Institutions weighing risks to portfolios against innovation opportunities
Technology and its potential to disrupt and impact investments is making its way up the agenda for institutional investors.
Sources said both the risks and opportunities afforded by technological advances are firmly in their sights, with some examining the impact across their portfolios.
Stanford University researcher Ashby Monk said he has heard a lot on the topic lately, with three angles to it. The first has institutional investors focusing on whether "technology is going to blow up the portfolio of assets we currently hold," Mr. Monk said. One example he cited were investments in parking garages in a world of driverless cars. "That is a big focus. If you're in a public equities team (at a pension fund or within any active management process), it's probably an area you're interested in unraveling as kind of a threat to the core assets in your portfolio.
"A lot of organizations (such as sovereign wealth funds and pension funds) are arriving in Silicon Valley, not (looking) for the next great startup, but to try to get a sense of the risk," he said.
Mr. Monk, who is the executive director of Stanford's Global Projects Center, Palo Alto, Calif., said the second angle involves investors considering "how to take this disruption and participate in it, to allow (investors) to get some of this new value."
He said bad experiences in the past with venture capital — a traditional way of accessing disruptive investments — mean institutional investors are "really scratching their heads and thinking, 'how do we do this?'"
Options include seeding new managers or direct investment, he said. "Nobody has really cracked it yet in terms of identifying the next great model."
The third element is institutional investors' own investment processes, and considering how technology might enable them to remove the cost of an external manager.
"All three have increased in their relevance in just the last six months," Mr. Monk added.
The issue of technology's potential to disrupt portfolios is under consideration by a number of pension fund executives.
"We're looking at it from a risk point of view — we've done work in the climate area, seeking better disclosure on climate risk, but we'll be looking very closely at how companies we are seeking to invest in are dealing with (disruption risks)," said Hugh O'Reilly, president and CEO at OPTrust, which manages the C$19 billion ($15 billion) Ontario Public Service Employees Union Pension Plan, Toronto. Plan executives want to know whether these companies are conscious of the risks and preparing for them, and want to see the innovative culture within companies. "We have to be thinking about where we are, where we're going, and be thoughtful and responsible around it," Mr. O'Reilly said.
Disruptive technology also filters through to the way pension fund executives manage the plan itself. "We view the world we're in now — the innovation economy — as a challenge,'' Mr. O'Reilly said. "Sure, it's a risk and we have to understand it. If you look at how technology has disrupted (to date), it's fundamentally about disrupting the way in which information is managed."
He said a pension fund is, at its core, an "information manager. We see that, over time, the way we serve our members in terms of how we communicate … is affected by new technology."
Disruption in information management also relates to the investment process. Mr. O'Reilly cited the rise of passive management, which "is going to find its way through all of the investment process, whether private equity, infrastructure, real estate. Automation is going to play a role as it can free up time. It's going to become more and more part of our reality, and means for us, our strategic plan is founded upon innovation. We want to view innovation as more of a mindset. Will we be comfortable failing, failing fast and getting better because of that? Are we going to be able to use technology … to figure out ways to better serve our members?"
Financial technology firms are finding themselves increasingly in demand for partnerships and work, said sources at these types of firms.
Trends toward increased alternative investment and insourcing have served SimCorp, a provider of integrated investment management systems, well.
"We're now getting to the level where some of our clients have 20%, maybe 30% in alternative investments," said Marc Schroter, Copenhagen-based senior vice president, product management at SimCorp. "As they do that, their need for technology support increases."
Mr. Schroter said investors might have used spreadsheets in the past or "best of breed" applications, "but if you have 25% of total assets in such an asset class, you want to consolidate with the rest of the asset classes and have a total overview of risk" and the ability to perform analysis functions.
The firm in June announced work with the 250 billion Danish kroner ($39.6 billion) PKA, Hellerup, Denmark, to develop a private debt module in SimCorp's Dimension platform. PKA has been a SimCorp client since 2005. Inger Huus Pedersen, Copenhagen-based head of fixed income at PKA, said it was "a very useful facility as we do invest more and more in private debt."
The increased move toward insourcing of money management is also increasing the need for technology system support, added Mr. Schroter. "As they move into doing a lot of the investments themselves, their requirements are more advanced than for asset managers because they have this link to their liabilities."
These investors want to understand the impact of a trading scenario or allocation change on risk and accounting figures, among other considerations.
Mr. Schroter said regulation is also impacting institutional investors. "Something we see a lot of clients asking for is driven by solvency (requirements) — investment forecasting, the idea that you would not make a big change in your portfolio without understanding exactly what are the impacts."
Fintech firm ClearMacro Ltd. is working to "automate as much as is sensible, bringing man and machine together" with its asset allocation, portfolio analytics and integrated research services, said Mike Simcock, London-based CEO and CIO at the firm. The process allows a chief investment officer or investment team to adjust the platform's algorithms to interpret masses of data, and users can also map ClearMacro's insights gained from data over their own portfolios to evaluate areas of risk and opportunity, according to different time horizons.
Mr. Simcock said the platform is in the early stages of marketing, with existing clients including a sovereign wealth fund. About 35 other investors are in various stages of conversation.
Advancing technology also is opening up new areas of investment opportunity for institutions and active money managers.
OPTrust's Mr. O'Reilly said executives are in the process of establishing an "incubation portfolio," accounting for 1.5% of assets — about C$300 million. Relatively small investments of around C$20 million to C$40 million will be made "into new areas where we have not historically invested, and we can learn about the new area to determine if (it) is scalable and how we best participate," be it directly or through funds. "This is one thing we want to explore. We are fiduciaries; we only invest where we think we will earn a return. One area of investing is emerging growth, a late-stage venture where a company has gotten off the ground, has a product, has consumers but needs capital to grow. We're going to get active in this."
Mr. O'Reilly said this is historically a difficult area because a small capital investment requires "a huge staff commitment. We're trying to work out how best to do it. We also think, by investing in this part of the economy we get insights into new technology coming and how it will affect our portfolio overall."
Added Stanford's Mr. Monk: "The rapid pace of technological disruption is highlighting a key part of successful active management."