When you ask an institutional investor what their investment time horizon is, you most likely get the response that they are a long term investor. Building up wealth for retirement is a multi-decade exercise and so pension money is patient, or so the story goes.
But in reality, most pension funds terminate investment managers if they underperform over a period of three years. This is not because pension funds are short-sighted, but because they often juggle multiple objectives.
Not only do investment teams aim to build up wealth for members, they also seek to outperform their competitors, implement changes because key staff leave or simply want to be seen as doing something.
The partnership model that has become popular in recent years mitigates some of these issues by cultivating longer relationships with a select group of managers.
The idea here is that one takes the time to get to know the manager, understand its expertise and where possible share knowledge to help the pension fund achieve its objectives.
New Zealand Super (NZ Super) embraced the concept of partnerships in 2013 and the fund has spent a good chunk of last year mapping out the strength of each partner and matching these with the fund’s areas of interest.
“We’ve gone through an exercise last year of mapping our managers’ capabilities against what our research priorities are,” Del Hart, Head of External Investments and Partnerships at NZ Super, says in an interview with [i3] Insights.
“It is really about connecting with people that have specific expertise. We don’t really ask our managers do research for us. We have done in the past, but it is not our current focus,” she says.
Hart, who spoke about the subject at the [i3] Pacific Investment Strategy Forum in Sydney last month, says NZ Super categorises fund managers into three buckets: strategic partners, high touch managers and non-target managers.
We look at our investment opportunities mainly as diversifiers, broad market mispricings or specific asset mispricings. All of our opportunities fit into those broad categories
“Most of our time is spent on our strategic partnerships,” Hart says. “Our high touch managers are categorised for a number of reasons: sometimes it is the mandate structuring that means we need to spend more time on those, or there is knowledge-sharing potential but they don’t have the breadth of a strategic partner.
“Non-target managers manage a mandate, but it is unlikely that other members of the investment team, outside the relationship management team, would ever speak to those managers. Fund-of-fund managers are an exception, because they have both the breadth of expertise and willingness to engage. They have been really valuable to our research efforts.”
“Fund-of-funds were our very first private equity investments,” Hart says. “Then we moved to commingled funds on the recommendation of advisers. But once we developed our reference portfolio in 2010, and our investment framework in 2011, we built up internal capability and we brought all of that manager search and selection process in-house.”
In contrast to other pension funds, NZ Super doesn’t carve out a slice of the portfolio for its partners to manage against a set benchmark. Hart says that this is largely driven by the fact that NZ Super’s investment model is quite different from most funds.
“We focus a lot of time on identifying an investment opportunity and then appoint a manager to manage a specific mandate to get that exposure. We look at our investment opportunities mainly as diversifiers, broad market mispricings or specific asset mispricings. All of our opportunities fit into those broad categories.”
“We don’t appoint multi-asset class investment mandates [for our strategic partners]. The main focus of the partnership approach is making sure that we are spending our time on value-add interactions,” Hart says.
“For example, we have a manager and have invested in its private equity portfolio but they also have expertise in real estate, credit and other areas that our broader investment team might be interested in.”
Hart has broken down the team’s partnership efforts into three areas of focus: research support, secondments and fireside chats. “We encourage that if managers have senior people traveling through the region that they come and run a fireside chat with our investment team,” she says.
“The knowledge-sharing is the main benefit, but we’ve learned over time that we need to be quite targeted in that. To get the broader benefit across the investment team, we need to understand our research priorities and map that against the capabilities of our external managers. “
“It is about having a very open, transparent relationship with our strategic managers so that they understand the way in which we invest. That puts them in a much better position to meet our knowledge sharing expectations,” Hart says.
To terminate a manager, they will underperform on two or more factors, it is not just solely performance
As NZ Super moved to create fewer but deeper relationships with its external managers, the assessment framework of managers has evolved as well. Performance is only one item of a broader framework that takes elements into account, including consistency, process capabilities and risk management.
“We have an eight factor model of which performance is one factor and the eight factors are equally weighted,” Hart says. “So, if a manager is underperforming we pay a lot of attention to people capability, process capability and really try to understand what is driving underperformance.”
True to its word, the fund has been monitoring a manager that has been underperforming for three years, but hasn’t yet terminated it.
“This manager has gone from being a good manager based on our conviction framework to a threshold manager, which means that we monitor them a lot more closely and really dig into the performance attribution to see what has led to their underperformance,” she says.
“If one particular stock as an impact on performance and you can understand the manager’s investment thesis, then we give them a bit more time, but we do monitor them extremely closely to determine whether they are improving or whether we need to terminate them,” she says.
“Often, to terminate a manager they will underperform on two or more factors, it is not just solely performance. If a key person has left or there is style drift that also adds to a decision,” she says.