David Bell recently became Chief Investment Officer at the $8.5 billion AUSCOAL Super (AUSCOAL) fund. Previously, he ran his own consulting business and spent 12 years at Colonial First State.
GH: Investing is an art as much as a science, how do you come into a business and bring your subjective opinions into an existing investment process?
DB: My first step is to make use of the asset management tools we have, and to realise the strengths and weaknesses of the science. Then you introduce the art. You have subjective overlays as you become more experienced. In a super fund, you are working with an investment committee and a trustee board to come to final decisions. An important skill is to explain the strategy clearly to both the investment committee and trustees so they are comfortable with your level of subjectivity. Some traditional trustees may not know the investment science, but they all have the subjective piece. AUSCOAL wants a CIO who can bring the thoughts together and lead the conversation.
GH: Is there anything in the portfolio that surprises you or you feel strongly against?
DB: It’s a good portfolio in good shape. AUSCOAL was one of the first super funds to have a default fund which ran a lifecycle strategy and allocated to private assets. After the introduction of MySuper, about 20% of the industry is now running a lifecycle default strategy, dominated by the retail players who put mostly liquid assets into their lifecycle funds. I think there’s a lot to be said to have a wider universe of investments, in terms of return and diversification opportunities. As long as you’re confident you’re being rewarded for it. So it’s good that we’re already investors in private assets.
GH: How much will you bring market timing into your investments and how will that vary from the past?
DB: In its recent history, AUSCOAL has not been an aggressive market timer. They make small tactical tilts in consultation with the asset consultant, Mercer, and the Investment Committee. It looks like some super funds last year made quite large tactical tilts, and some better performing funds probably did one or more of the following tactical trades: go overweight growth assets, go overweight global equities (even better if the currency exposure was unhedged) versus Australian equities. I’m not going to come here and say market timing is what differentiates AUSCOAL in the market.
GH: People will be encouraged by recent successes to do more market timing, so will you be managing that expectation?
DB: History and academia shows market timing is hard to do consistently. It is also one of those areas where it becomes clear in hindsight. We are probably more focussed on tactical asset allocation for risk reduction, and we will use our tactical budget when we see risks emerging. Even playing defensively you need to be careful. If you get out too early, you can have two or three poor years before you’re proven correct. Across the industry there is the risk that a trustee says they can’t take the heat. The investment committee and trustee have to come on the journey, buying into the process with you.
GH: How much pressure do you feel to match your competitors, putting emphasis on the peer risk?
DB: Since I’ve been here, there is more focus on member outcomes and our PDS defines our objective as CPI-plus. But the peer group element is still there. APRA has added to a peer group focus through initiatives such as the product dashboard. Nobody really knows what everyone else is doing, so it is difficult to manage for peer group risk on a forward-looking basis. You cannot be too worried about it and it’s not what members want anyway. If we’re telling members we intend to outperform a peer group, and in the GFC the median fund was down 20% and we were down 18%, the outcome is not properly aligned. In focusing on outcomes we create some risk that we might underperform peers in a good environment. To manage for this we need to educate – externally to explain to our members how we are contributing to their retirement outcome, and internally across all our staff, senior management and our trustee.
GH: Do you have a feeling this is not a great time to become a CIO with rates so low, US equity markets at all-time high, government debt out of control?
DB: You are challenged to find attractive value at present. But I would reverse the question and say, “Do you want to captain a ship in smooth waters or rough seas, where you can add the most value?” When values are stretched, that’s when you want to be there, when members will benefit the most.
GH: Can we drill deeper, with your defensive allocation, where do you put your money?
DB: Fixed income has become challenging, and defensive options are trying to earn real returns but the real returns on cash are currently negative. It’s a flat yield curve so taking term risk is not rewarded unless you think inflation will fall. Then you go out on credit spreads but both investment grade and high yield grade spreads are tight. So we start to see it’s a tough sector. Predating me, we moved away from managers who have benchmarked portfolios to those who are more flexible, with a total return focus. You might allocate to a manager who has a CPI-plus mandate or a cash-plus mandate. There is so much complexity in fixed income that there is value to be added in this sector by skilled managers. We pay a little more for these mangers but we feel they are a better fit with our objectives. There are some good opportunities in mortgage-backed securities in the US, so we give money to a manager in that space.
GH: Do you always gain exposure to an asset class through managers rather than going directly?
DB: Nearly everything we do is through managers. Generally, the industry funds who are managing money themselves have $20 billion plus and at that level they have a constant debate about efficient implementation. So for example Unisuper with $40 billion manages 50% internally. Some smaller groups such as Equipsuper manage Aussie equities internally.
GH: Do you give global managers currency hedging instructions?
DB: Generally, with global fixed income we fully hedge our currency exposure. Fixed income is low volatility and currency volatility would swamp it, defeating its role in your portfolio. We have a strategic target for global equities. We use a currency overlay manager to make and implement tactical calls around this strategic target.
GH: Are there any asset classes that you feel active asset management is not worth paying for, that you should save your ‘fee budget’.
DB: I’m a bit of a contrarian to the marketplace. I’m quite happy to pay higher fees than most for fixed income as I feel there are a lot of opportunities for value to be added. In equities, our managers have done well over time, but the question for me has been how much of that was due to the ability of the manager versus a simple style-based rule. That’s something we’re working more on. This brings it back to the point about ‘science’. Can we use some of these simple style-based rules ourselves?
I think there’s more potential for active managers to outperform in Aussie equities than there is in the global space. Much of the academic literature paints a poor picture of outperformance in global equities, where you pay fees without much reward, and our experience has been that active performance in global equities has not been as compelling. So what’s the best way to achieve global equity exposure? In recent years, the emergence of smart beta (style-based) strategies increases our ability to assess their true value-add, and also broadens our range of implementation options.
GH: Is it worth paying active fees for other assets such as property and alternatives?
DB: Yes, we have allocations there. But the more you move into non-traditional asset classes, the harder it is to benchmark your managers. For example we have found it difficult to find a good property benchmark which reflects what we are trying to achieve. The benchmark we have is a little more aggressive than our property objectives so you have to be mature to accept that our portfolio will likely underperform in current buoyant market conditions. We have a lot of team experience investing in hedge funds but again you have to really understand what you are getting for that exposure. I see a triangle of risk, return and fees, and one of my roles is to decide the appropriate balance.
GH: Australian super funds have traditionally focussed on accumulation, but more recently on retirement incomes and outcomes. Why doesn’t AUSCOAL make its best estimate of likely retirement balance and resulting income and give clients a number they can understand?
DB: There’s a lot of responsibility in providing that number. We are pushing down the path to produce the information. But there is much greater opportunity than the addition of a single number to a statement. Imagine if you had a tool that could project outcomes with a range of possibilities, and members could interact with this tool. This may help direct them to a more appropriate portfolio mix. Then if they give us a bit more information, such as their personal balance sheet and savings characteristics, we can give them an interactive tool with a clearer picture. This same system could be used to tailor the design of our lifecycle default strategy, and could also be used by our financial planners. We are building these models at the moment, I’m very excited about it.
GH: Do you think longer term you’ll be doing more in-house and having your own traders?
DB: I think there are a lot of good managers out there, and there’s a lot to be said for transaction skills. You might lose a lot through execution without realising it. Slippage and market impact costs are not well understood. If we have a good idea, we might use an external party to execute it. I can’t see us having ten traders inside the office. So even if we go down a core/satellite approach, we’d likely use a manager to implement the core for little cost rather than do it ourselves. We use mandates rather than unit trusts so we have all the tax efficiencies. I don’t think people overcharge for execution, and the big players have purchasing power. There’s a lot of operational risk doing it internally, one mistake and it’s very expensive. An external manager will generally pay for any mistakes they make.
GH: So have you seen where many of your members work, down a mine?
DB: That part of my initiation is coming soon. There are 2,000 kilometres of tunnels around Lake Macquarie, some two kilometres deep. It’s going to be quite an experience.
In addition to being Chief Investment Officer at AUSCOAL Super, David is working towards a PhD at University of NSW and is a Principal at Cuffelinks.