Reforming European capital markets could unlock a multi-trillion-dollar investment opportunity as investors seek alternatives to the US in the wake of Liberation Day, said Apollo Asset Management co-president John Zito. 

“If you look at the marketplace, you have a $24 trillion economy in the eurozone, versus a $30 trillion in the US, of which there’s $15 trillion securitised in the US and $500 billion of securitised market in Europe,” he said at the Fiduciary Investors Symposium at Harvard. 

“There’s a multi-trillion dollar opportunity to unlock the bank’s capital but that requires 35 countries to get aligned on policy, which is hard.” 

The Trump administration’s extensive Liberation Day tariffs in April shocked markets and undermined confidence in the role of the US as the natural home of capital and innovation.  

Zito said the balance of trade argument behind the tariffs neglected to consider the massive foreign direct investment coming back into US capital markets, which propelled growth and underpinned higher multiples in public markets.  

“One dollar spent on a good versus one dollar spent in equity that can be leveraged and then multiplied is worth infinitely more than the dollar on goods,” he said.  

However, the fast growth of large asset owners such as sovereign wealth funds meant they had limited options to deploy their funds outside of the US. Zito said he was positive that Europe would ultimately respond to the opportunity. 

Late last year, the European Commission appointed former European Central Bank President Mario Draghi to produce a report aimed at boosting European competitiveness. It highlighted the role of securitisation to increase the competitiveness of European financial markets, which remains heavily reliant on bank financing.  

“I think you’re going to see the German spigot turn for the first time in a decade in terms of fiscal spend. I think private credit and private capital will be a big proponent and part of that,” Zito said. 

“And just Germany turning on, particularly in conjunction with France, is going to change the whole narrative and just way the way people think about growth in the region. I’d love for them to consolidate their exchanges. I’d love for them to make it easier to do business.” 

While geopolitical forces continue to reshape the world, a technology arms race is also underway. Zito said the impact of artificial intelligence was impossible to assess, which made it a significant risk.  

“AI was not in any single investment memo for a software buyout in 2018 to 2021 and it was the single largest sector that bought out at 11 times revenue, and we still have not marked it. Meanwhile, I promise you that there will be massive amounts of disruption in software. It is the first thing that will happen. It’s the easiest thing to disrupt.” 

An economic slowdown would cause a re-rating of the sector as software retention rates declined. 

“In the LBO space, 40 per cent of private credit is software and in the equity space it’s a big percentage of total private equity outstanding, particularly stuff that has not been sold.” 

Zito said the pace of change was fast and companies needed strong leadership to pivot their strategies and a willingness to change. For example, just a couple of years ago, Microsoft was focused on workflow software but is now investing billions of dollars in AI.  

He also said it was time for large long-term asset owners to get more dynamic around their fixed income pools, given the end of zero or negative interest rates. 

“I think you’re going to see the sovereigns and the places that actually use their duration of capital to fund what is the two biggest gross spends – which is effectively infra and defence – they’ll end up having much larger pools and end up being the leader.” 

Equity markets have been the growth engine for the portfolios of many asset owners globally, fuelled by decades of low interest rates, rising economic growth and a relatively benign geopolitical backdrop.

But that seems like it’s beginning to change. Faced with increasingly fickle public markets, fewer and fewer companies are pursuing IPOs, while concentration risk has big investors questioning the size of their exposure to liquid assets.

“I think we’re seeing an evolution towards private markets because public markets are not functioning as well as they used to,” Anne-Marie Fink, chief investment officer for private markets and funds alpha at the $132 billion State of Wisconsin Investment Board (SWIB), told the Top1000funds.com Fiduciary Investors Symposium at Harvard University.

It’s getting “harder for companies to live in the public markets”, Fink said. But private market investing can remove some of the intermediary layers between companies and investors and allow both parties to properly orient their strategy towards the long term. SWIB’s portfolio is 65 per cent public assets, 20 per cent private equity and debt, eight per cent in real estate and 19 per cent in inflation-sensitive investments.

“We’re not all in privates, and we do think that publics have a place in our portfolio – in fact, a bigger place,” Fink said.

“We find that we get better returns from privates, just generally, relative to publics. We think they have advantages in terms of the way the governance works, the ability to plan things over a four- or five-year timeframe as opposed to a quarter-to-quarter timeframe, and then there’s the collaboration between your owners and your management teams of your companies. So for that reason we expect that private equity will outperform public equity.”

Gold rush

But the weight of money moving into private markets – a gold rush for established and new managers – belies the fact that many of the fund and fee structures on offer have not been particularly advantageous to their investors, while plenty of private market managers have grown up in the same benign macro environment that’s propelled public equities higher.

“There’s a lot of people that haven’t lost,” said James Clarke, global head of institutional capital at Blue Owl. “I’m 50; there’s a lot of people that are 40-odd, and they were 25 during the Global Financial Crisis, even younger, and they’ve had a tailwind of low cash, they’ve had a tailwind of people increasing private markets exposure.

“I think that the whole system has changed; I think that it’s moved from a tactical to a strategic allocation. I would say if Blue Owl, or formerly Owl Rock, had started in 2025 and not 2015 there would be zero reason for us to exist. None. I honestly mean that, and I mean that because a new entrant in this space right now would be awfully difficult. The world needs another private credit manager like it needs a hole in the head.”

To stay relevant, GPs can’t poke their heads out every three years when they want money for a fund.  LPs want partnership for the long-term value add it brings to their portfolios, and the firms that don’t get that are “going to languish”.

“Why is that beneficial? There’s scale,” Clarke said.

“There’s a fee premium through co-investment, it’s a volume discount that only a handful of managers can provide. Number two, they can access you in a way that’s more customised to their portfolio. It’s not a fund where they’re riding alongside XYZ $5 million investor. It’s SMAs, it’s funds-of-one, co-investment programs. And I encourage everybody to make sure that co-investment program is as tight as possible and replicates what the portfolio looks like, because I’ve seen co-investment programs at other firms and they can be 400 to 500 basis points off.

“There’s also fees. It’s not ‘we’re charging on committed capital’, it’s invested capital, in many cases it’s flat fees. The returns have compressed. I think it was a capital appreciation strategy in private markets and it’s now migrated to a capital preservation and income generation strategy, and that’s been the biggest change.”

Meanwhile, Kevin Kneafsey, senior investment strategist for multi-asset solutions at Allspring Global Investments, anticipates a “massive shrinking in this space” as more and more LPs realise that large chunks of the private credit, equity and real estate they’ve been buying offer them only “leveraged beta”.

“There’s a group in Chicago, Delaware Street Capital, that replicates private market assets with public market assets. The first thing they do is match the sector; the second thing they do is match the leverage. And if you do that you get a lot of what you’re getting. So if you want to pay two and 20, pay it for the alpha portion above the leveraged beta portion. I think that’s a washing out that’s coming. I think the fee pressure is coming.”

Kneafsey also thinks the market has gotten too large and that big investors “don’t need more of this” – but that many of the managers that already exist are solid, with strategies that make sense.

“When I was at BGI, back in the hedge fund heyday of the early 2000s, our CEO said there are now 5000 hedge funds. And he said there aren’t 5000 really smart people. Well, there are 17,000 private equity firms in the US. I guarantee you there are not 17,000 really smart people, and they’re all not in private equity. So this space is due for a real big shrinking and a rewriting.

“Do I think it’s going away? No, it makes a tonne of sense. There’s lots of reasons to finance companies in different ways, whether it’s venture, whether it’s private equity buyout or growth, whether it’s private credit funding these things. But the way it’s being done, the way it gets paid, the transparency – all of those things need to change.”

Carol Geremia, president of the Boston-headquartered MFS Investment Management, said “long-term washing” has become one of her biggest worries, with everyone claiming to be a long-term investor while failing to align their investment practices with that goal.  

MFS Investment Management, which Geremia joined in 1984, is a 101-year-old asset manager with $600 billion in assets under management.  

Throughout her career, Geremia said she has witnessed institutional investors’ increasing ownership of companies in the US, from 35 per cent in 1975 to 95 per cent in 2022. However, the average holding period shrank from close to 5 years in 1980 to just 5.5 months in 2022.  

“I’m constantly confused – as we talk about being long-term as an industry – [about] how we can get better aligned with the conversation around the markers to the longer-term destination,” she told the Fiduciary Investors Symposium at Harvard University.  

“We talk about ESG and the fear of greenwashing. I say the biggest fear I’ve had for the past 15 years is long-term washing. 

“If you say you’re long term, prove it. I don’t know why we don’t use the average holding horizon of a stock inside the portfolio to have a better conversation with an active manager.” 

She pointed to research conducted by WTW’s Thinking Ahead Institute which says that in the 2020s, the measurement of success of any investment should be consistent value creation for stakeholders, with a focus on overarching sustainability and achieving long-term goals. However, Geremia said it still feels like many investors are stuck in the “messy middle” when they transitioned from the ‘alpha era’ between the 2000s and 2010s, where success only means alpha generation against a benchmark with low tracking error.  

This is coupled with the fact that investors tend to turn to easy-to-use metrics to judge their organisation’s success, focusing on things like past performance and traditional benchmarks, while more difficult-to-measure qualities, like effective decision-making and empathetic communisations, are ignored. But the latter qualities are more likely to help an investor achieve their long-term goals and add value to alpha generation, Geremia said citing a State Street report.  

“It makes it easier to hold people accountable when you can measure the easier quantitative things, but it actually pulls us so far away from long term value creation, not to mention responsible allocation of capital,” she said.  

How MFS is holding itself accountable to act like a long-term investor is through its goal to perform over the full market cycle. The definition of how long a market cycle is might be contentious, but Geremia said MFS believes it is close to 11 years, despite its survey of 540 institutional investors in 2024 showing that 87 per cent of respondents believe it’s seven years or under.  

Over half of the respondents also said their organisational tolerance for underperformance against a benchmark is three years or under.  

“That definition of a full market cycle from perception is actually declining – why is that?” she said.  

“I said to our investment team [that] if we can’t define a full market cycle, we’re going to have a problem, because that in itself is the growing misalignment of the system. 

“I’ll quote Roger Urwin from Willis Towers Watson. He said the only way to generate returns in the future is in a system that works. 

“I think we talk a lot about returns, a lot about alpha, but in the way we look at our system and how we’re operating, we need to poke some really big holes in.” 

This article was produced by Capital Group without involvement from the Top1000funds.com editorial team.

Towards the end of 2024, one of our key economic themes was that the US and Europe seemed to be on divergent growth paths. Europe was becoming more fragile, both cyclically and structurally. Meanwhile, the US remained, what we called a grower economy, benefitting from both cyclical and structural resilience.

Our view was that if nothing changed, this trend was likely to continue. However, since publishing the paper, a lot has changed. Donald Trump’s return to the White House, and the announcement of reciprocal tariffs that were more draconian than anyone expected, pose a significant risk to growth and increase the potential for US recession in 2025.

At the time of writing, these reciprocal tariffs have been paused for 90 days. While the market has welcomed this development, it is worth noting tariffs are, for now, only paused, and, importantly, the political uncertainty resulting from the constantly shifting trade landscape is in itself likely to have a negative effect on investment and consumption.

On the other hand, Europe’s response of more fiscal spending helps support growth, partly offsetting the drag from tariffs.

From that perspective, we observe the dynamic between the two economies appears to have shifted from one of divergence to potential convergence, with a revitalised Europe and heightened risks that potentially lead the US to slower growth.

For investors, it is easy to get distracted by the headlines but a lot of what is happening is ultimately noise. We believe fixed income investors should continue to focus on the long-term fundamentals. Yields, which are a good proxy for long-term total returns, remain high and can therefore absorb a significant amount of near-term volatility.

 

The power of yield

 

Past results are not a guarantee of future results.

Data from 31 January 1973 to 31 December 2024 and in US dollar terms. Index used: Bloomberg US Corporate Total Return Index. Source: Bloomberg. YTM: Yield to Maturity

As simple as it sounds, yields are a proxy for future total returns. For example, looking at investment-grade corporate bond yields, history shows the correlation between starting yield and total return over the next five years has been extremely high.

Today, depending on the quality of issue, fixed income markets offer yields of between 4% and 8% across sectors and locking in these yields offers good value over the long term. Meanwhile, high-quality assets should benefit from duration in a recessionary scenario where rates are expected to fall and also provide diversification.

While credit spreads have widened sharply, they remain below long-term historical averages. Similarly, the differential between high yield and investment grade credit has widened significantly, but this has been from historically very tight levels. Consequently, the spread is now around the historical average. However, the likelihood of ongoing uncertainty could lead to further widening, with dispersion also likely to increase. For this reason, we remain defensively positioned with a bias towards higher quality.

Importantly, we have dry powder in portfolios and are ready to capitalise on any opportunities as valuations become more attractive.

The constantly changing macroeconomic backdrop underlines the importance of taking a long-term view. We believe investors should focus on idiosyncratic opportunities that can take advantage of the dispersion created and that are more resilient in this environment. A good example of such are electric utilities, which are solid defensive issuers not directly impacted by tariffs.

One area of opportunity is emerging markets (EM), specifically local currency bonds in Latin America and Asia. Fundamentals across many EM economies remain relatively healthy with a good ability to service debt thanks to continued reserves accumulation. Inflation has moderated substantially from 2022 peaks and is generally on a downward trend amid continued restrictive monetary policy stances. The impact from tariffs should weaken inflation further. Fiscal indicators are generally the weak spots, but most of the major EMs have lengthened the maturity profile of their debt and are issuing more now in local currency.

This is a pivotal time for the global economy, with many certainties of the past 40 years or more seeming to be in flux. The outcome, remains highly uncertain and to an extent binary, and the investment implications for this structural shift are not yet clear. We therefore continue to position portfolios based on the underlying fundamentals – which in our view remain strong, particularly in corporate credit and many emerging markets – while closely monitoring the structural developments.

To read more about Capital Group’s fixed income capabilities, click here. 

The Thinking Ahead Institute’s climate transition working group has been exploring a thesis – that a narrowly defined transition is likely to fail.

The narrow definition relates to decarbonising economic activity: ‘mitigation’. A more positive framing of the thesis would be that a broadly defined transition (including biodiversity loss, social inequality, and circular economy) – ‘adaptation’ – is more likely to be successful.

Here we report on the group’s exploration of adaptation, which is our collective, defensive response to a warming planet and changing climate. Adaptation is defensive because it seeks to enhance our future security in response to threat – so rebuilding a flooded house on stilts or changing where and how we grow crops.

Adaptation versus mitigation

It is useful to start by comparing adaptation with mitigation, as in the table below.

Adaptation Mitigation
Characteristic ‘Defensive’ ‘Offensive’
What it is Reduction in vulnerability Reduction in emissions
What it does Address the symptom Address the cause
Geography Local Global

The dominant focus in the investment domain has arguably been on mitigation, such as net-zero commitments. This position has logic behind it – if you solve the cause, you also address the symptoms.

However, we believe that adaptation should receive more attention. This is partly because mitigation and adaptation are not mutually exclusive – there is an intersection between the two, which might yield particularly compelling investment opportunities – and partly because they are in a dynamic relationship with each other.

If we had pursued an aggressive mitigation pathway starting in the 1980s, we might have found there was little current need for adaptation. Now, however, given insufficient historic mitigation we find that the temperature is rising, which requires more adaptation, reducing the focus on mitigation and the resources available for it. This locks in further temperature rises, which will require yet more adaptation, and so on.

Adapting to what?

There are multiple levels on which adaptation is likely to be needed. Most obviously, we can start with direct physical impacts and peel back the layers from there:

  • Climate change events: There will be increased frequency of extreme weather events (such as hurricanes and droughts). Rising sea levels will salinate fertile river deltas, erode coastlines and bring flooding.
  • Degraded ecosystem and weaker related services: We are likely to see a reduction in agricultural yields and drop in food security.
    Social and cultural shifts: We are likely to see higher levels of human migration and displacement, and potential shifts in consumption and lifestyles.
  • Energy disruption: Transitioning from the dominant fossil energy to renewables (mitigation) will bring adaptation problems because of the disparity in their characteristics. For example, energy density, availability, or transportability.
  • Economic disruption: The world is committed to an income reduction of 19 per cent within the next 26 years independent of future emission choices, according to a recent paper published in Nature.

However, I would like to take the adaptation thinking a bit deeper and more abstract.

My colleague, Roger Urwin, uses an ‘iceberg model’ to describe what is going on in a complex system. In our context, above the surface, we observe adaptation behaviours but right at the bottom of the iceberg, hidden well below the surface, is the mental model from which the behaviours arise.

One version of the mental model assumes there is a mean (for example, our living standards improve over time), and sees adaptation as correcting for the shocks that come our way – we assume there is reversion to the mean. If we hold this mental model then we can run down the bullet list above and quickly work out what we need to do to correct for any shock.

An alternative mental model could assume that there is no longer any mean to return to. In this model, temperature has already risen outside the range within which humans developed agriculture and created a civilisation (true), and we are at – or have already passed – a number of irreversible tipping points (possible).

This is a world of mean aversion, where there is no average, and no normal to return to. Adaptation under this mental model looks totally different. If we run down the bullet list now, it is far from clear what we should do.

We basically have three choices… mitigation, adaptation and suffering

The title above is a quote from John Holdren, an American scientist and climate adviser to former President Barak Obama. The quote continues with, “We’re going to do some of each. The question is what the mix is going to be”. The more mitigation we do, the less adaptation we have to do, and the less suffering we will experience.

However, it is possible that we have already left it too late to mitigate. We are currently on a path to around 2.7 degrees Celsius of warming by 2100 suggesting that the mix will be dominated by adaptation and suffering.

Assuming that we wish to avoid unnecessary suffering, we will have to do a lot of adaptation. We can categorise adaptation as follows:

  • Behavioural / voluntary: This occurs at an individual or community level, such as a corporation.
  • Forced / regulatory: This is imposed from an urban, regional or national level.
  • Technical / technological: These adaptations can be adopted voluntarily (perhaps ‘heavily sold’ by profit-motivated entities) or forced through regulation.

Adaptation is necessary and will be part of our future, but there are a number of issues that make this a difficult area for the investment industry:

  • Geographical disconnect / mismatch: Where emissions are produced (‘global north’) typically doesn’t match where the impact occurs (‘global south’). It follows that there is a lack of incentive for investors to direct adaptation capital where it is most needed.
  • Short-term uncertainty: The benefits may be difficult to capture in the short term. For example, assessing avoided future losses.
  • Market absence: The regions most affected by climate change (‘global south’) often have less access to capital markets.
  • High upfront costs: Large-scale infrastructure projects (such as sea walls or flood barriers) may require significant initial investments, and may have uncertain future revenues.

While there will be micro-opportunities to invest in adaptation and earn an investment return, the above points suggest that aggregate and large-scale adaptation may not provide attractive investment returns.

If this is true, a rather bleak question suggests itself: if we are not aggressively investing in mitigation, and we are unlikely to invest at scale in adaptation, are we setting ourselves up for suffering?

Tim Hodgson is co-founder and head of research of the Thinking Ahead Institute at WTW, an innovation network of asset owners and asset managers committed to mobilising capital for a sustainable future.

CalSTRS has plenty of cash as it positions for opportunities emerging out of the current economic volatility. In the longer term, the fund’s asset allocation will continue to move away from global equities into private markets as the dust settles and makes way for more US opportunities. Amanda White spoke to CIO Scott Chan about the fund’s plans.

An acceleration of some persistent themes coming into 2025, like deglobalisation and the increasing chance of recession, has positioned CalSTRS well for the volatility in markets.

As Scott Chan, the fund’s chief investment officer carried out its annual asset allocation exercise with June Kim, senior investment director of total fund management, the senior management team, directors, and staff, one of the concerns was balancing the long-term positioning of assets alongside potential repercussions of the current economic environment.

“One of the issues is that tariffs, and the theme of deglobalisation, is causing a lot of uncertainty and chaos,” he says. “If it means that trading partners will be shifting their reliance on trading with the US, there is a growing risk that capital might shift from the US. The future holds that risk in its hands, and we are trying to understand the magnitude and speed of a risk like that.”

Chan believes it is likely the US will experience higher inflation and lower GDP growth, and the upending of complex supply chains will mean company profit margins are likely to go down, not up.

“This puts into jeopardy some very high historical profit margins. The opportunity is how we might consider diversifying our public markets exposure as a lot of that is concentrated in the US,” he says. “We are working in a world with higher inflation, higher for longer interest rates, great policy uncertainty and geopolitical uncertainty. There is a lot for allocators to think about.”

But in “reading the tea leaves”, Chan’s view is that there will be more amazing opportunities for transformative capital to come into the US once the dust settles.

“There is a lot to unpack from the US perspective,” he says. “As we look to AI and whether there will be a manufacturing renaissance in the US, the themes of infrastructure, energy, and power come in. We see private markets as transformative capital, and there is a lot of transformation that is going to be needed.

“There’s always opportunities and risks, and you can turn risks into opportunities too. These are some of the thoughts emerging and in our annual asset allocation you can see how it is in line with that.”

The fund recently completed its annual asset allocation review internally across all investment divisions and while generally speaking, Chan says the environment is one where “staying the course” is important given the volatility, there is also a need to be more dynamic.

“We have a very diversified portfolio, and I don’t think diversification has paid off in the recent past because of the dominance of the US stock market. But we are quickly moving into an environment where diversification will pay off,” he says.

The fund is moving its “diversifying portfolio” from an underweight to target position, adding to fixed income, risk-mitigating strategies (including hedge funds), long-duration bonds, and cash.

“We are hoping in a turbulent market environment that portfolio would be up, or at a minimum outperforming the growth assets. We were underweight and over time we are bringing it to target and then moving into an overweight position. We have been on a path to move to target for 18 months and we accelerated that from January this year.”

Chan says in January the view was that the chance of recession or stagflation increased significantly and wasn’t priced into markets.

“So we became defensive in Jan/Feb, positioning the portfolio defensively. While market strategists began to raise the risk of the odds of a recession, the market was pricing almost zero back in that timeframe,” Chan says. “We have more and more conviction of the uncertainty and the probability of risk increasing. We didn’t have 100 per cent direction but as an allocator we have to look at the probability and expected return.”

For nearly two years, the fund has also been on a path to increase liquidity and that accelerated in January and February.

“We are looking at all the liquidity tools we have available, raising a bit more cash, and slowing down some of our transactions. We always want to have enough liquidity to take advantage of opportunities if the market declines a lot. We are in that position now,” he says, adding that “we have a lot of liquidity when the time comes, but we don’t think the time has come yet.”

In addition to cash, the fund has access to other tools, like the futures markets, counterparties, a formal leverage policy of 10 per cent, and widening of allocation bands, all giving the fund access to liquidity.

“They all provide us with the amount of liquidity we think we need to take advantage of a market crisis. We don’t want to put a figure on it but it’s very significant and I feel good about that in preparation for volatility and an uncertain environment.”

In line with its strategic thinking, CalSTRS is diversifying out of global equities, currently around 1.5 per cent underweight, and into private markets where it sees more ability to add value.

“We are building out infrastructure, the energy transition, certain areas of private credit like asset backed, all clear areas of private markets we think can provide very good returns at decent risk levels.”

Priorities

The end of June will mark the first year of Chan’s tenure as CIO, a year in which he has laid out organisational and investment priorities and appointed new senior team members.

A shared vision for the investment division, moving to a one fund approach and revamping how the fund uses technology are the top three priorities.

“As a new CIO I wanted us to look out five to 10 years at what we need to become, and what do we need to build now to fulfill on our mission well into the future,” he says.

CalSTRS has a 30-year average return of 8.1 per cent versus its target of 7 per cent, and as the second largest fund in the United States, doubles its assets under management about every 12 years.

“Every dozen years or so, if we are successful in achieving our returns – we create a whole new CalSTRS because we double our asset base and we need to prepare for increased size and complexity”, Chan says. The move towards a total fund approach, which has taken place over the past few years, including the appointment of June Kim last year to head of total portfolio management, has been fast-tracked as the need to allocate capital dynamically becomes more important. The fund’s collaborative model is deeply embedded and the cost savings and alpha point to its success.

“We want to look at what is the better value for the risk we are taking. There are more and more evolving opportunities and they evolve quickly, things like the energy transition, data centres, asset backed private credit. Some fall within an asset class and some in between. We need to be nimble and innovate in how we allocate,” Chan says.

A centralised view of the portfolio is also essential for reporting risk at the total fund level, and can be used to scale opportunities.

“I want to unlock the advantage of position sizing,” he says.