INTELLIGENCE FOR INSTITUTIONAL INVESTORS
ISSUE 155
NOVEMBER 2018
An optimist’s
LEGACY
First State Super’s outgoing chief executive MICHAEL DWYER on relationships, trust and industry transformation
INVESTMENT
ROYAL COMMISSION
POLICY
ROUNDTABLE
IS RISK PREMIA
REGULATORS READY
AIST CALLS FOR
INDUSTRY EXPERTS ON
BUZZ WORTHY OR JUST
TO GET TOUGHER
SUPERANNUATION FUNDS TO
THE DESPERATE NEED FOR
A DISASTER WAITING
ON RECALCITRANT
EXAMINE THEIR INCENTIVISED
EARLY-INTERVENTION PLANS
TO HAPPEN?
INSTITUTIONS
REMUNERATION AND MORE
IN THE WORKPLACE
THIS ISSUE \
CONTENTS NOVEMBER 2018
ROUNDTABLE
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21
IN THE GREEN ZONE
CUSTODY MATTERS
With the federal government turning its eye to the economic impact of mental health, industry experts gathered to discuss early intervention
Asset owners are seeking to generate a single data record, for governance, compliance and operational efficiency
GLOBAL CIO PROFILE
14 AROUND THE WORLD Top1000funds.com profiles Public School and Education Employee Retirement Systems of Missouri (PSRS/PEERS) CIO Craig Husting
FEATURES
18 FIS STANFORD A selection of coverage from the global symposium held at Stanford University in the US, including news on CalPERS and IFM Investors
24 ROYAL COMMISSION
06
COLUMNS
The Hayne inquiry’s interim report suggests regulators will soon be tough enough to make institutions think twice about wrongdoing
COVER STORY
“Even a big fund needs to have a sustainable business model going forward that ensures it can continue to invest in new products and services” MICHAEL DWYER | CHIEF EXECUTIVE | FIRST STATE SUPER
23 LIFESKILLS The removal of younger, generally lower-risk members from the group insurance pool increases risk, KPMG’s Adam Gee says
26 INVESTMENT Risk premia is a buzzword strategy for super fund investments, but it’s a disaster waiting to happen, Local Government Super’s John Peterson writes
28 INNOVATION The Medical Research Future Fund is ramping up its investments and is set to be worth $20 billion by 2021
30 POLICY All super funds must closely examine any incentivised remuneration, AIST chief executive Eva Scheerlinck says
03
04
\ FROM THE EDITOR
EDITORIAL EDITOR
Alice Uribe
ALICE URIBE / alice.uribe@conexusfinancial.com.au
DIRECTOR OF INSTITUTIONAL CONTENT
Amanda White HEAD OF DESIGN
C
Kelly Patterson
A LETTER from the editor
ART DIRECTOR
Suzanne Elworthy SUB-EDITOR
Haki P. Crisden PHOTOGRAPHER
Matt Fatches
WORKING TOGETHER, EVERYWHERE
matt@mattfatches.com.au CHIEF EXECUTIVE
Colin Tate
OLLABORATION AND THE best ways to do it are things we’ve been talking about here at Investment Magazine since I joined. My take is that good things can happen when you work alone but great things can happen when a team is united. One of our challenges, common to many businesses, is that staff travel both domestically and overseas. So it’s here that good communication skills become paramount to keep things ticking. Luckily, the mod cons of technology make this much simpler. Working together and the struggles and benefits that can come from it were raised at the recent Fiduciary Investors Symposium at Stanford University in the US. The event is run by Investment Magazine’s sister-publication Top1000funds.com and attracted a diverse group of delegates that included institutional investors. Attendee Mark Delaney, CIO of AustralianSuper, one of the largest investors with IFM Investors, said that working in such a collective was not always easy. “Everyone has an angle around ideas and portfolio construction,” he said. But fellow fellow attendee Sonya SawtellRickson, CIO of HESTA acknowledged successful collaborations involve larger and more experienced investors within the group acting as leaders. Read more about this in our FIS Stanford wrap on page 18. Learning from peers is something that many in the institutional investment industry prize, so
NOVEMBER 2018
continuing the global theme of this issue, my colleague from Top1000funds.com Sarah Rundell spoke with Craig Husting, the CIO of the US$43.6 billion ($61.4 billion) Public School and Education Employee Retirement Systems of Missouri. Her profile is on page 14 of this issue. Husting wisely says accusations of opaque fees for management and performance associated with private equity and hedge fund managers won’t go away until more investors display all the fees they pay by opening up their annual reports. Closer to home, the inner workings of superannuation funds, and the way they and their partners work together, will certainly be open to wider scrutiny as the financial services industry awaits the final report from the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry in February. Perhaps AIST chief executive Eva Scheerlinck captures it best in her regular column, when she writes that the royal commission has reminded the industry of the “enormous trust that consumers place in providers of financial services”. “From directors through to those working at the call-centre coalface, everyone in the super sector has a role to play in ensuring this trust is well placed,” she writes. Something to mull over when striving to work together in a time of great change. Thanks for reading.
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ADVISORY BOARD MEMBERS Debbie Alliston, head of multi-asset portfolio management, AMP Capital | Richard Brandweiner, chief executive, Pendal | Peter Curtis, head of investment operations, AustralianSuper | Joanna Davison, chief executive, FEAL | Michael Dundon, chief executive, VicSuper | Kristian Fok, chief investment officer, Cbus Super | Robert Goodlad, chief executive, CIMA Society of Australia | David Haynes, executive manager, policy and research, Australian Institute of Superannuation Trustees | Geoff Lloyd, chief executive, MLC | Graeme Mather, head of distribution, product and marketing, Schroders | Mary Murphy, chief digital officer, First State Super | Paul Newfield, senior investment consultant, Willis Towers Watson | Nicole Smith, former chair, MLC Superannuation Trustees | Anne Ward, chair, Colonial First State and Qantas Super | Nigel Wilkin-Smith, director portfolio strategy, Future Fund
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EXTEND YOUR GLOBAL REACH WITH FTSE GEIS From mega cap to micro cap, coverage of the FTSE Global Equity Index Series (FTSE GEIS) extends across 47 developed and emerging markets providing unparalleled scale, depth and reach. And with its modular structure, FTSE GEIS supports a broad spectrum of index options, offering a precise view of the markets relevant to any investment process. Over US$16 trillion in assets are benchmarked to FTSE Russell globally. Find out more at ftserussell.com Data as of December 31, 2017, derived from eVestment, Morningstar, and FTSEÂ Russell data as reported on April 2, 2018. No assurances are given by FTSE Russell as to the accuracy of the data.
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\ CEO PROFILE
An
OPTIMIST’S legac y FIRST STATE SUPER’S outgoing chief executive, MICHAEL DWYER has seen the industry transform over his 14 years in the role. As he readies to pass the baton, he shares his outlook for the future and discusses the importance of people and trust.
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CEO PROFILE \
By Amanda White + Photos Matthew Fatches T’S HARD TO imagine the Australian superannuation industry without Michael Dwyer in it. He’s been a central figure and wisdom are deeply valued by many for the last 30 years, longer of us. Many times, I have asked myself, than the mandated system, a ‘What would Michael do in this situation?’ status acknowledged when he before tackling a challenge. I am so grateful was appointed a Member of the Order for his influence and friendship.” of Australia in 2011. The honour also Dwyer joined First State Super from recognised his contribution to another Asset Super in 2004. Under his leadership, great passion, the UN Refugee Agency’s the fund has grown from $9 billion and Australia for UNHCR. 450,000 members to nearly $95 billion and Dwyer announced his retirement in 800,000 members. It now has 26 regional June. During his tenure as chief executive offices nationally with 1000 staff split of one of the country’s largest super funds, roughly equally between super and the First State Super, he has seen fundamental advice business (StatePlus). changes, including enormous business “The business is a lot more complex growth, a successful merger, public offer now than when I started at First State Super status, and the rise of financial advice. 14 years ago,” Dwyer says. He’s sitting in It’s his wisdom that will be missed by the First State boardroom holding Super those who work with him. Sam, the brand icon that represents the Dwyer is admired for his softer skills, fund member. Sam is a physical reminder, in particular his compassionate approach he says, that all decisions made at the to leadership. fund need to be made with the members Neil Cochrane, who has been chair of in mind. First State since 2014 and was also a former “I’ve been at board meetings where Fund Executives Association Ltd (FEAL) directors will pick this up [Super Sam] chair, says “Michael’s personal empathy
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and hold it in their hands and as we’re talking about a product or a service, they are asking how it might benefit the member, this person,” he says.
MERGER TALK Under Dwyer’s leadership, First State has grown organically and via the arguably more arduous route of the merger. It achieved public offer status in 2006, which opened the government fund to the public, and underwent a merger with Health Super in 2011. It also went through the integration of its advice business following the acquisition of financial planning group StatePlus in 2016. Some industry observers see the potential for self-interest to be an obstacle for mergers, but Dwyer is not as cynical about why there haven’t been more of them in the industry. “In my experience, many funds that are smaller than ours do a great job for their members in terms of investment returns,
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costs and relevance to the members in a particular industry or sector,” he says. “The chemistry that makes a merger work will be different depending on the partnership. “Even a big fund needs to have a sustainable business model going forward that ensures it can continue to invest in new products and services, and new forms of delivery for members. Whether mergers take place between funds is a deeper, more complex question than [what could be addressed with] a simple answer that says people don’t want to merge because they want to stay independent for its own sake.” Dwyer confirms that First State Super is having a number of active discussions with funds looking to form partnerships. “I’m very optimistic about that,” he says. “We are in the fortunate position of having a very strong base with $70 billion in accumulation and $25 billion in assets in the pension phase and a huge network of offices and planners. Other funds are attracted by that.” People are at the core of success for Dwyer, whether it be in his personal endeavours, at First State Super or with a merger. “People do business with people they
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Making merger history FIRST STATE SUPER’S 2011 merger with Health Super made it one of the country’s biggest funds and took about three years to bed down. Dwyer says bringing two groups of people together was the most challenging part of the process. “Bringing their hearts and minds together so they had a single focus and single purpose was a challenge,” he recalls. “We took our time, we had about 28 working groups, as well as an overarching group, and we examined where we did things the same and differently. We worked hard to bring those people together where we arrived at a situation where they felt their voices were heard.”
know and trust and like doing business with,” he says. As the industry has experienced this year amid the ongoing Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, trust is top of mind. It’s something Dwyer takes seriously. “We see ourselves as privileged to look after the retirement savings of nurses and midwives, teachers, police and emergency services workers; they are often referred
to as the carers of society, they are trusted by the community,” he says. “We’ve been given the responsibility to look after their lifetime savings, and we should project the same values they do and [show that] just as the community trusts them, they can trust us.” Dwyer was the founding chair of FEAL in 1999, remaining on the board, and has been a director of the Association of Superannuation Funds of Australia since 2009. He says many of his colleagues are
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One of the sayings we have around here is, ‘No perfect people allowed.’ We will make a lot of good decisions but sometimes we may not get it right and hopefully we will be honest about it, learn from it and not repeat it. It’s a challenge as a leader
focused on the notion of trust. “I’ve been fortunate that I’ve had that opportunity over many years now to join the debate and discussion about the industry,” he says. “I’ve got more out of it than I’ve given, because when you build trust with colleagues and have those relationships, the sharing of information is just amazing.” With people key to Dwyer’s success, he admits the biggest challenge as a chief executive is getting the right ones on the bus. “One of the sayings we have around here is, ‘No perfect people allowed.’ We will make a lot of good decisions but sometimes we may not get it right and hopefully we will be honest about it, learn from it and not repeat it. It’s a challenge as a leader.” In hiring, Dwyer looks for intellectual strength and experience but he is a big believer that those qualities alone will not be a differentiator in a competitive market. “People who exercise wisdom, judgement and a strong moral compass and who want to be here for the right reasons – they are the people we want,” he explains. “If you want to become a gazillionaire, this is probably not the place
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you should come. But if you really want a job with a purpose, and to be fortunate enough to impact people’s lives in a very meaningful way by what you do, that’s the sort of thing we look for.”
‘EXCITED’ ABOUT SUCCESSOR Deanne Stewart, the incoming chief executive of First State Super, started in the job on Monday, October 22, allowing six weeks of transition with Dwyer. “No matter how good the current leader is, a new vision after 14 years is going to be appropriate and exciting,” he says. “I’m excited by Deanne’s appointment. I’ve known her for a good number of years and she brings youth and intellectual strength and vision to the role. I’m very optimistic she will be a good leader for us. It’s also good to have a female leader of a fund where almost 70 per cent of members are female.” It’s no surprise that Dwyer’s wisdom and strong moral compass are now reflected in the organisation he has led for the last 14 years. “I want the staff to bring their whole self to work,” he says. “Another saying we have is, ‘I don’t care how much you know until I know how much you care.’ I want to be an
employer people want to work for and want to give their very best, and [for whom] they do that because of values and leadership not because we can out-pay someone else.” Being a chief executive, especially one who has a holistic approach to leadership, is not easy. “I always say the best thing about being a CEO is you know everything that’s going on, and the worst thing about being a CEO is you know everything that’s going on. By that, I mean caring for the entire life of a staff member, so that if someone needed time to deal with a family issue, we would give them that support,” he says. Drawing attention to the plight of women in super is something Dwyer remains committed to and if there is any unfinished business in the industry, he thinks it is the gap between female and male savings. “To have women sit at half the savings of men at this stage of our development is unacceptable,” he says. In the first week of December, a week after Dwyer leaves First State Super, he’ll fly to Geneva to map out the 12-month strategic plan for the United Nations High Commissioner for Refugees, an organisation he chairs in Australia. With the support of the First State Super board, Dwyer has championed the establishment of a paid internship program for recently resettled refugees and asylum-seekers and the fund has just placed its fifth intern. After so many years, leaving the industry does bring about some reflection on the challenges it faces in putting members first. “There will be challenging times ahead and the importance of superannuation as part of the economy is a responsibility that rests on the shoulders of all funds and is very significant,” Dwyer says. “But I’m very optimistic the directors and leaders in the industry are up to the challenge. I’ll be watching the industry with great interest.”
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AN INVESTMENT MAGAZINE ROUNDTABLE, sponsored by AIA AUSTRALIA
STAYING in the
GREEN ZONE With the FEDERAL GOVERNMENT turning its eye to the economic impact of mental health, employers, super funds and insurers gathered to discuss the importance of early intervention and prevention in the workplace.
By Alice Uribe + Photos Matthew Fatches
IT IS SOBERING to consider how widely mental illness affects Australian society. Nationally, more than 3000 people took their own lives in 2017, making suicide the leading cause of death among people between 15 and 44. With 1 in 5 people experiencing a mental health condition each year, the exact nature of the economic impact is beginning to be understood. But the government’s recent announcement that it had instigated a Productivity Commission to investigate the effects of mental illness on Australian business finally drew a line in the sand. It was an acknowledgement that while mental illness remains an increasingly concerning social and health issue, it is also one that costs the Australian economy $12 billion a year in lost productivity.
COLL ABORATION NEEDED The Productivity Commission is set to
examine the health sector, but also how other industries work together as it looks to assist in the design of the government’s long-term mental health strategy. It will include an examination of the education, employment, social services, housing and justice sectors. In the workplace, mental health is associated with high-levels of presenteeism (people coming to work even though they are unwell), but research in collaboration with beyondblue has also revealed that every dollar spent on effective mental health actions returns $2.30 to organisations. In line with this, the need for collaboration between superannuation funds, insurers and employers to support prevention was a key topic of discussion at a recent Investment Magazine roundtable sponsored by AIA Australia. “Mental health in the workplace, more
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JOANNE GRAVES AIA Australia JASON MURRAY KPMG
than anywhere, is a shared responsibility,” said Mark Leopold, head of workplace engagement at beyondblue. “We have a responsibility to put processes, systems, governance and policies [in place].” Leaders from the super, insurance and consultancy sectors also explored best practice for early intervention in the workplace, and how it could potentially reduce some of the more grim statistics. “It’s not just about supporting people with a mental health condition, which is critical, it’s actually about the idea of an integrated approach to mental health, which is about promoting the positives of work,” Leopold said.
THE EMPLOYER EXPERIENCE Workplace consultants on the panel – KPMG, Clayton Utz and EY – spoke about the techniques that could be employed by employers and companies to embrace an
attitude of early, sustainable, accessible intervention. “Certainly what we’re seeing inside of KPMG is that it’s something that everyone needs to be interested in from top to bottom, and we’re trying to equip everyone with the ability for that early detection,” said Jason Murray, director, people and change practice, at KPMG. A 2017 Safe Work Australia study found that when employers instigated early contact with staff affected by mental illness, 77 per cent of those employees remained in work, compared with 52 per cent who had no employer contact. Alexia Houston, head of insurance and risk at law firm Clayton Utz, said she had worked collaboratively with AIA and JLT/ Recovre (represented at the roundtable
by Alice Fung, the company’s national life insurance manager) to develop frameworks for mental health responses. “We can do so much more together than apart,” Houston said. At Clayton Utz, 10 per cent of staff are trained as mental health champions and that has made a difference for identifying symptoms of mental distress, “or someone who is not travelling very well,” Houston said. “We encourage people to come to us openly. There’s no stigma associated with seeking help in the workplace. We will tailor programs to help you stay in work.” Fung challenged roundtable participants to think about “self-compassion”. “When you can apply that to yourself...
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you can apply it to everybody connected to you. So if we can all walk the talk, then we can probably deliver that even better,” she said. For EY, the conversation has moved from simple resilience training to a “more integrated system-based approach” said Roberto Garcia, director for health, safety and environment services at EY. This includes looking at potential “hazards”, which can include processes that may stifle creativity, right through to bullying and harassment. According to the Black Dog Institute, up to 50 per cent of Australian employees have experienced workplace bullying, with the mental health consequences estimated to cost the economy $36 billion each year. Houston said organisations have an “obligation” not to tolerate negative behaviour and to make it safe for employees to speak out when they need to do so. “It’s stripping it back to basics about how, as leaders, as employees, as colleagues, we behave to build a positive workplace culture,” said Debra Brodowski, national manager for psychological services at the Centre for Corporate Health.
SUPER FUND CHALLENGES Beyondblue’s Leopold said it was essential to think of mental health in the workplace as a green-to-red “continuum”, where at the green end a person was thriving and at the red end they had a mental health condition. He said it was about keeping the “healthy, healthy” but also acting on the “amber” warning signals before people go into the red. For 118,000-member Prime Super – a comparatively small fund – working with employers to detect members in the “amber” zone remains an ongoing challenge. “We’re a regional and rural superannuation fund looking primarily after farmers,” said Dana Clarkson, senior manager for insurance and member services at Prime. “From an employment perspective, we don’t have a lot of big employers. From a mental health perspective, it’s just not talked about…in those types of industries. And that’s a real issue for our membership.” AIA chief group insurance officer
Stephanie Phillips acknowledged connecting with employers and members was a challenge for super funds, but urged funds to consider how they could create a closer relationship “much, much earlier”. “We’ve got to take some of the advice we’ve got from corporate funds that still have that relationship...with their staff,” Phillips said. “What we’re trying to do is be more proactive with our super funds in recognising that they’ve got multiple employers that could be ‘mum-and-dad’ operations or rural small businesses where they don’t have access to mental healthcare.” For Tracey Allan, the insurance and resolution manager for HESTA, the $50 billion fund for healthcare workers, considering mental health a continuum was a “fascinating” concept. Over the last two financial years, 20 per cent of HESTA’s income protection claims related to mental health, Allan said. “I think employers might talk the talk, but they don’t actually walk the walk... I think it’s about [having] a safe environment where you’re actually allowed to be yourself,” she said. At the larger end of the scale, AustralianSuper, with 1.4 million
DR SUMMER ZHU BT Financial Group
PA R T I C I PA N T S TRACEY ALLAN Insurance and resolution manager, HESTA DEBRA BRODOWSKI National manager, psychological services, Centre for Corporate Health DANA CLARKSON Senior manager, insurance and member services, Prime Super ALICE FUNG National life insurance manager, JLT/RECOVRE ROBERTO GARCIA Director, health safety and environment services, EY JOANNE GRAVES National rehabilitation manager, AIA Australia ALEXIA HOUSTON Head of insurance and risk, Clayton Utz RICHARD LAND Head of insurance, AustralianSuper MARK LEOPOLD Head of workplace engagement, beyondblue JASON MURRAY Director, people and change practice, KPMG STEPHANIE PHILLIPS Chief group insurance officer, AIA Australia ALICE URIBE Editor, Investment Magazine, Conexus Financial DR SUMMER ZHU Chief medical officer, life insurance, BT Financial Group
MARK LEOPOLD beyondblue
CH A IR COLIN TATE Chief executive, Conexus Financial
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ROBERTO GARCIA EY
STEPHANIE PHILLIPS AIA Australia
It’s really about how you connect with people way before they leave [work] because of a medical condition
insured members is adept at assisting members, in the “red zone” with regards to rehabilitation for its income protection claimants, but the fund’s head of insurance, Richard Land, said it would like to “get earlier access for its people”. “I think what we’re not quite so good at is in the ‘green’ area and engaging with our employers to help people stay in the green area,” Land said.
TECHNOLOGY ’S POTENTIAL Using technology and data analytics to better understand the health of super fund members and keep them healthy when they’re in the green zone remains a burgeoning area. AIA national rehabilitation manager Joanne Graves said it was about using the information the insurer has but also about getting more of it. “You might start to see an influx of claims come through for mental health for, say, one sector of the community,”
Graves said. “We tend to drill down on that...and then work with those organisations to create some early intervention and change. “We’ve done a lot on the red light of the spectrum, and we’ve done a lot on the green light...particularly with corporate employers. Over the last five years, we’ve really worked out, ‘How do we work with an employer to notify when someone’s not coping well?’” KPMG’s Murray said wearables, such as Fitbits, could be used to detect stress points across a population, or even a sector or division of a business. “Should they be going through a transformation, or a merger, etc, you might see spikes, so you can do early intervention from that,” he said.
BEING PROACTIVE AIA’s Phillips said it was also key to encourage members, and employers, to view super funds as a source of
information about mental health. “It’s about how to be more positive in the process,” she said. “There is a commercial aspect because you want to reduce premiums and increase wellbeing within the membership, but you also want to be proactive in helping employers understand this. It’s really about how you connect with people way before they leave [work] because of a medical condition.” BT Financial Group’s chief medical officer for life insurance, Dr Summer Zhu, suggested that super funds could “identify each individual member rather than just make them a kind of homogenous group”. “It’s their super [fund] actually possibly playing a more long-lasting kind of lifetime friendship role than their employer,” she said. Phillips cited employers such as Clayton Utz and EY as examples of what could be done when time and money were invested into changing processes and systems to generate better outcomes for the bottom line, staff and members. Clayton Utz’s Houston said: “The media have talked a little about the commercial benefits of investing in this [mental health prevention], but I think as employers all around the room, bottom line benefits aside, we really have an obligation to invest in the mental health of our people, and I think we can do so much more if we work together. “We know that being at work is good for people’s recovery...as an employer, we’re keeping people engaged, they’re performing, and we can get them back on the road to excelling.”
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AROUND the
WORLD
Insight from peers is a key element in the DNA of Investment Magazine’s sister publication Top1000funds.com. Here’s a sample of what the world’s largest INSTITUTIONAL INVESTORS are reading and sharing. THIS MONTH, TOP1000FUNDS.COM European editor Sarah Rundell, based in London, profiles Public School and Education Employee Retirement Systems of Missouri (PSRS/ PEERS) CIO Craig Husting and gets his views on fee transparency. Also, Top1000funds. com editor Amanda White speaks with Alaska Permanent Fund chief executive Angela Rodell about the need to collaborate with other investors.
PSRS/PEERS wants its fees perfectly clear By Sarah Rundell
PRIVATE EQUITY AND hedge fund managers are in the firing line for charging opaque management and performance fees. The problem won’t go away until more investors display all the fees they pay by opening up their annual reports with full fee disclosure. The US$43.6 billion ($61.7 billion) Public School and Education Employee Retirement Systems of Missouri (PSRS/PEERS) shows it can be done. The system stands out amongst many of its US public pension fund peers for its focus on transparency. PSRS/PEERS reports all the investment management fees in its recently boosted 25 per cent target allocation to alternatives,
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including the split of the investment profits or ‘carry’. Also witness fiscal year 2016, when the fund reported it paid one manager $19.2 million in fees, breaking down the total to $6.3 million in management fees and $12.9 million in performance fees. Other funds would’ve reported these figures quite differently. Pension funds that have a policy to reflect only fees paid through the accounts payable process would have reported a management fee of zero, while a pension fund with a policy to include only management fees and not incentive fees would have shown only $6.3 million in fees in its annual report. “For most private equity, real estate and hedge funds, fees are deducted from performance and thus not tracked,” PSRS/ PEERS CIO Craig Husting explains. “As such, the retirement system never directly pays a fee. The system gets a net return. Typically,
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a system will only pay direct fees – through accounts payable – to traditional managers in the public equity or public fixed income area.” Husting, who joined the fund in 1999, has made fee transparency a tenet of his strategy. “Our philosophy is to be fully transparent to the people interested in our system,” he says. “It’s the best way to do it.” That belief took root back in 2009 when a board member, Jim O’Donnell, pushed the fund to publish all fees in its annual report, Husting recalls. The process is now supported by internal staff tasked with extracting information from reluctant managers and checking every quarter to ensure the fund is billed correctly. Transparency and disclosure are also rooted in a fee philosophy with stated beliefs that give direction and confidence to manager selection in the fund’s active pursuit of a 7.6 per cent annual return. Investment selection is made according to expected net-of-fees returns and risk, meaning Husting is prepared to pay higher fees when performance is strong. Also, he won’t choose a manager just for its low fee. “Higher fees do not mean lower investment returns,” he says. “As a general rule, PSRS/PEERS only pays higher fees for skill-based investment returns, diversification that is not available through passive alternatives and access to hard-to-obtain asset exposures.” PSRS/PEERS now pays 6 basis points on more than $7 billion invested in fixed income strategies and 15 basis points on over $8.5 billion invested in large-cap equity strategies. Over the years, the process has revealed certain patterns. “The investment expense ratio will be very high in a year when the beginning assets of the systems are low and performance is very good,” he explains, noting that this is consistent with the PSRS/PEERS philosophy regarding fees: net-of-fees returns are the most important and the systems will pay higher fees when performance is strong. For example, in 2014, the fund returned 16.7 per cent and the expense ratio – or fees – totalled 1.15 per cent, compared with poorer returns and a correspondingly lower expense ratio of 0.84 per cent in 2014. In 2016, PSRS/PEERS total management and carry fees were 0.92 per cent but reflected
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through the accounts payable process this would’ve been just 0.20 per cent, and if policy were just to reveal fees but no carry, it would’ve shown 0.69 per cent.
HEDGE FUNDS True to PSRS/PEERS’ promise to negotiate the lowest fees possible, over the last three years the fund has taken advantage of the tougher climate for hedge funds to renegotiate terms. The 6 per cent target allocation sits in PSRS/PEERS’ 60 per cent allocation to liquid public markets but is overweight at 11 per cent of assets under management. Shares and bonds are overvalued and Husting likes hedge funds’ lower-risk alternative to equity. “With hedge funds, we typically try to renegotiate fees for a five-year period,” he says. “It’s a negotiating process between the asset-based fee, the carry and potentially a lock-up.” PSRS/PEERS runs two hedge fund programs. A standalone portfolio with a beta of .35 per cent, which is invested with 16 managers and no funds-of-funds in 21 assignments. The portfolio had a total management fee in fiscal year 2017 of 111 basis points and PSRS/PEERS paid an additional 89 basis points in performance fees.
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A second hedge fund portfolio, established in 2006, is an alpha overlay on the S&P 500, comprising 10 mandates with 8-9 managers. The alpha overlay costs 110 basis points in management fees and 75 basis points in performance fees, Husting says, frustrated that he can’t compare what he pays with other pension funds. “There is no industry standard regarding fee disclosure,” he says. “Each system provides varying levels of disclosure. The Institutional Limited Partners Association (ILPA) has had some success with its fee disclosure and reporting initiative but full adoption by investors and the firms they do business with will not occur in the near term.”
PRIVATE EQUITY In private equity, where booming demand has made fee negotiation with PSRS/ PEERS’ 86 general partners much harder, strategy focuses on diversifying amongst big and smaller managers. Rather than focus on large assignments with a limited number of managers, each manager gets the same bite-sized portion. “We think that if we were to give a $20 billion fund $500 million and a $1 billion fund $50 million, there would be too much weight on the $20 billion fund in the portfolio,” Husting explains. “We also believe that some of the smaller private equity firms can produce as good, if not better, returns over the long term.” He takes this stance even though it creates more work for his team. It’s much easier to give larger allocations to big GPs, since PSRS/PEERS has chunky amounts of capital to deploy. The fund also uses a consultant, Pathway Capital Management, to access the best funds and is gaining a toehold in venture capital by agreeing to take smaller, $10 million, allocations in the expectation more will follow. “Pathway reviews a large number of partnerships and then works in conjunction with our internal staff on a smaller focus list to conduct due diligence and secure an allocation,” Husting explains.
Collaboration will get you everywhere By Amanda White
IN A COMPETITIVE world, where much of the capital is chasing the same opportunities, sovereign wealth funds must collaborate to access investments, Alaska Permanent Fund chief executive Angela Rodell said in an interview at the annual International Forum of Sovereign Wealth Funds conference in Morocco. Alaska Permanent was a founding member of the forum and Rodell, who this week was elected deputy chair of IFSWF, said although the forum has evolved, it started with a mandate that included the Santiago Principles and creating a transparency framework for good governance. “There is also now an understanding of how our peers are operating and a higher degree of comfort,” Rodell said. “If you look at the investment opportunities and where global growth will come from, it is important for us to have those relationships, for example, in Africa, South-east Asia and China.” Alaska has launched two partnerships collaborating with other investors – one in private markets and one in public markets. Capital Constellation, which took about 15 months to create, is a joint effort between Alaska Permanent, the UK’s Railpen and Kuwait’s Public Institution for Social Security, to better access private markets. The second team-up for Alaska Permanent is a collaboration with McKinsey Capital on the creation of a public equity closed fund investing across 25 countries in the Middle East, Africa and south Asia. The fund’s heaviest weight, about 40 per cent, is in India. Alaska Permanent invested $100 million in this fund, and is encouraging other investors to allocate. The idea is to list the fund. “The idea is to gain access to those public markets that are hard to access and not overwhelm or create too much heat in that exposure,” Rodell said. While the modern world relies on technology, Rodell said nothing beats having personal relationships and people on the ground in various places. “Even if an SWF can’t invest side by side with you, [it] might give you insight and understanding that gives you a leg up as an investor,” she explained. “Some investors have a sense there is a finite set
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GLOBAL CIO PROFILE \
of investment opportunities and all the world’s capital is fighting for that. For some of us, the opportunities are limitless but harder to find, so it’s not so much a competition as it is [a search for the] hardto-find pathways to the opportunities.” Alaska Permanent gives all Alaska residents a dividend every year. Until 2016, there was a statutory formula for the amount but for the last three years it has been negotiated between the legislature and the governor. This year, the dividend will be $1600 a person. Rodell said Alaska is a vast state (three times the size of Texas at low tide, and twice the size at high tide) with a population of only 700,000. If the person/ square metre ratio of Alaska applied to Manhattan, only 30 people would live there. Alaska Permanent has a board meeting next week to look at how to invest in Alaska directly, along with emerging manager initiatives. In calling on other investors to collaborate, Rodell said it was important to be patient.
“From my standpoint, while you may philosophically be on the same page, the devil is in the detail. You have to have a lot of patience,” she said. Taking 15 months to create Constellation allowed time to generate alignment on expectations for outcomes and benchmarking for success. Similarly, the public market fund with McKinsey took about nine months to finalise. The new chair of the IFSWF, Majed Al Romaithi, executive director of the strategy and planning department at the Abu Dhabi Investment Authority, said that with long-term mandates, SWFs make natural investment partners.
“But we are still only touching the surface when exploring opportunities to collaborate,” he told delegates in his introductory remarks at the conference. The framework for integrating climate change risks that the One Planet SWF working group recently developed is a possible template for collaboration in other important areas going forward, Romaithi said. “SWFs share many similar objectives but also have differences, in many ways,” he said. “It’s important to welcome new members who bring different perspectives. Working together, we can be more successful in reaching our own objectives and contribute to the global financial system on which we depend.”
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NOVEMBER 2018
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\ FIS STANFORD WRAP
FIDUCIARY INVESTOR SYMPOSIUM Stanford University 2018 Social impacts and governance were among many topics as global industry leaders gathered. INVESTMENT MAGAZINE’S SISTER publication Top1000funds.com’s bi-annual symposium brought together 84 asset owners from 14 countries with assets of US$7 trillion ($9.9 trillion), to collaborate and learn from a range of influential speakers. Drawing on the esteemed Stanford faculty, and taking advantage of the Silicon Valley location, the event focused on innovation and its impact on investments. As with the upcoming domestic version of the event to be held in Healesville, Victoria on November 19-21, the Stanford symposium brought investors together to examine best-practice strategy and implementation. Here is a selection of coverage from the event.
Photos Hagop’s Photography
Protecting human capital helps everyone By Sarah Rundell
Investors have an important role in ensuring that advances in technology are managed from a human rights perspective, particularly workers’ rights. A panel of experts chaired by Fiona Reynolds, managing director of the Principles for Responsible Investment heard how there is little democracy in many workplaces, including the tech industry, many workers are on short-term contracts with little job security and few rights, and technology is making their positions even more precarious. Investors have the influence to change things, said Deborah Ng, director strategy
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and risk and head of responsible investment, at Ontario Teachers’ Pension Plan. About 60 per cent of OTPP’s assets are invested in private markets, where investments are often direct, allowing direct access and communication with management. OTPP ensures investee companies have board oversight of human rights issues with a dedicated committee. Ng said if the pension fund has invested in a company in a disruptive sector, it asks that managing the potential impact on human capital be a part of strategy. She said it also checked to see that policies were enforced and requested the data and metrics to prove it. “If we don’t see these, we know there is an issue,” she said. Data needs to move away from
disclosure and more to discovery and investors need to take more control over what they are discovering, rather than just relying on what the data is telling them, said Andrew Parry, head of sustainable investing at Hermes Investment Management. Parry also told delegates that the ‘S’ for social, in ESG, is often overlooked and pointed to the interconnected nature of many of the disruptions under way from climate change, technology and demographics. He said disruption would be significant across every industry and urged investors to focus their engagement activities on improving the quality of jobs. This can be done by putting pressure on employers to pay a living wage, and ensuring human rights throughout supply chains, particularly in the extractive industries. The panel discussed how decarbonisation would lead to significant job losses and affect whole communities and towns built around traditional energy sectors. “Don’t forget the human side,” Reynolds said. “It is not just about stranded assets, people and communities get stranded as well.”
CalPERS shake-up may delay PE plans By Sarah Rundell
The far-reaching changes the $365.5 billion California Public Employees’ Retirement System plans for its private equity program still need final board approval. Yet one of the new model’s most important advocates, Priya Mathur, lost her seat on the 13-member CalPERS Board of Administration. Speaking at the FIS, on the eve of her surprise election defeat, Mathur, a board member for 15 years who was voted CalPERS’ first female president in January, told delegates the board was still working through the governance process for the private equity program. “I really believe this is essential for us and I hope to see the board endorse it in coming months,” she said. Mathur’s sudden departure after losing to first-time candidate police officer Jason Perez means CalPERS needs to elect a new president, heralding a board shake-up that
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FIS STANFORD WRAP \
PRIYA MATHUR
BRIAN CLARKE + GARRY WEAVEN
We are a maturing system, paying a lot in benefits and don’t want to sell assets to pay benefits could delay the urgent plans. CalPERS is in the final stages of approving a separate entity that would make direct private equity investments and would be governed by a separate, independent board. CalPERS Direct would consist of two separate funds. One called ‘Innovation’, focusing on late-stage investments in technology, life sciences, and healthcare; and the other called ‘Horizon’, for long-term investments in established companies that kick off cash flow. The pension fund hopes to increase investment in private equity – its best-performing asset class – to between $10 billion and $13 billion a year. “We are a maturing system, paying a lot in benefits, and don’t want to sell assets to pay benefits,” Mathur told delegates. “As truly patient capital, we are not just looking to sell after five to seven years.” She said the pension fund needed to invest over the longer term to better match its liabilities and tap private opportunities as the number of public companies declines.
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Australia’s ‘phenomenal’ collaboration By Sarah Rundell
Persuading asset owners to collaborate and work together is challenging, given the inherent competition for investments and returns. Yet a group of Australian investors speaking at FIS proved that collaboration can create economies of scale and help reap rewards such as cheaper fees and improved access to opportunities. Australia’s investor-owned IFM Investors, set up more than 20 years ago, now manages A$107 billion ($76 billion) on behalf of 310 institutional investors with 27 Australian superannuation funds as its shareholders. Part of IFM’s success in persuading its institutional clients to forego selfinterest is rooted in the ’80s, when Australia’s industry fund movement began, noted Garry Weaven, chair of IFM Investors Australia.
ANDREW PARRY + FIONA REYNOLDS
“It was easier to create collectivism because it was a movement from day one,” Weaven said. “We were not trying to bring existing organisations together.” Attendee Mark Delaney, CIO of AustralianSuper, one of the largest investors with IFM, told delegates that working in a collective is not always easy. “Everyone has an angle around ideas and portfolio construction,” Delaney said. He added that it is instinctive for different investors to “seek an edge”. “It is not easy to invest collectively because people want credit for themselves, rather than give it to someone else,” Delaney said. Yet he called returns from AustralianSuper’s collective investments with IFM “phenomenal”, in infrastructure particularly. Successful collaborations involve larger and more experienced investors within the group acting as leaders. attendee Sonya Sawtell-Rickson, CIO of HESTA, the A$43 billion superannuation fund for health and community workers, noted the leadership role of larger investors within IFM. “The larger funds have stood up and been stalwarts, breaking ground and sharing learnings for the benefit of others,” Sawtell-Rickson said.
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\ SP X X ONSORED X CONTENT THIS REPORT IS sponsored by J.P. Morgan
China equities, bonds enter mainstream Inflows into the Asian giant are set to soar but choosing an investment channel requires careful consideration, J.P. Morgan explains. There is no one right answer and the path can change depending on several factors. It ultimately depends on investors’ strategy, including investment horizon and objective, and their preferred asset class. The Qualified Foreign Institutional Investor (QFII) scheme first opened access for foreign investors to China A-shares in 2002, followed by the RMB-denominated RQFII in 2011; however, the Stock Connect offshore access channel, launched in 2014, has since become one of the simplest ways to invest.
ANDREW LAWSON SENIOR PRODUCT MANAGER, INVESTOR SERVICES, ASIA-PACIFIC | J.P. MORGAN
INVESTING IN CHINA’S fast-growing market has always been attractive and complex in equal measures – until now. The recent decision by MSCI, FTSE and Bloomberg to include mainland China shares and bonds in their indices after a series of capital market reforms marks a turning point for investors. The portfolios of superannuation and pension funds, endowments and exchange-traded funds will be reshaped as China’s weighting in the MSCI Emerging Markets Index and the Bloomberg Barclays Global Aggregate Index slowly rises to 3.36 per cent and 5.49 per cent, respectively. But while China’s doors are now firmly open, choosing the right access channel is still a difficult decision. Investors have multiple options and all are continually evolving due to new rules and regulations being introduced regularly to expand or simplify the access channels. It is crucial that all parties get involved, including traders, portfolio managers, operation managers, risk managers, compliance and legal, before selecting an investment channel.
‘‘
The recent decision by MSCI, FTSE and Bloomberg to include mainland China shares and bonds in their indices after a series of capital market reforms marks a turning point for investors.
It can take three to six months to be approved for a QFII or RQFII licence, compared with just three weeks to set up via Stock Connect. The China Interbank Bond Market (CIBM) was first opened to QFIIs and RQFIIs in 2013, followed by CIBM Direct in 2015 and Bond Connect in 2017. Some J.P. Morgan clients started as QFIIs in 2002-05 and, over the years, have sold down their QFII holdings in
favour of the simpler Stock Connect and CIBM Direct channels but even Stock Connect looks very different today than when it launched in 2014, meaning investors must continually adapt. The US and mainland European investors without operations in Asia time zones can find the requirement of T+0 settlement challenging. We have helped clients manage risks such as avoiding counterparty exposure until the Stock Connect system launched Special Segregated Accounts (SPSA) to eliminate pre-delivery of securities in 2015 and a real-time delivery-versuspayment option (RDP) in November 2017. Bond Connect also recently changed its settlement process to better manage counterparty exposure, prompting some clients to gravitate towards Bond Connect as opposed to CIBM Direct. Recently, new regulations have also made it easier for QFII and RQFIIs to repatriate principal back to their home country. Nonetheless, some investors remain concerned about the ability of the government to restrict the flow of capital leaving China. Historically, foreign investors have been largely unaffected by temporary freezes, which have been applied to local investors, often for macroeconomic reasons. The over-riding trend continues towards opening access for foreign investment. In the 12 years that J.P. Morgan has been investing in A-shares, we have never had an issue repatriating capital, including when the market suffered issues in 2015 and in early 2016. Change is and will be continuous but drawing on the perspective of a business with a long history of offering global custodial and brokerage services in China, which can also rely on a Hong Kong-based sub-custodian partner, J.P. Morgan can provide investors with a path forward that will help them share in the China growth story. For more information on J.P. Morgan Investor Services, please visit: jpmorgan.com/is
The products and services described in this document are offered by JPMorgan Chase Bank, N.A. or its affiliates subject to applicable laws and regulations and service terms. Not all products and services are available in all locations. Eligibility for particular products and services will be determined by JPMorgan Chase Bank, N.A and/or its affiliates. © 2018 JPMorgan Chase & Co. All rights reserved.
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CUSTODY MAT TERS \
THE SEARCH FOR A SINGLE SOURCE OF TRUTH ASSET OWNERS AND MANAGERS are seeking to generate a single data record across the organisation, for governance, compliance, quality management and operational efficiency. By Rachel Alembakis
“This may well have contributed to recent developments where we have seen the emergence of standalone data solutions by some service providers to try to accommodate clients’ specific needs,” Nguyen says. When asset owners or managers use multiple vendors to manage data, they need to establish
CLIENTS ARE USING custodians and administrators to source a single set of data to feed processes across applications and platforms, Mercer Sentinel principal Tricia Nguyen says. “Custodians and fund managers typically source or retrieve asset data from multiple vendors to populate a single data record to be [used] for different purposes, [such as] fund accounting, performance reporting, etc,” Nguyen explains. A single data set would ensure consistent quality across the various platforms and uses, and reduce the need to reconcile data, she says. She notes that Mercer Sentinel has seen cases where clients have wanted an external vendor to manage and navigate data for a required outcome, making a single data set more difficult to achieve.
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costs, maintenance costs and data-hosting costs, along with change-management costs,” Nguyen says. “Alternatively, asset owners and asset managers may have internal databases, which may have [implications for resourcing and depend on key people for] maintenance and updates. “Outsourcing the datahosting services to a custodian is another option but this also bears cost implications and further
Strong oversight, access and interaction at the senior management level underpin a robust governance framework governance structures to oversee the relationships and reconcile data sets between the standalone provider and the data the custodian or administrator provides. Beyond such questions around governance structures, there are other decisions clients must make before choosing how to manage data. There are several options. “Various key aspects to consider include the significant cost of a data solution, as there are build
embeds the clients into their outsourced service arrangement, which may give rise to other relevant considerations.” Regulatory developments, such as RG 97, and an increased focus on data transparency have “arguably”
contributed to the push for a single source of truth in data management, Nguyen says. “Top-down regulatory sentiments around data transparency have been reflected in greater demand and increased complexity in requirements around data navigation and management,” Nguyen says. “In a fiduciary capacity, the onus, therefore, is on being able to reconcile the underlying data and demonstrate a consistent set of underlying data records,” despite diverse applications. The key to managing a single source of truth when it comes to data is to treat data as an enterprise asset, Nguyen says. “This requires ongoing monitoring under a clear governance framework that involves relevant stakeholders within the business via clearly defined responsibility in terms of managing the endto-end data flow through the investment cycle,” she says. “There must be alignment in terms of consistency of the underlying data source. “Notably, strong oversight, access and interaction at the senior management level underpin a robust governance framework, and a robust governance framework is especially pertinent in terms of proactively tracking any initiatives [for a datamanagement offering], to ensure timely and effective escalation for issues resolution.”
CUSTODY MAT TERS IN A SSO CIATION WITH
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LIFESKILLS \
COVER CHANGES MAY HURT OUTCOMES Proposed adjustments to group insurance could leave FEWER PROTECTED while increasing the cost to the government.
ADAM GEE PARTNER, SUPERANNUATION ADVISORY | KPMG
AS THE SUPERANNUATION industry continues to navigate its way through the maze of regulatory changes and industry reviews, one of the most complex areas trustees must consider is the small group of quiet material changes announced within the 2018 Federal Budget. The most significant budget changes were those relating to insurance within super. The main proposed adjustments include the referral of small, inactive accounts to the Australian Taxation Office for automatic consolidation, which will have a significant impact on some funds’ revenue models and ongoing sustainability. Whilst there is no doubt group insurance is not perfect and some tweaking could result in better product tailoring, we remain concerned that the Federal Budget changes in relation to insurance will
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have a significant number of unintended consequences that could result in worse outcomes for many fund members and their beneficiaries. We note that three key changes to insurance within superannuation were announced in the Federal Budget: • Complete removal of default insurance coverage for members under 25
removed if the Federal Budget’s changes are implemented without amendment. Whilst much of this relates to insurance for members with accounts that have not received contributions for more than 13 months, we remain concerned that the quantum of insurance removed from the system will have longerterm implications for the economy, given Australia’s
We remain concerned that the Federal Budget changes in relation to insurance will have a significant number of unintended consequences
• Removal of default cover for members with balances less than $6000 • Removal of cover for members who haven’t received a contribution for 13 months. Our review of the impact of these changes suggests that better tailoring of insurance products, which many of the funds have already commenced, would provide better outcomes for fund members than the wholesale removal of cover for certain categories of members. Based upon our analysis, we estimate that about half of the insurance provided through superannuation may be
already well-known underinsurance issues. A further concern is the impact of the removal of cover for members under the age of 25, which could have detrimental effects upon those who maintain cover within superannuation going forward. This is because group insurance is a pooling arrangement, in which pricing is based on the risk of the overall insurance pool. By definition, removing younger, generally lowerrisk members from the pool can serve only to increase the risk of the overall pool, probably leading to increases in insurance premiums for the
remaining members, to offset this higher risk. Our estimates have suggested that the overall increase in insurance premiums could be, on average, as much as 26 per cent across the industry, with some funds they have a substantially older demographic or higherrisk membership base faring much worse. We also remain highly concerned with the implementation timeframes the government has proposed. A commencement date of July 1, 2019 for the majority of these changes remains too short, particularly given they have yet to pass through both houses of Parliament, creating uncertainty for all funds and their insurers about which areas might become law. Some of the issues associated with erosion of small accounts due to insurance will probably be resolved by the account consolidations, which will be achieved automatically via the transfer to the ATO. Coupled with this, funds will be undertaking more tailoring of insurance to better suit their membership. Whilst we recognise the government’s intent to ensure insurance within super meets the needs of members and does not unnecessarily erode retirement benefits, the impact of the changes could be far-reaching and result in a material reduction in the number of members with insurance, the cost of which would ultimately fall upon the government. LIFESKILLS Lifeskills is a regular section in Investment Magazine. Each month, we publish an independent column from an industry leader with insights into best practice in the group insurance sector. This page is produced with thanks to advertising support from AIA Australia.
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NO MORE
‘WET LETTUCE’ The Hayne inquiry’s interim report suggests regulators will soon hand down discipline crisp enough to make institutions think twice about wrongdoing. By Andrew Main
GIVEN THAT MOST commentators cheered and some grumbled about the reach of the interim report from the Hayne royal commission, you could probably conclude that Commissioner Kenneth Hayne got it pretty much right. An interim report was never going to please everybody because in this case it’s all about what went wrong, most particularly in the bank lending and financial advice areas, and there’s a total absence of heads appearing on spikes. That said, some organisations got a pretty substantial towelling up, most particularly the supposed twin peaks regulators, the Australian Securities and Investments Commission and the Australian Prudential Regulation Authority. As Hayne put it, “The conduct regulator, ASIC, rarely went to court to seek public denunciation of and
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punishment for misconduct. The prudential regulator, APRA, never went to court.” There are ways to punish miscreants other than via court action. But as Hayne wrote, ASIC went for what has long been called the ‘wet lettuce’ penalty approach: “Little happened beyond apology from the entity, a drawn-out remediation program and protracted negotiation with ASIC of a media release, an infringement notice, or an enforceable undertaking that acknowledged no more than that ASIC had reasonable ‘concerns’ about the entity’s conduct. “Infringement notices imposed penalties that were immaterial for the large banks. Enforceable undertakings might require a ‘community benefit payment’, but the amount was far less than the penalty that ASIC could properly have asked a court to impose.”
We already knew that but when a former justice of the High Court spells out in easily understood language what has really got up his nose, you pay rapt attention. What rankled him was that once the big players realised they could arm wrestle and obfuscate their way to coughing up a financial penalty that was less than the profit they had made by doing the wrong thing, it was game over. APRA will be getting quite a serve in the final report, too. I’d often wondered how a prudential regulator charged with keeping an eye on financial institution solvency was ever going to get dragged into a fight about consumers being ripped off but the charter makes it clear. If anything, it puts consumers ahead of financial stability. Talking about the banks and insurers APRA oversees, it states: “These institutions currently hold approximately $6 trillion in assets
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ROYAL COMMISSION \
for Australian depositors, policyholders and superannuation fund members (our ‘beneficiaries’). APRA supervision is aimed at protecting the interests of these beneficiaries and promoting the stability of the Australian financial system.” It’s pretty clear.
ROYAL COMMISSION DEJA VU As a veteran of the HIH Royal Commission of 2002, I can’t help noticing just how much this is a case of history repeating itself. The two commissions seem to run in parallel in the area of ethics. Much of Hayne’s ire in the interim report is directed at bank employees and advisers who were more interested in earning lots of bonuses and commissions than in safeguarding the interests of their various clients. Looking, for instance, at the mortgage broking industry, he noted that, “For individuals, the conduct resulted in being paid more. For entities, the conduct resulted in greater profit. How is a value-based commission consistent with acting in the interests, or best interests, of the client?” That’s a punchy rhetorical question with an obvious answer – it isn’t – and it’s quite an echo of Commissioner Neville Owen’s musings in his 2003 report on HIH, in which he wondered whether insurance company executives doing dodgy things such as hiding reserve shortfalls ever asked themselves, “Is this right?” That question, of course, has the same obvious answer. In both commissions, there’s an air of judicially worded incredulity at how people with good salaries and financial educations can get themselves into such a mess that they manage to ruin their own reputations and those of their organisations for years or even decades.
REGUL ATORS AND RESOURCES Talk of reputation brings us back to ASIC and APRA. While the zealots are muttering about ditching both of them because of their feeble performance, let’s remember that APRA got a wholesale cleanout in 2003 after HIH. The entire top layer of management walked the plank. What replaced it was a triumvirate of commissioners headed by the wellrespected John Laker.
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You could be cynical about the fact that APRA’s back in the crosshairs but that doesn’t mean the overhaul was wasted. It’s generally believed nowadays that the reboot of APRA 15 years ago was the single most significant factor in Australia having avoided the GFC of 2008. APRA has basically done well on the financial stability half of its charter, at the cost of the near-abandonment of the other half. It might be logical now to hand the consumer protection side of the APRA charter entirely to ASIC or to a muscled up version of the ASIC we see now. Lots of things will have to change there because we know we’ve been lied to by the government, in particular our new Prime Minister Scott Morrison when he was treasurer, about ASIC being the “tough cop on the beat”. It’s telling that Peter Kell, the ASIC deputy chairman with the most responsibility for consumer protection, has announced he’s leaving his post before the end of his contract. That news came out a couple of weeks before the interim report. But he’s just a bloke who has been doing a very difficult job with limited resources. There will obviously be some damning recommendations in the final report but Kell will have made his exit by then. Meanwhile, new chairman James Shipton can safely claim he arrived after the train wreck. The ASIC people are culpable, as Hayne wrote, for beating up on the small fry while letting the big banks off very lightly, but it’s also true that the federal government has been careless in cutting ASIC’s funding at unsuitable moments, and it’s always more expensive to tackle big fish than small ones. Conclusion? The government must be prepared to resource the consumerprotecting regulator in such a way that it can treat both scales of villain equally – in court if necessary. What is bound to happen is that the ‘cost of doing business’ approach to penalties that the big banks have been enjoying will absolutely come to an end.
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INVESTMENT
THE TROUBLE WITH RISK PREMIA
It’s the hot new buzzword at superannuation funds and it promises standout returns with lower risk and fees. It’s also based on a flawed premise.
JOHN PETERSON PORTFOLIO MANAGER FOR ALTERNATIVE INVESTMENTS | LOCAL GOVERNMENT SUPER
RISK PREMIA – ALSO known by its aliases ‘liquid alternatives’ and ‘smart beta’ – is the latest buzzword strategy for superannuation fund investments. It is also a disaster waiting to happen. Go to any investment conference and the phrase ‘harvesting risk premia’ will be bandied about casually, as though risk premia – which are the investment returns from taking these ‘special’ market risks – were just lying around waiting to be collected. I’m not convinced. In 40 years in investments, I have never seen returns that are not accompanied by commensurate levels of risk – no matter how ‘smart’ a strategy may proclaim itself to be. So, what is the problem with risk premia strategies? In these strategies, rather than having exposure to a whole market (such as
Australian equities), the focus is on having exposure to only one, or a few, of the risk factors (market betas) that make up the overall market. There is nothing new about looking at a market as a combination of risk factors. Market risk factors have been analysed for decades and academic researchers claim to have identified hundreds of betas.
are supported by academic research. The proposition is that market factors identified by research as performing well in the past will be sources of ‘good risk premia’ that can be ‘harvested’ regularly and continuously in the future. It follows that a smart investor will invest in these ‘good’ betas and exclude the other ‘bad’ market betas.
It is the reliance on an academic foundation that is the Achilles heel of the whole risk-premia approach
Two things are new: 1 | First, the use of moderately sophisticated portfolio construction techniques to create investments with exposure to a greater number of more specific/ narrower market factors and associated returns (risk premia). 2 | Second, the focus on marketing these risk premia investments by saying they
NOVEMBER 2018
It is this seemingly magical promise of liquid alternative smart beta risk premia to deliver consistent excess returns that is so attractive, along with the fact that, as market exposures, they are available at minimal cost with no management fees. Unfortunately, it is the reliance on an academic foundation that is the Achilles heel of the whole
risk-premia approach. Academic research is only as good as its underlying theory and, unfortunately for risk premia strategies, current academic theory does not reflect the real investment world. For example, a basic premise of the current best academic investment theory – modern portfolio theory (MPT) – is that we get rewarded for taking risks (defined as the volatility of returns) and higher risks are associated with higher returns over time. This is the basis of the classic risk/reward trade-off and underpins the proposition that a strategy with exposure to good risk premia will consistently deliver excess returns that can be harvested. Unfortunately, even this core proposition of MPT does not hold up in reality – at least not over timeframes that are of relevance to superannuation fund investors. According to MPT, the returns of Australia’s balanced superannuation funds should have a positive, or upward sloping, relationship with volatility; however, the actual risk/return trade-off is consistently downward sloping over longer periods. In reality, risk premia are based on market risks, and markets, which consist of a diversified mix of risk factors, can and do underperform for long periods of time. We can expect that single market factors will also underperform – i.e., have negative risk premia – for even longer periods. Given that many risk premia were supposedly identified during the period of low interest rates and quantitative easing following the GFC, it is not surprising that the results being ‘harvested’ since QE are not living up to expectations.
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FEAL & PIMCO Institute Scholarship 2019 FEAL is currently inviting applications for the FEAL & PIMCO Institute Scholarship. The scholarship opportunity is designed to help fund executives enhance their skills and knowledge, inspire new ideas, deliver keen insight and support their on-going professional development. Made possible with the support of PIMCO, this scholarship provides a unique opportunity for participants to attend the exclusive PIMCO Institute, learn from leading academics and network with colleagues from around the globe. The three-day seminar emphasises content consistent with advanced academic study and incorporates a dynamic, team-based portfolio simulation exercise.
3 - DAY S E M I N A R 11 - 13 June 2019 Newport Beach, California
Applications close at 5pm (AEDST) Friday, 16 November 2018 TO PI C S I N C LU D E:
> Portfolio Management Simulation Exercise > Outlook for Global Financial Policy and Capital Markets > Credit Markets and Capital Structure > Evolution of Derivative Instruments > Equity Portfolio Construction
S U P PORT E D BY
> > > > > >
Critical Issues in Asset Allocation Emerging Markets: Issues and Opportunities Understanding Factor-Based Risk Metrics Managing Inflation Exposure Role of Alternatives and Absolute Return Investing State of the Housing Market
For more information contact FEAL on (02) 9261 5155 or visit:
www.feal.asn.au
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INNOVATION
OUTCOMES WORTH THE SLOW BUILD The government’s Medical Research Future Fund is ramping up its investments in groundbreaking health and medical research, just three years after it was established.
YASSER EL-ANSARY CHIEF EXECUTIVE | AVCAL
SOME HAVE SAID that it’s been a slow build for the MRFF, but it’s worth bearing in mind that the fund is set to become one of the largest medical research endowment funds in the world, with an anticipated $20 billion in assets by 2020-21. The 2018-19 Federal Budget unveiled a range of MRFFbacked research initiatives, including the multi-strand National Health and Medical Industry Growth Plan, which will invest $1.3 billion over the next decade. The program has the potential to cement Australia’s place as a world leader in research and technology development for health and medicine. Among its key investments is a $500 million program to develop a new
Genomics Health Futures Mission, which will ultimately deliver innovative drugs, devices and therapies to millions of Australians and others around the world. A deeper understanding of genomics – which essentially is the complete set of human DNA – may lead to targeted treatments of rare cancers and other diseases and complex conditions, by identifying single-point mutations in key genes. This in-depth knowledge has the potential to change the way practitioners administer clinical treatment to patients in the future. As we all age, that’s something we should all be excited about. The Genomics Health Futures Mission will also fund targeted and adaptive clinical trials and ways to improve research, industry collaboration and investment. Priority projects include a new pre-conception screening trial for rare and debilitating birth disorders such as spinal muscular atrophy. Another key National Health and Medical Industry Growth Plan investment is the Targeted Translation Research Accelerator program. It has been allocated $125 million over nine years to support early-stage health and medical research on chronic conditions such as diabetes and heart disease, which affect more than 5 million Australians.
NOVEMBER 2018
EARLY CAPITAL The program is expected to alleviate a key problem that sometimes faces early-stage health and medical research – a relatively shallow pool of capital available to be invested in commercialising these promising discoveries.
and medical technology programs. The MRFF will inject about $650 million into research in 2020-21 – almost triple the level of investment it will make in 2018-19. One of the pleasing outcomes from what the MRFF is doing is the knock-on positive effects it will have on the capacity of venture-capital investors to continue the journey of commercialisation for promising health and medical research discoveries. VC firms raised an impressive $1.32 billion in new commitments in 2016-17, more than doubling the previous year’s record. VC has backed countless medical successes over the
The MRFF will inject about $650 million into research in 2020-21 – almost triple the level of investment it will make in 2018-19
An expert advisory committee, led by me in my capacity as an MRFF board member, has been formed to identify research priorities, business and philanthropic co-funding models, and mechanisms for supporting these types of grants. The overarching Health and Medical Industry Growth Plan will also invest: $240 million over four years for a Frontier Health and Medical Research program; $248 million over five years for an expanded rare cancers, rare diseases and unmet-need clinical trials program; and $94 million over four years for industry research collaborations and biomedical
last few years, including from world-leading firms such as Vaxxas (which produces a needle-free, pain-free vaccine delivery solution) and Global Kinetics Corporation (which created the Parkinson’s diseasefocused KinetiGraph treatment system). There’s every reason to expect VC investors to drive even greater medical successes over the years ahead.
EL-ANSARY IS A BOARD MEMBER FOR THE AUSTRALIAN MEDICAL RESEARCH ADVISORY BOARD, WHICH PROVIDES ADVICE AND RECOMMENDATIONS TO THE GOVERNMENT ABOUT THE MRFF’S STRATEGY AND PRIORITIES.
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EVERY GREAT ACHIEVEMENT IS SIMPLY FUEL FOR THE NEXT Because ambition drives investment opportunity. At Franklin Templeton, we believe ambition is the engine of progress. That’s why we span the world to find companies on the verge of revolutionising their industries. It’s all part of our active investment approach – one that has discovered new investment opportunities for over 70 years. Learn more at reachforbetter.com.au
Franklin Templeton Investments Australia Limited (ABN 87 006 972 247) (Australian Financial Services License Holder No. 225328) issues this publication for information purposes only and not investment or financial product advice. Investments entail risks, the value of investments and the income from them can go down as well as up and investors should be aware they might not get back the full value invested. © 2018 Franklin Templeton Investments. All rights reserved.
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POLICY
‘IS THIS RIGHT?’ – A NEW CHECKLIST Greed and shocking misconduct grab the headlines but there are many sore spots funds must address to win back trust.
EVA SCHEERLINCK CHIEF EXECUTIVE | AUSTRALIAN INSTITUTE OF SUPERANNUATION TRUSTEES
THE HAYNE ROYAL commission has given us all plenty to mull over. Much of the recent commentary has rightly focused on the shocking misconduct of the banks and insurers and Commissioner Kenneth Hayne’s headline message in his interim report that greed was mostly to blame. But there is a checklist of other important observations that, arguably, all financial services entities should take heed of to assess how well their company is running. Here are my thoughts on what such a checklist might look like for a super fund: Independence and consultants: Two of the biggest news stories from the hearings were case studies in which so-called independent reports companies commissioned to provide to regulators were shown to be anything but.
Doctoring results or coercing consultants to change their findings is unacceptable. Fund communications: In many of the case studies, internal and external communications were shown to be sloppy at best and misleading at worst. This included overblown marketing statements on websites and loosely worded emails to members. Even the smallest website change needs a compliance lens. The potential impact should not be underestimated. Staff resourcing: Many entities before the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry blamed a lack of staff for errors that led to poor consumer outcomes. Hayne’s response was blunt: resources are within the control of boards and executives. He asked whether there should be greater consequences for
entities that fail to design, maintain and resource their compliance systems to ensure they are effective. Compliance: The interim report emphasises that compliance should be dealt with comprehensively, rather than on a piecemeal basis, “which does not readily permit identification of underlying causes”. In a highly regulated industry, compliance is a necessary cost of doing business and should be appropriately resourced. The report also notes that technology glitches can constitute serious misconduct because they represent a failure to meet a contractual promise. Staff training: Many case studies revealed that company policies were not well understood or applied by junior staff. Hayne noted the importance of adequate education and training of staff: “Those who know why the step
Even the smallest website change needs a compliance lens. The potential impact should not be underestimated
NOVEMBER 2018
is required are more likely to take it than those who know only that the relevant manual requires it.” Documentation: Improper and inconsistent documentation was another concern. This was most stark in IOOF’s case, when the company submitted hand-written board minutes as part of its evidence. But there were other instances of entities lacking documentation to account for key decisions and the monitoring of those decisions. The message for super funds? Less is not more. Whether it is the assessment of board appointments, sponsoring arrangements or outsourcing agreements, the reasoning behind decisions must be fully documented. This also applies to credit card expenses. Culture and remuneration: A key message in the interim report was that incentivised remuneration schemes fuelled a greed-driven culture. While this type of remuneration is far less common in the profit-tomember super sector, it does exist and should be carefully considered in light of Hayne’s observations. The royal commission has reminded us of the enormous trust that consumers place in providers of financial services. From directors through to those working at the call-centre coalface, everyone in the super sector has a role to play in ensuring this trust is well placed. In his final report on the royal commission into the collapse of HIH Insurance, back in 2003, Justice Neville Owen commented: “Did anyone stand back and ask themselves the simple question, ‘Is this right?’” Hayne is arguably asking the same question today, and funds could do worse than to add it to their decision-making frameworks.
investmentmagazine.com.au
13 -15 MARCH 2019
GOLD COAST CONVENTION & EXHIBITION CENTRE
The Australian Institute of Superannuation Trustee’s (AIST) flagship event, the CONFERENCE OF MAJOR SUPERANNUATION FUNDS (CMSF) is the premier idea sharing and networking event for Australia’s $1.2 trillion profit-to-member super sector. In providing a platform to dissect the most pressing issues, CMSF will be an invaluable opportunity for you to hear from distinguished speakers and gain practical insights into topics covering your industry, your members and yourself.
JOIN US AS WE HEAR FROM
WHAT WILL WE BE TALKING ABOUT? ROYAL COMMISSION PRODUCTIVITY COMMISSION INDIGENOUS SUPERANNUATION ADVICE SOLUTIONS POST ROYAL COMMISSION INNOVATION IN FUNDS FUTURE TRENDS IN CUSTOMER SERVICE
Adele Ferguson
Business Journalist The Age, Sydney Morning Herald & the Australian Financial Review
Ian Silk
Chief Executive Officer AustralianSuper
EARLY BIRD REGISTRATION For more information and to secure your early bird registration before December 12, visit aist.asn.au/CMSF
Craig Reucassel The Chaser & War on Waste
Dr Sally Auld
Chief Economist and Head of Fixed Income & FX Strategy, Australia and New Zealand J.P. Morgan
QIC LIQUID ALTERNATIVES FUND. WELL-DIVERSIFIED. MINIMAL EQUITY RISK. AUSTRALIAN BASED, GLOBAL CAPABILITY. Equity market risk continues to dominate institutional portfolios. Diversification from equities is a high priority for investors and is core to QIC Liquid Alternatives Fund’s construction. At QIC, we believe factors harvested from traditional asset classes can deliver a more resilient portfolio, built to withstand a range of market events. As an Australian wholesale funds manager, we uniquely understand the priorities and sensitivities of Australian clients whilst having the vision and implementation capability of a global manager. QIC.
Global Multi-Asset Global Liquid Strategies Global Infrastructure Global Real Estate Global Private Capital
www.qic.com QIC Limited ACN 130 539 123 (QIC) is a leading investment provider for sovereign wealth funds, superannuation funds and other institutional investors. Its products and services are not directly available to retail clients. For more information about QIC, our approach, clients and regulatory framework, please refer to our website www.qic.com or contact us directly.