The Abu Dhabi Investment Authority, the 46-year-old state-owned investor with an estimated $800 billion assets under management, is planning to set up a specialist independent research unit. ADIA Lab will operate as a standalone entity with broad research goals to explore the latest trends and technologies in data and computer sciences.

Projects and research programmes will not be designed specifically to enhance and support ADIA’s investment programme, which already has its own 50-person in-house team of quantitative researchers and developers. ADIA Lab’s research agenda will be set by an advisory board of scientists, independent of ADIA, and a key rationale for the new unit is to nurture an innovative IT ecosystem in Abu Dhabi as the economy diversifies from fossil fuels.

Still, that won’t rule out the research, which will span data science, AI, machine learning and quantum computing, all highly applicable to the global trends set to drive returns in the future like the transition, blockchain, financial inclusion, cybersecurity or space, informing ADIA’s investment processes.

Next step

ADIA Lab marks another step in the giant investor determinedly boosting its technical prowess and application of technology. Speaking to Top1000Funds.com last year Jean-Paul Villain, ADIA’s director of strategy and planning, said ADIA had missed out on opportunities to generate alpha because of a lack of investment in big data and AI.

Over the last 18 months ADIA has begun investing in different kinds of quantitative approaches staffed by an in-house team of quants, physicists, AI and computer experts drawn from hedge funds and academia. They collect, clean and test data to apply across the portfolio from long short equity allocations to tactical positions and facilitate access to the best managers – around 55 per cent of the portfolio is externally managed.

Collaboration

Perhaps one of the most important benefits to ADIA will come from the investor’s proximity to ADIA Lab. ADIA Lab may not be housed in the same high rise building as ADIA, but investment staff will be able to interact and collaborate with researchers, academics and global experts in data and computer science and further embed a scientific mindset through the organization.

Start-ups

ADIA Lab will also focus on projects that could lead to the creation of start-ups. This doesn’t mark the beginning of ADIA investing in start-ups like some other state-owned investors, however. For example, in a pioneering strategy, Singapore’s Temasek creates and seeds its own innovative companies from scratch, effectively building its own strategic capabilities rather than investing in entrepreneurs in the space. ADIA does invest in start-ups of a certain scale through a venture capital allocation in its private equity portfolio, but doesn’t tend to invest in the UAE.

In school, children are first taught to master the basics – what we used to call the “Three Rs” – “reading, writing, and ‘rithmetic”. These areas are widely understood to be the fundamentals of education, and without them a student cannot progress to higher levels of learning or reasoning.

The same can be said of investors. Many of today’s investors have been drilled in the basics of return and risk – or volatility, the traditional definition of “risk.” We know that there is no return without some risk, and we evaluate how much risk is palatable given our objectives. In years past, these two “Rs” were sufficient to succeed. But today’s investors know that isn’t the case anymore, and a third area is necessary to outperform in the future. The third R is resilience.

Resilience isn’t taught as a core principle of investing, but it should be. Investors today, particularly institutional investors that manage others’ money over longer horizons, must meet expectations that go well beyond hitting a target rate of return with a given level of volatility. Meeting these expectations means being able to adapt to unforeseen events or paradigm shifts, and incorporate objectives beyond return. These objectives may be related to targets on climate, progress on diversity and inclusion practices, limitations due to geopolitics, and many other issues.

When investors ignore these other objectives, disruption often occurs – usually enough to cause the investor to make costly changes at the worst time. Building portfolios that are resilient to changing expectations or guideline for how return is earned is critical, especially for investors with very long-term horizons.

Modern Portfolio Theory, as introduced by Harry Markowitz in 1952, taught us about risk and return and the “efficient frontier.”

This was the start of “two dimensional” investing. Prudent investors seek to build efficient portfolios – those that maximize expected return for a given level of expected risk. A portfolio with scope to target a higher return with the same level of risk – or the same return with lower risk – is considered “inefficient” it lies below the efficient frontier. Prudent investors could choose different combinations of risk and return along that line, but never below it.

During the second half of the 20th century, before Modern Portfolio Theory was fully incorporated into investment decision-making, there were likely many inefficient portfolios. But as tools improved, fiduciaries recognized that targeting efficient portfolios was both more beneficial and their duty. There are some drawbacks to such an approach, but the goal of building an efficient portfolio along return and risk targets is now universally accepted.

Today, in light of changing expectations and aided by new information, we are now considering how to build efficient portfolios on three dimensions: risk, return and now resilience. Rather than a simple two-dimensional curve, think of a building with a large, curved roof. Points along the axis are efficient combinations of risk, return, and resilience. As in Modern Portfolio Theory, prudent investors could choose different combinations of risk, return and resilience along this line. However, choosing a portfolio inside it – one in which risk, return, or resilience could be improved without affecting any of the others – would be inefficient and imprudent.

A three-pronged optimization of a portfolio isn’t a new idea. Investors have long been aware of a “3-D framework”.

In fact, a 2019 study from AQR Capital Management proposed a theory in which each stock’s ESG score both (1) provides information about firm fundamentals and (2) affects investor preferences. The solution to the investor’s portfolio problem is an “ESG-efficient frontier”, showing the highest attainable Sharpe ratio for each ESG level. Roger Urwin has called 3-D portfolio frameworks that incorporate impact “a game changer”.

For fiduciaries, it may be more intuitive to consider resilience than ESG or impact. If an investor has made a net-zero commitment, for example, then perhaps their measure of resilience is their carbon footprint, as they will be unable to hold investments with high carbon outputs over time. If the investor could meet the same risk/return targets with better resilience, why wouldn’t they do so?

Similarly, an investor may be concerned about being able to hold investments in certain countries over time due to geopolitical implications. If there were similar investments in countries without such risks, it would make sense to adjust their portfolio.

There is a lot of discussion today about whether sustainable, “ESG”, or net-zero portfolios entail trade-offs. The answer is that it depends on where the portfolio starts. Given how new this line of thinking still is, it is likely that the portfolio is inefficient by the standards of our three-dimensional frontier. In that case, there is no trade-off at all, and there may in fact be Markowitz’s “free lunch” of investing – building resilience by moving towards the “resilient frontier”. Of course, if the portfolio is already on the frontier, there will be trade-offs to increase resilience, just like there would be trade-offs to add return or reduce risk.

Given that the role of a fiduciary is to optimize the portfolio for their beneficiaries over time, a prudent investor must try to be on that new frontier to fulfill their fiduciary duty – to maximize return with a given level of risk in a resilient manner. Even under US law, “risk-return ESG” is permissible in contrast to “collateral benefits ESG”.

Some may say that this is simply good investing. But as prior work in this area has shown, there is indeed a method to considering changing environmental, social, or geopolitical factors in the investment process. And it is necessary to build portfolios that are well-positioned to adapt to a changing world and prosper in the long term.

The fading of the ‘American Dream’–along with similar ideals in other developed nations–reflects a fundamental change in the American economy, argued renowned economist Raj Chetty, in a presentation using big data to pinpoint causes and put forward possible solutions.

Large organisations have a role to play in policy initiatives that provide greater upward mobility to disadvantaged children, said Chetty, speaking at Conexus Financial’s Sustainability in Practice forum held at Harvard University.

Chetty, the William A. Ackman Professor of Economics at Harvard University, and director of Opportunity Insights, said a cornerstone of the American Dream concept is the idea that through hard work, any child will have the chance to rise up and have a higher standard of living than his or her parents.

But research by Chetty and his colleagues found while children born in the 1940s and 1950s had a “virtual guarantee” of moving up, the American Dream faded dramatically over time such that children born in the 1980s have roughly a 50-50 shot at doing better than their parents.

This trend is of fundamental social and political interest, he said. “I think it’s this very trend that underlies a lot of the frustration that people are around America are expressing, as reflected in electoral outcomes, that this is no longer a country where it’s easy to get ahead even if you work hard.”

His research and policy group has been using big data to study the question of what is driving the fading of the American Dream, and how to create better opportunities to rise up, particularly for kids from lower income backgrounds. At the Sustainability in Practice forum, he shared some of his team’s findings, and put forward some potential solutions.

Using anonymised tax return data for 20 million kids born between 1978 and 1983, his team found there are very sharp local differences in rates of upward mobility. In some areas like Dubuque, Iowa, children from low-income families making $27,000 a year on average, were making $45,000 one generation later, adjusted for inflation–a high level of upward mobility.

By contrast, Charlotte in North Carolina, which is a booming city in the United States with a number of major company headquarters including the Bank of America, has one of the lowest rates of upward mobility with children growing up in low-income families having lower incomes than their parents did, on average, 30 years later.

Some economists have hypothesised the strength of labour markets could play a strong role, but plotting city growth against job growth rates for the 30 largest cities showed “basically no relationship between these two variables.”

Areas like Charlotte and Atlanta with poor upward mobility import talent, Chetty said, so their growth doesn’t directly translate to better opportunities for the people living in that community.

Conversely, the team explored connection to race and ethnicity by linking tax records to census data. This found a dramatic difference in economic opportunity between black and white men in America, such that the two comparative maps showing distribution of opportunity appeared to be using two different colour scales.

“It’s essentially you have two different countries, or in more precise statistical terms, you basically have non-overlapping distributions,” Chetty said. “The very best place for upward mobility for black men–place like Boston–black men there actually do worse on average than the worst places for white men. Places like Charlotte for example.”

This showed “there’s no understating the importance of race” in driving economic mobility, even when class is brought into the picture to compare “a black and a white boy who start out at the same rung of the income ladder.”

Interestingly, comparing women yielded a very different result. When looking at black and white women in America, “we find that there are not large differences once you control for parental income,” Chetty said. This calls for explanations of what may drive these disparities, which could be “things like mass incarceration, that particularly affects men, things like racial discrimination that might particularly affect men in the labour market, and so on.”

The team also looked at downward mobility, tracking black and white men who started out in high-income families in the top fifth of the income distribution. It found black men show a disturbing pattern of cascading downwards, while white men tend to continue to rise to the top.

“For white Americans, achieving the American Dream is like climbing a ladder,” Chetty said. “You pretty much start off where you left off in the previous generation and go up from there. For black Americans it’s more like being on a treadmill. You rise up in one generation and there are tremendous structural forces that seem to push you back down in the income distribution, only to have to make the climb again.”

From a policy point of view, addressing the challenges in disadvantaged neighbourhoods where a lot of black children grow up is not enough, and it is important to figure out and address this “treadmill phenomenon,” he said.

“This suggests that we need to focus as much on tackling racial disparities in affluent areas, among affluent families, as we do at the lower end of the income distribution.”

Other data Chetty presented showed hyper-local differences in places where children grew up–sometimes even different housing developments on the same street–would lead to large average differences in their incomes as adults.

Childhood environment also played a large role. By looking at children who moved to more upwardly mobile areas, the researchers found the older they were at the time of the move, the less average benefit there was in their adult income.

“It’s really the formative years from birth to something like 23 that seems critical,” Chetty said.

Mixed-income communities tended to have higher rates of upward mobility than places with more poverty. Places with more stable family structures–two-parent families in particular–tended to have higher upward mobility. The same was found for places with better schools.

Lastly, places with higher social capital had higher upward mobility. This was measured using Facebook data to construct various measures including the degree of interaction across class lines.

“Places where low-income people interact more with high income people tend to be places where kids in low-income families are more likely to rise up,” Chetty said.

Chetty said the data points to a range of possible solutions to address these problems, some of which require the participation of big organisations like Bank of America by making place-based investments.

Bank of America has since committed to hire 1,000 people from disadvantaged communities who grew up in Charlotte, Chetty said. Bank of America recognised that there was a skill gap, and the reason the bank was not hiring locally was because they could not find people who were qualified for the positions they were advertising.

“So they teamed up with a group called Year Up, which runs sectoral job training programs that basically give people skills to acquire certain jobs at things like financial companies, tech companies and so forth along with mentoring,” Chetty said.

This puts children on a fundamentally different trajectory, Chetty said.

Another potential solution involves reducing segregation. A pilot program in Seattle called Creating Moves to Opportunity involved helping families receiving rent assistance to move to higher opportunity neighbourhoods if they wanted to, by removing some of the frictions such as providing short-term financial assistance to pay an application fee or security deposit. This was a “small tweak to an existing program,” Chetty said

“We estimate that those kids in the treatment group who ended up moving to the high opportunity places are going to go on to earn about $200,000 more over their lifetimes relative to kids in the control group,” Chetty said.

This program is now being replicated in nine other cities with greater funding.

Another area of focus is getting more lower-income children into the country’s best universities, such as Harvard, he said.

A recent biodiversity risk analysis at Ilmarinen, Finland’s €60 billion pension insurer, found that a quarter of the companies in its large, listed equity portfolio are highly dependent on biodiversity while one third of the companies in the portfolio actually have a damaging impact on biodiversity. Those companies are overwhelmingly in the raw materials sector, the analysis found.

Ilmarinen conducted the study as part of a concerted and bespoke push to integrate biodiversity into its investment processes via a four-stage program outlined in its Biodiversity Roadmap that includes measures to screen portfolio companies on biodiversity related issues and enhanced due diligence. Active ownership is also a key component of the roadmap, comprising voting and engagement on biodiversity, as well as possibly excluding certain economic activities from the portfolio.

“We need to identify and manage both biodiversity risks to investments and the harm to biodiversity arising from investments,” explains Karoliina Lindroos, Ilmarinen’s head of responsible investing. “So far, economic growth has happened at the expense of natural capital base that includes biodiversity. In investment terms, we should not consume the capital base itself but rather live on interest.”

Collaboration

The roadmap states Ilmarinen’s aim to collaborate with other asset owners and industry bodies leading on the issue. Publishing its own strategy and approach to biodiversity is part and parcel of fostering that debate, says Lindroos.

The growing number of biodiversity investor initiatives include the Taskforce on Natue-realted Financial Disclosure (TNFD), a 35-member steering group mirroring the work of the climate-focused TCFD with the objective of developing a risk management and disclosure framework for organisations to report and act on nature-related risks. Elsewhere, Nature Action 100, a collective engagement programme on biodiversity aims to replicate the impact Climate Action 100+ had on collaborative climate engagement with companies.

Measuring biodiversity risk in Ilmarinen’s equity portfolio marks the first phase of a process that will be applied across the portfolio to provide a broad estimate of the potential materiality of biodiversity at a sector level and across economic activities.

Once the investment team understand what types of investments are most significant from a biodiversity perspective, the investor will compare results against an appropriate benchmark and develop new investment and portfolio management policies.

“The aim is to gain better understanding on which sectors and economic activities are most relevant in our investment portfolio regarding biodiversity. This will help in developing further actions on company engagement and enhanced due diligence.”

Enhanced due diligence will  aim to screen and identify high-risk companies in the same way Ilmarinen currently analyses high carbon risk companies, she says.

Other approaches will include engagement with investee companies to better evaluate and report their biodiversity related risks and impacts. Potential strategies also include establishing investment selection criteria for biodiversity, supporting meaningful nature-positive AGM proposals or excluding activities that are particularly harmful to biodiversity.

Challenges

Lindroos notes significant challenges on the road ahead. Like the lack of information on companies’ dependency on biodiversity and natural capital due to the lack of consistent and reliable data at a company level. Biodiversity, and the need to protect it, is also often location-specific.  Something asset manager Robeco is working to address with the World Wildlife Fund, using its expert biodiversity knowledge in Brazil and Asia to add local, granular expertise to its research processes.

Gathering biodiversity data is more challenging that climate change data, says Lindroos. Climate change is measured by a single and global unit tonne of carbon dioxide equivalent (tCO2e), measured and priced; biodiversity does not have a similar single unit because it  has a wide range of local variations, making harmonization of measurement more challenging.

Looking to the future, Ilmarinen’s strategy might evolve through initiatives like geographic identification of high-risk areas and value chains, or enhanced due diligence to minimize risks and impacts on biodiversity as well as  selecting biodiversity-beneficial or net positive investments.

One-third of the world economy will likely contract this year or next amid shrinking real incomes and rising prices, warns the IMF in its latest report World Economic Outlook – Countering the Cost of Living Crisis

The global economy continues to face steep challenges, shaped by the Russian invasion of Ukraine, a cost-of-living crisis caused by persistent and broadening inflation pressures, and the slowdown in China, the report states.

The IMF predicts a broad-based slowdown in 2023 with countries accounting for about one-third of the global economy poised to contract either in 2022 or 2023. The three largest economies, the US, China, and the euro area will continue to stall. Overall, this year’s shocks will re-open economic wounds that were only partially healed post-pandemic. In short, the worst is yet to come and, for many people, 2023 will feel like a recession.

In the US, the tightening of monetary and financial conditions will slow growth to 1 per cent next year. In China, the IMF has lowered next year’s growth forecast to 4.4 per cent due to a weakening property sector and continued lockdowns.

However, slowdown is most pronounced in the euro area, where the energy crisis caused by the war will continue to take a heavy toll, reducing growth to 0.5 per cent in 2023.

Almost everywhere, rapidly rising prices, especially of food and energy, are causing serious hardship for households, particularly for the poor.

Inflation

Despite the economic slowdown, inflation pressures are proving broader and more persistent than anticipated. Global inflation is now expected to peak at 9.5 per cent this year before decelerating to 4.1 per cent by 2024. Inflation is also broadening well beyond food and energy. Global core inflation rose from an annualized monthly rate of 4.2 per cent at end-2021 to 6.7 per cent in July for the median country.

Downside risks to the outlook remain elevated, while policy trade-offs to address the cost-of-living crisis have become more challenging. For example, the risk of monetary, fiscal, or financial policy miscalibration has risen sharply amid high uncertainty and growing fragilities.

Global financial conditions could deteriorate, and the dollar strengthen further, writes the IMF. Should turmoil in financial markets erupt, it will push investors towards safe assets. This would add significantly to inflation pressures and financial fragilities in the rest of the world, especially emerging markets and developing economies.

“As the global economy is headed for stormy waters, financial turmoil may well erupt, prompting investors to seek the protection of safe-haven investments, such as US Treasuries, and pushing the dollar even higher.”

Inflation could, yet again, prove more persistent, especially if labor markets remain extremely tight. Finally, the war in Ukraine is still raging and further escalation can exacerbate the energy crisis.

The IMF estimates that there is about a one in four probability that global growth next year could fall below the historically low level of 2 per cent. If many of the risks materialize, global growth would decline to 1.1 percent with quasi stagnant income-per-capita in 2023. According to the Fund’s calculations, the likelihood of such an adverse outcome, or worse, is 10 per cent to 15 per cent.

Central banks need to get it right

Increasing price pressures remain the most immediate threat to current and future prosperity by squeezing real incomes and undermining macroeconomic stability. Central banks are now laser-focused on restoring price stability, and the pace of tightening has accelerated sharply.

There are risks of both under- and over-tightening. Under-tightening would further entrench inflation, erode the credibility of central banks, and de-anchor inflation expectations. As history says, this would only increase the eventual cost of bringing inflation under control.

But over-tightening risks pushing the global economy into an unnecessarily severe recession. Financial markets may also struggle with overly rapid tightening. Yet, the costs of these policy mistakes are not symmetric.

The hard-won credibility of central banks could be undermined if they misjudge yet again the stubborn persistence of inflation. This would prove much more detrimental to future macroeconomic stability. Where necessary, financial policy should ensure that markets remain stable. However, central banks need to keep a steady hand with monetary policy firmly focused on taming inflation.

Policy misstep

Formulating the appropriate fiscal response to the cost-of-living crisis has become a serious challenge, states the report.

Fiscal policy should not work at cross-purpose with monetary authorities’ efforts to bring down inflation. Doing so will only prolong inflation and could cause serious financial instability, as recent events in the UK illustrated.

Second, the energy crisis, especially in Europe, is not a transitory shock. The geopolitical realignment of energy supplies in the wake of the war is broad and permanent. Winter 2022 will be challenging, but winter 2023 will likely be worse. Price signals will be essential to curb energy demand and stimulate supply. Price controls, untargeted subsidies, or export bans are fiscally costly and lead to excess demand, undersupply, misallocation, and rationing. They rarely work. Fiscal policy should instead aim to protect the most vulnerable through targeted and temporary transfers.

Third, fiscal policy can help economies adapt to a more volatile environment by investing in productive capacity: human capital, digitalization, green energy, and supply chain diversification. Expanding these can make economies more resilient to future crises. Unfortunately, these important principles are not always guiding policy right now.

Strong dollar

For many emerging markets, the strength of the dollar is a major challenge. The dollar is now at its strongest since the early 2000s, although the appreciation is most pronounced against currencies of advanced economies. So far, the rise appears mostly driven by fundamental forces such as tightening US monetary policy and the energy crisis.

The appropriate response in most emerging and developing countries is to calibrate monetary policy to maintain price stability, while letting exchange rates adjust, conserving valuable foreign exchange reserves for when financial conditions really worsen.

As the global economy is headed for stormy waters, now is the time for emerging market policymakers to batten down the hatches.

Eligible countries with sound policies should urgently consider improving their liquidity buffers, including by requesting access to precautionary instruments from the Fund. Countries should also aim to minimize the impact of future financial turmoil through a combination of preemptive macroprudential and capital flow measures.

Too many low-income countries are in or near debt distress. The energy and food crises, coupled with extreme summer temperatures, are stark reminders of what an uncontrolled climate transition would look like. Progress on climate policies as well as on debt resolution and other targeted multilateral issues, will prove that a focused multilateralism can, indeed, achieve progress.

 

AP4, the SEK 459.1 billion ($41.4 billion) Swedish buffer fund, links the success of its hedge fund portfolio to a few key characteristics. Like other investors, AP4’s allocation is rooted in a belief that hedge funds are primarily a source of alpha and diversification, used to provide uncorrelated returns distinct from beta risk. Like others, AP4 also outsources the allocation, pouring its efforts into a rigorous selection process to hunt out managers (it currently has around 15) with the best processes to harvest the diversification and alpha it seeks.

However, in contrast to other investors, AP4 invests the vast majority of its SEK18 billion ($1.6 billion) hedge fund allocation with emerging managers in a strategy it believes taps both outperformance and lower fees.

“We invest most with early stage emerging managers because there is empirical evidence that when and if these managers reach scale, they tend to outperform. It’s also a way for us to access future capacity at a reasonable cost,” says Magdalena Högberg, head of strategic allocation and quantitative analysis at AP4.

Talent spotting is complicated by emerging managers lacking a track record or historical results like more established funds. Due diligence requires putting the hours in to understand and gain confidence in the strategy and the people behind it – as a long-term investor, AP4 wants to see past short periods of under-performance.

“A typical red flag is not understanding how the manager is making money,” says Högberg who also insists new managers have previous experience of building a strong team and business, despite striking out on their own. “We don’t’ want to be investing into an emerging fund run by an analyst that has gone into a portfolio manager role without having the experience of training people and creating a business. We want to invest alongside a supported team.”

AP4 typically adds one or two new lines a year and splits strategies between regions. Högberg doesn’t have a specific limit on how much she is prepared to invest, but ensures the allocation is never too concentrated. A key focus is on how a particular allocation will fit into AP4’s wider portfolio. Another risk she seeks to avoid in portfolio construction is a synchronised sell off whereby all allocations plummet.

“Many of the strategies we invest in, and the way we invest, make us vulnerable to deleveraging events – a sell off where everything is affected, and the uncorrelated portfolios also sell. This is when you must hold your nerve, and when understanding the manager and the process really kicks in and allows us to be long term.”

Högberg expects all prospective managers to have an ESG policy and framework, although she notes ESG integration is easier in particular strategies. For example, it is difficult to integrate ESG in a rates, relative value strategy. In contrast, equity managers are increasingly integrating ESG. She also notes the emergence of long short hedge funds that short companies that have bad ESG characteristics. However, she believes the impact of these strategies remains a grey area. “It’s still not clear what this means from an ESG perspective. If a manager is  shorting a company that is violating our ESG standards, is that a good thing? Sure, they are taking an active stance on not owning that company but is it better to not touch it at all?”

She also notes that investing in the climate transition can be complicated by hedge funds’ short-term horizon.

“Investing in the transition can take a long time and hedge funds are sometimes on a different time horizon. Are you allowing yourself enough time for the theme to play out?”

Strategies

Högberg’s focus remains on equity market neutral managers that seek idiosyncratic risk and avoid exposure to market factors.

“Market exposure is something we can source cheaper from other sources in our asset allocation – in places like market weighted equity indices or by buying interest rate risk,” she reiterates.

It leaves the portfolio’s 10–15-line items divided between a core strategy to equity market neutral funds alongside other allocations to relative value focused on the quant space and more event driven, long short and directional trading strategies.

New lines

She is pondering adding new lines, particularly macro-orientated strategies which appear well placed to capitalize from current and prospective macro dynamics.

However, any addition to CTA-like structures will be challenging given AP4 is prohibited from investing in commodities under an enduring law designed to ensure the portfolio doesn’t benefit from higher commodity prices that could also hurt beneficiaries.

“Trend exposure in macro funds tends to include exposure to commodities as well as financial futures. It’s not impossible to ask a manager to take it out, but we would have to be careful it doesn’t constrain or adversely affect the strategy in general.”

In another approach, the team is also looking at adding sector specialists focused on big secular trends to add alpha and diversification. Areas of particular interest include the energy transition and defence, two of the sectors most affected by trends in the world today.

“The energy transition, and its second order effects, has the potential to be a big alpha driver in the long- short space as different companies react to what lies ahead,” she predicts.

AP4 already has exposure to the energy transition in its infrastructure and in-house equity allocation.

Star performer

The equity long-short allocation has performed best in recent months off the back of increased volatility and dispersion. “It has been the standout allocation,” she says.

In contrast, volatility has hit the events-based allocation that aims to profit from takeovers and mergers.

“Events-driven strategies are struggling because the convergence to fair value is not as quick in this market environment.”

Elsewhere, a strategy oriented towards climate change- that also has some underlying exposure to economic growth – has struggled given the switch to fossil fuels in Europe in response to Russia’s invasion of Ukraine.

Fees are kept low by focusing on market neutral funds and ensuring the most alpha per fee spend. “Our focus is on finding and paying for a manager that consistently generates out-performance,” she says.

Typically, fees fall the longer AP4 stays with a particular manager given the fund can leverage its long-term capital. Lastly, investing with new managers also slashes the cost. “We can negotiate founder fee terms,” she concludes.