Sovereign wealth funds face similar challenges to many long-term investors in the current environment. But with very long-term investment horizons and little need for liquidity, they also have the ability to take advantage of opportunities that other investors cannot.
On the phone from Auckland, Adrian Orr, the Chairman of the International Forum of Sovereign Wealth Funds and the CEO of the New Zealand Superannuation Fund, talks to the Investment Institute about the challenges and opportunities currently facing these giant investors.
- Adrian Orr, the Chairman of the International Forum of Sovereign Wealth Funds and the Chief Executive Officer of the New Zealand Superannuation Fund
- Victoria Barbary, Director of Strategy and Communications at the International Forum of Sovereign Wealth Funds
In April, the Investment Institute spoke to Adrian Orr, Chairman of the International Forum of Sovereign Wealth Funds; Chief Executive Officer, New Zealand Superannuation Fund, about the challenges of allocating capital for the long term. They discussed stakeholder engagement, counter-cyclical investment strategies and how the relationships between investors and their managers are changing. They also discussed the opportunities presented to long-term investors by the current global imperative for sustainable development and the difficulties sovereign wealth funds face in an era of low oil prices, and how these might affect how they allocate capital.
What follows is an edited transcript of their conversation.
Investment Institute: How do you approach communicating the impact of the challenging investment environment to your stakeholders?
Adrian Orr: I think the hardest challenge facing any investor, including sovereign wealth funds, is communicating to your board, your team and especially the owners of the money, your stakeholders. People aren’t very good at thinking forward, thinking about the future state, their future selves and so we react so much to current news, current market volatility, current activities and, as we know, volatility often underlying it creates great opportunities. So globally at the moment it’s a real challenge across the sovereign wealth fund community to get stakeholders to focus truly on their long-term role in life and not get caught up by the short-term reportings of mark-to-market activities.
So at our board, we spend enormous amounts of time going back over what we call our investment beliefs and that is really the deep parameters, the things you have to hang on. When everything else is shaky, you hang onto these investment beliefs but you have to truly hold the belief and you have to be reminded of what those beliefs imply for your investment strategies. So if you can operate at that level and not get dragged down into short-termism, then sovereign wealth funds can start doing useful things – contrarian investing; liquidity provision; get involved in arbitrage strategies where illiquidity is creating unusual outcomes and actually be a seller of insurance rather than a buyer of insurance; get involved in distressed debt workouts and all of those types of activities that make the world a better place.
Investment Institute: Do you think sovereigns are getting better at these type of long-term strategies?
Adrian Orr: I wouldn’t say sovereign wealth funds are the leaders in this space at all. I would like to think they should be there over time. We have seen the larger, some a lot longer-term funds, particularly the Canadian [public pension] funds and some endowments funds, where you have got large internal resource, especially treasury-related and credit-related, where they have developed particular expertise to be able to do some of these strategies. Some sovereign wealth funds do, but the frustrating constraint on sovereign wealth funds will be this perception that you have a small internal team and you outsource lots of activity.
If you don't have a very sophisticated treasury or credit capability within your fund and some of these mandates are actually quite hard to outsource. You have got to attract, retain the people you need and you have got to be able to explain to your masters why that makes sense. I see funds which may spend tens of millions of dollars on external fees and are applauded for having only a small internal team. You have got to sit back and think about the business case each time for each one of these strategies.
Investment Institute: It strikes me that there is a lot more intelligent in-sourcing (for want of a better word) at the bigger sovereign wealth funds. Do you feel that counter-cyclical investing has been taken on-board by other sovereigns and long-term investors?
Adrian Orr: Yeah, I do. I mean the rise and shifts amongst investment peers, even in the short period that I have been involved in the industry, has grown rapidly. We have got far more comfortable with comparing strategies, collaborating on particular strategies and even co-investing and that I see as a significant growth area over the next 20, 30, 50 years, where large pools of capital can work together, share knowledge and get the comfort to do it.
The reason many sovereign wealth funds weren’t doing it was largely that fear that they could not hold the board calm through significant periods of time when you’re out of the money. When you’re buying more into a falling market, it’s not fun. So that confidence and maturity has grown and you are seeing more and more funds do it.
Also, with all of the changes that are going on across the regulatory environment, the banking liquidity requirements, it’s actually opened up opportunities and risks for us, you know which are exactly the same things. So we have to work much harder around managing our own liquidity and especially looking for opportunities to get rewards for providing liquidity to places that you would have never thought of before and so that’s fantastic.
The other area where sophistication I see growing is around this whole use of very clear, active [risk] budgets and having that used properly, as well as a lot of work around just risk factors and smart beta. Just sensible ways of sweating the portfolio and a lot less focus on short-term measures of risk.
Investment Institute: How do you think that changes your relationship with managers?
Adrian Orr: It’s a tough one. If you looked at the marketing material for most asset managers, you would think the relationship hasn’t changed at all! When you get under the bonnet and work really hard with the firms, it’s just impossible for a large manager with thousands of customers to have anything tailored or specific for the individual. The principal-agent risks multiply rapidly.
So you really want to buddy up with a few of the managers from whom you can get real comfort that they are going to be transparent with you, that they will share IP [intellectual property] (it’s a two-way street, you know, of sharing the IP) and even around flexibility at times. You might have an opportunity, you might have an account with an asset manager but if the opportunity is not currently particularly exciting, then just be prepared that we don't have any capital at risk at the moment, so that flexibility. It’s not about trying to turn an illiquid investment into a liquid one – it’s simply about just saying be flexible, be honest, be transparent.
That all sounds wonderful and I’m sure marketing brochures have all got that written but the real challenge comes that it’s expensive for an asset management firm to do that. You know we become a problem customer, you know a blue-chip pain in the backside, where we have got the wholesale money, hence wholesale prices, demanding top-end retail touch. So only a few asset managers can really get there and be bothered to do it.
Investment Institute: But isn’t this the way that the asset management industry is moving more generally? Towards greater value-add for clients?
Adrian Orr: I strongly agree. Our single biggest challenge at the New Zealand Super Fund was that we couldn’t explain ourselves well to the outside. Once we understood ourselves, we could better articulate then to our external managers. We have got fantastic relationships but they’re not all the same as when we started. So know yourself well and then hold – you know because that’s the way you can explain to your external partner what you want.
The challenge sits here, of course, that it’s a two-way street but also the large asset owners have to behave. If I’m sitting there and saying you give me all the service at the cost of some of my colleagues, then that’s not really fair; or you make sure I’m first out through the turnstile if this goes bad. It’s those types of behaviours that allow wealth destruction to continue you know around this short-term type of action.
Investment Institute: How are your members at the International Forum of Sovereign Wealth Funds dealing with low oil prices? There has been some hysteria around sovereigns liquidating at a very rapid pace because they need to bail out their economies. My tendency is to think that that is a gross generalisation, but I would like to hear what the pressure is on oil prices and on the other members of the International Forum.
Adrian Orr: I agree with you. I think it’s a gross exaggeration. Some funds are going to be hit in the revenue stream because the oil price hasn’t been coming up. They are going to be hit on the expenditure stream, especially if you’re a stabilisation fund, because that’s what you’re there to do – you pay money out when the fiscal balance needs it. All of us are going to be challenged by the reinvestment component, particularly with COP 21 [the Paris Agreement on Climate Change] and the climate change activity, and some funds which are really tough are going to be hit kind of four ways: revenue, expenditure, reinvestment and timing around how quickly they need to allocate capital to domestic development.
So it is a real challenge but from what I can see -- and I’m not sitting here with any inside information at all on other funds -- it’s working largely as anticipated.
Investment Institute: Do you think that agreements like COP 21 or the sustainable development goals are going to materially affect your investment horizon or your investment cases over the medium to long-term?
Adrian Orr: Speaking from the New Zealand Super Fund, I would say absolutely yes. Whether you buy in or not to climate change, there is going to be enough stakeholder demand and regulatory demand to have to have very considerable concern for carbon emission from portfolios and this would not be a surprise to anyone at all but there’s going to be a lot more heat than light over the next 3-10 years I would say around how to do it. So you are going to have the usual calls for divestment and that may have to take place for some funds in some very, very high carbon-intensive activities but they’ll have to choose. There will definitely be a drive for engagement between the asset owners and the firms they are invested in and engagement is going to come a lot around disclosure and reporting and dividend reinvestment. All of these activities are going to come under enormous scrutiny on the way through.
There will be lots of glamorous, shiny investment opportunities around alternative investment strategies or alternative energy strategies but that industry will always be higher risk and not all funds will be able to take part in it and there’s, you know, pretty limited investment opportunities compared to the scale of the funds that are available globally. So that will be highly competitive looking for the next big thing and there will be massive demands for funds to communicate around what we are doing. So it’s a significant issue for a long period of time ahead.
Investment Institute: Do you think that it’s more of a challenge for those resource-based funds? Is this a diversification challenge, that you’re getting your money from one source and therefore you should try and diversify away from it and particularly in this environment it makes that a bigger imperative?
Adrian Orr: Yeah, I think it’s a massive challenge. I mean I agree most of these funds were set up as purpose-built to diversify their people away from a single source of revenue, being oil in many cases. So a lot of countries sitting here in 2050 will be financial asset-dependent rather than oil-dependent and let’s really hope they all succeed because something about highly diversified, focusing more on educational activity and less on getting a fossil fuel out of the ground quickly. Then between-time the real challenge comes is do you dig and sell rapidly to make the revenue or do you play a longer-term game? So the politics and the impacts of that on the oil price we have all been observing with no particular insight. Globally it’s a real challenge.
I feel most for the newcomers to sovereign wealth funds who are oil-dependent and focusing on domestic development. You know you’re finally allowed to start making hay but you’re told you have got to do it real quick to get the investments made and now the developed world has come along with COP 21. So it’s a real challenge for some countries.
Investment Institute: Has there has been a big shift in the way that managing natural resource wealth is being thought about during the recent period when oil prices peaked and then collapsed?
Adrian Orr: Yes. You know the source of the revenue without a doubt is critical to the success of a fund. You know if the revenue source is drying up or it’s going to be taken away – I mean our fund had our funding halted in 2009 through the GFC [global financial crisis] and you know we would be significantly larger than we are now. So you know that revenue source -- without a doubt -- is a challenge but the investment challenges are the same for all of these sovereign wealth funds. You know it’s about thinking long-term, it’s about diversifying, it’s about truly understanding the risks and being rewarded for those risks.
Investment Institute: Finally, a bit on long-term finance. Will you say a little about the Focusing Capital on the Long Term initiative that you’re involved in as a broader initiative to bring long-term investing to the forefront?
Adrian Orr: Focusing Capital on the Long Term [FCLT], I think is a fantastic example of where you have got companies, investment managers, even regulators, officials, all in a room, all in agreement that things aren’t working as well as they could and all having to try and take responsibility for their corner of the room. It’s the interaction of those groups that creates short-termism. We all sign a 30-year strategic plan; we then agree to 5-year updates; we then agree to annual performance, quarterly notification and then real-time disclosure. It’s [FCLT] about how to break out of that and how to recognise and reward those companies or investment managers or asset managers who truly are focusing on the long term.
What I like about it is that when you look to your horizon, when you’re starting to think 20-plus years ahead, a lot of the negative externalities like perhaps societal challenges, poor working conditions, environmental challenges, governance challenges, all of those are no longer externalities. They actually come to be part of the initial investment considerations, to say “we have to leave this place better than we arrived in and have we got that fully priced into the investment opportunity.” So it becomes quite straightforward.
Investment Institute: So thanks very much, Adrian.Return to Investment Institute