Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
‘It’s not an automatic win’: Why size won’t come easily to super
Australia’s super funds are racing to achieve massive size in the understanding that it will create untold benefits for members. But “a little but of circumspection and caution” is required.
“People seem to be taking it as a fact that you just need to be bigger, and that it’s obvious you need to be bigger and that there’s no downside,” says Geoff Warren, associate professor at the Australian National University. “But that takes it too far for me – there’s lots of areas where you lose out as well. It’s not an automatic win.”
APRA research released last week shows that scale is a boon when it comes to administration fees, with significant savings to member coming above the $50 billion FUM mark. Warren, whose research focuses on superannuation and the wider financial services, believes that developing retirement products as the first full generation of superannuants enters the drawdown phase will also be easier for larger funds than smaller ones, which will have to outsource everything.
Size will be less helpful in public markets, but an obvious boon in the unlisted space, where funds can deploy hundreds of millions of dollars to high quality infrastructure projects and private equity. But that’s also where unfamiliar new problems arise. Many of the large sovereign wealth and international pension funds that have successfully pivoted to unlisted are defined benefit funds, making it “a lot easier to play.”
“If you’re in a defined benefit fund, you know what your liabilities are and where the cashflows are and how they pay out in time,” Warren says. “You have greater luxury to just sit there and manage it. It’s a different situation with an Australian super fund that’s going to be watching the performance test. That’s neither positive or negative, but it’s potentially a lot more volatile if you start to underperform.”
And just having the money does not automatically mean being able to deploy it effectively; segments of the global private markets that Australian funds want to play in are governed by relationships that they don’t necessarily have, and attracting global talent will not be an easy task. Over the course of several research projects, super funds have made the “valid argument” to Warren that they only want to attract purpose-driven investors – people who want to work in financial markets but desire a quieter life than they might get at some of the flashier managers.
In Australia that’s certainly paid off; the industry funds have performed excellently with the staff they’ve attracted, and the fact that they’ve been retained speaks to the power of super’s purpose.
That changes overseas. Super funds can’t pay bonuses of the same quantum as their competitors and have a responsibility for the retirement of a people distant from any international employees. It could be a tough call to find new recruits.
“You no longer have that connection to the member that you would if you were working in an industry fund down here in Australia,” Warren says. “You’ve got to employ people who are experts in overseas markets; they’re going to be expensive… This is just a continuum of the problem of having an expensive investment team, except it goes to the next level because you’re now building a global team.”
“It’s not the same as sitting in Melbourne and managing a nice, close-knit team. There’s certainly opportunity there, and to be a player in that area you certainly need size – but it doesn’t guarantee success. You need to execute properly, and you’re changing to something completely different.”
The culture problem is one that’s bothered AustralianSuper CIO Mark Delaney, who believes that the key to solving it is to ensure that some kind of purpose beyond service to members is maintained; sustainable investing could be a draw enough for many who have grown weary of the rapacious nature of international finance. But while Warren believes that many funds will be successful overseas, there will likely be ones that stumble – and by virtue of their newfound size, there will be many more members vulnerable to any misstep.
“APRA’s decided that it wants fund consolidation occurring as well, and it’s pushing it along,” Warren says. “The larger funds are gleefully going along with that idea. But I’d argue that just a little bit of circumspection and caution is what’s really required, rather than just saying “size is good” and putting your brain on hold. Size is good, providing you do it right.”
