It really does feel the same everywhere I go.
From Australia to China to Canada, long-term investors are all feeling the strain of their looming financial obligations. They now recognize that public markets won’t deliver the performance needed. At the same time — it seems obvious to say this — they realize that they can’t just keep adding risky assets to “mathimagically” allocate their way out of their funding gap.
So what can these investors do? Many are now looking in the mirror. Rather than searching for a product or manager with a shiny new alpha, Giants are taking stock of their own characteristics and how they might exploit them.
In the old days, people often regurgitated the gospel of financial economists, arguing that pension funds or sovereigns shouldn’t bother with unique or bespoke strategies because markets were efficient and actors were rational. Oh, and let’s not forget that pensions can’t be trusted with such important decisions.
That was then. Over the past few decades, we have watched those same financial economists make billions by building hedge funds that exploit market inefficiencies (or, in certain cases, lose billions by drinking too much of their own Kool-Aid). As such, today it’s not the pensions that can’t be trusted; it’s the asset managers. And as a result, many Giants are now actively pursuing strategies that leverage their unique comparative advantages.
This raises important questions: What qualifies as a comparative advantage, and how does a pension or sovereign or endowment build a strategy around one? Ultimately, these advantages come in two forms: categorical and cultivated.
Categorical advantages: Most Giants have advantages over the general market that are the result of birth. These can be a function of a sponsor’s profile, geographic location, liability structure, and so on. A pension fund may have certainty of cash flows, and a sovereign has unique tax advantages. An endowment may have access to remarkable deals thanks to its alumni, and a foundation can draw on the knowledge of its network of grantees. Some investors have long time horizons because of their liabilities, whereas others have enormous scale owing to contribution rules. Many enjoy a sentimental difference in that governments will view a pension or a foundation in a positive light, which can lead to deals that might not be offered to a hedge or private equity fund. In all cases, the funds are born with these traits.
For real-world examples of structural advantages, consider the University of California’s investment office, which benefits from proximity to Silicon Valley and unrivaled access to the biggest research university on the planet. Take Princeton University, which is close to New York, a major financial center, and has an alumni network that is second to absolutely none (cough, go Tigers!, cough). Look at Singapore’s sovereign funds, which sit at the crossroads of global trade and can tap into one of the most educated and competent workforces on the planet.
Cultivated advantages: Investors also have the ability to cultivate their own unique advantages. You can think of these not as the products of discovery, but rather as the products of invention. There are no blueprints for a cultivated comparative advantage, which often demands a robust governance structure and a culture of innovation and creativity. An investor can invent a dynamic and real-time governance structure, making it a good partner in fast-paced environments. It can invent a delegation framework that empowers investment teams to be credible players. It can invent new vehicles or new teams that lead to long-term advantages.
In terms of real-world examples, if you want a partner with good governance and operational excellence, look to New Zealand’s Super Fund. Seeding a private equity fund? Go see Kuwait’s WAFRA. Platform companies doing infrastructure? Head to Canada.These are real advantages that lead to unique deal flow. None were endowed. All were cultivated.
I freely admit that it can be difficult to separate the categorical from the cultivated advantages described above. One often goes hand in hand with the other in that you often need good governance and professionalism to cultivate any unique advantages. Can you imagine an endowment ignoring the value of its alumni or rejecting deals sourced on its campus because of conflicts of interest?
Faced with lower expected returns and high target returns, the Giants are increasingly looking to their own comparative advantages to build long-term strategies for investment alpha. This is positive, as these long-term investors can hopefully generate higher returns without all the leakage to high-risk asset managers. But this path is not without challenges. There are no off-the-shelf blueprints from consultants for how to develop cultivated, structurally favorable investment opportunities. By definition these opportunities are unique, which means that the only road available is the one not taken. Are many Giants ready for this? We’ll soon find out.
