It is not uncommon to hear institutional investors say today that they are looking to employ fewer fund managers, but to have deeper relationships with the ones they retain.
One of the closest ways of working together with an external manager is through a strategic partnership, an initiative that was pioneered by United States pension fund Teacher Retirement System of Texas, which introduced its partnerships program in 2008, giving $1 billion to four managers and assigning them specific research projects to conduct.
The idea behind a strategic partnership is that the asset owners gain insights into investment processes and the partners’ views on markets that will help them manage the rest of the portfolio better.
Or as David Veal, former Director of Strategic Partnerships and Research at Texas Teachers, explained to [i3] Insights in 2016: a partnership involves much more than increased face-to-face time with asset managers. It requires a deep understanding of how a manager operates, what its strengths and weaknesses are, and what bets it is taking in its portfolios.
Sunsuper was among the first Australian pension funds to explore this arrangement and started due diligence on managers in 2012. But it wasn’t until September 2015 that it initiated the first relationship, with two managers appointed initially.
The program has grown in the two-and-a-half years since to now include four managers: Neuberger Berman, JP Morgan Asset Management, Wellington and State Street Global Advisors.
The elevator pitch for this is simple: we have a clearly defined internal benchmark and by adding value to that benchmark we will meet our objectives
Andrew Fisher, Head of Asset Allocation, and Joshua Bay, Portfolio Analyst, Asset Allocation, at Sunsuper provided a glimpse into the program at the [i3] Investment Strategy Forum in Torquay, Victoria, last month and spoke with [i3] Insights afterwards.
“The elevator pitch for this is simple: we have a clearly defined internal benchmark and by adding value to that benchmark we will meet our objectives,” Fisher tells [i3] Insights.
“What we decided to do was take 4 per cent of the fund, slice it off and give 1 per cent slices to four managers and give them exactly the same benchmark as us.
“Then they need to beat the benchmark, show us how they beat the benchmark and finally help us do a better job with the other 96 per cent of the portfolio.
“That is where the rubber hits the road: can we do better in the rest of the portfolio? Relative to the fund, each of these individual mandates doesn’t really move the needle, so delivering a meaningful positive impact on the fund is the ultimate goal.”
When viewed purely through the lens of realised returns, the success of the partnerships has been somewhat lukewarm.
“They haven’t done particularly well or particularly poorly. They have all tended towards an overweight equity beta position recently; the timing of when they went long equity beta has been the biggest differentiator in terms of the returns in the last 2.5 years,” Fisher says.
“There has not been a lot of diversification. Of the four, there is one manager that has been diversified and they have had quite a different portfolio, while the other three are pretty similar.”
We thought we had put together a diversified portfolio of managers, but what we noticed was that our managers were less diversified than we thought
Bay adds: “We thought we had put together a diversified portfolio of managers, but what we noticed was that our managers were less diversified than we thought.
“The highest pairwise correlation between the excess returns of the partners has actually been 0.6. This was reflected in their positioning, with most of the partners converging to the same positions.”
Another surprising learning has been the reluctance of the managers to take meaningful positions in the Australian market.
“We believe that it comes back to the question of Australia having such a top-heavy market where the top 10 stocks make up a large amount of market cap. There is not a lot of breadth where you can implement strategies that take advantage of dispersion and gaining confidence in top-down market views is equally challenging,” Bay says.
“More often than not, we haven’t seen the partners take a meaningful view of overweight or underweight on Australian equities.”
Fisher agrees that in terms of the Australian market, the benefits have been limited.
“The biggest learning was that they weren’t prepared to take a bet against the Australian market,” he says.
Yet, the strategic partnership program has delivered invaluable benefits on other fronts, Fisher notes.
“It has been an incredibly successful program. We are very happy with how this is working out. One of the most successful things we have done to date is significantly improve the dialogue between the internal team and our stakeholders. I think an engaged investment committee is much more willing to challenge and is therefore more confident in the decisions that you recommend to them,” he says.
Sunsuper organises an annual forum in which it brings its strategic partners and key stakeholders together to discuss how each party sees the world. One of the key outcomes from the forum held in October last year was the disparity in views on emerging markets.
“We brought together our board and investment committee who heard from not just the Sunsuper team, but also some high-quality investors, and they got to hear everybody’s views and distil those into a view of the world. Are we seeing the world significantly different from our partners?” Fisher says.
“If you look at emerging market equities, our view versus the consolidated view of the managers was that we thought emerging market equities were approaching fair value, while the managers thought emerging market equities were cheap. Given the disparity in views, that was the key item that we discussed in detail.
“Time will tell whether we made the right decision, but we certainly tested our views and made an informed decision. We have reduced our exposure back to benchmark weight, but at the same time the investment committee has seen some very strong arguments against that view. We haven’t hidden anything from them; they have come in fully informed. That level of transparency was really powerful.”
He also points out that there are some significant initiatives under development that couldn’t have happened without the support of the strategic partners.
“To some extent it is a matter of watch this space. We have a big initiative on the horizon that we are hoping to implement in the next six months and that will make a big difference to the way we do asset allocation. That couldn’t have happened without the support of the strategic partners,” he says.