As opposing macroeconomic and geopolitical forces collide, chief investment officers at leading pension funds say that trying to predict the future is a “loser’s game”. The question today is no longer what comes next, but how to build a portfolio that holds together in any investment regime.
At the Fiduciary Investors Symposium at Harvard University, investment heads at US and European pension funds shared a common investment thesis that the era of predictable returns is over and that portfolios built for the future will look very different from those that delivered good performance in the past three decades.
One of the factors causing that shift is persistent and structural inflation, which poses significant risks for members and liabilities. It’s a challenge felt acutely by Dianne Sandoval, CIO of the Maryland Retirement System, who said the fund has an “inflation allergy” because the numbers are working against it.
“It’s a function of our demographics; it’s a function of the fact that we have 2 per cent negative cash flows; it’s a function of the fact that our funded ratio is below our peers at 75 per cent; and it is a function of the distribution of the age of our active members,” she told the Fiduciary Investors Symposium at Harvard University.
“What we’re building is resiliency and adaptability. We’re looking at how do we improve our liquidity management, so that whatever crisis hits, we can lean into our positions and actually – as long-term investors – take advantage of mispricings when those mispricings arise.”
Related to inflation, the second factor shaping the portfolio is currency debasement and the role that real assets can play in protecting portfolio value.
“The biggest concern I have is about the debt, deficit and the debasement of currencies, particularly the dollar,” said Farouki Majeed, CIO of Ohio School Employees.
“We have an opportunistic allocation which is outside the policy benchmark — I can go up to 5 per cent — so I have done a lot of things in stealth in there. Private credit came out of there, gold came out of there.
“Real assets are probably going to be the key for forward returns, as opposed to financial assets.”
The third factor shaping the portfolio is AI and technology development, which is potentially disinflationary. Michael Trotsky, CIO of Massachusetts PRIM, said both the investment and productivity opportunities in AI are “gigantic, and it’s only beginning”.
“Over the long period of time, it’s very difficult to predict exactly to whom the benefits accrue. My personal view… is that I believe it lowers the cost of expertise to those firms who are resource-constrained, like PRIM with 35 employees managing $135 billion.
“I think it evens the playing field for companies that are under-resourced, so I’m extremely excited about it.”
The final factor is geographical diversification, with investors increasingly concerned about putting the majority of their eggs in the US basket as the world’s largest economy becomes increasingly unpredictable on the policy and geopolitical fronts.
“In the public equity side, we’ve always had a broadly diversified benchmark from a regional perspective. Nothing to do with any view on US exceptionalism or not, [but] a simple view on concentration risk and diversification,” said Mark Walker, CIO of Coal Pension in the UK.
“We have a benchmark which is 40 per cent America, 30 per cent EMEA and 30 per cent Asia. Now, two years ago… that wouldn’t have been working very well.
“But if I look at our benchmark in the last three years, it’s outperformed, in our case, the FTSE All World equivalent by 1.5 per cent per annum for the last three years.”
But the private equity and credit side of Coal Pension is still more concentrated in the US (60 per cent) and Europe (35 per cent), with only around 15 per cent in Asia.
The challenge of building a resilient portfolio ultimately comes down to making the big calls correctly, and MassPRIM’s Trotsky believes investors need to leverage all the tools they have going forward.
“I believe there are statistical, quantitative techniques that are really underutilised in this [asset allocation] area that can ensure that you’re getting a more fully diversified portfolio, that’s what we do,” he said.
“Asset allocation is by far the hardest thing we all do, being in the right place at the right time in the right proportions.”
