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Investors are used to walking a tightrope of risk. But the current landscape of heightened geopolitical conflict, climate change and inflation has made that balancing act harder to pull off.
Innovation Unleashed: The Rise of the Total Portfolio Value Approach, a new report from the Chartered Alternative Investment Analyst Association (CAIA), points to the Total Portfolio Approach (TPA) as one way for institutional investors to build more resiliency into their portfolios. CPP Investments was among four institutional asset owners and co-authors of the paper—which also include the Australian Future Fund, New Zealand Superannuation Fund, and Singapore’s GIC.
The TPA is defined as “one unified means of assessing risk and return of the whole portfolio,” notes Geoffrey Rubin, Senior Managing Director and One Fund Strategist at CPP Investments. While strategic asset allocation (SAA) seeks to outperform benchmarks, the TPA focuses on the fund’s absolute-return goals.
CPP Investments employs a “factor lens” to better capture the underlying drivers that influence the risks and returns of specific asset classes. Investors use different “belief systems” to understand the sources of market returns and risks, say Rubin and Derek Walker, Managing Director and Head of Portfolio Design and Construction who both contributed to the report.
CPP Investments believes return-risk factors such as economic growth, rates, and credit spreads are compensated by the markets over longer term horizons. “All investments in our portfolio are assessed through this lens,” added Walker.
The relentless focus on justifying every marginal dollar of allocated capital against all other options is a defining differentiator compared with other models
The TPA is implemented through the Total Portfolio Investment Framework (TPIF). The TPIF first establishes a prudent and appropriate market risk appetite by using information contained in the triennial review of the Office of Chief Actuary of Canada. Factor risk and return expectations are then developed, to help determine the mix of factor exposures that maximizes expected return at the risk target. These targeted factor exposures are delivered by a range of investment strategies that reflect the modeled factor exposure and alpha expectations of each. Private and public investments, debt securities, equities and other investments are all weighed through these factors and must compete for a place in the portfolio. Additional holdings of public market securities are used to rebalance the portfolio to the intended factor exposure targets.
“The relentless focus on justifying every marginal dollar of allocated capital against all other options is a defining differentiator compared with other models,” the report notes.
The approach isn’t without its challenges and as “we move forward into a less certain world, we will need to continue to evolve our factor-based investment framework,” Walker and Rubin write. But with new risks on the horizon, it’s an increasingly effective way to navigate complexities where other approaches fall short.
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Over the past several years, Ed Cass has seen first-hand how labour issues, political tensions and technological change have impacted asset
Article
January 31, 2024
{:en}
Over the past several years, Ed Cass has seen first-hand how labour issues, political tensions and technological change have impacted asset prices. In this conversation, he reflects on the rapid advancement of AI, the Fed pivot, and why the current investment landscape is unlike any we’ve seen before.
How have recent geopolitical tensions challenged your investing process?
Ed Cass: Well, for the last three or four decades, countries largely worked together with a similar agenda within a rules-based international order. And one of the things we’re all struggling with now is whether we’re on the verge of a breakdown of that order—and what that will mean for investors. A different emphasis on industrial policy or security policy for instance, can have big implications on how the overall economic system functions.
This is a relatively new thing, at least in terms of our economic experience, and it’s tough to gauge it. We don’t have great economic data going back over six centuries, say, when there was a lot of geopolitical conflict that you could express in terms of impact on asset prices. That’s in essence, our challenge now.
How has this changed your thinking as a long-term investor?
Ed Cass: One of the big assumptions we make when we look at asset prices globally is the convergence of economies over time. Emerging economies will gradually increase their GDP per capita, they’ll open their markets and capital flows will become more global. If you believe in that, then there's a pretty strong forward connection between GDP and the size of investment universe. And when we think about diversification and asset allocation, the size of the investment universe 10 or 20 years out is one of our starting points.
Arguably, some of the things we're seeing globally right now could challenge that convergence path. If China doesn’t have the same objective goals as the U.S., Europe and developed countries, if it puts more emphasis on social goals than purely economic ones, does that impact the rate of convergence of markets over time? That's probably the biggest implication for us in terms of how we think about where we're going as an investor.
Right now we’re looking at what we thought five to 10 years ago in terms of where GDP per capita would be in China and India. Are they on the same convergence path or are they starting to deviate from that? And if so, what does that mean in terms of our future allocation of assets?
How do you go about building a portfolio that’s resilient to these kinds of shifts?
Ed Cass: You just have to continually challenge the beliefs you had when you went in. I think that’s a trap that a lot of people have fallen into over the years and it's one we try to protect ourselves against.
We examine our beliefs, and we try to set the criteria for when we're going to change our mind up front, as opposed to in the moment. In the moment, it's always very hard to be objective. That's where a lot of people have lost their way over the years.
So interest rates…
Ed Cass: One of my favourite subjects.
The Fed's hinting at rate cuts. Markets expect the Fed to cut even faster than it’s hinting. How does that change things in terms of opportunity?
Ed Cass: So this gets to the heart of a basic point we don’t always appreciate. It’s not what happens in the economy that matters, it’s what happens in the economy relative to what’s embedded in asset prices. All else being equal, if you said interest rates in the U.S. were going to go down by 300 basis points over the next year, it should be really good for asset prices. It lowers the cost of funding, it lowers the discount rate, it’s arguably a boost to earnings through the lower interest charge.
But the market already has six easings priced in over the course of the next year. So you need eight easings, 10 easings to be beneficial to asset prices. Looked at through that lens, you say, well, the bar for investing in risky assets is pretty high because the inflation process has been sticky at times. That’s a long way of saying that when you think about interest rates, you've probably seen most of the easy money made.
How would you characterize the current transition to AI?
Ed Cass: Well for us, the question is, how is the technology going to be used and what’s the implication for asset prices? Part of the problem is it's just really hard to tell—given what we know about AI right now—to say who's going to win in the future. We don't know the future capabilities. We don't know what the business model is going to be. We don't know who the winners and losers are going to be from a proprietary versus open AI standpoint.
So we're back in that land where we're going to have to make assumptions. One of the things we've been doing is, again, trying to set up the criteria. What are we assuming in terms of who the winners and losers are going to be? How do we think that's going to flow through in terms of economics? How do we think that's going to flow through in terms of asset prices? Then we try and compare our assumptions against what we see.
The hype over the last 12 months has been exponential.
Ed Cass: Although the underlying technological building blocks that enable AI (e.g. AI models and accelerated computing systems) have been advancing on an exponential trajectory, I'm not convinced the impact has been exponential. A lot of CEOs told me six months ago they were going to replace 10,000 workers, 20,000 workers and save billions of dollars in terms of operating costs. But we really haven't seen that come through in the data yet.
There’s an active debate about how fast companies can adopt AI—and whether it’s going to be as fast as what's embedded within asset prices. The prevalent view is that barriers to adoption are much lower with AI than they were with past technologies. People have talked about adoption cycles getting faster and faster, but when we look back over history, that wasn’t generally the case with respect to big transformative technologies.
If you want to rewire your manufacturing process for AI, it's not a question of just dropping AI down on the floor. You’ve got to rewire the floor. You've got to lay out a huge capital-intensive budget to design a new factory. It's not just a simple drop down of code.
Do you think we're in an AI bubble?
Ed Cass: Depends how you define a bubble. Certainly, the stocks are aggressively priced, and some will have to do a lot to hit what's embedded within that pricing.
We’ve taken a look at the lead up to the internet bubble and it looks really similar to where we are one year into AI. With the internet bubble, that process lasted three or four years. With AI, we’re only one year in. So, we have a long way to go before extrapolating from where we are now to where we were then. Asset prices and Magnificent Seven stock prices are aggressive, but they're priced nowhere near as aggressively as stocks were priced in the late 1990s.
Do you think AI can replicate human reasoning in the investing process?
Ed Cass: We’ll have to wait to see. The biggest impact we've seen from AI so far is an increase in efficiency—not an epiphany in terms of outcomes. It’s helped people perform their jobs quicker and faster. It’s allowed people to allocate more of their time to interesting problems, as opposed to mundane ones. But the causal reasoning isn't there yet within generative AI to provide an entirely different answer.
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Five Minutes with Michel Leduc
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Article
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{:}{:fr}
Au cours des dernières années, Ed Cass a pu constater par lui-même l’incidence des problèmes de main-d’œuvre, des tensions politiques et des changements technologiques sur les prix des actifs. Dans cet entretien, il évoque l’évolution rapide de l’IA, le changement de cap de la Fed et les raisons pour lesquels le contexte de placement actuel se distingue de ce que nous avons connu jusqu’ici.
En quoi les récentes tensions géopolitiques ont-elles perturbé votre processus de placement?
Ed Cass : Au cours des trente à quarante dernières années, les pays ont largement coopéré sur un ensemble d’enjeux communs dans le cadre d’un ordre international fondé sur des règles. Et l’une des questions qui nous taraudent en ce moment est de savoir si cet ordre est sur le point de s’effondrer, et quelles conséquences cela aurait sur les investisseurs. Un changement de priorité en matière de politique industrielle ou de politique de sécurité, par exemple, peut avoir d’importantes répercussions sur le fonctionnement du système économique dans son ensemble.
Il s’agit d’un phénomène relativement nouveau, du moins en ce qui concerne notre expérience économique, et il est difficile de l’évaluer. Nous n’avons pas de données économiques de premier ordre sur plus de six cents ans, c’est-à-dire une période riche en conflits géopolitiques dont on pourrait exprimer l’incidence sur les prix des actifs. Telle est la nature de l’enjeu à l’heure actuelle.
En quoi cela a-t-il changé votre façon de penser en tant qu’investisseur à long terme?
Ed Cass : L’une des principales hypothèses que nous posons lorsque nous examinons les prix des actifs à l’échelle mondiale est la convergence des économies au fil du temps. Les économies émergentes vont progressivement accroître leur PIB par habitant, elles vont ouvrir leurs marchés et les flux de capitaux vont se mondialiser davantage. Si telle est votre conviction, il existe alors un lien assez solide entre le PIB et la taille de l’univers de placement. Et lorsque nous réfléchissons à la diversification et à la répartition de l’actif, la taille de l’univers de placement dans 10 ou 20 ans est l’un de nos points de départ.
On peut avancer que certains des événements que nous observons aujourd’hui à l’échelle mondiale pourraient nuire à la convergence. Si la Chine n’a pas les mêmes ambitions objectives que les États-Unis, l’Europe et les pays développés, si elle met davantage l’accent sur les objectifs sociaux que sur les objectifs purement économiques, la convergence des marchés au fil du temps s’en trouve-t-elle affectée? C’est sans doute la principale incidence quant à notre vision de l’avenir en tant qu’investisseur.
À l’heure actuelle, nous nous intéressons aux prévisions que nous avons faites il y a cinq à dix ans concernant le PIB par habitant en Chine et en Inde. Sont-ils sur la même voie de convergence ou commencent-ils à s’en éloigner? Dans l’affirmative, qu’est-ce que cela signifie pour notre répartition future de l’actif?
Comment vous y prenez-vous pour bâtir un portefeuille qui résiste à ce type de changements?
Ed Cass : Il suffit de constamment remettre en question les convictions que vous aviez au départ. Je pense que c’est un piège dans lequel beaucoup de gens sont tombés au fil des ans, et nous essayons de nous en prémunir.
Nous examinons nos convictions et nous tentons d’établir dès le départ les critères qui nous amèneront à changer d’idée, plutôt que de le faire au pied du mur. Si on agit au pied du mur, il est toujours très difficile d’être objectif. C’est là que beaucoup de gens ont pu s’égarer au fil des années.
Concernant les taux d’intérêt...
Ed Cass : Un de mes sujets préférés.
La Fed laisse entrevoir des baisses de taux. Les marchés s’attendent à ce qu’elle les réduise encore plus vite qu’elle ne le laisse entendre. En quoi cela change-t-il la donne en ce qui concerne les occasions?
Ed Cass : Cela nous amène à un point fondamental que nous n’apprécions pas toujours. Ce n’est pas ce qui se passe dans l’économie qui compte, mais ce qui se passe dans l’économie par rapport à ce qui est intégré dans les prix des actifs. Toutes choses étant égales par ailleurs, si vous avez dit que les taux d’intérêt aux États-Unis allaient baisser de 300 points de base au cours de l’année qui vient, les prix des actifs devraient largement en profiter. Ça réduit le coût du financement, ça réduit le taux d’actualisation, et on peut avancer que ça stimule les bénéfices en faisant baisser les frais d’intérêt.
Mais le marché a déjà pris en compte six mesures d’assouplissement au cours de la prochaine année. Il faut donc huit mesures d’assouplissement, voire dix, pour que ce soit favorable aux prix des actifs. Si l’on examine la situation sous cet angle, on constate que la barre est assez haute pour investir dans des actifs risqués, car l’inflation a parfois été persistante. Pour résumer : sur la question des taux d’intérêt, les gains faciles sont probablement derrière nous.
Comment décririez-vous la transition actuelle vers l’IA?
Ed Cass : Pour nous, la question est de savoir comment la technologie sera utilisée et quelle sera son incidence sur les prix des actifs. Le problème tient en partie au fait qu’il est très difficile de dire, à la lumière de nos connaissances actuelles, qui tirera le meilleur parti de l’IA. Nous ne savons pas quelles seront les capacités. Nous ne savons pas à quoi ressemblera le modèle d’affaires. Et sur la question de l’IA ouverte ou privative, nous ne savons pas qui seront les gagnants et les perdants.
Nous nous retrouvons à nouveau dans la situation où nous devrons faire des hypothèses. Nous avons, là encore, essayé d’établir des critères. Quelles sont nos hypothèses quant aux gagnants et aux perdants? Quelles répercussions voyons-nous sur le plan économique? Quelles répercussions voyons-nous sur les prix des actifs? Ensuite, nous nous efforçons de confronter nos hypothèses à ce que nous constatons.
Le battage médiatique au cours des 12 derniers mois a été exponentiel.
Ed Cass : Certes, les composantes technologiques qui sous-tendent l’IA (comme les modèles d’IA et les systèmes de calcul accéléré) suivent une trajectoire de progression exponentielle, mais je ne suis pas convaincu qu’il en soit de même des retombées. Il y a six mois, beaucoup de grands dirigeants me disaient qu’ils allaient remplacer 10 000 ou 20 000 travailleurs et économiser des milliards de dollars en coûts d’exploitation. Mais ça ne s’est pas encore concrétisé dans les données dont nous disposons.
Le débat fait rage en ce qui concerne la vitesse à laquelle les sociétés peuvent adopter l’IA, comme sur la question de savoir si cette adoption sera aussi rapide que ce qui est intégré dans les prix des actifs. L’opinion dominante est que, dans le cas de l’IA, les obstacles à l’adoption sont beaucoup moins importants qu’ils ne l’ont été avec des technologies antérieures. Les gens disent que les cycles d’adoption sont de plus en plus rapides, mais un examen historique montre que ce n’est généralement pas le cas des grandes technologies transformatrices.
Si vous voulez remanier votre processus de fabrication pour l’IA, il ne suffit pas de programmer l’IA sur les machines de l’atelier. Vous devez revoir toute la conception de l’atelier. Et pour concevoir une nouvelle usine, vous devez vous doter d’un énorme budget d’investissement. Il ne s’agit d’une simple modification de code.
Pensez-vous que l’IA soit aujourd’hui une bulle?
Ed Cass : Cela dépend de la façon dont vous définissez une bulle. Il est certain que les cours boursiers sont très élevés et pour atteindre les objectifs intégrés dans ces cours, la marche sera parfois haute.
Nous avons examiné la période qui a précédé la bulle Internet et elle ressemble beaucoup à ce que nous connaissons depuis un an avec l’IA. Avec la bulle Internet, ce processus a duré trois ou quatre ans. Pour ce qui est de l’IA, tout a commencé voici un an. Il y a donc encore beaucoup de chemin à parcourir avant de pouvoir extrapoler la situation actuelle par rapport à celle d’alors. Les prix des actifs et les cours des « Magnificent Seven » sont audacieux, mais ils sont loin d’être aussi ambitieux que ne l’étaient les cours des actions à la fin des années 1990.
Pensez-vous que l’IA peut reproduire le raisonnement humain dans le processus de placement?
Ed Cass : Nous verrons avec le temps. Jusqu’à présent, l’incidence la plus importante de l’IA est un gain d’efficacité, mais nous n’avons vu de révélation quant aux résultats. Elle aide les gens à accomplir leur tâche plus rapidement. Ils peuvent ainsi consacrer plus de temps à des questions intéressantes, plutôt qu’à des problèmes banals. Mais l’IA générative ne dispose pas encore d’un raisonnement causal qui permette d’obtenir une réponse complètement différente.
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Five Minutes with Michel Leduc
Michel Leduc, Global Head of Public Affairs and Communications, explores evolving industrial policy, concentration risks, and why investors
Video
January 31, 2024
Who will win the global AI race?
Artificial Intelligence (AI) has the potential to revolutionize the way the global economy works and how many businesses generate profits.
Article
January 31, 2024
Done Deals: Hohe See and Albatros
Offshore wind at scale. That was the draw when CPP Investments bought its 24.5% stake in Hohe See and Albatros in 2018.
Article
January 31, 2024
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