Thinking for the future
You do not automatically associate The Netherlands with forestry, but timberland made it to the top of the agenda of ABP’s new innovation committee last autumn. Now the fund is looking to purchase real land and trees - something few Dutch, or European, investors have done before.
ABP’s innovation committee was brought to life last summer as part of a plan to seek out new classes of assets and to harness internal expertise in order both to seek out ideas and to assist with the various stages of implementation.
To understand the place of the innovation committee it is essential to look at ABP’s new strategic investment plan, which was announced earlier this year. This divides up the portfolio into two components - one using liability hedging assets, with cashflows and low volatility to create an “indexation portfolio”. The second involves riskier assets that aim to gain the highest possible return — a “return portfolio”.
ABP’s investment beliefs centre on a willingness to exploit the advantages inherent in the institution’s status as a long-term investor: there is a premium for illiquidity. Diversification, as ABP appears to understand it, and which it described in a recent document as a “free lunch”, goes beyond an orthodox three-way bonds-equities-alternatives split, hence the work of the innovation committee in finding this hidden treasure. The treasure, or at least the proceeds from return generating investments, will assist ABP in keeping premiums manageable and in granting indexation for pensions.
“One of the reasons for dividing the portfolio into two is to help us search for new ideas,” comments Stefan Lundbergh, secretary to the innovation committee. The division highlights more clearly the strategic purpose of different assets and strategies, and makes it easier to identify them.
But essential to the search for new ideas are people and culture, which ABP has described as a critical success factor. With a staff of over 400, ABP Investments is a large organisation and people have a diverse range of backgrounds, which the organisation hopes will spur creativity: “You don’t always know what people have done in their previous career,” Lundbergh says.
He adds that part of the success is also to foster the younger team members to come up with ideas and says that the 30 ideas put forward so far come from a real cross section of staff - not just from senior or experienced investment personnel.
The innovation portfolio also serves as a bridging role across asset classes and sub-classes, providing a natural home for investments that might not fit in one traditional area. “In the old days when convertibles were new,” Lundbergh points out, “the equity manager looked at them and said they were a lot of fixed income and the fixed income manager said that there is an equity part. What we are trying to do is find a home for ideas that are in-between. If it is a pure equity idea we have an equity department with a lot of skilled people so there is no point in pushing the idea through the innovation committee. We are trying to capture the things that are falling between the cracks.”
Given the international nature of ABP’s staff and operations - a Hong Kong office was recently opened to complement the existing New York presence - it is perhaps not surprising that the committee is international in composition. Stefan Lundbergh, a Swede who joined ABP in 2005, is secretary and it is chaired by Tom Steenkamp. Other members are Jeroen Schreur from the Hong Kong office, Tom Dunn, head of New Holland Capital, ABP’s own New York based fund of hedge fund operation, Tarek Saber, who heads the corporate opportunities strategies and Ruud Gilissen, director, investment and information services.
The committee’s remit does not solely lie in the area of newer riskier asset classes and ideas are welcome that would be applicable either to the return or to the liability portfolio. In any case, the emphasis is ensuring as short a time as possible from initial assessment of ideas to actual implementing.
ABP has established a multi-stage idea assessment process to reduce the likelihood of wasting staff and management time on ideas that will not come to fruition. This works in tandem with a low entry hurdle - initial submissions, known as insight notes, are only required to be 300 words long or so.
Lundbergh says: “If you want to be innovative you do not want people with ideas second guessing what you want. If you are going to put a lot of effort into something, you do not want to burn a lot of time just to find out that we are not interested. Therefore if you can put down the core of your idea on half a page we can discuss it and if we say ‘no’ you haven’t wasted too much time or effort.”
The committee discusses proposals as they pass the various stages, or gates, in the process, from idea to implementation, and decides whether to allow them to proceed or not. Detailed minutes of the meetings are kept and “digestible” summaries are posted on ABP Investments’ intranet site so that everybody knows what is going on.
The committee, which meets every three weeks, or more frequently if the agenda is heavy, first screens ideas to ensure that they pass a first initial compliance threshold, or “corporate minimum level”. Rather obviously, they must be legal, but they must also comply with ABP’s commitment to sustainable investing. Ideas must be scaleable - there would be no point in spending time and resources on ideas that did not hold sufficient capacity to impact on the risk-return profile of the innovation portfolio.
“Also if you look at an idea you need to understand financial logic of it and the risks it will introduce in our balance sheet,” explains Lundbergh. “We can take risk in our balance sheet at a certain premium. In order to get a return you need to take some kind of risk but we need to ask ourselves, why are we the natural holder of that risk?”
ne of the factors driving the timber business at the moment is the need for timber companies to make their balance sheets more capital efficient, says Lundbergh. “So you have a natural seller. As a pension fund we have long term commitments and do not need cashflow every quarter; if we can get the long term cashflows linked to inflation this is good to us. [Timber companies] have a different profile and it is natural for us as a pension fund to look into that.”
If the committee gives the go-ahead to an idea, the originator is asked to produce a skeleton business plan, outlining such factors as the nature of the market in the asset, the actors in its market and how it would fit in to the organisation.
“Some ideas won’t hold but other ideas move ahead,” says Lundbergh. “However, at this stage as an organisation we have not spent so much time. Perhaps half day on the first stage and 10 working days on the second, which this could be spread over say ten weeks. So at that point it is not a big loss for ABP or the innovator if we stop something.”
If the idea does pass the second stage, the committee sponsors a project for the strategic case, for example checking with the ALM team how it would affect the risk characteristics in the portfolio. “Now you have a project involving a lot of people moving towards the business plan phase,” Lundbergh explains.
“With timber the question was, is it a strategic asset for ABP? The second part was to understand as an organisation where it fits and who should manage it - should we do it internally or externally? There is no point in discussing who should manage it before we decide whether we do it or not.”
Finally, before the capital commitment, the idea is escalated to the board for final approval. Then follows the commitment of capital and the actual investment. So far eight of the 30 ideas submitted have got to some stage in the assessment process.
The person who produced the idea and who conducted the research is the natural candidate to spearhead the project says Lundbergh. With the strategic case for timberland the process took about three months from beginning to end.
Els Knoope, a senior portfolio manager, headed the project, but the core group involved the US hedge fund and real estate units, who also worked with representatives from ALM and legal. “I was really surprised how few hours they spent given the quality and in those months you had Christmas in between,” Lundbergh
Are there fixed risk and return characteristics for investments within the innovation portfolio? No, according to Lundbergh, but ideas should improve the risk-return characteristics in one of the two portions of the portfolio - liability assets and return assets. ‘We communicate within the organisation that if you come up with a good idea, you should be able to prove that the risk optimising or the liability portfolio benefits. Either something with long-term stable inflation linked cashflows or something on risky side with high returns.”
Unlike some, particularly Scandinavian institutions, ABP is not interested in the separation of alpha and beta, which would involve separating alpha and beta orientated investment teams. “Since ABP is a large institutional investor with a long-term horizon we feel that putting these people closer without having a wall between them will benefit the end result. We are trying to erase these ideas a bit about alpha-beta separation because if you allow the portfolio manager to look at the big picture I think we will get a better outcome than if we strictly separate alpha and beta.”
So far, ABP has set a strategic target for 2% of assets, or approximately €4bn, for the innovation portfolio by 2009, but will not spend it unless good ideas come forward.
“We say, challenge our current assets,” concludes Lundbergh. “Is the market weighted equity benchmark the best equity portfolio for a Dutch pension fund with our liabilities? If we come up with something better we are moving forward. Defining better is to see how you might improve the liability hedge and risk optimising strategies.”
ABP’s innovation committee
Tom Dunn (left) is a managing principal of New Holland Capital, a hedge fund advisory company established by ABP that focuses exclusively on the absolute return vehicles. Prior to launching New Holland Capital in 2006, Dunn managed the hedge fund group of ABP Investments from 2002. Tom holds two degrees from University of Chicago: an MBA in Finance (1986) and a BA in
English Literature (1981).
Ruud Gilissen (right) MA is director of investment and information services at ABP Investments. He was quality manager of alternative investments from 2005 to 2006 and co-chief investment officer, global fixed income, from 2003-04. In 2002 Gilissen participated in the international executive programme at Insead and in 2006 he participated in a programme entitled, ‘Creating Corporate Advantage: Strategy in the Multi-business Firm’ at Harvard Business School.
Dr Stefan Lundbergh (left) is a senior researcher at ABP Investments. He is the secretary of the innovation committee and heads a small team within the strategy and research group. Before joining ABP he worked for Skandia, the Swedish insurance company. He holds a PhD in econometrics from Stockholm School of Econometrics and has published scientific articles in leading academic journals.
Tarek Saber (top left, next page) has been head of corporate opportunities strategies at ABP Investments from 2003. He was global head of convertibles at HSBC, with operations in London, Paris, New York and Hong Kong, from 2000-03. Saber also headed the convertible bond desk at NatWest from 1991-96 and was responsible for trading, sales, research and proprietary trading at Schroders Securities from 1996-2000.
Jeroen Schreur (right) is the president of ABP Investments Asia Limited, which is located in Hong Kong and is responsible for ABP’s Asian non listed real Estate
and infrastructure investments. Schreur was CFO/COO of ABP Investments US from 2003-06 and holds a masters degree in econometrics from the University of
Professor Tom Steenkamp (left) is chief investment officer of allocation and research and a member of the board of ABP Investments. He is also chairman of the innovation committee. In 1999 Steenkamp was appointed professor of investment sciences at the Vrije Universiteit (VU) in Amsterdam, a post he still holds. In addition to his professorship at VU. Steenkamp is chairman of the executive committee of the postgraduate financial and investment analyst training institute at the university.