Japan’s 245.98 trillion yen ($1.5 trillion) Government Pension Investment Fund’s (GPIF) annual survey of listed companies designed to ascertain the stewardship activities of its external asset managers, reveals engagement in Japan remains an uphill struggle.

The survey seeks to gauge the degree of “purposeful and constructive dialogue” between listed companies on the Tokyo Stock Exchange and asset managers, offering a window into the ability of institutional investors to effect change in corporate Japan.

Only 717 firms (33 per cent) of the 2,154 listed companies on the Tokyo Stock Exchange responded to GPIF’s survey request.

Engaging on governance

Since the introduction of Japan’s Corporate Governance Code in 2015 the country has been trying to modernize corporate boards, long dominated by in-house executives. Outside directors currently occupy 44 per cent of the board seats of companies listed on the Tokyo Stock Exchange’s Prime section, up from 28 per cent in 2017, according to a data compiled by the Japan Association of Corporate Directors.

Still, 70 per cent of respondents said they did not receive a request from asset managers to conduct dialogue with outside directors and outside statutory auditors.

The Tokyo Stock Exchange, leading calls for stronger governance, is also demanding listed companies take “Action to Implement Management that is Conscious of Cost of Capital and Stock Price.” This new regulatory pressure is designed to improve underperforming companies, lift valuations and improve capital efficiency.

Although regulatory pressure was cited amongst corporate respondents as a focus of engagement activity alongside climate – only 10 per cent of companies said that they had received a request from their asset managers in the past year to conduct collaborative engagement.

Lacklustre asset manager engagement with investee companies comes as GPIF seeks to widen its manager pool.

The process will see the fund open up to new managers by reviewing criteria that have long-governed selection. Like its stipulation that its managers must have at least 100 billion yen assets under management and a fixed number of years of experience servicing financial products. The fund now says it will accept applications from investment management institutions with “a sufficient track record.”

Disclosure impRoves

Encouragingly, asset manager pressure on companies to disclose in line with Task Force on Climate-related Financial Disclosures (TCFD) recommendation is reaping change. Approximately 90 per cent of respondents voluntarily disclose non-financial information in line TCFD recommendation.

Still, asset manager engagement regarding Task Force on Nature-related Financial Disclosures (TNFD) is much less with only 35 companies responding that they have disclosed information in line with the TNFD – 79 per cent of respondents said they had no engagement from asset managers on TNFD.

Despite challenges around engagement, corporate responses highlight the effectiveness of engagement.

“They [asset managers] understand our company deeply and their advice through engagement is helpful. Many investors tend to hesitate in expressing their opinions to management, but asset managers give harsh opinions directly to the President and CFO. Therefore, the meeting is very beneficial in the sense that management can hear the voices of investors directly. For this reason, they have won deep trust from our CFO,” wrote one survey respondent.

“In particular, they explained frankly their way of thinking behind their ESG analysis and evaluation of our company, which helped us understand the “investor perspective.” We had a frank exchange of views on sustainability. Especially on materiality, we were able to obtain opinions on what institutional investors want,” said another.

Other corporate responses flagged continued short-termism among asset managers.

GPIF runs a policy asset mix of 25 per cent each in domestic and foreign equities, and domestic and foreign fixed income and targets a real investment return  of 1.7 per cent with minimal risks. Investment in alternatives, began 10 years ago, remains under a 5 per cent target at just 1.4 per cent of total AUM. The GPIF has been discussing changes to investment strategy, including its asset mix and will announce a new investment policy at the end of this year to enact through 2025.

The rally in global markets powered record returns at the investor, according to its annual results. Domestic equities are the fund’s best performing investment although the weakening yen lowered GPIF’s asset size in dollar terms to $1.53 trillion compared to Norway’s $1.6 trillion fund. The fund posted a 22.7 per cent annual return for the financial year ending March 31st.

Thailand’s $34 billion Government Pension Fund leads the region’s asset owners when it comes to integrating ESG, focusing on an optimal return for members and a social return for other stakeholders. Top1000funds.com talks to Man Juttijudata, responsible for GPF’s active investment strategy, outsourced funds management and RI strategy about the key challenges – like how to treat EV companies – and how he relies on fund managers for nuanced assessment.

Thailand’s $34 billion Government Pension Fund has developed a leading ESG strategy among institutional investors in the region that integrates sustainability into two thirds of its holdings spanning all asset classes, with the exception of government bonds and hedge funds.

“Our objective is not to just maximize returns,” explains Man Juttijudata, senior director, strategic and tactical asset allocation who is responsible for GPF’s active investment strategy, outsourced funds management and responsible investment strategy, and has been at the fund since 2006.

“We prefer to achieve an optimal return for our members and a social return for all our other stakeholders. We are not investing just for this generation but for future generations too and sustainability is the most important return.”

Sixty per cent of the portfolio is in fixed income comprising Thai government and corporate bonds, global sovereign and corporate bonds, and a smaller allocation to short term bonds and emerging market fixed income.

Risk assets claim the remaining 40 per cent, divided equally between equity (domestic, global and emerging market) and alternative assets where allocations include global real estate, infrastructure, private equity, commodities and two mandates with absolute return managers to support tactical allocation and with a low correlation to other assets.

“The economic cycle between the global and domestic allocation is different and by investing globally we can tap a wider and deeper market that gives us more opportunity to bring back returns for our members,” says Juttijudata.

Weights and scoring

The fund integrates ESG in its actively managed equities by applying negative screens and using an ESG weight and score asset valuation methodology that adjusts the weighted average cost of capital and stocks in the portfolio.

In place since 2018, the methodology scores companies using MSCI ESG data but also draws on additional, local analysis of Thai companies that includes governance data, a particular concern at the fund.

“We seek to assign a greater weight to governance in our investment process. We modify MSCI’s ESG data and scoring processes to integrate Thai-specific data sources to reflect our concerns,” says Juttijudata.

In fixed income, the fund draws on credit research that includes ESG performance, and also applies a negative screening process. It does not currently analyse ESG issues for its sovereign bond holdings, but does invest in sovereign Green, Social, and Sustainability (GSS) bonds which contribute to ESG outcomes.

Juttijudata won’t add any more fossil fuel holdings to the portfolio, but says the fund won’t divest on climate or emissions grounds either – although it does on governance concerns. He argues that divestment only leads to less scrupulous investors buying dirty assets and also worries that the data is too sketchy to inform accurate divestment decisions.

“We are trying to introduce more emissions data and quantitative analysis into our reporting. But right now, we are not confident that the data is accurate enough to make a decision on divestment so we concentrate on engagement.”

Recent engagement wins include persuading companies in Thailand’s power sector to increase efficiency.

“We engage with small cap stocks as well,” he says.

He observes that Thai companies are increasingly open to engagement. Last year the investor engaged with Thailand’s top 10 companies, most of which have a net zero target and have set caps on emissions.

“Companies that export to Europe know that if they don’t do this they may face a tax on their exports.”

Key challenges to the ESG strategy include the oftentimes absence of coherent beliefs around investing in sin stocks like alcohol. He is also struggling to develop the right nuance around stocks like EVs.

“EVs are good companies but lithium mining is ESG negative and you are always going to have this dispute with electric cars.” For now he relies on managers to conduct a trade off in the scoring process.

Looking to the future his focus is on improved reporting on GPF’s climate exposures; extending ESG to all assets in the portfolio and driving higher standards of responsible investment in Thailand, and across the Asian markets.

He says he has no plans to move into impact investment, primarily because he’s worried about the impact on returns.

“We do try to have a positive impact, but if we trade too much of our return we will lose the consensus from members,” he says.

The internal team manages the domestic allocations to Thai equity and bonds. In global investments where the team don’t have the expertise, he outsources and incorporates ESG into external manager selection, appointment, and monitoring processes.

He likes the competitive tension between the internal and external team and despite outsourcing, the internal team is still able to add top down tilts when they see an opportunity between sectors or regions that complements bottom up active management.

He would also like to build out the allocation to risk assets, namely public equity and a new allocation to private debt.

Governments and the private sector are supporting climate technology. Learn why net zero is the future.

(more…)

The $202 billion Texas Teachers is pioneering efforts to change the fee structure in hedge funds. Two thirds of its allocation is managed on a 1-or-30 structure and it is leading an industry-wide initiative, with more than 60 other asset owners, calling for cash hurdles in incentive fees. CIO Jase Auby says earning cash returns is not the reason institutional LPs invest in hedge funds.

The $202 billion Teacher Retirement System of Texas (TRS) pioneering effort to transform hedge fund fees is gathering momentum, according to chief investment officer Jase Auby, speaking during the investor’s July board meeting.

He said that around two thirds of TRS’ hedge fund allocation is now managed on a new 1-or-30 model counting for around two thirds of the number of managers in the portfolio. TRS has been investing in hedge funds since 2001 and has around $20 billion in the allocation.

Earlier this year, the pension fund launched an industry wide initiative to advocate for cash hurdles in the calculation of hedge fund returns that included an open letter to the industry signed by 29 Limited Partners. This year’s push builds on an initiative dating from 2016 when former CIO Britt Harris first began advocating to move from a 2:20 structure to a new 1 or 30 model. [See a podcast conversation with Albourne CEO, John Claisse, on the innovative fee structure Are managers rewarded for fee alignment?).

Under a 2:20 structure hedge funds are paid a 2 per cent base fee and 20 per cent of the profit. TRS is advocating to lower the base fee to 1 per cent and “make it an or, rather than an and” 30 per cent of the profit. Under the model, TRS pays hedge fund performance fees only after managers meet an agreed upon hurdle rate. Managers can then earn whichever is greater – either a 1 per cent management fee or a 30 per cent cut of the alpha or performance after benchmark.

Auby said that over the years the initiative has been well received, but that was when cash was at zero per cent and so the concept of a cash hurdle was not as necessary as today.  With cash currently up at 5.25 per cent approaching the industry again to put meaningful hurdles in place to better calculate hedge fund returns has been even more welcomed.

“We had 29 total signatories to our letter in May, now this is up to 60 and we’ve also received numerous calls (double than that amount) from others that are similarly inclined rooting us on anonymously,” he said.

The TRS portfolio is divided between (54 per cent) global equity (22.3 per cent) stable value including government bonds, absolute return and stable value hedge funds ( 21.6 per cent) real return and (7.3 per cent) risk parity with remainder in cash.

Introducing new fee structures takes time

However, Auby cautioned that introducing new fee structures takes time.

“We approach the ones that have had the worst performance recently first because they are the most amenable. As we go through the cycle we will approach others.”

Auby explained how the cash component is the preferred return. For a long only large cap manager the SP&P500 is the risk appropriate benchmark. For hedge funds which are not supposed to have any residual market risk, he said the risk adjusted return should therefore be cash.

“We are approaching the industry and advocating for a cash hurdle and the risk appropriate hurdle,” he said.

His comments are echoed in the industry letter, published in May, which stated how hedge funds may collect significant incentive fees based solely on skill-less returns generated from short rebate, securities lending, or unencumbered cash.

“These returns are easily obtainable by LPs outside of a hedge fund structure for free. Earning cash returns is not the reason institutional LPs invest in hedge funds,” it stated.

“In 2023, a $1 billion market neutral hedge fund could have earned ~$52 million (5.25 per cent) returns just by holding cash, and if that fund charged a 20 per cent incentive fee on absolute returns, would have taken home $10.5 million in compensation for taking zero risk. This is not sustainable, especially as it seems the risk-free rate may remain elevated for the foreseeable future; and it is not what LPs are asking GPs to do.”

Signatories to the letter include Canadian pension fund CDPQ, Singapore’s GIC, Korea Investment Management, UTIMCO, Healthcare of Ontario Pension Plan  Brightwell Pensions and Trans-Canada Capital.

Singapore’s sovereign wealth fund GIC is bracing for a period of “profound uncertainty”, as the fund looks to rely on more “granular” diversification and maintaining price discipline to traverse the environment.

In its 2023/ 2024 annual report the fund’s chief executive Lim Chow Kiat warned there are “no maps” for investors to navigate the volatility ahead, and the fund is looking to play into its strength as a provider of long-term capital.

The report said that several key markets had priced in a very positive outcome for the macroeconomic environment since the short-term probability of recession in the global economy had been reduced. Lim highlighted the benefits of nimble capital and a more bottom-up approach in this environment.

“Credit spreads in the US and Europe, in particular, are below or close to their lowest quartile in the past decade,” the report read. “However, there is a wide dispersion across markets and within asset classes.”

“This dispersion favours a more bottom-up approach, alongside more nimble capital allocation across different opportunities.”

In the report Lim said many markets are primed for a Goldilocks economy and “have not yet priced in the level of uncertainty investors face”.

“It is a plausible scenario, but only one of many,” he said.

“This signals a potential mismatch between investor confidence and the range of plausible outcomes.

“In such an environment, GIC must practise price discipline.”

The fund indicates that it intends to remain level-headed in the well-documented AI hype, as Lim said some early-stage AI businesses are commanding a lofty valuation.

“Hardware makers, including semiconductor firms and the infrastructure layer businesses such as cloud platforms, have less downside, though their valuations have also expanded recently,” he said.

“Each case requires careful assessment of its potential risk-return trade-offs.”

GIC has a total portfolio approach and when it comes to diversification, its process is to start with understanding of the real underlying risks, then stress test different combinations of investments in various amounts.

Lim said the fund won’t stop at diversifying on an asset class level but really digs into the “granularity” of investment opportunities, especially in private markets where the fund has built comprehensive capabilities over the years.

“Take real estate as an example. We have picked our spots across different sub-sectors — including data centres, student housing, and logistics — and different geographies,” Lim said.

“In a world where uncertainty has shaken the foundations of the investment environment, our response is to be ever more sure of who we are and to abide by our core investment principles.”

In the year to March 2024, GIC cut exposure to nominal bonds and cash by 2 per cent while upped allocations to inflation-linked bonds by 1 per cent. Private equity is also occupying a bigger part (up 1 per cent) of the portfolio due to capital deployment and returns.

The funds that take a total portfolio approach added 1.8 per cent per annum over 10 years above those that use strategic asset allocation in a recent Thinking Ahead Institute study of 26 asset owners, including the Future Fund. And the systems-thinking TPA approach, with the benefits of dynamism and joined-upness, will help asset owners in an environment of increasing complexity according to the report’s author, Roger Urwin.

Urwin said the institute has research to back up those claims with the results of the TAI’s recent Global Asset Owner Peer Study in conjunction with the Future Fund the latest data in support. The study examined 26 asset owners and found the 36 per cent with a total portfolio approach (TPA) produced superior returns that make Urwin’s estimate of value add look conservative.

“It’s a crude test, but the TPA organisations outperformed the SAA organisations over the last 10 years by 1.8 per cent. And 1.8 per cent per annum is just a very, very substantial margin in our industry,” he said. “Quite honestly I’ve never seen a margin out of one factor as big as that before.”

Urwin emphasised that in part the two portfolio allocation approaches solve different problems.

“SAA basically solved a governance problem, and it did it well. But it didn’t solve the investment problem,” Urwin said. “TPA is a really important design feature by which organisations can probably get better performance.”

The most recent asset owner peer study found that the number of funds doing SAA was half what it was when the same study was conducted seven years ago, and the trend to TPA was continuing, with 20 of the 26 funds stating they were either at their maximum TPA or moving more towards TPA.

The benefits of the TPA approach include a more dynamic portfolio and more “joined-upness” which were both useful in a more complex environment, Urwin said.

Managing complexity was the number one concern of the 26 funds, cited by 73 per cent of the CEOs and CIOs who participated in one-on-one interviews.

“When we did this study in 2017 it wasn’t on the list, it wasn’t anywhere,” Urwin said. “But over that time complexity has become one of the most difficult things for organisations to cope with.”

One of the key takeaways from this result, according to Urwin, is that individuals are spending most of their time on business as usual and not enough time thinking about whether their organisations are adapting to the changing world.

The study also showed that 88 per cent of the fund’s investment teams expect systemic risks will grow in number and size. These include geopolitical confrontation and climate change.

Building more resilience including more agile organisational design, better culture and stronger risk frameworks – combined with the systems-thinking TPA approach – will help position asset owners in this environment, he said.