CalPERS made history last week after it became the first US pension fund to adopt a total portfolio approach (TPA). The change, approved by the board after months of internal deliberation, is another mark of chief investment officer Stephen Gilmore, who before joining CalPERS was the investment head at NZ Super – one of the most prominent TPA adopters alongside Canada’s CPP Investments and Australia’s Future Fund.

Yet some US public pension funds doubt if yet another acronym to label something they should already be doing is entirely necessary. Like Ben Cotton, chief investment officer of $80 billion Pennsylvania Public School Employees Retirement System, founded in 1917 and one of America’s oldest pension funds.

“It’s interesting that we need a new acronym to help us focus on what should be common sense,” Cotton tells Top1000funds.com in an interview from PSERS’ Harrisburg office. He joined the fund in 2023 from overseeing retirement benefits in the motor industry, recruited as a safe and experienced pair of hands to shore up internal controls and governance after PSERS had reported an inflated investment performance in 2021.

“A lot of allocators have made the mistake of being too siloed and segmented, whereby rather than make decisions in the context of what is best for the whole portfolio, they make decisions focusing more on each different allocation. I have tried to approach investments more holistically my whole career, and adding an acronym doesn’t make it a new strategy.”

Cotton views TPA as allocating in accordance with the opportunities in front of him, and says PSERS has allocation targets with embedded leeway that already allow a conscious decision to overweight or underweight. Moreover, the board have always delegated to the investment team on rebalancing decisions and asset allocation adjustments within the context of the strategic asset allocation.

“We [always] ask ourselves if we are making decisions that complement the whole portfolio or if we are making decisions that just maximise a silo in isolation. The former is the better way to go,” he says.

PSERS is close to its target asset allocation, apart from a slight overweight to cash and underweight to long-duration fixed income. Positioning away from the long-term strategic asset allocation requires high conviction and in today’s climate, he argues that conviction is thin on the ground. “You need a high conviction to stray off your long-term plan, so in the current environment we’ve got closer to our targets as a result.”

He points to the recent decision to axe PSERS’ remaining 5 per cent allocation to leverage as a typical example of the investment team’s ability to adjust to an ever-evolving market environment.

“When cash is close to zero and the cost of leverage is zero, over the long run the risk premium you pick up with a modest amount of leverage is additive. But once you hit the point where the cost of leverage is as high as the risk premium you pick up, it starts to introduce undue uncertainty, not only in return expectations, but also liquidity needs.”

The decision to drop the hedging strategy also shows Cotton’s holistic approach in action.

For the last 14 years, PSERS has hedged around 70 per cent of its FX exposure to developed markets in a “winning” trade that has both reduced volatility in the portfolio and enhanced returns. But the Trump administration’s reshoring policies have turned the tide on the strategy: a cheaper dollar, he explains, makes it easier to onshore assets and ensure goods made locally in the US are more competitive with those from abroad. “On balance, we decided we’d rather not have that currency hedge,” he reflects.

He adds that removing the currency hedge has not increased volatility in the equity portfolio and is a strategy other funds are now also adopting. “Most of our peers in the public space were not hedging to start with, and of the few who did, we know of one that recently went to zero just prior to us.”

The value of liquidity at the fund, which is only 64 per cent funded, has also informed his decision to axe the strategy.

Paying out on hedges and settling on derivative positions should the currency move the wrong way requires cash and creates transaction costs, he explains. “In a period when we are concerned about our liquidity profile, we want to keep surprises at bay.”

It leads him to reflect how the funded status informs other decision-making too – namely forcing a level of risk and a larger appetite and tolerance of uncertainty. A strong funded ratio gives investors more freedom in how they approach the market, but pension funds with large deficits are compelled to take a minimum level of risk.

“Our funded ratio limits our options and opportunity to de-risk in light of uncertainty because de-risking exposes us to inflation at the same time as we are paying out cash to meet our liabilities,” he explains.

Keeping private markets within target

Liquidity has also played into Cotton’s firm cap on PSERS’ 30 per cent allocation to private markets which he says would have ballooned overweight if historical pacing models had been maintained.

The allocation, comprising private equity, real estate and infrastructure, was 8 per cent overweight when he joined but moderating pacing, combined with a more selective manager approach and selling off older assets, has kept the allocation in check.

“If we had blindly followed our pacing model in private markets based on historical experience, we would be significantly overallocated,” he says, adding that the team also struck it lucky when it came to re-investing money garnered from selling private assets in the secondary market.

“We sold certain private assets into the secondary market on average close to par and at a good clearing price. It helped us beef up liquidity and freshen our private markets book. We were also able to reinvest the proceeds into the April drawdown, so when we put the money back in the market, it was a fortunate time to be deploying into equity markets.”

Although private markets account for an ever-increasing portion of the investable market, his outlook for alternatives remains cautious because of the cost of capital and stop-start distributions. “The cost of capital is much higher, so to make it work, investors want to buy private assets at a lower price. We are seeing things improve, but distributions are still challenged, and activity is a lot slower than historically.”

He is also mindful of fees – even though PSERS rarely pays 2:20. “Our fee load is closer to 1:11 across private markets. This is not just because we are strong negotiators but mostly because we take advantage of our scale and lean into relationships.”

Rebuilding the trust

Rebuilding the trust and connection between PSERS’ investment staff and the board has been a key focus since he joined.

His efforts have focused on increasing transparency and reporting, particularly around investment management fees, and improving the context in which the investment team provide information to the board. Cotton says that information in and of itself does not amount to transparency – information needs to be presented to the board in context.

“It’s about providing the information that helps answer [their] questions.”

In a benefit that now reverberates throughout the entire fund, trustees have begun to delegate decisions to the investment team, increasing efficiency.

“Up until recently, we had to bring approval for every GP commitment to the board, even when we were re-committing to long-term relationships. Now our policy provides for delegation approval for mandating certain existing relationships to the investment team, and it has started helping us be more efficient on investment decisions,” he says.

Asset owners are witnessing a sea-change in data management and analytics as artificial intelligence opens doors to more efficient processing of investment information. But despite the promise, some may be wary of experimenting with the new technology due to the potentially negative consequences of failures on budget and culture.  

This tension was recently explored at the Top1000funds.com Fiduciary Investors Symposium. Jon Webster, senior managing director and chief operating officer at the C$777 billion ($554 billion) CPP Investments encouraged his allocator peers to first shift their mindset to one of “continuous exploration” when it comes to AI.  

He challenged the view that AI experimentation is inherently expensive to implement, at least for an organisation of the size of CPP Investments. It subscribes to the enterprise version of ChatGPT and uses DealCloud as its CRM software, whose combined fee is less than C$5 million a year against a C$2 billion annual operating budget and a C$10.5 billion investment budget.  

“I don’t think you should be afraid of the cost aspect of it. In fact, I’d lean very heavily into that,” Webster told the Fiduciary Investors Symposium at Oxford University.  

“To the experimentation point, it’s not that you should experiment. You literally have no choice but to experiment, because what the models can do tomorrow is just not the same as they were able to do yesterday.” 

To understand what AI can do for a fund, one needs to first understand what constraints it will remove, Webster said. He proposes that an organisation which is formed around investing is essentially “an information-processing supply chain” – it takes structured and unstructured data and turns them into investing ideas. 

The limitations, in turn, are “scarcity of expertise”, “high degrees of specialisation”, and “limited information processing capacity”, which is an intrinsic part of being a human.  

“Lots of those constraints are about what we prize deeply, as in ourselves, our own intelligence,” he said. 

“The thing we’re looking at inside CPP Investments is, how will our organisation get changed by this [technology]? How will work legitimately get redesigned? And are the constraints around which our organisational structure was formed, as valid as they were?” 

The C$26 billion ($18.5 billion) OPTrust has also been on a journey in the past six years to more comprehensively implement AI in its investment process. It started with using AI to determine risk on/off positions but now has a regime model of four macro quadrants upon which it makes asset rotation decisions, thanks to more accuracy in risk factor predictions enabled by large language models.  

“I don’t think we think about it from a perspective of, because this is a new technology, we have to chase it,” said Jacky Chen, managing director of completion portfolio strategies, total portfolio management at OPTrust.  

“It’s a very natural progression that as we think about our investment approach, we naturally gravitate ourselves towards that kind of decision making.” 

The most important principle of AI implementation at OPTrust is that a “human is always in the loop”, Chen said, but he acknowledged that the technology becoming a more prominent part of the investment process means portfolio managers also need to change their old behaviours.  

“As an example, when AI doesn’t know what to do when you ask it to build a risk indicator, it will immediately assume that risk equals to 0.5 times the fear index plus 0.5 times maybe the gold price. And they draw this beautiful chart,” Chen said. 

“[But] would you be able to make decisions on that? I think the traditional, more fundamental managers need to start understanding how to vet that and look into that [underlying model].” 

Conversely, quant portfolio managers need to be more market-driven, instead of treating market events as “noise” and focusing purely on their data sets as they traditionally have been.  

“The cycle is moving way faster now. If you don’t do that, you’re not able to very effectively manage your model,” Chen said. 

CPP Investments’ Webster said for asset owners, using AI is not about making faster but better investment decisions, “unless fast is your competitive edge”. 

“For many of us, it isn’t,” he said. 

“You’ve got to do something different with the technology, otherwise, it’s all a bit pointless.” 

Despite headlines of exponential escalation in the cyber attacks on governments and corporations, an expert says the core threats have remained largely unchanged in the past decade with only subtle shifts emerging today.  

Speaking at the Fiduciary Investors Symposium, former founding chief executive of the UK government’s National Cyber Security Centre, Ciaran Martin, said Western economies still persistently face the four types of cyber threat they’ve been dealing with for a long time: espionage from China; disruption from Russia; hacktivism from Iran; and political interference from North Korea.  

“The cyber security industry loves to say the threats are going up exponentially, and hackers are getting increasingly sophisticated and so forth. We say that all the time, every day, it’s not essentially true,” said Martin, who is now professor of practice in the management of public organisations at the Blavatnik School of Government, University of Oxford. 

What changed is these attacks’ efficacy and their ability to “inflict pain” on corporate or state victims. 

“[For example], the North Koreans have become very sophisticated cyber criminals… they account for a large part of the 20 per cent of unrecovered crypto heists,” he said.  

“They’ve stolen $3 billion this year alone, mostly from bridges because they’re innovating. That’s how they get past sanctions, and they’re very good at cashing it out before it can be traced and recovered.” 

Cyber criminals have also become better at squeezing companies to maximise disruption. Martin recalled the Jaguar Land Rover cyber attack in the UK in August, which forced the car manufacturer to cease all production for weeks and order staff to stay at home.  

The nation’s Cyber Monitoring Centre estimated that the incident led to a £1.9 billion ($2.5 billion) financial hit to the British economy. 

“They [the cyber criminals] really know how to inflict pain,” Martin said. 

“AI has not transformed cyber threats, not yet, and maybe it won’t. But it’s making it a bit cheaper and a bit more efficient to be a cyber criminal… the business model of criminals has got really good and that’s very worrying.” 

For financial institutions, there are three cyber security considerations to keep in mind: newer forms of assets such as crypto tend to be more vulnerable than traditional finance such as banking; sensitive information in the sector has more value and is therefore more monetisable; and the disruption of services to clients or transactions can carry greater consequences.  

Financial institutions can manage these risks by getting better at determining which types of data breaches matter the most.  

“At the moment, in terms of the way public policy is framed and the way public discourse is framed, it’s just ‘here’s a large number of data breaches’, whereas actually it’s just your name and your email,” Martin said. 

“If you go to the General Counsel and ask what’s our legal obligations, there’s only one: personal customer data. So if you take a legalistic approach to what your duties are, you’ll prioritise personal data.” 

While cyber attacks have rarely directly resulted in the loss of human lives, there are cases where that is a very plausible outcome. The Five Eyes – an intelligence alliance consisting of Australia, Canada, New Zealand, the UK and the US – has warned that the Chinese government has infiltrated critical infrastructure which could be used to their advantage if there is a significant escalation of tensions, Martin said. 

Martin also rejected suggestions that the superior power of quantum computing will dismantle cryptography as society knows it.  

But the risk lies in considerations such as which country gets there first – getting to that point three or five years ahead of international competitors would give a country a great advantage geopolitically. 

“It’s almost mathematically and engineeringly impossible to have something that can just break all of the modern cryptography and RSA algorithms without being able to write similar things that are equally secure,” he said.  

“There’s a lot of work in secret about quantum-resistant cryptography, and there has been for many, many years. Most people would say that when the quantum world comes in with this mind-boggling ability to calculate at scale, the security will be there.” 

Asset allocators are seeking new ways to optimise portfolios beyond using the historic mean variance tools in the face of higher and more volatile inflation expectations.  

At the Fiduciary Investors Symposium at Oxford University, a panel of top UK and US fund investment heads said breaking away from established practices – such as moving from strategic asset allocation to a total portfolio approach – is often a challenging task, but a new context demands modern investment frameworks.  

Elizabeth Fernando, chief investment officer of the £55 billion NEST said investors haven’t invested in an environment of high inflation, interest rates and bond yields for a long time.  

“One of the things that worries me is – if we’re building portfolios using historic mean variance optimisation tools – we’re in a very different regime to the one we’ve been in for the last 20 years,” she told the symposium.  

“If you’re relying on backwards-looking models, I would be concerned that you’re anchoring to the wrong things.” 

NEST, which is the biggest defined contribution fund in the UK, instead employs a form of TPA through which it looks for “incremental assets” that can improve the probability of meeting its various portfolio-level objectives. 

“What matters in terms of risk is very different between those, so it brings a very nice clarity to your decision making – it becomes very obvious when something no longer fits there,” Fernando said. 

“[It also helps with] decisions that previously would have been quite difficult to make because it’s risky against an SAA or reference portfolio.” 

Joe McDonnell, chief investment officer of Border to Coast, which is one of the Local Government Pension Scheme pools, said if forward-looking inflation leans towards the higher end of 3 per cent rather than 2 per cent, then investors would have a significant problem.  

“If you have 3 per cent inflation, there is one asset class that will save you and that’s commodities – nothing else does. Commodities is a difficult asset class for most of the asset owners, and I don’t see them holding 15 to 20 per cent in commodities,” he said.  

McDonnell suggested that asset allocators examine the level of inflation beta they have in their portfolios.  

“What you really want is an asset class that actually ticks along quite nicely, but if there is an inflation problem, it has a positive beta around that,” he said.  

“If we do have a 3 per cent [inflation], the correlation benefits or diversification benefits of bonds/equities breaks down, and does not recover. If you don’t hold a broad set of commodities, you have a problem, which means the majority of us will have a problem. So we need inflation controlled.” 

David Veal, chief investment officer of the Employees Retirement System of Texas echoed that there is a “fiduciary case” for investing in gold even though the fund traditionally hasn’t had an allocation. While it doesn’t generate income, the price increase of gold has been strong.  

The fund is also looking to real assets to as a line of defence in a high inflationary environment, working with many European managers to explore infrastructure opportunities.  

Border to Coast’s McDonnell added that UK private markets will benefit from the government’s push to invest more locally but a lot of the capital would likely come from the domestic listed markets, which have suffered a long period of underperformance. 

“Obviously you have the flow to passive management, active management clearly hasn’t worked. What you’re basically going to see is institutional investors who are investing UK will jump over the public market and more focused on the private market,” he said. 

“Not saying that’s a good thing. I’m just saying that’s what’s going to happen.” 

The ability of Europe’s innovative companies to grow and scale is stymied by a lack of access to capital and fragmented markets, and it is causing companies to move to the US in a downward spiral, said Ronald Wuijster, chief executive officer of Europe’s largest investor, APG Asset Management.

“Talent that wants to grow is not staying in Europe,” he told the Fiduciary Investors Symposium at Oxford University.

Wuijster listed roadblocks like Europe’s fragmented insolvency legislation, which differs between countries. Meanwhile, the absence of a capital markets union makes it hard for fast-growing companies to access the finance they need to grow and fire up a competitive European economy.

“There are fiscal reasons, regulatory reasons and many systematic reasons,” he said. “Reasons also maybe have to do with culture sometimes,” he added, referencing European member states’ deeply held national differences that thwart the prospect of a capital markets union, as well as a psychology of risk aversion.

Encouraging investors to take more risk would require a universal approach that includes fiscal policies – tax on equity returns acts as a deterrent, for example. He also called for cohesive action to encourage different stakeholders to work together. At the moment, the investor community is fragmented, characterised by small groups of asset owners, ETF suppliers, insurance companies and the like, who fail to act in concert.

Opportunities in quantum and defence

Wuijster said investment opportunities still exist in fast-growing companies in sectors like quantum computing and biotechnology. Patents are spinning out of European universities and there is a vibrant community of start-up entrepreneurs. He added that investment opportunities also exist in Europe’s large, old-fashioned sectors.

He flagged investment opportunities in private markets and said venture capital investors should focus on Europe as a whole. Security (rather than defence) is another emerging theme where APG is exploring opportunities in infrastructure and fixed income investments that support the institutions investing in defence.

APG has sizeable exposures to the US and Asia, where it has offices in New York, Hong Kong and Singapore. Wuijster said having boots on the ground supports investment because it allows APG to get closer to the companies in which it invests, and influence corporate boards.

But he also warned that Asia’s large slice of global GDP and growing populations don’t necessarily equate to great investments. Having investment teams on the ground brings cost pressures that bring margins down, and success requires operational excellence.

Meanwhile, successful co-investment requires alignment on return targets, duration and ESG, where APG focuses much of its risk management. But integrating ESG remains challenging because of crimped access to information and different sources of data. Positively, proximity to corporate boards and access to local information support ESG alignment.

APG also uses AI to identify the alignment of its investments with the Sustainable Development Goals, and uses the technology to analyse contracts with counterparties.

Maintaining APG’s culture and purpose in outposts in Asia and New York requires hiring people with shared interests prepared to stay for the long term.

“[We] attract a somewhat different workforce. And people like the atmosphere,” he said.

A hundred years ago, London had the largest population in the world of 6.5 million, closely followed by other European cities like Paris and Vienna.

But in a reflection of how fast populations can change, today Europe is experiencing unprecedentedly low fertility levels that are not compensated for by gains in life expectancy or migration, said Melinda Mills, professor of demography and population health and director, Leverhulme Centre for Demographic Science, University of Oxford.

Now countries like India, Indonesia and Nigeria count as the most populous while Japan, Germany, Hungary and South Korea face sharp declines.

She said the few bright spots stalling population decline include the fact that fertility is shifting to women having babies later in life.

“Women are having children successfully later in their lives because of medical interventions, and they’re healthier for many different reasons – they actually recuperate some of that fertility,” she said at the Fiduciary Investors Symposium at Oxford University.

Life expectancy has also increased over time, and now disruptors like GLP-1 will also probably, positively influence life expectancy.

Governments paying women to have children doesn’t work

Mills warned that oftentimes governments put in place the wrong policies to try and fix the problem. South Korea has declared a national emergency with just 0.6 births per woman; Hungary spends five per cent of GDP on pro-natalist policies – compared to around 2% on defence.

In Hungary, policies include tax incentives and giving women loans for each child. Once a woman has had four children, the loan is waived. Yet Mills said research shows women who had four children, always planned to have large families.

“Governments paying women to have children doesn’t work,” she said.

More successful policies comprise ensuring women with children can work close to where they live without a long commute. People also plan their families in line with economic security and housing. “When you have a precarious job, it’s hard to predict the future and if you can’t buy a house it stops people from having children.”

Cultural norms also need to change. In Korea, she noticed women are reluctant to have children because they already “take care of their husband and his parents.”

“Try and crack that in a room of policymakers where, like, you know, 95 per cent are male.”

Investor opportunity

Mills said that a shrinking European population will trigger significant changes in economic growth and investor opportunities. Certain areas will experience depopulation as highly skilled workers leave, creating a loss of services and fuelling political instability.

The future in many countries will be female because women outlive men. Demographics are also shifting consumer behaviour. Today, Gen Z (13-28) are the largest population characterised as high spenders and reachable by digital channels. In Japan, manufacturing has moved from producing baby diapers to adult diapers; in South Korea, it’s moved from infant formula to protein drinks for older people.

Cities will also change with shifts in demography – particularly given 70 per cent of the world’s population will be urban by 2050. This will equate to centralised services and a new configuration of transport systems – perhaps taking the elderly to hospitals. Expect the repurposing of schools into housing, and fewer family homes.

“We’ll have a lot of housing and things built for an older population. It will be interesting to see how that will be repurposed.”

Is immigration the solution?

Immigration is one panacea. For example, in the United Kingdom, foreign, highly-skilled care workers are essential to staff the NHS. But it is complicated by political tension and the rise of the far right.

In 1970, about 5 per cent of the population in the U.S. was migrants. Now it’s about 24 per cent. But she noted the high level of inter-country and inter-continent migration due to different migration rules impacting countries’ ability to hang onto migrant populations with different health profiles, different needs, and languages.

Companies will increasingly re-skill their current employees and give better benefits to try and retain people.

Technology will also do the work of people, but she predicted that the rise of AI won’t negate the need for populations, arguing instead that technology and AI will open up a new economy.

“If you take the long view across history, people argued that things like the printing press or the steam railways would take everything down. But at the same time, a new economy emerged and whole new jobs were created. And I think that’s kind of how we have to see AI as well too.”