Cbus - A strategy to mitigate risks
The building and construction industries have changed dramatically over the past 30 years and so has Cbus, the A$19bn ($19.6bn)-plus super which caters to the retirement needs of the sector. Established in 1984 and with a strong track record of investment returns, the Australian fund nonetheless undertook a review over the past two years which has led to a fundamental overhaul of its investment beliefs, objectives, strategies and governance.
The man tasked with leading the shift was Kristian Fok, who was appointed the fund’s executive manager for investment strategy in December 2012 after advising the fund as an asset consultant for some 15 years. He says Cbus’ investment committee “stepped back and asked the question: Do they have the right resources, the right investment structures in place at the fund – not just for today, but what it needs to be in 5-10 years time?”
The Australian retirement industry has been tackling several major pieces of new regulation, centred on the introduction of low-cost MySuper default retirement products, while absorbing the lessons from the global financial crisis.
For Cbus, a key outcome was to stop ranking its performance against other funds (it had previously attempted to outperform the median manager and aim for the upper quartile in performance tables) and instead focus on its primary objective: to outperform the rate of inflation by 3.5% over rolling five-year periods.
“We shouldn’t be focusing so much, particularly over the short and medium term, about what others are doing if it’s going to adversely impact the investment outcome,” Fok says of the fund, which is also a major investor in the property sector. “We know that if we get very strong equity market performance we’re likely to underperform others; likewise if there’s a pullback in equity markets we should actually do relatively well.”
Tied to that goal is a newly-acquired heightened focus on managing investment downside risk and, in particular, the ability to recover from losses over reasonable periods. The fund estimates that negative annual returns are likely to occur every one in eight years (or 2.5 in 20 years).
It is an outcome partly driven by the way investors reacted to the negative impact the GFC had on their retirement savings. “It’s being quite sensitive to the way our investors have reacted to volatility in the market… we don’t get a lot of switching between various investment options but we’re still seeing more than we have in the past when markets fall: members actually go to the more conservative options.”
Cbus’ investment strategy is now more flexible, allowing it to take advantage of changes in market conditions, Fok says. Cbus’ default growth investment option, which caters to the bulk of its 700,000-plus members, delivered an annualised 7.86% return over the 10 years ended 31 March 2013 and 3.51% over the five-year period. The median fund posted a slightly lower 7.2% and 3.2% over the same respective periods, according to research house SuperRatings.
Australian shares comprised the largest component of the fund’s portfolio (31.5%) at 30 June 30 2012, followed by alternative assets (22.5%), international equities (20.4%), property (15.1%), fixed interest (6.7%) and cash (3.8%).
Fok says the fund has made a number of changes since then which reflect its new philosophy.
“One of the earliest things we did was increase the allocation to credit because it has a relative attractiveness in relation to recovery from losses,” he says, “although since that time that opportunity has probably diminished.”
He says that quantitative easing around the world, and associated risk-free interest rates, has reduced the return profile of riskier asset classes. “It creates an interesting dilemma because those asset classes in normal circumstances you would probably say are overvalued relative to where else you can put the money and also given an understanding as to why investors are motivated to bid up prices. At the moment there are still asset classes where we can invest in where it makes sense, achieving our long-term objectives.”
Australian equities have become less attractive this year after a bull run largely built on an expected rebound in corporate earnings, which has yet to occur. “Equities generally are not the same attractive proposition that they were this time last year so we have been reducing our allocation as the market has risen and building up a bit of cash.”
Property investing has always been a focus for Cbus. The fund manages approximately A$1.4bn of its property portfolio in-house via CBus Property and also has a similar level invested via externally-managed pooled property vehicles. Over the five-year period ended 30 June 2012, Cbus Property averaged a healthy 10.7% return each year and it holds several commercial and residential property developments, largely in Victoria (where Cbus is based) and New South Wales.
There is an inherent risk to heavily investing in a sector which also employs the bulk of the fund’s members – if there is a property downturn members can lose their jobs while simultaneously watching their retirement savings decline. Australian funds are legislatively required to justify their investments based on expected returns rather than other factors, such as employment benefits for members. However, Fok says managing such a large proportion of its property exposure in-house via Cbus Property is a strategy which effectively mitigates that risk.
“One of the advantages of having your own subsidiary is that if you think that it’s not appropriate to have as much property from time to time – if valuations become excessive – then we can actually choose to sell. And there is an advantage there because not only does that help protect returns but we have an arrangement where any capital that gets returned on the sale of assets can be reinvested at a future time. So effectively we then have money available when markets go down, to then go back and repurchase assets and construct buildings at a time when there’s less competition.”
Property is an area where the fund believes it has a competitive advantage – one that it is also hoping to transfer to the infrastructure sector where it is becoming more active with other funds by setting up co-investments to target large assets. “If they happen to have compelling returns that consist with the target then we’ll look to invest.”
In April, Cbus formed part of a major consortium of Australian and international investors which committed A$5.07bn to acquire a 99-year lease over New South Wales’ Port Botany and Port Kembla. The strong valuation was surprising given the facilities which owned those ports, Sydney Ports Corp, and the smaller Port Kembla Port Corporation, posted net profits of just A$73.5m and A$17m respectively in 2010-11.
Fok declined to talk specifically about those assets but gave some insight into the fund’s analysis of such long-term infrastructure assets, noting that it had recently sold down a more highly-geared offshore-based infrastructure asset. “One of the things that we’re concerned about – or conscious of – is recovery from loss. So if we have two assets that are pretty attractive in the asset class itself but one has a lot of leverage and the other one has lower leverage – it’s geared to certain outcomes (in this case, the ports are geared to New South Wales’ state growth) but lower gearing, then we look at what happens to the asset if things go wrong – and the one with lower gearing has more robustness.”
Such co-investments bring greater transparency and more control over governance for the fund and Fok says it is also eyeing up other co-investments. The bulk of Cbus’ infrastructure investments in the past were made through a related company, Industry Funds Management, as well as Hastings Funds Management and AMP Capital. Those investments were predominantly focused on energy and airport assets, as well as water, roads, ports, social infrastructure and telecommunications. The fund’s default growth option had a target asset allocation of 11% to infrastructure at 30 June 2012 when its largest investment was in alternative energy company Pacific Hydro (a 13.8% stake, which was also Cbus’ fourth biggest investment in its entire portfolio).
The fund’s long-term asset allocation to alternative strategies, which includes private equity, hedge funds and long duration-type credit, is 10%. However, private equity is an asset class under review, with Cbus’ previous fund-of-funds approach set to be wound back. “We are going to move away from that except in very specific circumstances where it’s very hard to do it directed.”
Instead, Fok says the fund now has a preference for direct mandates (it has a major mandate with Macquarie) which gives the fund more transparency and control. “Through the mandate we can actually look at whether we think we’re that comfortable allocating capital given the environment going ahead – we can reduce the allocation on it.”
He says the fund will opportunistically look at hedge fund managers – in fact, as traditional investment opportunities dry up there may be a greater emphasis on the sector. “But again fees and transparency are more of a hurdle in that asset class – we are certainly open to investing in it.”
Cbus has a hedge fund investment with Bridgewater Associates although Fok says it does not constitute a large, diversified programme. With a more active investment strategy in place, Cbus has created a more robust investment team structure.
When Fok joined the fund, the investment team was re-structured to include an investment manager of strategy and an investment manager for environmental, social and governance (ESG). Cbus’ focus on incorporating such factors into its investment process recently saw it recognised by research house SuperRatings as one of 15 Australian funds to excel in the area.
Two new Cbus investment roles were also created: an investment manager of private markets and an investment manager of public markets, as well as some analyst roles. “A predominant focus of that will be getting better information for asset allocation decisions and also working very closely with our managers to collaborate around ideas and get the best performance out of the portfolio.”
Fok also says the investment team is prepared to take a more long-term outlook when awarding investment mandates than in the past. “Maybe it actually takes a little longer to achieve the outcome but that patience is rewarded.”
Potential future changes at the fund also include beefing up resources to allow more efficient implementation around asset allocation decisions, such as using futures and derivatives, as well as boosting resources to allow better transition of mandates. “If you’ve got big transitions, it doesn’t make sense to fully outsource everything – maybe there are some skills in-house that will make it harder for the market to predict what you’re doing.”
While property and infrastructure both remain major asset classes where the fund expects to continue as a direct investor, it has no plans to bring equities management in-house as rival industry funds AustralianSuper and UniSuper have done. “If we can work with our managers to get economic terms that are not too much different too the alternative of taking it in-house, we think there’s a lot of merit in working with the managers in the first instance.”
The annual fees charged by Cbus’ default growth investment option fell to 0.78% in 2011-12 from 0.83% the previous year, reflecting its maturing private equity programme and a fall in infrastructure and property costs. It was also approved as a default MySuper fund by the government in February, with the fund able to rely on its long-running investment review and overhaul of a way to prove the appropriateness of the strategy.
Other regulatory-influenced changes at the fund include the roll-out of the nextGEN programme, which comprises several technology and improvement programs, including the spRIGHT administration system. Cbus is a part-owner of its administrator, Superpartners, which has spent more than A$40m on the project, which will help the fund meet new requirements for electronic payment of contributions and rollovers.
The fund is also in the midst of an open market evaluation of its custodial arrangements, which have been overseen by National Australia Bank Asset Servicing since 1993. It expects to make a final decision early in the 2013-14 financial year.