This year’s top 10 stories included a peek into AustralianSuper’s international equities build out in London, AMP’s move to slash employee benefits, and plenty of hard-hitting analysis of the issues that matter in institutional investment. But the real story is how readers helped shape all of that coverage.
Orbis’ Stuart Place is riding from Melbourne to the Moon and Back to fund a treatment for the “monster of a disease” that his youngest son was born with. The investment industry is rallying behind him.
Why the internalisation debate still isn’t settled
Internalisation – when investment management is taken from the hands of highly remunerated external professionals and placed in the hands of merely well-remunerated internal professionals – is at an advanced stage in many of the largest Australian superannuation funds. AustralianSuper is around 50 per cent internalised, and wants to take that number higher. Cbus is heading to 50 per cent. UniSuper sits above 70 per cent.
But “advanced” doesn’t mean “settled”, and there’s still significant debate around how good it ultimately will be for funds – and their members.
The pros? The immediate cost savings can be passed on to members and are useful for mollifying a regulator hellbent on driving fees down (a regulator that has never heard the phrase “you’ve got to spend money to make money”), while funds like Cbus talk about the new level of control internalisation gave them over the portfolio and how they’ve used that control to make sure companies work harder on value creation.
But internalising asset management also means internalising asset management risk; what happens when your star stockpicker wants to hang out their shingle? What becomes of their strategy, and the technology and infrastructure investment built up around it? And what if the culture of an internal team goes totally sour?
Not that those who employ exclusively external managers are protected against governance debacles. But should they need to relieve a fund manager of a mandate, there is always somebody else waiting to manage it. There is not always somebody who wants to do the same in a big super fund, and if there was – if the pay and perks were so wildly attractive that there’s a mob of top talent breaking the door down – that might be a problem too.
For those that still preside over extensive rosters of external managers, it’s almost become their defining trait: think Hostplus CIO Sam Sicilia’s quip that he would only bring investment management in-house if there was some asset he couldn’t get outside – that asset being Martian real estate – or Australian Retirement Trust’s decision not to “hop on the internalisation roundabout” and follow other institutions that have gone through cycles of internal- and externalisation over the course of decades.
Those critiques of internalisation highlight that there’s no need for some big headline-grabbing blowup to ruin everything. It might simply be discovered that bearing some of these risks within the structure of the fund itself is not worth the reward that comes with cost savings and control. The notable example is the Harvard University endowment, which switched back to an externalised model in 2017 following years of underperformance, axing its in-house hedge fund and laying off half its staff in a bid to right returns (though that hasn’t been a balm for underperformance either, and Harvard has continued to lag other Ivy League endowments, suggesting the problem is not purely with the model).
The Maple Eight pension funds, upon which super funds have based their own internalised investment model, have also faced plenty of grumbling over how much they pay their staff – an issue that is far more potent in the land down under, and one superannuation funds will have to grapple with as they push beyond the ‘easy’ liquid asset classes and into alternatives, where managers on the outside command salaries that would make a super fund CIO blush.
It’s for all these reasons that funds and the regulator see internalisation as an area of both risk and opportunity, and emphasis the importance of getting the model right: ensuring that internal teams – especially internal teams working in niche asset classes that don’t fit as easily into the governance structures of super funds – are motivated (and incentivised) to think of their goal as not being their own performance, but the performance of the whole fund. Internalisation can create better returns, but it needs to be done in a commonsense way, with the understating that those returns are being created for the end stakeholder: the member. Clarity of the internal investment structure is one thing, and clarity of its mission is another entirely.
Or, as Sam Sicilia told this publication back in April, “please do it well”.
“Because if you don’t do it well, I cannot see the regulator coming down hard on just one super fund. Once you’ve made the decision to internalise, build robust systems, hire good people and engage with the regulator more often. If you’re not going to do internalisation then do that well – get great relationships with external providers and make sure you hold them accountable.”
