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APG’s Claudia Kruse reflects that the climate emergency, COVID and conflict has put SDG delivery at risk. But the SDGs remain the best roadmap out of crisis and the investor’s Asset Owner Platform has become an important tool supporting its quest to invest with impact.
At APG sustainability and digitisation are overarching themes shaping strategy. Recently, the giant Dutch asset manager combined these twin pillars in a Sustainable Development Investment (SDI) Asset Owner Platform, driven by AI technology.
Developed together with PGGM, the platform sifts through reams of structured and unstructured data to gauge the extent to which companies’ products and activities meet the SDGs. “The platform combines the core themes running through APG of sustainability and digitisation,” said Claudia Kruse, managing director, global sustainability and governance, APG, speaking at FIS Maastricht “These are the skills sets for the future.”
SDGs under threat
The UN says the SDGs are the world’s roadmap out of the crisis and remain the most compelling global and all-encompassing blueprint for those seeking to achieve real world sustainable outcomes. Meanwhile investors are increasingly incorporating risk, return and impact in a three dimensional model. But Kruse countered that the climate emergency, COVID and conflict has put SDG delivery at risk.
APG began integrating the SDGs in 2015 following requests from its major client pension fund ABP whose beneficiaries work in the government and education sectors. The platform, launched in 2020, is designed to deliver on the SDGs and support positive outcomes. It has been created by investors for investors, and is shaped around innovation and cooperation. It has also become a crucial tool in APG’s target to invest 20 per cent of its AUM in the SDGs.
The platform is used for monitoring achievement, risk management and accountability and includes progress reviews and a forward looking lens, she said. SDG analysis on the platform initially began with equities but now covers fixed income.
The platform scores companies’ products and services rather than corporate conduct, the traditional ESG lens. Enthusiasts argue that SDG scores are better at integrating impact. For example, research shows that some companies with poor SDG scores can secure good ESG scores and ESG ratings can struggle to reflect positive impacts.
Human judgement
Data is a crucial part of SDG analysis, but so is human judgement. The platform’s AI component uses natural language processing and algorithms modelled to specific topics to score and rank companies. But human judgement is important to assess platform insights on allocations with a negative contribution to the SDGs but important support for the climate transition, like transition minerals.
Analysis is focused on companies making a positive or negative contribution to the SDGs. But she noted every investor looks at the process from their own perspective and asset owners use the platform in different ways. For example, APG’s own internal portfolio managers have integrated the technology but other investors use the platform to monitor their external managers, using it to set them targets. Others use it for risk assessment and reporting.
The platform also provides key insights for investor engagement. She noted that investors have clear exclusion policies. However, the case for divestment is usually the consequence of unsuccessful engagement over time.
Investors have much to learn from the art world that goes beyond just investing in art for a return, or adorning their office walls with beautiful pictures. An appreciation of art will support better leadership, foster an organization’s culture and nurture diversity of thought, argued Rachel Pownall, chair of the finance department and Professor of Finance at the school of business and economics at Maastricht University.
Speaking at FIS Maastricht, she said that art brings positive externalities to an organization’s culture. Cultural experiences from visiting a museum to listening to music engender positive feelings, creating an energy that is possible to harness.
Witness the negative externality of, say, pollution that is not priced into the investment process. Access to art and culture bring a positive externality that is similarly undervalued, Powell who is founding director of the executive master in cultural leadership argued.
“Art brings a positive role within an organization that is possible to harness.”
Art investment
The investment community can buy art and hang it on the wall of their offices and homes. Art is an established asset class, but it is a small market.
True, it offers a source of diversification for investors, and record-breaking sales like Andy Warhol’s portrait of Marilyn Monroe, recently sold for $195 million fetching the highest price ever paid for an American artwork at auction, show the possible return.
Successful investors include the United Kingdom’s Railways Pension Scheme which made positive returns on art in the 1970s, a period of high inflation. Elsewhere, art has also been a source of investment amongst family offices. Microsoft co-founder Paul Allen’s art collection, up for sale this November, is expected to sell for over $1 billion.
But Pownell reasoned that few art lots sell for over a million. The art market is still small, despite growing over recent decades.
“It is clearly no space for institutional investors,” she said. She noted however that the extensive art collections at banks including Deutsche and ING offer a way to support younger artists and inspiration for employees. “Having new contemporary art round the building is inspiring; people choose meeting rooms according to the topic and what is on the wall. It changes the perspective of the conversation.”
Trend spotter
Art and beautiful architecture create areas where people want to work and live. Art also provides insight into key trends. Art has an “amazing ability” to provide us with a mirror image of what is happening in the world in terms of trends and the way in which society is moving over time. She urged delegates to think about how they value culture in their organization, stressing that the younger generation seeks purpose, wellbeing and belonging as well as a culture of integrity.
Lived experiences
One of the positives to emerge from the pandemic is a new appreciation for lived experiences. This gives investors the opportunity to think afresh at how to incorporate these values – and the positivity lived experiences bring – back into their workplace culture. Art fits into a post-pandemic world where people need to touch, feel and understand. Pownall also urged investors to support creative industries. When money flows into a local economy, it has many positive externalities.
Arts also helps complex issues make sense. For example, de-colonization reflecting the post empire state is a common theme in many contemporary artworks. De-colonisation can also be viewed through the lens of an investment theme alongside other “Ds” like de-globalization, de-carbonisation or de-coupling.
“We are moving away from the notion of a globalized supply chain, increasingly thinking local and putting more emphasis on the environment around us,” she said.
Pownall argued that art increasingly represents an inclusive economy: the work of Lee Krasner is now recognised alongside her husband’s, Jackson Pollock.
She also noted how artistic people bring a diversity of thought to decision making. “Artists think differently from the financial world. By working together, art and finance could come up with amazing creative products that will help solve the challenges of the future, building and using the innovation that is within our society,” she concluded.
Compared to many other asset classes, it is easier to set carbon emission reduction targets and collectively engage in real estate. Real estate significantly contributes to global emissions, and investors are in a position to meaningfully help reduce pollution.
“You have the power to do something about it,” said Piet Eichholtz, department chair and professor of Real Estate Finance, School of Business and Economics, Maastricht University and co-founder, GRESB, speaking at FIS Maastricht.
In countries that are urbanizing, it is possible to cut emissions by building green real estate from scratch. Eichholtz said that much of the developed world has sufficient real estate. In these countries, investors should focus on the opportunity to refit and climate-proof real estate, an area Australia’s Cbus Super is increasingly focused, said fellow panellist Kristian Fok, Cbus’ CIO.
Research now clearly proves that greening real estate and improving the energy efficiency of buildings is value enhancing.
“Academic consensus states that green real estate is value enhancing,” said Eichholtz.
It is possible to measure the energy consumption of a building. This means investors can make a meaningful and measurable impact. A measurement system allows pension funds to enter a dialogue with property companies, creating a popularity contest that brings developers towards alignment with the Paris agreement.
“It is useful, and creates incentives,” he said.
For example, the Global Real Estate Sustainability Benchmark, GRESB, provides validated ESG performance data and peer benchmarks for investors and managers, looking at every element of sustainability within a building from waste management to energy and water use.
“It was a strong example of racing to the top,” Fok said.
He added that Cbus encourages its managers to use the GRESB standards, although he noted that Cbus strategy is less focused on ranking and more focused on how real estate is changing and opportunities in the sector that will make the biggest difference.
Investors can also harness the tool for engagement. This is important because academic evidence shows that engagement in real estate works in terms of improving ESG integration and boosting operational and financial performance. Eichholtz noted how engagement in real estate is also relatively easy, and it is also possible to find a collective voice.
GREEN
For example, an initiative called the Global Real Estate Engagement Network (GREEN) aims to bring collective investor engagement further to the foreground.
It combines investor voices (with a combined €2 trillion assets under management, to date) in listed and private real estate together. Eichholtz noted that most investment engagement in real estate is reactive. A preferred model is continued, persistent engagement working to rolling targets towards the Paris goals, using benchmarks and disclosure to incrementally add value.
Australia has turned from laggard to leader when it comes to integrating sustainability in real estate, said Fok. A key accelerator in the transformation came via state governments requesting minimum sustainability standards.
“This catalysed the need for premium property,” he said. The introduction of benchmarking and ratings followed, forcing Australia’s real estate players to compete and lift standards.
Fok noted how the conversation around sustainability in real estate in Australia has now moved to focus on new areas like the indigenous workforce, as well as gender equality and innovation via technology.
“Sustainability has now evolved to ensure people get paid fairly and the industry is building capacity,” he said.
Progress in the Netherlands includes labelling buildings from next year, but Eichholtz called for ambitious legislation that also bites.
The sharp sell-off in United Kingdom government bonds after the Truss government’s mini budget spooked markets, has underscored the fragility in today’s financial markets. The sell-off also highlighted the importance of credibility in financial institutions, said Craig Mitchell, an economist at the UK’s National Employment Savings Trust, NEST, something that is particularly important given the need to anchor inflation expectations.
Speaking at FIS Maastricht, Mitchell noted that despite rising inflation and interest rates, and a cost-of-living crisis, economies may not experience a long and deep recession because corporate and bank balance sheets are healthier than in past crisis.
He warned that persistent inflation is rooted in the labour market.
“Once you get wages rising, it will stay around,” he said. He also noted that once inflation rises above 3-4 per cent (in the UK it is at a 40-year high of 10.1 per cent) it begins to impact financial markets and asset behaviour.
Mitchell noted how NEST is benefiting from its allocation to real assets in an inflationary environment, for example by tapping rising rental income.
The prospect of stagflation, which is difficult to hedge, is complicating strategy said Harold Clijsen, chief executive of PGB, the Netherlands €34.8 billion ($35.2 billion) industry-wide pension fund. He is currently mulling a balancing act whereby the fund keeps open interest rate risk, but diversifies the portfolio into different strategies in the hunt for return.
PGB’s assets are split 60/40 between a return and matching portfolio respectively. Although rising interest rates and inflation are concerning in the return seeking allocation, they have buoyed the matching portfolio where PGB’s coverage ratio is currently 120 per cent.
The internal team run a dynamic risk hedging strategy whereby when interest-rate risk is low, the fund calculates a lower risk budget and reduces its interest rate hedge; when rates move higher it increases the hedge. At the start of the year around 45 per cent of the liabilities’ interest rate risk was hedged, but this has now risen to around 65 per cent on the prospect of further hikes but where decision making also balances the threat of recession – and lower rates.
Clijsen noted that an end to war in Ukraine will have a key impact on inflation.
“Central banks can do something about demand,” he said, in reference to rate hiking policy. “But we need something else to do something about (energy) supply.”
He said high longer-dated yields threaten recession, yet bringing inflation down also remains key. He added that investors can play between regions to make use of different volatility in a more active stance.
Correlation
Edouard Senechal, senior portfolio manager, SWIB, shared his thoughts on the importance that investors get compensated for market risk. Two key components of market risk comprise volatility and the risk of a correlation between asset classes – particularly bonds and equities which are increasingly moving in tandem because of inflation.
Citing research SWIB conducted last year with other investors, Senechal noted that, “during times of inflation there is a higher correlation (between equities and bonds) and during times of lower inflation there is a lower correlation.”
He added that the pattern was true across most markets and the research drew on historical periods like the inflationary 80s and low inflation during the 90s.
“The correlation has been low and negative for the last 20 years when inflation was low,” he said. “If you look at Japan, declining inflation has led to a decline in the correlation in stocks and bonds.”
Higher inflation leads to more restrictive monetary policy from central banks that is challenging for both bonds and equities with an impact on risk premiums, Senechal continued. He said it is difficult to tell if central banks will get on top of inflation and economies will return to the world we had before, or if inflation remains high creating “a much more difficult environment.”
Panellists noted that central banks ability to control inflation is over-rated. “It’s not clear how much central banks can do,” said Senechal.
If central banks are successful, inflation could go back to 2 per cent by 2025. Enduringly high inflation will be bad for both equities and bonds as well as asset classes that use leverage like private equity. “There are not many asset classes that can do well in terms of high inflation,” said Senechal.
Expensive equities
Panellists noted challenges in pricing. For example, equities remain expensive, suggesting the market hasn’t yet priced in future inflation scenarios. Moreover, the volatility of short term returns makes it difficult to see if a relationship between asset classes is structural.
Panellists reflected on the importance of robust investment strategies in the current environment. Investors have to weigh whether they want to maximize returns and are willing to take on risk – or minimize the returns they want to achieve.
“Macro uncertainties are much larger than they used to be,” concluded Senechal.
A focus on partnering with specialist, differentiated, active managers with help from “the best board in America” has generated more than 200 basis points a year for The Investment Fund for Foundations. Amanda White looks at the fund’s approach to manager sourcing and the opportunities for alpha in a tough investing environment.
“It’s not a good time to try and be a hero,” Jay Willoughby, chief investment officer of The Investment Fund for Foundations (TIFF) says about the investing environment. “My bottom line on this is stick to your ‘home’ whatever that is, stay home, stay at your benchmark or neutral position.”
TIFF which manages $8 billion for more than 500 foundation and endowment clients in the US, offers five different funds all with a 65:35 allocation.
While generally speaking he says it’s a good time to be sticking to your benchmark, since Willoughby took the CIO helm at TIFF seven years ago the fund has diversified away from fixed income and allocated 20 per cent of the fund into a diversified hedge fund portfolio and 15 per cent in short duration.
“We have argued that fixed income is a lousy investment and that is the one thing we are not staying home on,” he says in an in-person interview in the fund’s Boston office. “And that has outperformed meaningfully over the time frame. It’s been a good decision. That’s the one big SAA bet we make against the benchmark.”
Within equities there are some minor deviations from the benchmark including the US (2 per cent underweight), Europe (4 per cent overweight), developed Asia (4 per cent overweight), and emerging markets (2 per cent overweight, made up mostly of a China allocation).
“They are small but clear positions,” Willoughby says.
TIFF has been an aggressive investor in China with an overweight position of 1000 bps going into 2020 which now sits at about 5 per cent.
More recently, beta has been weak in China but Willoughby says the fund’s managers continue to outperform.
“Longer term it’s too big a market to ignore. There is enormous alpha that can be generated there because 75 per cent of the market is retail traders and investors. If you have a serious research organisation that does real research there’s a lot of alpha to be had,” he says. “Coming into this year our managers have generated 600 bps annually, this year we are still ahead about 300bps.”
The value of active management
As long as inflation continues to dominant the market and the Federal Reserve is focusing on getting it under control, Willoughby believes there is risk in the market and it should be a much better market for active managers
“By having all active managers who are really smart, more will be right than wrong over time,” Willoughby says. “We can stay at our benchmarks and still add a couple of 100 bps of alpha each year, which is what history has shown we can do.”
The fund adds between 200bps to 250bps after fees each year.
“It is very much worth it,” he says.
When choosing managers the fund looks for differentiation and hires specialists, for example a US healthcare specialist manager, with 55 of the 65 managers identified as specialists.
“We hire specialist managers everywhere we can,” Willoughby says. “This means when you look through you have the portfolio you want by geography, sector and factor exposures.”
The team keeps a close eye on the sector positions, particularly any underweight position restricting it to 4 per cent.
“I will not allow more than 4 per cent underweight, so the portfolio has some balance. The overweights are conscious so I am less worried about them.”
The importance of manager selection
The fund’s selection process starts with sourcing. The belief is that if investors are to outperform they need to have differentiated ideas, which means a differentiated approach to sourcing.
Uniquely the fund’s board, chaired by Robert Durden, CIO and CEO of Virginia Investment Management Company, is an important access point for this.
“One of the reasons I came here and what continues to be an advantage is that we have the best board in America, and it continues to be, full stop,” says Willoughby of the board that includes the likes of Rick Slocum, CIO of Harvard’s endowment and Kathryn Koch, CIO of public equity at Goldman Sachs Asset Management.
An example of the board’s impact is when the team started researching China in 2014 and made a number of trips to visit managers. They asked board members for recommendations based on their contacts and that led to a number of good manager leads.
Another way the fund looks for managers is to look at who owns the public companies it considers to be good businesses, and to see who owned them before the company was well known.
All the senior members of the investment team at TIFF have invested directly themselves, so they are good at understanding businesses.
The team has an understanding of what it owns and can challenge managers and know when to add to investments or redeem based on an intimate knowledge of the underlying businesses. It evaluates their return streams and the attribution by various sectors, geographies, top holdings, and market cap which is put into detailed investment memos delivered to the investment committee and board.
Willoughby says it’s the team’s ability to ask deeper and more penetrating questions of their managers, and so get better answers, that contributes to TIFF being a better partner.
The average manager holding period is more than five years and some have been engaged for 30 years.
The fund values curiosity, imagination, integrity, independent views and repeatable competitive advantage and for Willoughby it boils down to two key things: a sustainable advantage and alignment of interest.
“We want our managers to have some sort of sustainable competitive advantage and to be able to articulate that. If they don’t have one then we are usually a pass, but if we wanted to hire them it would be because we thought they could do what everyone else does but better,” Willoughby says.
Alignment of interest is important, Willoughby says, not just because it usually means the fees are fair but because of what it says about the portfolio managers.
“Alignment of interest also means there are investors there who love what they do and would probably do it anyway without the money. They want to be the best at what they love to do and do it forever. We are often an early or seed investor because of that. We are not afraid of the track record thing, we think that’s an edge.”