Jonathan Bailey, Director of Research at FCLT Global, speaks to Carsten Stendevad about what it takes to build a long-term oriented investment organization.

Carsten Stendevad is CEO of ATP, one of Europe’s largest pension plans with 5 million members and $120bn in assets.  Under his leadership since April 2013, ATP has fundamentally redesigned its investment strategy and expanded its direct investment capability, delivering strong investment returns. ATP has also tripled the size of its benefit processing business, while substantially reducing operating costs. Carsten announced that he will step down from his role at the end of 2016.

JB: So, Carsten, what was attractive about the CEO role at ATP?

CS: I was working in New York at the time, and ATP, as a mandatory savings scheme for all Danes, has a known track record for an innovative approach towards investing. It represented the dream job for any Dane with an interest in investment! I felt that ATP had clear comparative advantages – scale, a risk-based approach to asset allocation, and permanent capital. It was well capitalized and had a well-functioning board.

JB: It sounds like you had a strong foundation to build on when you arrived at ATP. What were your initial priorities?

CS: There is this joke that when you become the CEO of a pension plan you are given a standard set of speaking notes about the benefits of being a long-term capital owner. Indeed, this ought to be a significant driver of value but in practice most pension plans have failed to take advantage of this. So early on I set out to ensure that we would capture the benefits of permanent capital, rather than trading it away through the wrong short-term strategies, or delegating it to external managers who could disproportionately capture the benefit.

A New York investment banker once told me “ATP’s challenge is to stay rich, not get rich”. Being long-term is more about downside prevention for us, which is different to many public pension plans who are underfunded and need to try and fill that gap. ATP has the flexibility to weather periods of weaker returns if it will help us generate stronger longer-term performance. More practically our approach was:

1. Introduce an absolute long term return target.

2. Institutionalize the risk-based investment approach throughout our investment processes from portfolio construction, hurdle rates, relative investment decisions, and performance management.

3. Have a clear and consistent external communication strategy, stressing that a long-term approach will create both economic and social value, but means being exposed to risk premia ahead of the rest of the market. Incidentally, when the rest of the market chases risk premia, it is usually late!

4. Increase exposure to illiquids, thinking carefully about when closed end funds made sense. For example, ATP had several excellent cash yielding assets inside infrastructure funds that we would have liked to own forever. But because we had invested via a fund, the manager had to sell and we ended up with strong realized gains whereas in fact we would have preferred to retain the cash yielding assets. We increasingly went direct – in real estate, for example, we moved from approximately 2/3 real estate investments in funds to 2/3 direct, gaining greater control of our assets.

“Our approach was to introduce an absolute returns target, build portfolio construction top down, have a clear and consistent communications strategy and increase exposure to illiquids.”

JB: How do you think about measuring long-term performance?

CS: I think about it like a pilot’s dashboard – you need a big dial with the long-term return target which is what you are primarily focused on, but you also need lots of small dials to manage day-to-day.

The benefit of a short-term approach is that it is “easy to measure”, but if the benchmark is inappropriate or inaccurate you may be measuring to the wrong thing. An absolute return target is much more relevant and appropriate, but harder to use to measure individual performance. I think of it as a 2×2 of ease versus relevance. The question is, how you can get the right long-term behaviors when using a long-term benchmark?

During my tenure, we changed our core pension product – this will have no impact for a decade, but should better position us for the next 50 years. We also made several changes to our hedging approach which enabled us to reduce the amount of fixed income assets used in our hedging and instead increase the number of real assets used. The effect of these changes is barely visible in the short term, but over 20-30 years, the impact will be substantial. If we had only looked to the short/medium term, we would not have bothered with these changes. But I believe these changes make long term sense for our members. They also give us several more immediate investment benefits because we can take advantage of market opportunities that may take some time to play out – something that most hedge funds and traditional asset managers could not do.

JB: How did the Focusing Capital on the Long Term (FCLT) initiative help?

CS: We had been thinking about ways to make our approach practical, and the FCLT initiative allowed us to compare notes with peers. In one of the early meetings I looked around and there were perhaps eight people representing $5 trillion or so in assets. This was not a disenfranchised group – we have the means to take a long-term approach under our own control! Asset owners have a responsibility to their savers and beneficiaries to take a long-term approach. Asset managers want to build and maintain profitable business models, and they will adapt if asset owners as a group push them to.

JB: Tell me more about the board – how does it support you and your investment team?

CS: Clearly, having a good mix of competences, with a strong dose of financial expertise is key and early in my tenure there were three financial experts added to the board. But a good board needs to have more than just investment expertise – it needs to have decision making expertise. Boards can become risk averse and avoid making decisions which can be just as harmful. Decision impotence is the biggest threat to the fund.

Markets are always changing so the board also needs to be ready to shift and update its approach. For example, in the early 2000s, ALM analyses made it clear that most plans were carrying an outsized risk of not hedging interest rate risk. I would guess that most boards of global pension plans saw some version of those analyses, yet only few global pension plans acted on this!

JB: What did you find more challenging during your time at ATP?

CS: The market for talent is highly competitive, and without talent it is hard to outperform. Fortunately, ATP operates on market terms and is thus able to attract strong talent locally but Denmark is a small country and there is thus a limit to how big an investment team one can build in-house. Even in areas where we might have scale to theoretically build in-house capabilities, we may still choose an outsourced solution – for example it would be hard to persuade ourselves that we could build a world-class direct investing team in emerging market infrastructure.

JB: Integrating sustainability factors has been a big topic for institutional investors in recent years. How did you think about sustainability at ATP?

CS: We think of a range of risk factors when we consider both our individual investments and our entire portfolio. We don’t have the capabilities to do thematic investing, but we do think about factors broadly, including ESG as fiduciary duty requires us to consider it, both in law and practice. Short-termism is the biggest enemy of ESG!

We try to integrate ESG deeply into our investment decision making process. We look at quality. For example, if we are buying a forest we will look at the climate-related risks of drought and any mitigating factors. All of this is clearly more material when you are taking a five year or more horizon as opposed to a three month one. We also spent a lot of time working on strengthening engagement and corporate governance in Denmark – including helping develop a new Stewardship code laying out the responsibilities for asset owners and asset managers in engaging with companies. We are clear that our approach to incorporating ESG factors must never sacrifice returns. We would never trade return for a better ESG profile – in fact, it would be a violation of the ATP act. So, the art is how to both get strong returns while also having a strong ESG practice. It is a balancing act, but I feel good about the way we have been able to deliver strong returns with a strong ESG profile.

“Being long-term ought to be a significant driver of value but in practice most pension plans have failed to take advantage of this.”

JB: Thinking beyond ATP, what is the biggest challenge to building a more long-term oriented capital market?

CS: The move towards defined contribution systems like the American 401k system is potentially a big obstacle to tilting the overall market to the long-term. There is immense performance pressure on a year-to-year basis in that market – people are rebalancing based on what performed well the previous year which is a very bad way to allocate assets. Even with all the advantages that ATP has, we would struggle to act long-term in that context!