Asian Development Fund Names Inaugural CIO

The Asian Infrastructure Investment Bank (AIIB)—a new collaborative development vehicle—has appointed a former Indian government minister as its first CIO, overseeing a portfolio of up to $100 billion.

DJ Pandian will lead “planning and supervision of the bank’s infrastructure investment” through promotion of sustainable investment across the continent, the AIIB said in a statement.

Pandian is one of five new vice presidential appointees. Previously, he served as the chief secretary for the Indian state Gujarat, and has held several senior positions in state, national, and international affairs. The AIIB called him “instrumental” in helping attract international investment in India’s much-needed infrastructure.

Among the other appointments to the AIIB’s senior management were Kyttack Hong, chairman and CEO of the Korea Development Bank, who became the multilateral group’s chief risk officer. The World Bank’s Joachim von Amsberg was named vice president for policy and strategy, and does not plan to give up his day job for the new position. Former UK government minister Sir Danny Alexander has been made corporate secretary.

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The Beijing, China-based bank announced Jin Liqun as president last year. He is also chairman of the board of supervisors for China Investment Corporation, and sits on the State Monetary Policy Committee in China.

The AIIB was established last month after several years of planning, and is designed to help fund infrastructure projects across Asia and promote co-operation between its member states. Thirty-seven Asian countries back the project, including China, India, and Korea, as well as 20 non-Asian countries, predominantly from Europe.

The AIIB is expected to raise as much as $100 billion from its 57 members, according to documents on its website.

Invest in private equity for the return-smoothing, not the absolute returns, concluded Harvard Business School researcher Erik Stafford after attempting to DIY the asset class.

“Return smoothing is an acute concern.” Passive listed portfolios of small-cap value companies
—favored qualities of private equity firms—outperformed the average US private equity fund, both net and gross of fees. Stafford applied two turns of leverage to his replication funds, and backtested the strategy over 30 years (1986 to 2015).

Two stark differences emerged between the alternative asset class and its public copycat: Volatility and fees.

“The risks of the replicating portfolios are extreme,” wrote Stafford, the John A. Paulson professor of business administration at Harvard. His two listed models “experience a massive drawdown during the financial crisis of 2008, with both portfolios losing more than 85% of their value relative to their historical peak valuation.”

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Compare that to a 20% drawdown in 2008 for Cambridge Associate’s private equity index, which Stafford used for the study. This was the largest drop for private equity since Cambridge began tracking industry performance in 1986.

With roughly half the annualized volatility of stock markets, private equity’s long-term risk-adjusted returns have topped nearly every other asset class.

But crediting managers with these results would be a mistake, Stafford argued. His study pointed instead to an accounting rule.

Private equity firms report performance based on the sale value of assets, a.k.a. book-value accounting, and highly malleable estimation. Listed portfolios mark their value to closing market prices, accounting for all the swings during ownership.

“Sophisticated institutional investors appear to significantly overpay for the portfolio management services associated with private equity investments.”Book-value reporting “significantly distorts portfolio risk measures,” Stafford wrote, calling into question “the strikingly attractive risk properties of the aggregate private equity index.”

To measure the impact of public-versus-private reporting methods on risk-adjusted returns, he recalculated the two listed replicas’ performance using book values.

“Remarkably, the worst drawdowns for the replicating portfolios with book-value accounting are only 15% and 7%, whereas the identical portfolios with market value accounting exceeded 85%,” the finance professor found. Absolute returns remained the same, of course: 21% and 19% annualized, while private equity gained 16% gross-of-fees.

After paying fees of roughly 6% per year, investors in private equity “are considerably underperforming the feasible alternative of investing in similar passive replicating portfolios.”

Listed portfolios cannot replicate all of the value-add avenues available to private-market managers—for example, improving operations—the author acknowledged.

However, Stafford concluded, “the results indicate that sophisticated institutional investors appear to significantly overpay for the portfolio management services associated with private equity investments.”

Cambridge PE Source: Cambridge Associates, US Private Equity Report 2015 Q1

Stafford published the results of his study—“Replicating Private Equity with Value Investing, Homemade Leverage, and Hold-to-Maturity Accounting”—in late December.