Asset Allocation

Australia’s VFMC goes whole-of-portfolio

In the 12 months that Russell Clarke has been chief investment officer of the $46 billion Victorian Funds Management Corporation (VFMC), he has been quietly getting on with it. In the last year, he and the team have undertaken a number of continuous improvement initiatives, including the creation of a centralised portfolio management group.

“When I joined VFMC, I was struck by how professional the organisation was; in particular, the team was very strong technically,” he says from the fund’s 101 Collins St office. Historically, the organisation has added much value at the asset class level, with infrastructure and non-traditional assets as particularly stellar performers. Infrastructure, for example, has added 9.2 per cent above the benchmark (CPI + 5 per cent) in the three years to June 2017.

“VFMC was a good example of very strong teams at the asset-class level, and they did a good job of adding value at the asset-class level. Credit to [former CIO] Justin Pascoe and the team,” Clarke says.

But in observing how the portfolio was managed, and the structure of the investment team, what struck Clarke was that the organisation would benefit from a whole-of-portfolio approach.

He points out that some functions, such as trading, previously reported to the CIO, but other functions, like asset allocation, didn’t. A restructure started nine months ago.

“We needed to think about things more holistically,” he says. “We recognised that and adopted a more whole-of-portfolio mantra.”

The centralised portfolio management group was created and Paul Murray, formerly head of fixed income and absolute returns, was promoted to head that. Nick Tribe has taken Murray’s old job. The portfolio management group covers all the functions that have an impact on the whole portfolio, including implementation, environmental, social and governance (ESG) concerns, strategic asset allocation and dynamic asset allocation, trading and investment risk.

Each asset-class team interacts with the portfolio management group, putting forward ideas, and is still responsible for manager selection. The fund has 85 manager relationships.

“Manager selection still resides in the asset class teams, and this is working well and I see no reason to change,” Clarke says.

While other Australian investors that have undergone recent organisational redesigns – notably TCorp and HESTA – have used Roger Urwin and the Willis Towers Watson team, Clarke and VFMC have gone it alone.

“We have done this organically, ourselves,” he says. “We have a lot of good expertise internally, and I am happy we could do that.”

Broad perspective

Before joining VFMC, Clarke spent 15 years managing assets at Mercer, culminating with his position as global CIO for mainstream assets and Mercer CIO, Pacific, responsible for investing $185 billion in assets for more than 200 funds. That role, and his previous experience as a consultant, gave him a broad perspective.

“I saw how clients were doing things differently and in those roles you also have to look at the total portfolio perspective,” he says. “My background was helpful in how to think about a portfolio, all it’s moving parts and how it fits together.”

In addition to creating a management group to look across the portfolio, Clarke has made the ESG focus holistic, too, refreshing the policy and making it an investment-led function embedded within the investment team.

“We now have a specific implementation roadmap for ESG, and are lifting our level of engagement with managers,” he explains. “We are not being prescriptive with managers but recognising [ESG is] an area of significant risk and opportunity and asking our managers what they are doing about it. We now have views and ratings of managers in that area.”

VFMC has also reviewed how it reports ESG and exercises proxies, and is doing a carbon footprint across the portfolio. There are about 100 staff at VFMC, 45 in investments, of whom about 15 are now in the portfolio management team. The team has been managing assets internally for about a decade, and roughly 30 per cent of the portfolio is handled in-house. There are no immediate plans to change this. Clarke says one of the by-products of the reorganisation is that he now has only four direct reports. Under the previous structure, he had eight.

12-step plan

Another step Clarke was keen to take soon after he arrived was to have an offsite for the whole investment team.

“This was really a brainstorming exercise, to improve everything we do,” he recalls. “As a result, we came up with a list of around 12 continuous improvement projects, and some will lead to material changes.”

These projects fall into three broad groups: foundation items; portfolio resilience; and data analytics and risk. Foundation items include reviewing and refreshing the fund’s investment beliefs, including an uplift in the investment philosophy and liquidity budget. It also includes reviewing all benchmarks, including an assessment of the balance between absolute and relative returns and the most appropriate benchmarks for unlisted assets, hedge funds and private credit. The team is also creating an improved process for debating ideas, including a discussion around developing the right forums for this. Portfolio resilience projects relate to VFMC’s 2020 strategic plan; they include introducing more flexibility in asset allocation and focusing on better beta; for example, by diversifying asset exposures.

Overall defensive strategies are also being reviewed, looking at ways to make the portfolio more defensive without having to put in expensive hedges. Lastly, resilience initiatives include what has been labelled a “fire drill project”, in which the portfolio will be tested with hypothetical situations.

“For example, we’d test how we would respond if there was a heavy fall in equities markets, what decisions would need to be made and who would need to be involved,” Clarke says.

In data and analytics, the fund has projects in train to improve risk analytics. In particular, it is looking at how to disaggregate risks appropriately, and feed them into the investment process to make better decisions. This means spending money on technology. There is a major IT project under way across the organisation.

“We have a strategic partner helping us scope out what we need and to select providers,” Clarke says. “This is a multiyear exercise and has a significant commitment from the organisation in time and budget.”

The team is also producing a whole-of-portfolio dashboard that is nearly complete. This combines data on performance, risk, asset allocation and manager allocation.

“It is a management tool for me but also, importantly, a great way to share information with the team and organisation to raise awareness of how we are travelling and also cement the focus on the whole of portfolio,” Clarke explains. “Cross-asset teams have been formed to work on all of these projects. It’s a different intellectual challenge that people are enjoying.” 

Down to flexibility

Clarke reports to chief executive Lisa Gray, who joined VFMC in January 2016. He is also chair of the risk allocation committee, which meets every two weeks or whenever needed. There is no investment committee in the organisation.

“We have a very good board that has a clear set of delegations that has allowed the investment team to get on with it,” Clarke says.

This structure allows the investment team to be responsive to market dynamics, and it can invest up to $1 billion without approval. Anything significant, such as strategic asset allocation changes, the addition of an asset class or investments over $1 billion will go to the board. VFMC has a core group of big clients. Its five largest represent 92 per cent of the fund’s assets under management and the investment team has a close relationship and meaningful dialogue with them. The other 25 or so clients are in a multistrategy portfolio, and are relatively low maintenance, Clarke says.

At the end of June 2017, the asset allocation of VFMC’s portfolio was international equities (33.9 per cent), Australian equities (19.2 per cent), diversified fixed income (10 per cent), inflation-linked bonds (9.8 per cent), property (7.7 per cent), infrastructure (6.1 per cent) private equity (0.5 per cent), non-traditional strategies (10.6 per cent) and cash (2.2 per cent). But Clarke says asset allocation changes are coming. While VFMC has been good at managing individual asset classes, he says the next step is to balance total portfolio construction, too.

“What we really want to do is pull all the elements together and have an evolving overall asset mix over time in a thoughtful way,” he says.

Obvious areas for change include fixed income and credit. The fund has historically focused on domestic bonds and has had no global credit or sovereign debt exposures. “Now is not necessarily the time to go into those assets but they are a key defensive lever and we want it in the tool kit,” Clarke says.

VFMC was also an early investor in private credit, which was an opportunistic allocation. Clarke is now looking to add it as a base exposure instead. Ultimately, Clarke sees flexibility as the key challenge. VFMC has a two-pronged approach to asset allocation, with strategic asset allocation covering a 20-year timeframe and dynamic asset allocation over 12 months. Now it is looking to incorporate a process that allows for an evolving asset mix and a cycle-aware approach to allocating assets.

“There is a big gap there between strategic and dynamic asset allocation,” Clarke says. “We are looking at how we might evolve the overall asset mix over time and we may need to make strategic changes that aren’t necessarily 20-year changes. There may be points in the cycle in five to 10 years’ time when we will have to evolve the portfolio.

“We want to have a governance structure to be able to do that.”

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