Market Uncertainty Prompts North Dakota Investment Board to Review Asset Allocation

The North Dakota State Investment Board (SIB) recently conducted a thorough review of the target asset allocation for the state’s Legacy Fund after projecting “change and uncertainty in the capital markets.”

“We’ve seen broadly across a number of consulting firms and asset managers risk assets have appreciated since the crisis, and arguably return expectations have come down,” Deputy Chief Investment Officer Darren Schulz told CIO.

“When we engaged [our consultant,] Callan, we utilized their most recent capital markets projections,” he added, “which have come down because of the likelihood of generating returns at the same magnitude [since the recession] likely won’t happen over the coming periods.”

The North Dakota Legacy Fund is a pool of capital fueled by taxes on oil and gas produced and extracted in the state. It originated in the summer of 2011 and is valued at about $6 billion today. The SIB also manages $6 billion in public pension assets and a $2.3 billion insurance fund.

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The SIB and Callan laid out several potential asset allocation mixes to defy the projected volatility. They are summarized below:

Callan and the North Dakota Retirement and Investment Office (RIO) deemed the current target allocation to be “reasonable,” but sought to review mixes 2, 3 and 4 with the board based on its desire to reduce, hold, or increase “targeted” risk levels.

But at the end of the day, Schulz and his team decided that the board will go “full steam ahead with the same strategy for now,” he told CIO. “It’s a fairly conservative asset allocation—steady as she goes. We’ll revisit it if we get some changes in spending [approximately 2-3% of the fund presently.]

“Any near-term volatility from risky assets is something we don’t have concerns about—we’re long-term investors,” he continued. “In the fourth quarter of 2018, we were well-positioned for rebalancing, given the weakness in equities [at the time] and we added some equity exposure to take advantage of that weakness.”

Schulz also commented on the strength of the oil and gas revenues flowing into the legacy fund. “The sheer magnitude of the revenues dwarfs the investment returns of the program—this is just a different beast. You’re getting about $60 million a month from oil and gas taxes. It’s like the Alaska Permanent Fund in 1987—the early stage of a commodity-driven sovereign wealth fund. “

The legacy fund is forecasted to reach $16 billion in 2028 under the current target allocation. It has an expected return of 5.82%, real return of 3.57%, standard deviation of 10.75%, and projected yield of 3.11%.

The SIB last reviewed the asset allocation of the legacy fund in 2013, the public employees’ and teachers’ retirement funds in 2016, and the insurance fund in 2017.

Tags: Callan, Darren Schulz, North Dakota State Investment Board, Pension

As the tide pulls some chief investment officers and asset owners toward improving corporate environmental, social, and governance (ESG) practices, there is strong evidence that ESG investing is now rewarded, especially in the Eurozone, according to a recent Amundi SA study. Investors are starting to see the positive effects of ESG investing on their returns.

Companies with high ESG scores in the Eurozone generated annualized returns of 6.6% from 2014-2017, compared to an annualized loss of 1.2% three years earlier. ESG investing in North America also saw positive returns, as top-rated ESG companies produced annualized returns of 3.3% during the same timeframe.

Until 2014, ESG best-in-class strategies provided neutral or slightly negative results, but when the study focused on shorter periods, it showed a positive selection effect on highly rated companies, sometimes combined with the underperformance of poorly rated stocks. According to the study, “The Eurozone and North America are particularly responsive to ESG integration, with a higher reward for governance and environmental pillars, respectively. Social began to be rewarded in 2016, and since then it is catching up.”

Martin Kremenstein, head of ETFs at Nuveen asset management ($970 billion assets under management), has also seen this surge, especially with small caps, “since quality is a key factor in deriving alpha.”

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In 2016, Nuveen launched ESG large cap value, large cap growth, midcap value, midcap growth, and small caps in the domestic space, and followed up with developed markets, emerging markets, and a core fixed income product in 2017.

Kremenstein is finding, “The alpha effect of ESG seems to be more cyclical in growth, but it seems to be consistent in value and small caps,” with his Nuveen ESG Small-Cap ETF (NUSC) in the top 6% of small cap core funds in Morningstar for the two years since launch.

For 2018, Nushares ESG Large-Cap Growth ETF (NULG) outperformed the Russell 1000 Growth by 230 basis points. The NUSC outperformed Russell 2000 by 174 basis points and the large cap actually outperformed by 395 basis points.

Screening Tricks

The trick is to start by ordering investments by sector, doing a controversy business screening (involvement in alcohol, tobacco, and firearms, etc.), scoring for the ESG material factors for that industry, applying the carbon screen, and finally optimizing weights, he says.

Ordering companies by sector ensures, for example, that Schlumberger is being compared with Valero. Facebook would be compared to Adobe and Microsoft (the latter two scored pretty well) and each would be given an ESG ranking relative to that sector.

During the second round, a company’s past response to controversy is assessed.

“A CEO’s misbehavior is one thing; a CEO’s misbehavior that reveals endemic structural and governance issues with the company is a much more significant event,” says Kremenstein.

Next, he scores companies on absolute carbon emissions, potential carbon emissions, and removes any with fossil fuel reserves. He then optimizes the weights of the sectors back to within 4% of the base non-ESG index, with 8% being the band for energy.

If this ESG screen was used to invest, the tanking of Equifax was likely missed because it revealed it wasn’t fixing the mounting problem that caused an earlier data breach in 2016 (of 430,000 names) before the big breach in 2017 (that could amount to 143 million Americans affected.) This same screen showed the waxing and waning of a Facebook investment due to the way it violated its privacy policies early on.

It begs the question: Shouldn’t investors know the ESG score of every company in their portfolios?

“There’s value that’s generated by employing the ESG metrics, because you’re essentially removing companies that have poor pollution and poor material resource management, companies that are wasteful, companies that have bad relationships with their investors, with their employees, and with regulators, and companies that have bad governance structures,” said Kremenstein.

Tags: Amundi SA, ESG, Eurozone, Martin Kremenstein