An identifiable trend has been for Australian superannuation funds to consolidate the number of managers in their portfolios, splitting the alpha and beta between managers in an environment where there’s pressure on the industry to keep fees low especially following reduced performance due to the global financial crisis. This has impacted directly on manager selection.
Passive investment management tracking the index is back in style in a fee-conscious environment, and if the MySuper proposals put forward in the Cooper review were to go ahead this would create an even bigger boost for passive managers. Concerns have been raised about the impact on innovation, and potentially even the impact on the macro economy should a large portion of the market move to passive management. And on the question of alpha, there is a realisation that super funds need to have experienced managers to find and manage alpha.
REST chief executive Damian Hill says “We see the market environment going forward continuing to be volatile. In that type of situation, we believe that you will want to use managers with strong fundamental research skills that feed into stock picking, rather than just receive the benchmark return. Certainly, there is a focus on due diligence post the GFC, but we retain an active management philosophy, and continue to fund a number of new mandates, some of which continue to be with boutiques.”
Sam Sicilia, chief investment officer of Hostplus, the $7 billion hospitality industry superannuation fund, points out there are other ways to exercise downward pressure on investment manager fees. “Obviously we are very interested in fees. Fees matter, but you can’t just throw the baby out with the bathwater and say we have to go passive.”
The move to cash
The global financial crisis caught the superannuation sector by surprise. Many super funds experienced waves of members moving to cash. Super funds were forced in some cases to monitor cash reserves on a daily basis, with new cash flow being held rather than otherwise allocated. Although the dramas of the GFC have subsided, many super funds have increased their allocations to cash in order to have a greater buffer against further shocks. The demographics of funds themselves are becoming important as members move into retirement. There are bound to be implications for fund returns over coming years. The ensuing market volatility could continue to impact on investment choices by members.
Investment volatility however does not seem to have impacted too heavily on members’ actions in relation to moving their super, potentially due to the broad level of member disengagement with superannuation generally. Some funds experienced moves into cash and some members have delayed retirement decisions as they saw their superannuation account balances heavily impacted by the fall in values following the GFC.
Sam Sicilia points out there was almost no switch to cash in Hostplus, the fund being a fund of predominantly young members. “Out of a $7 billion fund, we had only $200 million move. We’ve got younger members and it’s mainly older members that get more panicked about market fluctuations and move their money. But it’s always a case that timing the market is dangerous. It’s a bad habit to get into.”
It was a similar case at the REST super fund. “REST only saw a small increase in moves to cash during the crisis,” says Damian Hill. “The response by members was very fund specific. The factors that were most influential were the demographics of the particular fund and hence member engagement, the penetration of financial advice and the concentration risk of worksites. Funds with concentrated worksites were more at risk of a particular worksite moving more conservative.”
AMP’s Director of Wealth Management Products, Andrew Hobern, said there was a similar lack of movement on the financial services company’s $37.2 billion superannuation master trust platform, Flexible Super. “Most members on our platform take advice from a financial planner or follow default options set by the trustee. As a result of that, the amount of cash they went to in the GFC was quite modest. While there have been some moves out of cash since, it was quite subtle, so we’re not seeing massive moves at this point. Because they are coming through financial planners, the members go into investment options that suit their risk profile, so this is typically into a balanced option. There’s a full range of options, but most of it goes into a balanced or growth orientated strategy. Most members are not trying to time the market.”
What the funds also agree on is that there continues to be interest in alternative investments. Industry funds are increasingly looking to invest and will need to build the skills to do so. Hill says “REST has for a long-time been an investor in various alternative assets such as infrastructure, agriculture, and absolute return funds. We don’t see that diminishing in the medium term. During the crisis, we made a significant allocation to credit.” In April 2010, the Australian reserve fund, the Future Fund said, “We have continued to build our infrastructure and property sectors as well as increasing investments in the alternatives category through a diversified exposure to absolute return strategies.”
The area that is attracting much interest from pension funds is emerging markets. The Future Fund signed up a group of emerging market managers as parts of its portfolio and AMP’s Andrew Hobern confirms interest amongst members on AMP’s platforms. REST’s Damian Hill said “We have been a long-term investor in emerging markets. This has primarily been accessed through global equity mandates, though we do have two mandates, one of which is in emerging markets and the other in Asia ex-Japan.” Hostplus also has two emerging markets investment managers and is adding a third. The fund is also exposed to the emerging markets alternative asset class, through its investments in listed companies like BHP which operate and generate income in Asian emerging markets.
AustralianSuper has stated that it is reviewing opportunities to invest in assets that sit outside what might be regarded as ‘traditional’ superannuation fund investments including considering but not pursuing investments in gold, timber plantations and some more speculative investment strategies offered by absolute return managers. Seeking to add diversity to its portfolio AustralianSuper committed $40 million to sustainable agriculture and $200 million to unlisted debt financing.
Boutiques Under Pressure
The focus on costs by super funds has also led to pressure on boutique investment managers. The Australian funds management industry has produced a plethora of small boutique investment managers and there is now a question as to whether all will survive. Many industry funds are moving to a smaller number of mandates whilst the retail master trusts are looking to make sure that their platforms of fund managers contribute to the bottom line.
This aspect is receiving more attention from super funds as funds try to improve performance post-GFC. Holding lots of managers takes time, especially in these days of heightened due diligence, post GFC. Principal of research house Chant West, Warren Chant, says, “Each manager has to be looked at, no matter the size of the mandate they’ve been given. So that takes resources. But I think we’re using a healthy number of managers now.”
AMP’s Director of Wealth Management Products, Andrew Hobern was also of the view that there was not going to be a great cull of managers. Talking about AMP’s $37 billion Flexible Super master trust, he said, “We have 72 investment options on the platform and on a continual basis we review which options we should have on the platform. We don’t want to vary outside of 60-80 managers.”
In a performance and fee-conscious environment, funds are also openly more determined to drive a better bargain with investment managers. “The gap between active management fees and passive management fees - you can find the middle ground,” Sam Sicilia, Chief Investment Officer of the $7 billion industry fund Hostplus said. “You can say to active managers: ‘I am no longer prepared to pay 100 or 120 basis points for your services; I’m going to pay 80, or 60.’ In addition to that, you could ask: ‘What does it cost you to run your business - costs such as staff, electricity, rent, travel, other costs? Let’s make sure you’ve got enough money to remain in business and let’s put in an incentive plan so that we can share in the outperformance, because ultimately, you’re using my (the fund’s) money to make money, so we’re going to share the upside.’”
“A superannuation fund ought to be prepared to pay for skill,” Sicilia said, “but that doesn’t mean you pay today’s rates and that doesn’t mean you pay passive rates. Passive rates could still be less than what they are today. Ultimately, downward fee pressure affects everything. At the other end of the scale, you have unlisted assets like infrastructure, roads, private equity; these have other costs like legal, tax, commercial opinions. Someone’s got to pay for all of that.”
“So there is an element of realism that fund’s accept about the costs involved in investments, including the entry costs for unlisted assets, for instance.” Sicilia said. “There are ways to get these, unlisted asset, costs down too, and the way to do it is to get four or five super funds together to each get a slice of the asset. The other thing we say to fund managers accustomed to the ‘1 and 20’ model or the ‘2 and 20’ model, is we say ‘No, we are no longer doing that’ and wait to see how many go out of business, shut up shop and go off to sell something else. Not many of them do so. So, we have to find the common ground: enough incentive for them to stay in business, but always recognising that they are working for the fund, because ultimately the money belongs to our fund members.”
In an environment where funds are necessarily so conscious of their members’ returns and are looking at ways to reduce or keep fees and costs to members low, all of this will continue to impact on the position of investment managers in the market, including those currently holding mandates and those trying to win them, and will reshape Australia’s pension system landscape.
Damian Hill points out that for the latter trying to win mandates, excess capacity in funds could also be a problem. “In respect to a reduction in funds of boutiques, this may be a result of the valuation effect. Funds have managers with still significant capacity as a result of the fall in listed markets which have only partially recovered. There is not generally a need therefore for new mandates, depending on a fund’s cash flow. It could also be related to the general build up in cash in portfolios.”