Niagara Institutional Dialogue 2014
A number of simmering big picture issues seem to have boiled over in the past year. Taken together, these exogenous issues suggest that investors need to urgently revisit their assumed level of diversification. This was the backdrop for the 2014 Annual Meeting of the Niagara Institutional Dialogue.
Two of these forces had been building for decades and are now having a clear and present impact on the economy and monetary system: demographics and globalization. These mega-trends affected consumption patterns for decades, but now expose the economy to secondary “knock-on” macroeconomic effects that are only beginning to be understood. Two other mega-trends have recently added to these risks: excessive credit creation (what some have called “creditism”), and an increase in the global energy supply caused by new extraction technologies such as fracking and horizontal drilling.
This was the context to our discussions this year about fiduciary and investment issues. As always, sessions focused on a full spectrum of issues from geopolitics to social issues, to macroeconomic issues, capital markets, fiduciary challenges and, of course, specific investment strategies.
Exogenous Shocks (Geopolitical, Social, Macroeconomic, and Capital Market Developments)
Former CIA analyst and Fellow of the Council on Foreign Relations Helima Croft drew a series of direct links between world energy markets and geopolitical developments such as the Russia/EU conflict over Ukraine, Iran’s nuclear program, Saudi Arabia’s vassal states such as Qatar, Bahrain and Oman, and the latest chaos in Iraq.
Noted demographic economist David Foot showed how the “age pyramids” of various Canadian cities and provinces - not public policies - were the critical determinants of historical policy successes. Furthermore, he warned that demographic determinism will predict which public policies succeed and which will fail in the future. He also examined the demographic profiles of many countries around the world to gain insight into which ones face significant economic and social hurdles.
Participants’ views on the human lifespan were challenged by controversial scientist and author Aubrey deGrey, who contends that the first person to reach age 150 has already been born. According to deGrey, expected advancements will soon mean that the fundamental molecular damage done by aging can be reversed rapidly enough to allow those already in middle age to live dramatically longer than our current expected lifespans – or, as deGrey described it – “kicking the can down the road.”
Benjamin Tal, the deputy chief economist at CIBC discussed how the Canadian economy of the post-financial crisis period is dramatically different than that of the past. He warned that consumers are now more sensitive to rising interest rates and that the Canadian dollar would not approach parity in the future. He also suggested that renewed growth in consumer credit would fuel economic expansion in 2015 and beyond.
Shawn Driscoll of T. Rowe Price directly addressed the economic implication of the shale oil revolution. He refuted skeptics who suggest the explosion of shale oil production will be short-lived and confronted other “myths” such as the concern that shale oil was too expensive to drill, that wells were depleting too quickly and that fracking technology wasn’t improving quickly enough.
Noted author and economist Richard Duncan integrated these and other issues into a monetary policy analysis based on excessive credit expansion. He told participants that a falling US current account deficit would mean the Fed will continue to support expansion through quantitative easing. He believed that economic headwinds later in 2014 would give rise to “QE4.”
With these exogenous shocks in mind, participants then explored the governance and investing challenges facing large Canadian pension plans.
Jeffrey Scott, CIO of consulting firm Wurts & Associates discussed the trend toward “Outsourced CIO” services with UTAM CEO Bill Moriarty. Scott reflected on his experience as CIO of the $42 billion Alaska Permanent Fund where he was unable to assemble a large internal team in America’s smallest state capital (Juneau, Alaska. Population: 36,000).
Jim Leech, former CEO of the Ontario Teachers’ Pension Plan was recognized for his public advocacy on pension reform and for his best-selling book “The Third Rail: Confronting our Pension Failures.” Leech recounted various lessons from the book with thefirst CEO of the Ontario Teachers’ Pension Plan, Claude Lamoureux.
Alan Brown, Senior Advisor to Schroders and the firm’s former CIO addressed the issue of “de-risking” pension plans without having to execute a buy-out. He warned that continued positive correlation between equities and fixed income would be a “nightmare scenario” for liability-driven investing (LDI) strategies.
Robert Cultraro, the CIO of the Hydro One pension plan and Jim Keohane, CEO of the Healthcare of Ontario Pension Pan (HOOPP) discussed the creation of investment policies with Janet Greenwood of Aurion Capital, manager of the Shell Canada Pension Plan. Koehane described how HOOPP’s innovative portfolio construction strategy allowed a significant portion of the fund to be managed internally at a relatively low cost compared to external managers. Cultraro pointed out that for plans under $10 billion, it can be more challenging to keep costs low enough to justify such an approach.
The annual parliamentary debate pitted Don Raymond, former Chief Investment Strategist with the Canada Pension Plan Investment Board (CPPIB) against Don Ezra, the former co-Chairman of Global Consulting at Russell Investments. The resolution was based on recent academic research: “Investment consultants provide little or no demonstrable value in their manager recommendations.” Participants were polled twice. Initially, they showed a bias toward the affirmative – that consultants added little value – but were apparently swayed by Ezra’s arguments in consulting’s defence. Hugh Innes of the Rekai Foundation acted as Speaker of the House with his usual enthusiasm and flourish.
Endogenous Responses – Investment Issues
Many of the sessions at this year’s Annual Meeting concerned specific investment options such as fixed income, equities, real estate, infrastructure, foreign equities and absolute return strategies.
As a protégé of Benjamin Graham, Charles Brandes, founder of the eponymous firm Brandes Investment Partners emphasized that equities remained the best long-term investment for pension funds. He used the analogy of a soccer goalie during a penalty shot. Research shows that the best option is for a goalie to remain in the centre of the net rather than anticipating the shot and diving to one side. Yet most goalies dive anyway due to social pressure and convention. Acknowledging that a buy-and-hold equity strategy can be more “lumpy” than other strategies, he pointed out that the alternative - portfolio churning - is very expensive.
Erin Bigley of AllianceBernstein argued that historically low interest rates demanded a more nuanced approach to fixed income investing. She advocated for tail hedging strategies and long/short credit strategies that generate alpha through greater convexity, not through traditional security-selection.
Emilian Groch, CEO of the Alberta Teachers’ Retirement Fund Board, explored the pros and cons of absolute return strategies with Robert Doll, Chief Equity Strategist with Nuveen and Alex Johnson, Head of Fixed Income Absolute Return at BNP Paribas. Doll and Johnson were asked to represent their asset class as if at investment board meeting. Groch made good use of the format to challenge the duo on a number of issues important to all investment boards.
Terri Troy, the CEO of the Halifax Regional Municipality’s pension plan also explored an alternative asset class with two leading portfolio managers. She examined listed and unlisted real estate with Kate Giordano of Aberdeen Asset Management and Peter Zabierek of Presima.
With over $57 trillion to be investment in global infrastructure by 2030, this asset class was on the minds of many participants this year. Gregory Smith, the CEO of infrastructure manager InstarAGF, said that many lessons had been learned over the past decade by investors: demand projections can sometimes be overly optimistic, some assets are overvalued, prices can be too dependent on rising asset values, there can be unintended political risk in some assets, and some fund structures can been difficult to exit. He said that future opportunities may be found in power, water and transportation infrastructure.
Finally, Andrew Brown of Baillie Gifford made a compelling case to invest in Japanese equities – despite demographic warnings from other such as David Foot. According to Brown, Abe-nomics provides the foundation for “…the best chance Japan has had for many years to return to a sustainable growth path.”
Modern portfolio theory posited that a diversified basket of assets could provide a proverbial “free lunch.” But with the same fundamental drivers – creditism, demographics, energy prices and globalization – influencing a wide variety of assets, participants were encouraged to look beyond price history, correlation matrices and portfolio construction. By exploring the potential impact of political, economic, social, or financial “tail events” before they happen, and by establishing prudent risk management and governance processes, fiduciaries may be better prepared for the unknowable. Helping them prepare for these tail events was the mission of the 2014 Annual Meeting of the Niagara Institutional Dialogue.