Two themes dominate strategy in CalPERS’ $72.6 billion private equity portfolio as it gets back on course after an infamous lost decade of missed performance: co-investment; and reducing the bias to buy-out.

Co-investment, favoured for its structural alpha and dramatic savings compared to traditional fund investment, now accounts for 40 per cent of the portfolio. In marked contrast to the previous two decades when CalPERS prioritised large allocations to funds, in 2023 the majority of the pension fund’s private equity commitments were in co-investment which could, predicted Anton Orlich, managing investment director of the portfolio, save the pension fund $25 billion over the next ten years.

“Each $1 billion of co investment results in a $400 million saving thanks to not paying GP management fees and profit share. One third of those savings are made on the front end of the investment, and two thirds at the back end, meaning that the saving accelerates through the portfolio,” he said, speaking in a recent board meeting.

Nor does co-investment just lower fees. Orlich told the board that it had helped CalPERS develop its brand and trust with GPs, supporting key relationships so that the pension fund can still access investments, even when managers are oversubscribed.

“There is so much emphasis on cost saving within co-investment that governance gets overlooked,” he said.

CalPERS has increased its allocation to co-investment despite a tough climate in the asset class. The lack of deal flow and exits has knocked into new co-investment opportunities. “As the level of M&A declines, there are fewer co-investment opportunities,” he said.

Another important benefit of the co-investment programme is that it has avoided the build-up of large unfunded commitments. Co-investment has increased cash demand (which jumped from $3 billion to $9 billion in 2023) because commitments go straight into the ground. But Orlich espoused the benefits of quickly putting money to work over fund investments where GPs often delay capital calls and leave LPs at risk of meeting unfunded commitments in challenging markets.

The portfolio is cash flow negative because deal activity is slow, and CalPERS is seeing very little in the way of realised gains coming back into the portfolio. However, the lack of cash flowing back is impacting CalPERS less than others.

“It affects us less because of our under allocation during the current harvesting years,” Orlich says.

He predicts CalPERS will continue to deploy more than it gets back for another four years. Only then will the fund begins harvesting returns that can pay for future investment.

Mega buyout bias comes to an end

For the last two decades, large mega buyout funds dominated CalPERS’ strategy. Over the last two fiscal years, the team have reduced the allocation to buyout from 80 per cent of the portfolio – it used to account for 91 per cent in 2020-21 – to 67 per cent, equivalent to $48.9 billion. The shift has created an opportunity to generate alpha where there is a greater return dispersion across other allocations including growth, opportunistic, credit and venture.

Moreover, within the buyout portfolio, CalPERS is shifting to more mid-market buyout opportunities where managers are less dependent on leverage to generate returns.

But the strategy means manager selection (CalPERS invests with 126 managers and 363 funds) is even more important. Key deployment themes include vintage year consistency, along with a growing ($4 billion) allocation to diverse managers where CalPERS is able to tap into enhanced diversity and return dispersion. Orlich warned that allocating to emerging managers involves even greater emphasis on manager selection because there is more upside and downside.

He is also prioritising  consistent pacing. The team successfully allocated $15.5 billion every year for the last three years. Only with consistent pacing will it possible to achieve the fund’s recently increased goal to allocate 17 per cent of the portfolio to private equity – up from 13 per cent. “Consistency in commitments is important to avoiding another lost decade,” he said.

In another theme, the team have selectively diversified the portfolio geographically over the last two fiscal years. The program is still US centric (U.S. exposure is approximately 75 per cent) but European exposure is approximately 20 per cent.

 

Staff at Ontario Teachers’ Pension Plan Board, the $247.5 billion global asset owner, come into the office at least three days a week. Although some come in four, or even five days, the investor hopes its new downtown Toronto offices will encourage people to spend more time on site.

It is also the type of premises that will help lure top talent to the pension fund, explains George Konidis, managing director, Real Estate & Workplace Transformation, OTPP, who led the dramatic renovation of the landmark building.

Since the pandemic, we have proved we can work effectively from home. And mandates that compel staff to show up more regularly at the office are often unpopular – although banks are taking a much tougher stance, stepping up enforcement of days required in the office.

Konidis believes OTPP’s new offices will boost human connection and creativity and show the office in a new light, bringing people together in a different way.

“Our new workplace experience fosters the need for collaboration, networking, mentoring and productivity,” he says.

“We have invested in our teams by providing a space that enables a successful workplace experience while also giving people the flexibility to work from anywhere.  We’re pleased with what we’ve achieved.”

Flexibility and choice

The emphasis on flexibility and choice in work styles stand out as one of the building’s key features. OTPP’s new offices have tech-enabled work seats, lounge seating, collaboration seating, meeting rooms, cafés, lounges, quiet rooms, focused workspaces and amenities to support individual needs in the workplace.

Staff can work in different workspaces to suit their individual business needs and workstyle preferences, he explains. “The aim is to further elevate well-being and productivity by providing spaces that match how people want to work and the type of work that they will be doing.”

A suite of technology tools and solutions give employees the ability to work effortlessly from anywhere in the office and the range of rooms are designed to improve meeting equity by making the experience the same for participants in person and online via new, hybrid first meeting experiences, says Konidis.

“When we made the decision to create a brand-new workspace and head office, we were looking at and planning how we could drive an elevated workplace experience. We are proud to have created a space that reflects our culture and emphasizes sustainability, inclusion and well-being and one that, we see, will motivate employees and increase productivity.”

The investment teams can use the conference level floor and meeting space “to dial-up the experience when they are hosting meetings and events,” says Konidis. “Having the ability to elevate the in-person experience, coupled with being centrally located in downtown Toronto, will certainly be beneficial.”

He adds that the new office will also help attract top talent.

“We see the in-office experience – especially when a physical space can reflect an organization’s culture and draw-in priority elements to our teams like wellness, sustainability, and amenities – playing a vital role in attracting and retaining talent.

We took the time to speak with employees and understand what they were looking for in a workspace. The outcome was an amenity-rich space with sustainability, inclusivity, wellness and flexibility embedded in its design.”

 

 

 

Alberta Investment Management Corporation, AIMCo, the $160 billion asset manager for pensions, endowments and insurance groups in Canada’s western province, is developing a total portfolio approach in private assets.

Unlike other Maple Eight investors, AIMCo’s client funds decide their own asset allocation and most of them have reached their target in private markets. Rather than continuing to plough in capital, the investment team are now thinking more about comparing opportunities across assets and anticipating future trends.

“The investment horizon for these assets is long and the ability to rebalance in the future is hampered,” warns Marlene Puffer, who joined AIMCo as CIO in 2023 from Canada’s railway pension fund CN Investment Division.

This approach ensures AIMCo taps sufficient risk but also protects against embedding too much connected risk. Puffer says cross-functional conversations and analysis from the risk team supports intelligent decision-making and avoids unintended consequences.

The team is exploring how different themes cut across different asset classes, she says. The best example is AI which manifests in every corner of the portfolio, but in private markets is encapsulated in red-hot investor demand for data centres. These buildings touch infrastructure and real estate; they hold private equity elements in the construction and development phase; and that are also a renewable energy play.

“We are having more sophisticated conversations around where we want to play in this [AI] value chain and why,” Puffer says.

“It is about making sure we don’t miss part of the value chain because of our definition of what constitutes a real estate or infrastructure investment, or the geographical focus of the portfolio.”

AI is just one example. The total fund approach will touch every point of AIMCO’s strategic direction defined by global diversification, a focus on Asia, integrating climate and new energy opportunities, and garnering more strategic input from partners so that fund investments lead to co investments and direct investment.

“Global diversification, energy and climate opportunities and strategic partnerships all sit in total portfolio management,” Puffer says.

“It is about collaboration and breaking down silos.”

A new approach to risk

The new approach is supported by AIMCO’s rebooted risk culture following losses during COVID-induced market volatility when the investor shed $2.1 billion on a strategy meant to profit from low volatility in equity markets, known as VOLTS. A review found that escalation of the risk of the strategy to senior management and the board was “incomplete” and did not come soon enough.

Now the breadth and depth of risk governance and collaboration has been overhauled, fanning a new risk culture. The investment process involves a two-step approach to analysis whereby anything new coming into the portfolio (a manager or strategy, for example) is discussed first at the investment committee level, before further scrutiny by the investment, risk, legal and sustainable investing teams.

Governance has been reviewed and refreshed. The board has oversight of the risk parameters of every underlying product, and review and set the appetite for risk tolerance and the total fund risk budget. Escalation policies are also now embedded.

New high profile hires include Kevin Bong, senior managing director, chief investment strategist and head of Singapore; and chief risk officer Suzanne Akers who joined in 2022. Puffer says the pair represents a new level of talent and leadership that is now embedded into investment teams, weighing in on due diligence.

“Deals have not been done, or we’ve added more due diligence, as a result of these people,” she says.

There is an independent risk assessment for every transaction and Akers is a voting member of the investment committee.

New C-suite hires have helped build a new culture that encourages psychological safety in all interactions, and open and challenging conversations. Team building and in-person, regular offsites despite the teams being spread around the globe is fostering strong relationships and ensuring everyone pulls towards the same strategic goals. Puffer says gatherings may thrash out strategies, or just focus on building trust and understanding of each member of the team, she says.

“We all know where we are going,” she says.

Private credit is the star of the show

AIMCo’s $7 billion private credit portfolio is another a key area of Puffer’s focus. The investor is expanding its already significant private credit talent base in London and Toronto, with new hires in New York. Maintaining the portfolio’s size, and growing it further, requires stepping up from the small-cap investments made at the beginning and developing large-cap partnerships and deal flow out of New York.

It’s difficult to scale in small cap, she explains. The typical four- to five-year tenor of a private debt deal means around 20 per cent of the portfolio is in perpetual motion.

“You have to feed the portfolio,” Puffer says.

“We are a small team, and feeding it with large-cap deals is more effective. Although it’s possible to scale through small deals, they take up as much time as a big deal and require the same level of talent and staffing.”

AIMCo is one of many investors piling into the asset class which now accounts for some $2 trillion of assets under management. The IMF recently sounded the alarm at so much debt being traded out of the public eye in its latest Global Financial Stability report.

Puffer acknowledges the risk of scaling the allocation in an environment where interest rates are more likely to fall than rise, but she is reassured by an enduring return profile that adds value and provides an alternative exposure to liability matching fixed income.

“Private credit is the star of the show,” she says.

“The sensitivity to interest rates and duration is not the only reason we are in private credit. We are also in it for the credit spread, and for a little extra because of today’s base rate. Even as rates come down, it still has value because it will be down less than our other investments in fixed income.”

Moreover, she says AIMCo has an edge because of the team’s ability to execute. Private credit is shaped around fund investments, yet with each partner the team expects significant co-investment deal flow opportunities. Cue a sophisticated internal team not only with the ability to turn deals around quickly but also a familiarity with its partners and the way they work, and knowledge of the underlying companies.

Puffer will also spend the coming months sizing opportunities in Asia via AIMCo’s new Singapore office, opened late last year. She says fund mangers are increasingly setting up shop in Singapore, enabling new partnerships out of the city state that will lead onto co-investment opportunities, particularly in renewables and diversified infrastructure.

Pioneering responsible investor Brunel Pension Partnership is using AI to improve stewardship evaluation and has spent much of the last year improving the misalignment of interests between asset owners and managers in relation to climate stewardship.

The team uses an AI-driven tool called a generative pre-trained transformer (GPT) to analyse and compare the voting guidelines of approximately 20 asset managers and owners, according to the fund’s recently published Responsible Investment and Stewardship Outcomes Report 2024.

The £30.8 billion ($38.9 billion) Brunel uses the insights to update its own voting guidelines, ensuring they are ahead of current practices and expectations.

“It’s about understanding the broader shifts in stewardship standards and ensuring our guidelines reflect these,” says Oliver Wright, responsible investment officer.

Brunel has also developed a quarterly report reconciliation tool which uses AI to assess implementation of its voting guidelines. It then uses the reports generated as a tool to engage with its service provider where it sees discrepancies.

“Given the importance of voting implementation, the ability to automatically verify this information has been invaluable,” Wright says.

“It ensures the reliability of our reports and significantly reduces the time and effort previously required for manual checks. This means that we can devote more resources to engaging with investee companies and other core stewardship activities.”

Brunel believes AI’s role in stewardship is only set to grow. As the technology advances, Wright says he expects new tools for more effective engagement with companies, improved monitoring of sustainability factors, and even predictive analytics for identifying potential governance risks to appear.

The future of stewardship will likely involve a greater integration of AI to not only streamline operational tasks but also to enhance the strategic aspects of work like focusing engagements to ensure meaningful outcomes.

“GPT has already proven to be an asset, and its ongoing development will undoubtedly open up further possibilities for enhancing our stewardship practices,” Wright says.

However, whilst AI brings substantial benefits, Wright warns of its risks. Like the potential for social bias in AI algorithms. Given that AI systems are trained on large datasets that may contain societally biased historical data, there’s a concern that these systems could replicate and even amplify existing societal biases.

Alongside this, there’s the challenge of ensuring that the fund’s reliance on AI doesn’t diminish the value of human judgement, and that data privacy and security are rigorously maintained. To mitigate these risks, the team regularly audits AI tools for bias, ensures transparency in operations, and maintains a balanced approach that combines the efficiency of AI with the nuanced understanding of experienced professionals.

Addressing misalignment

In another noteworthy trend, Brunel has spent the last year working with other asset owners to address the misalignment of interests between asset owners and managers in relation to climate stewardship.

The 2023 proxy season provided signs that some asset managers had failed to unequivocally challenge oil and gas companies that were backtracking on their climate commitments, the report says. This contrasted with the positions of large asset owners that shared the view that if climate related risks are not addressed through stewardship activities, this can translate into investment risks for their portfolios, affecting long-term beneficiary interests.

To address the discrepancy, Brunel entered “robust and constructive dialogue” with its managers, identifying how fund managers can be better supported in delivering asset owners’ climate stewardship strategies.

Brunel’s analysis of the misalignment, and conversations with other asset owners, was framed by research findings presented by independent academic, Professor Andreas Hoepner. Using the energy transition in the oil and gas industry as a test case, Professor Hoepner and his team have evaluated the voting records of select managers on oil and gas majors.

This research provided evidence of a misalignment. The full research which was released in November 2023 provided insights on misalignment trends and voting rationales. For example, only a select few asset managers publicly align their reasoning with asset owners.

Some asset managers perceive voting and ESG engagement as mutually exclusive, raising concerns about potential access loss to management if misaligned.

The review also found distinct engagement process types ranging from persistent, long-term engagement with considerable progress to “quick fix” and “jumping the bandwagon” styles, pointing to issues around consistency and a long-term approach to engagement.

The research also put forward a number of rationales for the gap, highlighting that further research is needed to explore these issues in greater detail.

These include cultural misalignment – namely the differences between UK based asset owners and non-UK based asset managers – and resource allocation misunderstanding – aka the potential misunderstanding of the importance of stewardship and voting, leading to insufficient resource allocation.

Other reasons include a misunderstanding fiduciary duty, particularly in terms of risk management related to climate change and financial conflicts of interest.

In the next phase of the project, asset owner participants will initiate one-to-one bilateral conversations with their managers on the basis of the research findings. The next phase will also look into how asset owners can articulate their views on climate stewardship.

For Marcus Frampton, CIO of the $81.8 billion Alaska Permanent Fund Corporation (APFC), a handful of issues are front of mind in the current investment climate.

Tight spreads for corporate bonds, despite the likelihood of a default cycle in fixed income, have been driven by the fall in corporate issuance as companies wait on the sidelines for rates to fall.

Fixed income accounts for 20 per cent of the fund, and Frampton’s current focus is on quality investments only, avoiding more risk in the asset class.

In public equity, APFC is hunting opportunities in areas like value over growth, an overweight to gold miners and in a more contrarian allocation, China. None of the plays are huge bets (there is a 2 per cent tracking error in equity) but he is looking for pockets that run counter to wider market sentiment.

Alaska is approximately 1 per cent overweight the MSCI World allocation to China A Shares via KraneShares and iShares ETFs using dedicated managers that can trade a mix of A and H shares. The allocation sits in a sleeve of the portfolio called tactical tilts where the fund leans into opportunities.

“Lots of people are shying away from China but our overweight has done well in recent weeks.”

Hedge Funds continue to deliver

Hedge funds aren’t transparent; they are expensive, rarely put on high returns in a bull market and can be a tough sell with trustees and stakeholders. But Frampton describes APFC’s 7  per cent allocation as one of the most exciting and valuable corners of the entire portfolio, delivering 8.13 per cent and 5.74 per cent over 3 and 5 years respectively.

The allocation has come into its own in an environment where stocks are expensive and corporate bond spreads tight, and in the last quarter the APFC has redeemed several funds to lock in profits and bring managers to the desired allocation. It has around 20 mangers on its books including names like Elliot and Millennium, invested in equity market neutral, growth and multi-strategy funds; commodities and  CTA trend following strategies.

“If you are backing high quality macro, equity market neutral and zero beta managers it’s possible to outperform a 60:40 portfolio with no correlation.”

Real estate shows the cracks

In contrast, APFC’s slightly above target 11.5 per cent allocation to commercial real estate is showing some cracks. It makes the portfolio a natural place to source funds for recent asset allocation tweaks – namely increasing the allocation to private equity.

Alaska’s proactive build-up of real estate in recent years has focused on life sciences developments; apartments and industrial. Billion-dollar deployments also include active lending to construction projects via two separate accounts.

“If they don’t pay off at maturity, they are properties we don’t mind owning,” he says.

Still, the portfolio has experienced some lumpy patches. Like stakes in downtown office buildings, often only 20 per cent let, which remain an enduring drag on performance. The challenge lies in the fact these buildings are not easy to reconfigure into apartments. There are no balconies, and turning the existing space into apartment blocks would leave some like “the worst cabin on a cruise ship,” he says.

Frampton suggests the costs of converting offices into apartments may require subsidies from cities and reflects that many downtown office investments – often in the best locations – have now shifted to become a land play.

“Someone, at some point, will demolish the building and build apartments, but right now interest rates and construction costs are putting investors off.”

Turning up the heat in Private equity

APFC has just turned up the heat on private equity, increasing its target exposure by 3 per cent to 18 per cent, a tweak that brings the portfolio in line with the current overweight of 18.3 per cent.

With the S&P 500 up, the relative case for private equity is stronger than it was a year ago and Frampton is reaping the rewards of cutting programme pacing in 2021. Hitting the breaks back then meant allocations fell from $2 billion a year to $1.6 billion in 2021 and 2022, and  $1 billion in 2023 and forecast for this year too.

“It caused us to pass on somethings which was hard, but at the time everyone felt it was important.”

More so now given that investors that hit the accelerator coming out of the pandemic are now struggling. Witness Kaiser Permanente, and LPs USS and Washington State, reportedly selling in the secondaries market at a discount.

“We are in a luxurious position because we didn’t deploy,” he says. “I think 2021 and 2022 will go down as the worst vintages for private equity and I think we are coming out of it, this is an attractive market now,” he says.

He says AFPC is finding opportunities in industrials and the old economy. And with a typical cheque-size of $30-$50 million the investor can be nimble, unlike larger funds with ticket sizes of $100 million.

The venture allocation, sitting within private equity, has also been reset. APFC has a mix of fund investments and directs, and Frampton is currently figuring out whether to re-up with existing managers or explore new allocations given venture with a bias to software and biotech, has been hit hard in recent years.

“If you look at the private equity performance this year versus other state pensions, we’ve had a tougher time as venture has taken heavier market downs that buyout.”

He thinks the fund will reup with some venture managers but will also add new relationships in the more traditional buyout space.

Still, the team are quick to act when they see an investment they like. AFPC recently concluded a venture co-investment with a new manager for the first time.

“We know the manager well and we didn’t go into the first fund. But we looked at it and respect the team and made an exception.”

The £26 billion ($33 billion) People’s Pension, one of the largest master trust workplace pensions in the UK and forecast to reach £50 billion assets under management in the next five years, is modelling itself on Australia’s superannuation funds.

Dan Mikulskis, CIO of the People’s Partnership which oversees the pension fund, would like to set up an industry-owned asset manager modelled on Australia’s IFM Investors. He also likes the way Australia’s superfunds benchmark each other, and how they have built their own internal investment teams.

“We look outside the UK for our benchmark and the Australian superfunds are our closest cousins,” says Mikulskis who adds that the fund’s huge inflows will put it on a par with university scheme USS and NEST to become one of the biggest in the UK.

Since joining as CIO in September 2023, Mikulskis has spent most of his time developing the systems and processes behind the pension fund which was founded in 2012 off the back of auto-enrollment legislation. This has included building the team which now counts 900 staff working across the value chain in everything from customer service to administration.

Recently settled in new City of London offices close to the asset management community, he’s now turning his hand to investment strategy.

Most of the assets are invested in off the shelf index tracking funds, but Mikulskis has started to explore different products in a departure from a typical master trust. Around $15 billion (of the equity portfolio) was recently moved into climate indices, and now he is looking at how to move beyond index tracking to add value in fixed income and emerging markets.

“The huge choice of indexes means deciding which indexes to track is a strategic role. There are lots of choices we can make.”

Fixed income accounts for anything between 20-60 per cent of the (eight) different funds on offer and is focused on sovereign and investment grade global corporate bonds. He wants to push beyond standard products and approaches to include structuring bespoke mandates and leveraging the fund’s growing size and scale to shape a more adventurous approach to duration and credit, targeting parts of the market with more value for money.

“In fixed income, many of the products we use are higher quality and there isn’t much of a risk of defaults, but the returns are less.”

He says the delineation between active and passive has softened allowing a more creative approach. Strategies like buy and hold that involve more active decision making are now just part of a spectrum that includes custom indices and quant approaches.

He is also exploring different ways to access emerging markets which currently account for around 10 per cent of the equity allocation. Not only does he think emerging markets are cheap – “they were cheap a decade ago and have just got cheaper and cheaper” – he wants to carve out China where he says SOEs dominate. This could allow for increasing exposure to under-represented regions like the Middle East, South America and Africa.

“The term emerging markets is an early 80s label that doesn’t fit anymore. I’d like us to get more bullish on emerging markets and find a way of allocating that lets us unleash this. It’s difficult to get conviction in vanilla indices.”

The People’s Pension is still some way from developing an allocation to private markets, and one reason for Mikulskis’s caution is high investment management fees. The pension fund caps management fees at 50 basis points, and he doesn’t want to have to introduce a basket of investments with a higher fee. What he wants is a better split with alternative managers between economics and terms.

“In private markets, you can identify a good opportunity but end up paying a whole lot to the manager and it shouldn’t be the case. The end investors should benefit.”

Witness his decision not to join the Mansion House Compact. Names like Aviva, Scottish Widows, L&G, Nest, and Smart Pension have signed up to the endeavour by the UK government to get pension funds to invest at least 5 per cent of their assets under management in unlisted UK equities by 2030, but Mikulskis wasn’t keen.

“It is our choice where we invest, and we want to do it right. We want to dictate the terms and will allocate when the terms suit us and when the market is right,” he says.

He thinks the fund’s first foray into private markets will be in infrastructure, or possibly real estate, because these two asset classes are the most aligned around collaboration on fees, external co-investments and fund structures. “Open ever green structures are more prevalent in infrastructure than closed end funds which I don’t like.”

But for now he is prepared to wait it out. As the People’s Pension grows in scale, it will grow easier to swing fees in the fund’s favour and leave more of the return in the hands of members. He is also using the time to explore the possibility of setting up an industry-owned asset manager modelled on Australia’s IFM Investors, owned by a collective of 17 pension funds.

“This is one way to access private markets. We are talking to people about this, and trying to start the conversation.”

Despite the sizeable staff, there are only 20 people in the investment team. He says this will grow alongside AUM.

“We will get to 25 by the end of the year. It’s rule of thumb that you have one person per one-billion AUM, getting towards that.”

Once again, he is turning to Australia to see how to build internal teams and when to bring allocation inhouse. He also likes the Aussie comparison model that promotes competition in the sector via league tables, and has lead to underperforming funds merging with the most successful.

“The superfunds have a well-known and mature approach to compare performance.”

As he approaches his first year in the job, Mikulskis says his leadership will focus on cutting through short term noise and focusing on what the pension fund can realistically achieve. For example, introducing climate tracker funds will meaningfully reduce emissions in the portfolio and also chime with the fund’s competitive advantage, expertise and low cost priorities.

He wants to avoid being distracted by talk of uncertainty and risk, both of which are inherent to investment.  “We could walk in tomorrow, and our assets could be down by £2 billion. This will happen at some point and it is part and parcel of what we do.”

His approach is to shift his gaze upwards and draw on evidence of the past to see how asset classes will behave and have faith in the fact that in the long run stock markets go up.

“I like to start with the last five years, and focus on that number. Drop off those columns and rows that are short term and diving in too deep.”