NEWS

Interview by Muskan Arora

Laura Wickström recently got promoted to the role of CIO of Veritas Pension Insurance, Finland-based pension. In this conversation she dives deeper into the real estate allocation and emphasizes sustainability and climate investing as key while vetting managers.

Muskan Arora: Under your leadership, what are a few changes that you plan to make in the next two years and why? Will you be taking things in a different direction or roll with what's been happening with the portfolio?

Laura Wickström: No big changes in the big picture as it is. We are regulated and the solvency regulation includes the main restrictions and the risk level we are able to maintain. I think the focus will be more on efficiency. We're trying to do internally more to achieve some of those efficiencies as well as then look at critically some of the more alternative asset classes. If there are some things that we could do more efficiently, that's one thing that we're going to focus on.

Arora: With AI and technology growing, have your allocations to climate and sustainability changed?

Wickström: I think that our approach to climate and sustainability has been always more from the bottom up. We don't have separate allocation to climate or sustainable strategies or an impact portfolio as such. How we include sustainability is in our bottom-up process when it comes to the external managers as well as direct investments. Sustainability is one criterion that we use in the manager selection process.

We have a systematic way of analyzing and collecting information on how the managers are positioned, what comes to sustainability and climate is one of the subsets there. What then comes to direct investments, we use different data sources for the underlying investments and companies to analyze how these direct investments score in terms of sustainability or climate.

Technology or AI are tools for us to use to get efficiency and data from either the underlying managers or investments. Hopefully, those type of advancements in technology and AI will help us with access to more data and information, with analyzing larger datasets, what comes to sustainability and why not even climate-related questions regarding the external managers and our direct investment. That's how it comes to play, but it's more of a bottom-up process than a top-down process at least for now with those sustainability and climate questions.

The bottom-up process affects all of our investment decisions, so it's integrated with the investment decision regarding our manager selection, so our external managers and fund investments as well as direct investments, as opposed to having a earmarked position or an allocation to impact investments as such.

Arora: In the current environment, through which asset class do you think investing in ESG and sustainability would be most beneficial and why? Also, if you could highlight a few strategies, you are adopting there.

Wickström: We don’t have a earmarked allocation to those strategies, but one exception is our infrastructure portfolio. We have mainly dedicated that allocation to renewable energy. That would be one example of where we see that sustainability, maybe climate-related investments in the form of renewable energy investments, has provided a good investment opportunity and also, at the same time, we are able to provide capital to actually impact production of more sustainable energy sources. That I think is a concrete example of more of an impact-related allocation.

I think the private market in general provides more opportunities to influence the underlying companies and as an investor to have an impact more directly to the underlying companies. Although we tend to invest through funds, but especially buyout funds hold a control position in companies, and they can have significant impact in these underlying portfolio companies. That is another example of an asset class where we see that there is a possibility of having a positive impact, even though you wouldn't just label the strategies as impact investments.

Arora: Within infrastructure, would love to know what strategies do you find interesting to invest in renewables through infrastructure? Sectors and strategies there.

Wickström: Mainly what we have is renewable energy. That's different energy-related operational assets or then development projects around that. For example, solar and wind, both in Finland and globally focusing a little bit more on emerging markets where in many cases they are building new energy infrastructure and starting with renewable energy as the first source of energy. It's very important for those communities and countries to have a working energy infrastructure system, but also at the same time to ensure it is environmentally sustainable.

We have existing fund investments that are both in the harvesting and then new investment mode. It's an ongoing allocation that we already have had for a while, and some of the investments are exciting and then some of them are in deploying new capital. We are not increasing that allocation as it's already quite a stable and mature portfolio, but we're keeping that allocation and adding commitments to uphold the current allocation.

Arora: In your return report, you highlighted that returns within your fixed-income sleeves are driven by credit risk investments. Could you dive deeper into the type of strategies and sectors you look at in space?

Wickström: Opportunistic the sense that the funds and managers that we have are those that are able to move within different classes of fixed income as it's quite a broad asset class. We appreciate the flexibility and understanding of different fixed-income instrument types and the possibility to allocate between them as the investment landscape changes.

I think that there are many inefficiencies in fixed income that create opportunities for those that are able to understand, analyze and invest in them. I think that our approach to fixed income is weighing on a little bit more opportunistic approach and for the manager skill to be able to take advantage of different type of inefficiencies within the fixed income investment universe.

Arora: How do you see things changing within the current and the future interest rate environment?

Wickström: The market’s focus has shifted from inflation to growth. The main question is if a recession is coming at some point. For fixed income this provides a change in the investment opportunity. The difference I guess now is that government bonds provide diversification benefits as opposed to the previous time when equities and bonds moved in the same direction. There is room for interest rates to come down and better return potential for government bonds going forward if economic growth slows down more materially.

Fixed income and government bonds, at this stage, can provide diversification, which is quite a different scenario that we had compared to, for example, Year 2022 where both equities and bonds had negative returns. That dynamic with the bonds’ providing diversification is helpful for a portfolio investor compared to the previous years.

Arora: In your private market investments, what does risk look like for you?

Wickström: I think that, as we invest through funds in the private markets and private equity, we have found that the risk-return relationship is not as linear as it is may be on the liquid market as there is some performance persistence in the private markets what comes to certain high quality managers, it also manifests itself as a lower risk level such that the managers that are of high quality are able to control the risks better and achieve better returns consistently.

There is maybe a little bit less volatility between the returns of the portfolio companies they own. That's an important aspect as we try to analyze and select managers on the private market side so that we're able to find those managers that can achieve consistent returns through risk management and controlling the risks in a way that enables them to achieve consistent, good risk-adjusted returns.

Arora: Through which asset class would you say investing in this environment is a little riskier? In the US, for most allocators, it is private credit because of all the things that are happening with banks and interest rates. Where would you say that risk for you, within investing, lies?

Wickström: That's a good question. I think that, as the spreads are relatively tight on the credit side, maybe the return comes more from the interest rate component when it comes to corporate credit, for example. Then if you have a view on interest rates, it might be better manifested through just pure interest rate investments rather than taking on too much spread risk. There is less upside spread return potential compared to the average from these levels, but if we are not entering a recession the higher yields are attractive from a running yield perspective.

Most of the fixed income return came from the credit spread tightening on the first half of the year and the second half of the year might be different.

Arora: Which asset class do you think will, from here on, drive the most returns, and where, if you could dive a little deeper into the specifics of sub-strategies and sectors depth?

Wickström: Our allocation is based on long-term return potential and in the long term, listed equities and private equity have a higher return potential.

Then depending on the view regarding recession and the growth dynamic is, how risky you see the listed equity going forward and if you want to tactically underweight or overweight equities. I think the focus will then be on the diversification of the portfolio and the ability for the portfolio to withstand different types of volatility spikes or shocks that might happen in the change in growth expectations.

The focus on the portfolio construction is to consider different types of scenarios. Then test the robustness of the portfolio so that we're able to withstand different types of shocks if those happen.

Arora: Could you highlight a few red and green flags you look for in managers?

Wickström: We have a systemized questionnaire that we send to the managers and then evaluate the managers. That is both for private and public markets regarding sustainability, climate, et cetera. That's how we try to get a systematic view of each of the managers that we invest in. That way we can follow the progress of the manager in those issues. We send that questionnaire out annually to the existing managers as well and that way we see how those issues develop within the investments that we have.

There are differences between the level of how the managers perform on ESG related issues geographically. For us it's not a requirement that everyone should score a perfect score on the questionnaire, but the point is that we need to be aware of how all of the ESG issues are handled by the fund manager, and that we are able to monitor the development.

The final investment decision is made based on this information and also on other findings that we get from our due diligence process. ESG is one aspect of the process, and the final investment decision relies upon the full due diligence evaluation which includes a full investment and operational due diligence.

A definite red flag, as an example, would be fraud or those types of things, especially governance issues which I think, when investing through external managers, are the main thing that we are able to rely on.

If there are any reasons to worry that the corporate governance side of the fund manager doesn't hold proper checks and balances, or if there is evidence of some breaking of best practice standards, that would be an example of a red flag.

Arora: In the current environment, what kind of trends within your private market portfolio are you seeing growing, and what are you most excited about?

Wickström: I think that we've used the opportunity as it's been quite a difficult fundraising environment, as we all know, for private markets, even though the return history has been good, but since most of the investor base has maybe been a little bit more overextended in that asset class and the fund raises have increased, that we've taken the opportunity to really focus on the fund manager quality as there has been good quality managers available for investment as it's been more difficult to get the funds fundraising wrapped.

That's been the focus for us is to just really focus on the manager quality first and then as a secondary then thinking of different strategies and sectors of the market. That's how we positioned ourselves as we can commit to new managers that this would be a good opportunity to build long-term relationships with high-quality managers.

Arora: Your real estate returns are a little low. Will you change the way you invest for the rest of the year? How would investments for this year and the next year look for you in the way of, like, what strategies, what sectors would you be investing in now?

Wickström: I think that the real estate investment horizon is much longer than one year, and the illiquidity makes any short-term changes or allocation adjustments impossible. Everything must be long-term related. Although the return last year and this year was low, I think that it's more of a reflection of the general market situation than really related to our investment specifically.

Then to put it into context, we have had quite good historical returns from the real estate investments. We've been quite satisfied with the long-term returns.

There haven’t been any major changes and probably this market wouldn't be the right market to really start changing the allocation quite drastically as the market conditions are not most favorable to do larger transactions, and the pricing isn't maybe where we would like it to be.

Arora: Absolutely. I would love to pick that question that you just asked. If given a choice, would you start investing in real estate in this environment? If you were to invest for the first time.

Wickström: Has the return requirement adjusted as much as it should to make that asset class appealing in the current interest rate environment, maybe not. There is that element of a smoothing factor that probably the interest rate environment that we're now in isn't currently fully reflected in the real estate valuations and the premium above the risk-free rate is on the lower end historically, but at the same time then again the central banks are cutting interest rates and that will make the current pricing more appealing again going forward.

This is a slow-moving asset class with the valuation having a certain amount of autocorrelation both ways.