What can the larger investment community learn from how asset owners are thinking about and building their multi-generational, long-horizon portfolios?
At last month’s Alpha Summit GLOBAL by CFA Institute, Jaap van Dam, PGGM’s principal director of investment strategy, and Geoffrey Rubin, the senior managing director and chief investment strategist at CPP Investments, spoke with Josina Kamerling, head of regulatory outreach for CFA Institute for the Europe, Middle East, and Africa (EMEA) region about the future of pension fund management, how their organizations are adapting to meet the investment challenges ahead, and what they are looking for in the next generation of investment talent.
Positioning Pension Funds for Long-Run Sustainable Performance
PGGM is the investment organization of Pensioenfonds voor Zorg en Welzijn (PFZW), the second largest pension fund in the Netherlands. PFZW has about 2.4 million members in the health care and welfare sectors, of whom 80% are female. PGGM has roughly €280 billion in AUM and seeks to invest sustainably to achieve a high and stable return for responsible risk.
PGGM is transitioning its investment process to a 3D framework that integrates risk, return, and impact. “To my mind, the investment process and theory of the past 30 years, when I entered finance, is not the one we should use in the next 30 years,” van Dam said. “[Modern portfolio theory (MPT)] and shareholder value maximization led to a narrow focus on purely financial outcomes. And because MPT tells us that financial markets are efficient, there was no need to deeply think about the question: how is this value actually created?”
“We potentially have the power and means to steer and influence the outcomes in the real world, and this is partly our reason to exist,” van Dam continued. “So, that means to achieve long-term sustainable investment performance, we have to rebuild the investment paradigm. We have to supplement MPT with ‘Modern Investment Theory,’ where the financial and societal outcomes are the best possible.”
van Dam recognizes that humanity now faces serious dilemmas — climate change and biodiversity loss, for example — and society expects asset owners to contribute to their solutions. PGGM plans to direct 20% of its investment portfolio to helping achieve the UN Sustainable Development Goals (SDGs) by 2025. It is also expanding its commitment to impact investing and moving toward “impact creation” — to actively and intentionally contribute to value creation from a financial and societal perspective.1 The PGGM board wants the fund’s financial and societal objectives to have equal weight.
For CPP Investments, sustainability means the sustainability of the plan itself, according to Rubin. That sustainability is measured every three years with a 75-year forward look. “This is not about a five-year holding period, this is not about a near-term cycle,” he said. “This is about how our investments are going to support the sustainability of the plan and its financial standing over generations to come.”
CPP Investments manages C$539 billion in assets for the Canada Pension Plan, which serves 21 million Canadian workers and retirees. The fund’s investment objectives, as established by legislation, are to maximize long-term investment returns without undue risk. Rubin explained that the focus is on risk-adjusted returns, but “risk” encompasses all the risks that the organization and the investment portfolio might face. Risk means more than just the market, credit, and liquidity risks that are typically considered in portfolio construction.
When allocating capital, CPP Investments leverages its long-horizon advantage in selecting the sectors where it will compete and try to deliver outsized returns. Pure alpha or portable, zero-sum, incremental return is not always the target, Rubin remarked. Rather, it could be a combination of alpha and beta along with facilitating and growing investment opportunities in ways that benefit various stakeholders.
“What we are focused on particularly sharply right now is how we can continue to deliver maximum returns at our chosen risk level in the face of a world that is not only growing more complex but also growing more competitive,” he said.
The notion of “Know Thyself” is incredibly important for organizations like CPP Investments, Rubin noted. “You have to have a very keen understanding of what it is you’re trying to achieve and what are the constraints and risk appetites within which you should be pursuing your objectives,” he explained. “The first-order challenge in thinking about risk for our types of organizations is defining exactly what we mean by risk and what are the downsides. The answers are going to be different for every organization.”
Rubin is not convinced there is any one particular risk metric that is better than the others. They are all imperfect measures, and he prefers to use several different tools in combination.
“These are exciting times for us in our profession in terms of thinking about new ways to assess risk,” he said. “Let’s absolutely take best advantage of them all but also bring some humility to that exercise, be very deliberate and thoughtful around the tools that we use, and assemble them in ways that help us answer that bigger, first-order question of what risk really means at our organizations.”
PGGM is also reassessing its approaches to strategic allocation and benchmarking. To implement 3D investing, “You really have to start thinking about: Is there an alternative to this extreme benchmark orientation that we’re probably all caught up in?” van Dam said.
PGGM is exploring “well-formed portfolios” — those that are well diversified, have exposure to all relevant forward-looking human activity, and are value generating, with at least the same risk premia as are embedded in the equity markets.
“These ‘well-formed’ portfolios will be very far away from what we now consider to be a good benchmark,” van Dam explained. “Our board will have to agree that being in control [of policy and policy execution] no longer plays through by defining benchmarks but plays through different mechanisms. They’ve rightly asked very tough questions about how to be in control. So, that’s a big part of the research that we’re doing.”
The Investment Professional of the Future — Talent and Skills
Both CPP Investments and PGGM are working to assure their investment and organizational strategies as well as their talent management practices are built to serve their funds over the long term. Rubin and van Dam believe future investment professionals will have to be more tech and data savvy and have a greater breadth of knowledge and experience. They also expect future investment teams will be more T-shaped.
“I don’t think investment professionals will be working in the same [specialty] silo for 40 years anymore,” van Dam asserted. “I think they should bring a ‘growth and change mindset’ to the table where they’re willing to reinvent themselves during their careers.”
In such an environment, the breadth will be just as important as the depth of knowledge.
“An incredibly deep but siloed expertise and understanding might still be useful in certain limited circumstances,” Rubin noted. “But I’m most concerned about this profile because so many of the silos in which our industry operates — whether it be a quantitative hedge fund, private equity, or credit — those kinds of standardized silos will ultimately, I believe, lead to commoditization. And in turn, this is a threat to alpha and outsized-return generation.”
He emphasized that the more that we stay within our individual compartments or siloed specialty areas, the more we’re going to find that sharp competition drives returns.
Rubin believes a diversity of knowledge and skills is the answer to these competitive dynamics over the next 10 to 20 years. “Professionals need the ability to connect the dots across these different standardized silos into something that is more bespoke and unique,” he said. “That’s what has the possibility of generating outsized returns.”
“If you build teams with great breadth among all players in different areas of vertical depth,” he continued, “you’re covering a much wider swath of the relevant investment universe with a collection of folks who are naturally curious, engaged with one another, like sharing ideas, and do so with a real depth and focus in their particular areas. I think that’s an exciting talent model for organizations like ours.”
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1. In the past two years, PGGM joined with APG in 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).
All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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Julia S. Hammond, CFA, CPA, is Director, Events Programming on the Marketing & Customer Experience (MCX) team at CFA Institute, where she leads the content planning for the Alpha Summit series of events. Previously she was the lead content director for a number of annual and specialty conferences at CFA Institute, including the Fixed-Income Management Conference, the Equity Research and Valuation Conference, the Latin America Investment Conference, the Alpha and Gender Diversity Conference, and the Seminar for Global Investors, formerly known as the Financial Analysts Seminar. Prior to joining CFA Institute, she developed strategies for pension, endowment, and foundation fund clients at Equitable Capital Management (now AllianceBernstein), and she has also worked as an auditor for Coopers & Lybrand (now PricewaterhouseCoopers). Hammond served for a number of years as chair of the investment committee for the Rockbridge Regional Library Foundation. She holds a BS in accounting from the McIntire School of Commerce and an MBA from the Darden School at the University of Virginia.