Getting to grips with hedge funds, ESG and infrastructure investing

Mikael Huldt, Head of Alternative Investments, AFA Forsakring AB discusses the role illiquid assets play in institutional investment portfolios and the challenges facing newer investment strategies including responsible investments and infrastructure debt

Insurance Investor Editorposted on Thursday, October 17, 2019

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Insurance Investor: Are more institutional investors adopting ESG, RI or impact strategies?

Mikael Huldt: Yes, in Europe and particularly in northern Europe, it is definitely an area of focus, although less so in other areas.

But it is coming along. The issue is that people are putting varying definitions on the term ESG and whether it is the E, S or G that should be emphasised.

"There is an issue with “green washing” in the sense that some strategies are being labelled something that they perhaps aren’t"

This means that there are very different methods being used to address this issue within their investments. Alternatives will definitely play a role in the expansion of dedicated impact strategies and will see an increase.

As with everything new, there is an issue with “green washing” in the sense that some strategies are being labelled something that they perhaps aren’t. These types of issues will need to be addressed.

II: Which alternative strategies are being challenged in the current market and are there some which will not be viable in the long run?

Mikael: The only real strategy that I see being a challenged within alternatives is having reduced allocation in hedge funds as they have been underperforming and not delivering what they promised.

In addition, there are several changes taking place inside the institutional investors’ asset allocation strategies. With less emphasis put on alpha generating strategies and more on such things as smart beta.

"Hedge funds have been underperforming and not delivering what they promised."

The role of hedge funds within the institutional investors’ asset allocation framework has changed. The concept of adding low correlation hedge fund strategies has somewhat played out its role and institutional investors are turning elsewhere to achieve such exposure, for example increasing their infrastructure allocation.

This is driven by such things such as more focus on overall costs as well as hedge fund underperformance and not doing what they were supposed to do, i.e. being more correlated to other asset classes than expected.

II: What do investors need to think about when it comes to infrastructure investing?

Mikael: Infrastructure debt is a newer investment strategy, and no one really knows how these structures will perform in a downturn.

The data available from the GFC is based on very different capital structures and market conditions. While the perceived risk can be manageable, there is an apparent risk that the actual risk will be higher.

Looking at the concept of relative versus absolute risk and return, I believe that certain infrastructure debt strategies can be seen as attractive on a relative basis compared to low corporate and government bond yield.

Taking a longer view and looking at some of these strategies on an absolute basis and factoring in a more normalised interest rate environment, they may not look as attractive.

"Infrastructure debt is a newer investment strategy, and no one really knows how these structures will perform in a downturn."

This then becomes a problem is you have locked yourself into an investment for several years (sometimes decades) without any real option to get out.

The concept of entering into floating rate investments mitigates some of these issues, but the relative size of your risk premium, i.e. spread, may also be viewed differently several years out into the future.

I would also argue that that the regulatory risks have increased on a global basis, affecting the infrastructure markets.

This is driven by the asset class maturing and the various regulators being more active and watchful that asset owners should all not be extracting excess profits beyond what is reasonable.

"The regulatory risks have increased on a global basis, affecting the infrastructure markets."

In addition, the geopolitical uncertainties that we are seeing around the globe including protectionism and populism will have direct and secondary effects on several infrastructure markets.

For example, a recent development is that the sovereign wealth funds of certain countries are no longer welcome as buyers of certain assets in certain countries.

Generally, this would reduce the competitive attractiveness of such assets and their valuations should be lower since the buyer universe is more limited than otherwise.

It is hard to see that such developments were priced into historical deals and that similar future developments will be factored into the pricing of today’s deals.

This interview originally appeared in the research report Investing in Alternatives, 2019. You can download the full report here.

 

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