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.
Why funds still have a ‘long way to go’ on valuations
The sharp fall in equity markets last year has seen super funds hounded by controversy over the valuations they hold for the unlisted assets that comprise an increasingly large chunk of their portfolios and the variation in what different funds believe they’re worth. But valuations are never going to be perfect and fairly comparing them is “a bit of a mirage” according to Australian Retirement Trust CIO Ian Patrick.
“Will our valuation on a particular airport be any better or worse than (Cbus’) or any other fund’s valuation? I think what one has to rely on is the governance and the processes of the go-to valuation and the expertise brought to bear on informing the valuation,” Patrick told the final AIST Superannuation Investment (ASI) conference on Tuesday.
That means a regular cycle of review within the investment team and oversight by the board of the conclusions they reach, Patrick said, which should give members the confidence that the price they are transacting at if they want to switch is reasonable. Questioned on whether funds should be investing in an asset class where they can’t get completely comfortable with the valuations, Patrick said:
“Investment is about uncertainty. Just think about the context of that airport. Who would have foreseen a global pandemic? In underwriting an airport asset ten years ago, every reasonable expert view on traffic volumes and capex etc. would have been included in the underwriting and it’s no different for the valuation.”
“We know the valuation won’t be perfect to the dollar relative to what you could trade it at or whether you could go out and sell it or what may emerge in five years’ time as the valuation. My view is that’s what we’re dealing with. Markets are made up of a collection of views; there may be any number of views on the inputs to a valuation. Our job is to be close to management and ensure that discipline is built into the forecasting that informs the inputs.”
Still, Cbus CEO Kristian Fok believes that funds need to do better in explaining valuations to members and commentators, particularly given media and public skepticism about how their June 30 returns are calculated (i.e. with valuation data on hand that’s remained unchanged).
“There’s more of an onus around us to be more upfront,” Fok said. “The reality is that there are weaknesses in what we can do. There are overseas investments where we can’t get information at the time, and we have to think about whether that’s acceptable or not. I think there’s still a long way that we’ve got to go.”
Meanwhile, super funds have mostly learned to live with the Your Future Your Super (YFYS) performance test by managing towards it, according to Frontier director of consulting Kim Bowater, but that doesn’t mean they can’t still be caught out.
“I do think that with YFYS it’s happened and it’s been bedded down and people have kind of got their head around it and what risk they’re willing to take in the portfolio,” Bowater said. “There’s a lot of monitoring around that, so I think the chances of being caught out in terms of risk-taking versus that test are a lot smaller than when it first turned up and it was back dated… but it’s there and it’s real.”
And it still matters quite a bit what a fund’s historical experience has been with the test; whether it has a buffer and can continue on with YFYS as a side issue, or whether it’s “front and centre” in every investment decision. Fok said that the test is still an issue even for those funds that have done well.
“I think the other aspect is that it may in future discourage innovation,” Fok said. “If you’ve got an asset class that doesn’t have a benchmark that’s another consideration you have to get conviction on. I think if you’ve got a history with lots of outperformance it’s probably less of an issue, but even if you’ve got that there’s the potential for it to change how you approach the portfolio… You have to make sure you don’t inadvertently stick with the herd when better opportunities are available.”
