PLSA conference speakers call for smarter diversification push, focus on sustainability

Pension fund executives called on peers at an annual investment conference to be aware of the need to be on the right side of investment trends, including an ESG focus, as they deliberated over the challenges they are facing in 2019 and beyond.

Speaking at the Pensions and Lifetime Savings Association's investment conference March 6-8 in Edinburgh, asset owners agreed that diversification might not be as straightforward a job in the current macroeconomic environment.

"We are quite late cycle and there are quite a few imbalances. It's difficult to be defensive in a portfolio overall if gilts and cash (are) giving you negative return (over) a 10-year period," warned Daniel Booth, chief investment officer of Border to Coast Pensions Partnership, Leeds, England, a £46 billion ($60.7 billion) pool of U.K. local authority pension funds.

"Even though you know a recession is coming, it's not easy to know what to practically do about it," Mr. Booth said.

During the same panel discussion, Jo Holden, chief investment officer for the U.K at Mercer, called on pension funds "to think what they want to avoid ... (such as) disinvesting at the wrong time or being overreliant on one asset class."

Ms. Holden added: "Doing an analysis around cash flow ... really looking at multiple sources of alpha and contractual income" could help pension funds prepare.

Speakers also agreed they were concerned about the buildup of debt to GDP in the global system. "Balance sheets of U.S. companies are very stressed — cash flow is just enough to pay interest payment. For a small percentage of the largest mega-cap companies it is not that high … but for the remainder of all companies out there, we are already at levels we have seen in 2008," Roelof Salomons, chief strategist at Kempen Capital Management NV, said during the same panel discussion.

"But margins are much higher and interest rates are much lower than (they) were at that time," Mr. Salomons said, adding, "You'll get your coupon but it's not good for the economy."

"I was concerned in November and December (when) markets were getting illiquid," Mr. Salomons said. "The recession is now most likely (going to happen in) 2020 or 2021" after a strong rebound to the beginning of 2019, he said.

U.K. investors will also face the effects the U.K.'s exit from the European Union on gross domestic product. Paul Johnson, director of the Institute for Fiscal Studies, said during a keynote address that the forecast of real gross domestic product in the U.K. in 2018 was 14% lower than expectations 10 years ago. This gap could widen to 20% after Brexit, he warned.

Speakers also discussed how they could diversify defined contribution portfolios to improve the risk-adjusted return by adding asset classes such as private credit, venture capital and infrastructure. Mark Jaffray, head of DC consulting at Hymans Robertson LLP, speaking on a separate panel said, "Charge cap is not the barrier to investing."

In the U.K., defined contribution plans are restricted by a charge cap, which allows them to spend no more than 0.75% of funds under management on investment and administration fees.

An introduction of new asset classes is partly about needing to reach scale to reduce fees for current traditional managers to be able to plug in a new manager at a higher fee, Mr. Jaffray said. But he added plans have "no desire to raise the fees to participants," even if they are comfortably under the charge cap currently.

However, Nico Aspinall, CIO at the £6 billion People's Pension, sponsored by B&CE, responded: "We have got the ramp of scale. But that's not enough to push the 200-basis-point venture capital world to become 50 basis points" for DC plans to invest in. "The dynamic has shifted from what's the right price to what's the right scale to achieve at that price," he said.

"There are opportunities in the secondaries market to be a buyer … to construct a long-term evergreen portfolio," Mr. Aspinall said. "It will not be 75% (investment) for liquidity reasons but it won't be 40% for cost reasons (either)."

Emma Douglas, head of DC solutions at Legal & General Investment Management and chairwoman of PLSA's policy board, said incorporating performance fees is something that has not been solved yet. "(But) creating a class of fund that doesn't have performance fees would mean annual management charges goes up" and best-in-class managers might not have an incentive to work with DC plans without performance fees, she said.

There is a problem with the structure of performance fees, Mr. Aspinall said, adding that he wants the smallest possible non-management fee for illiquid investments.

Mark Fawcett, chief investment officer of the £4.5 billion ($5.9 billion) National Employment Savings Trust, London, which already invests in real estate and is in the process of adding private credit to its allocation for the first time, said during a breakout session that DC plans should be looking into adding illiquid asset classes as young participants have an appetite for them.

Environmental, social and governance aspects of investing were also on the top of the agenda of U.K. asset owners speaking at the conference. Mr. Aspinall called on DC plans to realize they need to "get access to the right parts of the economy" through investing in illiquid assets.

An illiquid investment means "you are the owner of assets and you can put values (of your participants) into that property or that business much better," he said.

Mr. Aspinall called on other asset owners to think about "what we can do better than defined benefits funds … how defined contribution (plans) could help innovate having an ESG agenda and low budget."

"We could be at the heart of disruption if we see ourselves in the right place of the challenges — how do we get the right data such that we can tilt (toward, for example, climate change) or have (an) integrated factor portfolio — compared to where the package was five to 10 years ago," he said.

Mr. Fawcett said in the breakout session that true ESG integration across asset classes is a good way to improve risk-adjusted returns. Just divesting carbon is not the right way and a systematic approach is needed. "We need the bad companies to get better (rather) than just the good companies to lead the way," he said.

Border to Coast's Mr. Booth said there will be investments that benefit from the transition to the to a low-carbon economy and those that are affected adversely. "We need to be making sure we are on the right side of trends," he said.

"We were not charging companies negative externality of fossil-fuel consumption and this will be addressed going forward and expedite these trends. ... I bought a peaking power plant for electricity generation in the past — but in 10 years there are batteries that will replace the plant," he said.

Jane Ambachtsheer, global head of sustainability at BNP Paribas Asset Management, during a separate panel, called on investors to adopt a fuller, more diversified approach across the different asset classes — including "climate consideration in index and engagement overlays."

"We already know we have enough fossil-fuel reserves than we can use if we are going to achieve the aim of 2 degrees Celsius temperature increase by 2050," Ms. Ambachtsheer said. "We don't have to be investing in companies to find more fossil-fuel reserves, which will become stranded assets. That's a $2.3 trillion loss."

Long-term fiduciaries have an opportunity and obligation to tackle issues and encourage changes at companies, she added, saying all asset owners will be "future takers" but they have an opportunity to be "future makers" for investments.

The PLSA discussions also touched on the sustainability in the business of money management. "We signed up to (a diversity agenda) because we think we should have (but) it is integral to sustainable business in a long term," said Debbie Gupta, co-director life insurance and financial advice supervision at the U.K. Financial Conduct Authority.

"You need a workforce and senior leadership that is bought into agenda," she said, adding, "You can't codify culture ... There is no alternative to a leadership buy-in."

Maria Lettini, director of the Farm Animal Investment Risk and Return Initiative, an investor initiative that aims at including factory farming on the ESG agenda, called on investors to consider the economic cost of antibiotic resistance globally, which could affect global output by $100 trillion by 2050. Over the past three years, she said, 18 of the 20 companies FAIRR has engaged with enacted some kind of policy to address the use of antibiotics in their supply chain, up from 1 out of 10 companies when it initiated its stewardship.

Similarly, Carola van Lamoen, head of active ownership at Robeco, said global production and consumption of plastic has increased 20-fold since 1960 to 311 million tons and is expected to double again in 20 years, with only 20% of plastic recycled. It is increasingly financially material, she said.