Gail Moss reports on how Compagnia di San Paolo has managed its assets while faced with the risks of low euro-zone growth and a major shareholding in an Italian bank - Intesa San Paolo

For Italian foundation Compagnia di San Paolo (CSP), the name of the game is diversification. Its portfolio includes significant holdings in private equity, infrastructure and hedge funds, as well as exposure to various currencies. Within the bond segment of its portfolio the foundation has rapidly multiplied the number of issuers.

"Three years ago, nearly two-thirds of our bond holdings were denominated in euros," says Davide Tinelli, chief executive officer of Fondaco, an independently-managed company owned by Italian foundations, which acts as the outsourced investment office for CSP. "Now it's only 14%, with the rest in emerging market and other international bonds. We are also diversifying country and geopolitical risk by increasing currency diversification in other assets. This international bias is unusual for an Italian foundation."

Currency diversification means buying assets not only in US dollars, sterling and yen, but also Singapore dollars, Malaysian ringgit, Mexican peso and Polish zloty.

Tinelli says: "We believe in the euro, but we are diversifying away from it at the moment because growth in the euro-zone is lower than everywhere else."

Besides expanding into emerging market currencies, CSP has also started investing in commodities and reinsurance.

"This strategy is already paying off, says Tinelli: "We have achieved superior results from our diversification portfolio, beating the benchmark - a composite of the main asset classes in the portfolio - and maintaining stability over the recent past."

For any institution, of course, diversification is the standard way of protecting against the cold winds of the global financial crisis. But for CSP, it is also a way of neutralising its 10% shareholding in the Intesa San Paolo (ISP) bank, which makes up 38.5% of its portfolio and which is held as a strategic, long-term asset. Over 2011, this shareholding gave a 4.8% dividend yield but a capital loss of 31%.

The shareholding is a result of CSP's long connection with the finance industry, common to many Italian foundations.

CSP was set up to alleviate poverty by a group of Turin citizens in 1563. Soon afterwards, the group set up a non-profit-making pawnshop to reduce the power of loan sharks; this developed into a credit institution, the forerunner of what is now ISP, Italy's largest banking group.

CSP originally acquired a 100% stake in what was then Istituto Bancario San Paolo when the banking sector was restructured in the 1990s. Profit-making banking activities were separated from non-profit-making foundations, which were set up as majority owners of their respective banks. The stake has since fallen to 10% because of privatisation and mergers.

At present, there is a media debate as to whether banking foundations should be able to sell their legacy shares; many commentators believe it could cause problems for the banking system.

Tinelli believes foundations have a stabilising effect on Italy's banking operations as shareholders. Over the past couple of years, for instance, CSP has injected capital into ISP to help it comply with the Basel requirements.

However, CSP will be considering hedging and the role of derivatives in improving its long-term position as a shareholder.

Most (57%) of the foundation's €4.6bn-worth of assets are invested in a segregated mandate run by Fondaco, set up in partnership with four other Italian foundations.
This mandate invests in 30 different funds including short-term fixed income, euro government bonds (indexed), global government bonds, global absolute returns, funds of hedge funds, and Italian infrastructure. Both active and passive management styles are used by the underlying funds.

Fondaco's Luxembourg-based subsidiary, Fondaco Lux, runs two funds - the Fondaco Global fund and the Fondaco Roma fund. These two funds are split into 15 sub-funds, run by external managers, investing in international bond and money market funds, and international bonds and equities, respectively.

In total, Fondaco manages €6bn-worth of assets for its clients, using a long-term investment approach to select strategies and management styles, and combine market principles with ethical values.

"CSP decided to adopt an outsourcing model in 2009, which meant adapting our governance procedures," says Tinelli. "CSP decides the investment strategy and asset allocation and also monitors results. The investment process is run by CSP's investment committee, which includes both internal and external investment competences."

The only equities in CSP's diversified portfolio is a 7% holding in emerging growth equities. All its US and European equities were sold three years ago because of market volatility.

In the direct portfolio, besides the ISP stake, CSP has four equity holdings worth less than 5% of the total.

The overall asset allocation is currently 30% in bond funds, 6% each in money market funds, hedge and absolute return funds, and reinsurance, commodities and currency. Private equity and venture capital together make up another 5%, with 4% in money market instruments and liquid assets.

There is also a small but growing component in mission investing, such as social housing and scientific research.

Returns for CSP's portfolio as a whole fell from 7.9% in 2009 and 6.2% in 2010, to 2.6% last year. Tinelli says they are currently 3.0 to 3.5%, with a target return of 2.5% in real terms, over a four-year investment horizon.

Spending on beneficiaries is also set as a percentage of asset value, but is not necessarily the same as the target investment return. The foundation supports activities in education, art, culture, health, social welfare, and scientific, economic and legal research.

Tinelli says the investment horizon of four years allows CSP to create stability rather than go all-out for high returns at greater risk. The time horizon will be reviewed this summer but major changes are not expected.

Meanwhile in order to boost returns, CSP is investing heavily on the quality of execution: "Reacting on a daily basis is important," says Tinelli.

The foundation has also been playing active beta, setting up the Citigroup Fondaco Non Eur WGBI EW custom benchmark, which has been successful in terms of performance, stability and diversification contribution. Hedge funds are also becoming increasingly important.

"However, we are looking for other return drivers as well because we want to be paid back by the market for the risk we bear," says Tinelli.