Top stories of 2023: Fed fights inflation, private markets face reckoning, ESG backlash and more

The continuing efforts by the Federal Reserve to quell inflation, a rebound in equity markets, turmoil in the private markets, a continuing emphasis on ESG — including legislation aimed to combat it — and a threat to the SEC's authority were among Pensions & Investments' top 10 stories of 2023.

The top story this year, chosen by P&I's editors, was the Federal Reserve's apparent success at controlling inflation through its aggressive hikes in interest rates. Last year at this time, many experts predicted a recession for 2023, one that did not come to pass, while equity markets, particularly growth stocks and tech stocks, experienced a spectacular comeback. Other big stories of the year included the Department of Labor taking another stab at a fiduciary rule, another change at the top at CalPERS, a flight of investors from a struggling China, and multiple victories for proponents of defined benefit plans.

The top story of the year might very well be what didn't happen: a recession that many experts in 2022 had predicted would take place by the end of 2023.

In 2022, the Fed's fight against inflation led to a hyper-aggressive series of rate hikes, with the federal funds rate ending the year at a range of 4.25% to 4.5% after seven rate hikes. In 2023, the Fed raised rates four times by 25 basis points each, ending at a range of 5.25% to 5.5% at the end of July. Since then, the Fed has held rates at that level and continued the pause at its Dec. 13 meeting.

Just one year after no end seemed to be in sight on rate hikes, the committee's median projection for the federal funds rate at the end of 2024 now sits at 4.6%, down from the 5.1% it forecast in September, and 3.6% at the end of 2025, down from a projected 3.9% in September.

Fed Chairman Jerome H. Powell said at a Dec. 13 news conference that while the committee is turning more of its attention to potential rate cuts, it hasn't made any decisions.

"We are seeing strong growth that appears to be moderating, we're seeing a labor market that is coming back into balance by so many measures, and we're seeing inflation making real progress," Powell said. "These are the things we've been wanting to see, (but) we still have a ways to go. No one is declaring victory, that would be premature, and we can't be guaranteed of this progress."

In December, Bureau of Labor Statistics showed that the consumer price index rose 3.1% from a year earlier in November, slightly below the 3.2% figure recorded in October. Powell said the central bank is committed to bringing inflation down to 2% over time.

For public pension funds and college and university endowments, the past year was marked by a comeback few had anticipated a year ago. For the year ended June 30 (fiscal year-end for the majority of those institutions), the Russell 3000 and Bloomberg U.S. Aggregate Bond index returned 19% and -0.2%, respectively, well above the respective returns of -13.9% and -10.3% for the year ended June 30, 2022.

Among the 79 public pension funds and 47 endowments tracked by Pensions & Investments for the year ended June 30, the median returns were 7.6% and 4.4%, respectively, miles above their respective median returns of -4.9% and -4.1% the prior fiscal years.

The positive returns, however, were tempered by a difficult environment for alternative investments.

The second-ranked story of 2023 was tumult in private equity and real estate, as write-downs that resulted from lower valuations arising from negative public equity returns in 2022 had a delayed negative effect on returns, with venture capital in particular feeling the brunt of losses. At the same time, institutions continued to run eagerly to the awaiting arms of private credit as an expected boom in investment-grade fixed-income returns did not come to fruition until late in 2023.

For the year ended June 30, the Cambridge Associates LLC U.S. Private Equity index returned -1.5%. Real estate had it even worse, with the NCREIF Fund Index-Open End Diversified Core Equity returning a net -10.7% for the period.

Jay Kloepfer, executive vice president and director of the capital markets research group at Callan, said in a September interview that alternatives will likely drag down returns for the fiscal year ending June 30, 2024, as well.

"Private equity and real estate are still in the process of writing down asset values, and this activity will carry into the third and fourth quarters of 2023. The delayed write-down for private assets showed up in force in the first half of 2023 and the fiscal year ending June," Kloepfer said.

Public pension funds and endowments with larger allocations to private markets, particularly in venture capital, experienced the lowest returns for the most recent fiscal year, with some institutions such as Princeton University's $34.1 billion endowment and the Massachusetts Institute of Technology's $23.5 billion endowment even posting negative returns in a period that saw public equities experience double-digit positive returns.

Even as private equity and real estate suffered from write-downs, private credit continued its impressive boom as more pension funds, endowments and foundations have been committing significant allocations to the asset class in their unquenchable thirst for returns as traditional fixed income still lagged behind in 2023.

In a November interview, Armen Panossian, incoming co-CEO of Oaktree Capital Management, said: "With the dislocation of the market now, we are seeing the best risk-adjusted returns in corporate private lending than any time over the last 13 years, so that's pretty attractive. That's a great way to invest capital for our clients, that's risk-adjusted or downside protected."

Fundraising also faltered in 2023, particularly in venture capital, which fell far below the previous year. In the first three quarters of this year, 344 venture capital funds raised a combined $42.7 billion compared with 593 funds that raised a combined $150.9 billion in the same period last year, according to the PitchBook-National Venture Capital Association's U.S. Venture Monitor.

The third-ranked story of 2023 was continuing backlash against ESG by some Republican-led state legislatures, which put rhetoric into action with laws that caused no end of controversy themselves. The epicenter of that fight in 2023 took place in Oklahoma, where in May Treasurer Todd Russ included Bank of America, BlackRock, State Street, J.P. Morgan Chase and Wells Fargo on an initial list of 13 financial institutions (reduced to six in August) that will be prohibited from doing business with the state for engaging in what Mr. Russ describes as "boycotts of fossil fuel companies." In December, the $20.7 billion Oklahoma Teachers' Retirement System, Oklahoma City, agreed to divest $184 million in the publicly traded securities of the above-named five firms. However, the $10.3 billion Oklahoma Public Employees' Retirement System voted to retain its investments with BlackRock and State Street Global Advisors after approving a fiduciary exemption, leading to a war of words between system executives and Russ, who claimed the system was violating the law.

Also this year, in May the dean of anti-ESG rhetoric, Florida Gov. Ron DeSantis, who officially launched a troubled campaign for the 2024 presidential election this year, signed a law requiring the $241.4 billion Florida State Board of Administration, Tallahassee, to make investment decisions based "solely on pecuniary factors" and not include environmental, social and governance considerations. The law formalized investment policy changes made by the board — which DeSantis chairs — in August 2022.

However, the law appears not to have changed the board's rationale for investing. One day before DeSantis signed the law, the SBA disclosed a first-quarter commitment of $200 million to Blackstone Green Private Credit Fund III, the latest in Blackstone's series of green-energy credit funds.

Heather Wyckoff, partner at private capital law firm Schulte Roth & Zabel, said in a June interview that the law doesn't define ESG and simply says money managers can't risk the profitability of the investments they make, which is already universally practiced by managers that offer the kinds of commingled funds and separate accounts in which SBA invests.

She said the law is essentially redundant, since managers are already managing money solely for that purpose.

Meanwhile, perhaps the most visible target of the anti-ESG laws was Larry Fink, CEO of BlackRock. The manager revealed in June that it had begun to pay for personal and home security for Fink and BlackRock's president Rob Kapito in light of the increased safety concerns related to their jobs. Later that same month, Fink said he no longer uses the ESG term due to the growing political backlash against the concept in investing. During a fireside chat with David Rubenstein, co-chairman of global private equity firm The Carlyle Group, at the Aspen Ideas Festival, Fink said the term has been "entirely weaponized" by both the "far left" and the "far right," according to an audio recording of the conversation.

"I'm not blaming one side or the other, but it has been totally weaponized," Fink said. "In my last CEO letter, the phrase ESG was not uttered once, because it's been unfortunately politicized and weaponized."

The fourth-ranked story was a tumultuous year for the Securities and Exchange Commission, which faces a real challenge to its use of in-house judges, as well as industrywide concern on the agency's pace of rule-making, including its developing stance on cryptocurrency.

On Nov. 29, the U.S. Supreme Court heard oral arguments in Jarkesy vs. SEC, a case challenging the constitutionality of the SEC's administrative law judges, or ALJs, which handle administrative enforcement cases in-house. While the justices' decision will likely not be disclosed until after the new year, it appears likely they will rule the SEC's use of judges to adjudicate enforcement proceedings violates Americans' right to a jury trial, according to legal experts after hearing the arguments.

The Supreme Court agreed to hear Jarkesy vs. SEC after the SEC petitioned it to review the case following a May 2022 decision from the 5th U.S. Circuit Court of Appeals in New Orleans. The 5th Circuit sided with the plaintiff and ruled that the SEC's ALJ system was unconstitutional.

Hamish Hume, a partner at law firm Boies Schiller Flexner, said in a December interview he thinks there will be five or six votes to uphold the 5th Circuit ruling and deal the SEC the loss.

In 2023, the SEC's regulatory agenda listed 29 items in the final rule-making stage and 23 items in the proposed rule-making stage, a breathless pace that some in the industry thought perhaps might be too aggressive.

Karen Barr, Washington-based president and CEO of the Investment Adviser Association, a trade association representing fiduciary investment adviser firms, described the SEC's rule-making pace as "very aggressive."

"The SEC has issued not only a large number of rule proposals, but the significance and substance and complexity of the rule proposals … these are all big deals," said Karen Barr, Washington-based president and CEO of the Investment Adviser Association, in a March interview. "These are rule-makings that could dramatically shift the landscape for investment advisers in a lot of different aspects."

One proposal that still is causing controversy over a year and a half after its introduction is the SEC's climate disclosure rule, which will likely be challenged legally once it is finalized. The rule would require public companies to provide a host of climate-related information in their periodic reports and registration statements. House Republicans have introduced multiple bills, which have not passed, that would block the rule.

Another one of the more hotly debated topics in 2023 among watchers of SEC decisions was the agency's continued refusal to approve a spot bitcoin ETF. James Angel, an associate professor of finance at Georgetown University's McDonough School of Business, said in a September interview he suspects the SEC fears that if it greenlights a spot bitcoin ETF, that will be seen as government approval of bitcoin. The regulator, aware of Wall Street's marketing muscle, doesn't want to "unleash a bitcoin bull" into the retail investor china shop, he said.

Later, in December, the SEC declined to create additional rules for cryptocurrency. On Dec. 15, the agency denied cryptocurrency exchange Coinbase Global's petition for the agency to issue rules governing digital assets, with Chairman Gary Gensler reiterating his position that "no further regulation is needed to oversee the crypto market."

Gensler said that SEC was denying Coinbase's petition because there are already laws and regulations in place that apply to the crypto market, the SEC is working on various rules that pertain to digital assets, and the commission must maintain discretion with respect to its rule-making priorities.

The fifth-ranked story was the Department of Labor continuing to deal with backlash against its now-in-effect ESG rule, as well as unveiling a new rule proposal to amend the definition of the term fiduciary and require rollover advice be in the best interest of the saver.

The new fiduciary rule proposal is a more narrowly tailored approach than its 2016 fiduciary rule proposal, which was ultimately vacated in 2018 when the three-judge panel at the 5th U.S. Circuit Court of Appeals in New Orleans struck it down 2-1. Opponents, however, claim the rule is still too close to the 2016 version.

In its new Retirement Security Rule, the DOL has proposed the removal of three prongs in the five-part test that was established in 1975 that determines when a financial professional is considered an investment advice fiduciary under ERISA: that the person providing the advice does so on a regular basis; the advice is pursuant to a mutual understanding; and that the advice will serve as a primary basis for decision-making. In the proposal's preamble, the existing test too often works to "defeat legitimate retirement investor expectations of impartial advice and allow(s) some advice relationships to occur where there is no best interest standard."

Opponents claim the new rule is still to close to the 2016 rule that was struck down.

"I struggle to see how this is a more narrowly tailored, carefully crafted approach. It seems to me that they've reshuffled the deck chairs on the Titanic, but we're still headed for that same iceberg," said Jason Berkowitz, chief legal and regulatory affairs officer at the Insured Retirement Institute, a trade group representing members that account for 90% of annuity assets in the U.S.

Also this year, on Jan. 30 the DOL's Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights rule went into effect. The rule allows ERISA fiduciaries to consider ESG factors but maintains the department's position that fiduciaries may not sacrifice investment returns or assume greater investment risks as a means of promoting collateral social policy goals. That same month, Republican attorneys general from 26 states filed a lawsuit — State of Utah et al. v. Su et al. — in U.S. District Court in Amarillo, Texas, arguing that the Labor Department's rule undermines key protections for retirement savers, oversteps the department's authority under ERISA and is arbitrary and capricious. In September, a Federal judge dismissed the lawsuit saying the rule does not violate ERISA, which was quickly followed in October by the attorneys general filed a notice of appeal with the 5th Circuit Court of Appeals in New Orleans.

The next story was institutional investors fleeing China due to its slumping stock market along with ongoing geopolitical concerns. One of the key events in that vein took place on Nov. 14, when after years of debate on the matter, the Federal Retirement Thrift Investment Board, Washington, voted unanimously to change the benchmark for its international fund to an index that excludes China and Hong Kong, shifting the $770.5 billion Thrift Savings Plan's I Fund benchmark to the MSCI All Country World ex-U.S. ex-China ex-Hong Kong Investable Market index from the MSCI Europe, Australasia and Far East index. As of Oct. 31, the TSP's I Fund had $68 billion in assets.

The move by the board came several months after President Joe Biden's executive order restricting new U.S. private equity and venture capital investments in certain Chinese technology companies and barring U.S. investment including joint ventures in Chinese companies focused on semiconductors and microelectronics, quantum information technologies and artificial intelligence. It also requires Americans to notify the Treasury Department of direct investments in those sectors.

Even before those moves, investors were cooling on China, as its economy has slowed and its long-term equity returns have been battered the overall emerging markets equity index. Year-to-date Dec. 15, the MSCI Emerging Markets ex-China index outperformed the MSCI China index 16.5% to -11.8%.

As a result of the orders and China's financial challenges, money managers have been reducing or eliminating their presence in China. In November, Vanguard Group announced it was completing its exit from China via the closure of its Shanghai office.

The seventh-ranked story of 2023 was turmoil at the top of CalPERS. In September, Nicole Musicco, whose arrival at the largest U.S. public pension fund 18 months earlier was one of P&I's top stories of 2022, resigned "to attend to the immediate needs of family in her native home of Toronto, Canada." Musicco, previously a partner at New York-based private equity shop RedBird Capital Partners, had arrived at the $470.2 billion California Public Employees' Retirement System, Sacramento, to succeed Yu "Ben" Meng, who had also resigned after 18 months in the position under a cloud of criticism related to his personal investments.

At her final appearance before CalPERS' investment committee as CIO on Sept. 18, Musicco said she appreciated the committee welcoming "the Canadian with big ideas," but acknowledged that during her tenure she did not get universal support from the investment team, which nevertheless delivered on "very ambitious goals." CalPERS wasted no time launching a search for a replacement for Musicco, hiring executive search firm Dore Partnership in October to lead the search.

Jim Scheinberg, the managing partner of fiduciary search firm North Pier Search Consulting, Marina Del Rey, Calif., said in September it will be difficult to find a new chief investment officer who will be the right fit for CalPERS.

"It's an incredibly high-profile job. Who wants to live under a microscope?" Scheinberg said. But, he added, "to deploy a half-trillion dollars in capital, that's the GOAT of the investment world."

The 8th-ranked story of the year was a series of victories for proponents of both corporate and union defined benefit plans. Corporate DB plans have experienced a long sunset over the past 20 years, as most of the highest-profile legacy DB plans have been frozen to benefit accruals and companies with the most assets like General Motors Co. International Business Machines Inc., AT&T Inc. and Verizon Communications Inc. have pulled the triggers on enormous pension risk transfer transactions that moved a large chunk of their liabilities to insurance companies.

Just over a year after its own transfer of $16 billion in DB plan liabilities — the second largest such transaction in U.S. history — IBM stunned the retirement world by announcing it will be eschewing its 5% 401(k) match for a cash balance component called a retirement benefit account, which is part of the IBM Personal Pension Plan, a defined benefit plan. The IBM Personal Pension Plan — closed to new participants since 2005 and frozen since 2008 — had a funding ratio of 116.8% and a pension surplus of $3.6 billion last year, according to the latest 10-K statement. The pension plan had $25.1 billion in assets last year.

Also in 2023, the Teamsters Central States, Southeast & Southwest Areas Pension Fund, Chicago, which for decades had been facing mounting financial problems and looming insolvency, received an extraordinary $35.8 billion from the PBGC under the Special Financial Assistance Program. The life raft for the largest U.S. union pension fund brought its funding ratio up to 98.5% as of August, according to its website.

As of Sept. 30, the PBGC had approved 100 applications for a total of $53.5 billion in special financial assistance, according to its most recent annual report.

Finally, the United Auto Workers' recent strike against three major automakers included a demand to restore their defined benefit plans. While the union did not receive that concession, its 401(k) plan benefits were improved significantly.

General Motors, Ford and Stellantis will boost contributions they make annually to their employees' 401(k) accounts to 10% of salaries from 6.4% now, a UAW spokesman confirmed Nov. 1. That significant increase will greatly improve workers' "ability to prepare for a secure retirement," according to a review on the UAW website of the benefits union members will enjoy from the recent accords hammered out with the three big automakers.

The ninth-ranked story of 2023 was the rising profile of artificial intelligence, as both asset owners and money managers have begun to position themselves for the future of investing. The year in AI could best be characterized by the extraordinary market performance of NVIDIA Corp., whose year-to-date return as of Dec. 18 was an eye-popping 243.8%. As public awareness of AI has skyrocketed since the much-heralded debut of ChatGPT in November 2022, multiple rule-making bodies have been attempting to build a framework around which AI will be allowed to affect future applications.

In July, the SEC introduced a proposal that would require investment advisers and broker-dealers to "eliminate or neutralize" conflicts of interest in investor interactions that use certain technologies, including AI, and in October, President Joe Biden signed an executive order to increase oversight of artificial intelligence, citing the economic, national security and other risks it poses to society. Biden's order also directs the Secretary of the Treasury to issue a report on the "best practices for financial institutions to manage AI-specific cybersecurity risks" within 150 days.

And in December, the world's largest money manager weighed in. BlackRock announced it will roll out a suite of new generative AI-powered tools for both its employees and its clients over the coming months — some of the first steps outlined in a new internal memo outlining the $9.1 trillion firm's approach to generative AI.

The 10th-ranked story of 2023 was the regional bank crisis. In March, Silicon Valley Bank, the high-profile venture capital and startup lender, was shut down by regulators and taken over by the Federal Deposit Insurance Corp.

While many institutional investors had tiny positions in the bank's stock within index funds, the real impact at the time was for private equity and venture capital firms and their investors, for which Silicon Valley was one of the biggest bankers. Sources and the bank website said that it not only provided debt financing that general partners needed to manage their liquidity, including distributions and capital calls, but they and their portfolio companies also had bank accounts with SVB.

While there was some fear of a contagion following SVB's collapse, as well as UBS Group's rescue of Credit Suisse Bank in Switzerland, it did not come to pass.

Austin Graff, chief investment officer of Opal Capital, said in March that the situation surrounding SVB says more about the state of unprofitable tech companies than diversified banks.

"SVB's business (was) concentrated in unprofitable technology companies," he said. "As funding options for these companies dried up they had to resort to previously deposited funds to keep the lights on — forcing them to sell securities that were supposed to be held to maturity at a loss."

Alecta, Sweden's largest pension fund with 1.2 trillion Swedish kronor ($114 billion) of assets, perhaps suffered the greatest fallout from its exposure to SVB, as well as Signature Bank, another U.S. bank that had failed, when in April its CEO Magnus Billing resigned. The pension fund had a total of 12 billion kronor invested in SVB and Signature — investments that were written down to zero. The pension fund also sold a 9.7 billion kronor holding in First Republic Bank at a loss, divesting its exposure in March for 7.3 billion kronor.