When leaders of large institutional investors aren’t kept up at night worrying about systemic risk, they dream of emerging markets.
At the 2010 International Corporate Governance Network conference in Toronto on Tuesday, a panel of powerful investors discussed valuation, opportunity and what strikes fear into their hearts.
Risk
David Denison, president and CEO of the Canada Pension Plan Investment Board (CPPIB), explained that systemic risk poses the greatest challenge to his organization for two reasons. It is extremely difficult to predict and prepare for systemic risk, and it cannot be hedged through diversification.
“Of course, we try to have mechanisms and procedures to forecast causes and signs of systemic risk, but we don’t believe that we should rely purely on prediction,” he said. “What we do is pay very close attention to how we construct our portfolio—particularly the liquidity elements.”
In designing his organization’s portfolio, he draws inspiration from aeronautical engineers to build in tolerances for bumpy markets. “We don’t assume we’ll stay on the runway in periods of turbulence or find a flight path to conveniently avoid it,” he said. “We’ve got to fly through it and come out the other end.”
For Scott Evans, president and CEO of TIAA-CREF Investment Management, USA, the main concern is risk concentration and due diligence.
He explained that his organization has an independent risk management group that reports directly to the global CEO, which ensures a smooth internal governance system. “They spend their days and nights scanning the skies for turbulent weather,” he said. “We have constant agitation and discussions that make our days uncomfortable so we can sleep at night knowing that the risks of our beneficiaries have been well researched and vetted.”
Opportunities
With the global economy still showing signs of weakness, institutional investors are walking a tightrope between protecting their assets and seizing upon favourable conditions where they appear. With Europe on shaky ground and North America mired in slow growth for the foreseeable future, many organizations are looking to emerging markets as the next fertile landscape. For the CPPIB, the big bet is on China as the fund builds its infrastructure there in anticipation of future deals.
“We are very keen to develop our capabilities, even prior to the existence of opportunities,” said Denison. “That’s certainly been the case for us in China. Accessing real estate investments and private equity investments for us is tough to do, but we’re willing to be there now with the belief that in five or 10 years it will be much more plentiful.”
Denison lauded the ability of many emerging market nations to weather the recent financial crisis, which he attributes to progress in the development of their financial systems.
Evans was blunt in his assessment of this area.
“They’re not important to the future; they are the future,” he said. “However, we have to realize that many of these markets—such as China—have entirely different systems than we’re used to.” He explained that on issues ranging from shareholder rights to engagement with policy-makers, investors must adapt their procedures just as they would when engaging in cross-Atlantic deals.