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IFSWF Annual Meeting 2019 Summary

Global Currents: Highlights from the 2019 IFSWF Annual Meeting

From 10 to 13 September 2019, the International Forum of Sovereign Wealth Funds held its annual meeting, hosted by the Alaska Permanent Fund Corporation (APFC) in Juneau.

This is a summary of the themes delegates discussed addressing how technology is disrupting the investment landscape and how SWFs are partnering in private and public markets. As the meeting was held under the Chatham House Rule, neither the identity nor the affiliation of the participants can be disclosed. 

Digital Disruption; the Emerging Landscape

New digital technologies are disrupting nearly every industry and, therefore, changing the investment landscape for sovereign wealth funds and other long-term investors. We hear a lot about fintech and its potential to disrupt the investment world, but which technologies are likely to transform the ways in which sovereign wealth funds invest? 

Institutional investors are already applying machine learning to process some of the due diligence decisions for their investments. But there are a number of other technologies that SWFs can use to improve investment decisions. What will these technologies mean for the way institutional investors structure their teams? Automated operational systems now generate huge amounts of data and understanding how to analyse and use it effectively is an essential step for institutional investors.

If they do not capture data on their workforces effectively, institutional investors will not be able to understand how to re-skill their workforce in the face of technological change or improve diversity and inclusion, which has been shown to lead to better decision making.

Harnessing Technology to Prepare for the Future

Three different types of artificial intelligence are developing, and they will potentially have important implications for the global economy over SWFs’ investment horizons.

  • Augmenting humans (e.g surgeons helped by data/machine)
  • Replacing humans (e.g an accountancy firm using AI to replace staff on accounts)
  • Doing things that humans cannot do (facial recognition for example used at big events)

Sovereign funds are preparing for disruption in three ways:

  1. Creating their own tech development team. 
  2. Aligning with external managers that have specific tech capabilities.
  3. Managing disruption risk in the portfolio. 

However, investing in disruptive technologies alongside venture-capital and growth-capital managers is not enough to protect SWF assets against disruption risk.

SWFs could (and should) learn from their venture-capital managers has much as they can; if a VC growth portfolio disrupts all other industries how can investors reduce risk?

The more experienced funds are also focusing on external managers and how they can help them plan for different scenarios. The goal is to have an actionable process to change the portfolio to accommodate major technological shifts. Shorting an incumbent company or an incumbent sector that is going to be disrupted is not always profitable, as the new tech companies can be bought by the incumbent before they actually disrupt an industry.

SWFs should take into consideration a twin disruption:

- Low cost of tech (disrupting companies) 

- Low cost of capital 

Currently, it is cheaper to fail and faster to scale than it has ever been. The cost of building businesses has fallen 100x and keeps on falling. Public markets have already been displaced (passive vs active). In private equity, returns are driven by different factors and some are building AI capabilities. 

ESG and AI

Should investors use an ESG screen when investing in technology companies? Most SWFs have a traditional ESG screen but they are not thinking about how technology could potentially violate human rights or be used against humans in a dystopic future.

 This may seem like a challenging and irrelevant question, but in addition to generating financial returns, SWFs work to improve their stakeholders’ economy and society as a whole. As such, these types of issues are more relevant for SWFs than may at first appear.

Key Takeaways on how to Harness Technology

How do we make investment choices in a world that is changing so rapidly? It is no longer enough to simply assess income statements and balance sheets. All megatrends are influenced and shaped by technology.

  • Rapid urbanisation
  • Climate change and scarcity of resources
  • Demographic and ageing society
  • The shift of global wealth away from Europe, US, and Japan to emerging markets.

SWFs need to think not just in terms of investing in the technology sector directly, but the implications of new technologies on global markets and investment processes.

Not all technologies or sectors will be fundamentally changed, but it is important for investors to challenge their underlying beliefs about how the global economy will evolve and how that will shape how and why they allocate to managers and invest directly. SWFs need to engage their networks to get long-term incentive alignment. 

The Future of Investing: How Technology and Data Analytics are Disrupting the Investment Process

The discussion focused on the future of investing in a data-driven environment and how data analytics enable investment managers to enhance alpha generation through valuable insights.

1) Technological disruption:

- Technology is disrupting all aspects of our personal lives. This is most evident in China (mobile payments), as well in the US and Europe.

- Technological disruption has arrived in listed equities (transparency via ETFs).

- Big data and machine learning will drive similar levels of disruption in asset management, and that most are still not prepared.

2) Impact on investment value chain:

Traditional methods of investing are being reshaped by massive advances in technology and data sciences. Generating active investment returns in today’s environment requires expanding and innovating sources of investment insights.

Technology allows investment managers with sufficient resources to use data analytics and mine the growing volume of structured and unstructured data for generating these alpha insights.

Big data can be used to create useful investment idea outputs, e.g. social media and Internet search data can be the inputs to forecasting when machine learning and artificial intelligence is applied. Big data implies a much higher spend on data, infrastructure and people, generating alpha is now a scale game.

Big data can be powerful to forecast what the markets are going to do. However, the data itself is not valuable without the accompanying insights.

3) The democratisation of information:

There is no longer an information advantage

While markets have become more efficient on some measures, they have also become more interesting for investors willing to make scaled investments.

With the increased instant availability of information, the traditional approach of investing has been challenged and it has become very difficult for fundamental portfolio managers to generate alpha 

One exception continues to be in emerging markets

4) Unprocessed data is useless:

Apply analytics to make data usable and transform into information to generate insights

Without the skill to generate information from data no competitive advantage

5) There is a difference between non-proprietary and proprietary information:

Proprietary data is what will give the longer-term advantage to investors

Asset managers are increasingly trying to find ways to get access to structured and unstructured data that others don’t have. This will be a big advantage in the future.

6) Scale matters:

Large asset managers have a clear advantage

Because of their diminishing marginal cost of production, they can operate at significantly lower cost

7) Importance of interpretation of data analytics:

Very important to have investors combine data analytics with human insight

Data analytics and technology need human interpretation to generate alpha

Harnessing Collaborative Advantage in Private Markets 

The following trends are shaping private markets:

  • Expanding private markets as public markets shrink, but the lack of evolution of the PE model (e.g. persistence of the 2 and 20 fee model).
  • Need for longer time horizon: super-long duration (“perpetual”) funds. 
  • Investors need more alignment between LPs and GPs. 

Many institutional investors are coming to the conclusion that they have more liquidity than they require and are, therefore, potentially leaving returns on the table.

Finally, either implicitly or explicitly investors are realising that public markets are easily accessible via indexing and exchange-traded funds, and they are searching for alpha in private markets.

Common perceptions of PE that are not true: 

- Top quartile firms are always better: the reality is that persistence is far less than it was in the past.

- The returns from best-in-class firms are driven by complexity. Actually no, strong companies with strong teams are better.

- PE managers are incentivised to hold great companies. Not at the moment with a 10-year term typical in PE.

Participants discussed some common issues, including the following:

- Carry and fees are not coming down further: A solution would be to realign incentives and to lower costs.

- The traditional GP-LP structure encourages a short-term mindset. Solution: permanent capital funds

- Focusing on MOIC (multiple on investment capital) and IRR (internal rate of return).

- Risk. The current private equity structure encourages excessive risk-taking and leverage. A solution is to create incentives for higher conviction base case and better distributions of returns.

Case Studies

Two IFSWF members shared their experience working as a partner to create a joint fund to invest in technology companies in both countries. An important feature of the partnership is that both SWFs chose a local private equity firm to manage and select investments on their behalf. The challenges of raising a joint fund are mainly managing communication smoothly across time zones. The two SWFs are still waiting to find opportunities to co-invest with the private equity fund. 

Best Practices in Partnering in Private Markets

Over the last four years, SWFs have invested alongside a range of partners. According to the IFSWF 2018 Annual Review, the trend accelerated to its highest level yet – particularly in unlisted assets, such as private equity, real estate and infrastructure – as part of consortia, over double the 92 deals completed as a solo investor in both public and private markets. Although SWFs have been partnering with each other for almost a decade, in the last two years they have found novel ways to collaborate with a range of partners.

There is a marked trend towards SWFs partnering with other, often government-owned, asset owners in both innovative new platforms and traditional private-equity-style transactions, which allow the partners to pool their networks and expertise for mutual benefit. 

The panellists agreed on the three most important features for a successful partnership: 

- Consensus between partners

- Complimentary geographies and/or sectors/ skillset

- Trust and reputation 

Creating Productive Partnerships in Public Markets

Increasingly, partnerships with asset managers are important for effective long-term capital allocation. Saving funds – typically with long-term goals – find it difficult to invest in quality listed companies that make multi-year investments in new markets, facilities or products without being overwhelmed by short-term behaviours in financial markets.

For equity managers, a successful partnership with their clients requires both sides to acknowledge that it is more than a transactional relationship. Productive partnerships require both parties to listen actively to understand their needs and articulate a strategy.

To execute, the asset manager and asset owner must work together at multiple organisational levels, including close collaboration between staff and portfolio managers (particularly on quantitative strategies).

New strategies will invariably face challenges and parties need to remain committed to maintaining a long-term, durable partnership. SWFs shouldn’t underestimate how time-intensive these strategies are. It takes a long time to develop the right relationship, gain market exposure, and work through challenges, particularly for a strategy in a new market or niche. Trust and understanding of common goals need to be clearly articulated as performance measurement may be challenging in the absence of comparable benchmarks for new strategies or factors. 

To set a successful partnership in public markets SWFs and partners need to:

  • Have a clear investment philosophy with agreed objectives
  • Take a long-term view
  • Be flexible and open-minded
  • Build two-way relationships based on trust
  • Diversify manager styles
  • Remember that talent is key – on both sides

Participants finally highlighted that external managers may have multiple partnerships, but they will all look different, depending on the strategies they are executing for clients and the needs of the client.
 

Lessons Learned

Some of the most important features for a successful partnership with external managers in publicly traded fixed income and equity markets: 

- Breadth (providing exposure across a range of access points and opportunities) 

- Capability (managers need to be experts in their field and willing to challenge common views, at the same time the have consistency in their investment approach)

- Willingness to collaborate (must include: evidence that the relationship extends beyond the specific fund under management, the manager is open and transparent, able to dedicate resources if required)

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