Transparency and reporting demand

Telstra Super’s head of alternative investments, Kate Misic, is a keen advocate for the open-protocol reporting system, saying she hopes it is adopted globally as it improves on the current proliferation of reporting methodologies and templates.

Misic monitors four hedge fund managers as part of her role managing alternative assets for the $11-billion fund.

The overseas hedge-fund managers with whom the fund has mandates have taken great strides in recent years to meet the demands of institutional investors for more transparent reporting.

Misic points outs that problems can occur when a third-party risk aggregator then takes that position-level information and crunches the numbers to provide risk reports, with sometimes limited input from the manager. There is the risk that reported positions might be misunderstood or possible hedges of risk positions missed.

“If everybody provides information in consistent format, then it allows someone like me, who is a one-person hedge-fund team to say, ‘OK, here are my hedge fund managers; they have provided information in the same format; I can then aggregate that information and I can understand my portfolio better than getting four different types of reports’,” she says.

Misic describes the open protocol as a “middle ground” because it attempts to balance the needs of investors for transparency with a cost-effective way for managers to meet the growing reporting demands of clients and regulators.

Standardised format

The open-protocol system also gives managers choice in the granularity of reporting they are prepared to provide.

The initiative is being used far more prevalently offshore, with around 40 global hedge funds that are willing to provide open-protocol reporting and more slated to join by the end of the year, according to Misic.

“We should see that the numbers of hedge funds adopting this will be substantial by year’s end and there are even third-party risk aggregators out there who are going to be able to provide that open-protocol report as well.”

“So, if your manager can’t do it but they can provide position-level data and you can then get your third-party aggregator to provide that standardised report, the endgame is that you will be able to get consistent information from all your managers so you can see your portfolio in a standardised format.”

Members of the OPERA working group include Albourne Partners Limited, Citco, Thomson Reuters, Goldman Sachs, Morgan Stanley and public pension fund, Utah Retirement System.

No substitute

Misic was quick to point out that the open-protocol system was not designed to replace the risk reporting that hedge-fund managers already conduct. However, this additional format could provide a better tool for risk aggregation.

“This is not designed to replace what managers’ report to their clients, I understand it is not going to tell the whole picture for a lot of hedge funds. It is more about how can I look at my total portfolio in the most sensible way,” she says.

The template does not change to take into account different strategies. Questions are focused on a range of general areas including counterparty weights, geographical allocations, equity and credit allocations, and liquidity disclosure.

A unique aspect of the open-protocol reporting framework is that it still allows aggregation, despite the various disclosure standards of the underlying hedge fund managers.

Managers can choose three levels of disclosure, with the first being summarised information and the third level providing the most detailed, granular information.

Misic is a speaker at Conexus Financial’s upcoming Sixth Annual Alternatives Conference at Melbourne’s Park Hyatt from September 5 to 6. The session will examine the developments in hedge fund reporting and risk analytics and includes a panel discussion with MSCI executive director HeongWee Chong. Other keynote speakers include the Future Fund’s chief investment officer David Neal, discussing the fund’s innovative hedge fund strategy, and Debra Ng, a partner at Albourne Partners, who will look at how investors around the world are using hedge funds.

Conexus Financial is the publisher of Investment Magazine Online.

The $43-billion fund’s chief investment officer Mark Delaney says the fund’s 40-member investment team – half of which are in the policy part of the portfolio – will be expanded as part of a push to eventually in-source management across asset classes.

“All asset classes are currently external, but we are looking to bring part of Aussie equities internal and we will look to diversify that over the next three to four years,” Delaney says.

Small-cap Australian equities will continue to be externally managed, but the team will focus on the broader market.

Currently, half of its Australian equities are passively managed.

Delaney says that the fund will look to add between 10 and 20 staff members to manage part of its allocation to Australian equities, with the team competing for capital with other managers and strategies.

“We will start carefully and if [internal management] proves to be successful, it will attract more capital, like any other manager works,” he says.

Delaney says that the decision to move to internal management is driven by its capacity to access a better portfolio of assets, whether it can be done cheaper and whether the strategy can be effectively executed.

The investment team currently operates an internally designed risk-management system that looks at risk across the portfolio.

In addition, the team also handles asset allocation and sector tilts.

Investment staff set broad sector strategies, while specific stock selection is left to external managers, Delaney says.

The controversial state of financial regulation around the globe, the difficulties of green investing and watching asset consultants go head-to-head in front of a room full of potential clients were some of the highlights of the Australian Council of Super Investors (ACSI) annual conference.

Held in Melbourne last month, the conference had a strong focus on environmental, social and corporate governance (ESG) risks in investment, with ACSI chief executive officer Ann Bryne saying the association was stepping up its environmental and social monitoring activities. This includes releasing research into sustainability-reporting practices, and labour and human-rights policies and disclosure at S&P/ASX200 companies, Byrne says.

Gerry Hueston also says regulatory uncertainty creates a hostile environment for clean-energy entrepreneurs and investors. A 34- year veteran of BP, Hueston says green start-up enterprises must navigate a “valley of death” before succeeding. Later entrants are typically the companies that eventually profit.

The commission, led by prominent scientist Tim Flannery, aims to provide independent advice and scientific information about climate change to interested parties.

Hueston thinks Australia’s attempt to price carbon is unlikely to outpace those being undertaken by other countries. Concerns around a winding back of the carbon tax by a potential conservative government under Tony Abbott are overblown, Hueston says, because legislation is likely to be crafted in such a way as to make it difficult for the federal government to extricate itself from any potential future commitments.

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John Oliphant, head of actuarial and investments at South Africa’s $130-billion Government Employees Pension Fund (GEPF), says the fund considers high-impact investments that develop the domestic economy as being in the long-term interests of its members.

“We [GEPF] are effectively a third of South Africa’s GDP so what we think is that if the country does not do well then the fund will not do well because we own a slice of the economy,” Oliphant says.

“Anything that you care to see when you arrive in South Africa – whether you arrive at the airport, whether you drive on the roads, whether you buy food in the shops or whether you stay in a hotel – we own a piece of it. So it is critical that the manner in which we invest somehow benefits the economy and benefits the GEPF.”

The defined-benefit (DB) fund has also been a trailblazer when it comes to environmental, social and corporate governance (ESG). A founding signatory to the UN-backed Principles for Responsible Investment, GEPF moved in 2010 to integrate ESG considerations into its investments.

This includes launching an ESG rating for companies it invests in as part of its engagement strategy. The fund is currently focusing on the top 100 companies on the Johannesburg Stock Exchange.

The fund is also structured in a way that allows it to focus on very long-term strategy. Day-to- day operational management of investments is handled by GEPF’s asset management arm, Public Investment Corporation (PIC).

HIP’s more than 23,000 members will now have access to financial planners who charge on a fee-for-service basis.

Members will receive flexible and scalable, single or multi-issue financial advice, according to an announcement from by the fund this week.

Under the fee structure agreed to with Bridges, the cost of advice will depend on the level of ongoing service a member receives and the complexity of advice provided. Under the deal, HIP members also get a discounted rate on fees.

Bridges has 260 authorised planners nationally and is part of the IOOF group, which provides wealth management advice to more than 700,000 clients around Australia.

To retirement and beyond
The push into advice follows a high-profile trail by industry fund giant AustralianSuper started a year ago. The trial partnership with six financial-advisor groups has tested the feasibility of using retail planners to supplement the existing arrangement in which advisors are licensed through Industry Funds Financial Planning (IFFP).

The panel of advisers includes the NAB-owned Godfrey Pembroke. Under the trial, planners can only charge capped time-based or schedule fees, which can be deducted from their client’s account.

Bill Buttler, director of Price Warner Actuaries, says the growing number of industry fund members who will retire and the increasing size of post-retirement assets is making providing financial advice to members a priority for funds.

The Australian Prudential Regulation Authority Super Trends figures show that assets held by industry fund members over the age of 65 have been growing at five times the overall growth rate of assets under management.

The annual amount of pensions paid out to fund members has also been growing at a similar rate.

Buttler says that by funds working with advisers, they can work to better retain these post-retirement members and stem the continuing flow of members into self-managed super funds (SMSFs).

“If AustralianSuper and its fellow industry funds are to succeed in their bid to retain retiring members, they will need to tap into the pool of aligned dealer groups,” Buttler says.

“That will demand concessions and flexibility from both sides, but ultimately it will be to the benefit of all parties if the partnership is made to work.”

Providing a potential pathway back to the fund for HIP members who have opted for an SMSF is one of the advantages HIP chief executive Ross Bernays sees in partnering with Bridges.

Without system reform, proxy-voting errors from superannuation funds representing more than $1.3 trillion in working Australians’ capital are inevitable, says Dean Paatsch, director of Melbourne-based governance advisory firm Ownership Matters, in a panel session at the 2012 Australian Council of Super Investors (ACSI) conference on Thursday May 10.

An overhaul of the antiquated proxy-voting system, which sees the majority of proxies faxed through to companies, is long overdue.

“There is still too much paper,” Paatsch says. “There is no audit trail, there is no accountability and there is still no real progress on reform.”

Paatsch, who co-founded Proxy Australia in 2003 and led the company as it morphed into ISS Australia and then RiskMetrics, says the proliferation of registrar systems and intermediaries – what he calls “rent seekers” – add layers of complexity to the proxy voting system.

“By far the biggest risk for the successful delivery of proxies comes from the interaction between custodians and registers,” he says.

Strict timeframes built into the voting system can also cause errors. Even if funds issue voting instructions well in advance, the number of shares that super funds own and their subsequent votes are still decided 48 hours before an annual general meeting. This is exacerbated when large numbers of votes are placed during the six-week AGM season from October to November.

Paatsch calls for separation of the vote-entitlement date from the voting date. This can allow issuers and super funds to force custodians and registrars to lodge and accept electronic instructions only, create an audit trail and appoint an independent party to scrutinise the process.

He also advocates compulsory voting be verified by fund boards.

Danelle Bereau, senior manager of intermediary services at Computershare, says funds should make custodians and other intermediaries electronically submit votes to reduce the chance of potential errors.

Ian Matheson, chief investment officer of the Australasian Investor Relations Association, says funds should ensure they are represented on shareholder registers, even if they are in a pooled fund.

“There are more conversations about long-term performance and a more conservative risk-and-return spectrum,” says Jason Peasley, head of infrastructure at AustralianSuper. Speaking from the $43-billion superannuation fund’s Melbourne headquarters, he says the phrase “excess leverage” is scorned in infrastructure circles. The fund seeks “equity-like” returns with less volatility from its investments in the asset class, he says.

Investors on both sides of the Atlantic also seek stable income from infrastructure assets instead of the capital growth that private equity managers aim for. Universities Superannuation Scheme (USS), the £32-billion UK pension fund, invests in infrastructure to try to secure income that is linked to inflation and matches its long-term liabilities, says Gavin Merchant, senior manager of alternatives at the defined benefit fund. Infrastructure accounts for about a fifth of the fund’s £5-billion allocation to alternatives. Merchant says the fund plans to increase its commitment to infrastructure in the coming years to between 5 and 7 per cent of its overall portfolio.

CalSTRS, the US$148.9-billion pension fund for teachers in California, also seeks stable, regulated assets providing an inflation hedge and matching its long-term liabilities. Diloshini Seneviratne, head of infrastructure at the Sacramento-based fund, says the investment team took more than two years looking at opportunities worldwide before making an initial allocation last year. It invested in the debut fund of First Reserve Corporation, a private equity firm, which targets energy infrastructure.

Seneviratne says CalSTRS is mulling an increase in its allocation to infrastructure to US$3.5 billion, or 2.5 per cent, of its portfolio. This would see infrastructure comprise half of CalSTRS’ US$1.61-billion investment in inflation-sensitive assets, which also includes global index-linked bonds and Treasury Inflation Protected Securities. CalSTRS aims for returns of consumer price index plus 5 per cent from infrastructure. Industry Funds Management (IFM), a Melbourne-based firm overseeing $30.2 billion, recently landed a mandate from CalSTRS to invest up to $500 million in global infrastructure. Chief executive officer Brett Himbury says institutional investors favour mature infrastructure assets in developed markets. But there is a shortage of deals that ultimately drives up the prices of assets on the market.

“We are seeing our clients increasing their allocations to infrastructure and we are seeing that globally,” Himbury says.

“In many parts of the world the risk-free rates are very low. If you combine that with a high level of capital flowing towards infrastructure assets, there is clearly a risk that prices may be bid up,” he says. “We have more capital than we have deals,” Himbury says.

IFM is owned by 32 industry super funds and manages more than $10 billion in infrastructure assets in an open-ended fund. Its Australian infrastructure fund has returned 12.48 per cent net of tax and fees since its inception more than 16 years ago.

GESB recently announced $2.28 billion of new fixed-income mandates to three managers, and a wide-ranging restructure of its fixed-income portfolio.

Steve McKenna, acting chief investment officer at the Perth-based fund, says that splitting its fixed-income portfolio into global government bonds and global investment-grade bonds was a reaction to the some of the difficulties the fund experienced in 2007 with its credit exposures and would help manage current concerns around sovereign risk.

“In 2007, the way GESB had its fixed-income investments arranged was generally in aggregate and composite-bond portfolios that mixed sovereign debt and credit and what that meant was that it was in the managers’ ability to change the mix between sovereign and credit – not really a lever that we could pull at the GESB level,” he says.

McKenna says that the old aggregate-style portfolios limited the fund’s capacity to move considerably away from a manager’s benchmark when wanting to change the underlying mix of credit and sovereign debt.

“Back in 2007 it turned out credit was the issue and that was the thing you really wanted to avoid. Fast forward to 2011/12 and a lot of the problems are in sovereigns.”

McKenna, who as well as performing the role of acting-chief investment officer also develops strategies for GESB’s fixed income, alternatives and cash asset classes, says the new structure also attempts to deal with inherent flaws in bond indices.

Ezra, a 35-year veteran of the consulting industry, says superannuation funds should aim to provide for the “life outcomes” of its members.

This focus on life outcomes entails a discussion around not only what is a necessary lump sum at the end of an accumulation phase but also a continuing investment strategy into retirement that ensures members’ desired lifestyles can be funded.

Saying the job is only half done by the time a member retires, Ezra points to research that shows that up to 60 per cent of retirement income is generated from investments made after an individual retires.

This demands a much greater focus on managing risk exposure as a member ages, as well as funds better understanding the needs of its members. Ezra is an advocate of glide-path investment strategies, in which investment risk is gradually decreased up to and beyond retirement.

“We have all focused too much on the investment aspect and not enough on the life-outcome aspect,” Ezra says.

“As investment geeks we have been reporting on the investment aspect and we don’t report on the life-outcome aspect, and that gives a more calming long-term perspective and actually, I suspect, makes the system look better.”

Re-frame results for outcomes

Borrowing from the idea of funded ratios in defined benefit, Ezra says that superannuation funds should be looking to communicate the funded status of their members’ desired life outcomes.

This funded status is crucial for a member being able to ascertain what investment risk they are prepared to accept, as well as how much they may need to contribute to achieve their goal.

He has written extensively about governance best practice in the defined contribution space and says that boards should be looking at how they can re-frame reporting to members to provide a better sense of how the fund is traveling towards achieving an individual member’s objectives.

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As a union secretary, Ian Robertson is used to delivering blunt messages – it’s an approach that hasn’t changed in 14 years sitting on the board of the $6.2 billion Local Government Super (LGS). “I suppose I don’t put up with wankers or posers,” the chair of the LGS investment committee says, when asked about his straight-shooting reputation. It was an approach that put some establishment noses out of joint when he was chair of the Australian Institute of Superannuation Trustees (AIST) from 2007 to 2010. But Robertson, who first pushed for LGS to drop its investments in tobacco in 1998, says he will not relent from challenging fellow trustees in other funds to match their words with deeds when it comes to concrete action on environmental, social and corporate governance (ESG) issues. Earlier this year LGS, along with Cbus, HESTA and MTAA Super, were the only large Australian funds to vote in favour of a resolution to amend Woodside Petroleum’s constitution requiring the company to disclose its carbon-price assumptions.

Robertson says it was a crucial litmus test for Australian funds, which separated those that had merely aspirational green marketing statements from those prepared to demand a greater level of transparency from companies in which they were long-term shareholders. “While funds can get away with saying they are UNPRI signatories and that ‘we belong to the IGCC’, but in reality do absolutely nothing other than that, they will,” Robertson says. LGS has taken an active role in developing a range of innovative in-house strategies for tackling climate change and equity market risk in its portfolio. This year it has extended a “socially-responsible overlay” across all its investments. This involves applying ESG principles to both its actively- and passively-managed equity assets, and an ongoing effort to measure its carbon risk across its entire portfolio. In addition, the fund is working on ways to hedge climate-change risk across all the asset classes in which it invests.

The fund has used external adviser Mercer to look at the overall carbon exposure of its portfolio, and uses other sustainability consultants to advise on what companies pose a potential risk. Since 2004 it has not invested in Australian companies that derive more than 10 per cent of their revenue from a range of areas, including armaments manufacturing, nuclear energy, uranium mining, gambling and the logging of old-growth forests. Earlier in the year it extended its socially-responsible overlay to its international equities portfolio. LGS presently indexes 50 per cent of its Australian equities portfolio and 40 per cent of its international equities portfolio. It has gradually increased its passively-managed mandates after re-examining its approach to equities in 2009. It also indexes a sizeable portion of its bond portfolio. The socially-responsible overlay the fund designed allows LGS’ internal investment team to short a particular stock in the index to hedge against its potential ESG risk.

An innovative NSW Government pilot project to launch a social bond could be attractive to sophisticated investors and provide competitive returns, compared to those achieved through sovereign or corporate bonds, a key research organisation says. The proposed bond, which was announced as part of the recent NSW Budget, is a financial instrument that pays a return to investors based on the achievement of agreed social outcomes. The Centre for Social Impact has provided research and advice to successive state governments on forming social partnerships with government, investors and not-for-profit groups, including a report earlier in year focussed on social bonds. Les Hems, the centre’s director of research, says the two social benefit bonds proposed by the State Government have the potential to provide a form of socially responsible investment that is also an attractive investment option.

“The discussions we have had with investors, not-for-profits and governments is that you have to make this as close to a commercial proposition as you can, where there is the added value of social benefit,” he says. The NSW Government has allocated $20 million towards the project and has flagged two areas that would be suited to issuing bonds. The first of the bonds would aim to reduce the number of children in foster care as not-for-profits focus on reestablishing families where children have become wards of the state. The second bond would fund programs aiming to lower re-offending rates among former prisoners through education and support. The State Government has called for expressions of interest from not-forprofits. The negotiations between the service providers and the government will determine the model that emerges. It is not yet certain if the bonds will be government-guaranteed, or if investors will have to bear the risk of a not-forprofit failing to deliver on the social outcomes and eventual savings that they promised to the government. “We are down the risk profile. If there is government guarantee then it would be close to a government bond,” Hems says.

“If it is something that a not-forprofit runs – but you are still getting the cash flow from government but [the not-for-profit] is driving it – then it might look more like a corporate bond.” Hems says institutional investors have expressed interest in the ideas of social bonds and their potential in the medium to long term. “From a timing sense there is a growing interest in not just screening out socially negative investments but also investing in things that have positive social outcomes.” The bond proposal looking at reducing re-offending rates in newly released prisoners is roughly modelled on a social bond program run through Petersborough prison in the United Kingdom. At Petersborough, a not-forprofit operates a prisoner release program. Every prisoner it handles is benchmarked against 10 similar prisoners with comparable age, offending and demographic characteristics who are released on the same day around the country.

As a union secretary, Ian Robertson is used to delivering blunt messages – it’s an approach that hasn’t changed in 14 years sitting on the board of the $6.2 billion Local Government Super (LGS). “I suppose I don’t put up with wankers or posers,” the chair of the LGS investment committee says, when asked about his straight-shooting reputation. It was an approach that put some establishment noses out of joint when he was chair of the Australian Institute of Superannuation Trustees (AIST) from 2007 to 2010. But Robertson, who first pushed for LGS to drop its investments in tobacco in 1998, says he will not relent from challenging fellow trustees in other funds to match their words with deeds when it comes to concrete action on environmental, social and corporate governance (ESG) issues. Earlier this year LGS, along with Cbus, HESTA and MTAA Super, were the only large Australian funds to vote in favour of a resolution to amend Woodside Petroleum’s constitution requiring the company to disclose its carbon-price assumptions.

Robertson says it was a crucial litmus test for Australian funds, which separated those that had merely aspirational green marketing statements from those prepared to demand a greater level of transparency from companies in which they were long-term shareholders. “While funds can get away with saying they are UNPRI signatories and that ‘we belong to the IGCC’, but in reality do absolutely nothing other than that, they will,” Robertson says. LGS has taken an active role in developing a range of innovative in-house strategies for tackling climate change and equity market risk in its portfolio. This year it has extended a “socially-responsible overlay” across all its investments. This involves applying ESG principles to both its actively- and passively-managed equity assets, and an ongoing effort to measure its carbon risk across its entire portfolio. In addition, the fund is working on ways to hedge climate-change risk across all the asset classes in which it invests.

The fund has used external adviser Mercer to look at the overall carbon exposure of its portfolio, and uses other sustainability consultants to advise on what companies pose a potential risk. Since 2004 it has not invested in Australian companies that derive more than 10 per cent of their revenue from a range of areas, including armaments manufacturing, nuclear energy, uranium mining, gambling and the logging of old-growth forests. Earlier in the year it extended its socially-responsible overlay to its international equities portfolio. LGS presently indexes 50 per cent of its Australian equities portfolio and 40 per cent of its international equities portfolio. It has gradually increased its passively-managed mandates after re-examining its approach to equities in 2009. It also indexes a sizeable portion of its bond portfolio. The socially-responsible overlay the fund designed allows LGS’ internal investment team to short a particular stock in the index to hedge against its potential ESG risk.

The outspoken former CIO of AMP Capital Investors brings day-to-day investment experience to his role steering overall strategy as chair of UniSuper’s investment committee.

Peacock and his committee recently guided the $28 billion fund into key infrastructure projects, reduced its exposure to European equities and moved more than $500 million into large-cap US technology stocks.

Peacock says the fund is cautiously optimistic about the investment environment, despite concerns about developed-world sovereign debt and whether China will falter.

“The reason we are optimistic is that we think the underlying investments themselves look a bit better than fair value.”

Last year UniSuper retained its position in SuperRatings’ top performance quartile for long-term investment returns. The fund’s balanced option returned 7.18 per cent for the six months to December 31, resulting in an average annual return of 7.17 per cent in the past seven years.

However, Peacock is no stranger to the vagaries of market cycles, having witnessed the frenzied mining boom in Western Australia in the 1970s.

As an institutional investor in the heady 1980s he also locked horns with failed wheeler-dealers Alan Bond and Christopher Skase when they bestrode Australia’s corporate board rooms.

But it was in the late 1980s and 1990s that he became known in the industry as one of the “three amigos” at AMP with former CEO Ray Greenshields and deputy Leigh Hall.

While reluctant to be drawn on his experience of having a ringside seat to some of Australia’s great corporate stoushes, Peacock has maintained his outspoken opposition to excessive corporate remuneration.

He was a trenchant critic on executive pay issues while at AMP. UniSuper has also been active on this topic. The fund reported that in the third and fourth quarters of last year, 17 per cent of the 89 resolutions it voted against involved remuneration matters.

Peacock says a growing focus by investors and their managers on governance in the companies invest in is one of the key changes he has seen in the industry in recent years.

“Almost all managers feel that they have some responsibility to take a view and vote.”

Having worked as a CIO, Peacock draws a clear line between the responsibilities of day-to-day management and the role of the investment committee.