There has always been something special about the start of a new year. Whether a list is about the satisfaction of a past year well done or the regret of wishing you had achieved more, putting it into print always brings about a renewed sense of purpose and focus.

Russian psychologist Bluma Zeigarnik describes our tendency to have nagging thoughts about unfinished tasks; research shows that making a list of these things can help free us from anxiety.

So what is your investment to-do list for 2018? We have come to the end of another eventful year: elections in Germany and Japan, historic US tax reform, central banks worldwide shifting to tighter monetary policy and the meteoric rise in cryptocurrencies, to name a few highlights. A cursory review of literature reveals broad general agreement on the future: the road ahead is more challenging. This provides an unsettling backdrop for even the most optimistic of investors. To ease our collective consciousness, we at the Thinking Ahead Institute have created our own list of five topics investors should think about in 2018.

  1. Sustainability and long-horizon investing

The Future Fund and Willis Towers Watson 2017 Asset Owner Study highlighted that while sustainability is an important emergent subject for leading asset owners, opportunities were being missed in the overlapping areas of sustainability, ESG, stewardship and long-horizon investing. Investors have to combine two drivers to build a successful sustainable strategy – investment beliefs and an understanding of their wider sustainability motives. Clear beliefs, policies and practices are critical to managing sustainability risks and thinking about long-horizon investing. Best-practice models fully implement financial and other factors into portfolios while reconciling wider stakeholders and time horizons. We continue to see the pace of adoption quickening for better sustainability practices. Investors need to up their game or get left behind. The old paradigm of investors managing risk and return is increasingly being augmented by a third consideration that analyses the real-world impacts of the portfolio, through the lens of the UN’s sustainable development goals. The prize for investors? A stronger social licence to operate, growing trust and the expectation of better long-term, risk-adjusted returns.

Building a robust risk-management framework

While the VIX volatility index is at historic lows (indeed, markets seem no longer surprised by the unexpected), the SKEW index suggests that investors are becoming increasingly concerned about low-probability, high-impact events (tail risk). Following a multi-decade shift towards the political centre in developed markets, the global financial crisis has reversed that trend and investors are likely to face heightened political uncertainty for some time. Over 2018, we face elections in Russia, Italy, Mexico and Brazil, the October EU deadline for the EU/UK agreement on the Brexit deal, proxy wars between major oil suppliers, Saudi Arabia and Iran, and increasingly tense jousting between the US and North Korea. These localised risks have the potential to morph into high-impact systemic risks. The US approach on free trade and China’s aim to deleverage its economy are further potential disruptors.

A robust risk-management framework is key in this changing landscape. Building a deep understanding of scenarios, extreme risks and the investment ecosystem, being adaptable and employing coping mechanisms (such as tail-risk hedging strategies) are vital to survival.

  1. Diversity

Biases in investment decision-making are more numerous and deeply embedded than investors readily recognise. The subject of diversity is attracting attention at all levels of society, with a particular emphasis on gender, age and background diversity. The merits of diversity and inclusion in an organisational culture follow, in part, from the values of fairness and integrity pursued by leading employers. But diversity also helps reduce groupthink and it has now become generally accepted that improved diversity has value. Several funds have already started putting such rhetoric into practice.

At the Thinking Ahead Institute, we have also sought to understand the benefits of cognitive diversity for the performance of teams. The research we have considered has thrown off some practical ideas along the way: Work hard on equalising the verbal and non-verbal contributions of everybody in the room, and let the task’s context guide the composition of the team. So how diverse is your investment board?

  1. Technology

Human decision-making has its limitations. To reduce biases, investors need to make their decisions through a combination of human input (we refer to this as ‘social technology’) and systems/support (we refer to this as ‘physical technology’). Recent research by the Thinking Ahead Institute on The Asset Owner of Tomorrow notes that the slow speed of change in social technologies, such as committees, is being overtaken by the fast speed of change in physical technologies, such as automation. Achieving balance and efficiency in relation to these will require considerable effort and skill in the coming years.

There are a number of new applications of technology that support better decision-making, notably new platforms, new asset allocation processes, artificial intelligence applications, Blockchain applications and machine learning. We are also beginning to see an overall shift from products to platforms, and from traditional core institutions to crowdsourced versions. While the need for human judgement remains critical due to the complexity of data, leading investors must upgrade their technology to be competitive.

Purpose and culture

The CFA study Future State of the Investment Profession, describes the scenario of purposeful capitalism, in which the investment industry raises its game with more professional, ethical, and client-centric organisations. While the ongoing debate on the role of the investment industry is unlikely to be settled in 2018, there is growing consensus that, as the CFA states, “The fundamental purpose of finance is to contribute to society through increases in societal wealth and wellbeing.” David Pitt-Watson and Hari Mann note in their recent paper, “A productive finance industry is one that fulfils its purpose effectively and efficiently, bringing benefits to all its customers and supporting economic growth.”

Purpose, trust and value are all connected. We believe the financial services industry will thrive only if end users have trust in the system and obtain fair and sustainable results from the services and actions of its agents. There is an increasing need for ‘T-shaped’ investment professionals (that is, those with both breadth and depth), who are machine friendly, adaptable, and have the technical skills to navigate the industry’s complexities. Additionally, investment organisations are increasingly differentiating themselves by referencing their values and culture. Culture is inextricably linked to (1) the purpose and drive of the organisation, particularly in its passion for serving and (2) the people ethos – how the team is treated and behaves. Asset owners should attend, first and foremost, to their own culture. Collaborating with organisations whose culture and values are aligned should also become an important part of an organisation’s cultural plan.

So that’s our list for the new year. We believe a focus on these topics will serve you well in 2018.

Marisa Hall is senior investment consultant in the Thinking Ahead Group, an independent research team at Willis Towers Watson and executive to the Thinking Ahead Institute.

Taiwan’s Bureau of Labor Funds (BLF), one of the largest public-sector funds in Asia, will increase its global multi-asset allocation through 2018 and boost alternatives and overseas equity. The NT$3.54 trillion ($120 billion) fund also plans to invest in an absolute return global equity allocation for the first time, to manage volatility and downside risk.

These latest strategies reflect the steady diversification BLF has pursued since it was established in 2014. That year, the bureau replaced the Labor Pension Fund Supervisory Committee as investment manager of the island state’s six labor funds, which include the Labor Pension Fund (the New Fund), the Labor Retirement Fund (the Old Fund) and the Labor Insurance Fund (LIF).

“With the ongoing growth of the labor funds, we will gradually increase overseas equity and alternative investment, not only by innovating with new mandates but also by placing additional amounts with existing ones, to diversify our mandate strategies and obtain long-term stable returns,” BLF director-general Feng-Ching Tsay says.

Developing the multi-asset strategy will be a core theme throughout 2018.

“We use ETFs [exchange-traded funds], funds and external managers to implement our multi-asset strategy, which seeks to maximise the total return and reduce volatility,” Tsay says.

Investment will focus on global equity and short-term government and corporate debt, he says, adding BLF has “no prescribed limits” but will emphasise dynamic and flexible allocations in response to markets and economic trends.

The alternatives allocation has grown from 3 per cent of AUM in 2014 to today’s 10 per cent; liquidity and transparency are priorities in the growing portfolio.

“We are allocating more assets to non-traditional territory, such as real estate, commodity, infrastructure, multi-asset funds, hedge funds and private market funds,” Tsay says. “According to our long-term strategy, the non-traditional target allocation is not less than 10 per cent of total assets.”

To date, allocations have included listed infrastructure and real estate investment trusts; BLF introduced a private equity allocation managed in-house within its alternatives portfolio in 2016, that year’s annual report states.

Assets at the fund are divided between bank deposits (19.85 per cent), domestic and foreign equities (39.37 per cent), domestic and foreign fixed income (30.68 per cent) and alternatives (10.1 per cent). Domestic investments make up 52 per cent of the portfolio, down from 60 per cent in 2014. BLF assets are divided between core and satellite investments. The core comprises global equities and bonds, satellites consist of regional investments and alternatives. In 2016, the BLF returned 3.58 per cent.

Diversification through outsourcing

Another aspect of the fund’s pursuit of diversification is the outsourcing of its allocations. The bureau is keen to build its manager roster for domestic and overseas investments.

The current search for an offshore equity absolute return manager will lead to the fund’s third new mandate in the last 12 months. At the end of 2016, BLF invested in an absolute return fixed-income strategy that was allocated to four managers, and portioned $2.4 billion in a combined ESG and multifactor strategy. Here, investments exclude certain companies and combine quality, value and minimum volatility strategies.

“Not only can we bring in private asset management’s professional skill and vast research resources, we can also reduce risks and enhance fund investment returns and benefits,” Tsay says.

The fund may also build on its smart-beta assets. These include allocations to fundamental indexation, minimum volatility, high dividend and quality, and to an index blending ESG and quality.

“Smart-beta investment earns better risk-adjusted return and diversifies investment risk in the long run,” Tsay says.

To encourage managers to win bids and assemble “the best investment and research teams”, BLF is open to increasing mandate amounts across all allocations and reviewing its terms of investment management.

“During regular evaluations, the bureau will review overall account performance and reward outperformers by renewing contracts or increasing mandate amounts, thus building long-term partnerships with excellent institutions and enhancing mandate performance,” Tsay says.

What stays in-house

The bureau also runs a dynamic internal team. All tactical adjustments are done in-house. The bureau uses an asset allocation simulation system to calculate risk limits for each fund in relation to day-to-day market risk monitoring. The in-house team also invests in hold-to-maturity bonds, mutual funds and ETFs; it is responsible for all foreign exchange management. In 2014, 43.5 per cent of the portfolio was with managers versus 56.5 per cent managed in-house. Today, in another reflection of the diversification trend, about 44 per cent of the biggest fund, the Labor Pension Fund, is managed internally and 55 per cent is invested with managers, the 2016 annual report states.

Since 2014, BLF has also prioritised ESG themes, Tsay says. The fund invests in ESG-themed mutual funds and ETFs and sets out its related priorities with managers; BLF also issued a social responsibility report in July 2016. To promote shareholder activism, the bureau signed the Stewardship Principles for Institutional Investors, initiated by the Taiwan Stock Exchange, and has urged all 12 of its domestic mandated institutions to follow suit.

 

Nearly two years after taking on the role of chief investment officer at CareSuper, Suzanne Branton is building out her team and settling in for the long haul.

Every workday morning at 9.00am, the A$13.1 billion ($10 billion) CareSuper investment team gathers for its daily meeting. The ritual is a legacy of chief investment officer Suzanne Branton’s years in the world of investment banking, although in her days as a young money manager at the Goldman Sachs-owned JBWere Asset Management, the morning meeting started at 7.00am.

“It was one of the challenging things I did very early in my career, and I think it taught me a lot, having to present to a couple of hundred people first thing in the morning,” Branton recalls.

Even though the CareSuper investment team numbers fewer than 10 people, the discipline still has enormous value.

“We are a fully fledged investment team and investment issues are the first topic of discussion every day,” Branton says. “Not in the context of something that happened last night…but [regarding] how our strategy is evolving.”

Team members talk about the managers they are meeting with and what they want from them.

“It’s a way to have all of those things known and monitored by the team…I’m not ever going to be splitting off sub-meetings. We deliver members a whole-of-fund return, so let’s have a whole-of-fund commitment to what it is we’re doing.”

Branton has recently implemented a program to deepen the integration of environmental, social and governance (ESG) risk management across the fund.

“The expansion of our ESG work has been about integrating the consideration of those factors more deeply into the research we’re doing on managers and their strategies as a whole, as we’re looking at them, and investigating them, and reviewing them,” she says.

Team builder

Developing a cohesive, collaborative team with a shared investment philosophy has been her greatest achievement since she left her previous role as a senior investment manager at another Australian fund, Equip Super, to join CareSuper as CIO nearly two years ago, Branton says.

Investment team members each bring an area of specialisation but must make decisions according to a whole-of-portfolio approach.

“There’s no capital allocation to individual people. You can still have specialisation and specialist skills, as long as you don’t make investment decisions in a siloed way.”

At the time of writing, a ninth member of the CareSuper investment team was due to be announced, and the CIO was foreshadowing more hires in 2018.

CareSuper is a Melbourne-based public offer industry superannuation fund with origins in servicing clerical and administrative workers. Virtually the entire portfolio is managed externally and, especially in light of Branton’s previous experience running money directly, the question often arises whether CareSuper is set to join the growing roster of industry funds that have insourced part of their asset management.

The answer is no – at least not anytime soon.

“We do some things like cash and term deposits internally, but predominantly it’s all externally managed,” Branton says. “How that will go over time, we shall see. But at the moment, there’s no immediate plan to change from that.”

For a fund of CareSuper’s scale, outsourced investment management is the most efficient model, she argues.

“We’re not constrained in what we’re trying to achieve and what we do by what’s available to us. Probably because we are able to…invest in things that are niche, capacity constrained, opportunistic and concentrated. Because we’re able to both do and find all those things, the efficiencies that would come from managing some bulk assets internally aren’t immediate.”

The day may come, however, when Branton will have to consider the needs of a fund with much greater scale.

After all, when asked how long she plans to stay in her role, Branton answers: “A long time. It will take me to the box, I think…It gives me a great amount of pleasure and satisfaction to do what we do.”

Origins in economics

Branton began her career in what she describes as “the murky world” of economics, which she says has left her with a lingering “interest in all things macro”.

“I’ve always been a person that is particularly interested in trying to identify major turning points and when conditions are really changing in a sustained way, as opposed to the things that come and go on a month-to-month basis,” Branton says.

When asked if global markets are on the cusp of such a turning point as the US Federal Reserve’s interest rate tightening cycle gathers steam, Branton is circumspect.

“What I would say is these things never are clear at the time,” she says. “It does feel to me as though we’re at the tail end of an interest rate cycle where [they’ve] just continuously fallen over multiple years. It feels like that is most likely done and we’re coming into something else, where interest rates can go both up and down.”

The prospect of a return to more market volatility is something Branton would cautiously welcome.

“I’m always cautious about welcoming volatility; a part of me does but welcoming volatility is welcoming the potential for poorer outcomes for our members, which we never want,” she says. “But volatility that we can recover from, where the medium-term outlook is still constructive for our members – yes, that would be good.”

Risks and adjustments

While not an immediate worry, it is never far from Branton’s mind that the biggest risk to the CareSuper portfolio today is the level of interest rate sensitivity inherent across the investment program that has been built up over a decade of extraordinarily loose global monetary policy.

“It doesn’t look as though that is going to be tested by the long end at the moment,” she says. “If anything, yields just don’t seem [like they’re] going to move up very far. But the most comprehensive risk that I think about, that would affect the investment program as a whole, is really that interest rate sensitivity that is now embedded in a lot of the asset classes we invest in.”

And that’s despite the fund now having a low allocation to fixed income markets. Reducing that exposure was one of the first things Branton implemented when
she arrived at CareSuper two years ago.

Not only are many listed companies now in a position where their balance sheets are interest rate sensitive, but also the valuations in infrastructure, real estate and infrastructure markets are now typically more stretched and interest rate sensitive.

“The question in my mind is to what extent is the valuation of our investments and their ability to deliver return in the future dependent on a low-volume environment,” Branton says. “Mind you, there aren’t any particular signs that environment is about to change dramatically any time soon.”

One thing is for sure, the market outlook for the next 25 years looks different to the one in which the superannuation industry has been operating since Australia’s compulsory system was introduced in 1992.

It was around then that Branton started running superannuation money, and she suspects memories of working through a string of financial market crises over that time shape her approach, even if only subconsciously.

Early in her career as a money manager, the 1994 bond crash hit, followed by the Asian crisis of 1997, then came the dotcom bust in 2001, before the global financial crisis seven years later. They have all been formative experiences.

“I distinctly remember, as though it was yesterday, the bond crash in 1994,” Branton says. “Maybe that’s a help, maybe it’s a hindrance in some ways, to have such a long memory…But I think it makes you cautious and it helps [you] have a long-term perspective when you’ve worked through those sorts of events.”

Branton is now approaching opportunities in listed equity markets “with a great degree of caution”, but notes she is less negative on the outlook for shares than many.

Downside protection

“It will be challenging to get decent returns from here in just about anything, to be honest,” she says. “We’re going to need every single source of return we can possibly get.”

She is certain the answer lies in a disciplined approach to active management with a focus on net returns and portfolio diversification.

The fund has recently expanded its alternatives program. Like many of their peers, Branton and her team have been spending much time in recent months researching credit managers and absolute return-style managers.

“A lot of the credit work is orientated to a shorter duration, but it’s also about finding sources of return managed very actively,” she says.

The fund still maintains “an opportunistic private equity program” that focuses on looking for good deals, including secondary offers, mostly from US and European managers.

“It is more of a case-by-case thing as deals come up…We don’t feel compelled to be cornered into vintages or strategies that don’t appear to have strong return potential,” Branton says.

CareSuper’s allocation to alternatives, including infrastructure assets, now sits at about 30 per cent of the total portfolio.

The fund’s ‘home bias’ to Australian listed equity markets has been reduced under Branton’s watch since early 2015.

That’s partly due to the fact it makes sense to have a higher allocation to global shares to reflect the overall market structure, but it’s also a reflection of a subdued outlook for the domestic market.

To complement the highly active approach of the CareSuper strategy, the fund also has a program of downside protection.

“Across the investment program, everything is probably more active than the average,” Branton explains. “And our asset allocation is active as well. We’re up at one end of the active scale, and so we also focus a lot on downside protection. We deliberately build a defensive portfolio, not a neutral portfolio. So, as you would expect, we have a skewed performance profile that favours more difficult market conditions.”

In this way, the downside protection program is more fundamental than derivatives driven.

A focus on active and bespoke managers also means needing to be prepared to pay higher investment management fees, and that’s OK.

“Our members retire on net returns, they don’t retire on what fees they’ve saved,” Branton says. “For us, it’s about value for money. We are prepared to invest in more complex strategies and things that are capacity constrained, but we endeavour to do that very carefully and prudently, and with a great deal of consideration.”

Governance upgrades

Soon after she joined the fund, CareSuper upgraded its investment review committee to a fully fledged investment committee with delegated powers.

This change, with the support of a program of director education and development, has fostered a stronger investment governance framework.

“You could ask any of our directors would we invest in a particular manager or strategy and they’d be able to tell you straight away,” Branton says.

She credits chair Catherine ‘Cate’ Wood and chief executive Julie Lander for their longstanding support of trustee education. JANA is the fund’s asset consultant, with the account led by Steven Carew.

Managing these and other important relationships is a key part of the role for Branton, who believes investing is “part art, part science” and says one of her strengths is an ability to grapple with the intangibles.

“I’ve always been a big believer in character strengths and character traits, and the extent to which they frame the person’s work and what they do, and their career, and why they do what they do,” she says. “I think character traits are a really important part of people’s career and career development.”

And her defining character trait?

“Determination. I’m a very determined person.”

There is less overt sexism for her determined nature to contend with in the industry today, thankfully, than when she embarked on her career, but unconscious biases still feed into gendered expectations about how women are supposed to behave.

“I don’t settle for OK, or it’s all fine, or that’s acceptable. I don’t settle for that, and I never have,” Branton says. “But people expect you to settle. They do. This is my personal view. This is one of the things I don’t think has changed. People still expect that women are going to settle for what’s fine, or what’s OK, or what they’ve been delivered.”

Branton mostly shrugs it all off, but it still rattles to be perceived as difficult in circumstances where male CIOs behaving similarly are more likely to be characterised as “strong, decisive, good businessmen”.

Fund managers who take this tone in fee negotiations should expect pushback.

“I absolutely fight for every dollar,” Branton says. “Every dollar, I fight for. And I never settle. I never settle for anything less than what our members deserve.”

 

 

Record valuations across all asset classes are among the most troubling threats lying ahead for veteran investor Chris Ailman, chief investment officer of the $221 billion California State Teachers’ Retirement System.

“We know that the reversion to the mean is a ruthless force of nature in the investment world and it will break,” Ailman warns. “We just don’t know if it will be two weeks or two years from now.”

As CalSTRS begins 2018, Ailman is preparing to navigate the widely anticipated correction in bonds, shares and towering real estate and private equity values. Higher interest rates and uncertainties such as North Korea and Brexit add to the risks.

It means charting a balance between staying in markets to benefit for as long as possible while the upside continues, and protecting the portfolio from the correction when it comes. Ailman must strive to hone portfolios for whatever value remains in individual countries and companies, while playing to CalSTRS’s strengths to ensure access to opportunities in a market so awash with long-term capital that even the US’s second-biggest pension fund feels the competition.

Risk mitigation

Protection against a correction is the idea behind CalSTRS’s new allocation to risk-mitigating strategies (RMS). The fund’s key holdings include a 55 per cent allocation to equity, 13 per cent to fixed income, 13 per cent to real estate and 8 per cent to private equity. Now a newly funded $18 billion RMS portfolio containing a mix of long bonds, equity risk premia and global macro strategies, all with a negative correlation to global sharemarkets, will account for 9 per cent of assets. The hope is RMS will offer the diversification the fund has been seeking since the financial crisis laid waste to traditional theories about non-correlating assets.

The RMS portfolio contains a “basket of strategies” rather than any specific security, Ailman explains. It “gets away from asset names” to look instead at the underlying characteristics of how allocations work in extreme market conditions. This is why the portfolio includes factor strategies that are defensive but also sit in the equity portfolio for their high beta.

“It’s about peeling away the cover and looking at the way these assets really move,” Ailman says.

The RMS allocation also reflects his belief that the characteristics of traditional fixed income have changed. CalSTRS’s assets are still split between equity and debt to the same degree they were five years ago, but with the introduction of the RMS portfolio, that debt portion is no longer just bonds.

“Some aspects of bonds are highly diversifying but others are kind of correlated,” he explains, listing large credit exposures, high yield and emerging-market debt as examples of the assets many fixed income investors have “drifted” into, thinking they bring diversification.

“These things aren’t fixed income like we used to know it, they are equity surrogates and have a much higher correlation to equity; that’s great in a bull market, but it won’t act as a brake or diversifier in extreme market conditions.”

He does say interest rates are set to slowly rise and that this will make traditional fixed income more attractive as a diversifying asset; however, he doesn’t think there will be much of a hike, given the fact the US Federal Reserve has significantly lowered its definition of “normal” levels to about 4 per cent.

“We have been vocal that we would like to see rates get higher,” Ailman says. “Rates near zero skew valuation metrics and cause higher-risk assets to trade at tighter spreads, which we don’t think is healthy.”

Private equity

The theme of evolving along with asset classes continues in CalSTRS’s $18 billion private equity program, where CalSTRS has also recently expanded the sub-asset classes by adding a core allocation that holds assets longer.

“Rather than traditional ‘2 and 20’ highly leveraged buyouts, this new allocation is a recognition that we are starting to see value in buying and owning private companies for longer,” Ailman explains. “We are long, patient capital and I would argue that even a buyout fund with a 14-year life is too short-term for us.”

The allocation will probably have lower returns than traditional private equity because it is less leveraged, but that will also mean less volatility.

“Time will tell what the correlation is between this and traditional private equity but we expect to see more funds expand into this area in coming years,” Ailman says.

Related to this trend is another change in the investment landscape – the steady fall in the number of public companies in the US and around the world.

“We are going to see more companies seek capital by staying private than we will see going public,” Ailman predicts.

Even private equity exit strategies are increasingly eschewing initial public offerings.

“Barely a third of private equity exits are IPO anyway,” he says. “There are more private-to-private transactions because of the high cost of being a public company.”

Along with the costs, vocal shareholders are also cited as a catalyst for this trend. Ironically, Ailman says shareholders have stronger rights in private companies, and that private companies can make better investments for pension funds because they are more focused on the long term than public entities.

“The value of a private company is that it doesn’t worry about 90-day earnings; they think longer-term, making investment decisions knowing that the short term may cost money, but in the long term there is a pay-out – and we know in life that these are the better decisions,” he explains. “Public companies know the right thing to do but they don’t do it because they are too focused on short-term profits.”

Ailman should know. He spends much of his time persuading companies to think long-term. Over his 17 years at CalSTRS’s helm, he has built the pension fund’s reputation for low-cost, passive investment and led the crusade for lower management fees. Taking long-term sustainability mainstream or, as he says, “raising the bar for everyone”, will perhaps be the most enduring hallmark of his leadership.

He says, for example, that it’s time to change the language of ESG because one of the barriers to corporate take-up of ESG is, in fact, the term ESG.

“People get hung up on words,” he says. “If you say ESG, it doesn’t resonate with the board or management. But if you say long-term sustainable profits, managers all nod their head and say, yes, we are interested in that, too. Many see ESG as a specialised, unique area but if you walk people through it, they get it.”

Staying competitive 

Ensuring CalSTRS’s continuing ability to access the best investments when the fund has to compete with long-term capital from giant investors in Asia, the Middle East and Norway is another challenge.

“We have situations where we meet with prospective GPs [general partners] and talk about a $200 million investment,” he says. “But when you come out of that meeting, a member from a new sovereign fund – not an old one – will be sitting in the lobby to go in after you and they are going in to talk about making investments of several billions.”

It means crowding-out in venture funds and private equity, and in traditional active management in equity and fixed income.

“People hit capacity and if you are at capacity you want easy money, you don’t want hard-to-get, demanding money like us,” he says, in reference to the many rules and regulations that govern US public-sector investment compared with other funds. “We are still well known and still have a strong brand, but the old, stable kind of money is not as interesting.”

His response is to play on CalSTRS’s reputation as a good business partner with stable, experienced teams and a long-term focus.

“New, fresh money looks interesting and catches their eye but there is value in having a long-term partner that you know well and understand, and who understands you,” he says.

Partnerships in infrastructure

Another way to stay competitive is to team up with other pension funds and cut out investment managers. Infrastructure investment, requiring an enormous amount of capital, is an obvious place to start.

Ailman notes initiatives such as IFM, a global manager owned by Australian super funds, and the UK’s GLIL, which is backed by five local authority schemes to invest in infrastructure, as examples of co-operation in practice.

“We will see more funds syndicating and doing deals together,” he predicts. “It won’t replace the money-manager world, but if we can buy direct and break the distribution chain, we will.”

The strategy doesn’t come without challenges, none bigger than building the right structures to hold partnerships together for the long term.

“When you do business with peers, you may get along at first, but the board changes, the staff change and, lo and behold, it’s not the same relationship,” Ailman says. “I’ve seen partnerships start out great, but not go so well over time.”

Even so, he’s encouraged by the growing co-operation among pension funds around ESG.

“In the past, we were spoon-fed by Wall Street, but now we are all sharing information ourselves,” he says.

Karl Morris, the chair of the board at the A$94 billion ($72 billion) Australian fund QSuper reflects on recent changes at the fund including going public offer and launching an insurance arm. The long-time Australian Liberal Party powerbroker also speaks in defence of the representative trustee board model.

Investment Magazine: QSuper opened to new members as a public offer fund on July 1, 2017. Are you pleased by the response so far? How does becoming a public offer fund change the conversation for the board?

Karl Morris: The response to date has exceeded expectations, we have been quite overwhelmed. The majority of new members are friends and family of existing members, and we are happy to be able to welcome so many of them. We’re also seeing past members who, having experienced other funds, have now chosen to return to QSuper. Becoming a public offer fund hasn’t shifted our focus. Members will always remain our key focus and we will continue to innovate and enhance the award-winning, tailored products and services we are renowned for.

IM: With advice, investment management, and insurance capabilities in-house, QSuper is one of the most ‘vertically integrated’ non-profit funds in Australia. How do you manage the governance risks that come with this advantage?

KM: Having so many of our capabilities in-house ensures that the teams are working together across the organisation and it provides great opportunity to share ideas and leverage expertise. Our Lifetime product, which is our default investment option, was made possible through the internal investment, product and advice teams working together to bring the idea to fruition. Internalising teams has required some changes to governance processes, but these changes have not been prohibitive and have positively contributed to member outcomes. These changes have ensured that appropriate delegations inform responsibilities around each function. They’ve also ensured clarity of purpose and role, along with setting in place strong due diligence processes.

IM: QSuper has posted some of the strongest investment returns in Australia in recent years while having a very different investment strategy to its peers. How did the board get comfortable with the ‘peer-aware but not peer-anchored’ approach?

KM: Having great clarity of a central purpose is very powerful. At QSuper the focus has been, and will always be, on achieving the best outcomes for members. The QSuper board holds this view strongly and we spend a lot of time considering the diverse nature of our membership, their needs and expectations and tailoring products and services to them. Anchoring our investment philosophy and strategy to peers would be contrary to this. Whilst we know that this may mean we look very different in fund comparison tables, positively and negatively, we believe that this is the right approach. Ultimately, we are targeting a smoother path to their retirement, with returns comparable to those of traditional balanced funds.

IM: Are mergers part of the growth strategy for QSuper?

KM: As one of the largest funds in the country, we already have benefits of scale that we leverage at every opportunity. Whilst mergers are not a priority at the moment, we are open to considering opportunities as they arise. The primary test for us is that any merger would have to be of benefit to our existing members.

IM: Are there any important ways in which chairing a superannuation fund is different to your previous experience chairing stockbroking firm Ord Minnett?

KM: There are a number of differences to being on the ‘buy side’ from the ‘sell side’. A stockbroking firm has shareholders who want a return on equity, whilst at QSuper we have the ‘sole purpose test’ and ‘best interest of members’ to guide how we best provide for members’ retirement. The board appointment processes are also very different and the nuances between directors representing shareholders to trustees representing members requires a slightly different fiduciary lens. There is typically a lower level of engagement from superannuation fund members, with many investing through the default offering. To make decisions for hundreds of thousands of members is a huge responsibility. I believe that QSuper took a big step forward when we separated our default investment option into eight smaller options, grouping members by age and account balance, and recognising that one size does not fit all when setting investment strategies for such a vastly diverse group of members.

IM: How have your views about what makes a good chair changed over the last decade?

KM: A good chair continually makes sure board members are collegiate and respectful of one another, whilst acknowledging that sometimes there may be different opinions. The key to getting a board to get big decisions right, is making the decisions in a considered and consensus way. In my career, I have had the opportunity to report to boards, be a director on boards, and chair various boards, so I’ve experienced both the good and bad from various angles. To be a good chair requires a keen interest in the business area, the desire to work collaboratively with a broad range of people, and the ability to see the big picture and identify priorities. I think that the role of boards is much more challenging today than a decade ago, and the chair’s role has also grown significantly in scope and complexity over this time. These days, organisational strategy needs to be more flexible, risk management is much more prominent, and the level of governance appropriately high.

IM: What is your top piece of advice to investment specialists for improving their communications with super fund trustees? 

KM: Make sure there are no surprises. It’s an obvious statement, but critically important to developing trust and collaboration. Continually update trustees so that they are attune and open in their thinking to cyclical and structural changes to economies and markets. I think it’s important that investment specialists communicate frankly with super fund trustees to ensure the full range of potential outcomes is understood. There are good and bad investments, and there are bull and bear markets. Boards need to be aware of both the upside and the downside of this and how this translates into the experience for members.

IM: What is the most valuable professional development or training you have done that has helped you be a better chair? 

KM: The Australian Institute of Company Directors course was very good but, in reality, director development is more experiential. I have learnt a lot from ‘good and bad’ chairs. One important thing I have learnt is that all directors must be equal in information and remuneration. And whilst not strictly professional development, the activity that resonates with me most regarding my fiduciary duty is attending QSuper member events and talking directly to our members.

IM: You are an independent chair governing a representative board. Do you feel that board composition model works well for QSuper? What are the pros and cons?

KM: I think the results speak for themselves. QSuper has long been fortunate to have trustee representatives from both the employer and member organisations who have truly championed the ‘best interest of members’ philosophy. The pros of a representative board are the direct channels of engagement with the employer and member organisations, while the cons are the relatively limited ‘pool’ of people available within these organisations from which to choose candidates. A board that operates as a high-performance team requires a group of people with diverse and complementary abilities. Ultimately, where the trustee directors come from (employer, member or independent), is less important than the knowledge and experience they bring and the commitment they demonstrate in their role as a fiduciary.

 

The State of Wisconsin Investment Board, which oversees the $105 billion Wisconsin Retirement System, is renowned for its diverse investment strategy, internal management, benchmark-beating results and fully funded status.

Now the Madison-based fund also leads peers in investment management technology.

SWIB has just completed an overhaul to streamline its operations at a cost of $46 million – just under the $48 million budget. The fund says the process is already reducing risk and boosting alpha generation.

The technology is also giving the fund, for the first time, its own timely, holistic measurement of risk and performance that goes beyond audited reports from administrators.

“This is the most comprehensive technological system in place in a public pension plan in the US; we are at the forefront,” says Michael Williamson, who joined as executive director of SWIB in 2012 and retired from the position at the end of 2017. It was his observations five years ago that helped inspire the fund to invest in the four-year technology overhaul.

SWIB began to realise it needed to boost its operations and technology to manage assets in-house successfully – the fund now runs about 65 per cent of assets in-house, up from 21 per cent in 2007. It also needed the ability to access the right tools for the ambitious and sophisticated alpha-generating investment strategies it wanted to use, Williamson recalls.

“The strategies we were putting in place pointed out the need for additional operational systems and infrastructure that we didn’t have,” he says. “We’d outrun our headlights. Our strategies were more demanding than our ability to support them.”

Comprehensive view of equity, fixed income

Together with fintech consultancy Citisoft, the fund has introduced a new single reporting platform for its $74 billion internally managed public markets allocations in fixed income and equity.

The new platform integrates data from these allocations into a format that combines risk management and investment performance data, scenario analysis, attribution and trading. The technology offers the team daily positioning functionality, profit and loss breakdowns and multi-asset reporting while cross-asset risk modelling allows internal teams to play out scenarios.

For the first time, SWIB has a comprehensive view of risk across its equity and fixed income investments. Before, the internal team could see individual risks in the equity and fixed income buckets but couldn’t see it at the portfolio level.

“We needed access to information at a higher level,” Williamson explains. “We had silos looking at equity and fixed income, but when you are beginning to play in all of these areas simultaneously, you need to understand the relationships between the different asset classes and it requires a greater level of knowledge and information to support decisions.”

Fixed income accounts for 29 per cent of assets under management at the fund, while about half of assets under management are in equity, divided between US and international stocks. The fund still uses external managers in private equity (8 per cent) real estate (6 per cent) and hedge funds (4 per cent)

Efficient rebalancing

The new platform also allows the fund to rebalance more effectively and efficiently.

“We are rebalancing earlier and beating market trends ahead of time,” Williamson says. “We used to rebalance a couple of times a year – I think last year we rebalanced around 10 times. Now we have the tools and ability to do this more efficiently and it means we can make real changes and generate alpha here.”

The platform’s whole-of-portfolio view and rebalancing efficiency have generated about $74 million in savings over the last year, Williamson estimates.

“We have already paid for our investment in generated returns,” he says.

SWIB and consultants Citisoft started the project with a strategic assessment that developed into a roadmap and delivery. The consultancy also played a key role in persuading trustees to support the plan.

“Our consultants showed us where we were, and where we needed to be,” Williamson says. “This way, our trustees were able to see the vision, and they supported the expenditure, which at $48 million was major. We were also able to say to our trustees that we could generate additional returns as a result, and they have been very supportive.”

Private markets next for integration

In 2018, SWIB plans to integrate its in-house private market allocations into the new platform, Williamson explains.

“I use the analogy of a property development: first you have to build the infrastructure, connect up the water and sewage,” he says. “We have now done this and it’s given us the ability to bond-on various applications and platforms on top of this. Private markets will be much simpler because of the infrastructure we’ve already laid.”

The new technology has transformed middle- and back-office processes, too. Other initiatives, such as an investment book of record providing timely data to the front office, have also been integrated.

The project hasn’t been without its challenges and Williamson has advice for funds planning similar investments: plan well; involve senior leadership throughout the project, it’s not something that can be delegated to a low-level team; and ensure excellent communication across the various project teams so they move forward in unison.

Finally, he advises, be patient.