In April 2016, John Stopford, Head of Multi-Asset Income at Investec Asset Management, met with Dale MacMaster, chief investment officer at the Alberta Investment Management Corporation (AIMCo). AIMCo is a crown corporation (previously a government department) which manages over C$90 billion for 26 Canadian public-sector pension, endowment and government funds. John spoke about how AIMCo is changing its portfolio strategy to address a low-return world. Dale has been with AIMCo for 18 years.
- Dale MacMaster, Chief Investment Officer at the Alberta Investment Management Corporation (AIMCo)
- John Stopford, Head of Multi-Asset Income at Investec Asset Management
Dale MacMaster: The two biggest challenges today are low-to-negative interest rates and low growth. It’s a real dilemma for pensions that have traditionally had as much 50% fixed income. Fortunately, our clients have been moving away from fixed income for some time, many into illiquid asset. Infrastructure looks attractive if the alternative is negative interest rates, despite the liquidity and credit risk that come with that.
John Stopford: How do your clients describe a mandate to you? What kind of objectives are they setting you?
Dale MacMaster: In essence, we’re an asset manager with 26 clients. They present us with an asset mix and ask us to deliver beta at the lowest possible cost, then add value over that. We’re aiming for top-quartile performance with bottom quartile fees and risk. We can’t control the absolute returns since we’re given wide ranging asset mixes, yet we have delivered 10-12% for the last seven years.
The last 7-8 years of double-digit returns have restored our clients’ pension funding to between 90% and 95% and they’re generally pleased with that. However, they’re concerned about the potential for another huge equity market correction. We’ve have seen three 50% corrections in equities in the last 15 years – the credit crisis in 2008, the tech bubble in 2001 and the 1998 Asian currency crisis. They’re trying to figure out how to immunise themselves from another crisis like those.
A lot of the opportunities today are in alternative asset classes. Many investors are constrained by rules and regulations, but we have the freedom to invest across the spectrum to deliver absolute returns and immunise our clients from equity risk.
John Stopford: How do you integrate that into beta requirements that clients have?
Dale MacMaster: We’ve put together a pool of hedge funds that are uncorrelated with our other assets. These include credit, multi-strategy, life settlements, volatility, reinsurance and catastrophe reinsurance. We’re looking for absolute return, overlaid with passive equity to delivery beta plus 4-7%. We’ve done that consistently with a stable of long-standing hedge funds.
We actually purchased a hedge fund in New York that specialise in collateralised loan obligations. We now have a dedicated platform to provide that at reduced cost. By lending our name to the firm, it can also attract third-party assets and grow. This allows us to generate attractive returns at a low cost by buying firms that give us access to certain marketplace niches. We have done this in a couple of other places and I think there’s room for more of that. Despite our size and growth rate, Alberta is not a financial centre. It’s difficult to attract people here. Buying niche firms gives us efficient access to a pipeline of niche product.
John Stopford: You mentioned private markets. How much of your personnel resource is geared towards that now? Has that evolved over time? What challenges you’re managing on behalf of long-term institutions? How do you factor liquidity and illiquidity into your investment return thinking and manage it over time.
Dale MacMaster: Pension and endowment funds need very little liquidity and that’s one of our advantages. We’re long-term, evaluating illiquid private market securities over 15, 20, 25 years. There’s no call on that capital. Private equity firms rollover those funds every five or six years, but we don't which gives us a great advantage.
Volatility and illiquidity are linked with the regulatory changes in banks, capital requirements, liquidity requirements, Dodd Frank, banks exiting businesses and not allocating capital in the same way. Portfolio managers need to rethink the way they look at their portfolio. We found that the perceived liquidity we thought was in middle market assets (ranging from highly liquid sovereign government bonds to less liquid higher yielding bonds) really doesn’t exist. Instead, why not barbell a portfolio of completely liquid securities and then completely illiquid securities? In other words, should we pay for non-existent liquidity?
The other trend has been ETFs, which people perceive as liquid, but they entail hidden cost. If you look at recent market corrections, ETF prices unhitched from their underlying NAV. If investors demand liquidity when the market is illiquid, there’s going to be a price to pay. We see this as an opportunity for pension funds to step in.
John Stopford: Are you finding enough things where you think you are being compensated for being insensitive to that liquidity? Are you being paid a premium return on those kinds of assets?
Dale MacMaster: Yes, definitely. We have completely restructured our portfolio to a culmination of highly illiquid securities and then private debt, levered loans, private mortgages, structured credit. We have also found opportunities to enter businesses that the banks are looking to partner with, for example trade receivables, supply chain financing, warehousing of mortgages, commercial mortgages. All of these pay an illiquidity premium.
John Stopford: With yields in the safest parts of the capital market decimated and growth harder to come by, is it your sense that expected returns are being eroded or are there still opportunities out there?
Dale MacMaster: I’ve been saying for a few years that returns are going to be lower. You have rates at 1 or 2% for a large portion of fixed income assets. We have been telling clients the last few years to expect lower returns. The market does present opportunities, but you have to be tactical.
John Stopford: You mentioned catastrophe bonds, which are a function of the reinsurance cycle which goes through ups and downs ...
Dale MacMaster: We don't consider ourselves catastrophe insurance experts, so a specialist reinsurer manages that for us. Once a hurricane hits the price spikes and then collapses. They’re the experts at playing that cycle and it has delivered a solid return for us that is not well-correlated with our other assets.
John Stopford: What is more valuable to you, the return or its ability to diversify risk? What do you find harder to find, a decent return or a less-correlated position?
Dale MacMaster: Our portfolio is not close to its active risk limit, leaving us plenty of flexibility to add more risk. Over the last few years we have earned a very high return with a low level of active risk. Our information ratios were quite high and I think one of the dynamics that worked is minimum variance.
We’ve had a portfolio that has 65% of the benchmark risk, yet outperformed it and that’s not sustainable. On performance measurement we’ve moved to a sort of absolute return benchmark CPI plus 450 or 650 basis points. On the risk side we’re moving towards risk factors to emulate risk.
John Stopford: You mentioned portfolio barbelling earlier, having super-liquid and illiquid components. I guess some of that is linked to clients’ cash needs. But maybe it comes back to this idea of being be tactical, that if you don't have any liquidity in the portfolio, you can’t take advantage of opportunities that come along?
Dale MacMaster: Sure. We have made some changes to dealing in the new environment, creating lines of credit within asset classes, for example, or doing more repurchase agreements. We have created a liquidity desk which will globally manage our assets, our collateral, our margin, our liquidity. In the past each manager looked after for their own liquidity. Now we’re looking to maximise our illiquid exposure while still having enough liquidity to meet our requirements and exploit opportunities.
We’re pushing the envelope in terms of how illiquid we can be and still manage. I think we have had too much liquidity but we’re being paid adequately for it. We’re now being much more cautious and careful about wringing as much from a dollar as we can.
John Stopford: Public sector clients are increasingly thinking about things like ESG (environmental and social governance) issues and building it into processes and return expectations. How does that fit with the approach that you have taken?
Dale MacMaster: We built ESG into our thinking and investing very early. We were early signatories on UNPRI. We have a team that’s dedicated to responsible investing. We have put them under the CIO in order to embed it into the investment process. We have a ton of oversight in terms of having our own board. Our clients will have their own boards with their own consultants. The government is also overseeing us. AIMCo has a lot of oversight – Auditor-General audits and internal audit.
From a governance standpoint, we were always there, doing business the right way, to the right standard. Social environmental has come along as the world has evolved and we do have some restricted securities, like tobacco, but our model has been to engage. We would rather engage with the company, vote our proxies, meet with management to try and elicit change rather than abandon it.
Our responsible investing team is at the forefront of getting a better understanding of our carbon footprint, which has been front and centre with the Paris Treaty. We have even invested in software which allows us to rate companies on ESG scores, but it remains to be seen whether that has investing value. We believe in this and it’s important to our clients as well. We produce an annual responsible investing report that we distribute to our clients and it’s part of our quarterly reporting.
John Stopford: Communication with clients when there’s so much change and new opportunities must be quite a big challenge. I assume that at least some of the people you’re communicating with are manager trustees or not hugely sophisticated. How much of a challenge is bringing your clients along with you on this and convincing them that what you’re doing is appropriate?
Dale MacMaster: Indeed, our boards do consist of lay board members, like firemen, nurses or policemen. They also turnover every few years. Likewise, with changes in government and even within a government that’s sitting in-house, there could be changes in the finance minister on average every two years. It’s just something we have built into the model. It’s a never-ending challenge and we must educate constantly.
Some of our larger clients have employed a full-time investment expert to liaise with us. They come and meet with us to understand our strategies and then report back to their boards. This model has helped a great deal, but communication will always be a challenge.
John Stopford: I’m guessing they don't ask as many hard questions when the performance is good? The time that’s more challenging is perhaps when the performance background is less favourable-
Dale MacMaster: That’s quite right, but the other challenge, is that they have a lot to do besides overseeing us. They have got so much other work to do worrying about liability and funding levels that they don't have much time to spend on investing. That’s why we run lunches and breakfasts covering one of our asset classes. We also run an annual symposium where we invite our clients to spend a full day off-site, much like an investment conference. We work hard at it but it’s a never-ending challenge.
John Stopford: You mentioned performance has been good but you have got some concerns about equity beta. How often do clients review the objectives that they set for you? Is that something that is slow-moving or do they change those quickly?
Dale MacMaster: It seems that with 26 clients and a number of pension funds, you’re in a perpetual state of studying their asset liability picture. Completing an RFP, hiring a consultant, reviewing the asset mix against the liabilities, coming out with a new mix, informing us and implementing it takes time. It seems like by the time we finish implementing the change, the process starts over.
There’s a tendency to get caught up in the latest fad that comes and goes, like commodities, small cap or emerging markets. Currently it’s minimum volatility. Pension funds should try not to over-think it. If you’re putting an asset mix together versus long-term liabilities, you have to let it run long-term and resist the tendency to tweak it. Thankfully, our clients give us wide tolerances within that asset mix so we’re not too constrained. We have also relaxed the buckets if you will. Ten years ago, it was like a cafeteria with this long menu that they could choose from, like small cap, emerging markets, large cap, value and growth. Today it’s just broadly equities and fixed income.
John Stopford: Is that a function of just having long-term, established relationships and delivering for clients? They trust you more and give you greater latitude?
Dale MacMaster: Definitely. When we delivered the results, they felt more comfortable, allowing us to select the strategies, but they still need good reporting and transparency. Our Global Equities bucket might include 60 different strategies that we’re tactically moving around. They want to see what we’re doing and have comprehensive attribution.
John Stopford: Can you outline one or two opportunities that you see today, along with a couple things that keep you up at night?
Dale MacMaster: We currently find infrastructure very attractive. After many years of government saying it wants to invest in infrastructure, it looks like it’s going to happen. There’s a need for infrastructure all around the world and we have capital. We should find a way to marry these up in a way that’s mutually beneficial. The Alberta government intends to build infrastructure and create jobs at a point where the economy is weak. You run a deficit, you build the infrastructure, take the opportunity when the costs are low, the labour is available. Marry that up with the pension clients’ need for the asset and everyone could win.
We also think there could be opportunities in private equity. Years ago we saw the Japanese diversify into other assets like the purchase of Pebble Beach and Rockefeller Centre. The Chinese follow that example. There’s trillions of dollars of capital and we expect to see this capital move into Europe and North America. This may lift valuations across private equity and perhaps real estate.
Risk wise, I’m not too concerned in the short term, but medium term I’m worried about low growth and interest rate normalisation. Some investors have taken on more risk than they understand, but they have been rewarded for it, reinforcing that behaviour. Every time you leverage yourself up to buy another asset – equity, real estate, infrastructure among others – there’s been trouble. Previously, monetary policies have come to the rescue and created another risk-on environment. At some point that will stop. Investors think they will be able to get out before everybody else. It could be ugly and investors are going to need liquidity and shouldn’t extend themselves too far. So we’re slightly overweight equities but nowhere near where we might be.Ritorna a Investment Institute