QSuper looks beyond benchmarks in remaking investment strategy

QSuper is re-inventing itself. On the eve of marking a century, the $27 billion superannuation fund for Queensland public sector workers is redefining its investment beliefs and living them through a strategy that is purposefully different from those of its Australian peers.

In its dynamic pursuit of risk factor exposures it aims to break the straitjacket of investment benchmarks that mean little or nothing to its members.

Next year QSuper marks a century. It will manage more than $27 billion for more than 530,000 members in a broad range of jobs: police officer, public servant, teacher, nurse, fire-fighter and ambulance worker, among others.

Since 2007 the fund has been open to the broader public. Legislative changes that have boosted State Government contributions plus a number of mergers with smaller funds have made the QSuper one of Australia’s largest investors.

Until now, the management of these assets was outsourced to state-backed funds manager Queensland Investment Corporation (QIC). But to broaden its membership, the fund needed to become an autonomous investor licensed by the prudential regulator. QSuper needed investment people. It needed its own ideas.

Early in QSuper’s re-invention, Brad Holzberger (pictured), then head of asset management at QIC, was hired as the fund’s CIO.

QSuper is expected to manage $60 billion within the next decade. This stunning growth trajectory spurred much debate among board members.

The board soon decided that emulating the common governance, asset allocation and internal structures used by super funds would not support its growth. It must be different.

“It’s no secret. Everybody acknowledges it: a lot of investment strategy in Australia is very introverted. The funds look a lot alike,” Holzberger says.

“Every fibre of my body says the standard solution is not right for this fund.”

QSuper’s new investment strategy seeks returns through flexible asset allocation decisions, not manager alpha, and is designed to remain potent as the fund grows.

It has envisaged the size of the alpha programs that it could run now and in the future.

“We looked at the alpha programs other funds were running and how much time that would absorb,” Holzberger says.

“We acknowledge there are managers that can create it. But it’s hard to find big institutions that year after year find alpha programs that reward them adequately for their risk.”

The fund has two pure alpha exposures gained through hedge fund managers, but will not pursue further investment ideas that are “artful and elegant” and don’t benefit the fund at its scale.

QSuper is playing a beta game. It aims to dynamically manage its beta exposures by accessing risk premiums – which are “easily identifiable and easily implementable” – in asset classes. “If we can’t identify them and implement them in a simple way, they’re not risk premiums, (s0) then we’re kidding ourselves,” Holzberger says.

The governance structure of the fund leaves the investment committee to tackle major decisions while leaving the investment team considerable autonomy to make decisions around dynamic asset allocation and hiring managers.

The investment committee focuses on setting return objectives and the risk exposures needed to achieve them, and crucial changes in risk management.

Holzberger and his team are empowered to implement dynamic asset allocation calls – which can be big enough to “move the needle” – and appoint funds managers.

The aggressive delegations enable QSuper to respond more opportunistically to changes in markets and ensure minimal or no ambiguity about who is accountable for each decision.

To date, the team has not been second-guessed by the board. They allow the investment committee to focus on strategy and not be distracted by monthly returns or the relative performance of managers.

Instead, other questions are discussed: “How different are we going to be, and why? What are we going to look like at $40-$60-$90 billion?” Holzberger says.

The investment team challenges the investment committee on this point. “How much of an idiosyncratic nature are you prepared to tolerate?” he asks, as the fund pulls away from the herd.

QSuper’s new investment strategy is most evident in the way it manages its $6 billion in fixed-income assets.

The fund has dispelled home-country bias by not running separate Australian and global fixed-income portfolios, and has discarded aggregate global bond indexes as suitable benchmarks.

Its focus on risk factors in fixed-income markets means that splintering its portfolio along sector lines – domestic, sovereign, high yield, emerging markets, global debt and so on – is a meaningless endeavour. Instead the fund manages exposures to three risk factors – interest rates, inflation and credit.

By investing in beta risks, rather than benchmark weightings, QSuper can exert more control over the outcomes it seeks from fixed income. It is not, for example, obliged to keep allocating more money to the biggest debt issuers in the world, such as the US and Japan.

QSuper uses fixed income to mitigate risk rather than seek returns. For the past year, it has held exposure to long-duration sovereign debt – in spite of the trend to buy short-duration debt to defend against inflation – because of the risks in equity markets.

“We were under a lot of pressure earlier this year but it has been the right thing to do,” Holzberger says. “That exposure has paid off as a risk mitigator. If there was a major equity market collapse – and it has almost come to that – we would have done well.”

Its exposures to risk factors change as they become more or less attractive at different points in market cycles. “You need to manage your entry point to them,” Holzberger says. “That has to be dynamic.” And these exposures need to be updated as the fund grows.

This approach aims to judge the way risk can impact different asset classes. The effect of inflation, for example, is not considered a risk for fixed-income investments alone.

Lower interest rates also impact equities and property as well as bonds. “When you manage risk at the highest level and inflation spikes rapidly, you [will] care more about your equity exposure than your bond exposure,” Holzberger says.

“It’s not rocket science but a willingness to think outside the asset-class model [of investing]. We’re the first to say that we are on a learning curve. We are walking, not running.”

The fund’s risk-factor approach to investing has not yet transformed its equity portfolio.

The board is now choosing the risk factors in equity markets – such as value, momentum and minimum variance – to which it will seek exposure.

From there the fund will dynamically manage its exposure to these factors and execute through a manager. If a willing manager cannot be found, the fund will develop the expertise itself.

For now, like most Australian funds, it maintains a strong bias to domestic equities. The board is acting to gradually reduce this exposure, Holzberger says.

The fund invests in unlisted assets around the globe. These are not managed internally and, under the current board and management, are not likely to ever be. The long lock-up periods involved make the illiquidity risk premium difficult to manage dynamically, and striking long-term contracts for property or infrastructure assets in overseas markets can be treacherous. “While risk premiums in private markets are relatively definable, to build a team to do idiosyncratic deals in private markets is too risky,” Holzberger says.

The fund’s performance aims for inflation-plus targets: beating a benchmark by 50 basis points is not prioritised.

QSuper used to outsource its capital markets operations to QIC but has moved that internally to better manage risk, particularly in stressed markets.

A capital markets function – to manage currency exposures, liquidity risk and, in time, execute asset allocation shifts – is seen as crucial to the new strategy.

The team and its systems have been two years in the making. But after being tested by external consultants and internal compliance staff, and eight months of preparatory “front-loading” to test its mechanisms, the team began trading in early May.

The capital markets team has the authority to trade equity and bond futures contracts, and over-the-counter future-forward currency contracts. It has executed large foreign exchange transactions and traded equity and bond derivatives.

Alpha-seeking and unlisted investments strategies are off-limits. “We certainly don’t envisage running active equity portfolios,” Holzberger says.

The team will enable the fund to maintain control of cashflows, and its currency hedging and rebalancing policies independently of managers.

It will also aim to improve risk management. Holzberger says funds invested with a range of managers can “lose control” of their cashflows, and liquidity and currency hedging programs in volatile markets.

“We see this as the natural growth of the fund,” he says. “If we’re not doing this at $30 billion, what are the chances of not doing it at $60 billion? Pretty high.

“We need to be working years in advance of what the fund looks like. The strategy is just too big and complex to happen overnight.”