Archive for June, 2011

Deep Thoughts By Leo de Bever

Ashby Monk

Alberta Investment Management Corp. CEO Leo de Bever is one of the most respected investors in the world. He built AIMCo into the world-class institutional investor that it is today. And, lucky for us, he gave Reuters some priceless nuggets of wisdom yesterday that I think earn him a “deep thoughts” post. Without further ado, here is Leo:

On how to make money in global infrastructure markets:

“The only way you’re going to make money is when you identify what we call here opportunities between the cracks — things that don’t look straight down the road as core real estate, or core infrastructure, or core anything,”

On his preference to do infrastructure deals in Latam over Asia:

“I can’t get my mind around investing in infrastructure in China, the chaos in India I don’t quite know how to make sense of…But then we look at Chile and I can figure it out. We’ve also been looking at Brazil.”

On the potential for a private infrastructure market in the USA:

“My guess is that it will take another one or two blackouts before people finally say ‘OK, we get the story. We’re going to have to spend some money there and we’re going to have to make some approvals for capital to go in there’.”

On being an independent investor:

“I’m not very much into testosterone. I will do good deals myself if I can find them and I won’t do them unless the conditions are right.”

Airplane Reading

Ashby Monk

I’m off to Washington, DC for the APEC Infrastructure Investment Workshop at the World Bank tomorrow and Thursday. I’ll be talking about some of the constraints limiting institutional investors’ interest in infrastructure as an investment opportunity. And I’ll be discussing innovative vehicles to facilitate access to the asset class. Anyway, that’s what I’m up to this week; it should be a lot of fun. But, first, it’s time to get on another airplane. So that means finding something to read.

For this flight, I decided to bring some research on the investment mandate decision-making of institutional investors. In other words, I’m interested in understanding  some of the nuanced factors driving the hiring and firing of asset managers by large asset owners. And I’m also interested in the results of these decisions. The following two papers look like they may fit the bill.

First, Christopher R. Knittel, John J. Neumann and Scott Stewart have a paper entitled “Why do Institutional Plan Sponsors Fire Their Investment Managers?” Here’s a blurb:

“…while institutional investors consider investment style in evaluating product performance, the degree of style exposure is not considered. This raises the possibility of gaming by the fund managers, who are aware of their ability to manage their level of style exposure and that they are not being held accountable for this risk when evaluated by plan sponsors.”

Second, Amit Goyal and Sunil Wahal have a paper entitled “The Selection and Termination of Investment Management Firms by Plan Sponsors.” Here’s a blurb:

“Plan sponsors frequently, but not always, terminate investment managers after underperformance, but the excess returns of these managers after being fired are frequently positive. Using a matched sample of firing and hiring decisions, we find that if plan sponsors had stayed with fired investment managers, their excess returns would be larger than those actually delivered by newly hired managers.”

Anyway, if there’s any great insights, I’ll share. In the meantime, we’re boarding…

These Returns Are for Locals Only!

Ashby Monk

Why am I bullish on the Russia-Direct Investment Fund? And why have I been extolling the potential benefits of SWF collaboration for years? Because the efficient markets hypothesis is flawed, and informational asymmetries that local investors have over non-locals generate additional returns for the locals. In short, when looking in foreign markets, if you can find some savvy locals to co-invest with then chances are you can make some good money. How can I be so sure? Because these three seminal papers say so:

  • Coval and Moskowitz show that fund managers in the US will earn an additional return of 2.65% per year from local investments compared to nonlocal investments.
  • Ivkovic and Weisbenner show that individual investors generate additional returns of 3.2% per year from local investments compared to nonlocal holdings.
  • Malloy shows that geographically proximate financial analysts possess informational advantages over other analysts, which translate into more accurate forecasts.

Basically, these papers are saying that foreign investors and analysts have less information than local investors and analysts and therefore perform poorly relative to their local counterparts. Non-random walkers rejoice!

Significantly, the benefits of local-to-local investing are most pronounced when the target firm is small, young, risky and with high levels of R&D. On the flip side, research also shows that local advantages are diminished when the quality of disclosure increases. So when information is hard to come by, the benefits accrue to the local.

This suggests to me that local advantages will be particularly pronounced in private equity investments (especially those at the growth stage). Indeed, so long as the SWFs do not over-invest in their back yard (i.e., allocate assets for domestic investments beyond the country’s share of global GDP) or fall victim to governance breakdowns, local private equity investments could be very attractive.

Conversely, if you’re a SWF looking to a foreign jurisdictions for PE investments, your first step should probably be to find some smart locals that will co-invest with you (e.g., the RDIF).

Long-Term Positioning for Environmental Risks

Ashby Monk

I work at Oxford University’s School of Geography and the EnvironmentI also work at Stanford University’s School of Civil and Environmental Engineering. I co-founded the environmental club at my high school. (We started the school’s recycling program, cleaned up a few local beaches and sold some T-shirts with endangered animals on the front; high-impact stuff.) So I think I know a thing or two about environmental issues. I don’t drive a Prius, but I’m kinda legit on the eco-front.

As such, I think I am within my abilities to say that the views expressed by a certain SWF boss this week about the role of carbon dioxide in climate change probably would not be characterized as ‘mainstream’. (In fact, I received a few emails that characterized this person’s views in far more colorful terms, but since this is a family show I’ll spare you the details).

Now, everybody’s got a right to his or her opinion. And I have no interest in getting into a debate about carbon’s role in climate change. But this individual’s comments do actually present a nice opportunity to talk through how other bosses of institutional investors are thinking about carbon, climate change and how they might position their funds to manage the associated risks over the long term. And, coincidentally, a small group of fringe institutional investors got together earlier this year to explicitly examine carbon and climate change and its implications for their funds’ long-term strategic asset allocation.

Sorry, did I say small and fringe? I meant to say the biggest funds in the world; the group consisted of APG, AP1, CalPERS, CalSTRS, GIC, GPF-G, OMERS, OzSuper, PGGM…you get the idea. These heavyweights got together with Mercer under the assumption that, in the words of Nicholas Stern, they were facing “the greatest market failure the world has seen.” And, lucky for us, this group published a report outlining their findings entitled “Climate Change Scenarios – Implications for Strategic Asset Allocation.” (Here’s a direct link to the PDF.) And here’s a blurb:

“It is widely acknowledged that climate change will have a broad-ranging impact on economies and financial markets over the coming decades. This report analyses the extent of that impact on institutional investment portfolios and identifies a series of pragmatic steps for institutional investors to consider, including allocation to climate-sensitive assets and the adoption of an “early warning” risk management process.”

Personally, I thought this was a really interesting and insightful report. It goes through asset class by asset class and talks about the risks and potential impacts on investment returns from climate change. In other words, it’s written for investment professionals by investment professionals. I think it’ll make perfect reading for a hot summer weekend…

Top Ten Tweets

Ashby Monk

Here they are: Your top news items from the past week’s @sovereignfund Twitter feed:

  1. CIC to name new CIO: Li Keping. He’s currently vice chairman of the $130bil NSSF. Apparently, Gao Xiqing will remain Pres.
  2. Israel will start investing forex reserves abroad.
  3. Will CIC be the first foreign fund to invest in Russia’s new RDIF? Seems increasingly likely.
  4. KIC’s Kalb: “The fee budget we have got now in terms of our external mandates is completely focused on active alpha.”
  5. Qatar Investment Authority has some big recruitment plans. Looking for a job in Doha?
  6. Vice governor of the People’s Bank of China: ‘We should use reserves to purchase energy assets of strategic importance.’
  7. BlackRock latest asset manager to bolster SWF ops.
  8. The APF’s very innovative CIO Jeff Scott is leaving APF. Joining Wurts and Associates.
  9. Will Norway’s SWF start investing in infrastructure? Due to personnel change at MoF, it’s more likely than ever!
  10. Norway’s NBIM tells its portfolio companies to do more to prevent child labor.

Norway’s SWF About To Get Aggressive?

Ashby Monk

I’ve given Norway’s SWF a bit of a hard time over the past few years for not taking more advantage of its long-term time horizon. My view is that the largest SWF in world (which claims to have an “infinite” time horizon) should be able to make very solid returns in the world of illiquid assets. However, to date, the fund has been (overly) conservative, preferring traditional asset mixes and ignoring illiquid assets, such as private equity and infrastructure.

Well hold onto your hat, people; that’s all about to change!

Bloomberg is reporting that former central bank governor Svein Gjedrem will replace Tore Eriksen as chief advisor to the MoF on the oil fund’s investment rules. Why is that a big deal, you ask? Because Eriksen was hyper conservative about investment policy. He was, a least to a certain extent, the man behind the fund’s conservative investment approach. Here’s a recent quote from Eriksen:

“…with a big fund there are a lot of management challenges and the more complicated we make the fund the more complicated the management will be…It’s much more complicated to invest in properties, in infrastructure than in equity and bonds, which you can buy every day on every market.”

Ugh. OK. Yes, Mr. Eriksen, what you say is technically true; investing in infrastructure is more complicated than buying a stock on the exchange. Buuuuut, with over $570 billion in assets under management, I’m pretty sure you could find the resources to deal with these new complexities. Think of it as an investment in the organization that will pay dividends in the long run. Parking half a trillion dollars in short-term, volatile, liquid securities is not always preferable to investing in real assets. Trust me.

Anyway, Gjedrem is a totally different type of player. In fact, while he was running Norges Bank, he was pushing Eriksen to let NBIM expand into more illiquid assets. So now that Gjedrem has Eriksen’s job, things are most assuredly going to change. How can I be so sure? Read this blurb taken from a letter Gjedrem wrote to the MoF while at the central bank:

“We [have] recommended that the fund’s investment universe should be expanded to include less liquid investments in private equity and infrastructure, as well as real estate…Investments in real estate and infrastructure confer direct ownership of real assets and an expected return in the form of stable, inflation-adjusted cash flows. This inflation adjustment comes from the periodic income from these investments often being linked to movements in inflation. An increase in this type of real asset in the portfolio should be aimed at, because this can help reduce uncertainty about developments in the fund’s international purchasing power…The fund is well-suited to bearing the risk and harvesting potential gains from investments in less liquid assets, as the fund does not have short-term liquidity needs. Nor is the fund subject to rules that could require adjustments to the portfolio at inopportune times…Investments in traditional infrastructure projects would, in portfolio terms, be expected to contribute stable, inflation-adjusted cash flows and so help safeguard the fund’s long-term international purchasing power. Any investments in infrastructure would consequently be part of the asset class of other real assets.”

That’s music to my ears. Here’s hoping Norway’s fund gets a bit more aggressive in the coming years.

From ‘Risk Allocations’ To ‘Risk Organizations’

Ashby Monk

Risk factor based asset allocation strategies are, as I’ve previously noted, increasingly common among institutional investors. A growing number of funds have adopted (or are in the process of adopting) allocation policies that discount traditional asset classes and instead focus on the underlying risk factors within the assets. Why? Traditional allocations based on equities, bonds, and alternatives provide little surety of diversification in terms of the underlying factors that actually drive returns. (Still lost? Go read this.) Some funds, such as ATP, got there years ago, while others, such as CalPERS, found the motivation to innovate in the depths of the financial crisis (note: the Californian giant lost $100 billion in 18 months). In all cases, however, the ‘risk model’ is popping up all over the world, from the APF to the KIC to the NZSF to the NBIM.

This then begs a rather important question: What will this new approach to asset allocation, and indeed institutional investment, imply for the organization and operation (i.e., behavior) of these funds? I guess what I’m wondering is whether we should expect institutional investors to begin hiring analysts and investment professionals into new groups focused on risks, such as a ‘credit group’, a ‘growth group’, an ‘inflation group’, etc? Or will they start giving mandates to “liquidity managers” or “interest rate managers”? Just as an investment bank has product groups (e.g., M&A, leveraged finance, and restructuring) and industry groups (FIG, TMT, Healthcare, Consumer, Energy, Real Estate, etc.), will institutional investors end up having asset groups and risk groups? Or will these investors end up dumping their asset groups altogether? It’s conceivable that this new way of thinking about allocation and diversification could translate into a complete overhaul of the design of institutional investors!

But…not yet. Why? Well, it’s called “path dependence”. At this point, re-organizing everybody would be much more costly than just tweaking things internally so as to hold onto the notion of risk, while still operating within traditional asset classes. The legacy institutions make innovation within many funds practically impossible. (Consider the challenge for a public fund that has a workforce with 80-90% unionized employees.)  In these cases, the only way to innovate is to do so externally or, gasp, to get even bigger.

And that’s what one fund I’ve been talking to has done. This large fund decided to set up a new committee made up of all senior investment staff (i.e., group heads and the CIO) to, in effect, translate the old asset allocation framework (guiding operations within the investment groups) into the new risk framework (for the purpose of asset allocation at the Board level). So, for this fund at least, implementing a ‘risk-based allocation’ has required a new “translation committee” to relay the demands of the board (in terms of risk) to the investment staff (in terms of assets).

It’s definitely not what we’d design on a blank piece of paper, but, given the existing commitments and institutions, it’ll work.


This website is a project of Professor Gordon L. Clark and Dr. Ashby Monk of the School of Geography and the Environment at the University of Oxford. Their research on sovereign wealth funds is funded by the Leverhulme Trust and The Rotman International Centre for Pension Management.

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