AustralianSuper has concluded an 18-month review of its investment risk framework, resulting in the pension fund place a greater emphasis on a total portfolio approach and enshrine a level of flexibility to act upon investment opportunities as they arise.
Alistair Barker, Head of Portfolio Construction at AustralianSuper, unveiled the new framework at the [i3] Investment Strategy Forum in Torquay, Victoria, last week.
In an interview with [i3] Insights, Barker explains the fund favours the use of a risk budget as opposed to a set of rigid limits.
“Under our investment framework we say that our risk limits apply at the investment option level, so the level that our members access, and that results in certain limits at a whole-of-portfolio level, where the focus is on ensuring that we manage the key risk which is: not meeting our investment objectives” he says.
“But up to that limit risk can be allocated flexibly between asset classes and different strategies.
“We think that aligns with our investment philosophy. Because we believe in active asset allocation and active stock selection, having a flexible approach is important to support the decision framework.
[The risk framework] has to support our process otherwise it will be an interesting paper with lots of glossy diagrams, but one that no-one can really relate to
“And it has to support our culture and processes otherwise it will be an interesting paper with lots of glossy diagrams, but one that no one can really relate to.”
This flexibility should not be confused with market timing, such as picking the bottom of a market downturn, he says, but instead it ensures the fund doesn’t mindlessly allocate according to a predetermined asset allocation policy.
“There has been lots of discussion in the marketplace that a static 60/40 portfolio is not a great portfolio to hold throughout the cycle and we absolutely agree,” he says.
“So part of what we are trying to do with our risk framework is acknowledge the fact that a static asset allocation to a series of asset classes, whose returns can vary substantially from their long-term average, doesn’t make a lot of sense.
“A lot of what the risk framework is really trying to outline is that the assets we invest in should be a function of what our investment processes of our internal and external managers suggests. Is it an attractively priced investment? How do you size those decisions? How do you make sure you’ve got the right mix?”
He illustrates the approach with a hypothetical transaction in unlisted markets, an opportunity that is infrequent but bulky.
“Having that flexibility in asset allocation is really important to the fund. In some cases that might be to fund a large direct transaction, where we say that we need some flexibility because the timing of when direct opportunities arise is not under our control, but that is hopefully where you earn an additional return,” he says.
Risk is a forward-looking conversation
When Barker started the review in September 2016, he realised the previous framework didn’t define risk by name. This was largely a function of risk having been traditionally perceived as a way to restrict the activity of investment specialists.
“We have quite a large base of internal and external people who are fundamental investors. Their historic experience from their funds management background was that the risk management function was a control function. It was something where lots of limits might be imposed, so it was seen as a constraining activity,” he says.
“The original investment philosophy was probably written with that ‘old world’ view of what risk was. What we’ve been trying to do is saying: ‘No, risk is really more a forward-looking conversation.’
“It is about saying: ‘What are the risks in these markets or assets that you are buying today, based on looking forward and research. And do you think you are being well rewarded for those risks?’
“When we explain it that way most people say: ‘Okay, well I’m doing a lot of that in my job already’. So all we need then is a few principles for how we link their analysis into the overall fund’s view of risk.”
“The added benefit from the framework has been the ability to start a more structured conversation about individual types of risk, either market-related or less conventional risks.
“So if you take climate change as an example, it is something we have now started work on. Our aim is to understand the risks from policy change and to assets directly.
“But rather than asset-level analysis, our focus will be to understand how these risks impact members’ long-term returns, and also get a sense of how climate change ranks is terms of its impact compared to other risks,” Barker said.