CalPERS’ sustainable investment strategy is predicated on a belief it can generate outperformance by investing in climate solutions – with $100 billion to be allocated by 2030. Peter Cashion, managing investment director for sustainable investments tells Amanda White why, and how, it looks for climate alpha opportunities.

CalPERS has been energetic in the implementation of its new climate action plan, developed under the leadership of Peter Cashion last November. Among other things, the plan includes deploying $100 billion to climate solutions by 2030 – just over 20 per cent of CalPERS’ $469 billion AUM – with the aim of both generating alpha and reducing the carbon intensity of the portfolio.

When the plan was devised, the fund already had $47 billion in climate solutions and the team under Cashion is hard at work to more than double that commitment, with nine new private investments made in recent weeks.

Reporting to the CIO – now Stephen Gilmore, who started at the fund this week – Cashion and his team have worked each asset class to develop a sustainable investment plan towards 2030.

“It’s not a fixed number for each asset class, but a range,” Cashion told Top1000funds.com in an interview.

“We see investment opportunities across the spectrum with the most tangible in infrastructure, private and public equities.”

Already CalPERS has worked with FTSE to develop a customised climate transition index, that evaluates the risks and opportunities of the global energy transition, and it has committed $5 billion in its public equity investments to this scalable alternative to a market-cap index.

It has also announced its first wave of private investment, with $1.1 billion in private equity and infrastructure committed across nine deals, and a further $3.6 billion across 19 deals in advanced pipeline.

Investments to date include supply chain optimisation, an energy company, a lithium-ion producer, electric boats, wind turbines and fossil-fuel-free logistics.

“In a number of opportunities we are seeing more in private equity, particularly in co-investment where we are very active,” Cashion says, adding that while infrastructure deals are fewer in number, they are much bigger in scale.

Infrastructure deals make up about $900 million of the recently committed $1.1 billion, so it’s a big portion of committed investment already.

“We will see opportunities in private credit and fixed income, but they haven’t matured or transpired as much yet as they have on the equities side,” Cashion says.

“The equity coming in is good, but to have the leverage to generate returns you need debt, so that’s why we see impending opportunity in fixed income and private credit, and we are actively having calls with fund managers.”

Cashion says one of the key differentiators for CalPERS’ climate plan is it is driven by the notion it can generate alpha and outperform by investing in climate.

He explains there are a number of reasons the fund sees investing in climate as a thematic that can generate outsized performance.

First is the size and scale of the transition opportunity set that is not only large but growing. It has also identified the theme of resource efficiency with companies more attuned to using less energy experiencing lower costs and so higher valuations. And the inclusion of both physical and transition climate risks as an area of focus means in both portfolio and security selection risk management is more robust.

“Taking in the combination of those three factors it’s a recipe for higher performance, particularly over time as these effects roll out,” he says.

While the fund hasn’t put a precise number or expectation on the alpha that it can generate from these investments, it has clear tracking of climate solution investment performance and will benchmark that against the asset class benchmark.

The nine recent investments were a combination of flagship funds and dedicated climate funds, and Cashion, who was previously the global head of climate finance and chief investment officer in the financial institutions group at the World Bank’s International Finance Corporation (IFC), says “we welcome both”.

“An investment through the flagship fund is indicative this is not a niche do-gooder pursuit, this is generally good business,” he says.

“But we also want to identify the exclusive climate-focused funds in private equity, infrastructure or private credit.”

CalPERS also plans to coinvest in climate solutions alongside the asset classes.

“This is not a carve out for sustainable investment, but we will jointly implement it with the asset classes,” he says.

“Once my team is built out we will have a joint process with one of my team sitting alongside the asset classes and I will jointly approve it. This is a more scalable model and with the urgency of the transition needed and the opportunity set it is better to play at scale.”

In fact, it’s the opportunity CalPERS presents to invest at scale that attracted Cashion personally from a 30-year career at the IFC to make the move to CalPERS.

“I made the move because I saw the potential and the scale. We are doing something big and new at scale,” he said adding that CalPERS is looking to recruit a further 10 people to the sustainable investing team, effectively doubling the size.

And while the team has made some quick progress since setting the strategy in November, Cashion is cognisant it won’t be a straight line.

“We have an additional $53 billion in incremental investment to make, we can’t just divide that by 6.5 years [to get to 2030] and that’s what we do each year,” he says. “The pace of the opportunity set may be uneven and that could be an obstacle.”

As a result of its climate investment ambition, and the $100 billion commitment, the fund has set an emissions reduction target for 2030.

It had already committed to a net zero 2050 target but one of the advantages of the new sustainable investment strategy work is to define a 2030 target of 50 per cent.

The emissions intensity of every portfolio at CalPERS has been mapped by the internal team taking into account any asset allocation shifts.

“An interesting component of that is the $100 billion investment,” Cashion says.

“Without that we wouldn’t reduce by 50 per cent. The $100 billion is driven by the fact we think we’ll make more money that way, but it also reduces emissions.”

The investment universe for climate solutions at CalPERS has been grouped into three buckets: mitigation, adaptation and transition. Cashion says he is aware that transition investments may come through buying into higher emitters, such as steel, that will mean an uptick on the emissions footprint of the portfolio.

“We are comfortable with that because we don’t just want to impact our own portfolio but the broader economy. We want to lean into these,” he says.

Another objective of the focus on climate investments is also to build more resilience into the portfolio and the fund will recruit specialists across both public and private markets to fully integrate ESG analysis into the portfolio.

Climate scenarios will also be incorporated into the fund’s capital market assumptions and asset-liability management process with climate scenario stress testing included in the top-down portfolio view.

“This is still an evolving science and we are developing that muscle from the top down and also within specific asset classes and sectors so we will look at the firm, asset and macro total fund exposure level,” Cashion says.

Key to that will also be more analysis and expectation of fund managers’ ESG integration capabilities and the internal sustainable investment team will give providers recommendations to work towards.

Peter Cashion will speak at the Fiduciary Investors Symposium at Stanford University from September 17-19. For more information click here.

Singapore’s state investor Temasek has a cautious outlook on China, despite having 19 per cent of its $389 billion portfolio invested in the country.

Temasek has been one of the big beneficiaries of China’s growth. But in recent years its allocation has struggled and underperformance in the country’s capital markets has dragged on overall performance in the portfolio, the value of which rose just 2 per cent on the year to March.

Speaking during the investors 2024 Review, the investment team said that despite a pro-growth stance from Chinese policy makers and an encouraging approach to foreign investment, structural demand challenges in China’s economy continue to weigh.

“We need to see a little bit more progress on that front before we can invest at a much faster pace,” said Chia Song Hwee, deputy chief executive officer.

Rather than companies focused on export that might be impacted by geopolitical risk, sectors of interest include Chinese companies that are tapping into domestic consumption. Other  examples include biotech, import substitution, robotics and the EV value chain.

While enthusiasm for China remains muted, Temasek will allocate more capital to developed markets like the US in the next 12-18 months.

The team did not give an exact breakdown of exposure to US assets but the Americas region constitutes 22 per cent of its portfolio. The US will continue to be the largest destination of capital outside Singapore, but Temasek will also increase its focus on India, Japan and south-east Asia, markets that have benefited as global investors seek to cut their exposure to China as growth slows and geopolitical tensions rise.

The size of the portfolio makes being nimble challenging. The team said that when they try to adjust the portfolio, the results aren’t immediately visible. “When we say “turn”, it will actually take quite a bit of time for us to make that shift,” said chief financial officer Png Chin Yee.

Temasek’s allocation to private assets is now over half the portfolio (52 per cent), up from 20 per cent in 2004.  The shift is a consequence of easier market access to unlisted assets and the ability to work with private companies, rather than a specific target to unlisted assets. Investment is made according to returns objectives and the opportunity in key themes. The increased exposure means the investor now reports unlisted assets at mark to market value, more in line with our peers.

Risk in real estate

Temasek has invested most in the credit side of real estate where it has found the best risk-adjusted returns that include a significant amount of downside protection through equity subordination. Assets include multifamily, other forms of living, data centres, logistics and hospitality.

The team said that data centres and logistics are still benefiting from secular tailwinds but warned that energy consumption in data centres is an increasing risk.

Owners are under pressure to integrate newer technologies and switch to more renewable sources. Temasek’s portfolio companies include  STT, Singtel, and Keppel and the team said the hype around data centres, along with AI and private credit, were front of mind.

“We have to have the discipline on valuing the opportunity and taking the appropriate risk measures when we invest, or not,” said Chai Song Hwee

Strength in partnership

Temasek is a renown early stage investor, but it is prepared to stay invested once companies go public to tap future appreciation. A good example is Adyen, the payments company, which Temasek invested in back in 2014 and still holds since it went public in 2018.

Partnerships in green investments include its stake in Pentagreen, a sustainable infrastructure debt financing platform set up with HSBC that focuses on lending to companies that struggle to tap traditional finance.

Temasek has also been active with the Monetary Authority of Singapore. Under the FAST-P initiative, Financing Asia’s Transition Partnership, a blended finance approach seeks to combine the private and public sector as well as philanthropy to catalyse financing for sustainable and transition finance in the region.

Climate, natural capital and inequality are three key themes that pose a material risk on client funding outcomes according to Brightwell, which manages around £37 billion of assets on behalf of the United Kingdom’s BT Pension Scheme, BTPS, as well as assets of the DB arm of the EE Pension Scheme.

BTPS rebranded as Brightwell a year ago, pitching to manage other pension funds’ assets alongside its own portfolio on the basis that working together and sharing operational resources has profound benefits. It says it offers pension funds a coherent, single approach to pension management that allows schemes to replace their cohort of actuarial, investment, fiduciary and covenant advisors, plus multiple asset managers, with a single operation.

It’s inaugural sustainability report details how it will invest in climate opportunities like new technologies and companies successfully mitigating the risk of climate change. But avoid investments in companies at risk of stranded asset, new regulation or high costs due to carbon pricing or extreme weather events disrupting supply chains.

“We help clients understand how climate change could affect their pension scheme and provide solutions to better insulate them from its effects,” states the report. “We encourage setting net zero goals where appropriate and review the impact of sustainability on investments on an ongoing basis, and measure the impact at least annually.”

Prioritising natural capital

A second investment theme will address natural capital. Biodiversity loss, ecosystem degradation and the associated value at risk are now key considerations in Brightwell’s investment process. Freshwater provision, sustainable agricultural, regional conflicts, and migration due to resource shortages are likely to be exacerbated by biodiversity loss and ecosystems degradation.

“The consequences will be felt in supply chains, the availability of resources and growth of most sectors around the world,” warns the report.

Brightwell also highlights the link between natural resources and businesses through their supply chains in a “notoriously complex” web. It warned that the impact from the loss of natural resources will likely to be felt gradually over a longer period of time, rather than a one-off, short, dramatic event.

The asset manager will also seek to address inequality via its investment process. Human rights, modern slavery, as well as diversity, equity and inclusion and the use of artificial intelligence are all now integrated into investment decision making.

“We believe systemic inequality has the potential to destabilise the financial and social systems within which our clients invest and benefit from. Increased inequality is likely to lead to reduced economic growth through greater financial and social instability, and reduced output. Having an awareness of inequality and addressing inequalities such as developing DE&I practices is an ethical and business imperative to have a licence to operate.”

Social mobility is a key theme in the asset manager’s own internal DE&I strategy. The company has developed Brightwell Pensions Academy to recruit people of any age and background, with little or no pensions knowledge, to join a year-long structured training programme.

Policy in action

Brightwell has developed a pillar framework covering portfolio construction, mandates and managers, stewardship,  advocacy and sustainability. Expertise BTPS benefited from in a number of ways last year.

For example, Brightwell has supported BTPS gather net zero data and improve climate reporting, including investment in new tools to improve collation and consistency of manager reporting on sustainability. It has helped the pension fund develop a new sustainability dashboard to improve portfolio and manager monitoring.

It has also represented the pension fund on the ASCOR project, an important initiative to improve sovereign climate reporting, and the Asset Owner Diversity Charter which promotes diversity, equity and inclusion in the investment industry.

Brightwell’s first sustainability report identifies the “critical enablers” that will support sustainability including people, processes and partnerships. The report also highlights the company’s commitment to positive real-world impact.

“What we do has a real-world impact, and we can positively influence the way business is conducted to reduce negative externalities. Our scale and governance mean we can be bold, nimble and take a leading position in areas where we feel we can make a difference.”

New Mexico State Investment Council (SIC) the $54 billion sovereign wealth fund, has so much money pouring in from tax and royalty collections on oil and natural gas production in the state that CIO Vince Smith is struggling to put the money to work. The SIC is expecting $5 billion in inflows this year following $8 billion in both 2023 and 2022, and is currently around 10 per cent overweight cash and bonds relative to target.

“We are seeing massive capital coming into our funds,” says Smith in an interview with Top1000funds.com from the SIC’s Santa Fe offices. “We are getting satisfactory yields in the bond market and 5 per cent on our cash, which isn’t damaging returns. But our large cash allocation is due to the large inflows, not by strategic choice.”

Assets under management at the SIC which oversees four permanent funds and is America’s third largest sovereign wealth fund, have grown from $13 billion when Smith joined 14 years ago and are forecast to hit $100 billion in the next 10 years.

The fund’s models suggest that inflows will meet SIC’s distribution needs to the state, much of which goes on education, for the next decade. This will allow all earnings to stay in the fund and compound. Only as the energy transition gathers pace and weighs on demand for fossil fuels will those numbers drop.

In a reflection of the fund’s growth, the internal team is also expanding. A new budget has just approved five additional positions in the investment department which will grow to 18 with three new analysts, an investment operations manager, and a cash manager to oversee the fund’s cash management program.

“We’ve had a team of 13 since the fund was $13 billion assets under management. To be honest, we’ve only just caught up,” says Smith.

Over valued equities

One of the reasons it is challenging putting the money to work is because of valuations in public equity. Smith believes public equity is highly valued across the board, and he is wary of the enduring dominance of tech stocks.

He uses three to four measures to value the portfolio, including the cyclically adjusted price earning (CAPE) ratio and Warren Buffett’s ‘Buffett Indicator’ that compares the total market capitalization of all US stocks with the quarterly output of the US economy.

“All the measures we use tell us that we are paying a lot, particularly relative to higher interest rates. When the Fed was at zero on the Fed Funds rate and 10-year Treasuries were 2.5 per cent, there was a case that stock markets should be highly valued. But now rates on cash are 5.4 per cent and we are seeing 4.3-4.5 per cent on the 10-year, and these valuations are a lot more challenging.”

The US election in November could be a source of welcome volatility that opens the door to deploying more to equity.

“Volatility would help us right now because we’ve got excess cash and bonds because of our inflows – volatility in the stock market would definitely be helpful for us.”

Strategies in public equity are mostly plain vanilla with a small (1.5 per cent) tracking error. The tracking error for the international portfolio is 3 per cent.

Smith employs a macro, top-down medium-term (7-10 year) strategy to guide asset-allocation and asset-class construction. He’ll publish this year’s annual investment plan in August, and predicts the next few years will be “interesting.”

For now, the surprising strength of the US economy prevails in a trajectory that wrong footed investors poised for recession at the beginning of 2023 and those that forecast six to seven rate cuts at the beginning of 2024.

“Here we are, seven months into 2024, and we haven’t had any rate cuts and the expectation is for just one or two. The US labour market is strong; stocks are doing better than expected and higher interest rates are earning good returns on the fund’s cash.”

Private markets

It’s no easier putting money to work in private markets. New Mexico targets 50 per cent of assets in private markets and allows five years to reach its target asset allocation in a pacing program run in-house.

The allocation to private equity and venture is below target, an underweight Smith attributes to the SIC slowing investment in 2019 and 2021. Aggressive fund raising between 2021 and 2023 means many fund managers have now slowed down on raising new funds. It’s one reason why he is expanding the manager roster, hunting for new relationships able to take large investments of $100 million plus in private equity and $300 million in private credit.

He is particularly focused on building the allocation to venture as a proportion of private equity, targeting 15 per cent of total AUM in venture. Strategy will centre on avoiding the riskier end, and careful manager selection, he says.

“We didn’t have much in venture and we are now putting more focus on this and expanding the allocation. For us it’s a matter of staying in the middle of our band and getting the allocation up over the next three to four years.”

Allocations to private equity, real estate, real return and private credit have a strong focus on US dollar-denominated, US-based assets.

New Mexico first began investing in private credit in 2021 and focuses on fund investment and direct investments with managers.

The IMF recently flagged risks in the $1.7 trillion market, warning that rapid growth in the asset class hasn’t been tested in a downturn, and questioning the impact of sudden demands on funds’ liquidity and the quality of underlying borrowers. Smith predicts investors will ultimately put as much to work in private credit as they have in private equity and says SIC strategy is on a sure footing.

“We deal with the larger, established managers and feel we have adequate transparency in the funds we commit to. We stay away from the riskier corners, and don’t expose ourselves to higher risk strategies,” he says.

 

A long-awaited review of Sweden’s buffer funds has proposed consolidating AP1, AP3 and AP4 into two funds.

Stating that the “advantages outweigh the disadvantages,” Tord Gransbo, an adviser to Sweden’s Ministry of Finance working on the review since last October, argued that consolidation would create efficiencies and scale, effectively managing the capital in the long term for a higher net return.

The many similarities of the three Stockholm-based funds (AP2 is based in Gothenburg) include their gradual move towards comparable asset allocations, assets under management (between $44 and 47 billion each) and increased co-investment. Moreover, Gransbo noted that they employ similar numbers of staff in the same job categories and compete against each other for sought-after staff.

In other shared seams, the funds have deepened cooperation on environmental and ethical issues through the Council on Ethics.

“The high degree of similarity means that there are good opportunities to achieve economies of scale in asset management through consolidation or mandatory administrative cooperation,” states the report, in Swedish.

“The consolidation proposal has a much greater potential to improve the conditions for efficient, rational and effective management of the buffer capital and thereby contribute to a higher net return in the long term.”

Gransbo flagged the complex process around consolidation would incur considerable direct costs and significant implementation risks that could impact returns.

The report did explore the benefits of greater cooperation (rather than consolidation) between the Stockholm funds. This would create cost efficiencies and reduce the risks that come with consolidation. However, Gransbo noted that the consolidation proposal carries a significantly greater potential to improve management of the buffer capital, which would, in the long run, contribute to a higher net return.

The report did not single out any of the three funds as a candidate to be split up. The report will now be consulted on, and the all-party Pensions Group will decide the actual shape of any changes to the system.

“We will now read very carefully and analyse the proposal and will of course assist in the formal consultation process that will soon commence,” a spokesperson for AP4 said.

“It is good and natural to regularly review the management of the public pension system’s buffer capital, and we welcome the fact that “Pensionsgruppen” has started to review how the pension system can be developed and strengthened.”

In addition, the report proposes changing the structure of the AP Funds’ boards, highlighting a possible reduction in board members and the requirement of specific skills.

AP6 benefits

Grasbo said his preference is to maintain the current organizational structure of small, private equity specialist AP6.However, he suggested AP6 should be integrated into the wider buffer fund system.

“The Sixth AP Fund has not been integrated into the buffer fund system. It is high time that this happened,” he said.

AP6 chief executive officer Katarina Staaf said the review points out that the expertise of AP6 should be scaled up and that AP6 should be fully integrated to the Swedish buffer system.

“One way of doing this, according to the review, is to remove today’s legal requirement of currency hedges, to allow inflows and outflows linked to the pension system and to open for AP6 to be enabled to borrow from The Swedish National Debt Office [Riksgälden], who is the central government financial manager,” Staff said.

“All are necessary changes that we welcome.”

 

Investment strategy at Seattle City Employees’ Retirement System (SCERS), is guided by an overwhelming focus on long term assets. Hedge funds and commodities are out and cash – not a risk-free asset for a long-term investor – is kept to a minimum. Instead, perpetual equity, long term fixed income and real assets are in, accounting for a combined three quarters of the $4.1 billion portfolio.

“The takeaway is that those of us with long-lived liabilities like pension funds, benefit from being invested in long-lived assets like equities, real assets and long-dated bonds and should leave the short-lived assets like cash, intermediate bonds and hedge funds to those with short-lived liabilities,” says SCERS’ CIO Jason Malinowski in an interview with Top1000Funds.

Malinowski calls the strategy liability aware investment and dates the approach at SCERS to a board request six years ago that the investment team think more about the liabilities when assessing risk and performance. It fired the starting gun on a conceptual and analytical framework, followed by an  incrementalist approach that is still not complete.

In the intervening years events like the collapse of Silicon Valley Bank (SVB) have built on Malinowski’s faith in the strategy. He uses the travails of SVB to illustrate what can go wrong when an organisation’s assets and liabilities are structurally misaligned. In this case, SVB’s substantial holdings of long-term bonds – which suffered crippling losses when interest rates rose – and short-term deposits.

“SVB failed to balance long-lived assets and short-lived liabilities when the opportunity cost of capital increased,” he explains.

It’s the exact opposite for pensions. “For pension funds, liabilities are long term and members can’t withdraw their funds. If they invest in short term assets like hedge funds and credit they have the opposite asset liability mismatch that is exposed if the opportunity cost of capital falls.”

He says the strategy involves a shift from thinking about risk and performance of the investment portfolio to the risk and performance of the total plan. SCERS’ liabilities are discounted according to expected returns, and the team need to understand the relationship between investment performance and changes in expected returns.

“We needed to switch our focus from asset volatility to funded status volatility.”

Hedge funds and core bonds

In 2019, Malinowski eliminated hedge funds, re-allocating money to equity and infrastructure. Last year he went a step further, trimming the allocation to core bonds in favour of a new 5 per cent allocation to long term bonds.

While many CIOs enthusiastically endorse hedge funds’ uncorrelated returns, particularly when bonds and equities fell in tandem in 2022, Malinowski believes he can find enough diversification between stocks, bonds and long-term real assets to override the need for hedge funds.

“Hedge funds do not have a role in a portfolio that funds long term liabilities,” he says.

Moreover, as a liability aware investor, plummeting stocks and bonds in 2022 were not a source of alarm.

“I had a different view of what happened in 2022. We saw negative asset performance, but it was also a period when expected returns were increasing – bond yields were increasing, and earnings yields also increased. Our assets fell for sure, but our liabilities were also falling because expected returns increased, and this made the pension maths work again.”

Liability aware investment also means Seattle loses out on bold allocations to star performing assets like private credit where SCERS’ small allocation is capped, but other investors continue to flock.

But Malinowski is happy with a limited exposure. He reasons that one of the biggest risks with private credit for investors with long lived liabilities is re-investment risk. “When we get our principal and income back after 3-5 years we will have to reinvest it into new credit allocations. But this is subject to the market environment at the time which could have lower interest rates and lower credit spreads,” he says.

Background to the strategy

The strategy has similarities to LDI – like a focus on the whole plan rather than just the investment portfolio, and funded status volatility rather than asset volatility. However, LDI liabilities are discounted based on long bonds and in a liability aware portfolio, all long-term assets are attractive because they align with long term liabilities.

“Yes, we like long bonds, but we also like equities because they are perpetual, and real assets like real estate and infrastructure.”

He says the strategy does not cut fees dramatically. SCERS’ long-term fixed income allocation is in passive treasuries, but the fees from the equity and real asset allocation are still high. “With 30 per cent in private markets we do have meaningful fees. This was not an exercise in minimising fees.”

The strategy doesn’t use leverage in the bond portfolio and is straightforward to implement, something that is important because it helps weather any storms. He is mindful of liquidity and the need to pay benefits, but says SCERS’ doesn’t need huge amounts of liquidity on hand. “You need to be aware of how much liquidity you can take, but our outflows are modest. Liquidity isn’t a meaningful constraint for our portfolio.”

Malinowski fields regular enquiries from peer CIOs  interested to know more. Many of their questions centre on how he got board approval and how the fund first initiated changes in its asset liability study to switch to long-term asset classes. He finds the process useful since it tests what SCERS has put in place – and it also reassures him that SCERS hasn’t strayed too far from peers.

“I am focused on how different we are  [to other funds],” he concludes.