The outlook for institutional investors may be gloomy, with the global economy in recession and interest rates stuck at extremely low levels.
- Healthcare funds are offering innovative solutions
- The impact investing community has been particularly active
- New issuance of sovereign debt can help towards COVID-19 objectives
The threat of further national lockdowns to battle a potential surge of COVID-19 cases adds to the economic uncertainty and financial market volatility. However, institutional portfolios seem prepared to face the challenge. The quick recovery that followed this year’s unprecedented market crash shows their underlying strength.
Cynical as it may sound, the COVID-19 crisis has created a plethora of opportunities for institutional investors that go beyond buying undervalued assets. There is huge demand for capital to finance the global recovery from the pandemic. Whether investment is needed to speed up the production of a vaccine, strengthen healthcare systems or help businesses through the difficult months that lie ahead, investors can actively participate in the global efforts to battle COVID-19. Some are already doing so, without sacrificing their existing investment objectives.
1. Innovation in healthcare
Investing in healthcare-focused funds may be the most obvious way to earn financial returns and win battles against COVID-19 at the same time. But that is easier said than done, given the hundreds of funds to choose from. Furthermore, the performances of global healthcare indices so far this year are mixed, with European indices severely lagging behind US ones (figures 1 &2).
But there are some standout performers among healthcare funds. Baillie Gifford’s Worldwide Health Innovation fund returned 44.4% between the start of 2020 to mid-September. The fund focuses on high-growth companies targeting innovations in healthcare. It was launched in 2018, with seed money from Guy’s and St Thomas’ Charity, a large UK health foundation.
The fund’s portfolio manager, Julia Angeles, says: “This strategy was shaped long before COVID-19. We were not predicting the pandemic, but we believed that health systems around the world had to change. Even in developed countries, healthcare systems are mainly reactive, rather than proactive, and inefficient. This was true before COVID-19, but the pandemic has brought all this to the forefront.
“Today, healthcare systems can change radically. Thanks to innovations in biological data-gathering techniques and progress in the areas of artificial intelligence and machine learning, it is now possible to derive useful new insights from genomics data. At the same time, we are seeing the emergence of new ways to treat the underlying causes of diseases, from gene therapy to gene editing.”
She adds: “We invest in the companies that can enable change in those areas. Our firm generally focuses on disruptive businesses, asking ourselves what changes our investee companies can bring to society.”
Baillie Gifford has been an investor in some of the fund’s holdings for long before the strategy was launched. One example is Illumina, a company engaged in genomic sequencing, which has been among the firm’s holdings for more than a decade, says Angeles. “It is one of the investments that has helped us appreciate the pace of change in this sector and the related opportunities it creates.
“If you map out the strategy in terms of growth and market capitalisation of the companies we are investing in, it is a genuine outlier, because it generally focuses on higher-growth companies. We do not hold any large pharmaceutical companies, and we are unlikely to hold them because, at the moment, we do not see them as the source of transformational change in the sector.”
The fund also invests in stocks that are not constituents of healthcare indexes, as long as their products or services can have an impact on innovation in healthcare.
In terms of direct COVID-19 impact, the fund invests in US-based Moderna, one of the leading companies working on a COVID-19 vaccine. It is the first company that started clinical trials on humans, weeks after a blueprint of the virus was made available. Moderna’s approach to drug development is based on messenger RNA, which can be likened to the ‘software’ that is read by cells to develop proteins.
The Baillie Gifford Worldwide Healthcare Innovation fund is not categorised under the ‘impact’ fund sector. However, Angeles says the company is working to estimate with more granularity what the impact of the fund’s portfolio will be, from the perspective of the UN’s Sustainable Development Goals (SDGs).
At the moment, the firm estimates that 30% of its holdings have a direct COVID-19 impact. Among its holdings, there are several examples of investments that may have significant bearing on the fight against the virus. The fund invests in AMBU, a Danish producer of single-use diagnostic and life-support equipment. It also holds shares in HealthCatalyst, a provider of data and analytics services that, among other things, helps hospitals identify which patients are at higher risk of serious illness and death from COVID-19.
Another standout performer among the healthcare-focused strategies this year is American Century’s Health Impact Strategy. The fund was returning 10.9% net of fees at the end of July. According to its latest quarterly review document, the fund invests in large healthcare stocks such as UnitedHealth Group, Bristol-Myers Squibb and Roche Holdings. However, the fund lists specific impact targets, pursued by investing in high-growth sustainable companies. Among its holdings are small biotechnology companies working on few drugs with potentially high impact, says Jamie Downing, American Century’s global head of institutional distribution.
The firm also offers an Emerging Markets Sustainable Impact Strategy that marries return objectives with SDG impact.
“Not only we can implement ESG and impact strategies in clients’ investment portfolios, but the profits we make go towards helping find cures for diseases around the world ” - Jamie Downing
As an investment management company, American Century provides clients with a two-fold opportunity to contribute to health impacts. It pursues an integrated ESG investment approach and offers. It also returns 40% of its annual dividends to the Kansas City-based Stowers Institute for Medical Research, set up by American Century’s founder Jim Stowers. Although American Century’s ownership is partly controlled by Nomura Asset Management, the research institute is the controlling shareholder. It has received dividends of about $1.6bn (€1.4bn) since 2000, which has funded its research on genetics, its main area of focus.
“When it comes to helping researchers in the medical field, we feel we have an almost unique position, because not only we can implement ESG and impact strategies in clients’ investment portfolios, but the profits we make go towards helping find cures for diseases around the world,” says Downing.
“As it relates specifically to COVID-19, the institute is working with a number of other medical organisations in the US to break down and track the genetic development of COVID-19 ,” he says.
2. Impact investors step up
The impact-investing community has reacted decisively to the crisis, according to Dirk Meuleman, CEO of Phenix Capital, a Dutch consultancy focused on impact and SDG-linked investments.
Meuleman mentions the efforts of the New York-based Global Impact Investing Network (GIIN), which launched the Response, Recovery and Resilience Investing (R3) Coalition in May. The R3 coalition is a project supported by leading global foundations aimed at streamlining impact investing efforts around COVID-19.
“In general, impact investors have been very active,” he says. “A number of impact funds targeting special opportunities have been launched. These funds target specific economic impacts on some of the worst-affected areas and sectors – for instance, SMEs.
Meuleman says that impact funds have adapted their strategies to the COVID-19 emergency in various ways. Among the areas of greater activity are distressed lending, social housing and community lending. Funds are also targeting education, channelling investment towards helping remote learning where it is most needed.
Healthcare has, naturally, been under the spotlight. Meuleman says: “Institutional investors that have active impact mandates tend to be overweight in healthcare, so many of them did pretty well financially in their impact portfolios, relative to their traditional portfolios. I think there is definitely a role for them in addressing the fallout from the crisis.”
More impact capital, however, is needed in a number of neglected areas, says Meuleman. “Emerging markets in particular have faced a flight of capital. There is also a need for capital to develop the supply chain that will deliver the vaccine, once it is developed.
“Large investors can also help a lot towards achieving a fair distribution of the vaccine with their engagement strategies.”
Meuleman says that the impact investing community has managed to mobilise capital towards short-term objectives, but is also conscious of the long-term ones. More importantly, new impact capital has been raised, according to Meuleman. “Overall, I think 2020 will be a transformative year for the impact investing industry,” he says.
Here is a selection of views of leading European pension investors shows a variety of approaches in terms of dealing with the fallout of COVID-19
Carina Silberg, head of corporate governance and sustainability and Peter Lööw, head of responsible investment, Alecta:
Alecta’s main purpose is to create long-term returns for our customers, which also are our owners, being a mutual company, consisting of 2.6m Swedish citizens and 35,000 companies. For many of our customers, we will start to make their payments more than 50 years from now. Their money should, of course, continue to grow during all of this time.
With this very long-term perspective, and our tilt towards Swedish investments, we always have to focus on creating favorable conditions for Swedish companies to grow, and that all parts of the Swedish society are functioning well, in both the short and long perspective. This is central in creating better returns for our customers.
As in all our investments, we assess the overall fundamentals of the business model to ensure long-term viability and where the effect of COVID-19 brings temporary consequences. That is how investments can contribute both to our investment objective and to the recovery post COVID-19.
In this sense, combining investment objectives with the aim of contributing to the fight against COVID-19 is fully in line with our main purpose.
Alecta has helped mostly Swedish companies to survive the current crisis by granting payment deferrals and waiving commitments, in addition to providing comprehensive investment support. For example, since the end of February, we have invested more than SEK 20bn (ˇ1.9bn) in bonds issued by Swedish companies, central government, municipalities and regions. We have also invested more than SEK 3bn in two social bonds targeting developing countries to assist companies, organisations and authorities in these countries to guide them through this crisis.
Christian Börjesson, head of fixed income & FX at AP1:
“We believe EU bonds will play a meaningful role for European fixed-income markets over the next decade. While the schedule for the recovery fund is uncertain, it’s fair to assume that the amount of duration entering the market will create interesting opportunities for fixed-income investors.
From a broader perspective, we believe EU bonds could serve as an interesting alternative to other supranational bonds, as well as to sovereign bonds. The ambitious plan regarding green bonds is also something that we monitor closely. We are currently investigating if EU bonds could fit in our portfolio and if we eventually decide to invest is, as always, a matter of price, risk and alternatives.
Christian Mosel, chief executive officer of ÄVWL:
“Regardless of the current challenges in the context of COVID-19, ÄVWL attaches top priority to achieving at least a net return equal to the actuarial discount rate as specified in the company’s articles of association. Thus, the focus is rather on identifying long-term trends than on reacting towards short-term market conditions.
On the one hand, looking for a vaccine against COVID-19, for example, is more a question of venture capital. Venture capital, though, generally plays a subordinate role for us due to its associated risk-return profile. EU bonds, on the other hand, are unlikely to meet our interest rate requirements.
For a pension fund like us, in the short to medium term, it is less about fighting against COVID-19 itself but more about mitigating adverse developments within our portfolio, for example in retail real estate.
In view of the challenging capital market situation, we continue to strive to pursue a sustainable investment policy, which guarantees that the demands of our beneficiaries can be met in the long term through appropriate diversification, the development of new investment areas and the collection of illiquidity premia.”
Peter Lindegaard, chief investment officer at Industriens Pension:
“We have investments in both biotech companies working on issues related to the fight against the COVID-19 pandemic, as well as in large pharma companies working on vaccines against the pandemic. This includes AstraZeneca and Pfizer.
In addition, we have a lot of investments that support European growth in different ways, including EU bonds, and we will also invest in bonds from the European recovery fund when they become a reality.”
Church Commissioners for England:
This should be thought of not just as a fight against COVID-19 but as a broader issue of supporting healthcare companies and cutting-edge technologies in areas like biotechnology.
Investors provide the funding through venture capital, private equity and listed companies. In addition, many of those companies providing equipment to hospitals and other healthcare settings are also funded by investors through those vehicles described.
Through our investment process we try to support new and innovative companies and in particular firms trying to tackle some of the key longer-term issues facing the world, such as climate change.
Since the COVID-19 pandemic hit, the Commissioners’ Responsible Investment team has discussed relevant related issues during every company engagement. Many of these discussions focus on the treatment of employees, where we seek to ensure that worker safety is being managed appropriately by the company, and that workers who are either sick or unable to be at work due to the need to shield or safeguard shielding family members, receive sick pay.
We have also joined forces with several other institutional investors around the globe, supporting a variety of collaborative engagements efforts, including an investor statement calling on companies to step up as corporate citizens and protect their workforces and communities (spearheaded by Domini Impact Investments, the Interfaith Centre on Corporate Responsibility (ICCR) and the New York City Comptroller’s Office).
3. Helping sovereigns
A less obvious but potentially effective way to fight against the COVID-19 crisis is to invest in debt issued by governments. The lockdowns imposed around the world have had a profoundly negative economic impact, which governments are tackling by significantly increasing fiscal spending.
Investors in euro-denominated debt have a whole new debt instrument at their disposal – newly-issued European Union sovereign bonds. The bonds will be used to finance the EU’s €750bn recovery fund and a budget exceeding €1trn until 2027.
The details of the issuance of the new debt instruments are still to be confirmed. It is reasonable to assume that the bonds will be triple-A rated and provide a higher yield than comparable issues.
Rik Klerkx, senior portfolio manager at Cardano, points out that these bonds would fit particularly well in liability-driven investing (LDI) portfolios. “While LDI may not be seen as a way to have a big impact on the COVID-19 crisis, through these new EU debt instruments, pension funds can achieve a lot. LDI portfolios are very large parts of balance sheets,” he says.
“The new EU debt programme foresees instruments that will tick several boxes. They will be high-quality and long-dated. The proceeds will be put towards helping economies come out of this crisis. We also expect that the yield will be attractive, especially if compared with German bonds, due to the size of the issuance,” Klerkx says.
These instruments could be similar to existing, but significantly smaller, EU issues, as well as bonds issued by the European Stability Mechanism (ESM) and the European Investment Bank (EIB). The bonds will most likely see the European Central Bank (ECB) among its biggest buyers, as part of its expanded quantitative easing (QE) programme.
Klerkx says: “The EU would be doing themselves a favour if they attached a specific ESG label to these bonds, demonstrating that they are being used for environmental purposes like decarbonisation, or social purposes like financing unemployment schemes. We, as investors, are going to have a good look at how the proceeds will be used.”
In the UK, LDI managers are anticipating the issuance of green Gilts, loosely based on the bonds issued by Germany and France in recent years. So far, the UK government has not issued such instruments. But given the government’s plan to expand the budget to mitigate the economic impact of COVID-19 lockdowns, the Debt Management Office (DMO) may seriously consider issuing such bonds, according to Simon Bentley, director for investment solutions at BMO Global Asset Management.
Bentley says: “The DMO has not had any issues with selling debt in recent months, because of the Bank of England’s debt purchase programme, but in the long term that buying is unlikely to be sustainable for the next few years. At the same time, the pandemic is creating a funding requirement for the UK government.
“A lot of the projects the government is trying to fund could be funded through green bonds, as they involve charging infrastructure for electric cars, flood defences to combat the impact of global warming, or social housing.”
The demand for green Gilts among pension funds is likely to be significant, according to Bentley, who cites research from UBS on this topic. High demand is not just likely because of pension funds’ LDI requirements, but also because most funds now focus on sustainability as part of their entire portfolios.
From the DMO’s perspective, issuing green Gilts will require more reporting work and a strict adherence to the international standards for green fixed income. The DMO may be reluctant to issue bonds with a higher yield than existing fixed income, as required by investors, but the government’s needs and investor demand may eventually meet at higher coupons and prices.
These examples suggest that COVID-19 is providing institutional investors with an array of new opportunities to put capital to work, not just towards traditional purposes, but also to manage the spread of the virus itself.
What remains to be seen is whether investors will feel comfortable enough to adapt their investment strategies within the highly volatile environment, given their financial and governance constraints.