Asset allocation is often nominated as the most important element in long-term investment performance. But the Fiduciary Investor s Symposium at Stanford University heard that no investment strategy or process can operate in a vacuum – it can’t happen effectively without operational excellence.

Operational excellence is as fundamental to maximising benefits for members as any other aspect of a pension fund, sovereign wealth fund or endowment’s activities, the Fiduciary Investors Symposium at Stanford University has heard.

A panel session chaired by Stanford Research Initiative on Long-Term Investing executive and research director Ashby Monk heard that ultimately all fiduciary investors are driven by the desire to maximise long-term returns, within the constraints of their respective organisations.

Monk said that when asked what the most important driver of long-term returns is, “most people would say asset allocation, that’s the foundation of performance”.

“Everybody refers to the lovely seminal paper in 1986 by Brinson where we learned that…93 and a half percent of the variability in quarterly performance is a function of asset allocation,” he said.

“Some people might go another direction and say portfolio implementation. Are we direct? Can we get better alignment of interests? Can we get deep alignment with our managers, some people might say security selection, all of these are often highlighted as components of performance.

“And I think we’re here on this panel to say, none of that happens in a vacuum. All of that is a function of your organizational capabilities.”

Critical ingredients for success

According to Monk the key ingredients of a successful organisation are a production function, people, process, information, and capital. He described these as elements of the organisation’s identity.

“You all have people that are using information in the context of a process to invest your capital,” he said. “It’s very simple, every investor does it. But I would argue that no two investment organizations in the world are the same.”

Australian Retirement Trust chief investment officer Ian Patrick said the merger of Sunsuper and QSuper in February last year was clearly “a bet on scale” and brought two entities together with the aim of improving outcomes for fund members through improved operational efficiencies. He said this included lower investment fees and better services.

“Those are all delivered,” Patrick said. “The ability to invest in capability that comes from scale, before you even get to investments, is very real. On the investment front, [there is] the capability to deploy larger cheques in more meaningful deals; and then [to] invest in the underlying technology, and other tools that will improve the investment process.

“I think those are all benefits from scale. Are there disadvantages? Absolutely. We may never be a meaningful investor in Australian small caps going forward.”

Patrick said the merger had “instant positives in terms of bringing together a collection of capabilities that each entity might have aspired to in its own right but would have been on a path to build”.

“But with that comes the challenge, or the opportunity, of two processes, two cultures, two governance mechanisms, you name it,” Patrick said.

“The important thing for us, I think, in the journey so far and that will carry us into the future is the fact that at the core, the identity is very strong, the identity of super, which is all about the end member. Delivering for the beneficiary binds everybody, and that’s particularly important.”

Franklin Templeton Advisory and Thought Leadership vice president Sandy Kaul said most organisations are slow to fully grasp the potential of new technology and the impact it can have on driving operational excellence.

“Technology is constantly redefining what we are able to do, and how we are able to do it.,” Kaul said.

“And we have seen this over and over in our own careers.

“So, when we say technology is [at] the heart of what is driving this industry, and you think about operational excellence, my biggest learning has been the people are very bad at taking advantage of what the technology can do. They bring in the right technology, and then they do the wrong thing to embed it into their processes, to update their people and to update their governance.”

Kaul said organisations also need to recognise that there is wisdom in crowds, and that they are not the sole repositories of knowledge or insights.

“In everything we’ve heard so far in the conference, I didn’t hear any discussion about the wisdom of crowds, about the ability to tap into community sentiment,” she said.

“These are all factors that are reshaping society. And we completely ignore that any of this is happening, because it doesn’t fit with the prescribed notions of our expertise. But our expertise is being very quickly democratized, through technology and through social media.

“The days of thinking that the crowd is dumb money is not really accurate,” Kaul said.

Kaul said access to information is becoming instantaneous and organisations can glean insights on hope to improve operational efficiency from understanding crowd dynamics. She said technology is allowing organisations to synthesise vast amounts of knowledge from often disparate fields.

“So, we need to rise to the challenge to think about what does this mean for how I think about what my portfolio is actually able to deliver,” she said.

“And I think that that is where we are seeing huge potential come in. Because what are we doing in this room, we are creating a community, this community. A lot of the value that you’re going to take away from this conference isn’t going to be necessarily only from the presentations on the stage, it’s going to be from the conversations you’ve had with other people in this room.

“What you now need to understand is that that community has expanded exponentially and has become virtual, and we need to join in those communities as much as we need to join in the communities physically in this room.”

Megatrends are the forces that will shape our planet, our society and our lives decades into the future. The Fiduciary Investors Symposium at Stanford University heard megatrends provide potentially rich pickings for investors, as long as they know how to use them, and how to start looking for the best opportunities.

Investing is all about making as well informed and accurate predictions as possible about the future directions of nations, economies, markets and securities. And delegates at the Fiduciary Investors Symposium at Stanford University heard that one of the most reliable investment indicators are so-called megatrends.

Pictet Asset Management senior investment manager and head of thematic equities Hans Peter Portner said megatrends are necessarily forward-looking, as opposed to benchmarks which by their nature are backward-looking, and they have three essential characteristics.

“First of all, they are long-term, they have a life expectancy of at least 15 years,” he said. “Then they are very deep and broad – broad, as they impact governments, they impact enterprises, they impact our personal lives; deep, as they change how we run governments, they change how we do business and they change we conduct our lives.”

Portner said a megatrend is made up of smaller trends that come together to form a forward-looking big-picture view. Pictet builds on the work of the Copenhagen Institute for Future Studies in identifying the megatrends it uses to begin its research.

“Megatrends conceptually are an aggregation, a complex aggregation, of trends, of sub-trends and fads,” he said.

“The way I depict it is you can imagine it as a river fed by streams and creeks and trickles.

“The investment concept behind all this [is that] where mega trends intersect, themes emerge.”

Portner said Pictet has identified 21 megatrends, collected into six major clusters (see box), but it is up to individual investors to determine which of them they believe are most significant, where they intersect, and hence which are potentially investable.

Delegates at the Fiduciary Investors Symposium nominated Technology and Science: AI and computing power (nominated by 73 per cent of delegates), Environment: Climate change (55 per cent), and Technology and Science: Life sciences (23 per cent) as the three most investable megatrends.

Once identified, the intersection or convergence of megatrends give investors an indication of where to begin looking for potential investment targets. But Portner stressed that while megatrends may provide a starting point, the onus remains on investors to do due diligence and deep company analysis to find the best investee companies.

“Megatrends are your friends,” Portner said.

“And the megatrend gives you the focus with these intersections. It is the starting point of your company analysis. You screen for companies that have a high exposure to the secular trends. And if you are a long-term investor, extremely focused, you’re also strategic partners to the management teams you invest in.

“So we are we are extremely active in engagement to extract further value. Our themes have also natural exposure to environmental and societal variables. So we are also impactful. This is a very big theme in in Europe, probably less so still in the US, but is certainly also coming.”

Portner said successfully investing in megatrends requires the right ecosystem of academic research to define the megatrends; investment professionals to conduct the analysis to find the companies likely to benefit most from those megatrends; and industry practitioners who can monitor the trends going forward.

“You need the infrastructure,” he said.

“You need to create the right ecosystem. And you need some academic input. You need some raw material. These sources are sociologists, people looking to the future. You find them, you find think tanks that offer this. And then you need, obviously, PMs who look at intersections. That’s our value-added, we create intersections of mega trends.

“And then as when themes emerge, they are not static. Megatrends remain stable, these are really, really steady things with a life expectancy of 15 years, as I’ve already said, but themes evolve over time.

“And that’s why we have also for each strategy an advisory board attached, composed of professors from universities dealing with the themes we are active on. We have independent analysts [and] we have CEOs of companies that are part of this segment of the market.”

Evolving portfolio construction techniques that include more attention to liquidity management, diversification and resilience are needed in a macro environment that has more complexity and volatility delegates at the Fiduciary Investors Symposium at Stanford University heard. Investors from CalSTRS, CPP Investments and MFS share their approach.

Evolving portfolio construction techniques that include more attention to liquidity management, diversification and resilience are needed in a macro environment that has more complexity and volatility.

Delegates at the Fiduciary Investors Symposium at Stanford University heard that inflation, geopolitical risk, and climate are contributors to a more complex environment that has a broader range of outcomes, dictating an evolving approach to portfolio construction.

Derek Walker, head of portfolio design and construction at CPP Investments and Geraldine Jimenez, senior investment director at CalSTRS both said that liquidity management was top of mind.

For CalSTRS it was focused on the funded status and the maturity of the plan and a larger allocation to private markets than ever before.

For CPP the focus on liquidity is to ensure “as much capital is put to work as possible”.

“Our focus on liquidity is quite intense, not because of cashflow needs but because we want to allocate as much as we can to active programs and that they are allocated as efficiently as possible,” Walker says.

The panel, which also included Benoit Anne (pictured), managing director of fixed income solutions at MFS, participated in a conversation about diversification that was anchored around liquidity and equity bond correlations.

CPP Investments has built its investment strategy on “three big planks” with one of those constructing resilient portfolios.

“Correlations are such a crucial part of diversification and something we have been trying to augment, in terms of, for example, adding inflation sensitive assets.”

Similarly, CalSTRS has added inflation-sensitive assets, a risk-mitigating strategy, and private credit.

With investors looking for a strategy to truly provide diversification, MFS’s Anne proffered the return of fixed income as an alternative to alternatives.

“I’m really excited about the comeback of fixed income as an interesting asset class after years of risking falling into oblivion,” he told delegates, pointing to duration risk in particular.

He said the analysis of macro regimes was a very important pillar of the investment process and was ecstatic to be moving away from the era of quantitative easing. Monetary policy, he said, was “back as a powerful policy tool” going forward.

“We are moving away from the fear of the Fed that was very toxic and painful for most investors for the past few quarters,” he said.

“Thank god we are exiting this long era of QE, which came with a lot of collateral damage and distortions and we are now facing the luxury of some sort of normalisation, the old normal. It is very good news, we are embracing the shift away from QE.”

Anne said there was definitely a shift to more complexity and higher uncertainty which was a favourable environment for fixed income.

“I think public fixed income provides one way to manage that complexity after the repricing because fixed income is back as a volatility management tool and return generator.”

 

Bridgewater Associates co-chief investment officer Greg Jensen said government policy has steadily increased in influence over the economy and portfolio construction over the past 20 years and now outstrips the importance of private sector incentives. The pace of deglobalisation is a key trend for institutional investors to keep abreast of, he says, as the US races towards another presidential election cycle.

Government policy has surpassed private sector incentives as a major factor influencing financial markets and portfolio outcomes, said Greg Jensen, co-chief investment officer at Bridgewater Associates.

Jensen, who leads portfolio construction at the storied hedge fund alongside Karen Karniol-Tambour and Bob Prince, told the Fiduciary Investors Symposium at Stanford University last week that investors need to pay more attention to geopolitics and public policy now than at any time in the past two decades of market cycles.

“This is a very time where politics matter a lot, with a lot of cross cutting ways,” he said. “If you turn back the clock 20 years … largely, in most of the West, the politics weren’t that important, the private sector was the more dominant driver of the economy.

“[But] today, with the geopolitics and the degree of government [intervention] … fiscal and monetary policy are as important drivers oif the economy as the private sector and the incentives of capitalism.”

Jensen listed climate policy and the energy transition as an example of a policy area in which the decisions of world governments would have an outsized influence over investments. Initiatives aimed at reducing wealth inequality was another.

The Connecticut-based investment chief estimated that government policy had grown from representing a 30 per cent influence over the global economy, with the private sector accounting for 70 per cent, to a 60/40 split in government’s favour.

Asked whether the outcome of next year’s US presidential election mattered to investors, Jensen said the “rate of deglobalisation” was one of the important trends that could be impacted. Republican frontrunner and former President Donald Trump was a vocal opponent of globalism and the US economy’s seeming reliance on foreign manufacturing.

In order to protect portfolios against the geopolitical risk, Jensen suggested CIOs consider an equation that analyses “ the effects of globalisation, and then reverse those things”. He said the pace with which deglobalisation was taking hold in the global economy was having an enormous impact on portfolios, referencing trade between the US and China, which took decades to build up gradually but “fell off a cliff” amid more recent diplomatic tensions.

Those trade tensions meant that “marginal dollars” are now flowing out of China to more expensive markets from the perspective of productivity, although Jensen added the labour cost gap between China and the rest of the world has reduced as living standards in the world’s most populous nation have risen.

“We’re trying we’re trying to measure those flows, trying to measure the economic quantities that are coming out of China, where they’ll go and how those things are going to be affected. And, that’s a huge area of work.”

Jensen admitted that Bridgewater had made a number of missteps that dragged on investment performance in the second half of 2022. Inflation in the US fell more dramatically than the firm and its analysts had predicted, while the downturn in economic activity was more muted.

But he stood behind the thesis that many economic indicators are “unsustainable”, even though the original call from Bridgewater may have been eight or nine months early.

“The big picture is that the profit margin picture for companies is getting worse,” Jensen said. “Corporations and households, particularly in the US have extended their duration to such a degree that debts are very long duration, [which] means the tightening plays out over a longer period of time than it would otherwise. Those things have slowed down the cycle, but I don’t think it’s ended the basic shape of the cycle. And so I do think you’re going to see weaker growth.”

Jensen said Bridgewater’s famed research process, which now incorporates elements of generative AI in the form of virtual investment associate, had input all the data relating to the misguided bets of last year and would factor them into future predictions.

“The great thing about markets is you have two outcomes,” he said. “You could be right, which is kind of cool. Or you could be wrong, and you get to learn, which is also kind of cool.”

 More than $4 trillion a year in investment is needed over the next 30 years to meet the goal of net zero by 2050, asset owners have been told. Arun Majumdar, dean of Stanford University’s school of sustainability describes it as the “defining challenge and opportunity of the 21st century” for investors. But Greg Jackson, chief executive of renewables pioneer Octopus Energy, says it is only feasible if a revolutionary new global energy grid is established.  

More than $4 trillion a year in investment is needed over the next 30 years to meet the goal of net zero by 2050, asset owners have been told.

The figure, an estimate of the International Energy Agency, was described by Arun Majumdar, inaugural dean of the Stanford Doerr School of Sustainability, as the “defining challenge and opportunity of the 21st century”, with a critical role to be played by private capital.

“All the major nations, fortune 500 companies have made commitments but no-one knows how to get there,” Majumdar told the Top1000funds.com Fiduciary Investors Symposium at Stanford University in California last week.

Majumdar, a former vice-president of energy at Google, said the scale of the challenge was vast but the commercial opportunities for investors were beginning to stack up. “We have never seen solar and wind this good and cheap in human history,” he said.

But Greg Jackson, chief executive of London-headquartered Octopus Energy – which has 5.3 million customers via its retail arm – said “incumbent thinking” was thwarting progress on net zero and investment in renewables.

“If anyone should understand exponential growth its investors,” Jackson told the symposium. “The only thing holding us back is actions of governments, companies and their investors.”

He joked that he was going to “ban the words ‘energy transition’” in his company, urging that a more wholesale shift in consumer and investor behaviour was required.

“We need to build an entirely new, upgraded global energy system,” he said.

Majumdar concurred, describing the approach as “powerful” and noting that the electricity grid used in most nations had not advanced much technologically since “Edison and Tesla”, a reference to 19th century inventors Thomas Edison and Nikola Tesla.

At the same time, Majumdar, who had just returned to the Stanford campus from a tour of Asia, including the G20 summit in India, said it was important that business and activists acknowledged that different regions must set their own timelines and commitments.

He gave the example of Indonesia, which he said would “love to transition” because its food production was already being adversely affected by climate change-related heat waves, but was also still opening and operating coal power stations years away from ammortization.

On the flipside, Jackson said there were signs of swift progress in the developed world, with the number of EV charging stations in the UK growing tenfold in a 12-month period.

In response to a question from the floor from an executive at a US pension scheme, who complained that some interpretations of the fiduciary duty precluded impact investing in renewable energy, Jackson reminded delegates to the symposium of their political clout, as the stewards of almost $8 trillion in investor capital.

“Talk to your governments – if you’re being forced to invest in the wrong things, they [will] listen to you.”

Investors face challenges finding opportunities among companies that don’t have a clearly defined transition pathway. But it can made more effective by a focus on the tangible investments being made by those companies, rather than listening too closely to pledges and targets that exist only on paper.

Investors that want to address the low carbon transition as a potential investment theme should build an investment process that helps them focus on tangible investments being made by companies, not just pledges made on paper, the Fiduciary Investors Symposium at Stanford University has heard.

Affirmative Investment Management sustainable credit specialist George Barnard told the symposium the first pillar of a research process for doing that is deep company-level expertise. The second pillar is a systems or whole-economy approach; and the third is “making sure that all of this is integrated into the investment process”.

Barnard said a deep research approach involves integrating often overlapping areas of investment expertise.

“The first and most familiar to us as investors is company-level expertise,” he said.

“This is an understanding of the company. Rather than from a fundamental credit perspective [it’s understanding it] from a transition perspective. We need to understand the plans, the targets…beyond just are they targeting X percent emissions reductions?”

Barnard said one of the hurdles to the low-carbon transition is scepticism about timeframes being unrealistic, or targets set and pledges made insincerely.

“We’ve seen a lot of net-zero pledges which functionally aren’t really worth the paper they’re written on,” he said.

But if that’s the elephant in the room of the transition debate, the key to solving it is to eat that elephant one bite at a time.

“One of the problems is that we’re dealing with a very large problem and we’re not breaking it down.

“When you look at transition as a theme, and it’s just this massive economy-wide problem, it’s very hard to engage with. It’s very hard to identify a company and say, you know, yes, this is a good candidate for the low carbon transition.

“So we also need to understand the tangible investments, the capital being deployed [and] the R&D going on in the background that will actually get that company to those targets.”

Barnard said some companies, industries and sectors have relatively clear transition paths but for others it’s less clear and considerably more challenging.

As an example, the production of aluminium can use renewable energy as an input to the manufacturing process, But on the other hand, it uses anodes that decay and release CO2 into the atmosphere.

“We know there’s a solution, in anodes which don’t degrade and therefore don’t release CO2 into the environment [but] we don’t know how to make them,” he said.

Barnard said engaging with companies in “in a constructive and robust way with respect to their transition plans” is key to identifying opportunities and investment targets and supplying the capital those entities need to make the transition.

“That requires an understanding of what those risks and opportunities are, it requires an understanding of what the potential future solutions are going to be, and whether they’re realistic, and in what timeframes. And that’s really the idea behind transition analysis.”

Barnard said a core component of any company analysis is the tangible investments being made and committed to, which can’t be rolled back or reneged on.

“We like to see robust targets and strategies, but they’re not as good as seeing that this car company is building a dedicated EV plant like they’re not going to not going to knock it down in five years, that it’s locked in,” he said.

“We like to see JVs with battery producers to build huge amounts of capacity. That’s the kind of thing that allows us to be confident in the longevity of that particular strategy.

“There is always uncertainty, and we have seen companies roll back on commitments, but we aim to be as confident as we can with the information that we have at the time.”

Affinity approaches transition finance from a fixed-income perspective, because that’s its background as a manager, but Barnard stresses that the strategy need not necessarily be restricted to bonds. The genesis of the strategy was to consider what a 2050 economy looks like, and a realisation there are hard-to-abate sectors in the economy that re not receiving the investment they needed to effect a transition.

“We were looking at portfolios and thinking, there’s a need to address here,” he said.

“But when we were building that strategy to address that need, it wasn’t from the perspective of let’s go into a new asset class. It was [that] we do this, and we want to support our clients to generate the most impact they can, and to provide innovative new solutions to generate that impact. And that’s really where the strategy stemmed from.”

Barnard said the strategy has started to shift into private asset classes but is moving slowly as it gathers and assesses the quality of the data it needs to support its deep-research approach

“You’ve got to work out, okay, how do I digest this new type of data, this new availability of data?” he said.

“What levers can I pull to increase the availability of that? And so that process is ongoing, but it will, [and] there are there are challenges to solve that.”