Iceland, the Netherlands and Denmark topped the Mercer CFA Institute Global Pension index overall for the second consecutive year, each earning an A grade for their sustainable and well-governed pension systems.

Iceland had the highest overall index value (84.7), closely followed by the Netherlands (84.6) and Denmark (82.0), rating highly for adequacy, sustainability and integrity. Adequacy looks at the system as a whole and measures the level of benefits from both the public pension and private superannuation. Sustainability measures whether the pension system will continue providing these benefits for decades to come and integrity examines how well governed the system is.

David Knox, senior partner at Mercer and lead author of the study said the top ranked countries benefitted from a generous minimum pension as well as a high proportion of people having a private pension. The percentage of the working population with private pension accounts in Iceland is 83 per cent, 88 per cent in the Netherlands and 92 per cent in Denmark according to data from the OECD.

“These countries have a generous minimum age pension as a percentage of the average wage. Most of the working population, which is defined as those between 15 and 65, have a private pension account,” he said.

The sustainability of these pension systems is anchored in a deep pool of savings, currently more than 200 per cent of GDP.

“All these countries in the top three are putting money aside for the future. They have done it for so many years, almost everybody is in the system and that’s why they are at the top,” said Knox.

By comparison, asset accumulation in the UK is 125 per cent of GDP while Australia is 140 per cent of GDP, OECD data shows.

The Mercer CFA Institute Global Pension Index is a comprehensive study of global pension systems, accounting for almost two-thirds or around 65 per cent of the world’s population. It benchmarks 44 retirement income systems around the world, highlighting strengths and shortcomings in each system, and suggesting possible areas of reform to provide more adequate and sustainable retirement benefits.

The research also revealed the gender gap in retirement income among top ranked countries has reduced due to government contribution to the primary care giver – often the mother – in the first year of a child’s life.

“Northern European countries recognise that women take time out of the workforce for caring responsibilities after a baby is born and… what they are doing is for the long-term benefit of the economy and they should get some credit for it in their retirement benefit,” said Knox.

 

CPP Investments has adopted a “pathway agnostic” approach to its net zero commitment which does not pre-suppose how the transition to net-zero carbon emissions will take place, its managing director of portfolio design explained.

In a fireside chat at Conexus Financial’s Sustainability in Practice forum held at Harvard University, Derek Walker, managing director, head of portfolio design and construction at CPP Investments, said after making a net-zero commitment CPP did not want to take a specific view on how the transition would occur, arguing “a blanket divestment approach really for us was pre-supposing a pathway, and we didn’t want to do that”.

Walker said the C$525 billion fund’s net-zero commitment considers that the whole economy will transition to net zero, and this will involve a range of elements including regulations, consumer and corporate behaviour changes and technological innovation.

“We know that will involve some combination of those things and we don’t know what,” Walker said. “So we want to be fairly open to those different pathways.”

At the end of the fiscal year last March, the fund had about C$66 billion of what it called “green and transition assets” and has committed to grow that to C$130 billion by 2030.

Green assets are assets where 95 per cent of their revenues are derived from green sources. Transition assets are looked at in several ways, such as credible commitments validated through the SBTi framework, or companies in green sectors that have not yet achieved the 95 per cent target but have a credible plan to get there.

“We’re invested in Ørsted which is a Danish power producer and one of the first energy companies to have a science-based net zero target,” Walker said. “So that would be an example of a transition asset. And on the green asset side, we would have an investment like Pattern Energy, which is involved in renewables in North America and Japan.”

Outside of these green and transition assets, the fund takes a range of approaches to navigating this space, Walker said.

From a bottom-up perspective, CPP has been integrating climate considerations in any deals that come through in investment opportunities, and working to establish a consistent approach across teams, which is not a trivial undertaking for such a large organisation, Walker said.

From a top-down approach, CPP began by estimating the physical and transition risk of assets and how it would impact growth across different economies in the world. “We would then–within our return framework–translate that into return impact, and that was something that we could use to inform our long-term strategic allocation,” Walker said.

The fund is now working out a better transition risk factor “that is forward-looking but relatively robust so that we can understand where those climate leaders and laggards will be,” Walker said.

“In turn, that will help us understand what’s the correlation structure, and the relationship of that climate risk to some of the other risks that we’re trying to manage in the fund. So that, for us, is really the target.”

More broadly, the fund is evolving its portfolio construction process by bringing together a range of disparate functions under new CIO Ed Cass, including management of leverage and liquidity “so that it was all under one roof under the CIO’s direction,” Walker said.

This was an opportunity to step back and re-imagine portfolio design, Walker said, warning that “reimagining…is not for the faint of heart when you’re willing to go that far.”

“But we’ve also tried to be pragmatic and say that the objective is to come up with a framework that is more transparent, that’s more attributable and is more efficient in terms of simplifying our overall processes,” Walker said.

See also CPP drives new corporate framework for emissions abatement.

Andrew Palmer, chief investment officer of Maryland State Retirement and Pension System, explains why he puts a policy mistake and the Fed raising interest rates too high at the top of his list of concerns and what it means for how he allocates assets.

The US economy is experiencing all kinds of shocks in today’s volatile world. Government and institutional responses to shocks create more shocks, triggering yet more responses as policy makers scramble to pull the right lever. As the noise and turmoil in financial markets continues, Andrew Palmer, CIO of $64.6 billion Maryland State Retirement and Pension System (MSRP) is increasingly aware of the growing risk of a policy misstep from the Federal Reserve, in danger of triggering a bigger contraction than the economy needs.

“My concern is that the Fed could make a policy mistake,” he says in an interview with Top1000funds.com. “In this environment, it’s very hard to know what they are pushing against. The Fed says it is data dependent, but there is so much noise in the data, it’s hard to know what is going on.”

Casting back to 2018, Palmer says President Trump’s tax cuts unleashed a shock stimulus on an already strong economy, sparking inflation. The pandemic resulted in another series of policy shocks that distorted the rhythm of the economy, most notably creating a demand shock by giving people billions to spend. Now the service side of the US economy has picked up but between the pandemic and immigration policies, the labour market has tightened.

Palmer’s own response has been to moderate risk in the portfolio. For example, he is considering revisiting early 2020 strategies like paring back on risk in the real estate portfolio, going more to core and reducing value add and opportunistic allocations. In credit, trimming risk could involve moving to higher quality and more liquid investments. He is also reconsidering the fund’s historical bias to growth equity. “We are increasingly thinking about growth versus value in equity over the next two to three years. Growth is going to slow – it is already slowing.”

Still, these are only tweaks on the margins of the portfolio. Rather than making significant changes, in times like this he says it is best to leave well alone and trust an investment policy shaped to work in every kind of environment and built for uncertainty.

Climate risk

However, Palmer has just adjusted the portfolio to accommodate another risk. This time last year, Maryland’s investment team concluded an asset allocation study that modelled the impact of climate risk on the portfolio. The conclusion of the study, which involved several years working with the System’s board and investment advisors Meketa, was emphatic: institutional investors are significantly overestimating future returns.

“Our big takeaway was that industry capital market assumptions are not incorporating climate risk at all and portfolios – under different climate scenarios – are all lower than standard models predict.” Arguing that returns are going to be lower “no matter what happens,” Palmer warns that predictions around growth and dividends are based on multiples that go back to historical norms. “Today’s assumptions don’t analyse the impact of climate change on earning streams,” he warns.

His response is to prepare for lower returns ahead, most likely between 50 basis points and 1 per cent over the next 20 years. He is also building out the allocation to inflation-proof assets after the analysis revealed that Maryland’s liabilities are more inflation-sensitive than its assets. To compensate, Palmer wants more infrastructure in the portfolio, targeting 5 per cent of AUM in an allocation that will avoid natural resources like oil, gas and mining investments, the usual go-to inflation-proof asset. “We are going to focus on infrastructure because we want to avoid the impact of climate risk that comes with natural resource assets.”

Private markets

In today’s challenging environment, Maryland’s large (35 per cent) allocation to private markets via private equity and credit, real estate, real assets and some more illiquid hedge fund allocations, which together provide lower volatility and lagged, more predictable returns through time, is the key source of return.

“Return seeking is a different exercise to beta-seeking,” he explains. “In private equity we are trying to do something that will generate a 20 per cent annualised return over a five-to-seven-year period no matter what happens to the S&P500. It’s a different exercise.”

He also notes other benefits from private markets, like returns being more closely aligned across regions compared to public market returns. For example, although the US has done a touch better than other regions, returns in private equity across US, Europe and Asia over the last 15 years are similar. In contrast, public market returns have varied widely.

The risk of private market investments that he is most mindful of include “dark pool” risk. Private equity investors ploughed money into their portfolios three or even two years before the GFC, unaware of what lay ahead. He is also mindful of liquidity risk, but explains that extensive precautions safeguard Maryland’s private investments from becoming a problem in times of market stress and posing any risk to the fund’s ability to pay out around 3 per cent of its assets under management annually to beneficiaries.

Liquidity

First and foremost, around 20 per cent of fund assets are in liquid TIPS and investment grade bonds. Secondly, the private equity allocation currently “pays for itself” in as much as capital calls are met by distributions, although he recognises that in times of stress this could change. Capital calls and distributions have notably slowed down (by around half) compared to last year. But he observes that in the GFC, distributions stopped but capital calls continued as GPs took advantage of cheap asset prices.

“You could end up with a denominator effect but we’ve done the modelling on this,” he reassures, describing a situation where the value of the portfolio falls because investors don’t get the liquidity back to fund private market capital calls, and must finance new assets by selling cheap public equities.

Other strategies that safeguard Maryland’s liquidity levels include using futures. MSRP can sell its most liquid assets if needed, replacing them with leverage or futures. “If we replace the exposure with derivatives, we have a little more flexibility about implementation,” he says. Finally, he describes the fund’s daily liquidity risk exercise that ensures a daily buffer by modelling potential cash flows from existing cash flows. “We watch it every day and check that the buffer doesn’t deteriorate,” he says.

Venture

A corner of Maryland’s private markets allocation carries out a different activity to the rest of the portfolio, offering respite from head-scratching liquidity modelling and return priorities. Palmer got his first proper taste of venture investment at Tennessee Consolidated Retirement System where as deputy CIO an inaugural venture investment, part of a new private equity portfolio set up in 2009 after the GFC, went straight up.

“Venture is like buying a lottery ticket,” he says. “You may invest in 100 companies, 30 of them will fail, you’ll get your money back with some, but one or two may give you ten times your money back and provide the returns for the whole fund.”

Palmer has led the expansion of Maryland’s venture allocation since he took the helm in 2016. But the allocation is still young (with most investments only three years old) with few near the IPO stage or experiencing any rapid ramp up in pricing. The allocation also underperformed in 2021.

“Funds with more mature assets have done better,” he says. Looking ahead, he also predicts managers will struggle to access capital. “Last year, money was free. This year, it’s going to be a struggle for marginal venture companies to access finance over the next 18 months unless they have a path forward.” Still, when creativity and cash successfully ignite he maintains investment becomes truly thrilling in a way that is unique to the US economy.

 

Abandoning ESG due to imperfect data would be like abandoning the judicial system for the same reason, argued the author of the controversial ‘Aggregate Confusion’ paper which sent shockwaves around the finance world.

“It is important to understand the fact that because the data is noisy, does not imply that it is useless,” said Professor Roberto Rigobon, Society of Sloan Fellows Professor of Management, and Professor of Applied Economics at MIT Sloan School of Management. “It is a very, very important difference.”

Speaking at Conexus Financial’s Sustainability in Practice forum at Harvard University, Rigobon likened the use of ESG data to the judicial system, which plays a critical role in society but relies on incomplete data and evidence to make often controversial decisions.

Despite the noise, there “absolutely” are useful signals in the available data, and investors can gain alpha from using it to change their behaviour.

“The question is, how can we extract that in a smarter way,” Rigobon said.

In 2019 Rigobon wrote a paper titled ‘Aggregate Confusion: The Divergence of ESG Ratings,’ which looked at the divergence of ESG ratings between six rating agencies, revealing ESG data was noisy and unreliable. This meant investors did not trust the data, potentially leading to inaction, or to corporates gaming the system. The paper led to the Aggregate Confusion Project, a consortium whose aim is to make ESG integration more defensible and more workable for the industry.

ESG-related advertisements are increasingly common across the financial sector. Coming against a backdrop of “the world upset about how the private sector is behaving” on multiple fronts, and consumers demanding change, the reliability of ESG data is extremely important, Rigobon said.

industry needs to adapt to imperfection

But while the measures themselves can be improved over time, there is no way to produce perfect data for a single attribute such as CO2 emissions or diversity, particularly with societal values continually changing over time, he said.

“So we need to learn to deal with the fact that that the data is imperfect, that it is uncertain, that it is ambiguous, and that decisions are very rarely considered just by all,” Rigobon said.

This is similar to the judicial system, he said, where the data and evidence is incomplete and imperfect, and judicial decisions usually upset some people.

“That doesn’t mean that we should just disband the judicial system,” he said. “I come from Venezuela where the judicial system has been disbanded. I’m telling you [that was] a very bad outcome in general.”

Like the judicial system, ESG is a measurement of unethical behaviour, he said. It will inherit similar features to the judicial system such as the use of intermediaries — which are ratings agencies in the case of ESG — and the continuous improvement of the practices involved.

The industry, academia, data providers and regulators need to collaborate, and while the measures are imperfect, the goal has never been perfection but to “do the best that we can,” he said.

Transparency is also critical, he said, and while creating measurement is complicated and a job that needs to be delegated, “it’s much better if we actually explain that process more openly, that we are willing to be judged, and that will allow improvements in that process, not only of the data collection, but on the data aggregation.”

Also speaking on the panel was Michael Trotsky, chief investment officer at MassPRIM, one of five founding partners of the Aggregate Confusion Project led by academics at MIT which aims to improve the quality of ESG measurement and decision making in the financial sector.

Trotsky said Rigobon was initially “a skunk at the party, saying the data stinks,” when he published his controversial paper which sent shockwaves around the world of finance.

“Everyone in this room is very excited about ESG products, and trying to make a difference,” Trotsky told delegates at Top1000funds.com’s Sustainability in Practice conference at Harvard University. “And then when someone pointed out that their data was unreliable and therefore, it couldn’t be impactful, it wasn’t a great message. And we all kind of reeled from that.”

Now it is widely accepted that the data needs to get better, he said, noting a lot of improvements have been made to the data since that time, and work is ongoing.

“We believe that with a better signal, with preference selection, we will be able to reflect the view of our constituents in a better way that’s more impactful both financially, and from an ESG standpoint,” Trotsky said.

Investors should avoid simple one-number metrics when assessing whether companies have good labour practices for their workers, according to labour lawyer and former Biden and Obama Administration official Sharon Block.

Rather, they should look to a range of metrics to gain a broader insight into worker conditions, and the level of respect a company has towards workers’ rights to organise and collectively bargain, she said.

Speaking at Conexus Financial’s Sustainability in Practice forum held at Harvard University in a session looking at inequality in the labour market and the case for reform, Block said investors and pension plan trustees play an important role in creating pressure for employers to provide good jobs that respect the rights of workers to engage in collective bargaining.

Investors can help prevent a “race to the bottom” that defines success as “minimising labour costs above everything else as a means of competing,” she said, particularly when governments are failing to adequately regulate this.

Block is a labour lawyer who has previously served under both the Biden and Obama Administrations, most recently as the Associate Administrator delegated the duties of the Administrator of the Office of Information and Regulatory Affairs. She is currently professor of practice and executive director of the Labor and Worklife Program at the Harvard Law School.

Investors are able to step back and apply a “longer-term, risk management lens” and can help impart this ethos to employers and drive changes in behaviour, she said, in conversation with David Wood, director of the Initiative for Responsible Investment at the Harvard Kennedy School.

“I think it’s hard for an individual employer to see how that fits into the risk to the economy overall of this growing income inequality and the destabilising effect that can have when it’s happening in so many sectors,” Block said.

A post-pandemic resurgence in workers organising for better conditions, together with a labour market which gives workers more leverage, has seen workers choose to stay and push for better workplaces rather than walk away, she said.

Organisations that present to the public as “a good guy company” are now being held to account to match that corporate persona with their labour practices, she said, pointing to recent examples of workers organising in companies such as Starbucks, REI and Apple.

Wood asked what kinds of metrics concerned investors should look for when trying to identify good and bad labour practices.

This remains a hard question, Block said, but it is important for investors to look beyond a single number to gauge a company’s practices overall.

“In the UK there’s the London Living Wage which is one number, it’s great, it’s actually brought wages up in a lot of employers in London, but I’m a little sceptical that it can be that easy to just pick one number,” Block said.

Things like employee turnover and worker mobility within the firm are also important, she said, in showing whether workers are given opportunities to move up within the company, or are rather “worked to the limits of their endurance and then leave.”

So is equity and diversity, showing whether people of different demographic groups are given higher level opportunities in the firm, and whether there is a pay disparity.

“If they’re doing good pay equity analysis using reputable experts to help them do it, that’s going to tell you a lot about how much they care,” Block said.

In addition to things like sick leave and paid parental leave, scheduling is another significant area, she said, pointing to situations where workers are on-call for hours on end which prevents them being able to organise their lives outside of work.

“You hear politicians talking all the time about the sanctity of the family and how pro-family they are, and yet they don’t support policies that let workers participate in their family because they can’t stay home with a sick kid,” Block said.

One of the hardest things to measure is how respectful companies are of workers’ rights to organise, Block said, admitting she does not know a good measure for this. But investors could gain some indication from whether companies have had previous violations of the National Labor Relations Act, or how much they are spending on consultants to fight union organising campaigns.

“They obviously have a right to [hire consultants], but I would want to know how much money they’re spending,” Block said. “There are reports about how much money Starbucks is spending in fighting the union across the company and it’s–by some accounts–a staggering amount and I think that’s reflective of where their values are, if that’s how they want to spend that much money.”

The current global context is testing the limits of the economic system built in the last century. This session looked at the need to accelerate the transition towards a more resilient and sustainable economy. In particular, it explored ways asset owners can influence this process focusing on the long-term outcome of their investments.


Speakers
Laurent Ramsey, co-chief executive, Pictet Asset Management and managing partner, Pictet Group (Switzerland)


Chair
Fiona Reynolds, chief executive, Conexus Financial (Australia)