The flow of money into passive and smart-beta strategies is gathering pace around the globe, but the investment chiefs of major Australian super funds are standing firm against the trend. The 2017 Investment Magazine CIO Sentiment Survey finds that 80 per cent of them do not plan to allocate any more funds to such strategies in the next three years.
The investment chiefs of the 100 largest institutional asset owners in Australia, New Zealand and Papua New Guinea were invited to take part in the sixth-annual CIO Sentiment Survey, conducted online over three weeks in October.
Overwhelmingly, the 38 respondents to the survey were from local superannuation funds. They represented a collective funds under management of $828 billion. While all respondents had their identity verified, their answers were anonymised.
The survey was produced in association with Frontier Advisors, whose director of investment strategy, Chris Trevillyan, said the consistently contrarian stance of local CIOs on passive strategies was the most striking theme to emerge from the survey.
“Globally, that’s definitely a major trend, but this seems to be going against the global trend,” he said.
A Boston Consulting Group report, released in July 2017, showed assets invested in passive strategies worldwide tripled between 2008 and 2016, from $US4 trillion to $US12 trillion, and forecast passively managed assets to hit $US19 trillion, or 20 per cent of total global funds under management, by 2021.
Trevillyan said local CIOs’ opposing views could be explained by quirks of the local equity markets that can lead passive and smart-beta strategies to produce “distorted portfolios”, and by the strong returns funds have achieved using active management in recent years.
“We’ve done quite a bit of analysis of performance and a lot of the top-performing funds have been driven by active managers,” Trevillyan said.
CIOs surveyed are continuing with active management strategies. Almost half plan to allocate more to liquid alternative hedge funds in the coming year. They also plan to allocate more to emerging-market equity, infrastructure and other real assets, private equity/venture capital, international equities and real estate.
“When you look at these asset classes, the key theme that runs through all of this is diversifying away from that equity risk,” Trevillyan says. “Liquid alternatives, infrastructure, real assets and private equity – they’re all trying to diversify away from that equity risk. That’s a clear theme from this, and it’s a clear theme we have from our clients.”
True tests of diversification
Trevillyan said the true test of this diversification comes when portfolios are genuinely under stress.
“If they’re taking [exposure] from government bonds and putting it into alternative liquid hedge funds, putting it into the model, if it is diversified and it delivers what it should, it will reduce overall risk,” he said. “But the problem is, how will it perform in stressed environments when that is required?
“The worry is that you do pick up threads of risk in these portfolios. It can look good in most environments, but then when you really need it to [shine], the property market can turn down or these hedge funds can underperform.”
SuperRatings chief executive Kirby Rappell said the risk characteristics of alternative asset classes posed some challenges for how funds communicate the issue of risk to members. He said alternatives present “greater variability of returns in challenging market conditions [and] your traditional measures of risk around volatility probably don’t capture that fully.”
If there hasn’t been quite as much volatility, it may look as if there’s been lower risk and higher return,” he said. “So how are funds able to communicate that back to clients and make sure that what a member perceives to be the risk in a portfolio aligns with the actual level of risk in the portfolio in the market cycle?”
Relationships with consultants, fund managers
Trevillyan said the survey also has highlighted how funds’ use of consultants is changing as they explore new strategies.
Almost half of respondents said they use consultants to help make investment decisions, but ultimately retain discretion themselves, while 39 per cent said consultants are not part of the investment decision-making process at all, and are used only for fund manager selection. Only 8 per cent of respondents said they did not use a consultant.
“There are quite a few funds using multiple consultants for different areas,” Trevillyan said. “There’s more project-based work, and it’s [focused on] contributing to the internal team. It’s not the outsourced CIO-style role; it’s more giving input into the work they do internally.”
Rappell said funds are looking for closer relationships with both consultants and external fund managers as they become more reliant on data to make smart decisions, and will demand more access to insights and research from managers.
“The way in which funds are looking to interact with consultants and managers is evolving, as funds find an increasingly competitive market where it’s hard to drive differentiation,” he said.