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UniSuper develops new risk budgeting

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January 2008 - UniSuper is the Australian industry superannuation fund for those working in the higher education and research sectors. The fund has approximately 425,000 members and more than A$24 billion in assets. Management of approximately 94% of the total assets of all the fund’s assets is outsourced to external professional investment managers. All managers are monitored constantly and are generally reviewed in detail at least once a year. The remaining 6% of assets is invested directly by UniSuper in a range of investments that consist predominantly of infrastructure projects. 

Chief investment officer David St. John has been with UniSuper for six and a half years, in which time the fund has seen substantial asset growth and expansion into international markets. Having built a solid process for investing in different asset classes and international markets, St. John says the investment team continues to broaden its horizons. “UniSuper constantly seeks to add alpha in all aspects of the fund’s investment arrangements. We were an early investor in some areas of alternative assets such as infrastructure and private equity and we continue to expand exposure to these assets in a controlled manner.”

The Fund’s exposure within the property and alternative investments asset class is presently biased towards domestic assets, though it is in the process of building its international exposure. Within the Default Balanced Option (which holds the almost 70% of the fund’s assets) the strategic exposure to property, and alternative investments is 10% and 7.5% respectively. The property exposure comprises 7% unlisted property and 3% listed property, while the exposure for alternative investments comprises 4.5% infrastructure and 3% private equity. 

St. John says of the fund’s exposure to private equity, “In the last five years, we have moved away from a domestic focus to international. We deliberated for one or two years and then decided to go ahead, using Altius Associates as our gatekeeper. At the end of 2007 we reached our targeted commitments. As well as meeting our objectives, it is the quality of the manager line-up that is particularly pleasing. Indicative returns are 19% per annum for the past five years, which is very good considering there was a large J curve for us through the early part. The private equity investments are skewed towards buy-out stage positions with smaller managers operating a low degree of leverage. We don’t really work with the mega-managers.”

In addition, the Fund is in the also seeking to identify appropriate opportunities to expand its infrastructure and property portfolios globally. St. John says, “One of our most recent investments is Texas Toll Roads, through Hastings, our infrastructure gatekeeper. We are in the process of appointing a property gatekeeper and will mainly be investing in unlisted pooled products.”

Despite its adoption of alternative strategies, UniSuper has stopped short of investing in hedge funds. St. John comments, “UniSuper is always open to innovative ideas for generating alpha, but does not blindly ‘follow the herd’.” Does he see the hedge fund sector as a trap for the unwary super fund? “There is a bit of ‘me too-ism’ about alternative investments,” he says. “They have become very popular and there’s a lot of talk about hedge funds. We don’t invest in hedge funds and we do have concerns about that particular area of the alternative space. We did our own extensive study three or four years ago, to establish whether we should invest. We decided not to, because we were worried about the lack of transparency, and the fees. We don’t see the evidence to support the investment case. Academic studies have shown that hedge funds shut down at a rate of 20% per annum. And the performance surveys are terribly selective. Returns are sometimes overstated by 6-10%.”

The market turbulence in the second half of 2007 didn’t unduly affect UniSuper’s investments. The international fixed interest asset class managers were not directly exposed to the sub-prime mortgage market, with the exception of a holding in two AAA rated securities, comprising less than 1% of the total international fixed interest portfolio. St. John notes, “The fund’s alternative investments portfolios performed in line with expectations over the period, producing modest, absolute positive returns. This was underpinned by the nature of many of the infrastructure holdings, which produced a steady stream of distributions over the period, together with some modest upward revaluations. However, there has been an indirect wider market impact on the yields for the investment grade and high rated credit MBS.” 

UniSuper draws on a comprehensive internal investment research capability and external sources in an effort to identify investment approaches that may add value for the portfolio. UniSuper has an extensive and ongoing investment research program. St. John says, “We are doing some major work on risk budgeting and we think we have come up with a completely new approach. It’s proprietary information, so at this stage I can’t talk about it, but once we have applied it to our own arrangements, we will consider sharing it. It’s a fascinating area, but sadly often neglected.”

The investment team is also working on a new strategic asset allocation project. UniSuper has a DB scheme and is doing some asset liability modelling. It is working on a tax streamlining operation: “We have 140 managers in our structure, so we need to have systems and processes in place to streamline the tax treatment of all these different entities.”

UniSuper constantly assesses each market separately in terms of whether opportunities exist for alpha generation and structures its portfolios accordingly. The fund currently makes use of a number of quant and enhanced indexed strategies within its investment structure. The most significant of these exists within the international shares asset class where the fund has almost $3b invested in enhanced passive mandates. In addition, enhanced passive management is used in the Australian fixed interest and indexed bonds asset classes.

The enhanced indexing portfolio is split between BGI and State State Global Advisers. “These products have a high information ratio, which is reassuring for a super fund”

UniSuper has a preference for its Australian managers to concentrate on adding value for the Fund in the domestic asset classes.  However, UniSuper has previously appointed managers in the Australian shares asset class which are the local subsidiaries of larger global groups where it considered the manager has the requisite capabilities. St. John says, “We are happy to work with active managers, but only where we are comfortable with their ability of generate the necessary returns for the fees they are charging.”

UniSuper targets international managers with global coverage and which are well resourced.  St John says the investment team has a strong knowledge of most international fund management groups and has undertaken extensive research to assess each manager’s capabilities.  Research is undertaken internally and UniSuper does not rely on any published opinions.

Socially responsible investment has been available to UniSuper members for the past five years, latterly under the ‘socially responsible high growth’ option. In January, members will be offered a new socially responsible balanced option, with 70% invested in growth assets. The scheme appoints fund managers to select investments for its socially responsible investment options.  These managers take a ‘best of sector’ approach (i.e. they select companies that rate relatively higher than other companies in the same industry on the basis of sustainability criteria). Their assessments take into account environmental, social and economic considerations. Performance returns of socially responsible managers are benchmarked against standard market indices (e.g. S&P/ASX 300 Index).  

The managers are now looking at adding alternative investments such as timber and water filtration plays. St. John says he expects the SRI idea to increase rapidly with the balanced option, which will appeal to a wide range of scheme members.

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