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.
CIOs learn to live with ‘a blunt and retrospective instrument’
The Your Future, Your Super (YFYS) test is here to stay – but CIOs are still adapting to the idiosyncrasies of their new benchmarks.
“The performance test gives you an additional target,” Anna Shelley, CIO of AMP, told the ASFA Conference on Wednesday (27 April). “And you can be the best archer in the world, but you don’t know which target you’re shooting at. It’s added a complexity there that investment teams have to then manage. I found that trustees fully understand the issue, but they have to trust in the investment team to manage that risk.”
“The performance test is a blunt and retrospective instrument that nobody knew they had back in 2014. It’s a hurdle that you have to meet, and it’s existential. What it comes down to is the headroom you’ve got versus that test. And that’s different for different options.”
Shelley notes that the issue is compounded by the idiosyncrasies of choice products, and the way those idiosyncrasies are measured – or rather, not measured – by the performance test. Shelley, like many within the industry, supports the philosophy driving the YFYS reforms, but believes that the choice heatmaps, and the looming application of the performance test to choice products, “hasn’t thought about the full range of choice, and retail platforms.”
“We’ve got retirement products that sit on platforms, and by the nature of platforms anybody can invest in it,” Shelley says. “So it has 90 per cent pension money but small allocations of super money – so they’ll be tested. Those products have a neutral asset allocation, but that’s not how they’re managed; they’ve got put protection on them, they’ve got income targets, they target a post-tax return.”
“None of that will be tested because there is no post-tax return in the platform rules, so it will have to be a pre-tax return measure. And it’s inappropriate to test those products like that.
AMP is currently moving from a conglomerate to a more focused business under the steady guidance of Alexis George, with an eye to “reforming and rejuvenating the business”; its master trust investment menu will move from 103 options to 37, and its nine different platforms will be “rationalised.” It’s a project that encompasses $90 billion of AUM, the end game of which, Shelley jokes, is “world domination.”
Meanwhile, industry fund Cbus is midway through an internalisation journey. 38 per cent of its $75 billion AUM is now managed internally, up from the six per cent in the Cbus Property vehicle. The original plan was 24 per cent; it will likely end up around 50 per cent.
“When we were internalizing, we were quite focused around traditional benchmarks and sectors. We do have a number of sectors where our benchmarks and deviate from that, and we had reasons for why we were deviating,” said Cbus CIO Kristian Fok. “In our circumstances, we’re fortunate enough to have more than one per cent per annum of outperformance. Our starting point gives us a bit more flexibility, and has been reasonably consistent over the years.”
“Having said that, there remains some elements of our strategy where I think as a team we don’t have the relative to benchmark conviction, and not the absolute conviction. We can focus on the larger positions where we don’t think we have the same level of conviction…For us, it’s a large emerging markets tilt in the portfolio that you can’t benchmark against. Up until last year, it was okay; this year it’s had a more adverse impact, though we still have the same conviction.”
Some commentators have warned that YFYS will force funds closer to the benchmarks, meaning a potentially reduced return for members. While Mercer Pacific CIO Kylie Willment still believes that super’s primary objective is still total member outcomes, she concedes that, when measured against the existential threat of failure, benchmark-hugging might win out for some funds.
“It’s very unfortunate that this test – the spirit of the reform is probably right, the test is not – puts these two things in contention… Some of the discussions we’ve had with the trustees are around confirming that total member outcomes remains the primary, and we’ve absolutely agreed on that,” Willment said.
“But I think you also have to land on a belief that passing the test is in member’s best financial interest, because there’s a huge amount of disruption that can come to your members if you fail the test.”
Photo: Jeremy Veitch
