Perspectives 2020-2021 Public Sector

Citi Perspectives for the Public Sector 16 17 Citi has deep experience guiding and partnering PSIF clients to design effective and creative solutions to achieve tailored return outcomes, reduce and transform risk, increase operational efficiency and decrease cost and complexity. Citi’s unrivalled global footprint, expertise and long history in advising on, and executing capital flows – from markets and banking, to treasury and trade – gives us the ability to assist public sector funds investing anywhere in the world. Below are some examples of capabilities that Citi can draw on to construct solutions that meet individual PSIF client problems. • Access to Global and Local Markets: Ability to reliably execute across assets and markets in a variety of liquidity conditions. • Access to a Broad Range of Investment Opportunities: Insights on public market investment trends, themes and strategies in all regions; connecting long-term investors to corporates keen to divest assets; navigating emerging channels to deploy capital, such as special-purpose acquisition companies, so-called ‘bad bank’ structures; entities to manage non-performing loans, and private secondaries. • Yield Enhancement: Securities lending, return-enhancing solutions for gold. • Customized Hedging and Diversification Strategies: Bespoke risk management for rates/credit/FX/commodity hedging. • Managing Inflation Risks: Public and private assets, e.g., TIPS and other inflation-linked securities; hard assets including real estate, timber, agricultural land, art, etc. • Portfolio Protection and Transition: Environmental, Social and Governance advisory for transitioning businesses and portfolios to sustainable investments. • Resource Optimization: Balance sheet and collateral optimization. • Asset Servicing: Custody and securities services. • Business Advisory Services and Global Data Insights: Strategic and technology consultancy regarding investment industry evolution and emerging fintech companies. • Payments: Domestic and cross-border payments and FX. Conclusion Public sector investment funds, custodians of $50 trillion of investable assets, face many daunting challenges given the changes in the economic and financial landscape. Low or negative interest rates on sovereign debt, political pressures, COVID-19 and potential inflation risks add considerable complexity, but do not change PSIFs’ fundamental imperatives of investing for safety, liquidity and return. Among PSIFs, public pension funds arguably face the greatest challenges given their explicit stream of growing liabilities, but similar challenges are common to all PSIFs. Tactical allocations will change over the coming years in search of higher yields and less crowded or less efficient markets, where there may be greater opportunities. Citi is committed to helping our PSIF clients navigate these challenging times and achieve their objectives of enhancing returns, reducing risk and improving efficiency. Our unmatched global presence, long experience in the public sector, and breadth of solutions and services make us ideally placed to meet your needs and deliver solutions to address a range of opportunities and problems. Our global team stands ready and we look forward to discussing how we can help. Inflation tolerance is likely to shift over time. The effect of increased inflation expectations and the emergence of actual inflation could fundamentally change the investment landscape after years of monetarist central bank orthodoxy, which prioritized fighting inflation. The vast amount of liquidity poured into the global financial system over the past 12 years, and particularly the amount injected during 2020, may prove problematic. Milton Friedman’s observation that “inflation is always and everywhere a monetary phenomenon” will continue to echo through markets and policymakers’ minds. Inflation may be a significant risk in the years ahead, and one that needs to be managed appropriately by all investors, but especially those with longer horizons such as PSIFs. Political challenges risk undermining long-term goals Given the unprecedented scale of the COVID-19 crisis, governments are turning to PSIFs to fund emergency measures and drive a sustainable recovery. These are worthy public policy goals but may be planting the seeds of future problems; the implications may even run contrary to the best interests of pension scheme members and SWFs. With governments' debt-to-GDP ratios surpassing their post-WWII record, there is little room to top up public pension funds if returns cannot meet liabilities – either tomorrow or in 20 years (regardless of whether that deficit is a result a function of low returns, high expectations, or inflation exceeding benefit caps). Record debt-to-GDP ratios are likely to prompt an increase in public/private partnerships. However, these are not a panacea and are frequently more complicated in practice than in theory. There can often be more effective alternative solutions, but these require breadth of expertise, imagination and genuine partnership between clients and advisors to design and successfully execute. Political involvement, both broadly in such areas as trade, supply chains, and stock listings, and narrowly, such as not allowing the U.S. Government Employee Pension Fund to invest in China 3 , increases challenges for PSIFs considerably. All public investment funds ultimately exist in the political sphere as well as the financial, and the degree of freedom and independence they enjoy are neither constant nor absolute. This is especially the case given that unavoidable government spending in response to the COVID-19 crisis is creating a mountain of future debt, and pre-COVID-19 austerity policies may be politically untenable in the future. Navigating through these unsettled seas will require PSIFs to exercise considerable skill and utilize a range of tools and approaches. Potential impact on asset allocation Given the financial, economic and – to a lesser extent – political challenges facing PSIFs, they are likely to allocate more capital to assets that are expected to produce higher returns. Put simply, we anticipate significantly increased allocations to equities, corporate bonds and a variety of other, less liquid, investments, particularly by PPFs and SWFs. While the two groups encompass a variety of investment horizons, these are on average considerably longer than the market at large. This affords relative freedom and the capacity to look through shorter-term market upheavals but will result in even greater competition for high quality assets in both private and public markets. There are limits to the extent that PSIFs can chase yield, however. Their problems cannot be solved simply by amending asset allocation. At least part of the solution lies in how capital is put to work and allocated, how risks are managed, and how efficiently the different components of the portfolio are married together. Rethinking safety, liquidity, risk and reward PSIFs face a range of significant challenges. However, they also have a great opportunity to reconsider their approaches to safety, liquidity, risk and reward in order to meet return obligations within the boundaries of their mandate. To do this effectively, it can be invaluable to enlist external support. 3 https://www.nytimes.com/2020/05/13/business/economy/china-tsp-federal-retirement-fund.html Investing Post-COVID-19: Challenges and Responses Given the unprecedented scale of the COVID-19 crisis, governments are turning to PSIFs to fund emergency measures and drive a sustainable recovery.

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