Australia’s superannuation trustees will be forced to lift their game, their roles will be restricted to avoid conflict and they will be hit with civil penalties for failing to act in the best interests of members.

The much-awaited final report for the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry  was released publicly on Monday afternoon.

Australia’s superannuation assets totalled A$2.8 trillion at the end of September 2018 and is the fourth biggest market for pension assets globally (after the US, UK and Japan).The royal commission, which kicked off in March and ran across 68 days of hearings and more than 10,000 public submissions, looked into bad practices in the superannuation, banking and insurance sectors.

The final report, by Commissioner Kenneth Hayne, made three key recommendations aimed at elevating the role of superannuation trustees. Hayne made 10 recommendations relating to financial advice and seven relating to superannuation.

Trustees should be prohibited from “assuming any obligations other than those” related to being the trustee of the fund, and be banned from “treating” employers in order to have their fund nominated as a default fund under a new civil penalty provision.

Further, the Hayne Commission also recommended trustees should be prohibited from hawking super products, should not be allowed to deduct advice fees from a MySuper account and should be limited from deducting fees from Choice accounts.

Importantly, the Commission has also recommended the banking executive accountability regime (BEAR), which governs who is responsible when issues arise, should be applied to the superannuation industry.

In the 951-page report publicly released on Monday afternoon, Hayne made 76 recommendations and highlighted 19 instances of potential misconduct through 22 entities. He referred 24 companies to regulators for possible criminal or civil action- the companies include National Australia Bank, AMP, IOOF, the Commonwealth Bank  and ANZ. In line with the interim report issued in September last year, it was scathing of regulators APRA and ASIC.

The federal government made its pledge to “act” on all the recommendations, despite it voting against a royal commission into the financial services sector 26 times. An Australian federal election will likely occur in May next year, and the opposition Labor party also supports the recommendations.

With regard to financial advice offerings Hayne recommended that opt-in periods become annual, with more focus on the specific services to be provided. This will dramatically change the ongoing service agreements that underpin most advice remuneration models in Australia.

“The central changes I would make are to require that ongoing fee arrangements must be renewed annually and that the client be told what will be done,” he stated in the final report, delivered Monday.

For background click here and for more on the royal commission visit Investment Magazine.

There is still alpha in public equities markets, says Ron Mock, chief executive of the Ontario Teachers’ Pension Plan, who supports the fund’s allocation to hedge funds.

“For us, active management has a very specific meaning and a lot of the return profile and beating of benchmarks occurs in our private space. But we also think in public markets there is still alpha to be had. That’s why we have sizeable investments in what we think are very, very good hedge funds,” he said. “I know hedge funds have had a tough run this year but at the same time, we have had some hedge funds that have done very well this year.”

The C$193 billion ($147 billion) OTPP has about $10 billion allocated to absolute return strategies, managed both internally and externally.

OTPP’s external equity manager program is based on relationships with about 12 global equity managers, with a focus on those that are valuation conscious and run concentrated, low-turnover portfolios.

In an interview with Bloomberg at Davos in January, Mock discussed the importance of active management, which OTPP uses mostly in its large allocation to real estate, private equity and infrastructure. (See OTPP’s private equity revolution.)

While Mock conceded it generally had to get alpha in large-cap equities, and even some mid- and small-cap equities, he said there were some specific strategies where uncorrelated returns existed.

Commenting on quantitative strategies, he emphasised that picking the “right” managers was key.

“I have faith in quant, if you pick the right managers,” he said. “Quantitative strategies always have difficulty when you get into volatile markets. Quant strategies and volatile markets typically are negatively correlated, so this is a problem. If you pick the right managers, you can find good returns that are uncorrelated, and there is alpha to be had through these strategies.

“It’s not like owning a T-bill, it will go up and down for sure. If it’s uncorrelated, then there are times, like this year, when quant-type strategies have kicked in beautifully and added a lot of value.”

The fund is very geographically dispersed, with investments in Canada (45 per cent), the US (19 per cent), Europe excluding the UK (10 per cent), Asia (7 per cent), Latin America (5 per cent), the UK (5 per cent), Australia (2 per cent) and the rest of the world (2 per cent). Some alternative investments have not had a country exposure assigned.

The fund takes a dynamic approach to managing foreign currency exposure, with about 60 per cent of assets in Canadian dollars.

It has an office in London, which was opened in 2007 and expanded in 2015, and the fund has been investing in the Asia-Pacific region since 1991. It opened a Hong Kong office in 2013.

“North America is not always in sync with Europe or Asia, so there is a lot of diversification benefit to be had,” he said. “We have expanded our global partnerships network, and work very carefully with local partners who have boots on the ground.”

Specifically, Mock said OTPP was finding good opportunities in Canada, China and Hong Kong, and is working on some deals in Europe.

“It is harder to come by because stuff is very pricey but if you dig deep enough and have the right partners, you can find the opportunities. In Europe, it’s everything from funeral homes to education. In Canada, we have just invested in GFL – lots of companies we can find.”

Recent investments include an investment partnership with technology company Fleet Complete, environmental services company GFL Environmental and, in October last year, an agreement with the Canada Pension Plan Investment Board to invest in Pacifico Sur, a 309-kilometre toll road in Mexico.

Mock said the fund’s approach to investing in China was to take a long-term perspective.

“There are always skirmishes in the short term, but we believe it is absolutely necessary to be there,” he says. “We invest a lot in technology in China, and that is very different to investing in technology in North America.”

Mock said the fund was also interested in the potential opportunities in Brazil arising out of President Jair Bolsonaro’s privatisation plan.

“Brazil has been through a very rough patch, we are looking at it very carefully,” Mock said. “We have assets there now, that have performed extremely well, and we have teams on the ground always looking for opportunities, and we think the opportunity set is starting to pick up.”

At the end of December 2017 (the most recent annual report figures), the fund’s asset allocation was equity (36 per cent), fixed income (33 per cent), inflation sensitive (14 per cent), real assets (25 per cent), credit (7 per cent), and absolute return strategies (6 per cent).

Investments at TfL Pension Fund, the £11 billion ($14 billion) fund for the public-sector employees running London’s transport network, span India’s biggest solar company, a Canadian environmental services group and a tertiary education provider in Brazil. Coupled with the fund’s sophisticated ESG risk management and persistent engagement with corporations and asset managers, they make for a developed and sweeping ESG strategy. Now, TfL Pension Fund’s trustees have released its first-ever annual report on sustainable investment, finally putting in place the communication pillar of ESG integration, to help ensure the pension fund’s 86,000 members are on board with all the scheme is doing.

“One of the main reasons we have put out this report is because we felt there was a disconnect between efforts of the scheme and members’ perception of what we are doing,” says Padmesh Shukla, TfL Pension Fund’s head of investments. “There are a great deal of interesting things happening in ESG at many pension funds, but the communication isn’t always there.”

The report outlines TfL Pension Fund’s progress on ESG alignment, integration and investment. It also includes two new investment beliefs: returns and sustainability are not conflicting objectives; and an active corporate governance program can add value.

“Good ESG is a good investment. It is hand in glove, not either or,” Shukla says.

Pressure on managers

It’s not just better communication with members the report targets. The pension fund wants to send an important message to its 30 external managers, which run 44 separate mandates across its bonds, equity, private markets and hedge fund allocations. The directive? Step up ESG integration so it sits alongside risk-and-return analysis. ESG is no longer a top-down, box-ticking exercise; the pension fund wants to see how managers are reflecting its policies and principles in their investment underwriting process, in a bottom-up fashion, Shukla says. He adds that the trustees are actively engaging with four managers who have decided not to sign up to the PRI.

“ESG should be part of the investment process, not a bolt on,” he says. “We need to see greater evidence about how managers are thinking about ESG in their processes. It’s not an easy journey because many managers are in their 40s and 50s and this wasn’t part of their toolkit in their earlier working lives. It is a big learning curve and some are changing more quickly than others.”

It is these relationships TfL Pension Fund will prioritise. Take, for example, the small-cap emerging market equity manager that drilled below the poor ESG metrics MSCI analysis revealed on an Indonesian cement company. It found the company had made important progress on health and safety and had stronger-than-reported governance.

“We are on the Aladdin platform, where MSCI tools flag up red cases when ESG scores are bad. In this case, we sat down with the manager. Rather than box-ticking MSCI’s scoring methodology, the manager found it wasn’t as bad as the score said.”

TfL Pension Fund now combines corporate engagement and monitoring with a more direct approach. It recently excluded from its private allocation any investment in power and extraction companies with more than a 30 per cent tilt of their business activities to thermal coal. It is in the process of extending this across all the fund’s active equity and bond segregated mandates. The fact that this strategy happened in private markets first reflects the fact ESG integration is more difficult in public markets, Shukla says. There is more control and visibility for investors in private companies, which are better engaged on the ESG issue, with a sharper focus and incentive to deliver long-term value creation, he says.

TfL Pension Fund has an actively managed £3 billion equity portfolio and a £2.6 billion passive equity portfolio managed by BlackRock.

“BlackRock has a strong track record of activism both at meetings with and in their engagement with management,” the report states.

TfL Pension Fund aims to invest 5 per cent of its AUM in ESG themes in coming years.

“It’s not just about alignment and integration. It’s also about opportunity,” says Shukla, who notes that most of the opportunities in renewables, waste processing, healthcare and ageing society are on the private side.

The report readies TfL Pension Fund for new UK regulations this October, by which time trustees must have updated their Statement of Investment Principles (“SIP”) regarding ESG issues, specifically including climate change.

“The trustees have embarked upon an important ESG journey and, like everything new, expect to learn, adapt and improve as it goes along. There will be a greater focus on not just doing the right thing as the trustees discharge their important fiduciary duty but also on being more transparent and communicative about such activities with members of the fund,” it states.

 

TfL Pension Fund asset allocation

Overseas equity: 48.1 per cent

Index-linked instruments: 11.6 per cent

Liquid alternatives: 10.6 per cent

Global bonds: 6.2 per cent

UK equities: 5.2 per cent

Private equity: 4.2 per cent

Infrastructure: 3.9 per cent

Alternative credit: 3.6 per cent

Real estate: 2.9 per cent

Cash and other: 2.9 per cent

Commodities: 0.5 per cent

Fixed-interest gilts: 0.3 per cent

The Netherlands’ Achmea Investment Management, Blue Sky Group and SPF Beheer, with a combined €172 billion ($195 billion) in assets under management, have established a joint platform for co-investment in private equity. All three have about 3-5 per cent of their AUM in private equity, mostly in pooled funds; the trio aims to halve costs and gain access to co-investment deals by working together.

Blue Sky Group runs €22 billion ($24 billion) for three schemes sponsored by Dutch airline KLM. SPF Beheer manages €20 billion ($22 billion) for clients including railways scheme SPF and the public transport pension fund SPOV. Achmea IM, with €130 billion ($147 billion) under management, runs the balance sheet for Holland insurance group Achmea and is also the fiduciary adviser for about 30 independent pension funds.

Jos van Gisbergen, senior portfolio manager for private equity at Achmea, speaks to Top1000funds.com about the rationale behind the collaboration.

What is the background to the private equity platform?

The three of us have always run our own private equity programs with our own activities, going out into the world, hunting the same opportunities. We said OK, it’s time to stop dividing up this landscape and work together. The platform is a program for co-investment and promises a bright future for all three of us and any third parties that want to join. We hope people will see this platform in operation and see how it works. We would like it to expand in the Dutch market.

How does it work?

Each of the third parties will decide annually how much they want to invest and will bring that money for co-investment. We will co-invest with GPs, we won’t go direct. We will focus on choosing managers with deep knowledge and specialism.

How popular has it been with GPs?

We have found that GPs like this structure because it is better to have a combined group with more capital to commit. With the platform in place, they know the money is there. Today in the co-investment market, it is increasingly common for money not to be available when the deal comes through the door. This structure is different and allows us to act quickly. However, in some ways, it is also more challenging for GPs having a bigger group the other side of the negotiating table. Divide and conquer has served GPs well; when we invest on our own, we pay higher prices.

Private equity funds usually charge management fees based on assets, including cash yet to be invested or un-called capital. How will this platform operate?

The fund will run a pool of capital on an annual basis. If there are no co-investment opportunities through the course of a year, rather than remain as uncalled capital, the money is freed up and released for the following year in new opportunities. We don’t operate like traditional private equity around committed capital and the fees that this incurs. We are paying fees only on invested capital. This is a new structure that is coming out of the pension community. We are not like other groups out in the market needing to maximise their returns in the short term. This is a product for our community and owned by our community.

What sort of fees do you pay?

As soon as a deal comes through the door and we have screened it and approved it – and the deal closes – we then pay a fee to reflect the extensive work of our GP partners. In the first year, we estimate that we will halve the cost of our private equity investment on a total expense ratio. There are good returns in this industry, and it’s the people providing the risk capital – not just the GPs – who should be rewarded.

Could this model be rolled out into other illiquid markets?

We hope that this platform is a first step in facilitating co-investment in other illiquid markets where pension funds can combine their efforts and resources to avoid the fee burn. A lot of pensions want to invest in the alternative space, but many have only small teams and can’t invest here in an efficient and structured way.

The annual Chief Investment Officer Sentiment Survey, conducted by conexust1f.flywheelstaging.com and Casey Quirk, a practice of Deloitte Consulting, has revealed a global asset owner community that is less tolerant of risk and more interested in negotiating fees.

Now in its fifth year, the survey gauges the tolerance of CIOs across a number of leading indicators. This year, survey respondents totalled 77 CIOs with $2.3 trillion in combined assets across 11 countries.

Risks and asset allocation

Falling equity markets were identified by respondents as the biggest risk to their portfolios in the year ahead, with nearly 20 per cent of respondents ranking them as the biggest risk.

This was followed by overvaluation in equities markets, rising interest rates and slowing global growth.

Respondents were also concerned about geopolitical risks and the impact on economic stability affecting their ability to meet their commitments. Specifically, China tensions and US politics were identified as the top geopolitical risks in the year ahead.

Across the entire respondent universe, the investors had an average return target of 4.4 per cent. This ranged from 7.75 per cent to as low as 1.2 per cent.

Confidence in meeting targets this year was muted. Less than half of respondents (44 per cent) were confident of meeting their return target. Confidence in achieving targets has fallen quite significantly over the last year, as 57 per cent of respondents in the 2018 survey were confident in achieving their return targets. That’s a fall of 23 per cent for the year.

But despite the lack of confidence in meeting return targets, respondents are cautious and, generally speaking, are not willing to take on more risk to achieve their targets. Only one in 10 said they would take on more risk.

This decreasing risk tolerance has been a gradual and steady trend. Over the past three years, respondents have become less willing to take on risks with those willing to take on more risk falling from 35 per cent in 2017 to 10 per cent this year.

Tyler Cloherty, head of the knowledge centre at Casey Quirk/Deloitte which has been partnering with Top1000funds.com for five years on the CIO Sentiment Survey, said this year’s survey revealed an interesting conflict around risk.

“One of the interesting things in this year’s survey was the ‘risk off’ nature and the willingness, or lack of it, to extend risk,” he said. “There is more conservatism in the overall approach from asset owners, you can see that in their projected allocations. There is little willingness to take risk in listed markets, but there is no slowdown of the willingness to take on more illiquidity exposures.”

To this end, one respondent said: “We are slowly de-risking, so new investments are selective nuanced strategies where managers have unique selling propositions enabling them to continue to add value in a market where assets are over-priced.”

Chloe Gardner, senior consultant at Casey Quirk, said the survey showed the shift in asset owners’ risk budgets where they are not taking on more equity risk but there is more diversification.

Overwhelmingly, asset owners are looking to infrastructure and other real assets in their asset allocation, with 41.2 per cent of respondents intending to allocate to that asset class, this was followed closely by private equity and venture capital, where a third of respondents are looking at allocating more.

Global and domestic equities were the least likely asset class to receive more allocations.

“There is tremendous global demand for private equity,” Cloherty said. “If investors do take equity risk, they are more likely to take that in private equity not listed markets. They see private equity as still worth the premium.”

Just over a quarter (26.1 per cent) of respondents plan to move more of their portfolio to passive or smart beta in the next three years.

The trend to insourcing investments appears to continue with 41.8 per cent of respondents saying that they have recently in-sourced or plan to in-source more of their investment capabilities. Control and costs are the primary reason for the move.

Costs and pricing

There was a divergence in responses when it came to questions around costs and fees. Around one-third of respondents said fees had increased, while a similar proportion said fees had decreased. Of respondents, 44 per cent said reducing costs was either extremely or very important.

Of those with rising investment costs, the most popular driver for increased or stable investment costs was the use of more high-fee products, with 52 per cent of respondents attributing rising costs to this.

A massive 86 per cent of asset-owner respondents said they were using negotiation as a way of reducing investment costs. A quarter were also using passive and smart-beta strategies to lower costs.

Respondents were asked to list their most preferred pricing structure and a performance-based fee with a smaller management fee the most popular (37 per cent). Most respondents had a mix of this type of fee structure alongside a flat fee for the majority of their assets.

Casey Quirk’s Cloherty said there were a couple of key impediments to moving to more innovative pricing structures.

“A willingness to negotiate down existing fee structures is omnipresent,” he said. “Often, negotiation starts with a new pricing structure but ends up with a discount on more normal pricing structures. In addition, alternative fee structures are hard to communicate to the board. There is also a risk that in a low-return environment, the fund will have a low return but end up paying out big fees to a manager because they have outperformed their mandate.”

He said managers also had some reservations about new innovative pricing structures, including concerns over revenue volatility and valuations.

“If there is going to be a move to more innovative structures, this needs to be driven by asset owners,” he said. “A performance fee is a more logical and philosophical way to pay for asset management, where you pay for value, and position against commoditisation (of beta).”

Manager relationships

The survey shows that asset owners are reducing the number of managers they have relationships with, with nearly 40 per cent indicating this direction.

On average, the respondents had 75 manager relationships, but this varied widely. A $200 billion US public pension plan had 300 manager relationships, while a $2.5 billion Papua New Guinea fund had only three manager relationships.

When asked if they considered any of their managers to be strategic partners, about three in five respondents said yes. Access to key investment professionals and customisation of products were the two most important factors from asset manager partnerships.

“Asset owners want to work with managers that are high quality, allow access to their teams, provide customisation and [facilitate] long-term relationships,” Cloherty said.

There are a number of lessons in this survey for managers. First, the decreasing number of manager relationships is making the environment more competitive for managers.

Casey Quirk’s Gardner noted that as asset owners become more complex, competitive differentiators are becoming more important for managers.

“Managers need to serve an investor on a more holistic basis, which includes giving them access to research, providing advanced risk management and a better client portal. Better service means catering to what the owner needs and is much less product oriented,” she said.

There is not a huge amount of growth for managers in the global institutional investment environment, Cloherty said, so managers should maximise retention.

“Be present, don’t be transactional,” he advised. “Extend the life, and reach, of the relationship. There is a lot more work involved and it is more costly for managers but asset owners want it for less. The question to ask is, ‘How do you deliver beyond just alpha?’ ”

For the results of last year’s CIO Sentiment Survey click here.

Sustainable investing is not about philanthropy or giving up returns.

The Office of Investment Management (OIM) at the United Nations Joint Staff Pension Fund believes portfolios that integrate material ESG metrics into their investment decision-making process, supported by active engagement, have the potential to provide returns that are superior to those of conventional portfolios while exhibiting lower risk over the long term. This view is supported by several published academic studies and our own research.

Journey on the path of sustainable investing

The United Nations Joint Staff Pension Fund is a defined-benefit fund established by the General Assembly of the United Nations in 1948, entrusted to provide retirement and related benefits to more than 205,000 staff and retirees of the United Nations and 23 other member organisations. The Office of Investment Management manages a US$63 billion multi-asset class, global investment portfolio, 85 per cent of which is actively managed in-house. The fund invests globally in more than 100 countries and 27 currencies, and in multiple asset classes: global equities, global fixed income, private equity, real estate, infrastructure, timber, and commodities.

OIM began the journey towards sustainable investing decades ago by restricting investments in tobacco and armaments, reflecting the values of the United Nations. The office became a signatory to the Principles for Responsible Investment (PRI) in 2006. This was followed in 2008 by investing in the first green bonds, issued by the World Bank, and being the catalyst investor in low carbon exchange-traded funds in 2014.

In recent years, OIM has been transitioning from a program of ESG-related activities to integrating ESG considerations across all asset classes.

OIM began introducing ESG metrics into the investment process by giving portfolio managers a broader set of tools to consider in their decisions. For internal actively managed public equity portfolios, we are piloting a four-stage process, tailored around PRI’s recommendations. In 2018, OIM implemented a new custom global equity index that can serve as a benchmark for other global equity investors. This index takes into account investment restrictions on companies that exceed a defined threshold of revenue generated from tobacco or weapons. Within fixed income, we have been increasing our portfolio of green bonds in line with net outstanding issuance in this market segment. For private markets, OIM integrates a comprehensive analysis of ESG issues into the due diligence process. We are exploring GRESB as an ESG benchmark for core real estate.

Technology and the availability of alternative data sets enables greater integration of ESG considerations in investment decisions

Asset managers require new technology and alternative data to make better-informed investment decisions and to better evaluate the risk-return characteristics of actively managed portfolios.

Integration of ESG considerations requires new tools and alternative datasets that are not conventionally used to support investment decision-making. OIM is leveraging its partnerships with key data providers to construct an internal proprietary ESG database, which will help distill material ESG data by separating the noise from the signal and also provide the investment teams with more robust screening capabilities. We believe combining financial and alternative metrics may increase the odds of improving the risk-return profile of our portfolio over the long run, compared with the conventional investment approach.

Our Sustainable Investing approach is beginning to incorporate forward looking methodologies in evaluating the impact of climate change on our investment portfolio

Likewise, investors need new tools that integrate energy economics, alternative climate scenarios and traditional financial data to evaluate return and risk exposures related to climate change and new sources of energy. These tools could help investors evaluate the climate change transition risk and achieve greater climate sustainability in their investment portfolios. OIM recently signed a strategic partnership with a leading provider of predictive climate analytics. Our efforts to signal our commitment to a low-carbon strategy through passive investment in low-carbon ETFs in 2014 was just the first step in addressing the impact of climate change. With the strategic partnership, we are now planning to move to an active strategy by using a highly sophisticated climate and energy simulation model to assess companies’ ability to adapt to various carbon emission scenarios. This ‘E score’ will be used as an input factor in developing our proprietary ESG investment-decision supporting technology, risk management and reporting.

UN Sustainable Development Goals

OIM is also conducting research on developing quantifiable SDG scores using artificial intelligence (AI) to leverage big data and systematically measure companies’ impact on the SDGs. This research will aim to provide empirical evidence that will address the widespread perception that there is a trade-off between incorporating ESG or SDG considerations into investment decisions and generating strong financial returns. It will strengthen our understanding of the interdependencies between a firm’s long-term economic value and its societal impact. OIM looks forward to publishing a more detailed white paper on this topic in the next year, which will be designed to serve as a catalyst for a broader discussion among long-term institutional investors.

Engagement through encouragement

The last pillar of our sustainable investing approach is engagement. An active sustainable voting policy, combined with engagement, can result in more effective and durable change consistent with the UN’s values. OIM believes in a collaborative and constructive dialogue with company management to achieve mutually beneficial outcomes. The fund is a signatory of the Climate Action 100+ initiative and is building up its engagement activities in collaboration with other long-term institutional investors.

We see evidence that ESG considerations are beginning to enter the mainstream investment world. ESG factors could affect the credit rating of corporate issuers. Fitch stated recently that these factors influence 22 per cent of its current non-financial corporate issuers. ISS reports an increasing number of ESG-related items on the proxy voting agendas of corporations.

As investors, we strive to avoid risks that may compromise long-term economic value. We need to rethink how externalities affect systemic risks and their long-term financial implications. The value of investments is influenced by many global drivers, including technology, natural resources and the environment, geopolitics, the inter-dependencies of globalisation, and demographics.

A world in transition is not particularly stable and the fact that systematically integrating ESG considerations into active portfolio management is not yet mainstream presents an opportunity.

Capitalising on it requires leadership, a culture of innovation and, perhaps most importantly, effective engagement with all stakeholders.

 

Herman Bril is director in the Office of Investment Management at the United Nations Joint Staff Pension Fund.