Border to Coast – Interview
If you look at the G in ESG, research from Cambridge University shows that there is no correlation between the FTSE and MSCI’s governance scores. This is quite shocking as it should be the easiest of the three pillars of
ESG.So, data quality needs a lot of work. That is why we have internal teams to sift through the data and under- stand the readings.
Is inflation a concern?
It is a big concern for our partners funds as they have inflation-linked liabilities. So, by default, it is a concern for us. I have been highlighting for the past year that we are going to see an uptick in inflation. We have record amounts of quantitative easing, record amounts of household cash on balance sheets and record amounts of corporate cash on balance sheets at a time when we have supply side constraints and potentially the unwinding of more long-term trends, such as corpo- rate taxes going up, ESG costs going up and labour costs going up through greater equality and better working standards. This massive amount of liquidity will drive changes in cyclical trends, which will push up inflation. We have seen infla- tion rise in the first part of this year and the second part of the year is going to be elevated because of supply side con- straints. My estimation is we will have high inflation going into 2022. That presents challenges. On the equities front, the immediate impact is higher earnings, which we are seeing. The next impact is a squeeze on margins, which we are starting to see. The eventual impact is that people want to pay lower multiples for cashflows, as inflation moves higher. The big unknown is how central banks will react in 2022 and what impact that will have on the economy – how accommoda- tive or aggressive they are going to be. In our alternatives programme, we are prioritising assets with inflation linkage. In our equity programmes we are looking at companies with pricing power that can pass costs through so the margins do not
get squeezed too much and we are aware of the potential impact of factor expo- sures: so higher inflation and higher rates probably favour value stocks over growth stocks.
It is a big issue for our underlying pen- sion plans. They are well funded, but a couple of years of 5% inflation could remove those surpluses quite quickly.
What are your investment aims? To be careful not to de-risk too quickly because assets should outperform cash. Although we are going into a more diffi- cult investment environment, de-risking too quickly will be negative for long-term returns. Assets are expensive, but cash even more so. We will be building out on our alternatives programme: we have saved 35 basis points, or £12m, a year through the alternatives programme, but we are only just starting to ramp up our current investments. We have quite a big pipeline and now have the team to deal with that. It will be a source of savings for our partner funds and a source of capital going forward, especially on the infrastructure side where we are going to be particularly active. We also want to continue to integrate responsible investing and ESG into the investment process. We have done a good job of integrating them, but you can always do more. We want to be ahead of new regulations not behind or in line with them as well as understand the data better.
On active equity and fixed income, we tend not to take too much factor risk and are focused on selecting stocks which could be more sustainable in the longer term, while being aware of the macro drivers that could affect the underlying companies. And making sure we have good risk management, which is essen- tial, as local government pension schemes have historically had less focus on risk management than the corporate sector.
Why is this?
They have viewed risk from a different perspective as they are long-term inves- tors. Corporate schemes are more focused on the quarterly earnings impact and are a little more sensitive to how it impacts their reporting. There are pros and cons here, but we want a high level of risk sophistication.
What plans do you have in the pipeline? We are excited by what we are going to launch on real estate. On the global front, most of our partner funds do not have access to real estate, so that will be a new offering for them next year.
ESG is not a separate discipline.
Global real estate is interesting because of the diversification benefits. Real estate is a local market. It is about the supply and demand in that local market, but equity markets are globalised. In the UK market, we have a mix of direct and indirect funds and are going to allow those indirect funds to access real estate cost effectively. That will be a good cost saving for [the partner funds] over the long term. We will be one of the biggest holders of UK real estate in the future once we have finished the transition. We are also launching a multi-asset credit fund, which gives funds access to high- yielding loans, bonds, emerging markets, local currency dollars, sovereigns, corpo- rates and securitised credit. A few of our partner funds have multi-asset credit funds, but few have good coverage across the board in those asset classes. So, this opens up a new income stream.
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