Kosovo, a small country in south-eastern Europe that emerged as an independent state after the Balkan conflict, plans to create a sovereign development fund, SDF, the first of its kind in the region.

The SDF, distinct from sovereign wealth funds set up by resource-rich countries to manage and ring fence surplus revenues, will act like a strategic investor in the Kosovan economy, tasked with transforming unprofitable state-run industries and attracting foreign investment into one of Europe’s poorest corners.

It is the latest country to establish a sovereign fund in a growing trend that has seen the number of funds jump fivefold from 20 to approximately 100 over the last 20 years.

“Kosovo has not done well in terms of attracting foreign investment,” explains Besnik Pula, associate professor of political science at Virginia Tech, the US university, who as chair of the working group behind the launch of the fund has helped shape its key objectives, institutional design and purpose, the details of which now await parliamentary approval. “With this fund there will be more certainty and security to invest in Kosovo.”

Kosovo’s SDF is modelled on Ireland’s €9.5 billion ($10.2 billion) Strategic Investment Fund (ISIF), established in 2014 with a double bottom line to both invest commercially and support economic activity and employment in Ireland, explains Pula.  The team have also drawn inspiration from the Slovenian Sovereign Holding, asset manager of Slovenia’s state’s holdings, and Greece’s similarly structured Hellenic Corporation of Assets and Participations.

Under the current plan, the government will seed the fund with a €20 million investment. Next, Kosovo’s state-run energy, telecom and mining groups (Trepča Mines, Kosovo Energy Corp and Telecom of Kosovo) will be absorbed into the fund, becoming its first asset base.

“A series of companies will form the base of the fund in addition to the investment the government will make,” he says. “Since independence, these enterprises have not been managed or governed successfully but there is great potential for these sectors. The idea is to incorporate these industries into the fund’s asset base and lead the development of these sectors of the economy.”

In time, additional assets will also come under the fund’s management umbrella, fed via Kosovo’s privatization agency and likely to include real estate and agricultural assets.

Once these companies are restructured, and management overhauled, the hope is foreign investment will follow. “The second step would involve opening up these companies for equity investment and introducing foreign investment into these sectors,” explains Pula. The fund would also be able to establish new companies, offering the potential for co-investment with foreign investors.

So far the team have talked mostly with peer funds and developmental banks like the EBRD and World Bank. The conversation is still focused on the best model, rather than pitching to investors, he says. “We want to make sure we have a structure in place before we reach out to investors and offer particular opportunities,” he says.

Still, conversations with peer funds can lead to investment under some SDF models. For example, India’s government-seeded National Investment and Infrastructure Fund, NIFF, has tapped a rich seam of investment from fellow sovereign investors including Abu Dhabi Investment Authority and Temasek.

Governance

Pula and the team are also laying governance foundations, designed to keep political influence at arms length. “It is a high priority to create a fund that is not under the political influence of the government,” he says. Kosovo’s parliament will monitor and supervise the fund, also responsible for appointing an independent supervisory board with ultimate control. The board will appoint a CEO and executive structure, and the investment strategy will be established and managed by these fund executives.

“Once the law is passed, hopefully everything will quickly move to a more concrete stage,” he concludes. “This is the first fund of its type in the western Balkans and if it succeeds it could be a model for other countries like Montenegro, Albania and Northern Macedonia. Our neighbours are taking an interest in what we are doing and if we succeed, more countries will follow suit.”

Kosovo declared independence from neighbouring Serbia in 2008. Serbia (plus a handful of EU countries) still doesn’t recognise its former province as independent.

 

 

 

Visible positioning on the inclusion of women and minoritized groups in financial services and investment management is now the norm.

Much has changed in a decade to improve upon diversity and inclusion in finance, and is wonderfully portrayed by “Fearless Girl”  and her statuary presence on Wall Street.  Many financial and investment firms have positioned themselves as advocates for gender and racial diversity across not just finance but throughout corporate America for years. But, as we all know, positioning and doing are two distinct things.

Initially “Fearless G,” as we now call her, was defiantly staring down the Charging Bull statue near Battery Park in New York’s Financial District. The statue was installed on March 7, 2017, in tribute to International Women’s Day and ever since has attracted ever-expanding interpretations of her purpose and import. To us, at least, she is more than a tip of the hat to International Women’s Day.

On our data, women represent just 19 per cent of CFA Institute members globally – often seen as a proxy for the investment industry – and only 17 per cent in the US. We are actively committed to changing these metrics.

Fearless G has since relocated to her new location across from the New York Stock Exchange, just a couple of blocks away from her original perch. Now she glares at Wall Street personified, the iconic stock exchange building located at the corner of Broad and Wall streets in New York, where her rebel with a cause symbolism has become even more pronounced.

Many feel she embodies a glass-ceiling protest in the financial services sector where women and other underrepresented populations have faced long and continuing barriers to promotion, equal opportunity, and equal pay.  To us at least, while it’s clear that Fearless G has more work to do, we think she shouldn’t have to do it alone.

According to 2023 figures reported in the Pensions & Investments publication, the use of money management firms owned by women, minorities, people with disabilities and veterans (WMDV) by the top 200 US retirement plans is exceedingly small. Of the top 200 defined benefit pensions surveyed for 2023, only 22 funds reported WMDV allocations, amounting to AUM of around $130 billion. It sounds sizeable and it is an increase over the $120 billion reported in 2022. Yet, when compared to a total AUM at these pensions of over $3.32 trillion – it is scarcely 3 per cent of pension assets held by the top 200 funds.

While progress has been slow in advancing the aim of diversity, equity, and inclusion in finance, many pension executives are affirming a commitment and focus on allocations to diverse managers. Actions have included the adoption of formal diversity hiring policies at funds as well as the addition of diversity and inclusion factors in every manager search process. Importantly, these plan executives are quick to point out these hires are not an affirmative-action plan for the pension fund but are an acknowledgment that a diverse pool of asset managers can reduce volatility as it increases cognitive diversity, portfolio diversification and alpha opportunities.

Beyond diverse management and ownership of firms lies the more foundational matter of ensuring that the broader employee base in the investment management and financial services industry is becoming more inclusive and diverse in its make-up. Human resource departments across a wide range of employers have worked at varying paces to build a more diversified work force for decades. But progress depends in large part on a range of factors including the available candidate pool, the size of firms and a level of dedication in the C-suite to race, culture, and gender diversity.

Based on the work we have done at CFA Institute with a wide range of asset owners, asset holders and other market participants, we lay out a few basic principles for expanding a diverse pool of employees and prospects that are vital to the investment industry’s long-term success.

First, ensuring that all aspects of hiring practice are equitable and inclusive, from university graduate recruitment to experienced hires and senior roles, is critical to improving diversity.

Second, the aspects of promotion and retention are key features of an effective diversity plan that are often overlooked. Firms that ensure access to training, new opportunities, and initiate performance appraisal processes that seek to improve diversity are key to building employee visibility and experience. The principle of retention involves designing and maintaining inclusive support systems, such as mentorship and sponsorship, work–life accommodations, and efforts to eliminate harassment, which can be a principal cause of departure.

Third, the attributes of firm leadership are key in the diversity equation. If leadership sets clear diversity expectations for inclusive behavior and then modelsthat behavior, they establish a culture that becomes embedded and supported. To drive progress, leadership itself must be diverse, inclusive, accountable to stakeholders, and trained to manage and lead diverse teams at all operational levels within the organization.

more action needed

We should be proud of the progress we are making, but it is safe to say that Wall Street diversity and inclusion is still a work-in-progress.

We are encouraged, however, that signs are everywhere that this has become far more than a talking point.

Women are now 28 per cent of CFA candidates in the US, those just starting out in their careers, 33 per cent pre-pandemic. Not enough, but back on an improving trend.

Now, progress is being supported by the growing influences of investment management clients and the consumers of other financial services that have the ability to urge principles and practices that promote greater diversity within the industry.

Whether it is diversity of financial firm ownership, within the firm’s leadership team or among the firm’s rank-and-file employee base, Fearless G’s steady gaze must persist.

Sarah Maynard is global senior head of diversity, equity and inclusion and Paul Andrews is managing director of research, advocacy, and standards at CFA Institute.

A couple of months ago, investment executives at Montreal-based Trans-Canada Capital, TCC, travelled to Colombia to carry out due diligence on a niche Columbian asset manager. It was an unusual opportunity.

Following a recent court decision, the Columbian government has pledged to pay reparations to victims of the Latin American country’s past conflict. The manager’s strategy involved settling the claims with the victims and waiting for payback from the government.

“It will accrue around 18 per cent interest. We hedge the currency risk and are then left with a 12-13 per cent risk on Colombian government paper. It’s a good trade that is already popular in Brazil but no one was looking at Colombia,” says Marc-André Soublière, senior VP fixed income and derivatives at TCC.

The strategy is a direct reflection of TCC’s innovative, untraditional investment strategy.

With a different world view from its Montreal home, the asset manager of flagship carrier Air Canada’s C$21 billion ($15.9 billion) pension fund fuses its pension fund roots with the ethos of a relative value hedge fund for a unique investment approach that hunts uncorrelated alpha across the entire portfolio.

Since setting up shop in 2019 after being spun out of the investment arm of Air Canada Pension Investments to create a new entity able to manage assets for external firms, TCC has attracted a growing cohort of institutional clients, and more recently, family offices.

Seed investor Air Canada remains TCC’s biggest client, comprising the bulk of its C$27.2 billion assets under management that includes leverage and LDI strategies. But Air Canada’s different portfolios comprising bonds (where it allocates 50 per cent) alternatives (30 per cent) hedge funds (roughly 15 per cent) and equities (5 per cent) now provide an investment template increasingly tapped by other clients, drawn to a bold strategy that has transformed the pension fund from deficit to C$4.4 billion surplus.

Multi-strategy hedge fund

One of the jewels in TCC’s crown is a $1.3 billion multi-strategy hedge fund targeting multiple, diverse alpha streams coupled with an eagle eye on tail risk and sizing. A 10-person team invests globally in all asset classes spanning volatility to credit, commodities, equity, currencies, and real and nominal interest rates to bring multiple diversification seams into the portfolio using different strategies and financial instruments.

All investments are viewed in the context of risk, and the strategy is fiercely anti-silo in an approach equally split between systematic strategies and human expertise.

“For us, it is one portfolio,” explains Simon Guyard, senior portfolio manager at TCC. “No one is forced to trade in a certain way. It is just about the best implementation and the best asset class.”

Add to this TCC’s pension fund roots allowing the hedge fund team to be patient and take a long-term view.

For example, Soublière, who was at PSP Investments and Hydro Quebec before joining Air Canada in 2009, says that for some trades, TCC is undaunted by the wide bid ask spreads that deter other hedge funds.

“If we look at it and it makes sense and we expect to make money, we will put it in the book.”

In another example, TCC gets involved in risk transfer trades, another area many investors steer clear.

“It surprises a lot of people that we do this because we are only a small hedge fund,” reflects Guyard, who explains the trade suits TCC because of its whole portfolio approach that prizes diversification.

Moreover, risk is always limited by a strategy to never invest too much.

“Instead of eating four slices of pizza we will be content with two, hedge out the risk and get a bigger sharpe ratio. We don’t just focus on returns; we focus most on the sharpe ratio and limiting the downside,” says Soublière.

Soublière and Guyard are also convinced TCC’s adventurous investment approach is also rooted in their Montreal base –  although a source of curiosity (and the odd joke) amongst hedge fund rivals in New York and London. TCC’s view of the world from French-speaking Quebec gives the firm a different perspective which in turn leads to different kinds of investments to other hedge funds, many of which, they reflect, are invested in the same trades.

It is also possible to attract and retain talent in Montreal thanks to Canada’s vibrant pension industry.

“We get them in and then get them comfy with taking risk,” laughs Soublière. “Our staff turnover is close to zero. Over the last 13 years I’ve lost two employees, and both wanted to come back!”

unconstrained Fixed Income

The same unconstrained approach characterises the fixed income portfolio. Here, like in the hedge fund allocation, sizing is key with a focus on independent trades that work together in a constant portfolio churn.

“Few other Canadian investors rotate their fixed income portfolio as much as we do,” says Soublière.

The allocation goes above and beyond a typical manager strategy shaped around duration, curve, and credit. Instead, TCC has developed a global-macro, relative-value approach that trades curves from around the world; corporate credit, negative basis and cross market long short positions.

It would be impossible to find uncorrelated trades by just staying in Canada, explains Soublière, who believes this makes the fund unique for Canadian investors.

“We blow out the silos, and look across European, US and Asian curves to find risks that are uncorrelated to our home market. Name a country and we’ve probably traded something,” he says, adding that trades in emerging markets are limited to swaps and futures, rather than buying physical paper.

TCC’s Alternative Fund is another key portfolio, a mature program invested across multiple managers in real estate, infrastructure, private equity, and private debt and increasingly popular with family office clientele seeking to outsource management of private markets.

“The big advantage for these investors is that there is no J curve,” explains Soublière. “They invest directly into a mature portfolio that also offers liquidity.”

The liquidity comes from a sleeve that allows TCC to keep a portion of the portfolio in liquid units, moving money around when it comes in to suit clients.

“It’s an open-ended fund with quarterly liquidity. It’s part liquid, part private,” says Soublière.

Other features of the private market allocation include eschewing core allocations in real estate where the risk premiums are too low. “We would rather do other stuff where the risk premiums are higher.”

Challenging environment

Despite welcome volatility and dislocation fanning opportunities over the last year, the rise in interest rates has provided challenges. None more so than careful cash management given the LDI element of the Air Canada allocation, and wide derivative use to express trades.

TCC posts collateral with its banking partners in return for balance sheet to allow it to use leverage. Yet banks grew wary when the value of the fixed income portfolio collapsed to the extent the levered long bond portfolio lost 45 per cent of its NAV in six months as rates climbed higher.

TCC runs a 2:1 leverage on one bond fund (in contrast to the UK where much higher leverage levels on longer duration bonds got many LDI strategies into trouble last year) but it was still hairy, explains Soublière.

“The last thing you want to do is run out of collateral to post to banks to get money for a capital call. When you do LDI, it’s important to never run out of repo-able assets.”

TCC’s holistic view of cash where stress tests are carried out weekly, monthly and yearly stood the investor in good stead, he adds.

“You never want to get close to a level where you might not have enough cash.”

In many ways the pandemic, which hit just a few months after TCC launched, was easier to navigate than higher rates. Not through any great foresight of a pandemic (Soublière and Guyard add in unison) but rather because of an early 2020 strategy to snap up cheap risk premiums, TCC found itself risk off with multiple hedges on its book just as COVID broke.

As central banks embarked on fresh rounds of quantitative easing, TCC pivoted the other way. “We kept a bullish view for the whole year,” says Soublière, explaining that relative value proved one of the best strategies, trading corporate spreads as central banks injected liquidity.

“The Fed was the first to act and corporate spreads in the US shrunk versus Canada and Europe. We bought the spread in Canada and Europe and hedged in the US and then rolled this trade as central banks rolled out QE,” he recalls. “It really is our edge to look everywhere and find the best way to implement a trade.”

UK politicians are urging the country’s pension funds to invest less in UK government bonds (Gilts) and more in riskier and complex assets, including young UK companies and infrastructure. Railpen’s head of investment strategy and research, John Greaves, explains the various problems with the plan.

The asset mix of closed defined benefit (DB) pension funds in the UK has been moving more into low risk assets like Gilts in recent decades as these schemes have matured.

The sudden rise in government bond yields over the past 12 months has accelerated this trend. It’s led politicians and some industry spokespeople to look at the £1.2 trillion of assets in schemes like these (around 5,000 DB schemes) and argue it shouldn’t all be invested in Gilts and corporate bonds.

That’s a perfectly reasonable argument, but the language being used by some implies that trustees are at fault and pension fund managers are risk averse, says John Greaves, head of investment strategy at Railpen, the £37 billion fund.

This misunderstands the role of defined benefit funds, mandated essentially via a contract between employer and member to deliver a particular level of benefits in retirement.

UK pension funds support this outcome; delivering on this pension promise is a great result and it’s the responsibility of the trustee to deliver on this without taking unnecessary risk. The Pensions Regulator has quite understandably been emphasising the importance of reducing investment risk over time for these closed DB schemes to reduce reliance on the sponsor.

“We must consider the current funding positions and scheme objectives before encouraging pension funds to invest in alternative assets such as infrastructure and private equity, which tend to be higher risk. Many closed DB pension funds are well funded and do not need to take this added risk to deliver the returns required,” he continues.

Additionally, for those schemes that wish to change their investment mindsets and take on more risk, Greaves notes that the wider regulatory and legal frameworks play a significant role in shaping the decisions of trustees, too. The idea that trustees are risk averse because many pension schemes own a material amount of Gilts is not true, because Gilts have a vital role to play in a portfolio to deliver on the pension promise mentioned before.

“I believe the issue lies elsewhere, particularly in regards to the low member engagement and contribution levels in the UK,” he says.

The relatively recent democratisation of pension saving, in the form of auto-enrolment, and the low levels of both employer and employee minimum contributions have created a wealth gap compared to other pension systems.

Auto-enrolment is moving in the right direction, but the UK is still a long way behind other countries. For example, in Australia, employer contributions are moving to 12 per cent minimum. In the UK, employer contribution minimums are only 3 per cent, and members contribute 5 per cent.

“We are not yet contributing enough into our pensions,” he says.

The UK has an unfunded state pension system and many larger public sector schemes are also unfunded. There is also a proliferation of private sector schemes and individually invested plans with an emphasis on member choice and flexibility, rather than scale and investing for the long-term. There is not a big pot of institutionally managed money, sitting in the accumulation and growth phase of investing, available to deploy.

risk management Benefits

Railpen manages around £37 billion of both open and closed DB pension funds, and also DC. Most of the fund’s assets back the liabilities of open pension schemes. Even in open DB schemes, government bond assets have an important role to play, providing diversification (although this varies when inflation is high) and today a reasonable return by recent history, even after inflation.

Bonds can provide shelter for open DB schemes in times of volatility – like a growth shock – or a shift in market and economic regime – like a potential return to the low yield world of only 18 months ago. If the return drivers in a growth portfolio stall, government bonds can help manage that risk.

“For Railpen’s open schemes, bonds are an important risk management tool, even if we don’t invest as much in them as the closed DB funds we manage. Of course it’s possible to find secure assets that have many of the same characteristics as government bonds over the long-term, like infrastructure and other real assets, where we invest a significant amount of the schemes money – around 12 per cent, mostly in the UK, with ambitions to move higher,” he says.

Ultimately, a trustee board, with support from advisors, is best placed to decide the right asset mix to deliver on a pension fund’s goals, concludes Greaves.

“We work closely with our trustee to continuously review our asset allocation and risk profile to deliver the best outcome for the 350,000 members that entrust us with this responsibility.”

The State of Wisconsin Investment Board, the $143 billion asset manager of state investment funds including the Wisconsin Retirement System has just launched a new Best Ideas active equity allocation.

The concentrated portfolio that will eventually comprise around 50-70 stocks, focuses on companies providing unique and interesting solutions that capture idiosyncratic, stock specific risk missed by the market.

“We are attracted if our idea is different to the market. That’s the opportunity,” enthuses Susan Schmidt, head of public equities at SWIB, overseeing the portfolio which will range from between $4-$15 billion depending on the opportunity in a highly selective, “choosy” strategy that takes advantage of SWIB’s long-term approach.

A month in, she says returns are already pleasing. “It’s ahead of benchmark and the portfolio is doing well.”

The new allocation was born out of a conviction that SWIB’s talented active equity team could hone a more creative and differentiating approach, she continues. A strategy that focused on specific company situations, delving into the weeds to expose individual opportunities at a company specific level would add more value than an all-market, cross-sector, allocation primarily concerned on beating MSCI AQWI returns.

Capital light

Strategy is capital light whereby SWIB invests with a long position, but also puts a short position against it, using less committed capital to fund the portfolio. Short positions are a way to increase exposure and raise cash, allowing SWIB to go long with the total amount that includes the cash raised in the short positions, she explains.

“It gives us more breadth. We think this capital light structure is a more efficient deployment of many of our assets and helps us get a better return,” says Schmidt.

Most of the Best Ideas allocation is invested in the US, mirroring the geographic allocations of the MSCI World to achieve a 70:30 split between the US and global markets.

The portfolio investments are focused on developed markets.

SWIB will continue to run its small cap portfolio, an allocation that has beaten the benchmark over multiple years.

Portfolio managers, all covering different sectors, find ideas and develop an investment thesis. Next they present a fully-fleshed out idea to the entire team, who then discuss the merits and risk of inclusion, and timing. Very high standards govern what companies come into the portfolio, she says. “There is a lot of debate back and forth in a process that is meant to ensure a truly best in class portfolio. Every investment is made with a high degree of conviction and seen as a true opportunity.”

Old school

It’s a strategy shaped around old school, fundamental analysis where the team take time to think through and identify unique situations. They meet companies, look at business models, dig through financials and talk to competitors and customers in a quest to understand the business and assess key influences on corporate cash flows going forward. “We get an idea of what will happen to a company.”

Moreover its an investment process she’s convinced can still add real value.

The skill of the team, strategy, and SWIB’s unique investment culture can unearth opportunities that the market misses. “Capital markets can be very efficient, but the market also misses things; markets can’t tell the entire story all the time. We have the breadth and depth to exploit when the market is missing things.”

It’s a deep dive approach that doesn’t come at the cost of being nimble. “We had an idea presented yesterday that everyone thought was good and it’s in the portfolio today. There can be a quick turnaround,” she continues, attributing such fleet of foot to the relatively small number of names in the portfolio (it will always be capped below 100) and the small (10-person) cohesive team where communication is a by-word. “It’s meant to be concentrated,” she says.

Technology allowing data collection and team collaboration is a vital contributor to speed.  An interactive platform ensures the availability of data and real-time communication between different teams. “The ability to look and share data with other teams and using technology to make sure we have the same knowledge, is a big part of why we can be as nimble as we are.”

As other investors pare back public equity or switch to cheaper index strategies, Schmidt is convinced the allocation adds value.

“Fundamental investment in public equity is still very important and economies of scale are in our favour at SWIB because it is cost effective. It brings another diversification tool to the table for the portfolio.”

She’s also undaunted by the fact that more companies are staying private for longer. To her this simply means that fewer people are looking in public markets – and there is more opportunity for SWIB. “Private equity is a great asset class and SWIB invests there too. For my team it’s great because if our competitors are diverting funds to private equity it means that they are not competing with us in the public space and aren’t in our way!”

Communication

In another nod to old fashioned skills, Schmidt prizes the ability to communicate amongst her team as highly as any expert analytical skills. Many people are good at analysis by themselves, but it is harder to recruit talent that is good at interacting around that analysis and sharing knowledge, she says. “Star players are great, but that is not our model.”

Communication is also vital if her team are to tap into SWIB’s huge resources and knowledge base. From credit analysts in the fixed income team to the quantitative expertise of the risk team, ensuring the portfolio doesn’t have any unintended exposures or hidden risk like an unseen large exposure to a single currency, is crucial. “The risk team are there to help us highlight things and make sure we don’t miss them.”

Communication also ensures that cohesion is needed to act quickly. “We don’t want to get bogged down. When we find an opportunity, we need to act.”

The other ingredient is passion. She believes fundamental equity investment requires a unique type of passion because it demands gruelling, long hours. “You are never off work,” she reflects. “There is never a moment when things are quiet. If you don’t love it, you will hate it because it takes up all your life.” Is her passion undimmed? “I love what I do, I learn something new every day, and although I’m frequently frustrated I’m never bored.”

Market outlook

SWIB’s launch of a Best Ideas portfolio follows one of the most torrid years for public equity. Last year was the worst year in public equity since 2008, and today volatility continues to characterise the market.

Equity markets remain in the throes of uncertainty because there is no clear data directing the market one way or another. It’s leaving investors unable to predict when central banks will win the fight against inflation and stop hiking up interest rates.

“At the moment, markets are dominated by emotion and indecision. Ultimately the Fed will stop raising interest rates, but the market is determined to try and micromanage the timing.”

Still, volatility is oxygen for her portfolio, revealing the opportunities at a company level where the market is mispricing shares. “We look for what’s changing in a company and what makes it special,” she concludes.

 

For investors struggling to develop better ways to measure private equity fund performance, researchers at GPIF suggest an alternative measurement model in a recent working paper.

Authors Koichi Miyazaki and Kazuhiro Shimada propose a measurement method that compares the performance of private equity funds and traditional assets more accurately than previous methods via a so-called Spread Based Direct Alpha methodology. The authors note that the performance measure is also applicable to other alternative assets such as infrastructure and real estate.

As of the end of March 2022, the total value of GPIF’s private equity allocation stood at ¥306.6 ($2.2 billion) in a jump of ¥245.6 billion ($1.7 billion) compared to the end of March 2021. Although still only a tiny portion of total assets under management at the giant ¥193 trillion ($1.5 trillion) pension fund, GPIF has been rapidly building out the portfolio.

The market value of the entire private equity portfolio increased due to new investments made through discretionary asset managers as well as market value appreciation of portfolio companies and foreign exchange fluctuations, says the fund in its 2021 annual report, published last July.

IRR v PME

While the performance of traditional assets such as stocks and bonds is often measured by time-weighted rates of return, the performance of alternative assets is generally measured by the internal rate of return (IRR) since inception. The report authors argue that when measuring the performance of private equity funds, the IRR and investment multiple, which measure the absolute value of the investment, is typically observed. While these are excellent for the purpose of understanding the absolute return of each PE fund, they are not suitable for comparing the performance of PE funds with that of traditional assets, they write.

Public Market Equivalent (PME) measures a private equity fund’s performance relative to the listed market. Various kinds of PME methods have been proposed, but the “direct alpha method” is widely assumed as the best. The PME methodology assumes that, at the point of a capital call, the same amount in question was invested in the benchmark and the performance is compared with that of the real PE fund.

“For the valuation of excess return against benchmarks, among the major PME methods, the direct alpha method, which has no mathematical defects and does not require any artificial corrections, is considered to be the best method for measuring PE fund performance at present,” write the authors.

The study proposes a measurement method that can compare the performance of PE funds quite accurately with that of traditional assets by splitting the performance of private equity funds into a beta portion, which is the market performance, and an alpha portion, which expresses the pure investment skill of PE funds, by way of the spread based direct Alpha (SBDA) and the alpha amount based on SBDA.

The alpha portion, which expresses the pure skill of the PE fund, should be extractable, and the performance relative to the MSCI ACWI ex Japan, the GPIF’s policy benchmark for foreign equities, should be measurable. Whether or not the double mandate is actually met in practice will need to be examined from various perspectives in the future. In the process, it will also be essential to improve the SBDA and the corresponding alpha amounts.

GPIF private equity portfolio ranges from buyout funds, growth equity funds, venture capital funds, turnaround funds and private debt funds. “GPIF makes diversified investments in PE funds of these type,” says the fund’s latest annual report.

Strategy includes a co-investment agreement with DBJ and the International Finance Corporation to invest in private equity in emerging markets, set up in 2015. In fiscal 2021, GPIF appointed additional external asset managers for a  Japan-focused strategy to capture domestic investment opportunities. Through a range of fund-of-funds, GPIF also invests in diversified PE funds, mainly in developed countries.

The breakdown of portfolio by region shows North America with the largest share at 77 per cent, followed by emerging countries mainly in Asia. By sector, information technology accounted for the largest share (37 per cent), while other investments were diversified across a wide range of industries, including consumer discretionary and industrials.

The IRR from the entire PE investment stood at 11.85 per cent in dollar terms (as of the end of March 2022) since its inception of in-house investment in investment trusts in June 2015.

Over the last ten years GPIF has steadily increased exposure to alternative investments (infrastructure, private equity, and real estate) seeking greater portfolio diversification, efficiency and to further ensure the stability of pension finance. As of the end of fiscal year 2021, the market value of alternative assets exceeded ¥2 trillion. Still, that only accounts for around 1 per cent of total assets – well below the funds 5 per cent threshold allocation to alternatives.