It has been 11 years since the global financial crisis rocked markets around the world and for most pension funds this means their 10-year track records have now shed the sharp drawdowns that were experienced at the height of the crisis.
Since February 2009, most developed markets have risen steadily, occasionally interrupted by a wobble. But this can give investors a false sense of security about the period ahead, especially if they entered the investment industry in the past decade.
“Markets always go up, right? What could possibly go wrong?” Andrew Howard, Chief Investment Officer at VicSuper, asks ironically in an interview with [i3] Insights.
Howard and his team at the $22 billion pension fund believe the world will see lower growth in the years ahead than historically has been experienced, accompanied by bouts of volatility.
“We are entering an environment where we are likely to experience a lot more headwinds and tailwinds,” he says.
“When we think about our future needs and what is fit for purpose, then what do we need to do to manage an environment that we believe is going to be lower for longer? Asset allocation will always be the main driver of your returns, so we are constantly looking to enhance diversification.”
Asset allocation will always be the main driver of your returns, so we are constantly looking to enhance diversification
VicSuper has spent the past 18 months adjusting its asset allocation to lay the foundations for a portfolio that can withstand higher levels of volatility and prolonged periods of weaker markets.
“Over the course of the last 18 to 24 months we have shifted the asset allocation quite markedly, reducing the equity exposure materially to fund increased allocations to real assets and alternatives,” Howard says.
“We are not trying to be cute in terms of timing markets or tactical asset allocation. It is about getting your foundations right so that you can start to think about the bigger picture and not be awake at night thinking about what markets could be doing. If you constantly have to think about markets, then you are in trouble.
“We’ve increased our exposure to real assets and for the first time the fund has gone offshore in property, so US property, European property, but also European and US infrastructure and timber. We’ve also increased our exposure to alternatives, including CTA (commodity trading adviser) strategies and some liquid multi-strategy funds as well.”
VicSuper is not the only institutional investor that has increased its exposure to real assets and Howard is well aware of the criticism about elevated prices in this space.
“Winding the clock back 12 to 18 months, there were real concerns around the valuations of real assets becoming a little bit toppy. The reality is that if you have $100 to invest, then you have to invest it somewhere,” he says.
“Do you want to put more money into equities? The reality is that all funds are chock full of equities. If you have real assets delivering, let’s say, circa 8 per cent over the course of the next five to seven years, then that still plays a very important role in your portfolio.”
But he does acknowledge investors should adjust their expectations about the level of returns these assets will generate in the future.
I’ll happily accept a lower return than what we might have received from real assets over the last 10 years to ensure we have enough ballast in our portfolio to deliver a smoother pattern of returns
“You need to shift your expectation because what we’ve seen over the last 10 years is this perfect tailwind. It has artificially inflated investors’ expectations of what to expect from core infrastructure and core property,” he says.
“The music will have to stop at some point. But I’ll happily accept a lower return than what we might have received from real assets over the last 10 years to ensure we have enough ballast in our portfolio to deliver a smoother pattern of returns.”
Having laid the foundations for the years ahead, Howard is under no illusion the asset allocation puzzle has been solved.
“We think the asset allocation conundrum is something that you should always be thinking about,” he says.
“At the end of the day, we can get so caught up in manager selection decisions that we don’t spend enough time on asset allocation, but as I respectfully say to all fund managers: ‘Even if you do a great job for me and you’ve generated 500 basis points of alpha, but we get the asset allocation decision wrong, then you are not going to make up for my sins.’
“So let’s make sure that we are focused on the most important part of the investment strategy, which is the asset allocation, and then fill out the portfolio from there. It starts and ends with asset allocation. That then drives a lot of the work we do as an investment team.
Don’t wait for the perfect solution; there are always things you can do better
“One of the things that we are currently working on is how can we further develop and build out our alternatives exposure.
“This is a period where alternatives should really come into their own, but what we’ve seen over the past 12 months is that a lot of these strategies haven’t actually delivered what you would expect. So alternatives is an area that we are thinking about.”
Howard has also worked hard to instil a culture of innovation in his team, where people are encouraged to think outside the box and think about the impact of data, climate change and other geopolitical issues on investing.
“Having grown the investment team over the last 12 months, it is about developing that culture of innovation and creating a safe environment for new ideas because every day that you work in investments there will be something new. You will learn from it,” he says.
“Don’t wait for the perfect solution; there are always things you can do better.”
Andrew Howard, Chief Investment Officer of VicSuper, will speak at the eighth [i3] Investment Strategy Forum, which will be held on 9 and 10 May 2019 in Torquay, Victoria. For more information, please see here.