Investment Magazine July18_Issue 151

INTELLIGENCE FOR INSTITUTIONAL INVESTORS

ISSUE 151

+

TENURE TALK

Trustees on setting limits

WORTH

the price

LG Super’s portrait of success with active management CHAIR’S SEAT

GEOPOLITICS

ROUNDTABLE

LIFESKILLS

AUSTRALIANSUPER’S

PRINCETON’S

CREDIT EXPERTS

WHERE DANGER

JIM CRAIG ON NEW

STEPHEN KOTKIN

HAVE RECESSION

MAKES INSURANCE

OWNERSHIP PRINCIPLES

EXPLAINS THE RISKS

IN MIND

A PRIORITY

JULY 2018

02

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THIS ISSUE \

CONTENTS JULY 2018

COVER STORY

18 CIO PROFILE LG Super CIO Craig Turnbull on why the fund is 100 per cent actively managed and why fees tell only half the story

ROUNDTABLES

10 GEOPOLITICS Geopolitical risk can’t be priced but investors should consider it in their decision-making anyway

14 CREDIT Where are we in the credit cycle and what should investors do about it?

FEATURE

24 BOARD TENURE Should trustees have hard term limits?

COLUMNS

23 LIFESKILLS The hazards of the construction industry make insurance even more important for Cbus Super than for most funds

30 POLICY The troubles within super are more manageable than the Productivity Commission’s report suggests

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CHAIR’S SEAT

“The investment committee has a key role in ensuring that the performance is as good, or preferably better, than using external managers for the same strategy.”

JIM CRAIG | INVESTMENT COMMITTEE CHAIR | AUSTRALIANSUPER

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\ FROM THE EDITOR

EDITORIAL DIRECTOR OF INSTITUTIONAL CONTENT AND ACTING EDITOR

AMANDA WHITE / amanda.white@top1000funds.com

Amanda White JOURNALIST

Jean-Paul Pelosi HEAD OF DESIGN

A LETTER from the editor

F

Kelly Patterson ART DIRECTOR

Suzanne Elworthy SUB-EDITOR

Haki P. Crisden PHOTOGRAPHER

Matt Fatches

SOME FEES ARE WORTH IT

matt@mattfatches.com.au CHIEF EXECUTIVE

Colin Tate

ADVERTISING BUSINESS DEVELOPMENT MANAGER

OR MANY YEARS, the Australian market has had a reputation for being too focused on fees.

The regulator’s obsession with detailed disclosure is evidence of that. But at least ASIC is prepared to contemplate whether the disclosure of fees and costs under RG 97 actually produces more transparency for consumers. A review of RG 97 by Darren McShane was due at the end of June.

Some funds, including our cover story subject, Local Government Super, have pointed out that the current disclosure requirements create a bias towards the minimisation of investment costs, which in turn biases investors away from active management.

But LGS, and other funds such as TelstraSuper, are 100 per cent actively managed, and have proven they can add value, after fees, from active management.

Instead of a pure focus on fees and costs, the conversation needs to be about the value being generated.

And my hope is that will be an outcome of McShane’s review.

No one, including LGS, is arguing that reducing investment costs is a bad idea, especially in active management. But the focus should be on aligning interests, allowing asset managers and asset owners to have a shared purpose and shared returns after fees.

The recent overhaul of active management fees by the world’s

JULY 2018

largest pension fund, the US$1.4 trillion ($1.9 trillion) Government Pension Investment Fund of Japan, demonstrates this.

About 20 per cent of GPIF is actively managed, but between 2014 and 2016, only a small number of the fund’s active managers achieved the target excess return their mandates dictated.

This, and some self-reflection from GPIF on its manager selection capabilities, prompted it to revise fees, with the aim of better aligning them with performance.

The result is that, for active management, the fund’s base fee will now be lowered to that of a passive fund and a ‘carry over’, which partially accumulates payment of annual performancebased fees to link them with midto long-term investment results, has been introduced.

In a quid pro quo, the fund has also introduced multi-year contracts for managers.

GPIF’s costs in fees are not astronomical. For fiscal 2016, the total was ¥40 billion ($370 million).

This represents an average rate on the investments of about 0.03 per cent.

But that doesn’t seem to be the point. GPIF was looking for a way to align managers with its purpose and, ultimately, have managers do what they say they will do.

Doing so puts the focus on value, not costs.

Karlee Samuels

karlee.samuels@conexusfinancial.com.au (02) 9227 5721, 0420 561 947 BUSINESS DEVELOPMENT MANAGER

Sean Scallan

sean.scallan@conexusfinancial.com.au (02) 9227 5719, 0422 843 155 SUBSCRIPTIONS

Caitlin Leitch

caitlin.leitch@conexusfinancial.com.au (02) 9227 5718 CLIENT RELATIONSHIP MANAGER (EVENTS)

Bree Napier

bree.napier@conexusfinancial.com.au (02) 9227 5705, 0451 946 311

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ADVISORY BOARD MEMBERS Debbie Alliston, head of multi-asset portfolio management, AMP Capital | Richard Brandweiner, chief executive, BTIM Australia | 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, Perpetual | 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, chair, MLC Superannuation Trustees | Anne Ward, chair, Colonial First State and Qantas Super | Nigel Wilkin-Smith, director portfolio strategy, Future Fund

investmentmagazine.com.au

SEEKING RELATIVE VALUE IN

GLOBAL PRIVATE DEBT Private debt continues to gain favor as yield-hungry investors look for solutions to help meet their portfolio return targets. Institutional investors in particular are often drawn to private loans for the potential to earn incremental yield relative to broadly syndicated markets.

MEZZANINE DEBT In addition to the global opportunity

Investing globally can significantly increase the opportunity set of potential private loan investments, which can allow managers to invest more selectively. This is an important point because the relative value of private debt investments in North America, Europe, Australia and developed Asia shifts as yields tighten or widen over time in each region.

in senior debt, investors can find potentially attractive opportunities in private mezzanine debt, a subordinated part of the capital

THE DIRECT LENDING MARKET OFFERS INVESTORS A RANGE OF ATTRACTIVE POTENTIAL BENEFITS, INCLUDING:

structure that can offer attractive absolute and relative returns.

Notably, due to the “originate to

•

POTENTIAL RETURN PREMIUM VERSUS BROADLY SYNDICATED MARKETS

•

CONSERVATIVE STRUCTURES AND LOAN DOCUMENTS WITH STRONG INVESTOR PROTECTION

•

INVESTMENT DIVERSIFICATION

have lower volatility relative to liquid

•

ACCESS TO A BROAD UNIVERSE OF INVESTMENT OPPORTUNITIES

traded assets. Whether secured by

•

LIMITED CORRELATION TO PUBLIC MARKETS

a second lien or unsecured, private

hold” nature of private mezzanine debt, these investments tend to

mezzanine debt is structured more

North America In North America, for example, private debt spreads were relatively tight during the first half of 2014, while the pricing of risk was much more attractive in Europe. Spreads in the U.S. then widened in the latter part of 2014 through 2016, but began to tighten modestly in 2017 as U.S. base rates increased. However, given the more pronounced tightening of spreads for broadly syndicated loans, the “originate-to-hold” spread premium for private debt remains attractive, in our view. Private loans to U.S. issuers that are structured with more conservative leverage and loan-to-value than broadly syndicated loans currently yield a premium of roughly 125 to 150 basis points, although it can be substantially higher.1

conservatively than high yield bonds, and loan agreements typically provide stronger creditor protections.

Additionally, given the lack of liquidity in the asset class, investors may be compensated with significant illiquidity premiums relative to the high yield bond market.1

Europe In Europe, private loans to European issuers continue to benefit from high upfront fees, stable spreads and, in some cases, base rate floors that exceed prevailing Euribor. As a result, the current premium for private debt as compared to broadly syndicated debt is particularly attractive in Europe, in our opinion. In Europe, private loans structured more conservatively than broadly syndicated loans tend to generate illiquidity premiums of 175 to 200 basis points or more.1

Australia, New Zealand and Developed Asia There are also opportunities in Australia, New Zealand and developed Asia, where spreads are currently tighter compared to the U.S. and Europe, but issuers are typically larger and have more conservative credit structures. In Australia, competition has intensified over the last 12-18 months as banks have sought to grow their loan books. However, due to the lack of depth of capital markets in the region, select opportunities exist to achieve a potentially attractive illiquidity premium while investing in issuers that, if located in the U.S. or Europe, would be large enough to issue broadly syndicated loans.

Conclusion A global strategy can be an efficient way for private debt investors to access opportunities as they are sourced across different regions and markets. Because countries differ in terms of where they are in their respective economic, interest rate and business cycles, the relative attractiveness of their private lending markets can change over time. Diversifying across North America, Europe, Australia and developed Asia, therefore, may better position investors to seek relative value.

1.

Based on Barings market observations. As of December 2017.

This article is to be used by investment professionals for informational purposes only and does not constitute any offering of any security, product, service or fund, including any investment product or fund sponsored by Barings, LLC (Barings) or any of its affiliates. The information discussed by the author of the article is the author’s own view and may not reflect the actual information of any fund or investment product managed by Barings or any of its affiliates. Neither Barings nor any of its affiliates guarantee its accuracy or completeness and accept no liability for any direct or consequential losses arising from its use. INVESTMENT INVOLVES RISKS. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. 18-527903

LEARN MORE AT BARINGS.COM

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\ CHAIR’S SE AT

Shaping

OW NERSHIP

JIM CRAIG has been chair of the $103 billion AUSTRALIANSUPER’S INVESTMENT COMMITTEE since April last year. He has been an independent member of the board since 2016 and brings a wealth of financial services knowledge from his many years at Macquarie Group.

He talks to Amanda White about principles and strategy for Australia’s largest superannuation fund.

JULY 2018

investmentmagazine.com.au

CHAIR’S SE AT \

By Amanda White + Photos Mark Dadswell

Q: LET’S START BY LOOKING AT THE AUSTRALIANSUPER INVESTMENT COMMIT TEE AND ITS STRUCTURE AND DECISION-MAKING. CAN YOU TELL US A BIT ABOUT HOW YOU MAKE DECISIONS, AND HOW YOU DELEGATE DECISIONS TO THE INVESTMENT TEAM? A: AustralianSuper’s investment governance framework provides a clear set of delegations, from the board to the investment committee, and down to [chief investment officer] Mark Delaney and members of the investment team.

The delegations were restructured in 2017 into the form of mandates, both for each investment option the members invest in and each asset class. These are formal mandates and look like they would for an external provider.

Under this structure, the investment committee retains oversight of key investment decisions, such as key strategies in the portfolio, key parameters such as investment return objectives, risk appetite, liquidity limits and large strategic investments.

This is an evolution in our governance to be as clear as possible, which is appropriate, given our size.

Q: GIVEN THE CONTINUED LOW-YIELD AND LOW-RETURN ENVIRONMENT, ARE YOU LOOKING AT YOUR STRATEGIC ASSET ALLOCATION IN A DIFFERENT WAY AND MAKING ANY CHANGES? A: During 2017, the fund did a number of things. We reduced the portfolio’s exposure to unlisted assets – particularly property and credit – given valuations. We were close to our limit in unlisted, at about 33 per cent of our asset allocation. We are now at about 25 per cent.

The fund rotated these proceeds to equities, to take advantage of the improved earnings outlook and improvement in global growth.

We also increased our exposure to cash to maintain flexibility.

Looking forward, our asset allocation is driven by our view on economic growth, which we see as slightly positive, the impact

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of risk factors such as rising interest rates, and the valuations and return outlook.

Q: IT IS NOW A WELL-VERSED STORY THAT YOUR FUND IS AIMING TO HAVE ABOUT 50 PER CENT OF EQUITIES MANAGED INTERNALLY BY 2021. WHAT IS THE ROLE OF THE INVESTMENT COMMIT TEE IN HOLDING THOSE INTERNAL TEAMS TO ACCOUNT AND HOW ARE YOU DOING THAT IN PRACTICE? A: The investment committee has a key role in ensuring that the performance is as good, or preferably better, than using external managers for the same strategy.

Pleasingly, although it’s early days, to date this has largely been the case.

The investment committee is responsible for reviewing and approving any new internal strategies, and in initial phases we had a subcommittee providing greater oversight and advice on the establishment of the program.

For example, for the last two years, we have been looking at an internal quant strategy. The strategy was reviewed by the sub-committee, and they had two or three meetings looking at it. Once they were comfortable, it went to the investment committee for approval, before we allocated a small portion to it. It then went back to the subcommittee to review and monitor, to make sure it was doing what we wanted.

Then we made a larger allocation.

Q: CAN YOU TELL US A BIT ABOUT WHAT IS STRATEGICALLY IMPORTANT TO THE INVESTMENT COMMIT TEE AT THE MOMENT AND WHAT IN PARTICUL AR YOU ARE SPENDING TIME ON? A: At the moment, our focus is around key medium-term strategic issues, the oversight of the investment program and the internal management program. For example, we are putting a lot of work into a set of ownership principles that clarify our approach to governance of assets.

These will be AustralianSuper specific, and will guide us and the investment

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\ CHAIR’S SE AT

team in our governance of the investments we make.

We have a separate set of investment beliefs, but the ownership principles will deal specifically with being an owner of assets.

Q: SO LET’S EXPLORE THAT

A BIT MORE, CAN YOU TELL US ABOUT HOW YOU CONDUCT YOUR ENGAGEMENT, WHAT PROCESSES AND PRACTICES YOU HAVE PUT IN PL ACE TO MONITOR LISTED COMPANIES, HOW YOU EFFECT CHANGE AND WHAT IMPACT THAT IS HAVING? A: AustralianSuper uses an extensive engagement program that works on two levels. The fund’s equity team meets with the management and directors of a range of the companies in which we invest. This is often either part of an ongoing dialogue about future strategy, or we meet to discuss specific issues that might arise from time to time.

The other level of engagement is through the investment governance team that manages our active owner program.

Last financial year, the team attended or supported 272 meetings with ASX-listed companies, on material ESG issues, directly or via our engagement partner, the Australian Council of Superannuation Investors (ACSI).

In relation to directors of listed companies, we maintain a database of each director of ASX 300 companies, evaluated against shareholder returns and our assessment of ESG performance.

Q: IN THE AUSTRALIAN MARKET, YOUR L ARGEST POSITIONS ARE WITH THE BIG FOUR BANKS, BHP, TELSTRA AND WESFARMERS – WITH THE L ARGEST POSITION BEING COMMONWEALTH BANK. HOW ARE YOU REACTING TO THE ROYAL COMMISSION AND ARE YOU MAKING ANY CHANGES TO YOUR HOLDINGS, GIVEN WHAT IS COMING OUT OF IT? A: I can’t comment on individual stocks, but in broad terms, AustralianSuper is a long-term shareholder and wants to see boards act in the best interests of staff, customers and shareholders, as this is the only way to build long-term value. For too long, boards have put short-term targets above other key strategic interests.

Q: AUSTRALIANSUPER IS THE L ARGEST, AND FASTESTGROWING, FUND IN AUSTRALIA .

CLEARLY THAT SIZE CAN BE AN ADVANTAGE, BUT IT CAN ALSO BE A DISADVANTAGE. CAN YOU TALK A LIT TLE BIT ABOUT HOW YOU ARE OVERCOMING THOSE OBSTACLES?

A: Our growth has been carefully managed over the last few years. A key factor is that we have an ethos of wanting to be bigger to be better, we are not interested in growth for its own sake. Another key is the fund’s culture. Every decision and action we take is through the prism of whether it is in members’ best interests.

For example, we had a debate for years about divestment from tobacco. The whole discussion was about what was the right thing to do for the members.

Q: CAN YOU TALK A BIT ABOUT HOW YOU ARE WORKING WITH EXTERNAL MANAGERS AND HOW YOU WILL WORK WITH THEM? WHAT YOU EXPECT FROM THEM AND HOW YOU NEGOTIATE FEES AND ALIGNMENT OF INTERESTS? A: Our medium-term goal is to move towards having 40-50 per cent of members’ assets managed internally.

Given this is only half of members’ assets, external managers will continue to play an important role in the remainder of the portfolio, particularly in the context of a global portfolio. However, what external managers do for us will continue to evolve.

Our position on fees is largely unchanged as we grow. We want to see value for money in the net returns our members get from fees spent. Further alignment of key investment decision-makers within external managers is critical.

Q: WHAT IS YOUR ADVICE FOR HOW TO CHAIR AN EFFECTIVE INVESTMENT COMMIT TEE MEETING? A: It is important that the committee respects a diversity of views from the internal team, external advisers, sponsors and independent committee members.

Good governance is achieved only by debating genuinely diverse opinions with respect.

Q: WHO ARE YOUR MOST IMPORTANT MENTORS? WHO DO YOU TURN TO FOR ADVICE NOW? A: I have been lucky enough to have worked with many great investors and inspiring business people. It wouldn’t be appropriate to pick one or two, as it is a network of mentors that has guided me.

JULY 2018

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INVESTMENT MAGAZINE

FIXED INCOME AND CREDIT FORUM

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fixedincomeforum.com.au CONTACT Alex Proimos

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\ ROUNDTABLE

AN INVESTMENT MAGAZINE ROUNDTABLE, with STEPHEN KOTKIN

NEIL WILLIAMS QIC

THE WEIGHT OF THE

WORLD

GEOPOLITICAL RISK is difficult, or impossible, to price. Despite this, investors at a recent Investment Magazine ROUNDTABLE agreed that global tensions are an important consideration in decision-making.

By Amanda White + Photos Matt Fatches

POLITICS CAN SEEM illogical. Listening to Stephen Kotkin, the John P. Birkelund ’52 Professor in History and International Affairs in the Woodrow Wilson School and history department of Princeton University, speak about President Trump and US politics provides evidence of that.

JULY 2018

While the headlines we read and the stories we hear might leave us feeling that Trump is unreasonable or even ridiculous, Kotkin argues he is in a strong position.

Trump has a loyal following among Republican voters; in fact, Kotkin said within that cohort, the Republican Party

is less popular than Trump himself. In addition, there is no unfavourable economic situation at the moment to encourage voters to choose Democrats. “The economy is booming, so the ability of the Democrats to mount a challenge makes sense in the liberal press, but it

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ROUNDTABLE \

PA R T I C I PA N T S STEWART BRENTNALL Chief investment officer, NSW Treasury Corporation (TCorp) MARK BURGESS Chair, investment committee, HESTA Super ROSSEN DJOUNOV Managing director, head of Asia, GAM DAMIAN GRAHAM Chief investment officer, First State Super STEPHEN KOTKIN John P. Birkelund ’52 Professor in History and International Affairs, Princeton University SHERIDAN LEE Founder and managing director, Shed Enterprises DAVID MACRI Chief investment officer, Australian Ethical Investment CON MICHALAKIS Chief investment officer, Statewide Super NADER NAEIMI Head of dynamic markets, portfolio manager, AMP Capital ALISON TARDITI Chief investment officer, Commonwealth Superannuation Corporation AMANDA WHITE Director of institutional content, Conexus Financial NIGEL WILKIN-SMITH Director, portfolio strategy, Future Fund

CH A IR COLIN TATE Chief executive, Conexus Financial

investmentmagazine.com.au

doesn’t make as much sense with the voters,” Kotkin said.

He adds that Trump is a genius at effective culture war and tribalism, which is how he won, and of course that continues.

The politics in the US, Kotkin said, are interesting and complicated.

“There are citizens of the United States who are supportive of Trump and Trumplike candidates at the local level, and because we live in a democracy, they’re entitled to exist and to have their voice heard, and it’s up to the Democrats to appeal to them and win them over, which is what could happen, but I’m not sure it’s going to happen [in the November 2018 mid-term elections].”

In more evidence of Trump’s strength, Kotkin emphasised the significance of the tax legislation, and Trump’s appointment of Supreme Court justices – another appointment to replace retiring Justice Anthony Kennedy looms, possibly before November’s elections.

“So the idea that Trump is incompetent and gets nothing done is partially true – the White House is empty, and of the 5000 available political appointments, he has made only several hundred, and half of them have been fired or quit. But on the policy side, there’s been a lot more than nothing, and depending on where you are in the social order and where you are on the values issues, it has been an extremely consequential presidency.”

Speaking at a roundtable hosted by Investment Magazine and sponsored

by GAM and Shed Media, Kotkin gave Australian investors an insight into the workings of the White House and the complexities of US politics, and traversed geopolitical hotspots such as the Koreas, Taiwan, China and Russia.

Kotkin has taught at Princeton since 1989, including courses on modern authoritarianism, global history and the Soviet empire. And as a specialist in communist regimes, he has visited the White House occasionally during the last three administrations.

In addition to learning more about the Trump enigma, investors at the roundtable were interested in learning more from Kotkin about the interaction and relationships between the US and key economies, such as China, along with how issues such as populism might

play out around the globe.

In terms of how investors view geopolitics in their decision-making, Damian Graham, chief investment officer of First State Super, sums it up by saying geopolitics “doesn’t matter until it matters”.

“It feels like the rubber band’s growing a little bit, where there could be some additional risks. This highlights a number of things [to watch]. Geopolitics is always relevant, sometimes more relevant than others.”

THE CHINA QUESTION First State Super is one of the few funds in Australia with a Qualified Foreign Institutional Investor licence from China, and Graham wanted to hear from Kotkin about the view of China from within the US, and whether that view was valid.

“How accurately do you think China is viewed by the US with what you know about China and the political system there, the market, and the market risks?” Graham asked. “It would be great to get a sense of how accurately you think perception is for the US around that, the relationships and also the forward-looking potential outcomes for China.”

Kotkin said: “In the Trump administration, there are hardliners in most of the important positions of influence and this includes on the big foreign policy issues, like Iran, North Korea and China.

“Cutting against enactment of [hardline policy] is the lack of policy process in the administration as a whole.” In addition, Trump’s behaviour around any particular issue is unpredictable and inconsistent.

The situation in North Korea continues to be volatile and many lives in the region could be at risk, but Kotkin said it is not a global system threat. What is a systemic threat is Taiwan, he argues. On one hand, the Chinese claim Taiwan as their territory and call it a core interest; on the other hand, the US has an act of congress that obliges it to defend the security of Taiwan.

“Taiwan is the systemic issue that can blow up everything, and miscalculation on one side or the other – or even the Taiwanese as the third-party actor in this – could lead to a systemic crisis of proportions where the risk [can’t be priced],” Kotkin said. “So you can see the Americans know that the Taiwan thing gets under the skin of the Chinese, and you can see how irresistible it is from the American side to play that card, and the

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\ ROUNDTABLE

hardliners around Trump are whispering in his ear.

“For the Chinese regime, they see that public opinion on the island has been moving definitely away from identifying as Chinese toward identifying as separate Taiwanese. Time is not on the mainland’s side. So I’m very concerned, the whole thing could blow up.

“I’m not saying that one side is right or wrong, the problem is the incentive to do something, to miscalculate and to take an action that destroys the global system.”

Kotkin, who has visited Russia many times, and was a Pulitzer Prize finalist for his book Stalin: Paradoxes of Power, also said Russia was a major piece of the global balance of power. But it is not Russia’s strength, but its weakness, that is the problem.

“It’s so ironic because Russia looks like this big bad beast that’s doing all these things, when, in fact, the thing is barely holding together in some ways, haemorrhaging human capital, and we should be afraid that without Russia, China has more wide-open space,” Kotkin said. “Now, once again I’m impressed with China, what they’ve achieved economically is breathtaking and every time I go back, I’m more and more impressed, but the regime is not a friendly regime.”

POPULISM WILL PERSIST In terms of big geopolitical themes, Kotkin told the investors that global populism is not going away, that it is structural and there is no reversal.

“Globalisation does not produce sameness, it does not bring people together. The internet didn’t do that either, it accentuates difference, so you get the nationalism, and you get the cultural responses,” he explained. “Globalisation is not Westernisation, China didn’t become like the US, and it’s not going to, it’s China. It has its own civilisation, its own institutional legacies, and this is true of any place you go. There is a level of Westernisation, harmonisation, of institutions in places like the EU, but now we also see the accentuation of difference, even in places like that.

“It’s a deeper, structural openmarkets assumption that if you integrate economically and technologically you then become more like each other culturally and institutionally. That assumption is

JULY 2018

PROFESSOR STEPHEN KOTKIN

DAVID MACRI Australian Ethical Investment

false. People retain their culture, they retain their institutions and, moreover, those are accentuated in the process of integration.

“Democracy must incorporate the entire political spectrum, from Trump to Zuckerberg and everything in-between.

We live in a democracy and people have opinions. It just so happens that the resentment, the anger, the culture condescension and the reaction to that – all of that makes it seem radioactive.

Trump voters have a legitimate opinion, and democracy gives a voice to that.

“I’m only afraid if the politics turns violent. I don’t see any trouble with rightwing nationalists or socialists having a voice, I just don’t want it to be militarised the way it was as a result of the First World War. From an institutional investor point of view, this raises some interesting questions, CSC chief investment officer Alison Tarditi said.

“I think that long-term investors, and decision-makers more broadly, are being challenged to keep pace with two fundamental shifts,” Tarditi said. “The first is a broad sociological shift towards connectivity, but not necessarily cultural connectedness. And the second is a shift in

our ability to imagine the future, which has been compromised by an unfamiliar mix of disruption from technology, policy and amplifying stakeholder voices.

“As investors, we’re all used to dealing with uncertainty. But it does feel as though we are having to adjust from decision-making with probable certainty to decision-making with much less, arguably constant, uncertainty. The potential tail risks associated with political strains across and between both the developed and developing worlds give examples of this. We all understand that the long-term consequences of these risks are likely to be important. Regulators, governments and policymakers are reacting to, rather than proactively driving, these forces. How cross-geography relationships develop or deteriorate and how global governance structures evolve or fail matter to long-term investors.

“It isn’t clear that these risks are adequately priced. Neither is it really possible to identify when, or indeed whether, they ever will be. Today’s discussion has been useful because it has provided a roadmap for thinking around these issues and their subtleties.”

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\ ROUNDTABLE

AN INVESTMENT MAGAZINE ROUNDTABLE, sponsored by PGIM

THERE’S A VIEW among economic experts that current low interest rates will rise and higher rates on high global debt levels will eventually lead to a recession.

Additionally, less liquidity in the market and the ‘late cycle’ environment are making many investors cautious, says the chief strategist at the $717 billion US-based investment management firm PGIM, Robert Tipp.

Tipp spoke at a recent Investment Magazine roundtable on ‘where we are in the credit cycle’ and noted that investors are still anxious about the so-called “spread sectors” in the bond market – corporate bonds, structured products and emerging market debt, which offer higher yields than safer government bonds.

This caution may result in investors leaving money on the table if it turns out to be a longer credit cycle, Tipp said.

“The general impression I get from investors is that there’s anxiety,” Tipp said.

“We’re nearly a decade into the expansion, the Fed is raising rates and spreads are tighter than average. Therefore, it warrants a cautious approach on the credit side.

“I don’t think this cycle is different, just the length.”

Tipp said there aren’t yet the seeds of a hard downturn, thanks to tighter regulations and the cautious approach central banks are taking as they move from quantitative easing to tightening.

PGIM’s general view was that with the best part of the bull market over, long-term rates should be low and within a tight range.

“The world has been on an ageing demographic trend for decades and the effects of that may have been masked by the rapid extension of debt,” Tipp said.

“So now that the debt cycle has maxed out, we’re left with an environment of very high debt levels, which may have lowered the equilibrium level of interest rates.

“I can’t say we’re not going to go to 3.25 or 3.5 per cent on the 10-year [Treasury] note yield but I think it’s more likely the sell-off

FINDING OUR PLACE in the CREDIT CYCLE

By Jean-Paul Pelosi + Photos Matt Fatches

Industry experts discuss how closely recession looms, how difficult it could be, and how investors should POSITION THEMSELVES TO TAKE ADVANTAGE.

stops around current levels. Eventually, we may find out that the new equilibrium level for 10-year Treasuries is actually even below 3 per cent.”

TIMING AND OPPORTUNIT Y Despite the possibility of a recession down the road, Tipp said it continues to look like a pretty solid environment for investing overall.

“The price-earnings multiples might look a bit elevated at first glance, but not if we remain in an environment of low long-term rates,” he said. “In that case, these multinational companies that dominate the major indices look reasonable, which also bodes well for the credit markets in fixed income.”

However, high debt levels across the world remain a cause for concern, head of multi-asset income at Morningstar Investment Management, Brad Bugg, said. Morningstar manages about B:213 mm globally, $200 billion worth of assets with about $10 billion across T:203 mm Australian institutional and retail S:193clients. mm

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“We don’t think the world can afford rates of 3.5 per cent to 4 per cent,” Bugg said. “Volumes of debt in the world today act as a natural ceiling for where they can go. If you’re worried about rising rates, are you going to be stepping back into the market? We think there’ll be some volatility around this dynamic as it plays out and that could potentially create some opportunities.”

Bugg said he thought markets were still pretty expensive, whether for bonds, credit or equities, and that opportunities could come from higher volatility; however, he was also concerned about the impact of unwinding quantitative easing, especially in Europe.

PGIM head of institutional relationship group, Australia and New Zealand,

Cameron Sinclair, said investors seemed to be more concerned about the maturing credit cycle and were either rotating into parts of the credit market where they saw better relative value and pricing or looking for investment managers to be more active in sector rotation.

Sinclair was concerned that the consensus view of a longer-term economic downturn might reflect a level of complacency around near-term economic strength globally.

That said, he sees evidence of a shifting mentality in the way investors are reorienting their investment strategies, increasingly looking towards unconstrained mandates as a way of navigating the credit space and building more resilience and downside protection mechanisms into portfolios.

“Investors are looking for absolute or total

PA R T I C I PA N T S CHRIS BAKER Principal, Mercer In vestment Consulting ED BROOKE Investment adviser, Escala Partners BRAD BUGG Head of multi-asset income, Morningstar Investment Management ROSS ETHERINGTON Chief investment officer, EISS Super GEORGE LIN Senior investment manager, Colonial First State Investments LYDIA SERAFIM Senior portfolio manager, AMP Capital CAMERON SINCLAIR Principal, institutional relationship group Australia and New Zealand, PGIM ANDREW SNEDDON Managing director and senior portfolio manager, Russell Investments ROBERT TIPP Managing director, chief in vestment strategist and head of global bonds, P GIM

CH A IR COLIN TATE Chief executive, Conexus Financial

1 PFI_Global_

GI_203x34mm. indd

Studio Valeria Moumdjian Job # A4938 Date 6-21-2018 4:13 PM Live Trim Bleed Gutter Pub P. Date

B:213 mm T:203 mm S:193 mm

193 mm x 24 mm 203 mm x 34 mm 213 mm x 44 mm None global intergration None

T:34 mm

B:44 mm

S:24 mm

GLOBAL SCALE. Approvals:

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\ ROUNDTABLE

return-style investments,” Sinclair said.

“That’s probably a sign that people are becoming a little more cautious.”

It’s important for asset owners to work out the timing of the next recession, said managing director and senior portfolio manager at Russell Investments, Andrew Sneddon, who is part of a team that invests $15 billion in assets for Asia-Pacific clients. He’s not sure Australia can avoid a recession.

“I think the consensus is that it’ll be a 2020 event, which means, from a marketpricing perspective, we’ll probably think about it more acutely towards the end of the year,” Sneddon said. “I think the timing of the recession is the anchor point around a lot of these [market] questions.”

Given this, Sneddon said there were some opportunities in loans and other parts of the market with high beta (high volatility), such as emerging markets and local currency debt.

“They offer an interesting journey, albeit a high-volatility one,” he said.

The general view at Mercer Investment Consulting was similar, Mercer principal Chris Baker said. He noted that corporate leverage had ticked up, economic fundamentals looked strong in the US and the shift from quantitative easing to tightening had changed the flow of money to credit.

“We don’t see a crash that’s imminent but we’re certainly conscious of it over the short to medium term,” Baker said.

“On the credit side, we recommend clients don’t allocate to single sectors but employ a multi-asset approach in a benchmarkunaware fashion instead.”

Senior investment manager at Colonial First State Investments, George Lin, agreed with Tipp’s view that there won’t be a sharp rise in bond yields.

“We talk to a lot of credit market managers and they say the fundamentals of credit sectors are reasonably OK,” Lin explained. “I think what Robert [Tipp] has outlined is a pretty plausible base-case scenario; with rates slowly rising, the credit spread may widen a bit and may tighten a bit, but won’t move much.”

CHRIS BAKER Mercer Investment Consulting

CAMERON SINCLAIR PGIM

LYDIA SERAFIM AMP Capital

On the credit side, we recommend B:213 mm clients don’t allocate to single sectors T:203 mm S:193 mm

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I don’t think interest rates will go up, but say they do, what’s the number?

I don’t think it’s as low as three or four.”

ROBERT TIPP PGIM

Lin, who looks after the fixed income portfolio in the $44 billion multi-manager platform, said Colonial First State had not changed its approach to fixed interest over the last seven years, as part of a benchmark-aware portfolio. He added that an increase in volatility over the last 12 months had been beneficial to the fund’s underlying managers, who could opportunistically rotate between different sectors when investing.

While it might be a growth environment, there were still reasons to be cautious, said AMP Capital senior portfolio manager Lydia Serafim who looks after fixed income and alternative investments as part of AMP Capital’s multi-asset group. AMP Capital has $59 billion of assets under management in its global fixed income and cash portfolio.

PFI_Global_ 1 can’t “We ignore the fact that we have GI_203x34mm. record high corporate debt in nominal indd terms and corporate leverage is high as Studio Valeria Moumdjian well,” said. “I’ve seen very little JobSerafim # A4938 literature show the breaking point.

Date to6-21-2018 4:13 PM Live Trim Bleed Gutter Pub P. Date

STAY AHEAD OF THE CURVE One of the headaches for institutional investors right now was finding an allocation that’s not too expensive, chief investment officer of the $5.5 billion EISS Super, Ross Etherington said. He pointed to the importance of diversification and the growing attractiveness of alternatives as a result.

“I’m thinking of investments that aren’t correlated to equities, where you might get something like 6 to 8 per cent in theory, with reasonable volatility,” Etherington said. “We use different levers like yield curves and currencies to add alpha in this low-return environment.”

He agreed it was late in the credit cycle and asked what was going to stop inflation from ticking up in the next 12 months.

Tipp responded: “Global competition in the goods and labour markets.” He was more concerned about the eventual long-term downside, warning that when the next recession arrived it would be difficult to revive economies.

“In the next major downturn, central banks will end up cutting rates to zero and maybe moving into QE,” Tipp said.

“If markets begin to price in that part of the probability spectrum, yield curves may end up looking more like the 19th century.

Back then, some developed market yield curves were inverted. Bond investors – or pensioners – were probably more concerned about locking in their annuity than pushing for potentially higher yields.

For now, there are still opportunities for good investment and, as such, Escala Partners is looking at high-quality investment-grade debt, Escala investment adviser Ed Brooke said. The firm advises wealthy families, high-net-worth individuals, foundations and charities B:213 has mm about $1.1 billion on investments, and under advisement.

T:203 mm “We think we are late cycle, in that bond S:193 mm

193 mm x 24 mm 203 mm x 34 mm 213 mm x 44 mm None global intergration None

yields will rise, probably more in line with just a gradual increase,” Brooke said.

“So, to keep volatility low, we’re avoiding the duration play. But we think you’ll get an increase in volatility in credit spreads and that’s actually not a bad environment to be in, because you can move your portfolios around.

“For example, in January, when credit spreads tightened, we were positioning portfolios in very high-quality bonds.

Now that we’ve had a spread widening, we think we get something extra by going into capital structure and the risk isn’t high at the moment. Economies are still going reasonably well, so that’s not a bad place to generate some extra yield.

“The other thing we’re looking at is market mutual funds and areas where volatility is a little bit more contained” Brooke continued. “What we’re seeing in the last two months is that a number of new funds opening up to private debt, with the banks stepping away, has alarm bells ringing. It’s not too bad [but it seems] a lot of new products are opening up.”

PGIM’s Tipp said many investment problems come from investors’ behavioural finance pitfalls.

“We want to think if we can just solve certain problems, we’re going to make money,” he said. “Right now, I think the misplaced focus may be on inflation and the central banks removing liquidity, and rate hikes leading to higher long-term rates.

“What investors may be missing is the bond market’s supply side. Even if price and wage inflation are a little higher and short-term rates are higher, long rates will ultimately be driven by the supply and demand for money.”

Demand for credit has been decelerating in the US, Tipp said.

This suggests interest rates are not at a level low enough to encourage investors to borrow. He concluded that with long-term interest rates within tight ranges and a moderate ongoing economic expansion, there should continue to be a good backdrop for adding value in credit sectors.

T:34 mm

B:44 mm

S:24 mm

GLOBAL PURSUIT OF CONSISTENT RETURNS. Approvals:

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\ COVER STORY

JULY 2018

investmentmagazine.com.au

COVER STORY \

active ambassadors THE

Seven years after restructuring around a passive core, Local Government Super has reversed course into a totally active portfolio – AND IT’S THRIVING.

By Amanda White + Photos Christopher Pearce

IKE MANY SUPER funds, Local Government Super (LGS) had a rough time in the global financial crisis. It performed poorly and its board became risk averse. As a result, by June 2011, the portfolio was restructured around a passive core. About a third of it was in passive investments, and in some core asset classes such as Australian equities and international equities, 50 per cent was managed passively. Australian bonds were entirely passively managed.

This plan was centred on reducing management fees at a time when performance was off, and as chief investment officer Craig Turnbull says, it was about controlling risk relative to the benchmark.

Fast forward to June 2018 and the $11 billion fund has no passive investments.

Over the last seven years, it has gradually allocated more and more of its portfolios into active strategies, culminating with the final chunk that was still passively managed – 10 per cent of international equities – moving to active last year.

Within equities, the change was

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focused on finding managers that were risk controlled. It’s true that some of LGS’s assets are managed in enhanced passive. In fact, four low-risk quantitative managers – State Street Global Advisors (SSgA), Hermes, BlackRock and AQR Capital Management – now account for 40 per cent of all equities, but “enhanced passive is still active”, Turnbull says.

The preference for active management came as Turnbull and the board gained confidence in finding active managers.

“We wanted managers that had a good track record and were willing to back themselves,” he says.

As part of the deal, new fees were put in place – a base rate that is the equivalent of a passive fee, and a performance fee where the manager keeps 10 per cent to 15 per cent of the outperformance over the benchmark.

These enhanced passive managers are complemented by a handful of highly concentrated active managers, with some mandates, such as ECP Asset Management and Ubique in Australian equities, holding only 20 to 30 stocks.

“Moving to active has worked well for us and our members,” Turnbull says.

For the period ending March 31, 2018,

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\ COVER STORY

performance numbers from the fund’s custodian, JP Morgan, show that for all of the LGS diversified funds, over one, three- and five-year periods, active management has added value after fees and costs.

“Every one of the 13 asset classes is outperforming; this is not what you’d expect and it is largely due to active managers,” Turnbull says. We have been in alternatives for eight to nine years, and they have very high fees, but even there we are getting positive returns after fees.”

In Australian equities, the portfolio has a slight tilt to small caps, with an allocation of 14 per cent, versus the 11 per cent benchmark, and while Turnbull acknowledges that “this has helped a bit”, he says the performance is still largely due to manager outperformance.

Similarly, in international equities, there is an emerging-markets tilt, with a 14 per cent allocation versus the MSCI benchmark of 10 per cent. But again, Turnbull says most of the outperformance has come from managers, rather than style or geographical tilts.

The fund’s performance attribution examines a number of elements, including asset allocation performance, manager performance, style bets and currency.

Turnbull says 80 per cent to 90 per cent of the fund’s outperformance has been due to managers.

“We don’t often take tactical asset allocation bets, it is hard to add value consistently. We don’t take extreme positions in style bets and currency positions can be volatile,” Turnbull says.

SPREADING THE WORD It’s a story LGS is keen to tell.

The team feels passionate about the impact active management has had on the fund’s performance, and ultimately the benefit to members.

It thinks the widespread focus on costs is potentially to the detriment of members’ outcomes, and the fund has been actively engaging with ASIC about the complication of assessing MySuper products on fees alone.

“The RG 97 disclosures don’t make sense,” Turnbull says. “Our outperformance

JULY 2018

Local Government Super The 21-year-old fund has 90,000 members, with about 80 per cent retention of membership into the retirement phase.

“We do a good job of retaining them,” CIO Craig Turnbull says. “The majority are still in accumulation but that is changing.”

The fund is one of only a few where default members are not all in the balanced option.

Instead, members go into the LGS MySuper age-based investment strategy, which automatically switches members into less risky investment options as they approach retirement. As a result, members are spread across the spectrum from high growth to conservative.

ASSET CLASS VALUE ADDED, THREE YEARS TO APRIL 2018 ASSET CLASS

(%)

Australian equities

0.56

International equities

1.20

Listed property

2.91

Direct property

7.47

Australian bonds

0.54

Inflation-linked bonds

0.76

International bonds

0.01

Absolute return

0.60

Cash 0.65 Commodities 6.56 Private equity Opportunistic alternatives Defensive alternatives

0.98 1.10 7.52

BALANCED FUND ASSET ALLOCATION AS AT MARCH 2018 ASSET CLASS Australian equities International equities International listed property Australian direct property

(%) 13.5 15.49 2.16 5.40

Private equity and opportunistic alternatives 11.29 Commodities 1.80 Bonds 25.92 Absolute return funds

14.32

Defensive alternatives

4.09

Cash 5.95

is because of the good performance from our active managers. We think the current disclosure regime is biased against active management. But active does add value for members. In this context, does RG 97 really make consumers make the right decision?”

Analysis by LGS over the last three years shows that a low-cost alternative would have produced 69 basis points a year less than the current LGS balanced fund, which includes alternatives and active management.

Chair of the investment committee, Craig Peate, acknowledges that it was a bold move to shift away from the fund’s traditional passive investment philosophy, especially after the GFC. “It took foresight and a concerted effort over the last seven years to convince the board and investment committee on the merits of active management and in particular manager performance,” he says. “We watch closely the benefit the members and the fund obtains from higher manager fees.”

MORE RISK Despite the shift to active, the tracking error of the portfolio has not increased.

“We have a 2 per cent limit on tracking error in the major sectors and the portfolio

investmentmagazine.com.au

COVER STORY \

is now sitting well below that,” Turnbull says.

In Australian equities, for example, he tracking error of the portfolio is sitting below 1 per cent, and Turnbull is, in fact, looking at ways to take on more risk. This might mean a re-weighting to more concentrated managers or allowing managers more freedom to move within mandates.

“This doesn’t mean more market risk, but it could occur in manager weightings or liquidity levels, there are ways to take on more risk,” Turnbull says.

The fund has a limit of 25 per cent it can invest in illiquid assets across Australian direct property, defensive alternatives, opportunistic alternatives and private equity.

“I think that is a bit low,” Turnbull says.

“In practice, we have to run it at around 20 to 21 per cent, so we don’t have to sell at the wrong time. Maybe we consider a larger illiquidity allocation.”

MANAGER SELECTION LGS has been well recognised for its commitment to sustainability. And Turnbull believes the integration with the sustainability team, led by Bill Hartnett, has given it an edge in manager selection.

investmentmagazine.com.au

“Being a long-term investor, we want managers that are focused on the long term,” Turnbull says.

The fund has a relatively low turnover of managers – about one to two a year.

“Some managers have been with us a very long time; for example, PIMCO has been managing money for us for 16 years and BT for 12 years,” he says. “But even though we are a long-term investor, we like to be able to terminate managers at short notice. We need flexibility.”

Turnbull points to some good manager appointments in the last year. These include Resolution, a local global real-estate investment trust manager, and BlackRock for a low-risk Australian equities mandate that Turnbull says is “off to a fantastic start”.

He also says the fund’s sustainability bent has led it to some good niche managers at the margin, such as Attunga, which is “a little hedge fund with incredible performance” that invests in the Australian electricity market. It’s returned 15 per cent for the last seven years, annualised.

The main consultant is JANA, and the investment committee typically takes on its recommendations, which are supported by the consultant and Turnbull’s team.

“We have good support from the investment committee, about 90 per cent of the things we take to them with the consultant they support. But if it’s a new field or they need more time, then they take the time,” he says.

Within alternatives, he gives credit to the advisers the fund has used. For the last three years, this has included Cambridge Associates, but for a long time the principal adviser was Quentin Ayers. These advisers did much work to get the fund access to managers that have performed well, and Turnbull acknowledges the importance of this access.

“Managers like Bain have been amazing, and Quadrant has been good. You can’t get access to new funds unless you have relationships,” he says.

While traditionally reliant on consultants, Turnbull acknowledges that the internal team of 10 has improved, in particular in areas such as manager selection, and has now built up a good long-term record.

The vast majority of LG Super’s assets

are managed externally but the fund does manage a 5 per cent property allocation in-house. It’s been a star performer, returning 21 per cent a year over the last three years.

The portfolio is Sydney-based direct property across retail and industrial, and has a very high green rating.

“The portfolio has 5 green stars, which is very high for a portfolio of older buildings.

This hasn’t hurt our valuations and our tenants are happy. Our team has performed very well,” Turnbull says.

In the last six months, the fund has had a governance review and a strategic asset allocation review, which resulted in a swing towards international equities and away from Australian equities.

“A year ago, we had more Australian equities than international equities, [unlike] other funds, now we are winding that back,” Turnbull says.

The governance and decision-making has also been honed slightly. Where previously the board had final sign off on investments, this has been delegated to the investment committee, giving Turnbull and the team one less hurdle to jump through.

Turnbull works closely with the investment committee and tracks and measures decisions closely.

For example, it measures the positive value add from the fund’s focus on sustainability and reviews a monthly table on the performance of its sustainability-focused managers.

“They have always made a positive contribution. Not every manager is adding value over every period but as a total they are,” he says.

He says sustainability is largely about having the right managers and whether they care about sustainability risk.

“We have developed a framework that rates managers on sustainability. Every manager gets a rating, we like to invest with leaders.”

The investment committee also tracks every decision it makes and rates them all as good or bad.

“The biggest lost opportunities for the fund have been the managers we looked at but didn’t hire. But you can’t invest in everything,” Turnbull says.

JULY 2018

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LIFESKILLS \

and total and permanent disablement (TPD) cover for most members, while increasing TPD cover for the majority.

For Cbus, a mandatory one-size-fits-all approach like the one initially proposed in the draft Code of Practice would have reduced the level and scope of our cover and left many members without any cover at all.

COVER THAT MATTERS MORE THAN MOST The hazards of the construction industry make insurance even more important for Cbus Super than for most funds. The incoming CODE OF PRACTICE makes a good guide for continuing to provide it.

A PRIORIT Y

MICHELLE BOUCHER GROUP EXECUTIVE, MEMBER EXPERIENCE | CBUS SUPER

SERIOUS INJURY AND death are not things most people ever consider when they head off to work each day. But for our members in the building and construction injury, the threat is real and present.

The construction industry in Australia is consistently rated as one of the most dangerous by Safe Work Australia, in terms of both fatalities and injuries.

Providing cost-effective and accessible insurance suited to the building and construction industry, in spite of its dangers, is a core part of our promise to our members.

If it wasn’t for group insurance provided through Cbus Super, many of our members wouldn’t be able to access insurance at all or the costs would be so prohibitive it would exclude many of them from purchasing cover.

investmentmagazine.com.au

We strongly support sustainable and affordable default insurance arrangements because we know the value and peace of mind provides to our members and their families.

Ensuring we can continue to do this is a priority and something we believe can be achieved under the new Insurance in Superannuation Voluntary Code of Practice.

As an active participant in

CL AIMS recognised the fact that young people are less likely to have dependants or mortgages and that more super savings earlier is critical over the long term for retirement balances.

This change was an example of the fund tailoring solutions to our members’ needs. Our experience is that by the time our members reach 21, they have been in the workforce for three to four years and often have dependants; this determination is supported by the fact that most death claims made in

We listened to our younger members and worked with our insurer to modify the insurance provided. the superannuation industry, Cbus is supportive of there being a code and participated in its development. Cbus considers this code’s introduction a sensible and workable approach to establishing best-practice guidance around group insurance provision without compromising fiduciary obligations on trustees that require them to act in the best interests of members.

Last year, in an industryleading move, Cbus reduced the default death cover for 15- to 20-year-olds. The fund

relation to members between the ages of 21 and 25 are paid to dependants. An overly prescriptive mandated code that included a catch-all definition of young people as under 25 would have had a negative impact on our members.

We listened to our younger members who need to maximise their super savings early and worked with our insurer, TAL Life, to modify the insurance provided. This resulted in a new deal from September 2017 that reduced premiums by 25 per cent per unit of death

Premiums and cover are important at one end but the claims process and outcomes for members are just as critical.

Our view is that insurance cover for members is valuable and our philosophy is that legitimate claims should be paid. In the last five years, Cbus has paid out $1.1 billion in insurance claims to about 10,000 members and their beneficiaries, with claim acceptance rates for all insurance types in total well in excess of 90 per cent and TPD claims specifically at 88 per cent.

As it stands, Cbus already exceeds many of the standards set out in the code.

The main area of change for Cbus due to the code relates to member communication requirements and we will be making improvements well in advance of the code deadline.

Cbus acknowledges that the code represents a first step in creating rigorous industry standards to support continuous improvement in member outcomes.

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.

JULY 2018

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\ GOVERNANCE

FIT for TENURE The regulator has offered guidance on how long is too long for FUND TRUSTEES to remain on boards. But how well does the theory suit the practice?

By Rachel Alembakis

TWELVE YEARS’ TENURE – maximum.

That’s how long the regulator decided was enough for most board members of superannuation funds. “[The Australian Prudential Regulation Authority’s] view is that long periods of tenure can affect a person’s capacity to exercise independent judgement,” the regulator’s SPG 510 – Governance reads.

The guidance, issued in late 2016, suggested it was important for superannuation funds to have a board renewal policy that documented the maximum tenure period for each director and the circumstances under which the board member may deviate from the tenure policy. The figure of 12 years was decided after broad industry consultation.

“APRA expects that the length of each director’s tenure would be examined shortly before the end of each term served and that there would be limited circumstances in which maximum tenure limits exceeding 12 years would be appropriate,” SPG 510 states.

The Australian Institute of Superannuation Trustees notes that the majority (81 per cent) of directors of AIST member funds were appointed to their positions after 2010. The average length of tenure is 6.3 years, and the median length

JULY 2018

of tenure is 4.4 years. Further, 40 per cent of directors were appointed after Jan 1, 2015.

AIST notes, however, that 19 per cent of trustee directors have been on their board for longer than 10 years. Research

by Investment Magazine has turned up examples of trustees who have served longer than 12 years – sometimes stretching into decades. The explanation boards

and trustees have offered for this centres around the balance between board experience, corporate knowledge and skills and the need for board renewal, fresh perspectives and further broadening of experience and skills.

AIST chief executive Eva Scheerlinck says: “We think, for the most part, 12 years would be appropriate for most

investmentmagazine.com.au

GOVERNANCE \

circumstances, because we value board renewal, particularly if that is managed properly alongside a skills matrix and a need for maintaining some corporate knowledge within the board through the time. We recognise that there are some exceptions and nobody should have a use-by date on their value, if you like.

Some of us can do it for two or three years,

investmentmagazine.com.au

some for 15. Boards need to know how things are working, how the dynamics are, what the level of knowledge and experience is – and that is a matter for them to decide.

There is plenty of regulation of how boards work, including the need for an annual assessment of the board’s performance.”

Investment Magazine spoke with board chairs and board members, some of whom

have served for longer than 12 years, some of whom are stepping down from their positions, and some of whom have less than 12 years’ tenure.

David Buley has been an employer director of NGS Super since December 2005, appointed as a representative of Association of Independent Schools NSW, where he is chief financial officer. He says

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\ GOVERNANCE

he has no plans to step down from the board.

“We have a skills matrix self-assessment to determine whether the board as a whole has the requisite skills,” Buley says. “I have, obviously, 30 years in finance and a CFA, as well as a master’s in applied finance investment. I sit on the investment committee. I do the 20 hours of personal development needed every year, and most of the boxes in that skills matrix I tick as advanced…From my point of view, I think I bring considerable value to the board, notwithstanding that it’s an employer/ employee representative board. There is an expectation that those directors offered up have the requisite skills. No one is sitting on the board as a passenger.”

NGS Super has a second board member who has served longer than 12 years – Peter Fogarty, the deputy chair, who has served since December 1995 as the representative from Catholic Hierarchy NSW. Fogarty was contacted by phone and declined to speak.

He did not respond to a follow-up email.

“We certainly chat from time to time about what skills the board needs, in terms of marketing and legal – you outsource what you need; however, what you really need on a board is the business acumen,” Buley says. “You’re advising on running a business, you have to have diversity, agreed, which is why the representative model works OK. But you can’t be oblivious to how you run a $10 billion fund. While I think that setting any number is arbitrary, [APRA] had to choose a number and we all tend to think in terms of threes – four terms of three, that’s quite generous.”

THE BIG TRADE-OFF That trade off of renewal versus skill and experience is at the heart of the questions chairs must pose to the board, said Peter Kronborg, a governance adviser to the Australian Institute of Company Directors (AICD).

“This is clearly a part of the art form of sound governance – where the wisdom

JULY 2018

We can’t just live with having passion alone, or years of service, as the key attribute that people are making the judgements/membership decisions on

of leaders has to come through,” Kronborg says. “There is no perfect answer. It’s not able to be done by a formula; it has to be done by human judgements and the particular judgement here is around wisdom. We do need a board that is populated by the relevant skills, diversity of viewpoints through age, gender, ethnic, and organisational experiences. We can’t just live with having passion alone, or years of service, as the key attribute that people are making the judgements/membership decisions on.”

“It’s jarring [when you see a bad board], a board that has just too many long-serving members or is too engaged in group-think and group-support. Again, this is one of the challenges; we’re looking for cohesive boards, but not a same-think board, and not an ‘I’ll scratch your back if you’ll scratch mine’ board. It’s obvious that the whole expectation of boards has risen progressively over the last 20 years, and significantly over the last two years.”

One long-serving board chair who has made the decision to step down is AvSuper chair George Fishlock. He joined the board of AvSuper in 1999 and became chair in January 2013.

“The reality is I’ve been on the board for a long period of time, and from a business planning perspective, you have to recognise at some point in your tenure that

you need to be looking at who’s replacing you and getting the right people on board for the right period of time,” Fishlock says. “[Part of this is] being able to train incoming board members up to a suitable standard. All of those factors lead you to a point where you have to pick the right time to leave both the board and, in my case, the chairman’s position, leaving the board in

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GOVERNANCE \

the best possible position, given knowledge and experience. You don’t want to lose all that corporate knowledge/experience at the same time.”

Fishlock notes that in some cases, it might be challenging for superannuation funds that have member-based nominees on boards to find new trustees with the requisite financial or investment skills, meaning that those trustees who do have those skills might need to remain in place longer.

“Some funds are limited by the skill set they can attract with direct nominees, so when you finish up in the situation with the right people, you don’t want to lose them,” Fishlock says. “That needs to be addressed. I believe superannuation board positions require a lot more understanding of the business and the regulatory environment that you operate in, than perhaps [board positions] in a broader organisation [require]. It takes longer for directors to get their feet under the table and then to be able to provide good input on the whole board process and the operation of the business. You need a few more years than the normal situation.

Getting someone up to speed and getting value add from people takes longer than on other sorts of boards.

“Most superannuation funds are about investment, and directors have to have a good strong understanding of that.

It is not sufficient to be able to delegate those authorities to people with more knowledge, because at the end of the day, the board director is the one who bears the obligations and the responsibilities.”

RENEWAL AND DIVERSIT Y As borne out by the AIST statistics mentioned earlier, superannuation funds in general are focusing on board renewal and on placing people with the diverse set of skills required for managing billions of dollars for member retirement outcomes.

Also, funds that have long-serving directors are taking steps towards succession planning.

A representative of LGIAsuper told Investment Magazine that Fiona Connor, a member-representative director since July 2001, will be stepping down from the board as of June 30.

Cbus Super has two directors who have served longer than the organisation’s policy of three, four-year terms: Glenn

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Thompson, chair of the remuneration committee, who has served since December 2001, and Peter Kennedy, who has served since March 2004.

“Cbus currently has two directors who, whilst exceeding the maximum tenure period, meet the exceptional circumstances prescribed in the policy,” Cbus writes in a statement. “Both directors are up for review in 2018 and Cbus has already commenced this process. Directors who fall outside of the maximum tenure period are reviewed annually by the board (or more frequently as required). Regular reporting on tenure and director appointments is submitted to the board throughout the year.”

Hostplus also has two directors that have served longer than 12 years: Mark Robertson, serving since June 2003 and Robyn Buckler, who has served since May 2003.

“Hostplus is governed by three independent directors including an independent chair, three employer directors and three employee directors,” a Hostplus spokesperson writes in a statement. “Our representation model ensures sound decision-making processes, and diversity of skill and experience, which contributes towards strong member interests.

“We believe well-functioning boards have a mixture of experience and new blood. All Hostplus directors are within the fund’s Board Renewal and Performance Assessment Policy. And, in accordance with APRA’s prudential standards and guidance, we undertake regular assessment of director performance.”

Angela Emslie, chair of HESTA, is also a long-serving board member, joining in 1999 and becoming chair in 2013. She has announced she will step down at the end of her term.

REST Industry Super has two particularly long-serving trustees: Joe de Bruyn, who has served since December 1988 and is sponsored by the Shop, Distributive and Allied Employees Association; and Rohan Jeffs, who has served since July 1990 and is sponsored

by Woolworths. Investment Magazine contacted de Bruyn by email, and he declined to comment, as he was overseas at a trade union congress at the time of publication. Jeffs did not directly respond to an email. REST chair Kenneth Marshman declined to comment on the record.

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RARE CIRCUMSTANCES AIST’s Scheerlinck points out other exceptional circumstances under which a trustee could stay on beyond the 12-year limit, such as in the case of a fund merger.

“Bringing together separate organisations and separate cultures might require a transition phase [in which] people stick around and exceed tenure limit; it’s very important to bring across the values of the transitioning fund in those circumstances,” she says. “There are also boards that have experienced a lot of renewal that might be out of their control because events happen. People get sick, people resign. You could be planning for someone to come off the board and then have a whole bunch of people leave in a short period of time, and you need that corporate knowledge to stay on the board for longer. I understand that we need guidelines; a number like 12 years is a useful guide, but it’s not necessarily reflecting the reality.”

With superannuation facing political scrutiny, calls for mandatory independent directors, and the overarching backdrop of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, there is a stronger focus on superannuation governance. Even so, in the event that a long-serving trustee does not step down voluntarily, or the board chair does not press for a trustee to step down, there is no direct provision under the Superannuation Industry (Supervision) Act for APRA to remove that trustee for long tenure alone.

Governance adviser Kronborg suggests boards must focus on improvement, rather than ad hoc decisions made to fit the specified tenure.

“The important thing now, with this greatly heightened focus on governance, is that we ensure our governance processes are enhanced even further, but that we don’t slip into risk aversion governance, which we’ve seen sometimes before – in fact, just about always after a crisis period,” Kronborg says. “So now the challenge for boards is to look at what they can do to improve but not throw out innovation, progression and even risk-taking decisions that advance the company, rather than just being focused on risk aversion [in] decisions.”

JULY 2018

Equip Super

CASE STUDY Four years ago, the $15 billion fund assessed the skills of its board members to develop a strategy to fill perceived gaps.

Equip Super hired executive recruitment specialists Heidrick & Struggles to perform a skills matrix assessment at what was then an $8 billion fund, Equip chair Andrew Fairley recalls. After getting the results, Equip worked with Heidrick & Struggles to implement a strategy to find candidates to provide the missing skills.

“We’ve said that we think we run three businesses,” Fairley says. “We run an investment business, we run an administration and insurance business, and we run an aftercare and advisory business.

For those three businesses, you need a broad subset of skills, and the soft skills you then need are understanding the issues of the employer, because $3 billion of our fund is in a defined benefit plan.

You need to understand the circumstances of members, and you need to be able to understand the superannuation landscape we have in this country. We think that you have to have the skills, but that you also have to have a pipeline of people who are coming through in succession.”

Equip has a policy of four terms of three years, Fairley says.

“Twelve years is probably about the optimal. There’s no hard and fast rule – some say nine years, some say six – we think 12 is the outlier, and it also comes back to one’s personal experiences.”

THE SKILLS Directors need hard skills around finance, risk, understanding of insurance markets, and administration of both a defined contribution and a defined benefit plan.

This led Equip to put an actuary on the board.

“Then there are commercial skills, the entrepreneurial skills – those that understand what drives a successful business, because we’re running a profit-for-member business,” Fairley says. “Around our

communications, we identified all those years ago that a key skill was having somebody who understands digital strategy and social media, and the whole idea of disruption.

“Those are the sorts of things we took into account, and [you also] need to have people who are collegial, but also not going to be intimidated by others into not asking questions.

Plus, we need people who will fit the culture of the organisation. That’s a really important consideration.”

The need for some of these skills led Equip to change its process for selecting board members, from a direct election by employers and members for the requisite representatives, to a nominating process by employers and members, with the long list of nominees given to Heidrick & Struggles, which then tailors the short list of candidates from whom the board chooses.

“For example, we’ve just been through a member appointment process and we’ve said there are two positions that are coming up,” Fairley says. “In one position, we need an absolute expert in investment. For the other position, we need somebody who is highly skilled in communications, but particularly in digital strategy and digital communications, and understands and can deliver, and appreciates the role disruption can play and will continue to play. We advertised that one on our website, and we got many, many applications – over 20 for each role, including the two directors who were up for re-election.”

Both roles have now been filled.

“We are a fund that is still – at the essence of our director appointment criteria – unabashedly committed to having the skills necessary to run a $15 billion fund,” Fairley says.

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A VOLUNTEERING DAY YOU CAN PUT YOUR HEART INTO The Wayside Chapel invites you and your colleagues to spend a day in Kings Cross learning about life on the streets and lending a helping hand to the most vulnerable people in our community. Come to hear about lived experiences of homelessness, learn about local social issues, and cook and serve a lovingly prepared meal.

You’ll leave with a different perspective of the people you pass in the street, and a whole lot of love.

an AWAYSIDE day A TEAM EXPERIENCE LIKE NO OTHER

FOR MORE INFORMATION AND BOOKINGS: EMAIL: groupvolunteering@thewaysidechapel.com PHONE: 9581 9101

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POLICY

QUIT POINTING FINGERS AND HELP The troubles within super are more manageable than the Productivity Commission’s report suggests, and they’d be much closer to being fixed with PROPER GOVERNMENT ACTION.

DAVID HAYNES EXECUTIVE MANAGER, POLICY AND RESEARCH | AIST

THERE ARE SOME uncomfortable truths in the Productivity Commission’s draft report: there are way too many super accounts; the cost of insurance has sometimes been paid at the expense of young and casually employed people building up balances in super; and there are some underperforming super funds. Most not-for-profit super funds are high-performing but a smattering are not. Most of the underperforming funds are in the retail sector.

As the superannuation industry, we need to be held to account by our members, government and the community. There is no place for super funds that underperform in the long term. Unnecessarily duplicated accounts should be consolidated.

Governments past and present also need to be held to account, particularly where they have been the brake

on improving efficiency and consumer protections. There are plenty of examples of where this has happened.

With its ideologically driven disdain for the Fair Work Commission, the current government has stalled the default selection process for four years. Despite calls from the Australian Institute of Superannuation Trustees and others to re-start the process, there was no attempt to implement increased consumer protections and accountability measures to remove underperforming funds from the default space.

Parliament passed these measures back in 2013 and the government itself had told the Federal Court it intended to implement them. As a result of the government’s inaction, thousands of Australian workers have been allocated to funds that should not have retained their default status.

This isn’t the only area where successive governments

JULY 2018

have sat on their hands and ignored reforms that could truly make a difference in member outcomes.

The auto-consolidation of lost and inactive accounts was meant to start in January 2014. Following extensive discussions with the super industry, the government had announced in 2011 that members would have a streamlined process for consolidating accounts and avoiding paying unnecessary fees, including insurance premiums, on multiple accounts. Any accounts with less than $1000 were to be automatically consolidated into the current active account, unless the member opted out; however, the government stopped this plan before it even started.

Instead, it increased the number of lost accounts transferred to the Australian Taxation Office, where the savings in these accounts are counted as consolidated

A recommendation to ban all commissions must surely be in order

revenue until claimed. The Productivity Commission’s draft recommendations ignore these stalled reform mechanisms, and instead propose dismantling the system as we know it.

The report fails to put into context the success of the Australian superannuation system and the fact that, by world standards, we are starting from a very high base.

The problems the commission identified are real but can be resolved without a sledge hammer.

The Productivity Commission also ignores Choice superannuation products, where the bulk of assets in pooled funds lie, and where underperformance is even more systemic. This is despite the commission finding that not-for-profit super funds systematically outperform for-profit super funds and feature overwhelmingly in the top-rated MySuper products, with default super posting (on average) investment returns almost 2 per cent a year higher than in Choice super.

In spite of this, the commission hasn’t made any draft recommendations that are directly about investment performance. There’s a weak recommendation that people being gouged by now-illegal, but sometimes grandfathered, trailing commissions should be told about them. A recommendation to ban all trailing commissions must surely be in order.

We do need to do more – much more – to ensure that we have the community’s trust but it’s a bit rich for the financial services minister to be scolding the super industry about these issues when the government should have worked with us to address these problems.

Many of them could have been largely fixed years ago.

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ASI2018

SUPER INVESTMENT CONFERENCE

Cairns Convention Centre

5-7 September 2018

Australia’s biggest profit-to-member superannuation investment conference ASI 2018 is back to deliver three days of discussion, debate and strategies to help funds meet their investment goals.

KEY TOPICS WILL INCLUDE • • • •

Geo political trends and their impact on institutional investors What you need to know about Sustainable Development Goals (SDGs) Latest investment policy and regulatory updates Investment strategies to maximise returns for members

Anthony Pratt

Cassandra Mathews

Michele Barlow

Sir Rod Eddington

Visy Australia

Investment Solutions Group, SSGA

KordaMentha

J.P. Morgan

For more details and to register, visit aist.asn.au/asi

Uto Shinohara, CFA

Mesirow Financial Currency Management (USA)

Catherine Alfrey

WaveStone Capital

Sally Warenford Schroders

Jai Jacob

Lazard Asset Management

32

2018 NATIONAL CONFERENCE

PRINCIPLES AND VALUES

Charting your course through shifting societal expectations.

1 & 2 August 2018 Hilton Hotel, Sydney

GUEST SPEAKERS

Peter Greste Professor, UNESCO Chair of Journalism and Communications at the University of Queensland

Sam Mostyn Non-Executive Director

Graham Harman Head of Investment Strategy, Russell Investments

Dr Attracta Lagan Co-Principal, Managing Values

J Register today at feal.asn.au