Amid uncertainty in the public markets, levels of portfolio cash are rising and asset owners with an ability to take a long term – but significantly more active – approach to excess returns are seeking opportunities to invest.
While private markets are not immune to the depressed mood that has taken hold across the globe, they don’t swing up and down between euphoria and depression as with public markets. That is where many of the best opportunities lie, according to some of the region’s largest funds. Investors are willing to trade a certain illiquidity for outperformance over time.
One by-product is that active risk, or the risk involved in efforts to outperform the market, is rising. Ben Samild, deputy chief investment officer at Australia’s Future Fund, told AsianInvestor: “We are looking at our total portfolio exposures and assessing the strengths and vulnerabilities of each of our assets. Where we feel we have vulnerabilities at the total portfolio level we are adding strategies across the entire portfolio.”
In its annual report, issued last week, NZ Super provided details of its approach to active investment and how it uses active risk to allocate risk to specific investment opportunities. Until recently the fund's passive equity and bond holdings have performed strongly, and this has had the effect of depressing active risk usage. But the active risk component is trending sharply upwards again. The fund expects the standard deviation of active returns will be 4%.
Timber is an active investment that has been a strong returning asset for NZ Super, including a large holding in kaingaroa timberlands, a radiata pine forest in the central North Island of New Zealand, which has been the dominant contributor to recent outperformance.
Global macro strategies run by Bridgewater, Citadel and Two Sigma, have also delivered strong active returns over the year and since inception.
In an environment where access to capital in the public markets is constrained, the ability of private markets to provide capital solutions is another important trend for asset owners.
Speaking at the Global Financial Leaders’ Investment Summit in Hong Kong last week, Michael Chae, Blackstone's chief financial officer, said, “Providing private credit to borrowers, is a highly attractive environment. You have floating rate debt, high base rates, attractive spreads, senior debt in the capital structure, pretty reasonable loans to value. This provides an excellent risk and return at this point in the cycle.”
NZ Super’s allocation to tactical credit has been another successful active position. It is an internal mandate through which the fund provides debt funding and sells downside protection to mitigate or prevent a decrease in the value of their investment. It has the highest information ratio out of the fund's current investment opportunities.
“We continue to look for ways to scale up this mandate,” the fund said in its the annual report.
Factor investing has largely underperformed in recent years, but NZ Super’s developed markets equity multi-factor allocation had a strong year. In particular, an allocation to the “value” factor, which had historically weighed negatively on performance, started to reverse in late 2021 when global equity markets began to pull back from all-time highs. The fund’s factor managers are AQR, Northern Trust and Robeco.
The fund has been underweight real assets for some time. This reflects their view that strong demand for real assets from pension funds has bid prices up to high levels. Having recently hired real-asset specialists, and as pricing has become more attractive, the investment team said it will look to actively build exposures back up.
On the appeal of the asset class, Blackstone’s Chae said many parts of the US economy are still running strongly, “though there’s clearly deceleration. We are seeing the Fed’s action filtering through to the real economy, but on a lag. At the tip of the spear, you have sectors like for-sale housing, travel, energy (traditional and transitional), rental housing and logistics. Demand is still robust amid a short supply in some cases. Investing in hard assets with short duration remains an area of strength in a rising rates environment.”