What can the larger investing community learn from how asset owners take into consideration and construct their multigenerational, long-term portfolios?
Positioning pension funds for long-term sustainable performance
PGGM is the investment organization of Pensioenfonds voor Zorg en Welzijn (PFZW), the second largest pension fund within the Netherlands. The PFZW has around 2.4 million members within the health and social services sector, 80% of whom are women. PGGM has assets under management of around 280 billion euros and strives to take a position sustainably with a purpose to achieve high and stable returns with responsible risk.
PGGM is transitioning its investment process to a 3D framework that integrates risk, return and impact. “In my opinion, the investment process and investment theory of the last 30 years, when I entered the financial industry, are not the ones we should use in the next 30 years,” van Dam said. “[Modern portfolio theory (MPT)] and maximizing shareholder value led to a narrow focus on purely financial results. And because MPT tells us that financial markets are efficient, there was no need to think deeply about the question: Is this value actually being created?”
“We may have the power and means to control and influence outcomes in the real world, and that is partly our reason for existing,” van Dam continued. “So this means we need to rebuild the investment paradigm to achieve long-term sustainable investment performance. We need to complement MPT with “modern investment theory” where financial and social outcomes are the most effective possible.”
van Dam recognizes that humanity now faces serious dilemmas – for instance, climate change and biodiversity loss – and that society expects asset owners to contribute to their solutions. PGGM plans to dedicate 20% of its investment portfolio to achieving the UN Sustainable Development Goals (SDGs) by 2025. In addition, the corporate is expanding its commitment to affect investing and moving towards “impact creation” – i.e. actively and consciously Contribute to value creation from a financial and social perspective.1 The PGGM board wants the fund’s financial and social goals to be given equal weight.
For CPP Investments, Rubin says sustainability means the sustainability of the plan itself. This sustainability is measured every three years with a 75-year look ahead. “This is not about a five-year holding period, this is not about a short-term cycle,” he said. “This is about how our investments will support the sustainability of the plan and its financial performance for generations to come.”
CPP Investments manages C$539 billion in assets for the Canada Pension Plan, which serves 21 million Canadian employees and retirees. The Fund’s statutory investment objectives are to maximise long-term investment returns without undue risk. Rubin explained that the main focus is on risk-adjusted returns, but “risk” includes all risks that the organization and investment portfolio may face. Risk means greater than just the market, credit and liquidity risks which can be typically considered in portfolio construction.
When allocating capital, CPP Investments leverages its long-term advantage in choosing the sectors through which it’s going to compete and seeks to attain above-average returns. Pure alpha or sustainable, incremental zero-sum returns aren’t all the time the goal, Rubin noted. Rather, it may very well be a mixture of alpha and beta, in addition to facilitating and expanding investment opportunities in ways in which profit diverse stakeholders.
“We are currently particularly focused on how we can continue to achieve maximum returns at our chosen level of risk in the face of a world that is not only becoming more complex but also more competitive,” he said.
Recognize yourself
The idea of “know thyself” is incredibly essential to organizations like CPP Investments, Rubin emphasized. “You have to be very clear about what you want to achieve and what constraints and risk tolerances you should pursue your goals within,” he explained. “The biggest challenge in thinking about risk for our types of organizations is defining exactly what we mean by risk and what its downsides are. The answers will be different for each company.”
Rubin is not convinced that there may be any particular risk metric that is healthier than the others. They are all imperfect measurements and he prefers to make use of several different tools together.
“These are exciting times for us in our profession when it comes to thinking about new ways to assess risk,” he said. “Let’s make the most of them all, but also bring some humility to this exercise, be very conscious and deliberate about the tools we use, and put them together in a way that helps us answer the bigger, first question “What risk really exists.” means in our organizations.”
Rethink benchmarks
PGGM can be reassessing its approaches to strategic allocation and benchmarking. To implement 3D investing, “you really have to think about: Is there an alternative to this extreme benchmark orientation that we’re probably all trapped in?” said van Dam.
PGGM explores “well-formed portfolios” – those which can be well diversified, engage in all relevant forward-looking human activities and generate value, with a minimum of the identical risk premiums as those anchored in equity markets.
“These ‘well-formed’ portfolios will be very far from what we now consider to be a good benchmark,” van Dam explained. “Our board has to agree that they are in control [of policy and policy execution] no longer through the establishment of benchmarks, but through different mechanisms. You rightly asked very difficult questions about how to maintain control. So that’s a big part of the research we do.”
The investment skilled of the longer term – talent and skills
Both CPP Investments and PGGM work to make sure that their investment and organizational strategies and talent management practices are built to serve their funds over the long run. Rubin and van Dam consider that future investment professionals will have to be more technology and data savvy and have a wider range of data and experience. They also expect Future investment teams will likely be more T-shaped.
“I don’t think investment professionals will work in the same way [specialty] “This is no longer a silo for 40 years,” claimed van Dam. “I think they should have a ‘growth and change’ mindset where they are willing to reinvent themselves throughout their careers.”
In such an environment, breadth of data will likely be as essential as depth.
“Incredibly deep but isolated expertise and understanding could still be useful in certain limited circumstances,” Rubin noted. “However, this profile concerns me the most because so many of the silos in which our industry operates – be it a quantitative hedge fund, private equity or credit – these types of standardized silos will, in my opinion, ultimately lead to commercialization.” And that, in turn, poses a threat to alpha and outsized return generation.”
He emphasized that the more we stay in our individual departments or isolated specialties, the more we are going to find that fierce competition drives returns.
Rubin believes that diversity of data and skills is the reply to those competitive dynamics over the subsequent 10 to twenty years. “Professionals need to be able to connect the dots between these different standardized silos into something that is more individualized and unique,” he said. “That’s what provides the opportunity to generate outsized returns.”
“When you build teams with great breadth of all players in different areas of vertical depth,” he continued, “you cover a much larger swath of the relevant investment universe with a collection of people who are naturally curious and engaged with one another.” , enjoy exchanging ideas and accomplish that with real depth and deal with their respective areas. I feel that is an exciting talent model for organizations like ours.”
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1. Over the last two years, PGGM has partnered with APG within the Netherlands, AustralianSuper and British Columbia Investment Management to create an asset owner-led platform committed to accelerating the adoption of Sustainable Development Investments (SDIs).
Photo credit: ©Getty Images/deliormanli
