Oregon State Treasury, which runs $80 billion worth of state investments including the $62-billion Oregon Public Employees Retirement Fund, is preparing the portfolio for a new dawn.

John Skjervem, chief investment officer of the treasury’s investment division, sees the speed and extent of the recent sell-off in fixed income as “a shot across the bow” that the benign bond environment is coming to an end.

“The secular bull market in bonds, over three decades old now, is over,” says Skjervem, who joined Oregon last November from Northern Trust Group, the Chicago-based bank.

He’s just overseen an adjustment in asset allocation at the fund to better protect the portfolio against inflation and the anticipated lag in bond market returns.

Newly approved asset targets include a 20-per-cent allocation to fixed income, pared from 25 per cent, a 37.5-per-cent allocation to public equity, down 5.5 per cent, an increased 20-per-cent allocation to private equity, an increased 12.5-per-cent allocation to real estate and 2.5 per cent each to absolute/return, commodities, infrastructure and other real assets, to which money liberated from bonds will flow.

The tweaks to Oregon’s asset allocation also show the fund unwinding investments it put in place to capitalise on dislocations created during the global financial crisis. These adjustments better reflect today’s changing economic climate, explains Skjervem.

“As the 2008-2009 crisis unfolded, Oregon increased its exposure to credit-sensitive fixed income, which subsequently generated several consecutive years of strong returns. But financial markets in general and credit markets in particular have recovered, so we think now is a good time to unwind at least part of that bet.”

He applauds his predecessor’s initiative and perseverance since these credit-sensitive investments benefited greatly “when spreads compressed by over a 1000 basis points” after the financial crisis. Now he believes the strategy’s risk-return profile is “no longer as attractive” and the tactical element of the strategy has largely “played out”.

Eye on the ball

Although Oregon was hit hard by the financial crisis, Skjervem says it was these kinds of strategies that helped the fund recover well. The board and staff didn’t “blink and commit the ultimate sin” of selling risk assets into a bear market.

Instead, led by Skjervem’s predecessor Ronald Schmitz, who now serves as chief investment officer for the Virginia Retirement System, the fund made tactical credit investments, specifically in high yield bonds and bank loans.

“I think it probably took real courage to increase the fund’s credit-sensitive exposure and buy all the way through the bear market.”

Warming to his theme, Skjervem explains that Oregon showed the same fortitude with its private equity allocation. It got board approval to actually increase its commitment in one particular case by providing rescue financing. It was a strategy, he says, that has “been vindicated by the generous private equity returns we’ve recently enjoyed.”

The fund currently has a 22-per-cent exposure to private equity, overweight its increased 20-per-cent target allocation but in “a fast and furious” stream of realisations this will soon fall back to target. Oregon was the first investor in private equity manager Kohlberg Kravis Roberts in 1981.

Back then a seminal investment when the industry was still in its infancy via a leveraged buyout of a local retailer generated six times multiple. “This was the beginning of what is now a big and robust private equity portfolio,” says Skjervem.

It’s an expertise that now informs all the fund’s private market allocations, like its newly increased 12-per-cent real estate portfolio, what Skjervem describes as Oregon’s “other success story”. To ensure the corresponding returns exceed liquid public-market alternatives, Skjevem applies certain criteria.

“First, we need to see evidence of a return premium net of fees and transaction costs and second, we need confidence that this premium will persist over time. Finally, we need access to top managers in these markets to make sure we actually capture these persistent return premiums. Medium private-market returns are usually no better than the liquid public-market equivalents.”

Getting to the real

Money from the reduced bond portfolio will be portioned to real assets, including infrastructure. It’s an asset class where the fund only has “a toe in the water”, but will now make an area of emphasis, although Skjevem notes that there are few well known funds through which to invest.

He likes infrastructure for its inflation sensitivity and the way it matches the plan’s intermediate liabilities.

“In these shorter time periods, inflation can be really corrosive to traditional equity returns,” he says. Last January the fund, which seeks high single-digit returns in the asset, committed $100 million to Stone Peak Infrastructure Fund, focused on US utilities, energy and transport.

Skjervem says Oregon is also exploring infrastructure investment collaborations with neighbouring states.

Domestic equity investments include a passive allocation to various domestic and international benchmarks as well as a set of “judiciously selected” active managers running quantitative strategies that are focused less on stock picking and more on exploiting return anomalies associated with risk factors such as size and value.

Elsewhere in the public equity allocation, a developed-markets portfolio is split between a passive MSCI World Ex-US IMI Index fund and active Europe, Australia and Far East mandates. An emerging market allocation is invested in an MSCI Emerging Markets Index fund.

Although Oregon has a 2.5-per-cent target allocation to absolute return strategies, Skjervem says he shares his staff’s and governing board’s hedge fund scepticism.

“If you apply empirical tests to hedge fund-return histories, you often find high correlations with common market betas that you could otherwise replicate with various ETFs or index funds for 20 basis points instead of paying the traditional two-and-20 fee structure. I think there are other, usually more cost-effective ways of building these types of return streams. It’s good to apply this level of rigour because it also helps you identify those hedge fund managers that are doing something truly unique and accretive.” He doesn’t believe hedge funds have an edge when it comes to market timing either.

“If they could do this consistently, fine, but I haven’t seen it.”

Lean and mean investment team

Along with the Retirement Fund, Oregon State Treasury oversees assets for the Oregon Short Term Fund, the Common School Fund, the State Accident Insurance Fund and the Intermediate Term Pool.

There are no plans yet to build a bigger internal team – for now a “lean and mean” staff include 12 investment professionals and five administrative assistants, with the team divided between offices in Tiger, which deals with the risk allocations, and Salem, where fixed income and cash allocations are managed.

“Ultimately we’d like to bring everyone together,” says Skjervem.

The fund, which is 84 per cent funded, has an assumed earnings rate fixed at 8 per cent since 1989. The latest adjustments will leave Oregon more reliant on private markets, private equity and real estate, as well as real assets such as infrastructure, to meet that goal. “Our strong brand, ability to write big cheques and continuity of staff and governing board make us a sought-after partner,” says Skjervem.

Reels of financial data and analysis coupled with the occasional piece of market gossip or personal hunch are the time-honoured tools investors rely on in building an active portfolio. More recently, an element of sustainability or corporate governance analysis has tried to muscle into the process. Soon there will be another revolutionary option complementing financial and non-financial data – if an ambitious project being launched in Germany has its way.

Murat Unal, head of the consultancy Funds@Work, is an aspiring Mark Zuckerberg of institutional investment – on a mission to shake up established norms by unleashing the power of social networks. He sees the interconnectedness of individuals to be a missing link in portfolio analysis, and an element that can be vital to the performance of investments. “People across the world are social beings embedded in social networks that can constrain or promote their assets,” he explains.

Unal draws on a long tradition of economic thought that takes social network capital to be a key driver of economic success. In any society there are probably those who get ahead thanks to an influential relative, a former colleague or university friend.

Such ties can be problematic, Unal reasons. “Say, for example, you have an independent director who is actually closely connected to the rest of the board. Their efforts to maintain independence might be compromised by having been recommended to the board by an executive director with prior social ties or sharing the same mindset – these kind of ties could be disastrous if they are unable to see a problem in time.” Merger and acquisition deals can also have distorted prices when key executives at the two parties are connected, he adds. Chief executives at big banking groups with divided retail and investment activities can likewise pay greater attention to the area in which they rose up through the ranks. That can be to the detriment of other less familiar spheres of their businesses.

While Unal feels financial data will always remain the essential component of financial analysis (and that environmental, social and governance data will become mainstream), he and his team reckon that social network analysis will be vital in helping sophisticated investors’ most difficult task – attempting to predict the future. “Financial data is like looking in the rear view mirror, but a social network analysis can actually project a company’s next moves,” he contends. As much as investors should know how a company has got where it is today, their assessment of future prospects is arguably the most vital factor in determining whether an investment succeeds.

Quantifying social network capital

You don’t have to be a believer in an evil elite to acknowledge the core tenets of the social network capital idea – that there is a definite interconnectedness between successful businesspeople and their social circles the world over. Determining how that all impacts the performance of investments is the tricky part. The pushes and pulls of vast social networks that everyone is a part of can, after all, hardly be written as neatly as a cash-flow figure or a price-earnings ratio.

Unal and his team are determined to give unpicking complex executive networks their best shot though. He says they are prepared to invest substantial resources and are convinced that they have a track record that can help. They want to “make social capital more tangible, moving investors and decision makers beyond financial and non-financial data, and see how social networks affect investment returns and risk profiles”.

SONEAN and yet so far

To help achieve this aim Unal has set up a new legal entity and project called SONEAN (the first two letters each of social, network and analysis). This has begun to rigorously examine connections between directors at Europe’s largest companies, as well as developing new methodologies and processes, he says. It aims to extend further to cover regions such as Asia and the Middle East. “We are tracing back thousands of directors’ social network capital to see what and where they studied, who else they have worked for, which governments and NGOs they have advised,” he explains. An analysis of their multiple ties and how it affects organisational outcomes will follow.

It’s a challenging task but Funds@Work boasts experience in the unique area, having connected data on networks between thousands of institutional investors, asset managers and consultants since 2002. SONEAN already offers several tailored services, but the team behind Unal is striving to develop its corporate-ecosystem database further to make investor portfolio screening of social networks possible for the very first time.

Technology makes this the perfect time to attempt such a bold project, Unal says, with online social media allowing additional insights. He reckons the success of social media platforms like Facebook and Twitter is also making investors more aware of social networking, even if he says these sites are just a fraction of his sources. “When we published our first analyses in 2008, a lot of people struggled to understand the concept of social networks, let alone analysis,” he says, “but awareness is growing rapidly.”

Network impact on portfolios

Despite investors requiring “a whole new mindset”, Unal is confident that they will share his vision on the need to analyse social networks. He argues that the environmental, social and governance movement flourished in the wake of the Enron scandal of 2001, yet can be “inadequate” at discovering personal conflicts of interest before they compromise performance. “A social-network view can fill that transparency vacuum and allow for better corporate governance too,” he says.

Social network analysis can also reduce the disadvantage of remoteness in a globalised investment industry, according to Unal. “If you are an investor from Singapore with exposure to dozens of European companies, you might find it useful to discover what kind of networks are having an impact on your portfolio,” he argues.

While the precise impact of social networks is a complex issue, a portfolio screening would likely lead to an investor overweighting ideal companies. These would likely have directors with a diverse set of ties to different social spheres in various parts of the world. “Say, for example, the network heterogeneity of the company in which you are going to invest is much higher than its peers, this is clearly an indication for greater innovation potential,” Unal says.

“More research needs also to be done from our side on the performance effects of interconnections at board level, but that is exactly why we set up SONEAN. We really want to equip investors with a whole new toolset so they can ask smarter questions and look beyond financial data to the human element of business,” he says.

Part of the whole

Not only looking at companies in isolation and focusing on financial and ESG data, but also considering the embeddedness of corporate executives will provide new insights helping investors to better explain why people act the way they do, according to Unal. Identifying the overall network of players will allow investors to spot central actors, network clusters and many more structural features of the network that might impact on performance.

Unal is under no illusions about the scale of his team’s pioneering ambitions, but with colleagues who match his academic expertise in social network analysis, he feels the time is ripe to bring the concept into investment strategies. “We have to define an entirely new market, but we would love to leave a small legacy in making investors aware of the power of social networks,” he says. “After all, what more is an organisation than an embodiment of all its people?”

Deficit and underfunding at the £6.7-billion ($10.4-billion) pension fund for employees of United Kingdom retailer Marks and Spencer had long weighed down one of the high street’s best known names. But a sustained, conservative investment strategy characterised by a “keen focus on risk management” and “an understanding of the scheme’s liabilities” has helped to turn the M&S scheme around. The fund’s decision to shrink its equity allocation and boost its fixed income portfolio has helped cut the deficit from $2 billion in 2009 to $450 million in March 2012. It has made strategy at the closed defined benefit scheme with around 125,000 members, of which just 14,000 are active, a template for other funds in de-risking mode.

Mixing and matching

In an interview from M&S’s Paddington Basin headquarters in London, Brian Kilpatrick, the head of Marks and Spencer Pension Trust Investments, explains the fund’s liability matching strategy. M&S has portioned 70 per cent of assets to a diversified fixed income allocation that includes investment in global sovereign exposure, a global credit portfolio, a material exposure to gilts as part of its growing liability-driven investment (LDI) strategy and emerging market debt. Here, Kilpatrick is encouraged by the “relative strength” of emerging-economies’ sovereign balance sheets compared with those in the developed world during the financial crisis. In the last year the fund’s best performing mandates have been benchmark-agnostic fixed-income absolute-return strategies.

Kilpatrick explains why not all of the fixed income portfolio is purely matching and the strategy the fund uses to counter this. “Some investments within the allocation have very high matching characteristics like gilts, but other allocations, like sterling corporates, aren’t purely matching because they include a credit-risk premium. When we construct an LDI hedge, we look at the different duration exposures within the fixed income portfolio and then use swaps to plug any gaps, relative to the liability duration at any point across the curve so we get the shape of the hedge where we want it.” Sterling corporate bonds are a good example of this strategy at work, he explains. Their short duration doesn’t match the longer term liabilities of the scheme so the fund uses swaps to “move duration along the curve”.

So far the scheme has hedged the majority of its interest rate and inflation exposure and the LDI strategy will evolve as the scheme continues to de-risk. “We will be opportunistic in our de-risking, de-risking when we are ahead of our journey plan and adding to our gilt portfolio when the trustee considers yields as being attractive,” he says. Explaining the rational behind the strategy, Kilpatrick says, “We have seen some schemes negatively impacted by interest rates falling over the last year or so; the consequent funding level risks can be material. Because we are uncomfortable being exposed to a rewarded risk of this magnitude, we have evolved our LDI portfolio as conditions permitted risk to be reduced.”

De-risking framework

The remainder of the scheme’s assets are portioned to growth investments comprising a 12-per-cent equity allocation, down from 40 per cent in 2006 when Kilpatrick fist joined M&S from the National Association of Pension Funds, where he was investment advisor. The rest is in infrastructure, private equity, hedge funds, property and bespoke opportunistic allocations that were born out of the financial crisis. Exposure to equity markets is largely indexed and the scheme has a dynamic de-risking framework in place, based on agreed funding level de-risking triggers, monitored frequently by the trustee. De-risking trades will be executed when these triggers are hit, but the composition of those trades will depend on respective market conditions when funding-level triggers are reached, Kilpatrick explains.

He says that the scheme’s infrastructure allocation is a mix of low-risk public-finance initiative assets, sought after for their liability-matching and inflation-linkage characteristics, plus more opportunistic allocations in the US. However, it doesn’t include any emerging market infrastructure. Hedge fund exposure includes allocations to two multi-strategy funds of funds and a number of single strategy funds. This includes some “more rewarding” specialised strategies that have focused on picking up distressed assets during the financial crisis and have earned “significant investment returns for the scheme”. Going forward, Kilpatrick says the fund plans to increase its alternatives allocation in private equity and infrastructure. It invests in private equity only via “traditional vehicles”.

Kilpatrick describes the funding level as “integral” to asset allocation at the scheme and the deficit has certainly driven some of the pension fund’s most innovative strategies – none more so than the decision to draw income from a $1.5-billion portion of the company’s property portfolio. Under a property partnership set up in 2007, M&S retains control over the selected properties, however the pension scheme is entitled to receive an annual profit distribution earned through leasing the properties back to M&S. As a result, the M&S Pension Scheme was able to recognize the fair value of these future income streams as an asset in its accounts, leading to an improvement in its funding position.

Marks and Spencer’s large diversified fixed income portfolio contrasts with other UK corporate pension schemes, which still tend to have big equity allocations. For Kilpatrick, it’s the safest strategy to steadily de-risk. “We know the return above gilts we need to meet our glide path,” he says.

 

Sustainable investing may be an activity that increasing numbers of investors want to get involved in, but for Germany’s Deutsche Bundesstiftung Umwelt (DBU) or federal environmental foundation, it has long been an integral part of its mission.

That approach makes sense in at a foundation set up in the early 1990s to use the proceeds of German steel giant Salzgitter’s privatisation to fund green projects around the country. Michael Dittrich, who oversees investments at the €2-billion ($2.6-billion) foundation, says a sustainable investment strategy was launched in 2004 as “it is important that our asset strategy does not contradict the good work of the projects we finance”.

Dittrich adds with a definite touch of pragmatism, “It was also a question of public reputation for us”. Intriguingly, he does not buy into the idea that a sustainable strategy is likely to see an investor outperform an average portfolio. “What we aim for, and what we achieve, is that our sustainable approach does not place us at a disadvantage in generating returns,” Dittrich says.

That assessment is no mere hunch, with DBU playing its own part in the development of the sustainable movement by commissioning studies into the impact on returns. Dittrich is convinced that the principal disadvantage and advantage of sustainable investing effectively cancel each other out – the limits of having a reduced investment universe, but the boon of avoiding the risks associated with unsustainable investments. He cites the kind of impact on BP shareholders following the Deepwater Horizon oil spill as a scenario that a sustainable approach can steer an investor away from.

“Essentially we feel we can get the same kind of returns, but we have the added bonus of having a sustainable strategy,” says Dittrich.

80-per-cent rule

The DBU’s sustainable focus hinges on the simple principal of making sure 80 per cent of equities and 80 per cent of corporate bonds are invested in firms listed on sustainable indices such as FTSE4Good. That has not changed since the strategy was launched in 2004, but Dittrich reflects that the sustainable movement has developed tremendously in the same period.

Back in 2004, there was very little focus on sustainable matters from the world’s biggest investors, he feels, but it has since become a much broader movement with a wider variety of supporters. Despite the increase in interest, he feels that “sustainable investing remains a niche movement”. Nonetheless, Dittrich is sure it has had an influence on corporate culture. “It isn’t possible for a company to be successful in the long term with a business model that the public doesn’t accept.”

While the development of sustainable investing has seen the debate spread to new areas such as sovereign debt assets and shareholder democracy, Dittrich feels it is impossible for most sustainable investors to analyse or act on each discussion point in full detail. That is due to the restrictions that sustainable investors face, he argues. “Sustainable investing requires extra resources and each individual investor has to decide how much they can commit for it,” he says.

Dittrich explains that the handful of investment staff at DBU’s office in Osnabruck, a picturesque city in Lower Saxony, are not able to screen every company the foundation invests in without the help of external rating agencies. Nor are they able to always make use of DBU’s shareholder vote. Being a large foundation with a good reputation can help in its engagement efforts, Dittrich says, but the foundation lacks the assets to give it the same kind of clout or resource base that Germany’s big insurers can enjoy.

DBU does run a blacklist of firms it shuns in common with most sustainable investors, but Dittrich says it is rather small, with the arms industry being the only sector completely avoided on principle.

Taking the direct route

When it comes to DBU’s asset structure, its sustainable credentials are less of an influence than its preference to invest directly as much as possible on cost grounds.

The foundation continues to shun alternatives. “We don’t have any alternative asset classes as we concentrate on those assets we feel most comfortable with as a director investor,” Dittrich says.

There will also be no space for any alternatives as long as the foundation’s asset management guidelines remain unchanged. They currently outline a 73.5-per-cent allocation to fixed income, 21.5 per cent to equities and 5 per cent to real estate.

Dittrich feels that this traditional-looking approach still offers the foundation space to diversify by investing across the spectrum in each of the asset classes. In the fixed income space, it counts covered bonds, and tiers one and two capital among its holdings.

So far, the structure has proved flexible enough to react to a low-yield era in government bonds. The foundation’s exposure to government debt has been reduced from 20 per cent to 6.5 per cent over five years as positions have been allowed to mature. Corporate bonds have been up-weighted as a result, but Dittrich admits low yields on highly rated corporate debt is now becoming problematic too.

An intense European focus – at least 90 to 95 per cent of the assets – has resulted from DBU’s wish to keep investment operations in house. “We don’t have the resources to look at global equity markets,” he adds. The foundation therefore focuses on EuroStoxx 50 and DAX 30 for its equity picks. This approach paid handsomely in the last decade and, despite the euro crisis, the foundation is happy to stick to this position for now.

Where the asset allocation most obviously takes a sustainable flavor is in a 1.5-per-cent allocation to microfinance. The revolutionary funding model popular in the developing world has impressed Dittrich on visits to India, despite some criticism in recent years. “Microfinance seems a great way to help poor people and to help develop their countries,” he says. It also offers returns comparable to equivalent asset classes such as emerging-market corporate debt, he reckons.

The DBU booked an overall return of 17.2 per cent in 2012 as bond prices rocketed with yields lowering and the German equity market thrived. That easily outstrips a performance target that the foundation has set to cover grants and ensure assets grow in real terms – around 4 per cent in total. Dittrich says there is a very good reason the foundation remains cautious though. “We have a lot of bonds that we are not interested in selling, so cash flow and yields are more important than performance for us.” That cash also can be used for the foundation’s grants, and thereby put the good work of DBU’s asset strategy into practice by boosting Germany’s internationally renowned environmental effort.

Renowned academic Ashby Monk said the best way to lure talent to US public sector retirement funds unable to pay Wall Street salaries was to hire the green, the grey or the grounded.

With a 30-year career spanning business, government and media, Theresa Whitmarsh, executive director of the $92.1-billion Washington State Investment Board (WSIB) laughs that her experience could count for the odd grey hair.

But it is a grounding and desire to give back in an area where she has lived for the last 23 years that she says best characterises her loyalty to WSIB, investment manager for 17 retirement plans for Washington State’s public employees from teachers to judges.

After joining in 2003 as chief operating officer, she now heads a fund that is unusual among its peers on several counts: it is one of only four US public sector funds that is funded at 95 per cent or more, and a quarter of its total assets under management are invested in private equity.

Capitalising on an accident

It’s a 25-per-cent allocation, drawing on relationships with over 100 managers, which Whitmarsh attributes as much to “an accident of history” as anything else. The program began with the fund’s first foray into the asset class in 1981 and the subsequent growth of expertise in the strategy led to confidence by the WSIB in an increased exposure.

The portfolio has now built a momentum of its own.

“Because we have three decades of expertise, we believe we have something of a competitive advantage, including both access to the best funds, that perhaps new entrants wouldn’t have, and access to larger allocations in the best partners because we are a preferred investor,” she says. The private equity portfolio has generated $15.8 billion in profits since its inception.

It’s a track record that lends perspective when faced with lacklustre short-term returns.

The portfolio’s 10-year return net of fees was 13.54 per cent, but five-year returns come in at 3.82 per cent and three-year returns at 12.68 per cent.

Whitmarsh attributes the short-term underperformance to private equity lagging public markets, which roared back to life last year. She says WSIB pursues a long-horizon strategy and stays the course through market cycles, though it does make tactical moves such as underweighting Europe and concentrating European allocations to Germany and the Nordic economies during the euro crisis.

More recently the fund sees real opportunity in the energy sector.

“We are putting more money to work here,” she says.

Investing mostly through limited partnerships, WSIB also has a co-investment program with manager Fisher Lynch. Because its limited partnerships span sectors, strategies and geographies, all co-investments are evaluated so as not to trigger concentration risk.

“Our co-investment program has grown but it is not as large as we originally thought,” she says.

Believing in equity risk premium

The public equity allocation accounts for 37 per cent of assets under management at WSIB and returned 11.58 per cent over the last year.

Allocations to domestic and international equity are in low-cost, broad-based passive index funds, with active emerging market and global mandates. The board is mid-way through reviewing its asset allocations, but Witmarsh only expects minor adjustments in the equity allocation.

“The Board believes in equity risk premium,” she says. The fund’s aversion to active equity management, accept these emerging markets and global mandates, partly explains why it doesn’t have any allocation to hedge funds.

“Most hedge fund strategies are active equity with private equity fees. We think it is really hard to consistently outperform passive equity.”

The fact that illiquid allocations already account for 40 per cent of the portfolio also explains why WSIB has neither room nor appetite for hedge funds, she says.

The Board’s 20-per-cent active fixed income allocation is designed to bring diversity and liquidity.

Although Whitmarsh acknowledges rising interest rates as a “concern”, she believes the fund is well positioned to weather expected rates rises.

One of the reasons is the track record of the fund’s 10-strong internal investment team. It has significantly outperformed the benchmark Barclays Universal Index every year for the last 10 years, something she describes as “very hard to do”. During the five years ending March 2013, fixed income was the best performing asset class in the whole WSIB portfolio.

Still defining the investment model

The fund’s 13.8-per-cent allocation to diversified real estate encompasses different geographies, properties and mangers with particular investment styles.

The focus is particularly on privately held properties leased to third parties. A tangible asset portfolio, begun in 2008, only has a 2.5-per-cent allocation despite its 5-per-cent target. The reason for the portfolio’s slow start reflects the fund’s careful approach, says Whitmarsh.

“Finding the good fund managers takes a lot of sorting and we are still defining our investing model,” she says adding that the tangible team is now three strong with two more hires in the pipeline.

“Good investment ideas draw capital, but so do bad ones. When it comes to investing, there is sometimes a first-mover disadvantage.”

Fully funded, WSIB has exceeded its rate of return every year since inception.

It currently has a state legislature-set assumed rate of return of 7.9 per cent, but this will be adjusted down to 7.5 per cent in line with the fund’s latest capital market assumptions. It’s indicative of the state’s flexibility and willingness “to put more money on the table” to meet contributions when economic conditions tighten, says Whitmarsh.

“There have been times when returns have been so great the legislature has been able to take a holiday.

Other times, in tougher economic conditions, it has guaranteed adequate contributions.”

Other signs of the proactive policy to manage funding levels include introducing new defined contribution retirement plans 10 years ago, something other public US funds are only now looking at. It’s a funding strategy that has helped give Whitmarsh and her team the freedom to hone an investment strategy focused on growth and the “real pleasure” of delivering superior returns for beneficiaries.

What is the optimum size for an institutional investor? This is a question foremost in the mind of Jim Christensen, chief investment officer of TelstraSuper, the pension scheme of Australian telecommunications company Telstra. After four years of expansion, he believes he has maximised potential by gaining the optimum level of inhouse investment. Now running 20 to 25 per cent of assets internally for domestic equities, fixed income, cash and property, he is stopping there and says that it is unlikely to change in the near term – if anything, it might decrease.

“Where we are now I would say is the right size. We could scale things up a bit further, but you start getting governance questions, like in Aussie equities: if you are running a quarter internally it is hard to justify taking it to 50 per cent when there is a reasonable number of capable managers in the Australian market.” He also believes $13 billion of assets is a size that enables a fund to afford good governance, to spot market opportunities and be nimble enough to seize them.

“If we were to triple in size, we would have to think about how we cut the cloth. Our size is big enough to be meaningful, but we can still do things that have an impact on the bottom line. A $100-to- $200-million investment does matter; it’s roughly 1 per cent or 2 in terms of the whole fund.”

He adds that it becomes more challenging to add value, particularly in the domestic asset classes as the fund grows.

“It’s very hard once you get to $50-70 billion. If you hire 20 managers, and some are over and some are underweight stocks in the Australian market, they cancel each other out. Even with seven or eight managers you struggle with getting enough active risk in the portfolio to meet your return objectives.”

Size awareness

Having worked in larger organisations, he is also a believer that there are benefits to smaller investors. He contrasts the 15-member team he has now with the 100 or so-member active management team he ran at QIC up until four years ago.

“When you have big teams they can become quite territorial, so it is quite good to have everyone sitting around the table at our weekly meetings and talking about the world and what they are doing, how they can improve things. It is quite refreshing. It makes people focus more on the bottom line of the overall fund.”

The virtue of a smallish team running internal and external mandates is not just in the overall savings on fees, but also in the creation of experience that allows smarter management of external mandates.

A key win he sees as coming from managing property in house and having external mandates.

“If you have got a guy who has done some buying and selling of direct investments, then he knows how he can negotiate with the managers to get more transparency on the fees and more control. Whereas if you have got someone who has never negotiated these things, they are likely to hand the manager a cheque and hope for the best.”

Inhouse investment saves around 10 to 15 basis points for TelstraSuper – “enough to take the edge off things”, says Christensen – and this all adds to the fund’s aim for above average or, at the very least, average performance. The edge is also taken off through running a tight ship on active fees and being successful in the choice of managers. Its active managers have outperformed more often than not, he says, with both the Australian equities and international equities funds ranked in the top quartile over long time periods.

He reckons TelstraSuper is achieving about 1 per cent more than average superannuation funds over the long term and this performance has been reassuring for members, particularly for those that might consider a self-managed super fund. There are road shows for members with balances over $300,000 and the message to those with, say, $500,000 was it would have achieved $1 million in the past 10 years with average growth, but with TelstraSuper’s level of outperformance it would be worth $1.1 million.

Defensive and retirement funds

TelstraSuper has innovated for those approaching retirement with high balances by creating a fund called Defensive Growth. This has a bias towards income and quality – Telstra stock, admits Christensen, could be in the fund – to the extent that it is targeting about three quarters of the return from income and only a quarter from capital gains. Equities, property and infrastructure feature heavily. The fund was not supposed to shoot the lights out, but ironically, says Christensen, it has done “tremendously well, because the whole world wants to own those assets right now”.

Another defensive fund is Diversified Income, launched a year ago, which is aimed at those in retirement and will pay an income or pension derived from dividends and coupons. It too has done well in current markets, despite the initial warning to members that it will only produce a coupleof- per-cent growth along with income of 5 to 6 per cent. It is designed to give transparency about what assets are earning, whereas usually investors are only given the unit price of a pool of assets to follow.

It also discourages the joy and pain that comes from following a unit price and the irrational decisions this can prompt.

“In periods of stress, if a fund’s value falls quite a way, members might look at their balances and say, ‘Hang on! I’m drawing $50,000 a year. If I keep pulling out money at this rate, I will have none left’. So the response then is to change from growth or a balanced option into cash and then they sit there and when the market goes up, they say. ‘I was a fool’ and will jump back in in time to get whip-sawed.”

The fund also has the option to return some income when the payouts are above average.

“So what we are saying to them is there will be times when you will see your price come down, but as long as you don’t sell any of the stuff, hopefully it will keep producing income. As far as we are aware no one is paying out income in a fund like this, everyone else just gives you a unit price.”