APG’s chief economist Thijs Knaap and senior strategist Charles Kalshoven lay out the case for not investing in crypto. Interrogating the investment case for cryptos they find that only an expected return of 25 per cent per year would make it worthwhile to add bitcoins to the portfolio, and even then there’s no cashflows. They argue that pension funds can afford to neglect this asset class.

Despite the recent heavy losses crypto investors have suffered and the crash of stablecoin, whose primary claim was that it could never crash, the returns are still impressive.

Take bitcoin for example, the oldest of around 18,000 cryptocurrencies that exist today. Trading at a little over €2,000 ($2,041) five years ago, today a bitcoin is worth around €20,000 (down from a high of almost €60,000 at the end of 2021). Among those million-plus crypto investors, there are undoubtedly some whose pension is being managed by APG. And if they are willing to invest their own money, shouldn’t their pension fund jump in too?

In July 2021, Germany’s financial regulator BaFin allowed just that when it enacted new regulations that say institutional investors can allocate up to 20 per cent of their assets to cryptocurrencies. As the FT wrote at the time, this was an attempt by BaFin ‘to balance its concerns about what is has described as the ‘highly risky and speculative’ nature of cryptocurrencies with its desire to encourage the development of new technologies that could have a significant effect on financial services.’

More recently, BlackRock, the world’s biggest asset manager, launched its iShares Blockchain and Tech ETF that ‘seeks to track the investment results of an index composed of US and non-US companies that are involved in the development, innovation, and utilisation of blockchain and crypto technologies.’

In an accompanying report, BlackRock is bullish: ‘While most of the market attention has focused on the price and volatility of cryptocurrencies themselves, we believe the broader opportunity – leveraging blockchain technology for payments, contracts and consumption broadly – has not yet been priced in.’

Is crypto investing appropriate for APG?

With retail and institutional investors alike flocking to cryptocurrencies, and regulators holding open the doors, should APG not follow suit? That’s a legitimate question.

“We’re regularly being asked why we’re not investing in cryptos, by media and by people on Twitter who point out that our coverage ratio would look a lot better if only we had been smart enough to invest in cryptos early. Look past the recent losses and crashes, and surely cryptos will increase in value again some day and new and improved currencies will be launched?”

But APG is not going to invest anytime soon.

The view outlined by Knaap and Kalshoven is that pension funds, even more so than other long-term investors, need to invest in assets that generate cash flows: stocks that pay dividends, bonds that pay interest, real estate for which rent payments are received. The basic idea is that every month about as much cash needs to flow in as APG pays out to pensioners.

“A fundamental objection against pension funds investing in cryptocurrencies is that they do not generate any cash. The only way to make a return on cryptos is to sell them to the next investor who is willing to pay more than you did. In the meantime nothing happens, to us that makes investing in cryptos unattractive as well as unpractical,” the authors say.

A fundamental objection against pension funds investing in cryptocurrencies is that they do not generate any cash

Pension funds do invest in other assets without cash flows, like commodities and gold. But apart from their inherent value, these assets have other appealing characteristics.

“We know, based on data that sometimes goes back hundreds of years, how they correlate with other asset classes or economic parameters. Gold for example moves along with the general price level and thus provides a good hedge against inflation. Bitcoin doesn’t have a 200-year history, and neither does it have a strong correlation with other assets. Well, lately maybe with stocks, but that provides no diversification to our portfolio and no hedge against anything. So in short: crypto currencies provide no cash flows and no hedges. From a technical investment perspective we therefore don’t see a reason to invest in them.”

Applying portfolio theory

The authors say that arguments from portfolio theory can also be applied.

“You can take a well-diversified portfolio with a certain risk and return ratio and study what happens when you add bitcoins to such a portfolio. Assumptions about correlations and volatility aside, the outcome was very clear: only with an expected return of 25 per cent per year would it be worthwhile to add bitcoins to the portfolio. With a horizon of 15 years, you have to ask if there is anything that justifies a growth of 25 per cent year on year for such a period. The answer is no, there is simply no way we can justify that. So along that line of thought you come to the same conclusion: the investment case for cryptocurrencies just isn’t there.”

If the board did decide to invest in crypto, investment staff would then be asked to develop a formal investment case and extensively document aspects such as expected returns, risk, liquidity, correlations and so on. ESG would also be taken into account.

To this end they say that the bona fides of counterparties would be a concern, as well as the fact that the mining of cryptocurrencies requires an inordinate amount of energy.

“A pension fund that has banned investments in fossil energy would have a hard time letting that pass. Then there are regulators that don’t have a favorable view of cryptocurrencies, and finally it would operationally be very challenging for us and different from how we manage our other assets. So apart from the lack of an investment rationale, there is also a host of practical reasons why APG won’t be investing directly in cryptocurrencies in the foreseeable future.”

Comparisons with other disruptors

The essential difference between early internet pioneers like Google and other search engines and bitcoins, the authors say, is that for search engines you could, even early on, imagine a viable business model that monetized advertising and services.

“For bitcoins really the only thing that allows you to make money is the greater fool approach to investing: find someone who is willing to pay more for them than you did. There’s just nothing else that would make them worth more.”

But while APG doesn’t see the investment case for cryptos now, they said they will continue to look carefully at any reasons that will drive their future value up. Acknowledging the basic premise of cryptos – that they cut players loose from the traditional financial sector that is slow, expensive and over-regulated – makes them attractive. Cryptocurrencies enable you to make transactions completely autonomously and with anyone anywhere, as long as they have a computer or a smart phone.

It’s like this nightclub that’s so great because only cool people go there. The moment we enter that club is the moment it stops being great and cool

“The main application for bitcoin so far seems to be the payment of ransom money to some Russian who has encrypted your hard disc. That shows you the basic idea works fine. You don’t have to bother with Know Your Customer or money laundering controls,” they say. “Pension funds however simply can’t be buying bitcoins from someone who may have earned them in some illegal manner, so they bring their whole regulatory apparatus with them. That will cause a strange dynamic to come into play once cryptos become so big and successful that traditional financial institutions have no choice but to get involved.

“When that happens, it will be the kiss of death. Cryptos will become wrapped in the traditional world of finance, which means the very aspect that made them attractive will disappear. It’s like this night club that’s so great because only cool people go there. The moment we enter that club is the moment it stops being great and cool. So there is trade-off: cryptos can either remain entirely separate from traditional finance and find little adoption, or they can embrace elements of traditional finance and lose some of their appeal.”

Sharan Burrow general secretary of the ITUC and Paddy Crumlin, president of the International Transport Workers’ Federation outline the recently released baseline expectations for asset managers on fundamental labour rights and why pension funds should be holding their managers to account.

Despite the enormous growth in responsible investment and interest in ESG, there is a looming sense that the global financial system is not serving the wider interests of society and is undermining efforts to build sustainable and inclusive economies. This failure has been acutely felt by workers around the world who are facing attacks on their fundamental labour rights, deteriorating working conditions, and a declining share of the income pie.

According to the International Labour Organization (ILO), between 2004 and 2017, the share of global income earned by workers declined from 53.7 per cent to 51.4 per cent. On fundamental labour rights, the 2022 Global Rights Index, highlights a series of worrisome trends: this past year, 113 countries excluded workers from their right to establish or join a trade union; the right to strike was violated in 87 per cent of countries surveyed; and trade unionists were killed in 13 countries. These are the worst results reported since the Global Rights Index was first published nine years ago and they are occurring against a backdrop of declining trade union density and collective bargaining coverage in recent decades.

The global attack on fundamental labour rights alongside pervasive economic inequality underscores the urgency for greater investor attention and action to address the “S” in “ESG”.

investor Guidance on labour rights

But, while there are roadmaps for investors to track progress on climate change, there is very little investor guidance in the area of labour rights.

Asset owners struggle to meaningfully evaluate their asset managers’ policies and practices in this area and yet those same asset managers often have significant ownership stakes in publicly listed companies and private assets where workers’ rights abuses are occurring.

Imagine if the world’s largest global asset managers used their sizeable influence to address workers’ rights abuses in publicly listed companies like Amazon.com and Teleperformance, or similar labour issues in private market assets like Cadent Gas in the UK or DIAM Group’s operations in Turkey?

This is what the Global Unions’ Committee on Workers’ Capital (CWC) has set out to achieve, mobilising its global network of trade unions and pension fund trustees to hold global asset managers accountable on workers’ rights.

Through the CWC’s Asset Manager Accountability Initiative, pension fund trustees and staff from over 40 pension funds in countries such as Australia, Finland, the Netherlands, Spain, the UK, Switzerland, Canada and the USA, are engaging with the likes of BlackRock, State Street Global Advisors, UBS Asset Management and Macquarie.

These engagements provide an opportunity for asset owner clients to express their expectations that the asset managers that aggregate workers’ capital use their influence to drive better outcomes for workers whose rights are being violated.

These engagements are guided by a set of baseline expectations for asset managers on fundamental labour rights, that draw from the ILO Fundamental Principles and Rights at Work, the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles for Business and Human Rights.

The Baseline Expectations provide the roadmap on labour rights that has been missing for investors, outlining expectations in four areas: overall stewardship framework; public equities (including proxy voting and engagement); private markets (including stewardship of infrastructure and real estate assets); and policy advocacy.

The CWC is using the Baseline Expectations to steer ESG discussions with global asset managers towards real-world impacts for workers – beyond mere box-ticking and ESG marketing.

Let us now see if, five years down the road, we can pen another op-ed and report that the asset management industry is responding decisively to worker rights violations in their investments.

In the meantime, the CWC will continue to mobilise asset owners to hold their asset managers to account on fundamental labour rights in ESG stewardship policies and practices.

Click here to view the CWC Baseline Expectations

Sharan Burrow is the general secretary of the ITUC and Paddy Crumlin is president of the International Transport Workers’ Federation.

The Global Pension Transparency Benchmark has revealed the top ranking funds globally for transparency of disclosure across cost, governance, performance and responsible investment. Click here for the results of 75 funds across 15 countries.

The GPTB, a collaboration between Top1000funds.com and CEM Benchmarking, measures the transparency of disclosures of 15 pension systems across the four value generating measures, with the country scores amassed by looking at the largest five asset owners in each country. Now the scores of these underlying asset owners have been revealed for the first time.

CPP Investments has emerged with the best score overall followed by the Government Pension Fund of Norway, the world’s largest sovereign wealth fund.

For cost disclosures the large Dutch fund, PFZW, ranked number one followed by CPP Investments.

CPP Investments also took the top honour for transparency of disclosure related to governance, followed by Australia’s Aware Super.

The two top funds for transparency related to performance were the large Californian funds CalPERS and CalSTRS.

And for responsible investment, funds in Europe dominated with Sweden’s AP4 taking the top spot followed by Varma.

It is the second year that the GPTB has ranked countries on the transparency of disclosure related to the four factors of cost, governance, performance and responsible investment. Both years Canada topped the country list overall.

Canada’s dominance is demonstrated by the fund five’s analysed in that country all featuring in the top 11 funds overall. They were CPP Investments (1st), PSP Invesments (3rd), Ontario Teachers Pension Plan (4th), BCI (8th) and CDPQ (11th).

Click here for an interactive table for all countries and all funds and click here for analysis of the individual funds, their rankings and related stories.

CPP Investments has topped the list of the most transparent funds according to the Global Pension Transparency Benchmark, which has revealed the scores of the 75 underlying funds from 15 countries for the first time.

The GPTB, a collaboration between Top1000funds.com and CEM Benchmarking, measures the transparency of disclosures of 15 pension systems across the value generating measures of cost, governance, performance and responsible investments.

The scores for the countries are amassed by looking at the largest five asset owners in each country. The scores of these asset owners have been revealed for the first time.

CPP Investments emerged with the best score overall and also the best score for governance disclosures.

Three Canadian funds featured in the top five of the best overall funds. Canada also topped the country list in 2022 for the second year in a row.

The Dutch fund, Stichting Pensioenfonds Zorg en Welzijn (PFZW), topped the list for cost; CalPERS for performance; and Sweden’s AP4 was the best fund for transparency of disclosures related to responsible investment.

The GPTB provides an insight into the disclosure practices of asset owners around the world with a focus on transparency.

The Global Pension Transparency Benchmark is a world first global standard for pension disclosure, bringing a focus to transparency in a bid to improve pension outcomes for members.

Revealing the underlying fund scores aims to focus on best practice and encourage improvement on transparency of disclosures.

Head of business development at CEM Benchmarking, Mike Heale, says transparency is the right thing to do and the smart thing to do.

“Congratulations to the top-ranking funds on the GPTB for leading the way on transparency and communication quality,” he says.

The top five funds overall and by factor are listed below and the full list with search functionality can be found here.

Click here for analysis of all the country results.

The GPTB measures whether pension organisations are disclosing what they do and how they are generating value for stakeholders clearly, completely, and concisely. Disclosures continue to be scored across four equally weighted factors: cost, governance, performance, and responsible investing, with more than 10,000 data points analysed across the 15 countries and 75 funds.

Click here for the full methodology.

Optimising portfolio design in a risk / return framework has challenged industry and academics for many decades. Incorporating impact into this framework creates additional dimensionality, significantly increasing the complexity of the portfolio design challenge. This article explores the technical challenge of navigating the 3-D investment framework.

A primer on modern portfolio theory – the 2-D challenge

The foundation of modern portfolio theory is the work of Nobel prize winners Harry Markowitz, James Tobin, and Bill Sharpe. There are various interpretations of the framework, and sometimes it is unfairly criticised. Markowitz sets out a framework for creating an efficient (mean-variance) frontier of portfolio opportunities. Tobin and Sharpe extend on this foundation to demonstrate how to improve risk / return efficiency by blending cash or leverage with the portfolio which has maximum (expected) excess return relative to variance (the ‘market portfolio’).

There are many challenges to modern portfolio theory. These range from the subjectivity of inputs, return distributions for different investments, the way that different investments blend, and liquidity. The broad takeout: be efficient with risk when seeking return.

Interestingly some institutional investors are better placed to efficiently manage the risk / return trade-off.

Pension fund leverage is one example: Australia’s superannuation funds are restricted from applying portfolio leverage directly whereas pension funds in the US, Canada and parts of Europe have fewer restrictions and have incorporated leverage into their portfolios.

Incorporating a third dimension: impact

Accounting for impact creates a fascinating, but complex challenge. Impact represents a third dimension in the portfolio decision framework. To enable us to explore this framework we make two important assumptions:
1. That sustainability and ESG can be aggregated into a single variable: impact.
2. That impact can be measured in a continuous manner (i.e. there is an infinite, not a discrete set, of impact measurements).
A third portfolio variable introduces significant complexity. Where there was one trade-off to consider (return versus risk) there are now three: return versus risk, return versus impact, and risk versus impact. Instead of searching for the optimal portfolio on a two-dimensional risk / return frontier, there is now a three-dimensional risk / return / impact surface on which to locate the optimal portfolio. We illustrate this in Figure 1.

Figure 1: A three-dimensional risk (volatility) / return / impact surface.

Based on Figure 1 we make some important observations:

1. Higher risk, measured by volatility in our simplified framework, can be applied to increasing expected returns and impact (or both).

2. We entertain the possibility that there is a trade-off between impact and return.

3. If we ignore impact the framework collapses down into the familiar modern portfolio theory efficient frontier.

4. For every degree of impact there exists a risk / return frontier.

Accounting for active ownership and engagement

The opportunity for active ownership and engagement activities to improve impact with no effect on returns is topical (here and here). We model the commitment to universal investor activities as incurring a fixed cost (establishing a team, systems etc.) and delivering a fixed expected benefit. Hence the outcome is a fixed uplift in impact.

This is reflected in Figure 2.

Figure 2: Illustrating the effect of undertaking a program of active ownership and engagement activities.

Figure 2 depicts two surfaces. The first (shaded yellow / red) carries over from Figure 1. The second (green / blue) sits further along the impact axis by the degree of expected net impact from undertaking a program of active ownership and engagement activities.

Identifying the optimal portfolio

Identifying the optimal solution becomes more difficult as more dimensions are added to any problem (econometrician John Rust famously described this as the “curse of dimensionality”).

For academics, utility functions remain the cornerstone for setting objectives, aided by ever-increasing computing power. Utility functions appear to be less applied in industry, perhaps because of their complexity.

A utility function assesses the distribution of possible portfolio outcomes. In doing so it implicitly establishes trade-offs between different dimensions. While traditionally the dimensions have been risk and return, the utility function approach has the capability to provide objectivity when faced with the 3-D challenge created by the incorporation of impact. Note that the trade-offs are not necessarily linear. The exercise of exploring and formalising these trade-offs would make for a wonderful learning experience for pension fund boards.

Two alternative approaches are more likely to be applied, at least in the near-term, as industry adopts 3-D investment frameworks.

Approach 1: Targeted impact

The first approach is to target a specific degree of impact. This effectively converts the 3-D surface back to a single 2-D investment frontier (the thick black line), detailed in Figure 3. This returns the portfolio decision to the familiar 2-D investment frontier problem.

Figure 3: Targeting a fixed degree of impact creates a single risk / return frontier.

Approach 2: Minimum impact threshold

The second alternative approach is to set a minimum impact threshold. This effectively divides the 3-D surface into two segments, both 3-D. In Figure 4 portfolios on the yellow / red surface fail to meet a minimum impact threshold, while portfolio managers are free to search the blue / green surface for the best portfolio outcome.

The advantage of this approach compared to Approach 1 is that it allows portfolio managers to further explore the trade-off between impact and return. For instance further impact may have been attainable, beyond the fixed threshold applied in Approach 1, with little impairment of returns.

Figure 4: Establishing a minimum impact threshold divides the 3-dimensional risk / return / impact surface into two segments.

Challenges in practice

There are significant in-practice challenges to 3-D investing, which exist over and above the known difficulties of 2-D investing (forecasting return, risk etc.). These include:

Measuring impact, where the availability of many different datasets creates confusion. A particularly difficult component is the challenge of integrating ESG into a single impact measurement.
Matching the timeframe of forecasts for risk, return and impact.

For these reasons it is unlikely that pension fund portfolio construction in a 3-D world will become purely systematised any time soon. For 3-D investing to approach systematisation it would require these issues to be addressed while resolving how to set an objective – perhaps utility functions will come to the fore.

Applying some of the outlined portfolio management science will be important: plan members and regulators will at some point want to understand how portfolio trade-offs have been determined. Many of the leading pension funds and asset managers are already well advanced on the technical aspects. But decision-making art will be an important complement to decision-making science.

A final observation is that the role of the portfolio manager will become even more important: portfolio managers will need to understand the range of portfolio outcome possibilities and lead their respective boards through a process for determining an appropriate portfolio. Education and communication remain essential skills.

David Bell is executive director of The Conexus Institute

BHP chief executive, Mike Henry, explores the growing role of mined commodities in the global energy transition. This fireside chat was hosted by Amanda White at the Australian Fiduciary Investors Symposium in June. Henry talks about the company’s progress and the challenges of Scope 3 emissions. Listen to the full interview here.

Demand for commodities is insatiable as emerging economies continue to develop and the challenge to ensure “the world’s need for metals and other resources is met in the most sustainable way possible,” says the boss of the world’s largest mining company.

Mike Henry, the chief executive of BHP, says the ambition to limit global warming to 1.5°C is a metals-intensive effort and increased supply will have to come from mines that are lower grade, smaller and in tougher jurisdictions.

“We’re at a point in time where industry, capital markets and other actors need to lock arms to figure out how we can go about accelerating the efforts to improve ESG standards and governance,” Henry said. “And in doing so ensure that the world’s need for resources is met in an efficient way, and a way that minimises the downside impacts.”

He was speaking during an interview with Amanda White at an event held by Top1000funds.com’s sister publication, Investment Magazine, where he said BHP had been making strides to lower its Scope 1 and 2 emissions. Scope 3, he admitted, had unique challenges.

Henry cited the example of BHP exiting coal-fired power generation for its copper production in Chile at a time where there was no external pressure to do so. The company initially used gas-fired power for its Chilean operations and is expected to rely fully on renewable energy in the next two years, a move that will reduce its overall Scope 1 and 2 emissions by around 15 per cent.

As one of the world’s largest dry bulk charterers, BHP is using its significant purchasing power to work with ship owners to develop LNG-powered bulk carriers, which emit about 30 per cent less greenhouse gas than existing bunker fuel.

However, Henry recognised the challenge in lowering Scope 3 emissions across its value chain as “we don’t have the ability to drive that investment decision.”

The lack of global standards on how to measure and report on Scope 3 emissions as well as the absence of technologies in certain supply chains to eliminate this category of emissions also add to the difficulty.

BHP is also collaborating with other firms to develop technologies to remove diesel from its operating sites such as using electrified overhead tram systems.