The $18.2 billion Australian superannuation fund, Sunsuper, is gradually lowering its exposure to domestic equities and moving into emerging markets. The fund’s chief investment officer, David Hartley, says the move is being driven by concerns about concentration in the local share market and the potential impact that proposed reforms to Australia’s pension industry – the world’s fourth biggest – could have on equity prices.
Hartley (pictured) says that the Australian Government’s MySuper regulations, which will target the fees that super funds charge members, have the potential to create market distortions similar to those that are a feature of “Ponzi schemes”.
Hartley argues that the reforms may lead to an unhealthy focus on what he calls “headline fees”, which are an amalgamation of a fund’s own administration fees and the fees paid to external managers.
Funds face a potential conflict, where they could seek to maintain their fee base, while cutting the cost of external managers by moving towards cheaper passive management, Hartley says.
The result would be too much money flowing to the biggest players in the Australian stock market, such as blue chip mining giants Rio Tinto and BHP, as well as Australia’s big four banks.
“If there is just a focus on that total headline fee, which includes the underlying managers, then it could drive the market to more and more passive management,” he says.
“If you get more and more passive management you start to lose the price discovery function of the market.”
Hartley says the fund has a long-term strategy to gradually lower its exposure to Australian equities.
This year, the allocation to Australian equities in Sunsuper’s main balanced option fell from 30 per cent to around 28 per cent.
Emerging markets now make up about a third of its balanced fund exposure to overseas equities.
“The concern in Australian equities is that the market is very concentrated and, in an overall risk management process, we are edging our Australian share exposure down over time,” he says.
Hartley says the fund also made a number of timely asset allocation decisions last year that eased some of the fallout from recent market turmoil.
Sunsuper doubled its holdings of cash to 4 per cent of the portfolio and increased its direct property and unlisted property trust investments from 7 per cent to 9 per cent.
While its infrastructure portfolio has been a strong performer, the fund also cut back its exposure to infrastructure from 7.5 per cent of the fund to 5 per cent.
The fund has invested in a number of regional and state capital airport projects. But Hartley says the highly leveraged, private equity-like infrastructure model that emerged over the last decade is not attractive, as this model moves away from the long-term steady returns that are useful for the overall portfolio mix.
“The model has to be rethought; you shouldn’t be targeting private equity-like returns out of an asset like infrastructure,”he says.
Similarly, in its property portfolio, the fund is looking for yielding assets that provide an uncorrelated return and a hedge against inflation.
In keeping with this objective, the fund has steered clear of listed property, or real estate investment trusts (REITs).
“If they [REITs] act, smell and look more like equities, then from a strategic allocation sense you don’t have a separate part of the portfolio for them,” he says.
“Why would you carve out a separate allocation for REITs if all they are giving you is just a concentrated exposure to one form of equity.”
Sunsuper also trimmed its exposure to hedge funds from 7.5 per cent to 7 per cent.
Within the hedge fund portfolio there is a big focus on funds that have very low correlation with the main asset classes.
“We did make some changes last year and by and large those changes made our position better in the recent turmoil than they otherwise might have been,” he says.
The fund’s most popular “balanced option” has returned 4 per cent for the year to August 31.
Hartley says the fund has seen virtually no flight to safety from its 1.1 million members, who can choose to tailor their individual portfolio from 20 options on Sunsuper’s platform.
These 20 options range from cash only, through to balanced and more heavily equity-focused options, with members able to choose a bespoke portfolio mix that fits their individual risk profile.
Hartley says that at the height of the global financial crisis, just $100 million was moved into cash or lower-risk options over a 12-month period, with most members confident in the long-term strategy they had chosen.
With the average age of its members just 34, Hartley says members are well positioned to gain from potential long-term buying opportunities in markets.
“The only time the market price of an asset is relevant is when an investor is buying or selling. Many of our members are blessed with a long time until retirement. For those members, periodic market falls give them the opportunity to own more of the world. They can sort of say, ‘I am putting my money in every month, do I need to worry, given I can’t touch it for a long period of time and, in the meantime, I am picking up some bargains’.”
Other than cash, the fund uses external managers to manage its various asset classes.
Hartley says this allows the fund to provide more investment options to members at a lower cost, while also providing flexibility to change managers if they underperform.
“We often look at the merits of external versus internal management, and there are advantages on both sides,” he says.
“The advantage of internal management is that as your scale improves you can get better costs. But the advantage of external managers is that you have a very robust structure. Contrast, for example, with a non-performing external manager. It’s a fairly simple task to terminate that contract and appoint someone else. If you have an internal team you have to go through a whole internal management process of trying to work out what is going wrong and how you are going to fix it.”
Sunsuper’s chief executive officer, Tony Lally, sits on the advisory board of the Rotman International Centre for Pension Management (ICPM), and he says the research provided on the question of internal versus external management has helped shape ideas for the fund as it looks to expand in the future.
Lally says the fund has gained ground in Australia’s competitive superannuation landscape, growing its membership through taking on a number of corporate retirement funds.
He says that as the fund grows they may look to more internal management; and research conducted by the ICPM continues to inform their plans.
“Far better results seem to come from bringing unlisted assets in-house rather than listed assets; because there is such a competitive market for listed assets, it almost seems a waste of time to bring them in-house, because there are so many managers to chose from,” Lally says.
“You can design mandates any way you want to, but private equity, property, infrastructure – they are the ones that you get the better return from bringing them in-house. So the research on these types of issues has been useful for us.”
Lally says he also brings the Australian defined contribution experience to ICPM – in particular the innovative types of retirement products that funds offer.
“We have had to develop pension annuity products that really match the needs of members without guarantees,” he says.
“So, this is things like portfolio construction, getting the right mix of growth and defensive type assets, assets that spin off income, and providing some derivative protection. We have had to be a lot more innovative in developing product and that is something other people are interested in.”
Members of Sunsuper pay $1 a week and five basis points in fees. Out of this, Sunsuper targets a long-term profit margin of 5 per cent to build operational reserves. As at June 30 these reserves stood at about 1 per cent of the fund.
Investment options – for example, the passive indexed equity option – are then unitised for each member and the external managers’ fees passed on to members at cost.
For the indexed equity option members pay an additional 0.16 per cent a year on top of their flat $1 a week and five basis points.
“Every option in our platform has a purpose and that is defined in our primary investment objective and that feeds into the KPIs for the investment team,” Hartley says.
“All options are priced daily so that members can easily tailor their own mix of assets in a timely manner.”
The various options have risk criteria that external managers must meet, with Sunsuper’s investment team monitoring managers as often as daily, depending on the risk profile of the strategy.
Typically, a manager is monitored monthly.
“We get compliance monitored once a month and on a random day within the month,” Hartley says.
“Basically, you just want to make sure that things can’t get away from you. Those mandates which are heavy in derivatives, for example, are the types of things that require closer monitoring.”
Sunsuper recently extended a three-year contract with consultant Mercer, which provides a range of services including operational due diligence.
Manager selection is implemented entirely by the Sydney-based investment team under delegation from the Board.
The fund has also looked to boost its environmental, social and corporate governance capabilities by appointing Stuart Wilson, the former head of the Australian Shareholders’ Association, as its ESG manager.
Hartley says Wilson will initially focus on governance issues, particularly the fund’s proxy voting policies, and coordinating the voting practices of its various external managers.
“We found in a number of cases that we were effectively voting against ourselves and we didn’t think that was sensible,” Hartley says.
“So Stuart’s first task is to get that proxy voting under control, and his objective is that we vote 100 per cent for all of our shares every year and, where there are different views being taken by underlying managers, we will take our own independent view and direct vote accordingly.”
The fund is also in the final stages of preparing its first corporate governance report to members.
The fund offers a specific socially responsible investment (SRI) option on its platform, which has returned an average of 5.2 per cent a year over the past seven years. This is only slightly behind the 5.4 per cent recorded by the main balanced option.
For the year to August 31, the SRI option returned around 2 per cent.
Beyond the SRI option, Hartley says that Sunsuper’s ESG policies are aimed at more broadly enhancing investment outcomes to members.
“ESG is a way to enhance return to our members and you can effectively look at that in three dimensions – risk, return and correlation with other assets.”
“We expect the benefits to emerge in one, two or all three of those areas.”