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.
YFYS sees a ‘bifurcation’ in property strategies
It’s a testament to the idiosyncrasies of the YFYS performance test that super funds are still trying to figure out the best way to invest within its constraints. In the case of international unlisted property, a benchmark based on Australian core unlisted property is now creating a two-speed system.
Smaller funds will have to stick to real estate in their own backyards in order to minimise tracking error while larger investors, wary of the concentration risk that comes with having a significant chunk of their unlisted allocation in the Australian market, are still forced to go offshore. Adrian Benedict, head of real estate at Fidelity International, attributes the paradigm to “the law of unintended consequences.”
“With the larger investors it’s more straightforward because they’ve got the ability to absorb that tracking error and that’s why they’re more prepared to continue down that path of going overseas, as well as playing at different parts of the risk/return profile,” Benedict said. “So it’s not just core, it’s actually value-add real estate or opportunistic real estate. But the small and medium sized schemes are limited in what they can do, and that’s reflected in their portfolio construction.”
“There is definitely that bifurcation of the market; the smaller schemes are still domestically-focused, and the large schemes are very much embracing that internationalisation.”
Benedict believes that while they’re still early in their development as international investors, Australia’s biggest super funds could have a more commanding international presence, but that their efforts are being stymied by YFYS and the liquidity provisions that are inherent to defined contribution schemes.
“AussieSuper is going to be $500 billion within the next few years,” Benedict says. “That puts it in the top ten investors globally. But does it behave and is it able to act as one, within these kinds of constraints? That’s what it comes down to – and how are member outcomes being influenced by that?”
The AustralianSupers of the world are now pursuing a model more akin to that of Canadian schemes, some of which hold private asset allocations of anywhere between 20 to 40 per cent, though the fact that these schemes are defined benefit means their liquidity provisions aren’t aligned to the superannuation experience.
“A large super fund in Australia is always going to have to be more mindful of ongoing liquidity restraints than perhaps some of the other global investors,” Benedict says. “Having said that, do they need to have liquidity for 100 per cent of their scheme, or is it 15-20 per cent of their scheme in any given year?
“If you take that further forward, does that necessarily mean they need to have such a substantial exposure to their domestic equities market, or indeed equities generally? You can then look at long-term risk/return profiles, and actually ask where the disproportionately attractive returns are. What you’re seeing is most large investors who are able to look at on a 20-30 year view are saying the private asset space is where you’re more likely to see that return.”
Of course, this all might be about to change. Labor’s election win raises the prospect of alterations to the YFYS performance test that could give funds the policy certainty required to invest more creatively and away from the benchmark. It also means that funds might take a bigger role in transforming Australia into the “clean energy superpower” new prime minister Anthony Albanese prophesied in his acceptance speech.
“Private capital needs to be doing more than just generating financial outcomes,” Benedict says. “Absolutely that remains a critical objective, but are we always going to be expecting public bodies and policy to direct outcomes? Whether that’s environmental or educational or a whole bunch of different things. Governments and central banks no longer have any tools available to them.”
“They’re not going to be able to tax anymore, central banks don’t have firepower in the way they used to. So the question is, how is private capital could be utilised to undertake that transition we all know economies and countries need to move towards.”
Funds can’t have all their cake and eat it too, Benedict says, but they might be able to get a sizeable chunk. While they’ve previously been warned to stay out of the transition debate, Benedict believes the change in government represents a “seminal moment” for how funds invest.
“I used to come to Australia to learn about ESG investing. Today, I’m educating. That’s within 15 years,” Benedict says. “Australia used to be the leader. Now it’s Europe telling Australia what they could be doing. I can easily see a circumstance where Australia retains its leading position and leading voice on some of these things.”
“So it’ll be really interesting to see to what extent government legislation and policy actually make that more possible. Right now, it’s very clear what they’re going to be judged by. For them to do anything otherwise is very difficult. But if the electorate is making it very clear to politicians what they’re expecting, what politicians know is what’s going to take to make them remain popular. You need capital to be able to execute those plans. “
