Big pension and sovereign wealth funds around the world are still sweating the possibility of a global recession, according to the Official Monetary and Financial Institutions Forum (OMFIF), while inflation fears haven’t been dispelled even as it eases in many developed economies.
Meanwhile, geopolitics, technological change and climate change are the top three influences for longer-term investment approaches – and funds are split on how to react.
“Global public funds are adopting various investment approaches to address these challenges,” OMFIF says in its 2023 Global Public Pensions report. “Some have opted for a more patient approach, tolerating losses in the short term as they anticipate that inflation and interest rates will come down and that valuations in traditional asset classes will recoup.
“As one survey respondent explained, ‘In our strategy, a large allocation goes to capital preservation assets such as government bonds. For the rest, we try to optimise risk/return, but we do not have a specific target return.’ This reflects the ‘wait-and-see’ approach taken by many funds.”
But not everybody is willing to sit back and see what happens. Singapore’s GIC and Australia’s Future Fund are both switching things up, with the former adopting a more granular total portfolio approach and the latter taking a more active approach to investing as the strong beta returns seen over the last decade seem to be drying up.
“We have focused on creating liquidity and flexibility across the portfolio to ensure we are able to direct capital to opportunities in a quickly changing macro environment,” Craig Thorburn, director of research and insights at the Future Fund, wrote in the report.
“This has included increasing the amount of developed market currency we hold, reducing our foreign exchange hedging requirement and increasing the amount of domestic assets in the portfolio. We have also expanded the remit of our treasury management function to include flexibility management to allow us to harvest more investment opportunities when they arise.”
The Future Fund has also refined its dynamic asset allocation process and governance to preserve flexibility and capture mispricing opportunities in liquid markets; built a “meaningful” exposure to commodities; and reduced its exposure to hedge funds that are challenged by the new environment and replaced them with ones that are “truly diversifying and generate liquidity”. All up, the changes effected more than $60 billion of assets across the year.
“The investment market remains highly uncertain,” Thorburn said. “This creates challenges as well as opportunities for investors. Leaning into our joined-up, whole-of-portfolio approach will stand us in good stead as we evolve our portfolio in response to the changing macro environment.”
While GIC was less specific in how it had changed up its portfolio – it’s considering “both alpha and beta return drivers” and wants to “build resilience in the total portfolio” – it shares the Future Fund’s view that the world is becoming less predictable and that big investors will have to adapt their approach. Decarbonisation, geoeconomic fragmentation and the rise of artificial intelligence will all define the longer-term macro environment.
“These three factors point to a world that is likely to feature more shocks to supply relative to the pre-pandemic period, which was widely dubbed the ‘Great Moderation’,” Prakash Kannan, GIC chief economist and director of economics & investment strategy and Mark Tan, head of macro research, wrote in the report.
“A world with more supply shocks might see shorter cycles as central banks will need to be more active in trying to achieve their inflation targets from above rather than from below. Higher macro volatility for financial markets will lead to higher risk premiums being priced in, both in equities and bonds.”
Taking a wider view, plenty of respondents are still padding their portfolios with inflation-linked bonds, commodities and infrastructure, but there’s a renewed demand for risky asset classes; public equities are the asset class with the second highest demand, while a net 13 per cent of respondents expect to add to corporate bond holdings even after expectations of a net drawdown for both assets. There’s also lower net demand for private equity than in previous years, with 71 per cent sweating illiquidity and 57 per cent worried about valuations.
Clive Horwood, OMFIF deputy chief, says in the report that the public pension and sovereign fund market features a “remarkably even split” of assets between regions and a common challenge.
“Wherever these funds are located, and wherever they invest, they face a demanding period ahead,” Horwood says. “As one leading US pension fund said: ‘One thing is clear, the investment strategies that worked over the last ten years may likely not work the next ten years.’”
The OMFIF survey covers the top 50 funds in both the public pension and sovereign wealth sectors with collective assets under management of almost US$26 trillion. With US$43 billion under management as at last year, the NZ Superannuation Fund ranks at 42 on the OMFIF list of the 50 largest sovereign wealth funds.
Lachlan Maddock is editor Investor Strategy News (Australia)