Investment Magazine » Simon Mumme

Better beta from less passive indexes

Simon Mumme — Mon, 27 Aug 2012 06:04:21 +0000

Tim Gardener was disgruntled. “I worry about the corporate bond space. If you invest according to market capitalisation in the corporate bond space, you invest the maximum amount of your allocated money in the most indebted companies, all else being equal,” Gardener said in an interview at AXA Investment Managers’ London office on May 25. “Lending more of your money to someone with a huge amount of debt, rather than some who has got less, doesn’t strike me as a winning strategy.”

Gardener worked for more than 23 years in the UK at Mercer Investment Consulting and its predecessor company, Wyman, rising to become global chief investment officer before exiting in August 2010. He struggled “on and off” with clients’ use of market capitalisation- weighted indexing as a low-cost way of buying bonds. The strategy was used “because there wasn’t anything else,” he said. Before the financial crisis broke, he advised pension funds to not track the UK corporate bond index because it then directed more than 60 per cent of capital to financial companies. At one point, Lloyds Bank, which was later bailed out by the government, accounted for about 7 per cent of the index, Gardener recalled. “I had nothing against financials at the time but it seemed that they borrowed an awful lot of money,” he said.

Gardener wanted a smarter way of investing in the beta, or common risks, of credit markets that does not have the flaws of funds which passively tracked market-cap weighted indexes. Such funds don’t adapt to changing markets and buy new bonds regardless of the creditworthiness of issuers. There was, however, one major problem. “I’m not a Rob Arnott,” Gardener said, referring to the Research Affiliates founder who pioneered fundamental indexing as an alternative to market cap-weighted funds. “I could see the problem but not the solution.”

Get smart

In 2012, as head of institutional client strategy at AXA Investment Managers, he challenged the company’s fixed income team: “What I want is something that is buy-and- hold as far as possible, and is designed to catch as much of the spread of a corporate bond over a government issue, without taking any bets.” The team trialled complex ways of tracking corporate bond indexes. They were expensive and opaque, and none worked as well as a strategy similar to an equal-weighted index-tracking fund, which puts companies of all sizes on the same footing. “It annoyed our rocket scientists,” Gardener said.

The fixed income team drew on their experiences managing buy-and- hold credit portfolios for insurance funds with different return targets. The “smart beta” strategy they developed uses proprietary screens to gauge the creditworthiness of debt-issuing companies. It buys securities that are at least two rungs above a lower credit rating. This prevents the strategy from being forced to sell downgraded securities in order to stay within mandate covenants. Trading discipline is also important.

Much of the “smartness” of the strategy is buying securities as cheaply as possible, Gardener said. “If you don’t, it just cripples you,” particularly since the portfolio sells one-eighth of its assets each year to maintain a constant duration. The proceeds from these sales, plus income from coupon payments, are re-invested.

“As much as the credit filter is important, how you deal in the marketplace and manage downgrades are just as important.”

Avoiding duds

Bond investors can gain make gains as valuations rise and coupon payments are made or lose all of their capital if issuers default. Buy-and- hold credit investors should therefore prioritise the “buy” part of their strategy, according to Gardener.

“You’ve got to make sure that you don’t buy the duds,” he said. “The difference between this and active management is that we’re not trying to find the best securities. We’re trying to take out the worst stocks and diversify as widely as possible with the rest.”

The strategy does not invest large sums of money in the debt of any one company. “If you’re investing in an environment of uncertainty, very naïve diversification is a good thing,” Gardener said. “Because almost by definition, the things that hit you most are the things you haven’t thought of.”

Investors should seek out active managers with genuine insight into the relative quality of bonds and financial market and macroeconomic conditions. “I genuinely believe there are some investors out there with vision. The average fund manager doesn’t have any more vision than the man on the street about the way the world is going.”

Super fund fusion

Simon Mumme — Mon, 20 Aug 2012 04:10:18 +0000

Mergers can benefit superannuation funds: favourable mandate structures, terms and fees can be secured; co-investments or direct investments in unlisted assets can be made; more money to allocate becomes available in a capital-constrained world; and capital-gains-tax credits can be used to offset future profits from domestic stocks.

What can go wrong? Funds don’t agree on how their merger can strengthen their investment strategy or they don’t lay thorough plans to combine portfolios. The cost of failure is daunting.

About 1 per cent of net returns can be lost if a merger fails, according to Ashley O’Connor, senior consultant at Frontier Advisors, which consults on $117 billion in institutional assets. Volatile investment markets can exacerbate losses from such breakdowns. Also, the “limbo effect” of suspending investment decisions in the months or years preceding a merger can curb performance. Following a merger, fund performance can suffer if strategies have not been prepared in advance and are not executed well.

Each merger is different. They involve funds with different membership demographics, investment portfolios, governance policies and organisational cultures. In O’Connor’s experience, however, common principles can be used by merging funds to ensure that investment performance does not suffer amid myriad other tasks – including governance, custody, member administration, regulation and public relations – that funds must also deal with while becoming a new entity.

Equal say

At least 12 months before the merger date, funds should create a steering committee comprising equal numbers of senior people and empower it to make important investment decisions, O’Connor said in an address at the Frontier Advisors client conference on June 15. The group must envisage how the combined portfolios can take advantage of scale benefits and make sure, as much as possible, that members of either fund are not disadvantaged. The committee must have decision-making continuity and be held accountable for results. Clashes over trustee elections must be prevented.

In May, the two-year plan to merge Equipsuper and Vision Super broke down. Before this, in preparation for the merger, Equipsuper became an investor in Vision Super’s existing pooled superannuation trust. The $4.6-billion industry fund placed its cash and fixed income assets, totalling $1.3 billion, with Vision Super. (The government’s temporary withdrawal of capital-gains-tax offsets for merging funds stopped it from transferring equity investments.) The funds then established a joint-venture company, Pooled Super Pty Ltd, to be trustee of the assets, and an investment committee comprising equal numbers of directors from both funds to monitor fund managers (see figure 1).

Fund trustee directors then tasked their investment teams and lead consultants, Kristian Fok of Frontier Advisors and Duncan Smith at JANA Investment Advisors, to determine how the merged entity should invest.

“We took the view that the two asset consultants and internal investment teams should work together to establish a recommendation of what a future asset allocation should look like and what assets should be managed internally,” Danielle Press, chief executive of Equipsuper, a $4.6-billion Melbourne-based fund, said in an interview on July 16. “We said, ‘Let’s work out what the goal is, what the ideal portfolio is and then work out how we get there’.”

The $46.5-billion AustralianSuper, which was formed by the 2006 merger of the Superannuation Trust of Australia and the Australian Retirement Fund and has joined with other funds since then, now assembles staff members and service providers from various fields – investment, operations, member administration, communications, finance, risk management, tax, human resources and legal – to oversee various aspects of mergers. “It’s almost business-as-usual doing mergers,” Peter Curtis, head of investment operations at the Melbourne-based fund, said in a July 17 interview. “We have a team of people that we pull together for the job.”

New characteristics

Merging funds should forecast what the characteristics of the new member base will have and how it will influence investment strategy, O’Connor said. They should discuss the following points: the range of ages, occupations and investment-risk appetites members of the new fund will have; the new volume of contributions; the number of members likely to remain invested in the default investment option; and members’ record of switching between investment options in a market rout.

AustralianSuper, which will grow to $50 billion following its merger with AGEST Super and potentially become the third-largest superannuation provider, considers growth a vital part of its investment strategy.AustralianSuper’s 2011 merger with Westscheme, a $3-billion fund, and it’s current absorption of the $4.6 billion AGEST Super will boost current-member cash flows into AustralianSuper. This steady volume of new funds must be channelled to investment managers and used profitably. “On top of the 9 per cent coming in every day, it cranks up the activity,” Curtis said.

“How can we use size to get better net returns?” Curtis asked. “By being able to look at larger investments, listed and unlisted, and by trying to get first-mover advantage into Asia. By starting to do portfolio management internally, doing unlisted investments more directly rather than through pooled vehicles, and looking for co-investment opportunities.”

As plans for the Equipsuper and Vision Super merger progressed, the funds’ investment teams began working together in Equipsuper’s office at 114 William St in central Melbourne.

Michael Strachan, chief investment officer of the fund, was slated to lead the merged fund’s investment activities. The internal team he oversaw – which manages Australian equities, fixed income and infrastructure assets – would have been allocated more capital to invest.

“Investment management is a scale business,” Press said. “We wouldn’t have added to the internal investment team. It’s a scale business so there would have been cost savings.”

The merger ultimately failed because the two funds could not agree about the future role of the internal team.

Tricky illiquids

The investment philosophy, performance objectives and governance principles of the new fund must be clearly defined. This should include an analysis of potential scale benefits and admission of how seriously the fund will compare itself against the short- and medium-term returns of peers as it seeks to beat inflation over longer time periods.

In this, the funds should decide their tolerance for negative returns that are publicised in league tables. “Sometimes trustees can come from funds with completely different investment philosophies,” O’Connor said. “You don’t want trustees – one year after the merger – to still be discussing investment philosophy.”

The asset classes that the new fund will invest in, and the desired blend of growth and defensive assets, should be decided. Its appetite for private market assets, including direct holdings or co-investments in property or infrastructure, should be gauged. Future liquidity needs may make it necessary to put unlisted assets up for sale.

The contrasting asset mixes of the defined-benefit funds within Equipsuper and Vision Super meant that they would have remained separate. Private equity and infrastructure assets of different maturities were difficult to combine in a single portfolio that benefited both memberships.

Their intrinsic value was difficult to carry into a merged portfolio, Press said. “How do you make it equitable? That was the biggest challenge.” However the two funds’ default options, in which defined-contribution members invested, “were almost identical.”

AustralianSuper seeks details of its merger partner’s investments. It asks: “What are the underlying assets of the fund that we are merging with: are they held in unit trusts? Shares in a discrete portfolio? How many of the assets are unlisted or held in partnership around the world?” Curtis said. “We work with the other fund to understand what they own and how they have structured their portfolio, and what we need to understand that is unique.”

Existing investment options and tax positions of the merging funds, plus their methods used to calculate unit prices and crediting rates, must also be known.

So far, AustralianSuper has not merged with a fund that has a meaningfully different balanced fund.

Consequently, the asset allocation of its default option, which manages most of the fund’s assets, has not undergone a “significant shift” during mergers.

“Once we understand their investment portfolio, we pick it up and move it into our portfolio on the merger date,” Curtis said. “Once we get the portfolio on board, we due diligence it to decide which assets we’d like to keep or sell over time.”

Combining the unlisted assets of the merging fund can be the most complex part, according to Curtis. They can be very difficult to sell – some are held in private equity partnerships for many years, while others need time and management effort to be sold at a higher price – in order to meet the investment and liquidity aims of the new fund.

Build the portfolio

The long-term strategic asset allocations for all investment options should be set to meet new investment objectives and abide by the new philosophy. This includes deciding the number of member investment choice and sector- specific options, O’Connor said. Policies for reviewing long- and medium-term asset allocations, and for portfolio rebalancing, need to be determined.

The mergers with Westscheme and AGEST have not fundamentally changed AustralianSuper’s investment strategy. This is because the funds are much smaller than their merger partner: they represent about 10 per cent of AustralianSuper’s capital and can be absorbed into its portfolios. “If one of them was a $30-billion fund, there would be much more planning,” Curtis said.

Fund manager line-ups should then be consolidated. This reduces the number of fund managers to monitor and provides opportunities to reset fees and terms with preferred managers. “Managers know that consolidation is inevitable with mergers. So it’s a great time to renegotiate terms,” O’Connor says.

Equipsuper and Vision Super aimed to gain fee discounts this way. “A lot of the gains for members would have come.

Inside the Qantas investment engine

Simon Mumme — Mon, 13 Aug 2012 02:20:11 +0000

Basis points matter, according to Andrew Spence, chief investment officer of the $6-billion Qantas Superannuation Plan, because the volumes of money in superannuation are “enormous.”

He is not talking about incremental investment gains on billions of dollars of invested capital. He’s speaking about saving money.

Specifically, the $1.42 million that the fund saved in the year to June 30, 2012 by taking control of foreign exchange transactions made for its $2.5 billion in global equity and alternative asset holdings. It’s the first of many net savings that Spence believes can be made for the fund’s 33,000-plus members by reducing the hidden costs of investing through “implementation efficiency” processes.

Working as a fund manager in London and Sydney for 20 years until 2005, then as an investment consultant to super funds until 2007, made Spence aware that investment processes incur implicit costs, or “slippage”, that are not covered by fund manager fees.

In 2009, about one year into his tenure as Qantas Super’s first CIO, he began analysing every foreign exchange trade made over two years by the global equity managers, who invest about $1.5 billion of the fund’s capital, and alternative asset managers, such as private equity firms, that oversee about $1 billion. Spence and his team measured the difference between the prices at which fund managers transacted and the best on offer at the time, called the spread. They always expected to uncover some expensive currency trades, “but you don’t really know until you do the work,” Spence said in an interview at Qantas Super’s offices at Sydney Airport on July 20. “Foreign exchange seemed to be the area that was most inefficient in trade execution. It’s a dark art.”

Their findings were striking. In currency trades totalling $1 billion over two years, managers paid six-to-eight times more than necessary. The results were consistent with industry research.

Special FX

Qantas Super found that most fund managers depended on custodian banks to execute currency trades, which in turn dealt with parent investment banks. Fewer managers transacted through internal trading desks and these processes were typically opaque. There was scant evidence that counterparties always sought optimal prices for currency trades made on the fund’s behalf.

Following due diligence, Qantas Super hired Russell Implementation Services (RIS) to take control of managers’ foreign exchange trading. A unit of Russell Investments, RIS seeks best prices from a panel of counterparties rather than being part of the trade. It is a “fiduciary agent”, Spence said, that fully discloses costs to Qantas by time-stamping each trade it made with 18 counterparties in the past year. Each transaction was externally audited to ensure that “best execution” was achieved.

“We’re turning implicit costs into explicit costs. Once you measure explicit costs, you can manage them,” Spence said. “If they do not become explicit costs, they are an unseen drag on members’ returns.”

Currency trading is just one investment process where slippage can be stopped. Portfolio rebalancing, tax management of stocks, securities lending and transition management are others. The $18-billion HESTA Super Fund measures how much tax its Australian equity managers incur and whether this can be minimised without compromising investment decisions. Qantas Super is now doing due diligence on whether it should seek similar discipline from domestic stock fund managers.

“Implementation efficiency is an important part of the value chain. What we’re trying to do is deconstruct the value chain and reconstruct it in a way that works for our members rather than another part of the industry,” Spence said. “It’s not a sexy area, but meaningful benefits are to be gained from it.”

RIS also manages Qantas Super’s currency hedging programs for developed and emerging-market stocks and alternative assets. It helps the fund limit the costs of shifting capital between fund managers, called transition management, by aiming to transact at the best prices.

Five people, one focus

At Towers Watson, Spence worked with David Neal as lead consultant to Qantas Super.

Like Neal, who is now CIO at the $77-billion Future Fund, Spence has ingrained a “single total portfolio” way of investing at the fund.

The investment team debates investment strategy, portfolio construction and risk management together. Each bears responsibility for decisions affecting the whole portfolio. None of the five people in the team focuses exclusively on an asset class and all are skilled in portfolio management, performance analysis, compliance and tax. Spence hires “people who are comfortable in the front, middle and back-office” departments of investment management, he said. “We’re building the internal capability to better manage the complete value chain. Not to manage the assets.”

Qantas Super’s focus on reducing the implicit costs of investing is not pursued at the expense of high risk-adjusted returns, or alpha. The fund will pay bigger fees to hire fund managers that it believes will provide strong returns without inappropriate risk. Such abilities are rare: the alpha-generating skills of managers are “cyclical”, meaning that they succeed at different times, “and are expensive,” Spence said. “Our focus is on getting value for money.”

AIST: tax relief to spur more mergers

Simon Mumme — Mon, 06 Aug 2012 06:40:37 +0000

Incoming laws preventing tax losses in superannuation mergers will spur more funds to unite as they face greater compliance workloads, according to an industry peak body.

The draft legislation, aiming to allow merging super funds to offset investment losses against future capital gains tax (CGT), will trigger the latent plans of many funds to join forces as they seek to provide better services and cope with the administrative burden of running mandatory default funds from mid-2013, according to the Australian Institute of Superannuation Trustees (AIST).

“A lot of member funds that were looking at merging were not going to without CGT relief,” Fiona Reynolds, chief executive of AIST, said in a telephone interview yesterday. “They were going to have to pay so much money that it would have been against members’ best interests.”

The industry fund representative, AIST expects some funds to undergo mergers as they design and seek licenses for MySuper funds before compulsorily operating the new default products on July 1, 2013. “We expect to see more funds merge during the MySuper licensing process,” Reynolds said. “A lot of smaller corporate and industry funds will roll into larger funds because of the added complexity and compliance.”

Obstacle identified and overcome

Earlier this year, a survey of AIST members, who oversee about $450 billion, found that at least 20 funds cited the lack of CGT relief as an obstacle to mergers. Not knowing whether $45 million in tax offsets would be gained stalled the union of AustralianSuper and AGEST. CareSuper and ASSET Super set a merger date of October 30 after guaranteeing that $30 million would be deducted from a future tax bill.

The draft legislation, released on Friday August 3, provides so-called CGT relief to funds merging between October1, 2011 and July 2, 2017. The offsets can be claimed on all revenue-generating assets irrespective of the net performance of funds. The rules, which are subject to public consultation until August 24, should improve the confidence among trustees, according to the Association of Superannuation Funds of Australia (ASFA), another industry peak body.

“There is no doubt that conversations about mergers are happening in board rooms. Trustees will now have greater certainty about the legislation,” Pauline Vamos, chief executive of Association of Superannuation Funds of Australia, said in an interview yesterday.

Equipsuper to managefutures in-house

Simon Mumme — Mon, 30 Jul 2012 06:04:30 +0000

Staff at the $4.6-billion Equipsuper could start making tactical investment bets through futures contracts by the end of the year.

Equipsuper’s seven-person investment team aims to begin making investments in all asset classes by using futures based on major stock and bond market indexes by December. The contracts would enable the fund to place trades without incurring the transactional and tax costs of shifting assets among outsourced investment managers.

“It gives us flexibility to move money more quickly,” Danielle Press, chief executive of the Melbourne-based industry fund, said in a telephone interview yesterday. “It gives stability to investment managers because we will not be taking physical cash from them.”

Equipsuper’s investment team, led by chief investment officer Michael Strachan, will be responsible for managing the publicly traded securities, which are agreements to buy or sell an asset at a specified time in the future.

Futures could provide tax benefits by preventing Equipsuper’s fund managers from realising capital gains on sold stocks and breaching the so-called 45-day rule, which blocks franked dividends to short-term investors.

Equipsuper’s investment committee, comprised of fund trustees, supported the decision to start trading futures in a meeting one year ago, Press said. Merger negotiations with the $4.9-billion Vision Super, which collapsed in May, stalled the plan.

Qantas Super tracks market threats with RiskMetrics

Simon Mumme — Mon, 23 Jul 2012 07:23:46 +0000

Qantas Superannuation Plan has begun using a RiskMetrics system to gauge how its $6 billion in assets can withstand various investment risks.

The fund, which manages the retirement savings of more than 33,000 Qantas Group employees, started using the RiskMetrics product, called RiskManager, in late June to better track how changes in investment markets affect its investments.

“We’ve implemented a whole-of-fund risk platform,” Andrew Spence, chief investment officer of the Mascot, Sydney-based fund, said in an interview on Friday July 20. “Ninety per cent of what it shows will be no surprise at all. But I’m hoping to know more about the 10-to-15 per cent that are more opaque.”

Qantas Super oversees the work of fund managers chosen to invest in equity, fixed income and so-called alternative assets, such as private equity. The risk management system would provide more information about the nature of the fund’s investments, most of which are managed through individual contracts or exclusive unit trusts, Spence said.

“It’s like getting a high-performance car. You need to understand how it will operate in a range of situations,” Spence said. “Which fuel is best? How does it go in the wet? The next six months will show us how to better understand the portfolio.”

One trustee, multiple funds

Simon Mumme — Mon, 23 Jul 2012 05:01:34 +0000

Managing conflicts of interest, setting rules for investment executives and thinking about what people want are part of Dick Morath’s fiduciary duty. Morath, a former chief executive of MLC’s retail and corporate fund businesses, influences how billions of dollars of Australians’ money is invested. He is a trustee of MLC Nominees, the board governing two MLC superannuation businesses, and PFS Nominees, which oversees Plum Financial Services, a master trust managing about $14 billion in corporate superannuation benefits. He is also chair of the administration business behind Plum and oversees MLC’s financial planning units.

MLC manages $48.6 billion in superannuation savings. Giving two boards control over the investments in MLC Wrap, the MLC MasterKey platform and Plum is convenient. It also creates conflicting interests.

“There are logical efficiencies and strengths but sometimes we have to think about related-party decisions,” Morath says, reflecting on his role in helping to govern the National Australia Bank-owned businesses.

When MLC Nominees decided to close one fund and shift its assets to another, the eight-member trustee board split so that half of the directors spoke for the closing fund and half represented the recipient. These so-called successor-fund transfers must benefit members and happen only if members of both funds have equal rights and representation. Both sides of the split board bargained in the interests of their members, Morath says.

“This is fiduciary duty. Half were responsible for the transferring trustee; half were responsible for the receiving trustee. There are always solutions to conflicts of interest.”

MLC Wrap hosts more than 300 managed funds. Individuals can only invest in these funds through a financial adviser. MLC’s investment-manager research team and a sub-committee of MLC Nominees, using ratings from researcher Lonsec, choose funds for the Wrap and MLC MasterKey, which sells multi-manager funds, and for Plum.

MLC runs “three funds with three different approaches because members in these funds are different,” Morath says. The company encourages members to seek financial advice and improve their financial literacy rather than rely on default investment products.

“Our duty is to make sure that members are educated. We want to give them a range of options. We don’t want to be paternalistic and say: this is what’s right for you,” Morath says. “We have to engage members in a way so they ideally make the decision and understand why they are making it.”

Equipsuper advice push starts with ex-AIA man

Simon Mumme — Mon, 16 Jul 2012 10:00:57 +0000

Equipsuper wants to strengthen its financial planning unit under a newly appointed boss, Justin Sadler, a former AIA Financial Services executive.

Sadler, who started work at the $4.6-billion industry fund on July 9, will oversee the advice delivered by its financial planners and the expansion of the team beyond five people. He led about 80 AIA financial advisors until the company shut the division in February 2011.

Equipsuper is keen to forge closer relationships with members, particularly the 40 per cent that are between 30 and 45 years old. Australian workers in this age group typically become more interested in superannuation as their balances grow and they lay plans for retirement.

“This is when super starts to matter to people,” Danielle Press, chief executive officer of Melbourne-based Equipsuper, said in a telephone interview yesterday. “How do we help manage people as they transition to retirement and how do we manage 40-year-olds who want to set up a self-managed super fund?”

Most of Equipsuper’s financial advisers work in the fund’s head office at 114 William Street in central Melbourne. The fund, which manages the retirement savings of many former electricity workers in Victoria, wants to employ more planners in rural areas. Earlier this year it assigned an adviser to work in Traralgon in Gippsland, close to major power stations such as Loy Yang.

LUCRF hires Grioli to map post-crisis markets

Simon Mumme — Mon, 16 Jul 2012 10:00:09 +0000

LUCRF Super, the $3.1-billion superannuation fund, has hired ex-FuturePlus investment analyst Daniel Grioli to help it adapt to volatile markets.

Grioli, who joined LUCRF’s nine-person investment team as a senior analyst in late June, will help the fund develop an investment strategy that is more responsive to changes in financial markets. He reports to head of investment strategy, Ben Samild.

“The post-financial crisis environment is a difficult one,” Greg Sword, chief executive officer of LUCRF, said in a telephone interview from the fund’s head office in Melbourne’s Docklands on Thursday July 12. “These days, you build your strategic approach upon what you think the environment is going to be and you have to be able to change it.”

Superannuation funds target returns that outpace the consumer-price index (CPI) over long time periods. LUCRF’s average net annual return in the 10 years to 2011 is 4.94 per cent, according to the fund’s website. The rate of CPI, which averages price changes among staple consumer goods and services, was 3.1 per cent in December 2011.

Grioli worked as an independent consultant for six months after leaving FuturePlus Financial Services, a Sydney-based investment office and administrator whose main client is the $3.3-billion Energy Industries Superannuation Scheme, in February.

He joined LUCRF, which formed in 1978 as the Labour Union Co-operative Retirement Fund, two months after it hired Duncan Graham, a former property investment manager at the $77-billion Future Fund, to oversee real estate investments.

Grioli regularly writes columns for Investment Magazine.

Global Dialogue spurs pension-fund collaboration

Simon Mumme — Mon, 16 Jul 2012 06:23:42 +0000

Geoff Mellor, chief executive of the £20-billion UK fund Coal Pension Trustees (CPT), used his opening words to ask why the audience of Australian superannuation bosses were still in the room.

“Do you feel that travelling half-way around the world, sitting in a conference venue and listening to serial speakers is a better use of your time than actually getting out and about into the UK market?” he asked delegates of Global Dialogue 2012. The conference was organised by the Australian Institute of Superannuation Trustees, the peak national body for industry superannuation and held at the Hyatt Regency London from May 21 to 25.

Fund executives and trustees shifted in their seats and murmured. No one answered aloud. Mellor, the first speaker in a day-three panel session about collaboration between pension funds worldwide, clicked to his first PowerPoint slide. The conference resumed.

Mellor joined the CPT, which oversees the £11-billion Mineworkers’ Pension Scheme and £9-billion British Coal Superannuation Scheme, in 2007 from managing the pension scheme at hospitality behemoth Whitbread. Coal Pension Trustees’ government- guaranteed benefits and exemption from certain UK pension regulations make it different from other pension funds, Mellor said.

It wanted to act according to its specific risk tolerances and return objectives. This strengthened its resolve to not tolerate the standard way of managing a UK pension fund through “generic solutions” from consultants and “poor-quality trustees and management”.

“So the challenge for us was not to follow the herd,” Mellor, a trained actuary, said. “We had to work it out for ourselves.”

Lessons at home and away

Coal Pension Trustees found good and bad practices when it interviewed funds in Europe and the US about their investment governance principles and ways of management.

Flaws included the trap of funds spending 80 per cent of company time on matters equalling roughly 20 per cent of importance. Spending more time on fund-manager selection than asset allocation is a common instance of the so-called 80/20 rule. Unaligned interests between funds and their service providers and an inability to clearly articulate fund objectives were other common flaws.

Mellor highlighted three funds – the 400-billion-Danish-kroner ATP, the District of Columbia Retirement Board and £15-billion medical endowment Wellcome Trust – as practicing admirable governance.

“They’re absolutely paranoid about risk,” Mellor said. “Everything is driven from their risk agenda.”

At ATP, fund objectives permeated senior management and their employees. “What we found in those organisations was alignment from the top to the bottom. The chairman of the advisory board and the most junior person in the organisation can articulate what they’re trying to achieve.” Investment risk also dictated many policies of the Hillerod, Denmark- based fund. “They’re absolutely paranoid about risk,” Mellor said. “Everything is driven from their risk agenda.”

Pension funds buy up Barangaroo

Simon Mumme — Mon, 09 Jul 2012 07:06:48 +0000

Pension funds are major backers of the $6-billion Barangaroo South office towers being constructed in central Sydney by property developer Lend Lease.

Canada’s largest pension fund, the $161.6-billion Canada Pension Plan Investment Board (CPPIB), invested $1 billion in the development. Australian funds First State Super and Telstra Super together committed $250 million to the Australian Prime Property Fund Commercial (APPF), a vehicle run by Lend Lease’s fund-management arm that backed the deal. The APPF injected a further $250 million and Lend Lease itself gave $500 million.

Barangaroo South’s 41- and 38-storey towers will front Sydney’s Darling Harbour in the city centre. Westpac, one of Australia’s four largest banks, has committed to renting 70 per cent of one tower. Lend Lease and corporate services firm KPMG will occupy 75 per cent of the second tower upon completion in 2015. Talks of a third tower are underway.

“It’s a new development in a precinct that the business community is focusing on,” Michael Dwyer, chief executive officer of First State Super, the $32-billion Sydney-based fund, says. “We’ll wait and see how plans for the third tower develop.”

Expanding property portfolios

Barangaroo South is CPPIB’s largest single asset in its $16.4-billion portfolio of property assets, of which $1.63 billion is invested in Australia. The deal marks the first time the fund has invested directly in real estate instead of through a fund managed by a third party.

First State Super’s stake is part of the fund’s $1.92-billion property portfolio. Telstra Super, which manages $11.5 billion in retirement savings for employees of Australia’s largest telecommunications company, owns $1.5 billion in property assets. The super funds were already clients of Lend Lease’s $11.8-billion fund-management arm before the Barangaroo deal.

MySuper to split fund industry

Simon Mumme — Mon, 09 Jul 2012 03:08:11 +0000

Cost pressures arising from MySuper could split the default superannuation market into cheaper and more expensive funds that deliver varying investment returns to consumers.

Some super funds will set low caps for investment costs and others will pay more as they seek better returns net of fees for MySuper members, says Paul Costello, the former chief executive of the $77-billion Future Fund, who consulted the government and industry on legislating the new regime for default super.

Watch Paul Costello, who led the MySuper consultation between government and industry, speak about cost and value in default superannuation funds at investmentmagazine.com.

Costello, currently non-executive chairman of buyout firm Blackstone in Australia and part-time associate commissioner with the Productivity Commission, says funds will likely develop a consensual investment cost for MySuper funds and then split into two camps: those sacrificing performance to sell cheaper products and the others paying more for better returns.

“Many institutions are likely to say: ‘That’s where we stand, that’s part of our headline offer, there are some things that we will exclude because it will threaten that hard line,’” Costello said at the Fiduciary Investors Symposium, a conference run by Conexus Financial, publisher of Investment Magazine, on May 16.

“Others will take a different path and say: ‘If we were to collectively agree to take another 20, 30 or 40 basis points, we genuinely believe that we will be able to reduce the amount of uncertainty in the outcomes and give people much more predictability in the journey.”

Early political and media commentary on MySuper, the legislation for new default funds from July 2013 that is part of the federal government’s Stronger Super reforms, said that the funds will be simple and cheap. This emphasis mellowed by the time Jeremy Cooper handed the MySuper recommendation to government as part of the Super System Review that he led.

The MySuper concept is aimed at lowering overall costs while maintaining a competitive, market-based, private sector infrastructure for super.

“The MySuper concept is aimed at lowering overall costs while maintaining a competitive, market-based, private sector infrastructure for super. The concept draws on and enhances an existing and well known product (the default investment option). MySuper takes this product, simplifies it, adds scale, transparency and comparability, all aimed at achieving better member outcomes,” part one of the review says.

To read the latest on MySuper from the Australian Prudential Regulation Authority (APRA), click the box below.

The cost of value

During the 2011 consultations, MySuper morphed from a “simple, low-cost product” to a default super fund that is more “thoughtfully constructed,”Costello said.

This change of focus, while supported by industry supervisor the Australian Prudential Regulation Authority (APRA), has not been well publicised.

“This point – which isn’t well understood by the media, is therefore not well understood by the public or even the industry – continues to focus on the fear of what MySuper will become, which is to provide the cheapest, the simplest and arguably the most dumbed-down product of them all,” Costello said.

“APRA frets about the lack of any clear deal between the investor and the provider. I think they will enthusiastically be prosecuting this point about trying to get the industry to be much clearer about what it’s doing, to report much more regularly about its progress against those objectives, and how we compare against our colleagues in achieving those goals.”

Default-super billions may change hands

Simon Mumme — Mon, 02 Jul 2012 06:05:18 +0000

Industry superannuation funds could lose their claim on billions in new cash flows as the Productivity Commission seeks a new way of choosing workers’ default funds based on MySuper.

Industry funds’ preferred status saw them gain much of the $3.5 billion in superannuation payments made through industrial awards in 2010, according to the Productivity Commission. Now, they risk losing similar inflows in the future as the way default funds for workers are chosen is changed.

The draft Productivity Commission report, Default Superannuation Funds in Modern Awards, seeks transparency and consumer protections in the default-super market. It says criteria for default funds under MySuper legislation funds can be used to choose and monitor funds for awards.

MySuper requires registered superannuation entities to offer default funds meeting standards for investment strategy, cost and fund size that are set by the Australian Prudential Regulation Authority (APRA). It is slated to begin on July 1, 2013. Other factors – such as fees, insurance and the provision of basic and complex financial advice – should be considered, the report says. Information about the quality of fund governance – including guards against conflict of interest, the likelihood of members being moved into high-cost divisions of the fund or being charged large fees upon retirement – will also be sought.

Modern industrial awards specify default funds into which employees’ pay super if they do not choose a fund themselves. Of the 67 listed default funds covering 102 awards, 46 are industry funds, 11 are retail funds, seven are public sector funds and three are corporate funds. AustralianSuper, which is the country’s largest industry fund with $46 billion, is the most listed with 69 awards.

The Productivity Commission seeks input from funds and other industry stakeholders on two options for choosing default funds in modern awards: that all funds be allowed to apply for inclusion by a panel of Fair Work Australia, or a new body that is independent of FWA be created with the sole purpose of choosing and assessing funds. The options allow employers to choose a fund not listed in an award if they can prove employees are not invested in a bad fund.

Industry response

REST Industry Super, which draws about 45 per cent of its 1.9 million members from industrial awards, supports MySuper standards as the basis for inclusion.

REST, the fund for retail-industry employees, says industry funds’ knowledge of “the needs of a specific industry” beats a one-size-fits-all approach for default funds in awards.

Qantas Super hires WorkCover NSW’s investments boss

Simon Mumme — Mon, 25 Jun 2012 06:09:33 +0000

The $6-billion Qantas Superannuation Plan has hired Chris Grogan, the former acting-general manager of investments at WorkCover Authority of New South Wales, to reduce the costs of investing.

Grogan and Matt Wacher, who joined the fund in February from Russell Investments, are responsible for limiting foreign exchange and tax losses and improving the fund’s risk management and investment strategies, according to an e-mailed statement from Qantas.

“Implementation efficiency and risk management are at the heart of our fully outsourced investment model,” Andrew Spence, Qantas Super chief investment officer, says. “It is important for our organisation to have the right people with the right skills to monitor and manage increasing investment complexity.”

Qantas Super, the Mascot-based fund for employees of Australia’s national air carrier, saved $1.5 million through a foreign-exchange program introduced in July 2011, the statement says. The program, run by Russell Implementation Services, manages the currency transactions of Qantas Super’s global equity and alternative investments. It assesses bids from a secret panel of banks rather than dealing with one.

Grogan managed the $12-billion investment portfolio of WorkCover NSW, the statutory body for workers compensation, after former general manager of investments Jerome Lander left to join Russell Investments in June 2011. Wacher was regional director of indexes at Russell Investments.

Qantas’ five-person investment team consists of Spence, Grogan, Wacher, head of investment operations Peter Savage and analyst Rita Kwan.

With $30-million tax credit, Care and Asset set merger date

Simon Mumme — Mon, 25 Jun 2012 06:09:51 +0000

CareSuper and Asset Super will merge into a $6.4-billion superannuation fund on October 26 this year after keeping tax credits worth more than $30 million.

The funds’ initial plan to merge on June 30 was stalled amid uncertainty that the federal government would not allow merging super funds to offset capital gains tax (CGT) losses against future profits. This would have lost Asset Super tax offsets worth about $30 million if it shifted its assets to CareSuper, says John Paul, chief executive officer of the fund.

The $43-billion AustralianSuper and $4.6-billion AGEST Super similarly halted their merger until the government extended the so-called CGT-rollover relief for merging funds beyond June 30. AGEST Super stood to lose about $45 million in tax credits.

Merging in late October will enable Asset Super to finish investment and tax reports after the third quarter, Paul says.

Julie Lander, chief executive of CareSuper, will continue to lead the fund after the merger and four Asset Super trustees will join CareSuper’s nine trustees on the new fund’s board.

Super funds wanting to lower investment and administrative costs are seeking mergers. On March 1, the $320-million UCSuper merged with the $4.1 billion NGS Super. This followed AustralianSuper’s merger with the $3-billion Westscheme on July 1, 2011, and deals that created the $3.3-billion Maritime Super and $2.7-billion Media Super.

Not all proposed mergers succeed. In May, plans to unite Equipsuper and Vision Super into a $10-billion fund were scrapped when the funds disagreed about investment policy.

Paul, 63, is “keeping an open mind” about continuing to work in superannuation once his obligations to finish the merger end. “If nothing is on the wind, I’ll ride off into the sunset and do some travelling with my wife.”

Advance adapts to macroeconomic change

Simon Mumme — Mon, 25 Jun 2012 06:08:32 +0000

Some of the most dangerous risks that investors face today are reported in news headlines. Underpinning stories about Greece’s potential exit from the shared euro currency and anaemic United States economic growth is a key theme that Patrick Farrell and his investment team use to oversee $9.8 billion in multi-manager funds at Advance Investment Solutions.

“2012 and 2013 are going to be years when risk management is the focus – as opposed to chasing and maximising returns,” says Farrell, head of Westpac- owned Advance, which runs the multi-manager products of Advance Asset Management, Asgard Capital Management and BT Financial Group.

“2009 was about a rebound and regaining some of the doom and gloom that got priced into the market,” says Patrick Farrell.

Bullish attitudes towards resource stocks and a theory that the economic fortunes of India, China and Brazil had de-coupled from the West fuelled the last charge of the bull market until mid-2007. Then speculative bets on US subprime mortgages crashed and the 2008 financial crisis showed how interconnected global markets had become. Investors sought the safety guarantee of US Treasury bonds amid bad news.

But 2009 showed how willing governments and central banks were to pump cash into economies to prevent the banking system from collapsing.

“2009 was about a rebound and regaining some of the doom and gloom that got priced into the market,” Farrell says in a broad Australian accent from the boardroom of Advance’s George Street offices near Circular Quay. “That was also the point where you needed to realise that authorities will step in and the sun will still come up tomorrow.”

Bailouts preventing sovereign-debt default in Ireland, Portugal and Greece sparked a “risk-on” stock-market rally towards the close of 2011. But further political fracturing in Europe, culminating in the election of socialist Francois Hollande as president of France and a Greek national election in May renewed investor uncertainty at the dependence of the US and European economies on policymakers.

When the return is not justified by the risk you’re taking, you need to do something about it.

“We feel that event though the market has had the ability to rally over the year to date, the good performance that we’ve seen is more of a reflection of the liquidity that has been pumped into the system,” Farrell says. Europe’s debt crisis and the uncertain outcomes of fiscal stimulus in the US prompted Advance to redeem 3.5 per cent of invested capital in Australian and international stocks to increase its allocations to so-called growth- alternative investment strategies, such as global macro hedge funds. The multi-manager currently invests 8.5 per cent of its diversified funds in the strategies to better capitalise on shifts in market sentiment. It also invests 4 per cent of its assets in commodities and 2 per cent in credit strategies classified as defensive alternatives. This should enable Advance to capitalise on sentiment shocks from Europe and the US as the world’s largest economy endures political gridlock in an election year, according to Farrell.

“There are still too many one-off factors that can come out of left field and cause a risk-off trade,” he says. “You have a political landscape that is dominating the market and political events are very hard to predict.”

Continue taking risks

Capital preservation is paramount. But it doesn’t justify abandoning the search for returns.

“It’s not about avoiding risk. You’ll never get the timing right. It’s about continuing to take risk, but when the return is not justified by the risk you’re taking, you need to do something about it,” Farrell says. “You’ve got to not fall in love with markets when they’re rallying, but not to get too bearish at the bottom.

“If I was to put options protection in place all of the time, I might as well put my money in cash. So you only need to contemplate these strategies when the market is well and truly over the top and is not accounting for risks.”

Advance manages short-term risks by purchasing options that complement the securities held by underlying managers. The short-term, or tactical, limits and long-term strategic asset allocation are approved by the board and allow the team to underweight asset classes by up to 10 per cent if market risks rise.

“We’ve explained to the board that if there is a situation when we really think there is a greater need for capital protection – if markets rallied aggressively and we didn’t think that was justified – that we would go to them and say we’d like to put in place downside strategies.”

Advance uses macroeconomic and financial-market research to inform its selection of fund managers. It seeks liquid, decisive investment strategies and demands transparency on managers’ positions and risk- management policies. Dan Simpson, senior investment consultant at Towers Watson, is responsible for co-ordinating investment advice, manager research and running day-to-day interactions.

The global endgame

Felix Stephens, Advance’s head of capital markets research, recently returned from an annual round of meetings with senior central bankers, economic researchers, political advisers, academics and fund managers in overseas markets. He learned that markets might become even more reliant on policymakers. “We get the sense that there is still more stimulus that can be pumped into the economy, and they can do it in more direct ways,” Farrell says, relaying Stephens’ report on the US Federal Reserve’s capabilities. “If you have a shock to growth and get high unemployment, they will act.”

Mercury to herald Frontier research

Simon Mumme — Mon, 18 Jun 2012 11:30:33 +0000

Frontier Investment Consulting, which advises on $117 billion in assets, will sell its proprietary research of investment managers through an online database called Mercury.

Melbourne-based Frontier will offer Mercury to clients and non-clients seeking information and ratings on 1600 managed funds run by 1467 investment managers. The subscription database, available from October, will also contain notes from 4100 meetings Frontier has held with managers.

“It can be a standalone service to non-clients,” says Allison Hill, senior consultant at Melbourne-based Frontier. “Funds that don’t have a generalist consultant can use it to access broad information about managers.”

Quantitative analysis about manager performance will soon be added to the database, Hill says. Users of Mercury, which is named after the mythological Roman messenger god, can create customised data feeds through a “My Portfolio” function that aggregates information.

“It responds to what we see as quite significant changes within our client base, which is using more internal resources,” says Kristian Fok, deputy director of consulting at Frontier. “So how we deliver information to them is very important.”

The database was announced on Friday June 15 at Frontier’s client conference in Melbourne to an audience of superannuation fund executives. The consultancy also unveiled Prism, a project drawing on quantitative data to determine the characteristics of top-performing superannuation funds.

It announced that its name will change to Frontier Advisors in mid-July, when the business relocates to new offices in TAC House at 222 Exhibition Street in the Melbourne central business district.

Running with the herd

Simon Mumme — Mon, 04 Jun 2012 01:08:18 +0000

Michael Drew, like many finance professors, played sport at school. One year he won two coveted cricketing trophies at the end-of-season awards: best and fairest player, and batsman with the highest average-run score. But these achievements did not reveal the full story about Drew’s sporting prowess.

“We never won a game and my batting average was 23 runs,” says Drew, who works at Griffith University in South Brisbane. The awards decorated him as the best player in a losing side: his performances only shone against the weaker play of his teammates.

Drew, of course, was never a cricketer. As a finance professor he uses sport as a metaphor to explain how the framing of a question can mask reality. In this case, the young, fake Drew shows us how superannuation funds that rank highly on investment performance tables when markets fall can claim similar honours: they beat their peers but can still fail in their absolute goal of preserving and growing members’ money. “It’s like being awarded the best-and-fairest medal in which your club won the wooden spoon,” says Drew. In down markets, superior peer-relative performance is cold comfort.

Super funds and the financial media take the monthly and quarterly investment-return tables published by ratings companies SuperRatings and Chant West very seriously. They aren’t alone. Fund members also want to know how their fund ranks. The tables tap into our love of competition by intimating that returns are everything. Outpacing inflation, the stated aim of many funds, relents to the primacy given to quarterly returns. Failure is not losing money but falling from the top quartile of performance tables. “Peer risk translates the definition of risk from an absolute to a relative,” says David Neal, chief investment officer at the $73-billion Future Fund.

In all aspects of life, Australians seem hooked on competitive rankings. “We’ve got ‘My School’, ‘My Hospital’ and ‘My University’ websites,” Drew says over a ham and salad sandwich at an outdoor table at Griffith’s student refectory in Nathan. “We’ve got this problem: league tables abound.”

Rankings, which make funds fearful of slipping behind their peers, compel them to invest in similar ways. Captive to so-called peer risk, funds move as a herd.

Peer-risk reasons “Herding sounds bad,” says Justin Wood, a finance academic and former chief executive of Barclays Global Investors in Australia. “Like a bunch of sheep walking off a cliff at the same time.” He prefers to say that funds “succumb to peer risk – it’s less pejorative”.

Solar flair: the rise of Sunsuper

Simon Mumme — Sun, 20 May 2012 23:42:25 +0000

In late 2005, Sunsuper trustee Peter Annand spoke frankly with the fund’s new chief investment officer. “He said the fund is $6.5 billion and growing and that we have to set up some delegations,” recalls David Hartley, who has been Sunsuper’s CIO for more than six years now. “At the time, every investment decision was a board decision.”

The Milton, Brisbane-based industry fund has more than tripled in size and now manages $19 billion. Its investment team has grown to five portfolio managers and nine analysts. The team, tasked with implementing the investment strategy set by the fund’s board, has been assigned duties that once fell to Annand, who was then chair of its investment committee, and other trustees. “The investment committee has to be focused on governance,” Hartley says. Day-to-day matters, such as keeping track of enlisted fund managers and others pitching to win investment mandates, can distract them. “I’ve seen a lot of fund manager beauty parades over the years. How you determine your choice of manager on the basis of a 30-to-40-minute presentation is hard. That’s $200 million swinging on people you’ve never met.”

We’re speaking in the Plato meeting room at Sunsuper’s investment office on Hunter Street in central Sydney. Neighbouring rooms bear capitalised surnames of Western intellectuals who have “changed the way people think” such as Da Vinci, Einstein and Keynes. A signed souvenir photo of Cathy Freeman crossing the finish line to win the women’s 400-metre sprint final at the 2000 Olympic Games in Sydney hangs on the bright orange wall behind Hartley. Less than 10 minutes after being photographed outside Australia Square for this story, he is relaxed, his pale bronze and blue-striped tie and black pinstriped jacket already hang on the back of the vacant chair beside him.

In addition to selecting managers, his team has rein to make opportunistic investments without board approval. They also execute co-investments. If, for instance, a privatemarket fund manager running Sunsuper money has reached capacity, the team can use the manager’s research and due diligence at no extra cost to make their own investments in similar deals. Such transactions include the fund’s 2008 co-investment with The Sentient Group to buy 11.8 per cent of Australian geothermal energy start-up Geodynamics.

Despite Sunsuper’s strong growth, it can still make small and opportunistic investments that can potentially boost the large fund’s headline return, Hartley says. “We’re big enough to be meaningful for investment managers and small enough to be interesting with investment strategy.”

Super tax slug hits wealthy Australians: Tria

Simon Mumme — Mon, 14 May 2012 08:14:20 +0000

Australians earning high incomes, who have large balances in collective superannuation funds, will have less confidence in the system following tax changes in the federal budget even in the context of recent laws boosting workers’ mandated rate of savings, according to Tria Investment Partners.

Superannuation’s viability has declined on a “slippery slope” under federal Labor even after the rate of compulsory savings was boosted from 9 per cent to 12 per cent of workers’ pay in March, Tria says. The halving of concessional contribution limits and the recent budget’s doubling of the super-contributions tax to 30 per cent for people earning more than $180,000 make super less attractive for at least 209,000 Australians on high incomes.

Such moves, which can be seen as making the system more equitable, may dissuade high-income earners from using superannuation as their major way of investing life savings, Tria says. Collective super funds are already losing wealthy members to self-managed super funds, which accounted for $392.7 billion in assets at September 30, 2011, according to the Australian Prudential Regulation Authority.

The maximum contribution an individual can make to super under the current concessional cap is $25,000 minus 15 per cent, or $21,250, Tria calculations show. A person aiming to commit 12 per cent of their pay to super can have a maximum annual income of $177,000, slightly less than the annual pay of people whose income is taxed at the highest marginal rate of $54,550 each year, plus $0.45 for each dollar earned beyond $180,000.

“This is a pretty bad outcome for super. Not only do funds start losing their effectiveness to serve members’ retirement needs once they hit the top marginal tax bracket, there is increased risk that those members – who have some of the highest balances – will defect if they have to go elsewhere for tax advice and non-super investments,” Tria says.

High-income earners enjoy no taxes in retirement. But the new tax rules play to the strengths of accountants, financial planners, investment banks and fund managers as financial-service providers to wealthy people. These businesses can provide alternative savings funds, such as trusts, and assets that incur low taxes, such as stocks paying franked dividends, low-turnover stock funds, exchange-traded funds and real estate.

“This is a good example of failing to consider the cumulative effect of small changes,” Tria says. “Each change has been sold as minor or affecting only a small number of people. But put them together, and here we are questioning the future role of super for anyone on the top tax bracket.”