Institutional investors strive to link their strategic asset allocation to their key objectives and ensure it evolves alongside technological advancements. A discussion at Fiduciary Investors Symposium Oxford explored the complexities and trade-offs inherent in portfolio construction.
At the C$25 billion Canadian pension fund OPTrust, the portfolio is tailored to meet liability and funding commitments alongside returns, and risk mitigation. The investor has a total portfolio approach and views risk and liquidity as scarce resources. Elsewhere, the public allocation is dynamically managed and includes a currency management approach at a total fund level.
The illiquid allocation adds another level of complexity, particularly given that at any time, total fund-level risk is deployed. OPTrust actively manages its private market exposure where investments include private equity and real estate, said Jacky Chen, managing director, completion portfolios, total portfolio management.
Railpen, the multi-client pension fund for the United Kingdom’s rail industry is open and growing, and its strategy is keenly focused on asset valuations and cash flows. A key priority for John Greaves, director of fiduciary management, is to understand the objectives and preferences of trustees. Asset management is approached with the view that both public and private markets are exposed to the economy and shouldn’t be viewed in silos: although real assets operate on a different cycle, they are still blown by the same winds as public market investments.
The analysis extends beyond just risk-return and correlation to integrate different scenarios. For example, what if illiquid investments don’t distribute much? This will result in a need for higher cash flows, alongside careful analysis of any over-allocation to illiquid investments.
Governance is focused on ensuring the team can manage the portfolio through time with an eye on resilience, liquidity, complexity and sustainability that goes beyond just risk and return.
The team also explore trade-offs. For example, real assets might not offer as high a return as other assets, but they bring valuable diversification and inflation protection and can also support sustainability.
“It is about finding the right balance,” said Greaves.
Adam Petryk, chief executive of solutions at Franklin Templeton, counselled on the importance of integrating qualitative and quantitative factors. Pension funds must first think about their diverse range of clients, understanding their differences in liquidity premia and risk appetite.
“Start first with the client need,” he said, highlighting the importance of using proxy assets to ensure a better-informed risk perspective.
Border to Coast, an LGPS pool in the UK, provides its underlying local authority pension fund clients with investment choices, offering a detailed proposition in private debt and infrastructure, amongst other assets. Its offering is balanced by the experience and knowledge of the right investment models amongst the skilled investment team.
More work in benchmarking
Joe McDonnell, CIO at Border to Coast, explained how the asset manager is selling public markets, buying private markets and moving more into alternatives. Conversations with partner funds include the importance of benefiting from long-term secular trends like climate investment and investing more in the UK.
McDonnell said one area of ongoing work includes benchmarking and measuring success. He noted that building out internal capabilities includes ensuring the fund has the right tools and learns from best practices.
“We are confident we are moving in the right direction,” he said. “Private markets for us is hugely important as a long-term investor.”
McDonnell noted that other LGPS pools need to catch up with pooling assets and allocating to illiquid investments, and called the government’s move to mega funds a positive development for the LGPS. However, he also recognised the need for leadership in the LGPS and that board turnover is high.
Petryk agreed that measuring success in achieving outcomes and gauging the success of the team and investment strategies remains one of investors’ biggest challenges. Articulating the investment value proposition through the lens of outcomes requires consideration of what investors are trying to achieve and the integration of peer benchmarks. The process is complicated by the fact that end investors are individuals who don’t measure you “against the S&P.”
Chen said that OPTrust is focused on managing the portfolio more dynamically to achieve long-term value and noted the importance of aligning incentives. In public markets, the team are responsible for beating the benchmark and trying to make sure they manage returns and drawdown risk.
Some of the team focus on portfolio construction and others focus on security selection. The process also allows them to work together to manage asset allocation and execution, and manage the portfolio dynamically on a day-to-day basis.
Chen referenced the importance of going into assets at different times in the cycle, and warned that investment in buckets risks missing out on opportunities. OPTrust is currently exploring the right governance to support a better understanding of assets through a factor lens rather than an asset bucket silo.
Railpen’s Greaves also reflected on the importance of alignment between investment decisions and ultimate goals. For example, the capital markets group at Railpen has an inflation-plus return target that is challenged when inflation spikes. Like Chen, he reflected that a top-down strategy to fill buckets doesn’t reflect changes in opportunities, and things fall between the gaps, requiring the team to meet their investment objectives “in different places.”
He noted how many investors are currently experiencing the impact of being over-allocated to illiquid investments. They have made decisions that risk undermining their long-term objectives and the benefits that these assets can bring.
“Think through the scenarios,” he warned.
McDonnell spoke about the importance of moving away from a culture characterised by investment teams talking their own book by championing preparation and consistency instead. In alternatives, teams often fight for the same space, but success involves thinking through why a particular decision makes sense. “It is about your own book and the wider book of the pension fund,” he said.
Panellists reflected on the importance of liquidity, a constant constraint that forces schemes to think about the trade-off and put a liquidity premium on valuations. It’s possible to have a situation where investors think they are delivering a risk-adjusted return but are, in fact, loading on the same type of risk.
