THE BLOG - LATEST THOUGHTS
Each year, we carry out global surveys on emerging investment issues, involving key decision makers in various pension jurisdictions. In addition to the resulting survey reports, we also publish regular thought leadership articles in the Financial Times and IPE that touch upon the burning issues of the day.

Together, they provide a timely pulse check on the latest thinking on issues of interest to decision makers in asset owners, asset managers and asset distributors.

Having had the privilege of doing over nearly 40 global surveys and over 100 thought leadership articles over the past 20 years, the updates found below provide the basis for discussion and debate.



Negative rates cannot cure the problems that caused negative rates
Fri, 10 Jul 2020

Negative interest rates are back in the news, currently accounting for 11 per cent of global outstanding debt. Even a long time hold-out like the Bank of England has recently thrown in the towel by issuing a negative yielding bond for the first time in its history.

Seen as extraordinary and unconventional on their introduction in 2014, negative rates have since become ordinary and conventional, as the global economy remains haunted by the spectre of secular stagnation – even well before the current crisis.

Of course, unusual times demand unusual measures. But that does not mean they will all work. Despite its formidable arsenal, the Fed has been powerless to force creditworthy households and enterprises to borrow, nor to create profitable ventures for capital to invest in. A research paper by PIMCO shows that negative rates, on balance, do more harm than good. For pension plans, their side effects are too obvious to ignore, especially in Europe.

Those plans that are regulated under the Solvency II regime are enjoined to hold a certain amount of ‘risk-free’ assets in their portfolio as a safety measure. Typically, such regulation has been used by governments in the past as part of ‘financial repression’, which keeps rates near zero and makes the cost of mounting public debt more manageable.

At the other extreme, those plans that have healthy funding ratios need to de-risk their pension portfolios via safe haven assets, even if that means paying their issuers for the privilege of lending them their money.

Either way, negative rates mark the latest phase in the long drawn-out downward trend that started in the 1980s. They have proved the Achilles heel of DB plans, holding more than half the retirement assets in the developed world.

The reason is that, in the investment universe, interest rate risk carries no reward — only a double whammy. Falling rates mean lower cash flows, as plans typically rely on bonds to fund regular payouts to their retirees. To cover the resulting shortfall, they have to invest even more.

Falling rates also inflate the present value of plans’ future liabilities, as calculated under prevailing pension regulations. As a rule of thumb, a 1 per cent fall in rates delivers a 20 per cent rise in pension liabilities and a 10 per cent fall in the funding ratio — a measure of a plan’s ability to meet its future commitments.

In a typical pension portfolio, a lower discount rate tends to be net negative: its positive effect on equity assets is more than offset by its negative impact on liabilities.

No wonder the Dutch government has just decided to reform its occupational pension sector by heralding a dramatic shift towards defined contribution plans where interest rates can no longer determine pension affordability. The details are yet to be worked out. But the message is not lost on regulators in other pension jurisdictions.

The harsh truth is that low rates have made it ruinously expensive for plan sponsors to honour their pension promise.

I wrote more about this subject in yesterday’s Financial Times (9th July 2020). The link for the subscribers is here.


Has investing been reduced to second-guessing the next move of the central banks?
Wed, 03 Jun 2020

The Covid-19 crisis has inflicted a triple whammy on the global economy: a demand shock, a supply shock and a financial shock. It has also forced a moment of reckoning for key central banks who have been obliged to overplay their hands.

The US Federal Reserve’s balance sheet has ballooned tenfold since 2007 – out of nowhere. Bailing out junk bonds, buying high-yield ETFs and lending directly to corporate America has pushed the Fed well out of its comfort zone to stave off a 1929-style market meltdown.

The resulting blatant disconnect between financial markets and the real economy is yet another sign – if one were needed – of the over-financialisaton of advanced economies.

Historically the primary role of equity markets has been to channel capital from savers to enterprises that want to grow their businesses. Savers were thus issued shares that were meant to provide a claim on the future profits of the borrowers.

Over time, however, trading in such claims itself has become more profitable than the reward for holding them, giving rise to two other outcomes: a vast growth in financial activity via derivatives trading; and the conversion of investment returns into a monetary phenomenon, influenced far more by top-down central bank action than by bottom-up securities selection.

The perception that the Fed would always intervene if markets tumbled has become deeply ingrained in investor psyche since the 1980s.  With every slide, markets have welcomed back their sugar daddy with open arms.

After the 2008 crisis, central banks reduced the interest rate to near zero, then brought in quantitative easing, then issued “whatever it takes” type statements, then more QE – all in a vain attempt to reboot their economies and rekindle inflation.

And now, an over-reach: not only more QE and yield curve control, but also direct lending… No wonder markets are delighted. The prevailing narrative is “bad news for the economy is good news for risky assets”. Why? Because central banks would be forced to open yet more financial spigots.

Of course, monetary stance has always been a factor in the short-term cyclical movements of asset prices. ‘Short term’ has now lasted for decades, giving rise to moral hazard as investing has become a one-way bet.

Notably, however, the majority of respondents in the 2019 Amundi–CREATE* survey believed that the central bank stimulus has long since reached a point of diminishing returns. Each boost only gives a temporary sugar high while adding to market fragility.

The current crisis will be a true test of the old refrain “don’t bet against the Fed”. Some investors are relieved by its jaw-dropping action. But many more fear that markets will become even more distorted and fragile. Before long, therefore, they will be forced to  learn to stand on their own two feet via painful adjustments. Time will tell.

I have covered this topic more fully in my FT article, published today (3rd June 2020). If you are a subscriber, you can access it here.


*Quantitative easing: the end of the road for pension investors.


Rewriting the pension promise requires less talk and more action
Mon, 20 Apr 2020

The financial meltdown sparked by Covid-19 is yet another nail in the coffin of the final-year salary scheme, where employers bear all retirement risks.

Yields have plunged to record levels and will be kept there for a long time to enable governments to fund their ballooning deficits. Schemes that are unhedged will be the hardest hit. To make matters worse, the asset side of the balance sheet has also seen plummeting values.

The sad truth is that even before the crisis, defined benefit plans worldwide struggled to build up healthy finances even against a background of the longest running bull market in history. Only around 40% of schemes went into this crisis with a funding level above their statutory level.

Last year, for example, six multi-employer pension plans in the US were terminated and sought assistance from the Pension Benefit Guarantee Corporation, the federal backstop for plans that can no longer provide the promised benefits. The main culprits were either zero-bound rates that inflated liabilities or inadequate contributions or both.

The harsh truth is that the DB pension promise was easy to make but hard to keep. It faces death by a thousand cuts. It’s time to rewrite it. That is easier said than done, since the promise is hardwired into members’ job contracts. Unless laws are changed, all that scheme sponsors can do is to chip away at the benefits piecemeal.

Across Europe, some schemes have changed the benefit structure: retirement age has been raised, payouts cut and the indexation of benefits made discretionary. Some have sought extra cash injections: both employers and employees have been enjoined to raise their regular contributions, with employers also providing hefty one-off top-ups periodically. Some have restructured the plans: existing members’ future benefit accruals have been frozen and new members have been advised to join defined contribution (DC) plans where they bear all the investment risks. Those scheme members approaching retirement have been offered an attractive lump sum in lieu of an annuity, thereby offloading mortality risk, interest rate risk and inflation risk onto them.

As a default option, it is not at all clear why DC plans would succeed while DB plans have struggled, despite their access to the best advice and higher annual contributions. DC plans are neither a comfort blanket nor the only source of certainty.

There has also been a lot of talk about making DB plans less onerous for their sponsors by, for example, linking retirement age to life expectancy and replacing final salary by career average salary in calculating the entitlements. Politicians have shied away from the necessary legislative action for fear of alienating voters. It is unlikely that they will be able to long grass the problem when the full damage from the current crisis becomes clear.

If you are a subscriber to the FT, I have provided more details in today’s edition (Monday 20th April 2020).


Going ‘green’ sounds simple but it’s not easy
Mon, 23 Mar 2020

“Our neglect of socio-environmental issues will shock future generations, just as our predecessors’ neglect of slavery shocks us today” said the chief investment officer at a French pension plan participating in the latest KPMG/CREATE report on sustainable investing.

But he was also quick to point out one salutary lesson from history: when lofty ideals clash with on-the-ground reality, progress can only come in small steps, even when the direction of travel is clear. And so it is with climate risks. Three contributory factors stood out in the interviews I did with asset owners and asset managers.

The first one involves a lack of reliable data on three foundational concepts: materiality, intentionality and additionality. Respectively, they seek to assess three things: how material climate change is to a company’s financial performance; whether the company intends to act on it and ‘do good’ via its products and services; and whether the company generates societal benefits in addition to financial benefits.

The second factor is the creeping rise of quarterly capitalism over the past 30 years. Under it, listed companies have been incentivised on short-term profits at the expense of long-term viability. Markets have, as a result, morphed from a source of investment capital for growing companies to a vehicle for cash distribution and balance sheet management. Long-term issues like climate change have not been on many chief executives’ radar.

The third factor slowing down progress is the tentative nature of the evidence now available on whether climate change is indeed a risk factor that generates returns. Specifically, the evidence shows that it is a risk factor for sure; except that, so far, it is a compensated factor in Europe but much less so in the US and Asia Pacific. The compensated element has also varied over time during the last decade.

Such evidence sits uncomfortably with those over-discerning investors who argue that for climate change to be treated as a risk factor, it needs a long performance history over multiple cycles in multiple regions. Currently, the available data on the subject fall well short of these criteria.

Still, the majority of participants in our survey took a forward-looking view on climate change, as summed up by the chairman of an Anglo-American asset manager “Just as it is foolhardy to drive a car by looking in the rear-view mirror, so must investors look forward and factor in change. The world does not stand still.”

After the huge collective push from governments, international bodies and investors worldwide, it is hard to believe that climate change will not emerge as a compensated risk factor before long. The role of the US government, however, remains crucial in this respect, as I have argued in my article in today’s FTfm (23rd March 2020). If you are a subscriber to the FT, you can access it here.


Going ‘green’ sounds simple but isn’t easy
Mon, 24 Feb 2020

Future-proofing their portfolios has been racing up investors’ agendas since the Bank of England Governor Mark Carney’s 2015 landmark speech Breaking the tragedy of the horizon.

He categorised three risks from global warming: physical, such as damage to property or business disruption from extreme weather events; transition, such as a huge drop in the economic worth of fossil fuels with the rise of renewable energy; and litigation, such as lawsuits against carbon emitters for inflicting damage on the natural environment.

No wonder investors have flocked to green funds in their droves.

The Taskforce on Climate-related Financial Disclosures was formed by the International Financial Stability Board in an attempt to improve transparency around climate risks so as to enable markets to price them more accurately.

While progress on creating the necessary infrastructure of data, skills and technology has been exponential, huge gaps and inconsistencies persist.

Lately, I have been talking to some large institutional investors who have been early adopters of green funds. For them, the lack of a robust framework for assessing climate risks, with consistent definitions and reliable data, remains a major barrier.

Trying to spot companies who are reducing their carbon footprint is proving daunting for them, especially with the inevitable double counting of the carbon emission in their supply chain. Data from different vendors on the same companies differ, in some cases by a factor of 20.

The picture is further clouded by the uncertainty around carbon pricing. Transition towards a low-carbon future will require fossil fuel prices to rise substantially, if the targets set by the Paris Agreement are to be met.

Currently, prices are moving at a snail’s pace, leaving investors wondering whether draconian rises will be inevitable and, if so, when. With its many moving parts, climate change remains an inexact science for investors.

I have illustrated the resulting challenges via a case study in my article in today’s FTfm (24th February 2020), which you can access if you have a subscription. It shows that, given the severity of climate risks, institutional investors believe they can’t afford to wait for the data to become more reliable. Some are rapidly building credible in-house capabilities that could give them an information edge; others are intensifying pressure on data vendors for step improvements.

These collective efforts will ensure that data issues will be in the rear-view mirror before long.


When technology runs like a hare, can fund managers afford to crawl like a tortoise?
Mon, 27 Jan 2020

2016 ushered in an age of techno-utopianism when a computer algorithm called AlphaGo made history.

It beat the 18-time world champion of Go, a fiendishly complicated ancient Chinese board game with an astonishing 10170 possible moves – more than the total number of atoms in the entire universe.

It provides stunning evidence of the leap from the traditional algorithms that carry out routine instructions to the era of cognitive computing: systems that work and learn like human brains as they crunch vast amounts of structured and unstructured data; not to mention blockchain, which will cause massive disintermediation in all businesses.

Fund management is especially amenable to such revolutionary advances. Data is its lifeblood and intermediaries cause all manner of information asymmetries across its entire value chain. But their adoption so far has been a matter of more haste, less speed. The reasons are legacy IT systems, legacy thinking, day-to-day pressures, high margins and low risk appetite in corporate culture.

As the new decade unfolds, this dynamic is set to reverse – due to two underlying structural catalysts that are already reshaping the fund industry beneath the surface of today’s euphoric markets, which are far removed from their fundamentals.

First, the fund industry desperately needs organic growth. One of its largest client segments – defined benefit plans – is advancing rapidly into the run-off phase with aging demographics. In the 2010s, as much as 85% of growth in global AuM came from markets that were artificially boosted by central bank largesse that brought forward future returns. The next bear market may well be very painful when it comes.

So, finding the new generation of long-term clients is vital. In this context, the rise of Millennials as a distinct investor group could have a profound impact. As an Internet generation, they haven’t known the world without technology. E-commerce is in their DNA.

Many among them stand to be the beneficiaries of the biggest wealth transfer in history – from their baby boomer parents, the richest generation in history. Their ranks will be swollen by women investors, who now own a rising share of global wealth. These newly emerging clients will have different risk profiles and product needs.

The second reason behind the faster rise of AI is alpha–beta separation becoming more pronounced. Many among the new generation of investors will want to manage their own retirement planning, while expecting strong digital client experience that is on a par with what they are accustomed to in other sectors.

They will want to see a clear line of sight between fees and returns. Managers without a meritocratic fee structure are in for a hard time. Active or passive funds will no longer be theological concepts. Everything will boil down to price and value-for-money.

Fund managers thus face two daunting challenges as they plan for the new decade: how to grow the business organically by shrinking its cost base; and how to adapt to accelerating innovations that are so disruptive in their impact.

Those who can rise to the challenges are assured a place in a vibrant industry where technology-driven operating leverage will be a key differentiator. The rest will become unwitting victims of new Darwinian forces that will reshape their industry – if the examples of the retail, media and music industries are any guide.

If you are interested in the implications for fund managers’ business models, please see my article in today’s FTfm (27th January 2020).


Shareholder engagement 2.0
Mon, 09 Dec 2019

The idea that companies that are rated high on a myriad of ESG metrics will deliver superior investment returns has long lost its currency. The key issue now is how far ESG considerations are pertinent to a company’s business performance.

Materiality, as an investment concept, has thus come to the fore with the rapid rise in global assets flowing into ESG investing over the past three years.

This is because robust templates, consistent definitions and reliable data are still evolving. As a result, institutional investors are now treating engagement with their investee companies as a catalyst for change on the ground.

Hitherto, engagement was often merely a tick-box exercise for compliance experts. However, two high-profile corporate disasters in the US in this decade have proved a turning point: BP’s Deep Horizon oil spill in the Gulf of Mexico in 2010 and Volkswagen’s emission-cheating scandal in 2014.

In both cases, their shareholders were branded as financial bandits with no regard for their social or ethical responsibilities. They were deemed to have failed to exercise their ‘duty of care’ in minimising negative externalities that often result from day-to-day corporate activities that inflict uncompensated costs on wider society, while also exposing wrong-doers to existential risks.

The emerging model of engagement seeks to future-proof investee companies by identifying and mitigating all manner of risks – especially sustainability risks. The new model relies on a year-round dialogue with investee companies beyond shareholder meetings on issues that impact on long-term value creation.

Specifically, engagement seeks to re-emphasise the core purpose of financial markets in channelling capital to growing businesses and ensuring that their operations impose least harm on the environment.

The key aim is to deliver businesses of enduring value – for their shareholders, employees and society.

More information can be found in my article in today’s FTfm (9th December 2019).




A trifurcation in the asset industry
Mon, 04 Nov 2019

A growing number of institutional investors are switching to alternative risk premia: a systematic rules-based style of investing used by hedge fund managers for the past three decades.

Under it, asset classes can be broken down into factors that explain their risk, return and correlation. Factor investing gained traction after traditional diversification became unhinged during the 2008-09 market meltdown, when it was most needed.

Since then, the rise of smart-beta strategies marks a big departure, as investors have sought to remodel their portfolios by allocating assets to risk factors such as value, size, momentum, market, low volatility, term and credit.

Smart beta is part of a new generation of strategy – alternative risk premia – that blends risk factors with techniques such as shorting and leverage.

Research shows that a high contribution to today’s market-beating returns comes from simple systematic exposure — conscious or unconscious — to these or other factors.

ARP is coming of age and causing a trifurcation in the asset industry.

First, the rise in pure passive investing, based on traditional cap-weighted indices, will slow down, as ever more investors are enticed by the prospect of earning cheap alpha returns at near-beta fees. Lately, traditional passives have disrupted traditional actives. Now the disrupters face the prospect of being disrupted themselves.

Second, ARP will not dumb down the craft of investing. Portfolio managers will still need to make judgment calls on which factors to select and which data to apply. After all, factors can become overvalued as they attract new money and hit the capacity ceiling above a certain level of assets.

Third, the term alpha will be refined into two distinct versions: the commoditised one will refer to market-beating returns that are increasingly targeted by ARP; and the informational version will seek to beat its commoditised rival by solely relying on managerial skills and proprietary research.

In a typical portfolio, these two versions will compete alongside traditional cap-weighted indices. At a time when fees are under pressure, price competition will intensify.

Active managers who fail to deliver more than commoditised alpha will be hit by the brutal Darwinian forces sweeping away the distinctions between passives and actives.

More information can be found in my article in today’s FTfm (4th November 2019), if you are a subscriber.


India’s premature maturity
Mon, 07 Oct 2019

Remember BRIC?

If not, you’re not the only one. In hindsight, it seems like a big marketing ploy.

The acronym was coined in the last decade to highlight the rise of four awakening giants – Brazil, Russia, India and China – destined to dominate the global economy by the end of this decade.

They have grown, for sure, especially China and India. But, in the process, growth has laid bare embedded problems. These are creating a jagged transition in their growth trajectories.

China is caught in a tit-for-tat tariff dispute with the US that is escalating into a technological arms race and a beggar-thy-neighbour currency war.

Russia is reeling under Western sanctions. Brazil is mired in a massive corruption scandal.

For its part, India has lot going for it. Growth, at a healthy clip of 7% in recent years, looks impressive. Yet, problems continue to dog its economic model.

One of them is crony capitalism under which corruption dominates political and business life. The infamous “licence Raj” under which politicians and their officials sold trading permits for personal gains is alive and well on the ground, despite high-level initiatives.

The other problem is corporate governance. Listed companies tend to be large family-owned businesses where the dividing line between ownership and management remains blurred. Family takes precedence over shareholders.

The most worrying problem, however, has centred on the veracity of official data on key variables like gross domestic product and unemployment. The former chief economic adviser to the prime minister, no less, has publicly voiced his concerns.

Growth has generated new wealth, which has found its way into mutual funds at a rate that will turn India into a key source of new funds in the next decade.

But it will not be a destination for funds from the West, unless it takes big strides towards cleaning up its political and business culture.

Rapid growth has caught the attention of yield-hungry foreign investors. But they don’t like what they see under the bonnet.

If you are interested in more details, and are a subscriber to the FT, please see my article in today’s FTfm (7th October 2019).




The greenwashing cloud has a silver lining
Mon, 09 Sep 2019

Being ‘green’ is simple but not easy.

An outstanding investment phenomenon of this decade is the sky-rocketing popularity of investment funds that embed environmental, social and governance principles.

Its speed and scale have, in turn, exposed a major faultline: there is no widely accepted definition of what constitutes ‘good’ corporate behaviours consistent with the principles.

The available definitions are invariably based on value judgement. As a result, data providers adopt diverse criteria to such an extent that it has conspired against a standardised reporting framework.

Such ambiguity has played into the hands of asset managers seeking to burnish their ESG credentials by ‘greenwashing’: respraying the old products ‘green’.

Under the resulting regulatory crackdown, such funds have lost market share in Europe lately, according to data from the Global Sustainable Investment Alliance, an advocacy group. The share has declined from 53% in 2016 to 49% in 2019.

The burden of proof is shifting: end-investors are becoming aware that product labels can be misleading. Talking the talk is one thing; walking the walk quite another. Their asset managers are being forced to address many difficult issues hitherto pushed under the carpet.

First, what criteria should their portfolio managers use if a company is strong on governance and less so on society and environment?  What weights should be accorded to these disparate individual components?

Second, should a company be avoided if it has any revenue derived from, say, defence or fossil fuels?  In these and other examples on the exclusion list, what threshold is high enough before a company is deemed ‘bad’?  What if the company has other activities that are viewed as beneficial from its exemplary practices on, for example, workforce diversity and community involvement?

In this context, the EU’s latest action plan goes a long way towards creating what it calls ‘sustainable taxonomy’ that offers guidance on what constitutes ESG-friendly activities and how to seek out reliable data.

Just as importantly, a consensus is emerging that ESG investing should not solely focus on ethical screening. It should also fast forward the transition towards meeting the UN’s 17 Sustainable Development Goals by promoting the required innovations.

The purist approach that characterised ESG investing in the last decade via sifting out ‘sin’ stocks is being augmented by hard-nosed pragmatism. This, in the belief that ESG investing is an inexact science. And will always remain so.  As investors and their managers progress up the learning curve, greenwashing can be minimised, but not eliminated.

For more details, please see my piece on the subject in today’s FTfm (9th September 2019).


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