What can the larger investment community learn from how asset owners think about and build their multi-generational and long-term portfolios?
At last month’s CFA Institute GLOBAL Alpha Summit, Jaap van Dam, Chief Investment Strategy Officer at PGGM, and Geoffrey Rubin, Senior Managing Director and Chief Investment Strategist at CPP Investments, spoke with Josina Kamerling, CFA Institute head of regulatory outreach for the Europe, Middle East and Africa (EMEA) region on the future of pension fund management, how their organizations are adapting to meet future investment challenges and what they are looking for in the next generation of investment talent.
Positioning pension funds for sustainable long-term performance
PGGM is the investment organization of Pensioenfonds voor Zorg en Welzijn (PFZW), the second largest pension fund in the Netherlands. PFZW has around 2.4 million members in the health and wellness sectors, of which 80% are women. PGGM has approximately €280 billion in assets under management and aims to invest sustainably to achieve high and stable returns for responsible risk.
PGGM is transitioning its investment process to a 3D framework that integrates risk, return and impact. “In my mind, the investment process and theory of the last 30 years, when I got into finance, is not what we should be using 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 since MPT tells us that financial markets are efficient, there was no need to think deeply about the question: how is this value actually created?”
“We potentially have the power and the means to direct and influence outcomes in the real world, and that’s partly our reason for existing,” he continued. “So this means that to achieve long-term sustainable investment performance, we need to rebuild the investment paradigm. We need to supplement MPT with ‘Modern Investment Theory’, where financial and social 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 allocate 20% of its investment portfolio to help achieve the United Nations’ Sustainable Development Goals (SDGs) by 2025. It is also expanding its commitment to impact investing and moving towards to “impact creation”, to actively and intentionally contribute to the creation of value from a financial and social perspective.1 The PGGM board wants the fund’s financial and social goals to have equal weight.
For CPP Investments, sustainability means the sustainability of the plan itself, according to Rubin. This sustainability is measured every three years with a 75-year vision of the future. “This is not a five-year holding period, this is not a short-term cycle,” he said. “It’s about how our investments will support the sustainability of the scheme and its financial position for generations to come.”
CPP Investments manages C$539 billion in assets for the Canada Pension Plan, which serves 21 million working and retired Canadians. The fund’s investment objectives, as set out in 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 the organization and investment portfolio may face. Risk means more than the market, credit and liquidity risks that are typically considered in portfolio construction.
When allocating capital, CPP Investments uses its long-term advantage to select the sectors in which it will compete and seek to generate outsized returns. Pure alpha or portable, zero-sum, incremental performance isn’t always the goal, Rubin noted. Rather, it could be a combination of alpha and beta along with facilitating and growing investment opportunities in a way that benefits various stakeholders.
“What we are particularly focused on at the moment is how we can continue to deliver the highest returns at our chosen level of risk in a world that is not only growing more complex, but also more competitive,” he said.
Know yourself
The notion of “Know Thyself” is incredibly important to organizations like CPP Investments, Rubin noted. “You have to really understand what you’re trying to achieve and what the constraints and risk appetite are within which you should pursue your goals,” he explained. “The primary challenge in thinking about risk for our types of organizations is defining exactly what we mean by risk and what the downsides are. The answers will be different for every organization.”
Rubin isn’t convinced there’s any particular risk metric that’s better than the others. All are imperfect measures, and he prefers to use several different tools in combination.
“These are exciting times for our profession in terms of thinking about new ways to assess risk,” he said. “Let’s all take advantage of it, but let’s also bring some humility to this exercise, be very deliberate and thoughtful about the tools we use and assemble them in a way that helps us answer that larger, first-order question of what risk really. means to our organizations.”
Rethink Benchmarks
PGGM is also reassessing its strategic allocation and benchmarking approaches. To implement 3D inversion, “You really have to start thinking: Is there an alternative to this extreme reference orientation that we’re probably all stuck in?” van Dam said.
PGGM is exploring “well-formed portfolios”: those that are well-diversified, have exposure to all relevant future human activities, and generate value, with at least the same risk premiums as those included in equity markets.
“These ‘well-formed’ portfolios will be far from what we now consider a good benchmark,” explained van Dam. “Our board will have to accept that he is in control [of policy and policy execution] it is no longer played by defining reference points but rather it is played through different mechanisms. They have rightly asked very difficult questions about how to be in control. So that’s a big part of the research we’re doing.”
The investment professional of the future: talent and skills
Both CPP Investments and PGGM are working to ensure that their investment and organizational strategies, as well as their talent management practices, are built to serve their funds for the long term. Rubin and van Dam believe that future investment professionals will need to be more tech and data savvy and have a greater breadth of knowledge and experience. They also expect future investment teams to be more T-shaped.
“I don’t think that investment professionals work in the same way [specialty] silo for another 40 years,” said van Dam. “I think they should bring a ‘growth and change’ mentality to the table where they’re willing to reinvent themselves during their careers.”
In such an environment, breadth will be as important as depth of knowledge.
“Incredibly deep but isolated experience and understanding can still be useful in certain limited circumstances,” Rubin noted. “But I’m very concerned about that profile because a lot of the silos that our industry operates in, whether it’s quantitative hedge fund, private equity or credit, those kind of standardized silos, ultimately I think they’re going to lead to commoditization. And that, in turn, is a threat to the alpha and high-achieving generation.”
He emphasized that the more we stay within our individual compartments or separate specialist areas, the more we will find that strong competition drives returns.
Rubin believes that 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 of these different standardized silos into something more personalized and unique,” he said. “That’s what has the potential to generate outsized returns.”
“If you build teams with a large breadth across 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 people who are naturally curious, engaged among themselves. , they like to share ideas, and they do so with 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 (SDI).
All posts are the opinion of the author. Therefore, they should not be construed as investment advice, nor do the views expressed necessarily reflect the views of the CFA Institute or the author’s employer.
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Julie Hammond, CFA, CPA
