A look at macro trends driving DB pension investment strategies
BY Martha Porado | February 1, 2019
It’s too early in the rise of populism to determine whether it will turn out to be a secular or a cyclical trend, according to John Denham, chief investment officer at the Workplace Safety and Insurance Board.
As a result, populism has yet to have a firm affect on overall investment strategies, he noted during a panel at Benefits Canada‘s and the Canadian Investment Review‘s inaugural Investor Insight Breakfast in Toronto on Jan. 10. The issue is really whether populist policies have a tangible impact on global gross domestic products, inflation, interest rates and, therefore, various markets, he added.
“We’re currently in a new cycle [of populism], but it’s been pushing up since the 80s,” said Jean Michel, chief investment officer at the Investment Management Corp. of Ontario, also speaking on the panel. “It’s really created by income inequality around the world.”
He said the rapid rise of technology has disenfranchised less skilled workers. As well, politicians are using a lot more anti-immigrant rhetoric. “The expectation is that if you have less immigration, you have more jobs for your people. So we’ll see down the road if that turns out to be the case, but that’s clearly one of the themes they have.”
The implementation of more populist policies would have an evident affect on inflation, said Michel, noting wages would be pushed up by a lack of competition between countries. “From an investment point of view, if the trend is hard enough, that’s going to be a disruption. There are going to be winners and losers among the companies. So from an active management perspective, [it’s important to have] an understanding of what companies, assets classes and countries are going to have the headwind and tailwind from these changes.”
“If populism leads to trade protectionism, then that’s generally economically linked to lower growth,” said Denham.
As for how to react, now is the time to be nimble, said David Kaposi, chief investment officer at Ontario Power Generation, during the panel. “One of the reasons we’re looking at emerging markets fixed income is because it’s been on a pretty severe downtrend. If we see some dislocation, and I think this is the output of the populism issue, it’s a second order effect on markets.
“It’s going to introduce volatility. Some of it might be good, some of it might present opportunities and, if we can, we will adjust for that. But it hasn’t resulted in anything specific in terms of massive asset allocation changes. Around the edges, we’re looking for places where there is value in the markets so we can make some moves.”
Another potentially disruptive factor for defined benefit plans’ investments is the ever-rising popularity of environmental, social and governance issues.
“At the university, if we listened to everybody, we would be divested from everything,” said Guy Burry, chair of the pension fund investment committee at York University, during the panel. “We actually do not believe in divestment. We believe in guiding our managers to look at sustainable investment for the longer term. We’re not flavour of the month, I don’t think.”
When searching for investment managers to work with, it’s key to ask the right questions where ESG policies are concerned, he said. “When we did our search for concentrated managers, we were explicit in asking managers how they look at sustainable investing. And we had some good responses, [though] we had some greenwashing, which I would caution everybody in the room about.”
In an environment where most managers are trying to put an ESG spin on their strategies, it’s key to approach the issue with a critical eye, said Burry. “You need to ask them how they’re doing it, what measures they’re using.”
As an example, he referred to an interaction with a hedge fund manager who claimed that buying an equity stake in Apple Inc. was an impact investment. The logic was that recent updates to the company’s products allowed parents to limit screen time on their children’s devices, he said, noting that doesn’t make the grade as an active ESG play and is an example of how a lot of what managers are saying on these topics is little more than marketing.
Michel weighed in on the energy sector, noting a pension fund can’t invest in infrastructure without knowing what’s happening in that sector. “Whether you want it as a policy of being proactive or active and want to change the world, or if you’re just being a normal investor looking at what disrupts your investments, and looking at opportunities, I think this number should be 100 per cent and people should at least be looking at it from a disruption point of view at the minimum.”
As well, governance is an obvious risk issue, far better understood by managers and potentially easier to fold into an investment strategy than other sustainability topics, said Kaposi. Any good equity manager should be looking at issues of governance, and is probably avoiding a number of problem companies regardless of whether those actions specifically fall under an ESG mandate, he said.
As for specific assets classes, the way private assets fit into a pension plan’s overall portfolio has changed, said Michel, noting it used to be enough to simply have some allocation to this asset class, taking advantage of the illiquidity premium and increased diversification. Today, there’s a premium on private companies compared with the public equivalents, so simply following the trend and adding private assets to the mix isn’t sufficient justification, he added.
“Now, you really need to have a story around your investment. On private equity, you need to have an operations story, a value-creation story. And in infrastructure and real estate, you need to be in more on the greenfield and the development to really create value.
“I think it’s more complicated to access the asset class, but I think it’s worth it because they are so good in the total portfolio,” he added. “But I don’t think people should be naive, in just having it there. In the next 10 years, it’s going to be more complicated to get for a portfolio what these asset classes are supposed to be doing.”
This article originally appeared on CIR’s companion site, Benefitscanada.com. Read the full story here.