Common themes, different aims for GPIs
by Colin Robertson
Global Public Investor 2015 analyses the growth in assets across the public sector in 2014 and indicates the likely investment strategy this year. The themes are similar to those in the private sector: diversification away from equities, a desire for real inflation linked assets and a search for income.
However, global public investors are not a homogeneous grouping and they will need to handle these themes according to their own individual responsibilities.
For decades sovereign funds have invested in public equities, often taking substantial stakes in western companies. In many cases the mandate has been to preserve wealth derived from oil revenues for future generations and the long term nature of equity investment has matched this well.
Attractive returns Returns have been attractive and this has encouraged greater investment in equities, notably when there has been a very high level of existing investment in bonds. Often this has incorporated a less domestic focus, spreading the risks.
These trends can be expected to continue. The danger is that other types of public investor, with different aims – and which therefore may not be able to handle the volatility inherent in equity markets – get drawn into this asset class. Public pension funds are conscious of the length of their liabilities. Many are contemplating some degree of ‘derisking’ by switching equities into bonds. Equity purchases by central banks to obtain higher yields, influence risk appetite, or boost the economy in some other way, seem a dangerous game.
The intention of global public investors to allocate more money to real estate and infrastructure is a key conclusion of Global Public Investor 2015. This is supported by the behaviour of private sector institutions which, following the credit crisis, have been diversifying away from equities in an attempt to reduce risk while maintaining exposure to growth orientated assets.
The linkage to economic growth of real estate and infrastructure is clearly attractive to public sector investors, which have long-term investment horizons and hence no need for liquidity. For these investors in particular, an added attraction is the potential for an element of ‘self-investment’ as social and political needs can be simultaneously satisfied.
The very strong performance of commodities in the run-up to the credit crisis, and their supposed lack of correlation to other asset classes, drew attention to inflation-linked assets. For some investors, the aggressive actions of central banks have strengthened the argument for holding ‘real’ assets.
Real estate and infrastructure stack up well on this criterion, with rents and revenues often formally linked to the inflation rate. The huge potential supply of infrastructure investments is an attraction to large institutional investors. The inflation protection case for real estate and infrastructure has been boosted by the fall from grace of investment in commodities.
However, with the notable exceptions of some Canadian and Australian funds, investment in infrastructure has progressed slowly. The need for a sizable skilled in-house team poses challenges. So does the mismatch between the desire of investors to buy mature infrastructure with attractive yields and the requirement of governments to obtain capital to initiate projects.
Investment in commodities is likely to remain unfashionable for private sector investors. But some large sovereign funds may be able to take advantage of distressed sales of commodity assets to further national economic security.
Search for yield
The collapse in government bond yields and narrowing of credit spreads has prompted pension funds and central banks to maintain income by moving up the risk spectrum. However the risks implicit in this strategy are different for these two categories of investors.
Pension funds have introduced or increased allocations to emerging market and high-yield debt. Fearing a future rise in government yields, they have also invested in ‘absolute return bond funds’ which have targeted ‘Libor plus‘ returns. The problem is that all of these new investments have much shorter durations than their liabilities. So derivative strategies are needed to maintain the duration of their assets.
In contrast, moves by central banks along the credit spectrum tend to lengthen the duration of their portfolios and increase the credit risk. In many ways ‘absolute return bond funds’ should be more suitable for central banks than for pension funds. But avoiding conflicts of interest, as well as liquidity considerations, can make external management difficult.
With yields higher than investment grade bonds, real estate and potentially infrastructure fit the bill for pension funds. However, a problem for pension funds is the artificial distinction made by investment consultants between ‘matching’ and ‘growth’ assets. Real estate and infrastructure lose out by qualifying for both categories but not being the most attractive asset class in either.
Hedge funds are the least attractive broad asset class according to the investment intentions indicated in Global Public Investor 2015. This reflects poor returns and high costs, as well as the difficulty of selecting suitable hedge fund managers.
Nevertheless, ‘Libor plus’ hedge fund mandates should be appealing to those seeking cash like investments and hedge funds do offer diversification.
Different categories of global public investor in different regions will share intellectual leadership and best practice. To meet its overall targets, individual global public investors have no alternative but to examine very closely their own mandate and liabilities, and take appropriate matching steps .
■ Colin Robertson, Advisory Board Colin Robertson, former global head of asset allocation of Aon Hewitt, is an independent consultant. Global Public Investor 2015 is available for purchase at www.omfif.org or email@example.com. Back