Key takeaways:
- Investors are questioning long-held assumptions and investment norms amid regime change
- The pandemic and geopolitical volatility has prompted many to realise that risk can come from within. It’s time for schemes to rethink how they prepare for risk events
- Investors are responding by seeking to invest in a wider range of asset classes. The momentum seen in private markets is set to continue.
Even before the Covid-19 pandemic created existential questions for businesses, governments and society, some pension schemes saw a shift on the horizon.
Prior to 2020, interest rates were low and inflation in negative territory. At WTW’s recent Thinking Ahead Institute event which gathered pension fund leaders from around the world, one asset owner explained that they were already clear that the current regime was unsustainable.
“By the end of February 2020, our conclusion was: this is a catalyst for a lot of regime change,” he recalled.
At first, the scheme took half its team away from working on business as usual to look at the implications of the burgeoning regime change– by the end of the exercise, most of the organisation was involved. They established ten important shifts which were happening in the world, from geopolitics and the rise of populism to demographic change.
The scheme had such conviction in its findings that it changed how one billion dollars’ worth of its portfolio was invested. “It hasn’t always resulted in better outcomes for the period we’ve been in, but we feel more resilient and prepared,” said the same asset owner.
This pension scheme is far from alone in asking fundamental questions about the way we invest. Many investors are questioning long-held assumptions and investment norms amid regime change.
In 2020 Covid happened and very quickly, we formed the view that it wasn’t very important as a pandemic; as far as pandemics go, with a mortality rate of 1%, it wasn’t that significant. But it was a catalyst for a lot of other changes. Covid was more about policy decisions the government made, rather than the disease. Why would governments have the political courage to behave in a certain way? That was a more interesting question for us.
Asset owner participant
Investors are observing unprecedented stress on multiple fronts, from macroeconomic shifts, climate change and geopolitics to changes in long-held investment norms and frameworks.
In this three-part series, we’ll discuss some of the most important changes and what they mean for asset owners.
Risk in three dimensions
Investors are realising that they need to build a three-dimensional (3D) picture of risk and resilience. A number of crises in recent years have prompted this epiphany.
In the financial world, we used to think of systemic risk as exogenous, stemming from external factors like political volatility, climate change or demographic shifts. However, the financial crisis showed investors that risk can come from within.
The sheer degree of complexity investors face today is a risk factor in itself. Today, the world’s ecosystem is so interconnected that the ‘Great Acceleration’ in technology, demography, globalisation, the environment and social norms combine and multiply. This makes it far more challenging for investors to predict where the next big risk is likely to come from and how it will affect their portfolios.
We believe the emergence of systemic risk is of fundamental importance to the industry.
Andrea Caloisi, Associate Director, Thinking Ahead Institute
Responding to the Covid-19 pandemic, many investors swiftly adapted their operations. However, most realised that, despite their best efforts, they were underprepared for a large and multifaceted global emergency like a pandemic.
Andrea Caloisi, Associate Director at the Thinking Ahead Institute, summarised the challenge for investors. “We believe the emergence of systemic risk is of fundamental importance to the industry. There is no upside to systemic risk, there is only downside. Therefore, changes to the risk management framework are needed.”
The knowledge that investors need to be better prepared for multifaceted risk events has prompted them to realise that…
The 60/40 portfolio is dead
Investors are realising that they need to rethink portfolio construction. They are moving away from the traditional 60/40 equities/fixed income split, adding a wider range of alternative asset classes to their portfolios.
“The momentum we’ve had in private markets is set to continue,” noted Roger Urwin, Co-founder of the Thinking Ahead Institute. An upcoming report by the Institute will show that investors are accessing a wider range of asset classes than they have done historically, in search of diversification and a smoother path to risk-adjusted returns.
However, there are risks to large asset owners pursuing the same private markets trajectory, cautioned Urwin. “There is an execution challenge for [global asset owner] peers in terms of the macro consistency of all of them going in the same direction. Watch out for that.”
To manage the complexities associated with accessing a wider range of asset classes, pension schemes are increasingly bringing investment specialists in-house. Insourcing has been a trend over the last two decades; over half expect to insource more over the next five years.
Insourcing puts pressure on the traditional model of asset owners outsourcing to multiple external managers. The process requires careful management; “it takes a system to manage a system”.
Speaking at the Thinking Ahead Institute event, one large asset owner added their perspective. “There are conceptual advantages with private assets. You can get into smaller exposures you can’t access through listed assets. Time horizon is also important – listed markets often have a short term focus, whereas investing in private equity, you can have a much longer focus and add value.”
However, private assets do not come without hurdles, such as the risk of intergenerational inequity, the asset owner added. “Conceptually, I understand there are reasons why you might be able to achieve strong gains. The challenge is: who gets the benefits?”
This is one of three articles compiled from insights from the Thinking Ahead Institute events, Exchange+: TAI & Future Fund Global Asset Owner Peer Study symposium and summit on beliefs and best practices.