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1、McKinsey on RiskNumber 13,October 2022Performance edge:Investors hone their strategies for a new eraInstitutional investors are rethinking their strategies for a new,less stable era.AuthorsIsmail Bel-BachirSacha GhaiDuncan KauffmanEser KeskinerRobin MatthiasElizabeth SkoviraMarcos Tarnowski July 202
2、3Private Equity&Principal Investors PracticeRyan Herron/Getty Images1Performance edge:Investors hone their strategies for a new eraThe three decades from 1990 to 2020 were a great time to be an institutional investor(II).While there were stormssuch as the Asian financial crisis of the late 1990s,the
3、 tech bubble of the early 2000s,and the 200809 global financial crisisthese events punctuated an otherwise steady and stable economic order with consistent“rules of the game.”IIs grew significantly,in terms of assets as well as people,and delivered strong returns.Now,in the third decade of this mill
4、ennium,IIs are operating in an environment quite different from the 19902020 period they had become accustomed to.Prominent features of this new environment include uncertainty,disruption,and radical shifts in public expectations of business and society.Institutions feel pressure to adapt.To underst
5、and how IIs are responding to this new context,we collected perspectives from senior executives at 40 of the worlds top pension and sovereign wealth funds(SWFs),which collectively manage$10 trillion in assets worldwide(Exhibit 1).Our research shows that they are rethinking their strategies across th
6、ree major dimensions:purpose,portfolio construction,and proficiency.Their purpose is evolving in light of the new salience of social factors and an intensifying focus on the climate transition.Portfolios are being dynamically redesigned in pursuit of resilience and returns in uncertain times.And IIs
7、 are developing proficiency in specific areas of expertise while seeking complementary partnerships in other areas.Leading investors are revisiting many of the assumptions they grew up with and are asking themselves difficult questions about how to square their fiduciary duties to their beneficiarie
8、s with the broader expectations of their societies.A“Goldilocks”market in which it was relatively easy to generate returns has been replaced by one with diminished return expectations.In the face of this 180-degree change,investors know they need to hone their edge while also becoming nimbler.This r
9、eport is structured in two parts.Part one explains how IIs are thinking about the upheavals in the external environment.Part two dives deeper into the three areas of focus for IIs aiming to thrive in an unpredictable world and sets out some of the questions that the leaders of these institutions are
10、 asking themselves.IntroductionExhibit 11Assets under management.2Europe,the Middle East,and Africa.McKinsey collected perspectives from 40 institutions that,together,steer$10 trillion in assets under management.McKinsey&CompanyNorth America15 institutions$2.9 trillion AUM1EMEA211 institutions$3.3 t
11、rillion AUM1AsiaPacifc14 institutions$3.8 trillion AUM1Global40 institutions$10.0 trillion AUM11Performance edge:Investors hone their strategies for a new eraA global pandemic.Economic regionalization.War in Europe.An energy crisis and disrupted global supply chains.The return of inflation and risin
12、g interest rates.Increasing social division.Over the past three years,there have been extraordinary changes in the environment in which IIs operate,perhaps akin to such historical inflection points as the upheavals of recovery and reconstruction after World War II,the 1970s oil crisis,and the reshap
13、ing of the world order following the breakup of the Soviet Union.Each of these earthquakes changed the global landscape with the sudden release of powerful underlying forces that had been building up around a fault line over time.Each of them ushered in a distinctive new era,the most recent being th
14、e 30 years of peace,rising prosperity,and increasing global economic integration that followed the fall of the Berlin Wallthat is,from 1990 to 2020.According to data from CEM Benchmarking,IIs were able to capitalize on this environment across the board,with virtually all delivering strong and stable
15、 risk-adjusted returns over the decade leading up to 2021(Exhibit 2).By contrast,the distribution of investor returns during periods of economic uncertainty has been observed to be much more uneven(Exhibit 3).Exhibit 2Performance of institutional investors,201221 Net returns18.6%Bottom quartile9.5%1
16、0.1%0.80.91.06 bps 36 bps70 bpsSharpe ratioNet value added1Funds total return net of costs.2Net returns minus the funds policy or benchmark return;the equivalent of returns from active management.Source:CEM BenchmarkingInstitutional investors delivered strong and stable returns between 2012 and 2021
17、.McKinsey&CompanyMedianTop quartilePart one:A new world disorder2Performance edge:Investors hone their strategies for a new eraExhibit 3Top-and bottom-quartile annual return spread,%Source:200121 public plans data from the Center for Retirement Research at Boston College,Government Finance Ofcers As
18、sociation,MissionSquare Research Institute,and National Association of State Retirement Administrators Dispersion of investor returns has increased during periods of economic uncertainty.McKinsey&Company200430072009200Performance edge:Investors
19、hone their strategies for a new eraAmid the many uncertainties concerning the worlds trajectory in the next ten years,all our investor intervieweeswith varying emphases and points of focusagree that the current environment differs fundamentally from the global investment conditions of the last three
20、 decades.All concur that the course of future events has become much harder to foresee,and most believe it will be more challenging to generate returns.As the chief investment officer(CIO)of a leading AsiaPacific fund put it,“Theres a regime change from what existed from 1990 to 2020.Deglobalization
21、,geopolitical conflict,aging populations:all these things will make the environment riskier and make it more difficult to achieve the returns of the previous 30-year period,which were in excess of what people expected.”The McKinsey Global Institute has identified significant shifts in five domains t
22、hat are likely to define this new era:changes in the world order,technology platforms,demographic forces,energy systems,and capitalization(Exhibit 4).1 The changing state of the world order,featuring geopolitical conflict and new challenges to globalization,is top of mind for many of our interviewee
23、s:90 percent of respondents cite the world order as a concern,considering the impact of sanctions,legislation restricting financial flows,changes in their investment mandates,and heightened volatility in asset markets triggered by war.In the short term,investors worry that geopolitical shocks could
24、harm their portfolios by causing markets to seize up.The leader of an SWF said the sheer unpredictability of events has shrunk his investment horizon:“Because of geopolitics,one may need to rethink what long term means.For example,you always want some companies in your portfolio that you think can b
25、e compounders for ten to 20 years.In markets such as China,Exhibit 4McKinsey&CompanyThe world may be transitioning to the next era.The recent global landscape and open questions for the next era020002020Postwar BoomEra of ContentionEra of MarketsThe next eraGlobally interconnected world b
26、uilt on factor-cost arbitrage and cooperative economic rulesDigital emanation:connected and enabledGlobal convergence to small,urban family with better health and educationFossil fuelabundant world with global access but climate damageMassive debt expansion with low infation,supplydemand shock as bi
27、llions enter global market economy Multipolar world with global connectedness coexisting with increased polarization?Postdigital world where transversal technologies take of?Aging gracefully as health improves and social inequalities are reduced?Afordable and feasible transition to low-carbon energy
28、 amid growing resource competition?Outgrowing debt enables orderly stabilization of the large global balance sheet?World orderTechnologyplatformsDemographicforcesResource andenergy systemsCapitalizationSource:McKinsey Global Institute analysis1 Chris Bradley,Jeongmin Seong,Sven Smit,and Jonathan Woe
29、tzel,“On the cusp of a new era?,”McKinsey Global Institute,October 20,2022.4Performance edge:Investors hone their strategies for a new erawhere policy risk has now become a much bigger issue,Im not sure I can think of companies I want to hold for ten to 20 years.I need to think about it in five-year
30、 cycles in which I can have visibility of policy direction.”Some feel geopolitical tensions could also create new national barriers to global investment operations in,for example,sensitive areas such as strategically important infrastructure assets.One AsiaPacific CIO said the increase in great powe
31、r rivalries could also force IIs to introduce a degree of segmentation into what have traditionally been seamless global operations:“I think its going to be a lot tougher.We have to think about how we internally organize ourselves.We may have to have some limitations in terms of sharing of informati
32、on across teams in these different spheres.This may be a reality we have to live with.”Many worry that geopolitical conflict,together with the effects of the COVID-19 pandemic,is reversing the trend toward increased economic integration and globalization.Our interviewees in general do not contend th
33、at globalization is undergoing a reversal,but they do observe a trend toward economic regionalization rather than global integration.The third most salient shift for our sample of investor interviewees is in technology,with four-fifths of respondents citing this as an area of concern.They are partic
34、ularly preoccupied by an unfortunate by-product of the age of digital technology:the rise of cyberattacks,to which the financial industry is especially prone.In 2022,the sector saw an astonishing 243 percent increase in ransomware attacks,a 269 percent increase in“crypto jacking,”and a 94 percent in
35、crease in intrusion attempts.2 This suggests that as IIs seek to navigate extreme uncertainties in their external environment,they will also need to be more vigilant than ever on the home front and become more proficient in using the latest technology to improve their operations.The shift in demogra
36、phic forces looms large for interviewees:76 percent of our sample cited it as an area of focus.In our interviews,demographic forces surfaced as an issue by way of a new focus on the social contract and concerns that included declining social mobility and increasing economic inequality and political
37、polarization.These challenges are compounded by the tensions created by an aging society,not only in Western countries but also in Asia.For investors,this suggests a heightened imperative to make economic growth more inclusive and,in aging societies,to create structures enabling a more equitable bal
38、ance between generations.Broader social issues have become more pronounced in three ways:as investment criteria shaping their portfolios,as factors guiding how they do business,and as a focus of risk management.Social issues are also topics on which they are under significantly increased public scru
39、tiny.“I think this is a secular shift,”said the leader of an AsiaPacific SWF.“Social aspects such as income inequality and fair labor practices are becoming more important factors.”Of the themes outlined above,the one that resonates most with our interviewees is the challenge facing global resources
40、 and energy systems.Every interviewee cited this as a defining issue for their investment strategy.Many realize that the energy sector has been building up a deficit in capital expenditures,exacerbated by the conflict in Ukraine.They are conscious of the vast capital spending that will be required t
41、o move the global economy toward net-zero emissions(about$275 trillion on physical assets for energy and land-use systems between 2021 and 2050).3 Our interviewees realize that because governments are unlikely to be able to underwrite this level of investment,large IIs will be expected to finance a
42、significant proportion of it,creating both risks and opportunities.2 Mid-year update:2022 SonicWall cyberthreat report,SonicWall,August 2022.3“The net-zero transition:What it would cost,what it could bring,”McKinsey Global Institute,January 2022.5Performance edge:Investors hone their strategies for
43、a new eraThe focus on climate change means investors face increased regulatory scrutiny and disclosure requirements;mounting public pressure to set,meet,and report on increasingly exacting and detailed climate targets for their portfolios;and particularly acute scrutiny of emissions-intensive compan
44、ies in their portfolios.On the other hand,investors are also under pressure from an increasingly vocal group of stakeholders,especially in North America,who resist the adoption of net-zero strategies.Many of the investors we interviewed expressed unease about these challenges,especially about the li
45、mitations on their capacity to accelerate the pace of change and the primacy of their fiduciary duty to their beneficiaries or shareholders.Several are intensely focused on the realities of effecting the transitionincluding risks and challenges such as“greenwashing,”the paucity of reliable data to s
46、upport decarbonization efforts and carbon markets,and the many uncertainties involved.In addition,as one North American CEO put it,simply divesting from high-emitting assets(as public companies and large investment funds are under pressure to do)does not in itself amount to an answer.Some investors
47、are concerned about disruptions to the energy supply and the demand likely to be created by the climate transition.These dislocations are already visible given the increasing share of renewables in the energy mix and the additional reliance on baseload fossil fuels that this creates.To the interview
48、ees,the energy crisis sparked by Russias invasion of Ukraine is a graphic illustration of this challenge,showing how geopolitical conflict can exacerbate the effect of historic underinvestment in needed fossil-fuel resources.Furthermore,many investors are analyzing the impact of such disruptions to
49、supply chains and the knock-on effects of these energy-related disruptions,with agriculture being an important area of focus.The shift in capitalization is a pressing issue for interviewees,with three-quarters citing this as an area of concern.Investors variously describe the current rebalancing of
50、the global balance sheet in the fight against inflation as a“reset”or a“regime change.”“I believe we are seeing the end of a paradigm and beginning of another,”said a leading North American investor.“In the paradigm that prevailed from 1991,it was great to invest:money was free,you would get bailed
51、out when in trouble,and deep integration of the global economy allowed for a high level of optimization.But this was politically very fragile,and we are seeing the impact economically and financially.”Another North American CIO said,“In the near term,this is a headwind for all asset classes,though i
52、ts likely stiffer for some than others.We are going to be more cautious on equities;we will likely shift into private credit on a more regular basis,and commodities may perform a little better.Shifts in portfolio composition will be on the margin,though.In the bigger picture,we will persist with our
53、 fundamental portfolio construction given that we expect the inflationary environment is not forever.”Against the backdrop of these shifting domains,we believe IIs will need to transform themselves radically to become faster,nimbler,and better at anticipating and responding to change.Tomorrow will b
54、elong to the investors that manage to build agility into their operating models.6Performance edge:Investors hone their strategies for a new eraGiven the scale,pace,and uncertainty of the changes confronting them,it is perhaps unsurprising that IIs are evolving their strategies and organizations.Our
55、interviews reveal intense focus in three areas:purpose portfolio construction proficiency In this chapter,we take a closer look at each of these themes.1.Purpose:Integrating fiduciary and societal responsibilities IIs are built around a compelling purpose(for example,delivering pensions to their mem
56、bers)that is typically well understood within their organizations.“Its a huge benefit for us as a pension plan,having a clear mission and purpose,”said a North American investor.“We try to go back to talking to people about valueswhy and how we do things.”At their core,pension funds and SWFs are als
57、o compelling instruments to drive economic inclusion,allowing workers and citizens of all socioeconomic levels to benefit from world-class investment strategies.However,as IIs grow in size and complexity,maintaining coherence and alignment with the overarching purpose is becoming both more difficult
58、 and more important.Generating returns for their beneficiaries remains their fundamental purpose,of course,but IIs increasingly need to take other factors such as environmental and social responsibilities into account.Integrating these imperatives with their fiduciary duty is crucial.This dilemma is
59、 clearly coming into focus in relation to climate change.IIs direct upward of 30 percent of the worlds capital and are inherently focused on the long term.They are thus central to the worlds biggest long-term problem:the rise in global temperatures,the physical climate risks this rise entails,and th
60、e transformational investments needed to slow and then stop climate change.But investors are also becoming more engaged with broader social concernsthe“S”in environmental,social,and governance factors(ESG)because of increased public attention to social and racial inequalities and the long-term polit
61、ical and economic consequences these inequalities may have.Practical approaches to the climate transition Most leading institutions have begun to develop their approach to the“E”in ESG.Indeed,the effort to integrate environmental concerns with their fiduciary responsibilities goes to the heart of th
62、eir overall investment strategies.This reflects two convictions:that investing in decarbonization can generate attractive returns and that developing an adequate assessment of physical climate risks and transition risks is a crucial task for any long-term investor.“Sustainable investing and long-ter
63、m investing are ultimately the same thing,”said a leader at a large fund in EMEA(Europe,the Middle East,and Africa).“We have a future-generations mandate.Environmental factors are critically important for future generations.And sustainable investments will deliver better risk-adjusted returns over t
64、he long term.”Part two:Honing a performance edge in institutional investing7Performance edge:Investors hone their strategies for a new eraThe key to success for investors is picking where in this vast investment universe to focus.For several interviewees,the answer is what one investor termed“transi
65、tion businesses”that is,companies that have set net-zero targets and are doing the hard work to reach them.These investors are concentrated on the practicalities of real-world abatement.They are developing a subset of high-conviction investment themes and organizing to deliver themengaging with port
66、folio companies and other stakeholderswhile retaining sufficient flexibility in their investment framework to deliver on their fiduciary obligations.Commitments to net-zero emissions are a case in point.Many investors are moving away from a sole focus on financed emissions accounting,recognizing tha
67、t these commitments can create the wrong incentives and starve high-emitting sectors of capital they sorely need to transition.Instead,they are espousing portfolio coverage methodologies,targeting an increasing percentage of holdings that are on credible net-zero trajectories,regardless of their sta
68、rting point.As one EMEA CEO observed,the good news is that the investor conversation regarding climate is becoming more honest:“It is less about just telling positive stories and more about acknowledging the difficult trade-offs and challenges we are grappling with.Every decision maker in our instit
69、ution needs to be able to talk about ESG and how he or she integrates it into their decision making.”Approaches to assessing climate and transition risk are also evolving.Sophisticated investors are moving beyond risk-scoring approaches and striving to develop a perspective on both physical and tran
70、sition risks across their portfolios.In the case of large illiquid holdings in private markets,for example,that means conducting robust value-at-stake assessments,including valuation of the impact of risks and opportunities.Our experience suggests that 15 to 20 percent of portfolio holdings typicall
71、y account for 80 to 90 percent of climate value at risk.Given that performance must always come first,the key question for IIs,then,is how to identify and measure winwin solutions that both meet their performance goals and deliver emission reductions for society.An emerging focus on social issues So
72、cial issues such as heightened inequality and its potential political and economic effects are a new area of focus for many investors,and they have been exacerbated by the COVID-19 pandemic.But many interviewees admit that they are just beginning the process of incorporating social impact into their
73、 strategies and operations.“We cannot quarantine this;it has to be central to what we do,”said a North American investor.“It also has certain risks,and you cannot start doing this overnight.We have to do all the work to make sure we get it right and make what we do in the social and environmental ar
74、eas fit with our strategy.”Funds are at different stages of developing their social strategies,with some pension funds pursuing“socially responsible”investment options for their members.Meanwhile,others are exploring potential areas in which they could launch investment programs that will deliver bo
75、th financial and social returns,such as venture capital(VC)funding for minority-and women-led businesses.Large direct infrastructure investors are now monitoring social factors in their portfolios at least as frequently as they monitor greenhouse-gas emissions and pollution,the most monitored enviro
76、nmental factors(Exhibit 5).Diversity within the management of institutions and their investment partners and portfolio companies is also an increasing focus,with more than a quarter of the institutions we spoke with having joined an organization or initiative committed to improving diversity across
77、the investment industry,such as the Asset Owner Diversity Charter;the Institutional Limited Partner Association Diversity in Action initiative;and the CFA Institute Diversity,Equity,and Inclusion Code.However,when it comes to the“S”of ESG,we see it as similar to where“E”was a decade ago:most leading
78、 investors recognize that something needs to be done but lack the frameworks and the 8Performance edge:Investors hone their strategies for a new eramethodology to do so.As they move to develop such frameworks,the issue of how to integrate social responsibilityand investors social license to operatew
79、ith fiduciary duty will loom ever larger.2.Portfolio construction:Redesigning for resilience and returnsThe challenging macro environment has increased the imperative for IIs to evolve their asset allocation approaches.In the short term,many interviewees made clear that their focus is on derisking t
80、heir portfolios.To the extent that investors believe higher inflation is entrenched,they are paying greater attention to inflation-linked assets.This is particularly important for illiquid assets such as real estate and infrastructure,in which asset class lines have blurred and not all investments h
81、ave the inflation-hedging properties that were originally intended.Exhibit 5Environmental and social factors monitored,%of respondentsSource:CEM BenchmarkingLarge direct investors monitor social factors at least as frequently as they monitor greenhouse-gas emissions and pollution.McKinsey&CompanyHea
82、lth and safetyEnvironmental8679797979797171716464Child laborDiversityGreenhouse-gas emissionsModern slaveryPollutionEnergy usageGreen certifcationWater usageBiodiversityWaste reductionSocial9Performance edge:Investors hone their strategies for a new eraInvestors are adopting new approaches to portfo
83、lio construction,recognizing that their ability to restructure asset class,sector,and geographic exposures will be critical to success in an era of compressed returns.As one North American CIO put it,“Beta is the new alpha”that is,finding ways to dynamically manage exposures for improved total retur
84、ns is vital to offset economic headwinds.Alpha will still be a focus,but investors recognize how challenging it can be to deliver.Over the past 30 years,though IIs have spent$722 billion to deliver alpha strategies and only$15 billion on beta strategies,alpha accounts for only 20 basis points of fun
85、ds total net returns(Exhibit 6).“I think there will be a definite move to better factor portfolio construction,”said an AsiaPacific CIO.“I wouldnt say we have a true understanding of factors today and a deliberate factor portfolio construction;we have factor insights,but we still are principally con
86、structing portfolios through asset classes instead of determining the factors then translating those to asset classes.That will shift as that capability builds out.”Asset allocation is also becoming more dynamic.A North American CEO described the process as follows:“You look at the entire portfolio
87、and think about the exposures you want to take in the market through different lenses:different asset classes,internal or external,active or passive,rules-based strategies.But we also want to have a liability hedging part in there,a risk mitigation portfolio.If we think there is too much risk in our
88、 portfolio,we can bring down our overall level of risk.”Dynamic portfolio tilts of this kind,reflecting investors changing beliefs on medium-term Exhibit 6Asset management costs1 at institutional investors,19922021,$billionReturns,19922021,annualized bps1Adjusted for infation.Source:CEM Benchmarking
89、The search for alpha has an enormous cost,but total returns from alpha pale in comparison with those from beta.McKinsey&Company722Beta85520875AlphaTotal net return73715Alpha strategiesBeta strategies10Performance edge:Investors hone their strategies for a new eramacro trends,are becoming increasingl
90、y common.These can be hugely impactful and create more alpha than any other lever available to CIOsbut institutions risk destroying years of alpha in their portfolios if they tilt incorrectly.One North American institution tilted away from fixed income at a particularly opportune moment:its fixed in
91、come allocation peaked at 46 percent in March 2020 but was reduced to just 16 percent by the end of that year,driving more total return impact than all of the alpha strategies of that institution.“Portfolio management needs a healthy dose of tactics;you need to be nimbler and accept significant mome
92、nts when you stick your neck out and make the right moves,”said a North American investor.“You have to be alive to the environment and risk;the risk of not doing something is so much higher than that of doing something.”In addition to top-of-the-house portfolio construction,investors shared three em
93、erging practices:a reappraisal of how they invest in private markets;shifting views on geographic allocations;and a move toward earlier-stage investing.Reassessing how to invest in private marketsAs the macroeconomic environment becomes more difficult,many IIs are taking a closer look at their priva
94、te-market exposures and at how they manage private-market investments.Most IIs believe that private markets remain attractive,but many also believe that they will need to pay much closer attention to how their existing private-market portfolios are being managed and which partners they engage to hel
95、p do so.These IIs plan to maintain or increase their private-market allocations,but many are also focused on building their internal capabilities to insource a greater part of their private-markets portfolio or seeking a higher share of co-investments from their main GPs.Some institutions that curre
96、ntly find themselves underinvested in private markets are waiting for markdowns to materialize to increase their participation at attractive prices.“Were going to be long-term holders of private-market assets for ten,20,or 30 years,”said one AsiaPacific investor.“With the right internal Key question
97、 for IIs:How do we identify winwin investments that fulfill our fiduciary responsibilities and deliver positive environmental and social impact?11Performance edge:Investors hone their strategies for a new eracapability,the passive management of those long-term holds can be done internally.We dont ne
98、ed an external partner for that.We need external partners for origination and partnering on due diligence.”A North American investor said,“Private assets are here to stay.Private debt is expanding even faster than before.And the majority of large energy-transition assets will stay private because pu
99、blic markets are too volatile.So were increasing our private markets allocation,with a focus on co-and direct investing alongside external managers.”Some IIs are planning to reduce their allocations to private markets,highlighting valuations relative to public markets,fee levels,and alignment of int
100、erests as current areas of concern.“In general,going forward,we will likely reduce our exposure to private markets by 20 to 25 percent,partly because of fee levels,”said an EMEA institutional investor.Attitudes to geographic exposures are divergingThe changing world order is forcing a reappraisal of
101、 geographic exposures by many leading IIs.In particular,we observe differing convictions in emerging markets(EMs):some investors are reducing allocations or growing them less aggressively than before,while others are viewing the current moment as a strong buying opportunity in which they finally sta
102、nd to benefit from the intrinsic growth of the EMs devoid of“hot money chasing returns.”In the latter category are institutions that see EM investment as a good way of building diversification in a“deglobalizing”or“decoupling”world.Looking ahead,we expect this divide may become even more pronounced,
103、with some investors staying away for the medium or even long term while others double down by opening more foreign offices and hiring more local talent to stake a claim in these markets for the long term.Russias invasion of Ukraine marked a wake-up call for many investors,serving as a brutal reminde
104、r of EM risk.“What happened with Russia will really change how people think about investing going forward,”said one North American investor.“Country risk has become an important factor,”added an AsiaPacific investor.Investors attitudes,then,will reflect their appetite for risk to some extent.“People
105、 want to get into EMs because they see it as a higher-return option.But weve also seen that its the higher-risk option.We have to be very cautious on that.We see it as both a diversifier and a big source of risk,”said the CEO of a North American fund.“Were still investing in China,”said another CEO.
106、“But would we buy a large unlisted asset in China?Probably not.”Despite these concerns,it seems unlikely that IIs will divest from EMs en masse any time soon.EMs make up 86 percent of the worlds population and 58 percent of its GDP.4 McKinsey research shows that nearly one in four EMs has achieved r
107、apid and consistent growth over long periods,with these outperformers collectively accounting for about a quarter of global trade in goods and services.5 This proportion is continuing to grow,so for investors with long time horizons,not having exposure to EMs may be a risky proposition in itself.But
108、 it appears that investment in EMs is becoming more of a country-by-country exercise,with investors focusing more specifically than before on each countrys strengths,weaknesses,and risk profile.4 World economic outlook:Countering the cost-of-living crisis,International Monetary Fund,October 2022.5 O
109、utperformers:High-growth emerging economies and the companies that propel them,McKinsey Global Institute,September 11,2018.12Performance edge:Investors hone their strategies for a new eraEarlier-stage investing in search of alphaTraditionally,early-stage investing was not the domain of IIs.Indeed,it
110、 was viewed as an overly risky niche that was inconsistent with the investing style(and long-dated liabilities)of a pension fund or SWF.All that has changed.Over the 201621 period,global VC fundraising increased by 9.8 percent annually,6 with significant amounts of capital flowing into a wide spectr
111、um of earlier-stage vehicles,from seed to VC to growth equity.Underlying this increase in early-stage investing is a two-part belief:that an ever-larger piece of value creation is happening in the earlier stages of a companys development and that companies are staying private longer.This trend is di
112、rectly linked to other forces,such as technological disruption and the disintermediation of private investing,in particular.IIs undertaking early-stage investments also stand to gain secondary benefits such as a privileged view of emerging technology developments and the opportunity to use this unde
113、rstanding to shape their broader portfolios.“The pace of innovation has accelerated.There are a lot of things happening across a number of areas that we need to be on top of,”said one CEO.“That means more investments at an earlier stage,visibility into some of these transformative technologies,and t
114、hen doubling down as they prove themselves.”This,of course,requires IIs to build out new areas of expertise:“People need to be equipped to understand whats happening in Level 4 autonomous driving,green cement,or quantum computing.If you have the knowledge base to do that,it allows you to understand
115、which shifts are relevant for your mature companies,”said an AsiaPacific CIO.To capture these opportunities,leading IIs are setting up a variety of early-stage platforms,often referred to as“innovation platforms”or“labs,”and investing in a wide range of technologies,from vertical farming and alterna
116、tive protein to biotechnology.For example,one North American institution established a venture platform to invest directly in innovative,late-stage companies,with a team of more than 25 dedicated investment professionals and net investments of more than US$6 billion.While it is too early to judge th
117、e results of this transition,IIs are now important players in early-stage investing and are likely here to stay.3.Proficiency:Evolving capabilities and partnershipsAs IIs have grown in scale and scope in recent years,many have increasingly sought to internalize investment operations rather than rely
118、ing on external investment managers.This process continues,but leading institutions are recognizing that they cannot internally hold the full range of talent and expertise needed to thrive 6 Private markets rally to new heights,McKinsey,March 2022.Key question for IIs:Have we done enough to establis
119、h a distinctive and nimble approach to portfolio construction?13Performance edge:Investors hone their strategies for a new erain an uncertain world.They are increasingly focused on building proficiency in select areas of expertiseincluding in cross-cutting areas such as technology and risk managemen
120、tand partnering with other organizations to complement their core skills.The war for talent is changingAlthough the market for talent appears to be leveling out,specific skill sets remain difficult to attract and retain,including IT and responsible-investing professionals.As the CIO of an AsiaPacifi
121、c fund put it,“When we first started internalization,no one else was doing it,so there was a much greater opportunity to get talent.We followed other peoples strategies,and now quite a few are following the same strategy as us.Theres a lot more competition.”“We remain committed to internalization ac
122、ross asset classes,”said another CIO.“But we are being thoughtful about where it makes sense and where it does not.When we cant do it internally,we build platforms where we have more controltypically corporations with their own management teams that we own or control that can put capital to work on
123、an ongoing basis.”Several leaders observed that their organizations are looking for different skill sets to reflect the changed external contextfor example,looking for people who can build partnerships and those with horizontal expertise across asset classes.“Its a different skill set to think about
124、 developing long-term relationships and using those in a way that creates opportunity,”said a CIO.“We have to be very clear about our value proposition:what we believe in,how we think about organizing ourselves,and what skills we need.Some of it is about leadership skills,working on complex problems
125、 and bringing people in to agree to a pathway forward.”Applying technology to improve the investment processOne area of particularly intense focus(in terms of talent and spending)is technology.In the past,skepticism about the value that technology can add to the investment process as well as budget
126、limitations resulted in IIs incorporating tech at a glacial pace.This mindset appears to be changing following the COVID-19 pandemic,the height of which left IIs reliant on technology to maintain day-to-day functionality.Now that IIs have woken up to the importance of incorporating technology,they f
127、ind themselves in the same position that banks were in at the start of the past decade:ready and willing but unsure where to begin.How much capital expenditure should be dedicated to technology?Which processes should be prioritized for the incorporation of technology?How should technology-related st
128、aff and providers be incorporated throughout the organization?Leading investors we spoke with made it clear that they are moving to embed data and analytics more rigorously in their investment and portfolio processes.While they reported differing strategies for incorporating technology and analytics
129、,most said they are focused on using technology to strengthen their decision-making capabilities.As one CIO remarked,“The investment industry doesnt suffer from a lack of data;it suffers from a lack of clear thinking.”Several leading investors are working to improve decision making by directly incor
130、porating technology within their investment teams.Rather than relying on a separate data analytics or IT team,these groups are focused on developing self-serve data analytics capabilities to enable their investment teams and hiring investment professionals with technology skills and accompanying min
131、dsets.“Almost everyone we hire at the junior level should have the tech capability or the ability to learn quickly so that they can do their own programming,access their own data,and do their own visualization,”said the CIO of an AsiaPacific fund.“If thats embedded in every team,its a lot easier tha
132、n a central source.”Other IIs are working to improve efficiencies within their teams by automating the manual parts of what they do,such as accounting 14Performance edge:Investors hone their strategies for a new eraand reconciliations,while drawing a clear line to ensure that technology is supportin
133、g the investment process rather than determining it.“We dont believe in the power of AI to pick a portfolio.That wont be part of our approach,”said one North American CIO.An AsiaPacific counterpart echoed that view:“We dont want to be data-led;we want to be data-enabled.”Bringing risk management to
134、the fore,including cybersecurityIn response to an environment clouded with uncertainty,leading IIs are evolving their risk management functions to address the new and emerging risks they face.These institutions are preoccupied with developing the expertise needed to identify,assess,mitigate,and moni
135、tor risks that could materially affect their organizations and the beneficiaries they serve.Risk functions,in some ways,are at the front line of change in this new era.The ability to develop and assess potential risk scenarios and improve institutional readiness is an increasingly high priority on C
136、EO agendas.For example,IIs are aware that they have become a target for cyberattacks around the globe.Accordingly,developing proficiency in cybersecurity and implementing the technology and processes necessary to mitigate potential breaches has become a vital focus for IIs.These institutions not onl
137、y face cybersecurity risk at the organizational level but are also exposed through the numerous financial institutions on which they depend and the portfolio companies in which they invest.Additional exposure comes through critical infrastructure.The Colonial Pipeline attack in May 2021,the largest
138、cyberattack on an oil infrastructure target in US history,is just one recent example of an II-owned asset subject to a cyberattack.Many leading IIs we spoke with are responding to increasing risk by incorporating cyber risk in their due-diligence processes and reassessing their organizational cybers
139、ecurity to ensure they have the policies,procedures,and personnel needed to address the current threat landscape.Accessing broader capabilities through partnershipsWhile IIs have long understood that“no person is an island,”they are currently making a new push for partnerships to efficiently access
140、the capabilities they lack internally.Some are exploring ways in which they could pool resources to benefit from the longer-term and more stable nature of the capital that they manage.Several told us that they expect an evolution of investment approach,with the continuation of the“Canadian direct in
141、vestment model”being complemented by“smart partnering,”in which IIs partner with each other or GPs to pool their capital in co-investment or direct-investment platforms.Examples include partnerships between investors and banks to develop private debt-financing platforms.One AsiaPacific CIO said:“Wel
142、l form a long-term cooperation agreement with other institutions or with large private equity Key question for IIs:How do you decide where to build truly world-class capabilities and where to partner?15Performance edge:Investors hone their strategies for a new eraco-investment or direct-investment p
143、latforms that value the reliability of our capital.But in an attractive system that has some built-in growth,forging partnerships with large stable institutions will be very attractive.”We are also seeing increased focus on platform investments in specific areas,with IIs acquiring a 100 percent stak
144、e in a specific company and using it as a vehicle to deploy more capital in a specific area over time.Examples include platform investments in growth themes such as battery storage and agriculture technology.Some investors are also considering establishing platforms in niche areas(rather than making
145、 direct investments through their own investment teams)as a more effective way to attract and retain the relevant talent.As one CIO put it,“If we wanted to get into a new area,we could look to set up a subsidiary platform;we fund it,but they set up their own compensation structures to be able to att
146、ract the right talent and deploy the capital.”Another trend is moving toward collaborations between IIs on policy issuesfor example,to develop standardized or comparable ESG metrics.If government regulation does not resolve such issues effectively,IIs will have to collaborate to produce a workable s
147、olution.More broadly,large IIs are increasingly being compelled to collaborate with governments on decarbonization and other global issues.16Performance edge:Investors hone their strategies for a new eraThe authors wish to thank Sara Bernow,Morgan Brokaw,Jonathan Christy,Antonino Piazza,Gregory Vain
148、berg,and CEM Benchmarking for their contributions to this report.Copyright 2023 McKinsey&Company.All rights reserved.ConclusionThe world of institutional investing is in the throes of adjusting to a new era likely to be defined by disruption and uncertainty.In geopolitics,the world order has been tu
149、rned on its head with the reemergence of great power rivalries and conflict in Europe.Serious obstacles confront the continuation of global economic integration.A Goldilocks economy has been replaced by inflation,rising interest rates,and balance sheet stress.Unprecedented fissures are emerging in t
150、he social contract,the global energy system is being reshaped by the increased focus on mitigating climate change,and the onward march of technology presents multiple new risks and opportunities.In establishing their path forward,investors would do well to recall a maxim from champion Formula One dr
151、iver Ayrton Senna about the relationship between circumstances and success:“You cant overtake 15 cars in sunny weather,”he said,“but you can when its raining.”It is our belief that this environment will create higher dispersion in investment outcomes,and those investors that are able to hone a true
152、performance edge will win.The winners in the next five to ten years will be those institutions that evolve their purpose,portfolio,and proficiency in ways that improve their resilience and ability to nimbly act and react to a changing environment.17Performance edge:Investors hone their strategies for a new eraApril 2023Designed by LeffCover image:Maskot/Getty ImagesCopyright McKinsey&CompanyMcKJune 2023 Copyright McKinsey&CompanyMcK