The inevitable move to more modern food production will create investment opportunities as the food industry moves to revolutionise but also reduce its own environmental impact. PGIM thematic research group director Jakob Wilhelmus outlines the risks and opportunities inherent in this mega theme.

The industry of food production has received a lot of attention due to food price inflation, but not enough attention has been paid to the food system itself is at a critical point, with technology and production systems not updated since the 1960s.

Jakob Wilhelmus, PGIM’s thematic research group director, says the two main challenges in the food chain right now are due to the outdated production systems, that helped meet past challenges, but produced a devastating impact on the environment .

“Going forward, agriculture not only needs to adapt to climate change, but also has to reduce its own environmental impact,” Wilhelmus says. “This will bring great change to the food system and will create investment opportunities across the food value chain.”

 

PGIM’s latest thematic research focuses on food and looks at the modern history of food production and consumption.

In the 1960s, food underwent “The Green Revolution’, Wilhelmus says. “It was really the starting point of modern agriculture. And similar to our current situation, food demand was growing exponentially and there was little hope that the food production and the food system that was in place back then would be able to meet demand, to the point where the idea of widespread starvation was a real concern. And the breakthrough that really changed that was crop science.”

In response, scientists started developing more efficient seating crop varieties, particularly wheat and rice and that really led to an explosion in overall production, which together with the use of fertilisers and pesticides, was large enough to meet the challenges of that time, he says.

Changing menus

Over the next 30 years, food demand is set to increase by 60 per cent by 2050. As the population grows, there will be demand for more food. However, as the population in different regions becomes more affluent, there will be a growth in different types of food – in particular more meat and convenience food – coming particularly from sub-Saharan Africa and South Asia.

This is something he calls the “globalisation” of food, and has implications highlighted in the research for cold storage and transportation.

“The distance from where we grow our food to where it is consumed, is becoming ever larger, but at the same time, more and more of that food is reliant on a consistent cold chain,” says Wilhelmus.

“Packaging is one of the many other trends that are also very much driven by both the convergence of diets and growing affluence. More and more of the food that is shipped, needs packaging, but also more and more of the convenience food that we desire needs packaging, it needs innovative ways of packaging. So packaging is another big trend.”

Meat no more?

Although Western diets are looking beyond animal based meat – Wilhelmus says this is not a trend that is threatening the meat industry.

“To put it a little bit into context, the global meat market is around $1.7 trillion, and is still set to grow by 14 per cent by 2030. In comparison to alternative meat, which is less than 1 per cent of [the global meat industry] and growth rates are at best flat, if not declining.”

The impact agriculture has on the environment is immense. Agriculture alone is responsible for 30 per cent of all greenhouse gas emissions, and 70 per cent of freshwater use. Wilhelmus believes investors should think about the food system as being very similar to where  the energy sector was a few decades ago.

“We cannot live without it, but its environmental impact is devastating. And so the only solution is to invest in the technology and innovation that will allow us to grow productivity and reduce these negative externalities.”

Putting your money where your mouth is

On the supply side of food production innovation and technology are key. According to Wilhelmus, the most attractive investment opportunities are around increasing production and becoming more sustainable.

Climate change and how it is affecting different regions is today’s big challenge – so adapting seeds to specific groups, specific regions and their climate challenges will allow farmers to increase crop yields and meet demand.

However, the replacement of traditional fertilisers and pesticides by so called biologicals is only a matter of time, Wilhelmus says.

Being a large player in a small pond comes with many challenges and advantages.

Folketrygdfondet, the asset manager of Norway’s Government Pension Fund Norway’s NOK330 billion ($31.4 billion) allocation to domestic and Nordic fixed income and equities, is restricted by the requirement of an 85 per cent allocation to domestic assets.

Consequently the fund has about 10 per cent of the free float on the Oslo Stock exchange which means it has the advantage of knowing its investee companies very well and through active ownership has an ability to influence them. But it also creates challenges for rebalancing and when changes to the benchmark occur.

The fund is looking to shift the domestic restriction and increase its ability to invest in other jurisdictions and is currently waiting on two possible changes in strategy.

Folketrygdfondet, distinct from its high-profile sibling Norges Bank Investment Management, investment manager of the giant sovereign wealth fund’s global allocation, invests 85 per cent of its assets in Norway and 15 per cent in the Nordics. It is waiting to hear back on an application made to the Ministry of Finance back in 2019 on whether it can increase its equity and credit allocations to investments in Finland, Sweden and Denmark.

“We’d like to have an enhanced universe,” says Kjetil Houg, CEO of Folketrygfondet in an interview with Top1000funds.com. “Our share in Norway has grown overtime and we have reached our limits,” he says. “We are still waiting for a final response from the Ministry.”

At the moment, Folketrygdfondet’s expertise is primarily in listed markets, although the manager can invest in unlisted shares if a company’s board has expressed an intention to apply for a listing on the stock exchange.

“We have an edge in listed markets, but we are also asked to look for opportunities in private equity,” says Houg who describes a close relationship between the investment unit and the Ministry of Finance shaped around daily contact focused on practical and fundamental discussions.

“Politicians acknowledge the work we do is important to Norway,” he says. “Our investments have a stabilizing effect on the market, and we are counter cyclical, buying when others are selling.”

Liquidity issues

Only managing the fund’s large active allocations to the Norwegian market is increasingly challenging.

“We have almost 10 per cent of the free float on the Oslo Stock exchange,” continues Houg. “That means we will typically have a 10 per cent stake in a free float company.”

The challenge manifests particularly when Folketrygdfondet rebalances back to its classic 60:40 (equity/fixed income) portfolio boundaries.

“We bump into liquidity issues quite often,” explains Houg. This becomes more of an issue if the market moves against the portfolio whilst the rebalancing is in process, increasing the difference.

“In 2021 we had a particular difficult time, selling a lot of equities to bring the portfolio back into balance,” he says. “The Ministry of Finance expects 60:40 over time and we have to bring the allocation back to basics.”

Having such a large domestic allocation is also challenging during changes in the benchmark index. Index revisions happen twice year, and oftentimes cause the same liquidity headache by triggering overweight and underweight positions and the need to adjust the portfolio.

Folketrygdfondet’s diversified, bespoke, benchmark comprises around 150-200 names in both equity and credit. Some of the positions are held for years and holdings in blue chip stocks will be large. The active strategy aims to beat the benchmark, but one way the fund navigates the risk of being such a large investor is via its strict adherence to the benchmark with a maximum tracking error of 3 per cent.

“Relative to other investors we are always looking at our benchmark. In contrast to more actively managed funds that have more idiosyncratic risk, we have more market risk in a diversified benchmark. This is very important in terms of how we manage our risk.”

The fixed income allocation taps a variety of listed and liquid sources spanning different segments of the universe from investment grade to high yield; a special liquid allocation and stock lending. “It is not risk free. We have quite a lot of risk embedded here,” he says.

Credit and equity strategy is wholly shaped around a team approach and ethos.

“We don’t have any strong egos; everyone is making the same product. The managing director has ultimate responsibility, but decision-making is also bottom up and calibrated at team level.” In equity, nine portfolio managers specialise across specific sectors and all managers sit in the same room and discuss ideas across departments.

Alongside liquidity risk, most other key risks fall under an all-encompassing ESG umbrella that spans everything from money laundering issues with banks in the region to taxation in the fish farming industry.

“All our ESG issues are considered financial items,” he says.

The team seeks to underweight companies with ESG issues, he continues. “Typically, when we have experienced a loss, it is because we are on the wrong foot in terms of being under or overweight. We always try and close that gap and have introduced stop losses in some of these positions.”

Ownership

Ownership responsibility is another consequence of being the largest player in a small market.

“We get to know companies much better than other investors. It also gives them a chance to see into our decision-making processes so that they understand how we operate as an investor.”

Members of Folketrygdfondet’s investment team currently sit on 16 corporate nomination committees, nominating members to investee companies’ boards in a process that involves meeting different board candidates and bringing names to the committee.

“The aim is to ensure the best possible board of directors for a company,” he says.

Folketrygdfondet is a smaller player in Sweden but is just as vocal when it comes to board makeup. The asset manager is  using its ownership stake in Swedish corporates to boost board independence from corporate management.

“Swedish rules allow CEOs to also be board members, but we are voting according to the Norwegian code of conduct where the CEO and chairperson should be independent from the management of the company,” he says.

Folketrygdfondet may also end up running a new asset management unit and Houg and the team are currently carrying out analysis, coming up with suggestions on how a new and expanded mandate may look, and are due to report to politicians in mid-September.

“It’s very exciting. If it ends up being our responsibility, we would like to build something that lasts with purpose and the possibility to establish a modern investment unit with digital solutions,” says Houg.

Managing costs is the central driver behind €470 Dutch civil service scheme ABP’s recent decision to switch much of its public market allocation to passive, index-led strategies, according to a spokesperson at the fund.

“Until now, ABP has been an active investor. Now we are looking more closely at costs, and we do not want to make the portfolio more complicated than necessary to achieve our goals,” said spokesperson Jos Van Dijk. ABP has been one of the few remaining Dutch funds to still pursue an active investment strategy and Van Dijk said the switch will begin this year, but won’t be completed by year-end.

ABP’s growing concerns around rising costs was visible in its (latest) annual report which flags that “asset management costs” had increased “significantly.”

The report states that total asset management costs were €5,596 million in 2021 compared to €3,548 million in 2020 writing that “despite the realised returns, costs are rising at an amount that is increasingly difficult to justify to our participants and stakeholders.”

Still, the report also notes that higher costs were mainly due to the higher returns (at the time) and notes that the alternative allocation accounts for around three quarters of asset management costs.

Van Dijk said that although passive investment will be the starting point for investment in both bonds and equities, ABP won’t rule out active investment.

“We can add forms of active investing if we have sufficient evidence in advance that, after deduction of costs, this structurally contributes more to achieving our ambition than index investing on the scale we have at ABP.”

The low-cost strategy at Europe’s largest pension fund is accompanied by sustainability and simplification priorities.

ABP stopped investing in fossil fuel producers in 2021 and its latest Sustainable and Responsible Investment Policy outlines key ambitions including carbon reduction in the equity portfolio and increased investments in the Sustainable Development Goals. In December 2022, ABP updated its Climate Policy for 2022-2030 targeting net zero greenhouse gas emissions by 2050 and 50 per cent less greenhouse gas emissions in 2030 than in 2019. Other targets include investing €30 billion in the climate transition by 2030, €10 billion of which in impact investments.

Quarterly returns

ABP has just posted its first positive returns in over a year, thanks in the main to equity. First quarter results revealed the pension fund’s assets had grown by €11 billion while the fund posted a 2.3 per cent return on investment.

Still, ABP flagged concerns about economic growth ahead, particularly inflation, warning of the possibility of disappointing returns because of weakness in the financial system.

ABP’s 40.1 per cent allocation to fixed income (government bonds, long-term government bonds, corporate bonds and emerging market bonds) returned 2.6 per cent. The 27.4 per cent allocation to equity (developed market equities and emerging market equities) returned 4.6 per cent and a 22.1 per cent allocation to alternatives (private equity, commodities, infrastructure and hedge funds) made a loss of -0.8 per cent. The hedge fund allocation is also being wound down.

ABP also has a portfolio overlay comprising interest and inflation hedge, currency hedge and cash allocation that also contributes to overall return.

“I am pleased that after a turbulent investment year in 2022, we made money again this quarter with our investments,” said Harmen van Wijnen, chair of the board of trustees in a statement.

The slight fall in interest rates means the value of the pensions that ABP must pay out increased by €6 billion. The current coverage ratio increased slightly in the first quarter from 110.9 per cent to 111.9 per cent due to the development in returns and liabilities.

Increased scrutiny on the transparency of disclosures is driving measurable improvements among some of the world’s largest asset owners, as refinements to the Global Pension Transparency Benchmark methodologies and board oversight boost attention on transparency.

The Global Pension Transparency Benchmark (GPTB), a collaboration between Top1000funds.com and CEM Benchmarking, was launched in 2021 to highlight best practice and focus asset owners on more clearly, completely and concisely disclosing what they do and how they are generating value for stakeholders.

The GPTB ranks 15 countries, and 75 underlying pension funds, on public disclosures of the key value generation elements (or factors) of cost, governance, performance and responsible investing.

Since its launch the benchmark has been a facilitator for improved transparency in the industry. The results of the third annual GPTB will be launched in June with added process refinements.

“In our experience, as benchmarks mature, the performance of leading funds drive lagging funds to improve,” says Edsart Heuberger, product manager and GPTB lead at CEM Benchmarking.

“In the third year of the Global Pension Transparency Benchmark we are noticing that the leading funds in the world have improved their transparency scores the most. These are funds that have publicly declared it is their goal to be number one. We expect more of the lagging funds to embrace transparency and improve their performance in the coming years.”

New and improved process driving transparency

The GPTB focuses on the transparency and quality of public disclosures with quality relating to the completeness, clarity, information value and comparability of disclosures.

The overall scores and rankings are measured by assessing hundreds of underlying components and analysing more than 14,000 data points.

This year the process has been refined with  additional governance measures  to ensure better data and assessment.

“We recognise that a benchmark that publicly scores funds on their transparency creates new discussion,” Heuberger says. “We wanted to provide the reviewed funds with more transparency. Fund feedback prompted us to implement more robust governance and processes to document and validate our work. We will proactively share our insights with funds prior to the publication of their 2023 transparency scores. Funds now have the option to appeal a question score if they believe they were scored incorrectly.”

“Greater transparency promotes better understanding and trust”

The scoring process follows a four-tiered system including an initial review, factor-team review, CEM team reviews including a review by the Top1000funds.com team, and an advisory board review. Following these four steps there is also the chance for a one-on-one informational meeting with the underlying funds.

If there are any issues raised with regards to the scores, the advisory board will review these. In the event that the board cannot come to consensus,an independent arbiter will be consulted. David Atkin, chief executive of the PRI and original GPTB advisory board member, will fulfill this arbiter’s role.

new advisory board members

Given that Atkin is now taking on the role of independent arbiter a new board member, Fiona Dunsire, has been appointed to the advisory board.

Dunsire spent the past 29 years at Mercer including roles as chief executive of the UK, and wealth leader Asia, ME and LatAm. She has extensive experience invaluable to the GPTB including the Mercer CFA Global Pension Index and work with the World Economic Forum which culminated in developing a benchmark to measure progress on integrating climate factors within investment processes.

“Greater transparency promotes better understanding and trust in pension systems, ultimately encouraging higher levels of engagement and long-term savings,” Dunsire says. “Even the most sophisticated pension funds can struggle to assess their progress against peers in many areas. The GPTB provides a standard for best practice and highlights opportunities for improvement, allowing all funds to learn from the leading practices and raising quality over time.”

“I am delighted to join the Advisory Board of GPTB at this time. Throughout my career I have been motivated by supporting the delivery of high quality pensions that people can trust. Greater transparency should lead to better decision making and better long term outcomes for people in their later life,” she says.

Other members of the advisory board include Keith Ambachtsheer, Lorelei Graye, Angelique Laskewitz and Neil Murphy.

The way the industry has embraced the GPTB is a positive reflection of how seriously funds take transparency, and their drive for improvement is an indicator of the power of the benchmark which reframes the transparency narrative from a narrow and negative focus on costs to a more holistic and positive concept of transparency that includes governance and strategy, value generation and sustainability.

While overall in the past three years there has been positive momentum in the advancement of transparency across all the factors, there is still room for improvement.

“Leading countries excel in different areas. Canadians have terrific reporting on governance and investment performance. The Dutch are world-class on costs. The Nordics excel in responsible investing,” CEM’s Heuberger says. “Generally, funds would gain the most by improving their external investment cost and responsible investing disclosures.”

View the scores and ranks of the 75 funds from last year’s results.

 

Private markets are the cornerstone of CalPERS’ 2030 goal and strategic destination according to CIO Nicole Musicco, which will include building capabilities inhouse for direct investing.

Musicco said there were “a ton of structural changes in the market right now” – pointing to the geopolitical, climate change and the interest rate environment – that were informing the fund’s strategic focus. She said the 2030 strategy will be centred around a larger illiquid exposure in a cost-effective way, “as we gear ourselves to best in class pension investors”.

“We feel fortunate in a way that we are a little late to the game in investing in alternatives,” she said. “Our illiquid exposure is a lot less than our peers and with the structural changes, where we truly feel there will be some dislocation, we are not suffering from the denominator effect like others are. And that speaks to opportunity. What we are spending a bunch of our time on is thinking about how we allocate more to illiquid areas.”

As a result, the fund is focused on improving liquidity management, understanding the portfolio risks and what it is willing to pay for those risks, as well as more cost-efficient allocations.

She said CalPERS’ view was that in the current market, dislocation was going to happen and business structures would be turned upside down.

“So we think this is a very interesting time for us to have some dry powder to invest in some of the more illiquid areas,” she said.

Musicco recently boosted the team with the appointment of deputy chief investment officer for private markets Daniel Booth , former CIO of the UK’s Border to Coast, and Anton Orlich as managing investment director for growth and innovation, as well as Peter Cashion as the new head of the sustainability program.

“I’m excited about the leadership and talent we have been able to attract,” she said. “Daniel is knowledgeable in portfolio construction and has real expertise in private markets. He has tools in his toolkit that will help with continuous learning and professional development to bring us to best in class status, and to be my partner in leaning into the private market space through that lens of what does it mean to be a great direct investor.”

Musicco, who has spent much of her career in private markets including Ontario Teachers, IMCO and RedBird Capital Partners, said over time the plan was to move to direct investing and bring knowledge and capability inhouse.

Orlich re-joins CalPERS after spending the past three at Kaiser as head of alternatives where he grew the alternatives allocation from 15 to 50 per cent of the portfolio. He also held roles as the head of private equity at the Pivotal Group, as a portfolio manager in CalPERS’ private equity program from 2013 to 2016 and was a former consultant at McKinsey & Co.

“We are bringing on folks with more direct investing capabilities and bringing in a more global mindset to our thinking. It is easy to have a north American focus if you don’t have diversity at the decision-making table,” she said. “We want to have more of a global exposure over time and more cost-efficient direct investment exposure over time. Co-investment has been part of the lingo for the past 15 years, but I’d like to move over time to direct investing. This will mean hiring in more people.”

Private equity is the highest performing asset class in the CalPERS portfolio and returned 21.3 per cent to the end of June 30, 2022. The board increased the strategic asset allocation to private equity from 8 to 13 per cent starting at the beginning of the 2022-23 fiscal year.

See also CalPERS’ leadership trio on culture, mission and responsibility.

Beneficial tail winds including a lack of liquidity and reduced bank lending are set to fan returns in private credit, allowing investors like pension fund manager $87.5 billion New Jersey Division of Investment with scale and flexibility to provide solutions for cash-strapped borrowers.

“Banks are sitting on the side-lines,” said Jessie Choi, private equity portfolio manager and head of hedge fund/risk mitigation strategies at the Trenton-based fund, speaking in a recent investment council  meeting where discussions centred around investment ideas and new allocations to particular managers.

“A dynamic tail wind in private credit bodes well for this investment,” she said.

New Jersey is in the process of rebalancing its allocation to private credit, titling to stable direct lending strategies to anchor the portfolio.

Choi said analysis of the asset class shows that non-sponsor-backed deals (lending to companies that aren’t owned by a private equity sponsor) see less traffic and competition, giving managers the ability to negotiate directly with companies. This in turn makes the underlying loans more secure in a proactive value-add relationship with corporate borrowers.

Manager selection

New Jersey looks for managers with low loss rates and strong track records in an asset class where corporate default is a key risk. Other important manager characteristics include cradle to grave deal teams that not only structure and negotiate the transaction, but stay with the investment throughout so that senior team members that were originators and underwriters, remain on side for the duration.

In a conservative approach, New Jersey channels investment into the senior part of the capital structure, targeting returns of 6-7 per cent. However, the rise in interest rates means returns are now higher and committee members heard that demand for credit over the next two to three years should bring above average returns. It will also drive a safe set of structures for institutional investors that include stronger covenants, not seen for some time.

“It’s good to hear managers are getting stronger covenants,” said Division of Investment director and CIO Shoaib Khan. Khan added that the return of covenants and spreads offers a window into a more challenging business cycle ahead.

This most likely means that default rates pick up, but investors sitting at the high part of the capital structure (unlike high yield which has a different risk return profile) will see less turbulence. Secure, protected investments with equity-like returns promise an attractive outlook for private credit, said Choi.

Asset allocators v asset gatherers

Investing with the best managers is vital to portfolio success but the committee voiced concerns at the ever-growing size of external manager private credit (and private equity) funds. The trend towards larger capital raises, frequently amounting to billions of dollars, could start to impact managers ability to execute and deploy capital. New Jersey is increasingly mindful of the risk of allocating to asset gatherers where managers harvest lucrative management fees but are slow to allocate and invest.

One way to navigate this risk is to ensure asset managers increase their resources. New Jersey’s investment team’s due diligence includes ensuring the opportunity and strategies exist for managers with large sums to deploy.

restructure of risk mitigation strategies

New Jersey is also in the process of restructuring its portfolio of Risk Mitigation Strategies, targeting increased diversification, and a reduction in volatility and fees – alongside improving liquidity via strategies with shorter redemption windows. Choi said that the current environment of elevated volatility because of higher interest rates offers an opportunity for hedge fund strategies.

In 2019, New Jersey dropped the hedge fund share of the portfolio to 3 per cent from 6 per cent following a spate of enduring high fees and mediocre returns.

The reshaped portfolio will involve allocating to around 12-13 funds of which around six are already in portfolio. Hedge fund returns are likely to spike with increased macro and geopolitical volatility, added Daniel Stern, senior managing director in the hedge fund research team at investment advisor and asset manager Cliffwater, also speaking to the committee,

The restructured portfolio will seek investments in macro, trend following, currency and commodity strategies and will be able to invest in assets that are not available in other parts of the portfolio. It will also benefit from the ability to go long or short. The new look RMS portfolio will remove strategies that have a higher beta component and the committee heard that it is possible to reduce fees by moving away from traditional long-short strategies within equities and event driven allocations towards systematic strategies that charge less.

Committee members honed-in on manager selection, and the extent to which New Jersey ensures access to the best managers with strong pedigrees in its top-down approach. Other concerns focused on the need for third party managers to invest assets, rather than hold the allocation in cash/bank accounts, given the current returns available on cash.

Market outlook

Although markets have rebounded, Khan warned of continued volatility, and said small caps and emerging markets trail other market segments. Interest rate hikes, regional bank concerns and fears of a recession merit continued investor caution ahead.

In a few noteworthy strategies in response to market uncertainty, New Jersey is overweight cash in an allocation that is benefiting from higher interest rates.

Elsewhere, the fund has maintained its exposure to equity and fixed income, positioned to capture returns as the market rebounds, and avoiding the need to chase markets if they edge higher. In private markets, New Jersey remains below its target allocations across the board, positioned to take advantage of opportunities undergoing a reset that could include reups and new opportunities where the fund doesn’t have exposure.