Building and construction industry pension fund Cbus has finalised the foundational work for the internalisation of asset management functions and has reached a scale where it is reaping the benefits of the internalisation.
The fund has just over 100 staff in its internal investment team, including middle and back-office employees, covering strategies in equities, fixed income, credit, cash and infrastructure. And although the internalisation will continue to evolve over time, the fund says the bulk of the team is now in place.
“It has built up significantly in the last three to four years, but we are now in a phase where we are effectively bedding down and have bedded down a lot of the strategies, so the rate of [staff] growth has slowed this financial year,” Brett Chatfield, Deputy Chief Investment Officer for Cbus, says in an interview with [i3] Insights.
“As we look forward to next financial year, the growth rate will be much more modest. The bulk of the build out of the team has already been completed, so now it is about extracting all the benefits from the internal strategies.”
The fund has gradually increased the allocations to the internal strategies and most are no longer at an incubation stage, especially the equity strategies.
“Over the last 12 months, we’ve increased the size of a number of internal strategies as they have bedded down. So global equities is now over $2 billion in AUM, the emerging markets strategy over $300 million and our small-cap fundamental strategy is about $400 million. So we’ve built them out towards their longer-term target weights now,” Chatfield says.
Cbus started its internalisation journey in August 2016 when the board approved the decision to internalise strategies across a range of asset classes and to build the infrastructure necessary to implement them, as well as build out enhanced capability within asset allocation, strategy and responsible investing.
Since then the team has built capabilities across most mainstream asset classes, but has taken a very specific approach that emphasises concentrated portfolios of quality stocks, sometimes with a slight lean towards a growth style of investing.
“What we’ve got at the moment is internalisation across most asset classes. We have it in global equities, which was one of our early strategies and that has been running for over two years, which is a concentrated quality strategy that has done very well,” Chatfield says.
“It has done over 9 per cent per annum in excess returns since inception to 30 April and has provided solid downside protection over this [March] drawdown period as well.”
Global equities are run by a fundamental team based in Melbourne, led by Anthony Seabrook, Senior Portfolio Manager, and they have adopted a traditional bottom-up stock research and stock selection process.
“That team also runs an emerging market strategy now that was launched in September last year, and they are leveraging off their philosophy and style and then apply it in the emerging markets. Again, that strategy has started really well, albeit it is a short time period,” Chatfield says.
“In Australian equities, we commenced with an Australian small-cap capability and that was with two senior members of the former Antares team, Stephen Croft and Paul Dewar. Again, they run a traditional bottom-up, slightly growth-tilted strategy. And they have been running for a bit over a year as well and they’ve outperformed since starting, which has been pleasing.”
Many external small-cap strategies have struggled in recent years as the market has been driven by forces other than fundamentals, including quantitative easing, volatility in commodity prices and the search for yield.
It is a more difficult period for small caps over the last few years, compared to the preceding period, where there was a period back in time when small-cap managers were outperforming by 4 to 5 per cent per annum
Asked if the Cbus small-cap strategy hasn’t suffered along with the rest of the sector, Chatfield says: “I think that is true through different periods, but since inception they are up 3.0 per cent above benchmark to 30 April, so they still have been able to outperform, notwithstanding some headwinds,” he says.
“It is a more difficult period for small caps over the last few years, compared to the preceding period, where there was a period back in time when small-cap managers were outperforming by 4 to 5 per cent per annum. But they have been able to add about 3.0 per cent since they started in February last year, which is a pleasing start.”
Cbus also runs an Australian corporate opportunity strategy, which looks to build a highly concentrated portfolio of stocks, each consisting of a meaningful stake in the relevant company. The concept for this portfolio is not unlike the Canadian Model, where funds take a large stake in companies and become more of a strategic partner in the business. This portfolio can invest in listed and unlisted companies.
“We are looking for quality businesses where there is either a dislocation that has occurred or where there is an opportunity to build out a broader relationship as a long-term capital partner with the company,” Chatfield says.
“These are very high-quality businesses that should do very well over the long term. A couple of them we’ve started to build out more recently as they start to come under pressure, which we think is just a short-term position created by the coronavirus. This has created an opportunity for us.”
This portfolio has just three securities in it and Chatfield is unable to disclose who they are, considering the sensitivity of the holdings.
“It is not designed to be fully invested all the time. It is designed to be opportunistic. At some stages it might have built up a number of positions, while at other stages it might have very little in there,” he says.
More recently, Cbus has added a new strategy that seeks to make use of the best of both the quantitative and qualitative approaches to investing. The strategy is led by Clyde Haldane, who previously managed a similar strategy at IFM, The Myer and Calvert-Jones Family Offices, and also worked as a senior member of the equities team at AustralianSuper.
“We have another Australian equity strategy, which actually just has launched, and this is an ASX 300 quality growth strategy that we call ‘quantimental’, which has about 20 stocks. It is a mixture of quantitative inputs combined with fundamental research. Our quantitative team works closely with the two portfolio managers that run the strategy,” Chatfield says.
[Quantimental] is particularly focused on companies that are continuing to reinvest in their own R&D and their own businesses. In our view, companies that continuously reinvest in their business and incrementally grow the return on every dollar reinvested into the business should outperform over the long term
The focus of the strategy is on businesses that gain an incremental return on reinvesting retained profits and this in turn underwrites their overall earnings growth, which over time should result in solid share price appreciation. The quantimental strategy is still a fundamental strategy, Chatfield says, but it has extensive quantitative inputs in the process, for example around the screening of the stock universe and the weighting of individual securities.
“It is particularly focused on companies that are continuing to reinvest in their own R&D and their own businesses. In our view, companies that continuously reinvest in their business and incrementally grow the return on every dollar reinvested into the business should outperform over the long term,” he says.
Cbus still runs many equity strategies with external managers, and this is unlikely to change anytime soon as Chatfield is well-aware the team can’t run everything internally and believes there are some very high-calibre external managers in the market. But the fund also has developed a hybrid model, where the internal team works closely with a number of partners to develop investment strategies, specifically quantitative alternative beta equity strategies.
One of Cbus’s strategic partners is Realindex, which runs Australian small-cap and global equities strategies for the fund.
“Realindex is our main partner and they have developed a number of strategies, including in Australian small caps and global equities, where we have a number of strategies in place,” Chatfield says.
These strategies are often quite different in style than the internal fundamental team’s approach and they function as a completion portfolio to ensure the fund is not overly exposed to one style or factor, he says.
“We will continue to build a diversity of different styles and approaches and historically we’ve had that by using external managers, which we still have, but we would like to have diversity in different styles and approaches within our internal team as well. Because clearly there are times where different styles are in and out of favour,” he says.
Infrastructure and Debt
Apart from equities, Cbus has also internalised parts of its infrastructure, fixed income and credit sectors. The infrastructure team has been in place for about three years and was until early 2020 led by Diana Callebaut. Callebaut left Cbus in January to join NSW Treasury Corporation and the fund has just appointed Alexandra Campbell as its new Head of Infrastructure.
“We’ve got an infrastructure team of seven people that looks at transactions both in Australia and offshore, and both in brown field and green field opportunities. The team applies a hybrid strategy to evaluate opportunities across the spectrum of ownership options, including Cbus’s pooled fund exposures managed by IFM and Morrisons. They have done a number of direct transactions since they started, including the purchase of a stake in UK ports group Forth Ports and in Bright Energy in Western Australia, which combines a portfolio of wind and solar renewable energy assets,” he says.
Cbus has been managing cash internally for some time, but it is now also investing directly in fixed income instruments, including in credit, corporate loans and housing bonds.
“We manage a large portion of our cash internally and we’ve had that in place for quite some time, but we have built that out over the years,” Chatfield says.
“We also have a direct debt strategy that does corporate debt and also property construction financing, for example. That is an area where we look at a number of opportunities, including as a senior, first mortgage debt provider in residential apartment developments.
“We also have a specialised Australian fixed interest strategy, where we invest in things like National Finance and Investment Corporation (NHFIC) housing bonds. We were quite involved in the initial work around the development of NHFIC.
“They provide loans to community housing providers who provide affordable and social housing. It is a mechanism that allows them to have a cheaper cost of financing and that allows them to do more in the housing space, which is obviously quite positive from our perspective because we are supporting affordable and social housing.”
As with equities, Cbus also makes use of the hybrid model in fixed income and has partnered with Vanguard to implement a customised global fixed income strategy.
“We’ve built our own global fixed interest index. We’ve customised the index and then have Vanguard implement that for us. It targets a specific number of countries and targets a specific part of the curve as well to achieve the broad duration that we want, and also targets where we think the risk/return looks most attractive over the longer term,” Chatfield says.
Cbus is the direct owner of Cbus Property, a property development firm established more than a decade ago. Asked if owning this entity has given the fund any insights into how to structure the internal asset management team, Chatfield answers that despite the different sectors, it has been extremely helpful in relation to the governance of the teams.
Just as with its external managers, its internal team is given a clear mandate against which it is measured, both by its internal research team and by its independent asset consultant.
“As with our internal strategies, Cbus Property has its own investment management agreement. It is subject to the same ongoing monitoring and assessment as external managers, so having that rigour is probably the key to our internal strategies,” Chatfield says.
“Our research team has the same monitoring processes for the internal investment teams as they do for external managers. We also have Frontier Advisors do an independent annual review, which is reported to our investment committee.
“So there are a lot of processes around the internal strategies and in some ways they are treated as external managers. They’ve got a mandate and they get incorporated in how we do our multi-manager structure and risk management.”
Attracting the Right People
With the experience from Cbus Property, the fund quickly realised that to implement the internal strategy successfully it needed to get the right people for the right jobs. But this doesn’t necessarily mean it wants only finance professionals.
“Clearly having the right people and getting the right people is quite critical and we’ve been very focused on the team. Probably one area where we have been focusing on is around diversity, in particular cognitive diversity,” Chatfield says.
“If you look at our global equity team, it is highly diverse in terms of gender diversity, diversity of backgrounds, diversity of experience. We’ve got some more traditional buy-side investors. We’ve got some sell-side exposure.
“We’ve also got people with non-financial experience. The Head of Research, Global Equities in the team, Allison van Lint, her background is in immunology, she has a PhD and studied at Harvard Medical School and her research capabilities are incredibly strong.
If you look at some of the best fund managers around the world, having that mix of thought and mix of individuals is critical to your long-term success. You are getting very different inputs and very different ways of approaching challenges. That is something we embrace.
“She brings something quite different to the team and is an incredibly valuable resource. So we are not just hiring financial people, but also trying to get a good diversity of backgrounds and thoughts.
“Because that is probably another observation or lesson we’ve learned through time: if you look at some of the best fund managers around the world, having that mix of thought and mix of individuals is critical to your long-term success.
“You are getting very different inputs and very different ways of approaching challenges. That is something we embrace and that has been a key focus and the global equities team is a good example of that.”
It doesn’t hurt either that the person with no financial background happens to be an immunologist at a time when the world is engulfed in a pandemic. Chatfield agrees when he is asked about this.
“It has come in quite handy; she is getting a lot of questions about the coronavirus,” he says.
“But clearly she has a lot of insights in the healthcare space. There are some very large names that the team knows well, for example Illumina, a gene sequencing business, which is clearly her background and experience. That said, these strong research skills are very much applicable across other sectors as well,” he says.
Internalisation has been a big topic in Australia as almost all of the large pension funds are currently moving to such a structure in some shape or form. The case for internalisation is clear: with many fund managers charging fees based on the assets under management, the appeal of having an internal team with relatively fixed costs becomes greater as the fund continues to grow.
But there have also been some questions raised about whether internalisation still makes sense if we are faced with an extended period of low investment returns and low economic growth. Would it still make sense to have such a costly capability? Chatfield believes that not only does it make sense, but also it is now even more important to have such capabilities than ever before.
“If anything, internalisation is so much more important when returns are lower because you are clearly reducing your costs. You are able to control your costs more tightly, which in a low-return environment is critical,” he says.
“But also it gives you a much greater flexibility having an internal capability to consider opportunities across the various asset classes as teams are working together on different opportunities. In addition, having a strong internal direct investing capability also provides deep insights for our asset allocation team, as well as sharpening the questions and due diligence undertaken by our external manager research team.
“We would say having the internal capability puts us in a much stronger position during those more difficult environments versus a fully outsourced model.”
For a general guide on pension fund issues in Australia, please see here.
[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.