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Invest like a mega fund

We look inside the world's biggest funds to find out what lessons private investors can learn
Invest like a mega fund

Here at Investors Chronicle we’ve covered big tech, large-caps and income majors. This time, we’ve decided to go mega – mega-funds to be precise. Typically valued at over $5bn (£4bn), these investment behemoths wield significant influence in the financial markets. For sovereign wealth funds alone, their assets under management reached a staggering $8.1 trillion in 2018 and on average they own 5 per cent of all globally listed equities. Little wonder, then, that big capital has earned a reputation of being faceless and herd-like.

But some of the largest, most powerful and indeed most interesting of these investment vehicles stand out from their fellow leviathans. We have selected four of the more unique mega-funds to see what ordinary investors can learn from a church, a university, the world’s largest sovereign wealth fund and a Japanese billionaire. Over the ensuing pages, our writers will appraise the investment philosophies, portfolio composition, holdings and performance of four diverse mega-funds – the Church of England (CoE) investment fund, the Harvard University endowment, Norway’s Government Pension Fund Global (GPFG) and SoftBank’s $100bn Vision Fund. We aim to answer two key questions – what can ordinary investors learn from mega-funds and how easy is it to mirror their portfolios?

Upon first glance, comparing multi-billion-pound funds and the comparatively modest portfolios of private investors may seem ludicrous. Indeed, at the most basic level, it is often impractical for individual investors to copy the exact behaviour of mega-funds. Investment strategies such as venture capital and leveraged buyouts are not exactly available to the masses. It is doubtful that many people could afford to mimic the Vision Fund’s $100m minimum on its investments. But even without the same eye-watering levels of capital, there are valuable lessons to be gleaned from the shared behaviours these very different mega-funds display.

Before looking at the investment giants in turn, we have identified three common themes:

First, all the mega-funds being examined have a long-term investment horizon. Norway’s £868bn GPFG aims to secure “wealth for future generations”, Harvard’s $39.2bn endowment is a permanent source of funding for the university and the CoE’s £8.2bn fund is “managed in perpetuity”. Even the relatively junior Vision Fund imagines sustaining an artificial intelligence ecosystem for over 300 years. While a three-century plan is perhaps excessive for the ordinary investor, it is clear those with deep coffers are less concerned with short-term market fluctuations, instead focusing on generating healthy long-term returns.

Second, the longevity of these mega-funds relies on the diversification of assets. All the funds we will be looking at (bar the Vision Fund) involve some combination of equities, real assets and fixed income. While the different asset classes are more difficult to mimic, some of their investments will be very familiar to private investors.

Mega-funds typically seek international exposure to avoid home bias. However, if you wish to give your portfolio an Ivy League education, one of Harvard’s top holdings, the iShares Core S&P 500 UCITS ETF (CSP1) was recently featured as one of our top 50 ETF picks for 2019.

Third, ethical investing appears to be playing an increasingly important (if not questionably successful) role – mega-funds cannot afford to ignore major disruptors such as climate change. But as you will discover, the difficulty is striking the right balance between exclusion and active engagement. After all, the companies that ‘do good’ are not necessarily the ones that ‘do well’.

Some of the mega-funds discussed will be more immediately accessible than others. In seeking to emulate these multi-billion-pound success stories on a more humble scale, it is worth bearing in mind these overarching strategies as a starting point.

 

The sovereign wealth fund

Visit the website of the Norwegian government pension fund, and you will be confronted by a headache-inducing flurry of moving digits. The GPFG is managed by Norges Investment Bank on behalf of the Norwegian government’s ministry of finance, which it owns in turn on behalf of the Norwegian people. The ministry regularly transfers Norway’s oil revenues into the fund’s capital, and also invests abroad to shield the fund from oil price volatility. It is currently valued at around 9,385bn Norwegian kroner (£868bn). Beneath its dizzying valuation, the fund’s mission statement simply reads: “We work to safeguard and build financial wealth for future generations.”

Founded in 1990, the fund’s title is a misnomer. It has no formal pension liabilities, and no political decision has ever been made as to when the fund may be used to cover future pension costs. It focuses primarily on equity investment, with stakes in 9,158 companies, although it is also invested in fixed income and a smattering of unlisted real estate. Along with its size, the Norwegian government pension fund is known around the world for what it chooses not to invest in. 

Tobacco companies, weapons manufacturers and fossil fuel giants sit on a naughty step that includes London-listed British American Tobacco (BATS), BAE Systems (BA.) and Drax (DRX). The fund has a history of revoking these exclusions when companies meet its standards. For example, in June it lifted its 2008 exclusion of Rio Tinto (RIO), which had been based on a risk assessment of “severe environmental damage” related to the Grasberg mine in Indonesia. Rio Tinto’s exclusion was revoked after it informed the fund’s Council of Ethics that it had signed an agreement to sell its interest in the mine.

The fund’s investment philosophy reflects both its scale and its limited short-term liquidity requirements, in that it does not anticipate any sizeable withdrawals. By its own admission, some of its divestments have not come without a cost to Norwegian citizens. The fund’s value actually fell year on year in 2018 after over 20 years of consistent growth. With an overall return of -6.1 per cent last year, it accepted that “product-based exclusions had reduced the cumulative return on the equity reference index by around 1.8 percentage points, or 0.07 percentage points annually”. The fund added that “the exclusion of weapons manufacturers and tobacco companies have contributed to the reduced return”. An Investors Chronicle reader would probably settle for its 10-year annual return of 8.3 per cent, though, while its equities returned 12.2 per cent in the first quarter of 2019. But the fund has cautioned that “we should not expect this return to be repeated in the coming decade”.

What might an investor learn from the Norwegian government pension fund? Not a lot, according to a fund spokesperson, who said that the fund’s size and timescale “gives us a very different starting point than most private investors”. While its product-based exclusions hurt the fund last year, divestments based on conduct have actually improved the fund’s return by around 0.7 percentage points, or 0.03 percentage points annually. A helpful policy then, but not something that has exactly put the afterburners on performance. Not that the GPFG’s performance is to be smirked at, given that it has gone from Nkr172bn kroner in 1998 to its present level of around Nkr9,385bn at the time of writing, an increase of 5,356 per cent. But if investors are to usefully apply the fund’s practices to their own portfolios, they will likely need a trillion pounds, government backing, copious amounts of oil on their doorstep and immortality. AJ

 

The church 

The nominal head of this fund would have far more horse racing tips than investment strategies, so we have to turn to her second in command, the Archbishop of Canterbury, for guidance. 

Justin Welby wrote in his foreword in the CoE's Church Commissioners Annual Report for 2018 that there was a key issue now driving those managing the £8.2bn investment fund (separate from the church’s pensions scheme). “The urgency of climate change continued to be a major theme for the commissioners as they continued to use engagement and their voting rights with some of the world’s largest oil and gas suppliers to drive change,” he said. 

The practical outcome of this is that the CoE will start to sell companies “not taking seriously their responsibilities to assist with the transition to a low-carbon economy” from next year. On the resources side, tar sand oil extractors and thermal coal miners are already excluded,  alongside gambling, tobacco, alcohol, weapons and payday lending companies. 

For the rest it has an inside-the-tent approach, similar to fellow Climate Action 100+ signatory Legal & General Investment Management. In its 2018 annual report, the fund said it had divested £9m from oil and gas companies that have not met its climate standards, equivalent to £125 from a £10,000 portfolio if looking at the CoE’s UK equities holdings. That part of the portfolio (8.8 per cent of the £8.2bn total holding) includes shares in Glencore (GLEN), Anglo American (AAL), Rio Tinto, Royal Dutch Shell (RDSB) and BP (BP.), identified through the commissioners’ activism. 

The global portfolio also includes ExxonMobil (US:XOM). At the end of 2017, just 4.48 per cent of the portfolio was integrated oil and gas companies, and as of 31 December 2018, Shell and BP are in the top 20 largest holdings alongside portfolio stalwarts such as Alphabet (US:GOOGL) and GlaxoSmithKline (GSK). Companies that do not align with the Paris climate agreement goals will be sold off from 2023, a policy announced last year. 

Sometimes the climate focus can overshadow the fund’s real aim, to generate cash. The goal is 5 per cent plus inflation (retail price index) per year in returns. It had a big miss last year with a return of 1.8 per cent, compared with 7.1 per cent in 2017. First Church Estates Commissioner Loretta Minghella, who represents the church commissioners in the General Synod, said this had to be read with the FTSE 100’s 12.5 per cent fall over 2018 in mind, with the defensive equities portfolio (8.1 per cent of assets) holding its value. The three-year return is 8.5 per cent, and in the past 10 years the fund has managed 9.6 per cent. There are a few strings to the church’s bow unavailable to single investors: its commercial, agricultural and residential property portfolio, private equity investments and all the usual advantages of holding big stakes in companies, such as private and public engagement over strategies you don’t like. 

The conclusion here is that diversification is good in a difficult market and change is slow if a fund working to slow climate change still holds Exxon stocks. The church commissioners’ total assets under management “invested in low carbon and climate resilient portfolios, funds, strategies and asset classes” totals a paltry £344m, 4.2 per cent of holdings. And the majority of this (£295m) is the “sustainable” forestry portfolio. 

Nonetheless, Ms Minghella said the ethical investing practices had improved the performance of the global and UK equities divisions by 0.6 per cent and 1.8 per cent, respectively.  This is not to be sniffed at. When investing like the CoE commissioners, aim for the companies it will still hold in 2024. AH

 

The futurist

In its own words, Softbank (JPN:9984) is “an internet-based innovator operating a wide range of sector-leading businesses”. The group was set up by Masayoshi Son in Japan in 1981, and listed on the Tokyo Stock Exchange in 1998. It is “looking to the next 30 years and beyond with a vision for innovation and growth”.

The SoftBank Vision Fund ostensibly exemplifies this focus. First announced in October 2016, the fund is backed by the Public Investment Fund of the Kingdom of Saudi Arabia (PIF) and the United Arab Emirates’ Mubadala Investment Company, along with other investors. As outlined at the time of its first major closing in May 2017, it targets “meaningful, long-term investments in companies and foundational platform businesses that seek to enable the next age of innovation”. 

SoftBank’s results presentation for the year to March 2019 revealed that the Vision Fund had almost $100bn of committed capital. And its net equity saw an internal rate of return (IRR) of 45 per cent (after fees). Including preferred equity, net “blended” IRR still came in at 29 per cent. 

Meanwhile, as of May, the fund comprised 82 companies (including investments and the pipeline for upcoming investments). Its holdings span areas such as fintech (financial technology), health tech, transportation and logistics. Within these categories, one can find the likes of chipmaker Arm, food delivery business DoorDash and robotic process automation (RPA) company Automation Anywhere.

So far, so interesting. However, UK retail shareholders can’t invest in the private Vision Fund. And, such are the nature of its investments that it would arguably prove challenging to mirror them in one’s portfolio. 

Is that such a bad thing, given the risks at play? Tech can be an inherently speculative investment. And there’s an argument that ploughing money into a late-stage start-up could create a bubble of sorts – leading companies to seem more valuable than they would be in other environments. 

When Uber (US:UBER) – a Vision Fund investment – floated in New York earlier this year, the shares made a lacklustre debut. Now, they trade slightly below their IPO price ($45) – perhaps indicating that unicorns (non-public businesses valued at over $1bn) don’t necessarily translate into stock market darlings. Particularly, one might imagine, if they’re lossmaking. 

That all said, for those willing and able to take a punt, the Vision Fund throws up a number of themes that constitute serious bets on how the world is evolving. Ride-hailing apps might not be everyone’s bag, but there are ‘pick and shovel’ options that one could consider. Within the IC’s recent ‘Hidden tech gems’ feature, we touched briefly on Twilio (US:TWLO), the (albeit unprofitable) cloud communications platform, which has facilitated driver-passenger interaction and updates for both Uber and Lyft (US:RIDE).

Meanwhile, on the RPA front, Blue Prism (PRSM) is a UK-listed competitor of Automation Anywhere. The group’s revenues have grown rapidly, but investment in sales and marketing and product development have driven widening losses

WeWork – another Vision Fund investment – represents the trend towards shared work spaces. We learnt this year that the company (known officially as The We Company) has confidentially submitted documents to the US’s Securities and Exchange Commission (SEC) pertaining to an IPO. As with RPA, UK investors could consider other routes into the flexible workplace opportunity. For example, cloud computing can enable employees to work flexibly, collaborating on tasks remotely. Iomart (IOM) offers just one example in this space.

In any case, the Vision Fund is certainly one to watch. Or, rather two to watch. Indeed, at the time of writing, SoftBank had just unveiled plans for the SoftBank Vision Fund 2 – a new private investment vehicle. It explains that the fund’s goal is to “facilitate the continued acceleration of the AI [artificial intelligence] revolution through investment in market-leading, tech-enabled growth companies”. 

As things stand, the total expected contribution of capital to the fund has reached around $108bn. SoftBank itself intends to invest $38bn – up from the $28bn it invested in the first fund. Expected participants in the sequel fund include (among others) tech giant Apple (US:AAPL) – an investor in the original fund – IC buy tip Microsoft (US:MSFT) and Standard Chartered (STAN). For now, the Saudi Arabian PIF and the UAE’s Mubadala vehicle have not been cited as expected participants. HC

 

The university

Harvard’s endowment fund is the university’s largest financial asset and the largest university endowment fund in the world. Since 1974 it has been managed by Harvard Management Company (HMC) and is designed to produce long-term income to fund teaching and research. The endowment is made up of more than 13,000 individual funds that invest as a single entity, with the two largest categories of funds supporting faculty and students, including professorships and financial aid for undergraduates, graduate fellowships, and student life and activities.

HMC says its “generalist investment model breaks down silos among asset classes” to generate the most attractive risk-adjusted returns. In practice it invests across eight asset classes or themes, including private equity, hedge funds and publicly listed companies, with the former two accounting for more than half of the fund’s assets. 

However, the endowment fund’s performance has lagged peers in recent years. In 2016 – the year it recorded a five-year return of 5.9 per cent, behind a long-term goal of 8 per cent – HMC hired NP Narvekar as chief executive to instigate a five-year overhaul of the investment office. HMC – which had faced criticism for paying investment professionals more than peers despite underperforming – plans to lay off half of the fund’s internal investment staff, to hire external asset managers and to tie bonuses to overall performance rather than the asset class in which staff specialise. Mr Narvekar also shifted away from making direct investments in real estate – transferring responsibility to Bain Capital – and using hedge fund strategies in-house. 

While the fund’s natural resources, real assets and private debt investments weighed on performance last year, there was an improvement on prior years. In 2018 it returned 10 per cent, taking the value of the fund to $39.2bn. That was the first time its nominal peak value had exceeded the $36.9bn realised in 2008, but it was still behind Ivy League peers including MIT and the University of Virginia. “While we are not pleased with this performance, we are mindful that ours is an organization and a portfolio in transition,” said Mr Narvekar at the time, also emphasising the long-term investment horizon of the fund. 

Is there much retail investors can learn from the Harvard behemoth? The scale amassed by Harvard Endowment Fund allows it to invest directly in private equity and agriculture in a way that is far out of reach for the average UK retail investor, as well as exert activist pressure within the companies it puts its cash behind. Likewise, the team of internal and external professionals on its payroll gives it the ability to scope out potential investments in a far more granular way than the average investor might. Similar to some other mega-funds, perhaps the only lesson to be learned from Harvard’s endowment for retail investors is that of diversification and balancing risk levels, if not by investing directly in the underlying asset, then in actively managed funds that can also provide access to more illiquid investments. EP