Australian super funds may have just posted their strongest annual investment returns in more than a decade but, for Vision Super, it is also a sign that equity markets have become fully valued. “It’s now more of a stock pickers market,” says Vision Super’s Manager of Investments Graeme Smith.
In response, the fund has reduced its allocation to enhanced passively managed strategies from about 40% to just 30% of its A$6.2bn ($5.7bn) portfolio. It has been a trend for the fund over a number of years – half of its assets were once passively managed – and also played a contributing factor in scuttling a near merger with VicSuper in June, which would have created a A$16bn-plus fund.
But while both targeted similar members – VicSuper represents most Victorian public servants while Vision Super predominately caters to Australian local government employees – their investment strategies differed. About 80% of VicSuper’s A$10.9bn in assets were passively managed and the two funds could not agree on a joint approach forward despite several months of discussions.
“Certainly everyone recognised we were more culturally aligned but it was too far for them to go and too far for our board to go the opposite way,” Smith says.
Industry consolidation The Australian industry has been consolidating for several years due to increased regulatory and fee pressures. Corporate super funds have declined from over 3,000 to under 122 during the past decade, while industry, retail and public sector funds have all roughly halved in number, according to the Association of Superannuation Funds of Australia.
But mergers prompt an overhaul of investment decisions and Vision Super has also come close to merging with two other funds since 2005: Care Super and Equipsuper, although both discussions fell through.
“No-one wants to really go and make dramatic changes to line-ups and pursue something which might be changed on the merger,” Smith says, noting the fund is now entering a new phase following the VicSuper merger talks and will be reviewing its investment strategy (the fund recommenced its normal annual investment review process after the Equipsuper merger talks ended).
Vision Super is comprised of two sections: the main Local Authorities Superannuation Fund, which also includes a A$1.3bn closed defined benefit plan, and the public offer Vision Superannuation Fund. About 90% of assets are held in the Local Authorities Superannuation Fund.
Keeping ‘balanced growth’ The default investment option for investors is “balanced growth”, which holds about A$2.1bn. The option has 30% allocated to Australian equities and 25% to global equities although Smith says the fund is currently considering raising the international exposure as the US economy begins to recover and the Australian economy, underpinned by a commodities boom which is slowing in line with China, begins to cool.
The Reserve Bank of Australia is expected to cut the official interest rates in August, which are currently at a historic low of 2.5%, in the hope that it will stimulate subdued sectors of the local economy such as housing and retail. Nonetheless, the Australian share market, which is dominated by the resources and financial services sectors, surged 21.9% in 2012-13 while hedged international shares rose 21.3%.
“It’s a realisation that we’ve got a fairly limited index – people say it’s a banking and mining index and it certainly feels like that when you look at the top 20 stocks,” Smith says of the push to increase Vision Super’s global exposure.
The fund has also had about 10% of its balanced growth option in diversified bonds, which it has lowered over the past year, and 5.5% in cash, which it has slightly raised. Smith says the prospects for government bonds around the world are less positive now. “Fixed interest and that yield part presents a problem for most funds: where does it go to in the future? Some sectors in credit look alright but government bonds look challenged.
“We’ve had a 20-year rally there and depending on growth, the prospects for returns from government bonds have to be pretty limited over the medium-to-longer term. Still, over the next year or two, it might be ok but we don’t see that as a big area where we’d earn money from so consequently in terms of returns we’re saying equities and there’s a bit of an adjustment in thinking going on: do we maybe pull back from our rather full allocation to domestic equities? Does that come off a bit, and maybe top up a bit international equities?”
Emerging markets Vision Super is looking towards emerging markets as another opportunity to pursue growth although it has had some difficulty gaining more exposure – it has one emerging markets equity manager (Colonial First State’s Global Emerging Markets Leaders Fund) which is closed to new funds. However, it often gives its global equity managers an ‘all countries’ mandate, which has partially boosted its exposure to the sector.
The remainder of the balanced growth investment option is comprised of infrastructure (10%), direct property (9%), private equity (8%), opportunistic investments (4.5%), which includes property development or non-core property in closed ended funds, and absolute return strategies (2%).
Smith says the fund will probably start winding down its private equity portfolio over the next few years, partially to match the asset profile with the ageing demographics of the fund.
“Our portfolio now is very mature so we’re really in the harvesting stage and we’ll probably wind it down to what we see as more sustainable levels over the next few years… we have quite a mature membership, so we think it’s appropriate that over a period of time that ratchets down on a progressive basis. We don’t see any reason to dispose of those assets especially at the time when you’ve worn the J-curve for four or five years: let’s sit down now and enjoy some of the cash flows that come from it.”
Vision Super has just one absolute return manager (Bridgewater Associates’ Pure Alpha Fund). Smith says it is an area the fund may develop in future although it remains wary of the level of fees given the recent introduction of MySuper – the low-cost default investment product aimed at the majority of the public.
Period of upheaval It has been a particular period of upheaval for the A$1.5tn Australian super industry, which has also been coping with a regulatory overhaul to streamline back office systems and to remove conflicts of interest in the financial advice sector. An industry backlash prompted the Labor government in late-July to pledge that it would make no further major changes to superannuation for five years if it is re-elected later this year – a pledge also matched by the Coalition party which has said it will make adverse changes if it wins the election.
In 2011, Vision Super closed its sustainable premixed options (which mirrored the five mainstream options: conservative, balanced, balanced growth, growth and just shares). The fund instead moved to a more active strategy, encouraging its fund managers to employ sustainable principles when selecting stocks.
“We’re keen to see on appointment that managers are signed up to the UN responsible investment approach and do bring those risks into consideration when they make active decisions about which stocks they go into and really most managers will do that – it’s not always explicit.”
It is a trend across the industry: funds employing an ESG overlay rose from 55% in 2010 to 65% last year while specific sustainable investment options fell from 45% to 34% over the same period, according to research house SuperRatings.
Vision Super also closed its property investment option to new money in 2011 due to concerns about the illiquid nature of those investments when the fund offers daily investment switches. “We felt that was too much of a risk and so we took that out as an option.”
Liquidity remains a concern across the Australian industry, particularly for industry funds which typically hold a greater proportion of infrastructure and direct property. The Australian Prudential Regulation Authority has flagged its concerns about illiquid assets given the impact of market volatility through the global financial crisis (GFC), ongoing mergers between funds and competition (funds must liquidate their assets within 30 days if an investor switches to a rival provider).
The lessons learnt by the industry from the near-collapse of the A$6bn MTAA Super fund – which initially had about half of its assets in unlisted assets – remain strong. MTAA topped the performance tables before the GFC and then plummeted to the bottom as it struggled with liquidity and valuation issues.
Defined benefit option Smith says Vision Super is comfortable with its 9-10% exposure to infrastructure through the balanced growth and defined benefit (DB) options. The fund was a participant in Industry Funds Management’s A$5bn-plus Port Kembla and Port Botany acquisition earlier this year through the IFM Australian Infrastructure Fund. A number of larger industry super funds, such as HOSTPLUS, AustralianSuper, Cbus, and HESTA, also made direct investments. On average, industry funds allocate almost 21% of funds under management to alternative assets and 10-16% to infrastructure – well above the level of commercial retail super funds which invest just one-quarter of that level.
Vision Super’s DB plan was closed in the 1990s but still presents a particular challenge for the fund. DB funds have been phased out of the Australian industry in favour of defined contribution funds over the past few decades although they still account for about 1 in 10 super funds, according to the Reserve Bank of Australia.
The GFC has impacted a number of DB plans, such as UniSuper, and Vision Super has not been unscathed. In January this year, the fund informed local councils that they were required to invest an extra A$2.7m (plus 15% contributions tax) after the fund had accrued a total unfunded liability of A$453m.
However, Smith says a number of local councils have made substantial contributions this year. The DB fund’s position was hurt by two main factors: a downturn in markets and escalating local government salaries (which rose well above the actuarial forecast of 4.5% per year).
“Prior to 2007, the fund was 168% funded – it’s marvellous what a GFC can do to you… combined with that salary growth.”
The DB plan’s assets are managed separately to the accumulation plan and in a more conservative fashion and with lower volatility. For example, it has 45% of its portfolio allocated to equities compared to 51% in the accumulation plan’s balanced growth option.
“Certainly we see perhaps a greater asset allocation to some absolute returns in that area and certainly cash at different times has been a bit higher and bonds but bonds, being part of this cycle where they are at the moment, that becomes a bit difficult. Whether we look at floating rate debt or those types of products, we’ll consider.”
In the wake of the GFC, it has been a strong period of performance for Australian super funds: the past four years have provided an average return of 8.8% a year and the median growth super fund’s 15.6% return in 2012-13 equalled the best performance in the past 16 years, according to research group Chant West.
Vision Super’s balanced growth fund posted a 12.85% return (net of fees and tax) over the 2012-13 financial year and 6.59% a year over the past 10 years. Smith says investors could be in store for a period of more subdued global growth and ongoing volatility across global markets.
“After such a big pullback in markets in 2008-09 and that period, equities have run ahead quite a bit and the discussion seems to be have they run too far? Are earnings going to catch up?”