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 wont deliver the
performance needed. At the same time it seems obvious to
say this they realize that they cant 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
shouldnt bother with unique or bespoke strategies because
markets were efficient and actors were rational. Oh, and
lets not forget that pensions cant 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 its not the pensions that cant be
trusted; its 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 sponsors 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 Californias 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
Singapores 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
Zealands Super Fund. Seeding a private equity fund? Go
see Kuwaits WAFRA. Platform companies doing
infrastructure? Head to Canada.These are real advantages that
lead to unique deal flow. None were endowed. All were
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? Well soon find out.