As more super funds merge and become increasingly larger, the role of asset consultants changes. We speak with Frontier’s Kim Bowater about internal teams, the impact of Your Future, Your Super and the increasing importance of technology in advice.
Consolidation of the number of funds continues to be a key trend in the Australian superannuation industry, not in the least place pushed onwards by regulators and new government reforms.
Once all mergers that have been announced up to May 2021 are finalised, 76 per cent of all superannuation assets under management will be managed by just 12 funds, KPMG said in a recent report.
Last year alone, the number of APRA-regulated funds fell from 171 to 154 entities and those that remained were increasingly larger in size – some hitting well over $100 billion in assets, a point at which they qualified as ‘mega-fund’, the accountancy behemoth said.
This ongoing consolidation, the rise of internal asset management teams and the dominance by mega funds not only affects the funds themselves, but also their service providers, including asset consultants.
As a result, the role of asset consultants has changed, where the larger funds increasingly use these firms as sounding boards of ideas, rather than as the main drivers of strategic direction, Kim Bowater, Director of Consulting at Frontier, says in an interview with [i3] Insights.
Super funds that manage an internal strategy..., they are now one body, whereas in the past there might have been an asset consultant making the recommendations or a manager implementing. Having an independent opinion, we find, is valued by the investment team and the fund investment committees
“There are no single, clear answers for investments, so we find that internal teams value an independent view to test their thinking,” Bowater says. “We get involved with new ideas, market insights, second opinions, using our technology, which we developed for use by internal teams.
“There is also the governance aspect. Super funds that manage an internal strategy…, they are now one body, whereas in the past there might have been an asset consultant making the recommendations or a manager implementing. Having an independent opinion, we find, is valued by the investment team and the fund investment committees.”
But the heightened merger activity itself has also provided much work for the asset consultant. Frontier has been involved in a number of mergers between funds and helped them shape the new entity.
“Over the years, we’ve worked with quite a few funds on mergers in all kinds of combinations – large funds merging with smaller funds, funds of similar size merging and one case where there were three funds merging into one fund. But certainly we are seeing more merger talk today,” she says.
Fund mergers mean investment teams suddenly increase in size and with that greater size comes added complexity in terms of decision making.
“We provide advice to quite a wide range of super funds today, across smaller, mid-sized to the very large,” Bowater says. “We’ve forged a really good understanding of the way the investment function can evolve at different sized funds and how funds can optimise their competitive advantages, which are often size related.
“So when it comes to a merger, particularly where there is a step change in size, we think that is a great opportunity for the new, combined entity to consider their investment model and what it wants to be in the combined entity, and we think we can add a lot of value in that process”.
Increasingly, Frontier consultants are also asked for their views on broader industry trends, both in the superannuation and the wider investment industries.
“I think within superannuation there is more focus on things like the Your Future, Your Super performance test, the [APRA] heatmap, further consolidation, extra complexity, peer comparisons and how to achieve outperformance in a peer relative sense, in addition to the goal of achieving strong long term returns for members,” Bowater says.
“These are things we talk about more and provide insight and advice around compared to 10 years ago,” she says.
Frontier has also been able to tap into markets outside of the traditional superannuation funds, adding several insurance clients in recent years. It now has seven liability driven investor clients on retainers, while undertaking projects for others.
“We come from a profit-to-members, superannuation heritage, but today just over half of our clients are outside of superannuation,” Bowater says. “We are focused on asset owners that are seeking institutional quality investment advice, across a range of investor types.
“Insurance is one that we have specifically focused on in the last couple of years, both (APRA) regulated and unregulated [insurers], as well as other liability driven investors. We also focus on charities and other foundations, universities, and other organisations with pools to invest needing advice.
“Over time, we have built up our offering to meet the needs of those different types of investors. So, for example, we recently launched an asset risk charge analytical tool to help regulated insurers with their portfolio modelling. We find that this intersection of tailored modelling and advice to be well received,” she says.
Technology and Development Team
Technology, such as the new asset risk charge tool, is becoming a larger part of the services asset consultants provide. A few years ago, Frontier made the call that this trend justified the appointment of a permanent internal technology development team, which has now grown to about 10 people, who are constantly updating the systems and adding new features.
“We hired a dedicated development team, which means that we can evolve that technology quite quickly,” Bowater says.
“For instance, last week we released a modeling capability within our portfolio analytics tool to help funds model their YFYS performance test SAA (strategic asset allocation) and understand that versus their existing portfolio, so that we can incorporate this issue in our advice.
“Having technology professionals internally that can build that in conjunction with our investment team is really valuable,” she says.
More recently, Frontier has changed the way it stores data, as more and more data becomes available. Centralising all of this information means its consultants can analyse data points across a broad range of fund managers and asset classes, where previously this data was stored on individual computers or servers.
“In terms of big data, there has just been a huge increase in the amount of data that you can collect on markets. It has grown exponentially,” Bowater says.
“We have spent quite a bit of time making sure we are collecting and managing data well. The old ways of storing things in the local drive and in your email doesn’t really cut it, you really need to optimise data usage.
“So we use third party software to support the collection and processing of fund manager data and this delivers us scale and the ability to look across information that previously we wouldn’t be able to do easily.
“We had it in place for about a year and we can already see that it will be quite powerful at the topic level. For example, for a number of years we have been collecting information about fund manager gender diversity.
We have spent quite a bit of time making sure we are collecting and managing data well. The old ways of storing things in the local drive and in your email doesn’t really cut it, you really need to optimise data usage
“Each year, we have been collecting that and this system will have all of that data in one place. So the ability to extract data over time and between asset classes will be really powerful,” Bowater says.
There has also been much interest in machine learning techniques in recent years and how these techniques can be applied to investing. Bowater says Frontier sees particularly interesting applications in portfolio construction and analysis.
“We use some machine learning techniques in our portfolio analytics system, which I think is useful in separating statistically relevant factors from noise,” she says.
“We want to be able to have a good insight into what is driving portfolio outcomes, so I think that is an area where technology can help and there will be more tools available to investors that help with this as well.
Although these techniques are interesting, the focus remains on finding practical tools that help Frontier’s consultants and their clients make decisions efficiently and accurately.
“If there is data that gives us insights more quickly, then that will help in gaining a good understanding and improve decision making,” Bowater says.
Regulations and Performance Test
Regulatory reform not only drives further consolidation, but it also continues to shape the way funds invest. The Your Future, Your Super reforms recently became law, which means that from 1 July 2021, superannuation funds will be subjected to an annual performance test.
There has been much criticism that this test will cause super funds to aim for lower tracking error versus the benchmarks and push fees even further down to levels where some funds might simply opt for passive investments, rather than try and achieve better risk-adjusted returns over the long term.
But Bowater isn’t convinced that the reforms will push fees down to a level where it affects funds’ ability to create thoughtfully constructed portfolios.
“I’m not entirely sure that that is the direction it will go in,” Bowater says. “We certainly have a view at Frontier where our thinking is oriented around funds achieving a strong outcome for members, and fees are a part of that. You don’t want to be giving away an undue share to those who are managing the money,” she says.
“But in combination with that, we also have a view on the value of active management and the value of having diversified portfolios that have unlisted assets and alternative strategies, and those things cost a bit more.
I think for funds that have an investment philosophy around well constructed, diversified portfolios and the value of active management, they would view it as an opportunity to outperform the [Your Future, Your Super performance] test, rather than to go passive
“It is about what is a reasonable share of fees and what is not in terms of providing strong outcomes for members,” she says.
What the performance test has brought into a sharper focus is the type of active positions funds take versus the benchmark and how this translates into tracking error. But it shouldn’t necessarily change the way most funds invest, Bowater says.
“I think for funds that have an investment philosophy around well constructed, diversified portfolios and the value of active management, they would view it as an opportunity to outperform the test, rather than to go passive,” she says.
“The issue with going passive is that you are reducing the number of bets you have versus the test benchmark.
“Our thinking is that the focus should be at the total portfolio and understanding where you are taking active risk, having a diversified spread of risks and a good chance of beating the test. And having an awareness of those things is now required in addition to what was already being done in terms of building good diversified portfolios.”
Although Bowater expects that the primary focus of superannuation funds will still be the long term outcomes for members, she also has some reservations about how the performance test is implemented being too narrow.
For example, APRA takes the standard asset allocation as reported in the product disclosure statement of fund options. But funds regularly deviate from their reported SAA in order to navigate volatile episodes in markets.
“It is a tricky test,” she says. “It doesn’t represent how some funds run their investment strategy. A fund that has a higher risk SAA, but that has implemented each asset class in a more defensive manner is really in a difficult spot with this test, because it can’t reflect that.
“I think that working through what this means for alternatives is a good example. It was completely reasonable to have lower returning alternatives portfolio with a stable return profile and/or with a greater pay-off during difficult market environments from a total portfolio perspective. Funds could choose what role they wanted alternatives to play. .
“But now, a fund like this has got this new benchmark and so the portfolio is potentially set up to fail. Those things need to be thought through,” Bowater says.
[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.