Manitoba and is not offering to provide such investment advisory or portfolio management services in Manitoba by delivery of this material.

Japan: This material has been issued or approved in Japan for the use of professional investors defined in Article 2 paragraph (31) of the Financial Instruments and Exchange Law by Goldman Sachs Asset Management Co., Ltd.

South Africa: Goldman Sachs Asset Management International is authorised by the Financial Services Board of South Africa as a financial services provider.

Colombia: Esta presentación no tiene el propósito o el efecto de iniciar, directa o indirectamente, la adquisición de un producto a prestación de un servicio por parte de Goldman Sachs Asset Management a residentes colombianos. Los productos y/o servicios de Goldman Sachs Asset Management no podrán ser ofrecidos ni promocionados en Colombia o a residentes Colombianos a menos que dicha oferta y promoción se lleve a cabo en cumplimiento del Decreto 2555 de 2010 y las otras reglas y regulaciones aplicables en materia de promoción de productos y/o servicios financieros y /o del mercado de valores en Colombia o a residentes colombianos. Al recibir esta presentación, y en caso que se decida contactar a Goldman Sachs Asset Management, cada destinatario residente en Colombia reconoce y acepta que ha contactado a Goldman Sachs Asset Management por su propia iniciativa y no como resultado de cualquier promoción o publicidad por parte de Goldman Sachs Asset Management o cualquiera de sus agentes o representantes. Los residentes colombianos reconocen que (1) la recepción de esta presentación no constituye una solicitud de los productos y/o servicios de Goldman Sachs Asset Management, y (2) que no están recibiendo ninguna oferta o promoción directa o indirecta de productos y/o servicios financieros y/o del mercado de valores por parte de Goldman Sachs Asset Management.
Esta presentación es estrictamente privada y confidencial, y no podrá ser reproducida o utilizada para cualquier propósito diferente a la evaluación de una inversión potencial en los productos de Goldman Sachs Asset Management o la contratación de sus servicios por parte del destinatario de esta presentación, no podrá ser proporcionada a una persona diferente del destinatario de esta presentación.

Israel: This document has not been, and will not be, registered with or reviewed or approved by the Israel Securities Authority (ISA”). It is not for general circulation in Israel and may not be reproduced or used for any other purpose. Goldman Sachs Asset Management International is not licensed to provide investment advisory or management services in Israel.

Jordan: The document has not been presented to, or approved by, the Jordanian Securities Commission or the Board for Regulating Transactions in Foreign Exchanges.

Bahrain: This material has not been reviewed by the Central Bank of Bahrain (CBB) and the CBB takes no responsibility for the accuracy of the statements or the information contained herein, or for the performance of the securities or related investment, nor shall the CBB have any liability to any person for damage or loss resulting from reliance on any statement or information contained herein. This material will not be issued, passed to, or made available to the public generally.

Kuwait: This material has not been approved for distribution in the State of Kuwait by the Ministry of Commerce and Industry or the Central Bank of Kuwait or any other relevant Kuwaiti government agency. The distribution of this material is, therefore, restricted in accordance with law no. 31 of 1990 and law no. 7 of 2010, as amended. No private or public offering of securities is being made in the State of Kuwait, and no agreement relating to the sale of any securities will be concluded in the State of Kuwait. No marketing, solicitation or inducement activities are being used to offer or market securities in the State of Kuwait.

Oman: The Capital Market Authority of the Sultanate of Oman (the “CMA”) is not liable for the correctness or adequacy of information provided in this document or for identifying whether or not the services contemplated within this document are appropriate investment for a potential investor. The CMA shall also not be liable for any damage or loss resulting from reliance placed on the document.

Qatar: This document has not been, and will not be, registered with or reviewed or approved by the Qatar Financial Markets Authority, the Qatar Financial Centre Regulatory Authority or Qatar Central Bank and may not be publicly distributed. It is not for general circulation in the State of Qatar and may not be reproduced or used for any other purpose.

Saudi Arabia: The Capital Market Authority does not make any representation as to the accuracy or completeness of this document, and expressly disclaims any liability whatsoever for any loss arising from, or incurred in reliance upon, any part of this document. If you do not understand the contents of this document you should consult an authorised financial adviser. The CMA does not make any representation as to the accuracy or completeness of these materials, and expressly disclaims any liability whatsoever for any loss arising from, or incurred in reliance upon, any part of these materials. If you do not understand the contents of these materials, you should consult an authorised financial adviser.

United Arab Emirates: This document has not been approved by, or filed with the Central Bank of the United Arab Emirates or the Securities and Commodities Authority. If you do not understand the contents of this document, you should consult with a financial advisor.

East Timor: Please Note: The attached information has been provided at your request for informational purposes only and is not intended as a solicitation in respect of the purchase or sale of instruments or securities (including funds), or the provision of services. Neither Goldman Sachs Asset Management (Singapore) Pte. Ltd. nor any of its affiliates is licensed under any laws or regulations of Timor-Leste. The information has been provided to you solely for your own purposes and must not be copied or redistributed to any person or institution without the prior consent of Goldman Sachs Asset Management.

Vietnam: Please Note: The attached information has been provided at your request for informational purposes only. The attached materials are not, and any authors who contribute to these materials are not, providing advice to any person. The attached materials are not and should not be construed as an offering of any securities or any services to any person. Neither Goldman Sachs Asset Management (Singapore) Pte. Ltd. nor any of its affiliates is licensed as a dealer under the laws of Vietnam. The information has been provided to you solely for your own purposes and must not be copied or redistributed to any person without the prior consent of Goldman Sachs Asset Management.

Cambodia: Please Note: The attached information has been provided at your request for informational purposes only and is not intended as a solicitation in respect of the purchase or sale of instruments or securities (including funds) or the provision of services. Neither Goldman Sachs Asset Management (Singapore) Pte. Ltd. nor any of its affiliates is licensed as a dealer or investment advisor under The Securities and Exchange Commission of Cambodia. The information has been provided to you solely for your own purposes and must not be copied or redistributed to any person without the prior consent of Goldman Sachs Asset Management.

Date of First Use: August 7, 2023 328954-OTU-1846189

European Economic Area (EEA): This marketing communication is disseminated by Goldman Sachs Asset Management B.V., including through its branches (“GSAM BV”). GSAM BV is authorised and regulated by the Dutch Authority for the Financial Markets (Autoriteit Financiële Markten, Vijzelgracht 50, 1017 HS Amsterdam, The Netherlands) as an alternative investment fund manager (“AIFM”) as well as a manager of undertakings for collective investment in transferable securities (“UCITS”). Under its licence as an AIFM, the Manager is authorized to provide the investment services of (i) reception and transmission of orders in financial instruments; (ii) portfolio management; and (iii) investment advice. Under its licence as a manager of UCITS, the Manager is authorized to provide the investment services of (i) portfolio management; and (ii) investment advice. Information about investor rights and collective redress mechanisms are available on www.gsam.com/responsible-investing (section Policies & Governance). Capital is at risk. Any claims arising out of or in connection with the terms and conditions of this disclaimer are governed by Dutch law. In Denmark and Sweden this material is a financial promotion disseminated by Goldman Sachs Bank Europe SE, including through its authorised branches (“GSBE”). GSBE is a credit institution incorporated in Germany and, within the Single Supervisory Mechanism established between those Member States of the European Union whose official currency is the Euro, subject to direct prudential supervision by the European Central Bank and in other respects supervised by German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufischt, BaFin) and Deutsche Bundesbank.

Japan: This material has been issued or approved in Japan for the use of professional investors defined in Article 2 paragraph (31) of the Financial Instruments and Exchange Law (“FIEL”). Also, Any description regarding investment strategies on collective investment scheme under Article 2 paragraph (2) item 5 or item 6 of FIEL has been approved only for Qualified Institutional Investors defined in Article 10 of Cabinet Office Ordinance of Definitions under Article 2 of FIEL.

Key Takeaways

A blend of cyclical fluctuations and structural forces are driving economies and markets. These factors can serve as important reference points to guide investment decisions.
To ensure long-term success, we see opportunities for investors to position their portfolios on the right side of structural changes, including higher mean level of interest rates through the next number of business cycles as well as disruptive megatrends.
The evolution toward a new structural paradigm is unlikely to occur in a straight line. In our view, investment flexibility and a heightened focus on risk will be needed in a dynamic environment.

Cyclical fluctuations and structural forces are changing the shape of economies, markets, and the way we invest. At this year’s Jackson Hole symposium, European Central Bank (ECB) president Christine Lagarde pointed out that elements of clarity, flexibility, and humility are required for robust policy making in an age of shifts and breaks.¹ We believe these principles also hold the key to prudent investment management in a highly dynamic world. Longer-term paradigm shifts, such as structurally higher interest rates and disruptive megatrends, may call for a re-assessment of portfolio themes and asset allocation mix. Shorter-term fluctuations along the business cycle may require nimble actions to capture opportunities. Identifying these forces can give investors important reference points to guide their decisions and position for success.

Cyclical, Structural, and Long-Term Outlook

A potential starting point for investors is to consider the outlook for monetary policy. It is viewed as “neutral” and therefore neither stimulating nor restraining the economy, if the policy rate is aligned with the sum of inflation target and the so-called “r-star,” the natural real rate of interest. The US r-star rate is currently estimated to be around 0.5%, compared to nearly 4% in 2000 and even higher in the 1960s, according to the Federal Reserve Bank of New York’s Holston-Laubach-Williams model. Other studies have also found a similar downward trend over past decades.² This may have been driven by structural factors such as demographic aging, a global savings glut, productivity declines, and so on. While it is difficult to state where r-star is heading, we believe some shifts in these factors are worth noting.

We expect higher fiscal deficits and government debt, including US national debt, to result in an increased demand for savings and potentially higher interest rates. The digitization of more activities across industries and the emergence of generative artificial intelligence (AI) may also have the potential to lift productivity. When coupled with deglobalization trends, this creates a different dynamic for central banks to deal with than past decades. These structural changes suggest that it is possible for the mean level of interest rates to shift higher through the next number of business cycles, which has potential implications for equity and bond portfolios.

Structurally higher interest rates, negative effects of persistent inflation and higher debt levels could weigh on US economic growth over the long-run. Additionally, academic studies presented at the Jackson Hole meeting suggest that factors which may have contributed to growth in past decades, such as a higher rate of investment in ideas and substantial increases in educational attainment, could be difficult to keep up.³This suggests that growth rates may slow in the future. On the other hand, underlying changes in sector composition (e.g., more services, less manufacturing) and a high share of fixed-rate debt in the US housing market implies that the US economy may have become more resilient to higher interest rates. Furthermore, cyclical factors such as the easing of supply chain pressure and inventory de-stocking have been part of the re-normalization after the pandemic. These developments may contribute to an increase in activities and prolong the current late economic cycle. This makes the outlook for growth even more uncertain as cyclical and structural factors partially offset each other, at least in the short term.

Japan shows that structural trends do not always need to be global. The country finds itself on the cusp of a new economic dawn characterized by an unfamiliar yet desirable cycle of rising prices and wage growth. Japan’s shrinking and aging population may have the potential to cause either inflation or deflation in the years ahead. The outcome should depend on the country’s ability to improve labor force participation, and the interaction of demographics with other structural forces such as deglobalization and digitization. We also expect corporate governance reforms in Japan to create long-term winners and losers as some firms use it as a channel to achieve growth, while others fail to keep up. We believe investors that focus on secular growth winners committed to reforms may end up on the right side of change.

Decarbonization is another structural trend affecting not only economies and industries, but the future health of the planet. Sustainable transformation creates both new risks and opportunities for investors. The US Inflation Reduction Act’s (US IRA) clean-energy incentives have encouraged companies to announce a wide variety of investments, with more set to come.⁴ Across the Atlantic, the European Union’s RePowerEU plan is helping to catalyze clean energy investments and diversify the bloc’s energy supplies. Other markets, such as China and India, may strengthen existing climate incentives in the future. A less predictable but more competitive geopolitical environment may also require a focus on any short-term fluctuations in climate policies globally and potential impacts on commodity prices.

Investment Implications

A world of potentially higher rates and slower growth may require long-term capital market assumptions to be re-evaluated, which could potentially lead to shifts in long-term asset allocation. The evolution toward a new structural paradigm is unlikely to be a straight line. For instance, with rates rising, concerns over the sustainability of fiscal paths forward have continued to build. Companies face higher cost of capital, making businesses with weaker balance sheets potentially more vulnerable to defaults. Opportunities for alpha generation in public markets may not only become more global but also more bottom-up and determined by profitability. Structurally higher interest rates have the potential to alter private market dynamics, too. Private credit yields have been increasingly attractive and private equity is evolving, with operational value creation levers poised to potentially become the main determinants of success in the new regime.

As investors recalibrate portfolios to a structurally higher interest rate environment, we believe being positioned on the right side of powerful megatrends may prove to be rewarding in the long run. However, capturing the best opportunities may require an understanding of the complexities associated with secular growth themes and certain industries, such as AI’s potentially transformative impacts on healthcare and life sciences. A focus on nuances in specific markets and countries may also uncover long-term opportunities. For instance, we expect Japan’s revitalized economy and corporate governance reforms will create winners and losers in the years ahead. Other opportunities may emerge in commercial real estate with some assets positioned to potentially capitalize on shifting demographics and sustainability trends, while others miss out.

In an uncertain world of cyclical and structural changes, it may be time for investment playbooks to change too. An environment of deviation, differentiation, and volatility may require a more active and diversified investment approach across public and private markets, in our view. Long-term success may depend on a mix of creativity and courage to look beyond convention, but also deep experience gained through previous market cycles. We can relate to Federal Reserve Chair Jerome Powell’s analogy of “navigating by the stars under cloudy skies”.⁵ Predicting precisely what lies ahead is unrealistic in a dynamic world. It’s important to contemplate a wide range of future scenarios and build up an expanded set of instruments and tools to help manage risks and capture opportunities.

Important Information

¹ Reuters, “ChatGPT sets record for fastest-growing user base – analyst note.” As of February 2, 2023.

² MIT Technology Review, “ChatGPT is about to revolutionize the economy. We need to decide what that looks like.” As of March 25, 2023.

³ World Economic Forum, “The pace of US interest rate hikes is faster than at any time in recent history. Is this creating a risk of recession?” As of October 12, 2022

⁴ Goldman Sachs Global Investment Research, “First to the Finish: Early Hikers and the Rate Cut Outlook.” As of July 27, 2023.

⁵ Bureau of Labor Statistics, Bloomberg, HFRI. Analysis from 1990-2022.

⁶ Defined as inflation less than 2%.

⁷ Defined as inflation greater than 4%.

⁸ Goldman Sachs Prime Services, Prime Insights, May 2023.

⁹ MSCI, See additional disclosures.

¹⁰ Goldman Sachs Asset Management XIG Hedge Fund Database. As of 2022.

¹¹ The other three criteria as part of the XIG process are Governance, Infrastructure, and Process.

Glossary

Alpha refers to returns in excess of the benchmark return.

Carry is the return obtained by holding an investment for a given period.

Price-to-earnings multiple is the ratio of an asset’s price to earnings.

Price-to-equity is the ratio of the price per share to the book value per share.

S&P 500 index is the Standard & Poor’s 500 Composite Stock Prices Index of 500 stocks, an unmanaged index of common stock prices.

Risk Considerations

All investing involves risk, including loss of principal.

Investors should also consider some of the potential risks of alternative investments:

· Valuation risk. There is risk that the values used by alternative strategies to price investments may be different from those used by other investors to price the same investments.

The above are not an exhaustive list of potential risks. There may be additional risks that are not currently foreseen or considered.

General Disclosures

This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities.

THIS MATERIAL DOES NOT CONSTITUTE AN OFFER OR SOLICITATION IN ANY JURISDICTION WHERE OR TO ANY PERSON TO WHOM IT WOULD BE UNAUTHORIZED OR UNLAWFUL TO DO SO.

Examples are for illustrative purposes only and are not actual results. If any assumptions used do not prove to be true, results may vary substantially.

· Goldman Sachs Asset Management, LP (GSAMLP), Goldman Sachs & Co. LLC (GSCo), pursuant ASIC Class Order 03/1100; regulated by the US Securities and Exchange Commission under US laws.

· Goldman Sachs Asset Management (Singapore) Pte. Ltd. (GSAMS), pursuant to ASIC Class Order 03/1102; regulated by the Monetary Authority of Singapore under Singaporean laws

South Africa: Goldman Sachs Asset Management International is authorised by the Financial Services Board of South Africa as a financial services provider.

Jordan: The document has not been presented to, or approved by, the Jordanian Securities Commission or the Board for Regulating Transactions in Foreign Exchanges.

Date of First Use: August 7, 2023 328954-OTU-1846189

Around £1.2 trillion of UK pension fund assets lies in around 5,000 defined benefit schemes that primarily invest in Gilts and corporate bonds. With a suite of initiatives, the government is attempting to get the country’s fragmented DB (and DC) pension sector to invest more in illiquid assets and help fuel economic growth, as well as exploring how to consolidate these funds into larger pools.

The biggest UK pension funds like Railpen, Nest and LGPS already invest in alternatives and nine of the UK’s largest defined contribution (DC) pension providers have pledged to allocate 5 per cent of assets in their default funds to unlisted equities by 2030 as part of the Mansion House Compact. Discussions on how to consolidate fragmented defined benefit pension funds have begun led by the Pension Protection Fund and Brightwell.

Rory Murphy, trustee chair of the Merchant Navy Officers Pension Fund, MNOPF, believes the transformative benefits and opportunity of the push are clear, but says it will require nothing short of a pensions revolution if the government is to successfully persuade funds to invest in alternatives rather than low-risk, liquid government bonds.

“Why can’t money be released and invested in infrastructure that would support the whole economy and improve society? All the ingredients are there, and it would help pension funds, members, corporates, and society but it requires someone with real flair and imagination to go figure how to do it.”

Murphy links resistance to enduring factors. Pension funds multiple service providers from investment, fiduciary and covenant advisors have a vested interest in the status quo. While a pervasive risk aversion from the UK regulator has steered the country’s defined benefit pension funds onto de-risking paths. Meanwhile rising bond yields have reduced scheme deficits and provided an opportunity for corporate sponsors and trustees to negotiate so-called risk transfer deals, where responsibility for payments is shifted to insurers like Legal & General who promise to pay employees’ retirement payments at a fixed level – and continue to invest in the least risky assets.

“It’s hard to change from the slow lane to the fast lane,” says Murphy, who notes that the low-risk strategy actually failed protect these funds from dangerous exposure to interest rate risk in last year’s LDI crisis.

Murphy is well positioned to flag the issues at hand as a trustee of the MNOPF. The pension fund, which represents around 350 employers and currently manages around £2.5 billion, is illustrative of the strategy in action. The MNOPF hasn’t had any alternative exposure for years and is steadily de-risking, handing assets under management over to insurers. “In the next 2-3 years we will wind up,” he says. It abandoned any in-house investment ten years ago when it switched to a delegated fiduciary manager which implements a strategy enshrined in investment principles and a clear de-risking journey plan.

Trustees tend to be risk averse, admits Murphy. “Trustees employ skills and decision making defensively. They don’t want to do anything that puts them at risk. If they take advice and it goes wrong, they are not to blame but if they don’t take advice and it goes wrong, they are.”

He believes trustees should take a more active role by questioning and challenging advisors view of the world. “Why aren’t trustees saying hang on, this could be a great idea. Trustees need to challenge advisors but that requires the government to fundamentally review how pensions work and the role of the regulator.”

Part of the problem is that many trustees’ lack investment expertise. In recognition of this, the government has launched a call for evidence to explore how to support trustees to improve their skills, overcome cultural barriers and realise better outcomes. Elsewhere, larger funds like Railpen spend time educating their trustees on alternatives investment.

But Murphy believes the lack investment expertise shouldn’t impact the important role trustees play in holding advisors to account. Simple questions, he says, are often the most difficult to answer. “It is these people who cut through the jargon that surrounds investment and what advisors are saying, and remind everyone that pensions belong to beneficiaries because they are deferred pay.”

The MNOPF is also proof that trustees can shake up governance, he says. When the fund adopted an outsourced fiduciary management model, trustees pushed to scrap the investment committee in an important adjustment to governance.

Under the old structure, the board would “nod through” investment strategy on the assumption it had already been approved by the investment committee. Now the fiduciary manager reports directly to the whole board and the investment committee no longer filters what information reaches the board. In another pro-active strategy, Murphy is supporting education and wellbeing initiatives for members, including efforts to secure beneficiary payments twice a month.

Many institutional investors are increasing their allocations to private credit, jumping on the idea of lending to companies on a floating rate in the current interest rate cycle. But Charles Van Vleet, CIO of the $10 billion corporate pension fund for US aerospace and defence giant Textron, is not going to get lured onto the rocks of high yields.

He remains resolutely in favour of private equity over private credit when considering how best to tie up money long-term in illiquid, draw down vehicles.

“Where I have limited ability to tie up my money, I am not going to tie it up in private credit,” he says, speaking from the fund’s headquarters in Providence, Rhode Island. “Investing in private credit in a 7-8 year tie up and expected IRR or yields of 10-12 per cent is attractive but with bonds you can never get back any more than par, and you will soon wish for the asymmetrical upside of equity rather than the asymmetrical downside of bonds.”

Adding: “I hear lots of people saying my gosh, who needs to buy equity when you can buy high yield bonds with a 9-10 per cent coupon but my focus remains on equity.”

A year ago in July, Textron (which has returned 4.6 per cent year to date) stopped all new commitments to private credit and cut its spread exposure in half as Van Vleet opted to gain exposure to corporate growth through junior equity tranches over senior fixed income via private credit.

“We replaced spread exposure with beta-weighted allocations in the S&P. High yield bonds are correlated with the S&P at 0.6 per cent so when we sold 1 per cent of high yield we bought 0.6 per cent of the S&P.”

Van Vleet’s aversion to private credit is twofold. On one hand he believes that although the next default cycle (about to begin) will witness fewer defaults, the ability of investors to recover assets will be significantly lower. The problem lies in the absence of residual assets available for bond holders because the type of companies most likely to default are in tech.

“The nature of what America makes is different compared to a decade ago,” he says. “For many of these companies the most valuable asset goes down the elevator at night.”

Another reason that recoveries will be lower is that many of the covenants binding the loans are wanting. In the past, investors set covenants around the amount of cash to keep in the bank, leverage and margins, but these once weighty documents are notably lighter today. “By the time a lot of these companies are bankrupt they have bled the balance sheet. There just aren’t the covenants in place for lenders to come in and give the business a stern talking.”

The other reason for ditching private credit is wholly positive. Van Vleet is an enthusiastic investor in the corners of the US equity market that capture the scale of change ahead and offer the kind of unlimited return impossible to tap in bond markets.

Take technological leaps like LLM (large language models) powering the AI revolution visible in ChatGTP; the new generation of weight-loss drugs know as GLP1-agonists. mRNA, the biological unit that Pfizer and BioNTech used to make Covid-19 vaccines that scientists now believe will help the body fight other diseases or Crispr, the first drug to make use of revolutionary gene-editing technology. Not to mention innovations like cellular meat or when-not-if technological take off in fusion.

“Six weeks ago, we did not know of GLP-1. Six months ago, the term LLM was unknown. Three years ago, mRNA was non-existent, as was Crispr, two years prior. Some people think fusion is 20-years away but for long-term investors that’s tomorrow – and it will take the carbon challenge away. All of these are transformative events and inventions. In short, North America equity investing is the best place to find the winners and losers of the exciting decade ahead.”

Apart from a small pocket of passive that Textron keeps for liquidity purposes, Van Vleet has an active stock picking strategy around these themes. But despite Textron’s focused investments he doesn’t believe only active strategies will reap the benefits.

“A rising tide will lift all boats, just be invested in boats, just be invested in equity,” he says. “Who is going to reap the benefits of this productivity? Its not going to go to labour – it’s going to go to the capital providers; to the equity investors, and it’s already priced into the market.”

And these themes are accessible across all asset classes. For example, Textron’s 12 per cent allocation to real estate comprising 22 direct investments in buildings and with no fund investment includes ownership of data centres fitted with the complex cooling requirements needed for vast servers.

In another nod to his contrarian approach, Van Vleet concludes that real estate investors continue to overlook opportunities in life sciences, cold storage and multifamily because they have been wholly focused on plummeting office values.

“They are throwing the baby out with the bathwater,” he concludes.

Sriram Lakshminarayanan, chief investment officer of $38 billion Iowa Public Employees Retirement System (IPERS) has spent recent months carefully paring back and moulding the allocation to active risk in a three-pronged approach.

Active risk exposure is currently minimal, as it has been for a few years, he tells Top1000funds.com in an interview from the fund’s Des Moines offices.

“Portfolio construction in public markets begins with a default of all passive, all the time. We have a low active risk allocation because we can’t convince ourselves there are enough managers out there who provide what we want at a reasonable price.”

The approach has involved axing the active risks he didn’t want in the portfolio and then, in a more complex process, onboarding the risks he seeks – aka uncorrelated returns that can be integrated alongside these market betas. That quest follows a systematic three-phase approach comprising a portable alpha overlay framework, alternative risk premia (ARP) and a tactical asset allocation program.

Lakshminarayanan particularly likes portable alpha because it allows IPERS to actively seek returns across all asset classes, regardless of whether they are part of the strategic asset allocation.

“We might find a commodity manager that we like and want to add the active return, inflation or equity hedge they provide but can’t because we don’t have commodities in the portfolio. Using portable alpha, opens up active strategies we wouldn’t otherwise have the opportunity to tap through traditional implementation.”

Portable alpha involves separating the beta and alpha returns, he continues: “Sometimes you need the beta, so you buy the manager, but sometimes you just want the excess return, so you have to go to a counterparty and swap out for another beta you do want. Our goal is to create a potential shield against short-term downturns while aiming for longer-term gains.”

Another component of active risk has involved beefing up IPERS’ ability to tactically allocate when opportunities arise – the strategic asset allocation contributes to 90 per cent of returns. Rather than something that can just be turned on, tactical asset allocation requires a change in mindset that is rooted in constant communication with managers and their views on the market.

“Our oversight of managers is not based on the idea that we know best. It’s based on knowing what they are doing. It requires active readjustments and wanting to learn. It’s a mindset change around how much risk you can deploy and if you can monetise it.”

The alternative risk premia allocation, the third element, has only been in place for a year and therefore hasn’t been tested as much as he’d like. The small allocation comprises a $300 million investment at 10 per cent risk, which could increase if the risk goes down.

“For example, if we set the risk at 5 per cent, we could allocate $600 million,” he explains.

Another facet of successful active investment comes via the team dedicating much of their time to manager selection, particularly eliminating unconscious biases from the selection process. About a decade ago, IPERS initiated a comprehensive effort to document essential characteristics, both quantitative and qualitative, to guide the fund in selecting active managers.

Since then, it has consistently applied this systematic approach to all searches within public markets to identify what it considers to be alpha. “While it has been challenging to find managers who fully meet our criteria, we remain committed to the pursuit. An encouraging outcome is that active risk in our portfolio has significantly decreased, and the limited active strategies we do employ generally align with our expectations.”

reshaping Private markets

In another initiative, Lakshminarayanan is in the process of establishing an internal private market co-investment program. The portfolio is already well established (including a 17 per cent allocation to private equity and 8 per cent allocation to private credit) and IPERS will use these existing relationships with managers to tap high quality co-investment and cut costs.

“Our approach involves initially selecting a handful of core managers to establish a strong foundation in the asset class. From there, we seek complementary satellite strategies to create a well-rounded portfolio in the given asset class.”

The co-investment program in private markets also aims to provide the team with much greater transparency on IPERS’ exposure. The fund is in the process of onboarding an administrator to run a program that will introduce a new level of transparency of all the alternatives holdings.

“It really makes sense to centralise all our strategies so we can see the whole picture and avoid concentrated risk in the portfolio. A co-investment program with each manager risks the investment team not knowing what each of the other managers are doing.”

The private markets portfolio is currently in line with target allocations apart from slightly higher exposure to private equity because of the denominator effect. “We don’t intend to make abrupt shifts in our allocations to private markets in the short term. Instead, we control our commitments and pacing to regulate this.”

A few central themes run through Lakshminarayanan’s investment approach. He counsels on the importance of embracing the fundamentals and staying humble, yet not shying away from taking a contrarian stance when needed. He says successful long-term investment reuqires a healthy dose of patience and he also adhere to the 20-80 principle.

“Allocate 20 per cent of your time to discover promising ideas and dedicate the remaining 80 per cent to their steadfast long-term implementation,” he suggests.

He thinks that the best asset ownership organisation revolve around a flat structure comprising generalists, complemented by a diverse team of analysts with varying expertise. Instead of designating asset class leaders in the six-person investment team, he has focused on aligning individual skills with the organization’s needs.

“It has proven to be a successful and satisfying approach.”

A spanner in the wheels to recruiting the skills he requires (and a plan to double the size of the investment team) comes courtesy of a recruitment challenges. “Iowa has lot of large insurance companies who are also talent thirsty. We are all fishing from the same pond, and hiring young professionals is hard.”

Still, he’s encouraged by progress over the past few years, and says board approval to increase compensation is helping recruitment.

For the third consecutive year the retirement income systems of The Netherlands, Iceland and Denmark were given the highest rating in the Mercer CFA Institute Global Pension index, with Israel also joining the top rank this year.

The Netherlands had the highest overall index score for 2023 (85.0), followed by Iceland (83.5), Denmark (81.3) and Israel (80.8). The index has been measuring retirement systems since 2009 with new countries added each year. Israel was only added in 2020 and has improved its score in every subsequent year, moving from a B+ rating last year to the highest A-rating in 2023.

Speaking to Top1000funds.com’s sister publication Investment Magazine, David Knox, senior partner at Mercer and lead author of the report, said there is one thing that all the top countries have in common.

“The top four countries that are A-grade – The Netherlands, Iceland, Denmark and Israel – all of them require that most of your benefit be taken as a pension or income,” he said.

By comparison he said countries such as Australia (overall score 77.3) in the B+ tier needed to be more sufficiently geared towards decumulation and focus on retirement income.

The index compares 47 retirement income systems around the globe with three new countries introduced this year – Botswana, Croatia, and Kazakhstan. It covers around 64 per cent of the world’s population.

The index is made up of three sub-indices: adequacy, defined as the system’s design features and how well it caters to people with different levels of income and wealth; sustainability, defined as whether it can continue to perform over the long term; and integrity, which is how well governed the system is.

Countries such as Italy and Spain had a reduced sustainability score this time due to falling birth rates and consequently greater pressure on the pension system. Meanwhile, several Asian systems including those in China, Korea, Singapore, and Japan, have undertaken reform to improve their scores in the last five years.

This year the report also took a deep dive into a topic of special interest and the potential for artificial intelligence (AI) to improve pension and social security systems.

“The ongoing expansion of AI within the operations and decisions of investment managers could lead to more efficient and better-informed decision-making processes, which could potentially lead to higher real investment returns to pension plan members,” Knox said.

“AI by itself is not the complete answer. There will always be a need for human oversight. Despite these risks, AI has the opportunity to deliver a higher standard of living in retirement — a worthwhile objective for all pension systems.”

Meanwhile Marg Franklin, president and CEO of CFA Institute said pension funds face increasingly complex challenges that impact retirees in significant ways and the index plays an important role in pension system accountability.

“More and more often, individuals will have an increasingly important role to play as it relates to their own retirement. As investment professionals, we need to help them prepare for that. Each year, this index serves as a critical reminder that there is a long way to go in many jurisdictions to make pension plans function at their best and for the long-term financial security of beneficiaries.”