Australia’s A$35bn ($35.8bn) UniSuper has been one of the country’s strongest performing pension funds in recent times although the fund’s administration has not been without controversy.
UniSuper, which caters to the higher education sector, spent much of the last few years weighing up a number of options for its defined benefit (DB) plan - which controversially included shifting members to its accumulation (or defined contribution) division - as the global financial crisis undercut valuations. However, the worst appears to have now passed as markets have strengthened.
UniSuper Chief Investment Officer John Pearce has overseen the strong performance and a number of strategic changes since joining the fund in 2009. “Valuation is everything - that’s a guiding principle but that doesn’t mean we’re value managers or growth managers.
“I don’t really believe in those sorts of labels. But ultimately, if you pay more for an asset than what it’s worth you’re probably going to lose money; if you pay less you’re probably going to make money - it’s pretty simple.”
Over the financial year to 31 Jan. 2013, the fund’s accumulation balanced option returned an impressive 12.64%. Over the seven-year period, it returned an annualised 5.07% a year.
Managing the DB assets
The accumulation division accounts for about 60% of the fund’s total A$35bn assets with the remainder in the defined benefit plan. One of Pearce’s first moves after joining the fund was to separately manage the DB assets in an effort to more accurately meet those predicted liabilities.
“There was probably a little bit of push back at first because it’s not the way we did things but I think everyone saw the logic in it all,” he says. “Once you separated you can actually start making, I believe, sensible investment decisions: what assets are we really looking for here?”
With a liability profile largely tied to wage inflation (and using annual Australian inflation of 3-4% as a proxy), the fund settled on a significant exposure to high-yielding Australian shares. Among its significant Australian share holdings are toll road operator Transurban Group, telecommunications company Telstra, and a number of real estate investment trusts such as GPT Group, CFS Retail Property Group and Westfield Retail Trust.
“Low-beta, blue-chip Aussie equities would be far more prominent in our portfolio than your average portfolio,” Pearce says, although he also points out that it is not an ideological position. While the Australian S&P ASX 200 recently hit a four-and-a-half year high in early-March at around 5100 points, he says “you’d find us doing a lot of de-risking” if the market rose to, say, 6000.
“A lot of those equities would be going down the risk spectrum to de-risk the equity component and assuming the bond market gets to some normality - we would consider the current bond market as abnormal - we potentially take on more fixed interest exposure but sovereign bonds at the moment are just not doing it for us. But that’s dynamic - we could move to a completely different asset allocation depending on where the funding of the portfolio is and market circumstances.”
The DB plan’s accrued benefit index (ABI) has now climbed back over 100 (a fully-funded level) while the more difficult-to-meet measure, vested benefit index (VBI), is close, at about 95. In March, the fund wrote to its approximate 80,000 DB members and informed them that a reduction in benefits now appeared unlikely in the short-term although two separate monitoring periods are still underway and end in mid-2015 and 2016 (it has already been under review for the past four years). Unlike most defined benefit plans in Australia, UniSuper’s division is still open and accepting new higher education employees (although they can later voluntarily move to the accumulation plan which offers six pre-mixed sector investment options and nine asset-class specific options.)
Pearce points out UniSuper’s DB plan’s funding level is, despite the recent attention, currently very healthy compared to many offshore defined benefit plans. “A lot of DB funds around the world - to us - took off risk at absolutely the wrong time. You had the crisis, you had the big sell-off and everyone says ‘we’ve got to de-risk this portfolio, and match our duration with bonds’. Well, that sounds crazy to me: sell equities after they’ve fallen.”
Asset mix At June 30, 2012, almost half of the DB plan’s assets were held in Australian shares, followed by fixed interest (15.7%), international shares (11.9%), property (11.2%) and alternative assets (11.1%). It is a growth-oriented mix well above the typical DB plan and even UniSuper’s accumulation plan, where investors bear all of the risk. (UniSuper’s accumulation plan had 28.4% of its assets in Australian shares, 20.8% in fixed interest, 21.2% in international shares, 16.1% in cash (compared to just 0.3% in the DB plan), 6.2% in alternative investments, 4% in property and 3.3% in socially responsible investments.)
“Given the duration of these [DB] liabilities, there’s no perfect match,” Pearce says. “One thing we do know is that 10-year government bonds at 3.5% would be the least perfect. So that’s why we think we much prefer to own Transurban than a 10-year government bond even though one is an equity with potentially variable returns.”
Pearce also notes that, while the fund couldn’t achieve its targeted returns from a portfolio with a heavy cash and fixed interest exposure, it did build up its exposure to non-government subordinated bonds, “particularly in the major banks when they were under a bit of pressure and [we’re] getting some really good deals offshore”.
Australia’s big four banks have been rated Aa2 by ratings agency Moody’s, which makes them among the strongest in the world.
However, it was holding such significant stakes in listed equities as well as unlisted infrastructure assets - largely in the DB plan - that prompted the fund to build a significant in-house management team over the past three-and-half years. The fund manages 30-40% of its A$35bn in-house, including “plain vanilla” assets such as large-cap Australian equities, Australian property, cash and fixed interest. It is a strategy that several major Australian funds have been following, such as the A$59bn AustralianSuper.
Pearce says in-house management brings a number of benefits: lower overall investment costs and more leverage to negotiate fees with external fund managers, access to company boards and greater participation in investment deals, the ability to screen out certain stocks (for example, the fund has not invested in tobacco stocks since 2011) and apply overlay strategies to tilt the portfolio to more favourable sectors. One of the most important benefits is the ability to customise portfolios, such as taking significant stakes in an asset (such as its near-8% holding in Transurban).
“It’s not that easy to outsource that… because an external manager would have their risk limits.” Pearce says the fund assesses the performance of its internal investment team in the same manner as its external managers. Last October, it closed an internal strategy, which the investment committee felt could be better performed by an external manager (not wanting to single out internal team members, he declined to name the strategy or asset class).
Alternatives Alternative assets such as hedge funds and private equity play little role in UniSuper’s investment mix. Pearce says he respects hedge fund managers but their higher fees and lack of transparency are insurmountable hurdles. UniSuper’s balanced investment option (accumulation division) charges members a competitive 0.47% a year and A$115 in administration fees. “We’re a low-cost provider: that’s our positioning in the market. To the extent that you’re paying one and 20 [management and performance fees] there to commit to a low total-cost outcome, we’ve got to find a lot of savings elsewhere.”
The fees charged by fund-of-hedge-funds have come under particular scrutiny by the A$1.4rtn Australian superannuation industry as government-mandated MySuper funds (a low-cost default offering aimed at the bulk of the public) are launched from July 1.
Pearce is far less positive about private equity and has overseen a sharp reduction in the fund’s exposure to approximately A$500,000 from about A$2bn three years ago. A lack of liquidity almost sank a small number of high-profile Australian funds, such as MTAA Super, during the global financial crisis. “Once you strip out leverage etcetera, and add a premium for illiquidity risk, I think it’s just an under-performing asset class. But most importantly we cap our illiquids - we don’t have this bottomless pit to take on illiquidity risk… and we’re seeing much better deals in infrastructure and property.”
The private equity sector, which returned 2.97% over the five years ended September 30, 2012, according to the Cambridge Associates LLC Australia/AVCAL Index, has generally fallen from favour among Australian super funds. Carlyle Group’s Sydney-based managing director Simon Moore recently told an audience at the AVCJ Private Equity and Venture Capital Forum that the average holding period since the global financial crisis had increased to five to seven years from three to five years amid growing investor concern about companies’ post-float growth prospects.
In recent years, UniSuper has backed two recent unlisted infrastructure projects: Aquasure (the Victorian Desalination Plant) which is being built and operated under a 30-year public-private partnership; and the A$1bn Victorian Comprehensive Cancer Centre - a Melbourne-based cancer research, treatment, care and education facility, which is also currently being built. While both are major projects, Pearce is also quick to point out that “we don’t get into these big bidder duels,” when weighing up potential unlisted infrastructure investments.
While Pearce joined UniSuper (from Colonial First State) just after the global financial crisis first hit, he says it has reinforced well-known investment lessons rather than overturning accepted wisdom. “If you sell things to people that shouldn’t be buying them you’re going to get in trouble; if you buy things that you don’t understand you’re going to get in trouble, and excess leverage is a certain killer… under every bubble and crash you’ll find those three things.”
While listed markets have performed strongly during the first few months of 2013, Pearce remains relatively confident about their prospects. “From where we stand, based on current valuations, we are very confident that equities are going to outperform bonds over the medium term. It sounds like a bland statement but I hope we’ve got the wisdom to say the reverse when the time comes because we are not of the view that equities always outperform bonds over the long term. It’s all based on valuation.”