AustralianSuper’s Mark Delaney addressed a common criticism of internalisation of investment functions during a fireside chat at the recent Morningstar Investment Conference.
An often-heard criticism of pension funds that internalise asset management functions is that it is much harder to terminate an internal team than an external manager because of the relationships that have been built between colleagues.
But in a fireside chat at the Morningstar Investment Conference in Sydney earlier this month, Mark Delaney, Chief Investment Officer of the $280 billion AustralianSuper, said internal investment staff were likely to receive more scrutiny from management rather than less.
“We’ve terminated internal fund managers for not delivering the performance we’re after. If anything they get more scrutiny than the external managers do because the investment committee and everybody else is all over them,” Delaney said.
We've terminated internal fund managers for not delivering the performance we're after. If anything they get more scrutiny than the external managers do because the investment committee and everybody else is all over them
In fact, he said if AustralianSuper was guilty of anything, then it was of holding on to external managers for too long.
“When you look at our history, we’ve hung on to external managers who haven’t performed for too long. How long does it take for you to give up faith? It’s always when you look back on your record you should have gotten rid of them when you first started to worry about them,” he said.
“How many of them come good after you first start to worry about them? One in three? Even when we know this, we still don’t do it fast enough. So reluctance to do anything affects all investment decision-making.”
He argued that logistically it was actually easier to take money from an internal team than from an external manager, as once you took money away from an external manager it would be hard to give it back when conditions changed.
“If we don’t like it, or we’ve got worries about the [internal] strategy, [then] we can defund it pretty quickly. We can halve their allocation, cut it to a quarter, while they’re rebuilding or structurally adjusting,” he said.
“You can’t go to external fund management and say ‘I’m going to cut your allocation by two-thirds’ and expect to get that back next year or the year after.”
AustralianSuper runs two Australian equity portfolios internally with a combined size of about $60 billion. One is a large-cap portfolio that consists of companies chosen from the top 50 largest companies on the Australian Securities Exchange.
It also runs an ex-top 50 portfolio with smaller companies. Delaney says the internalisation makes it possible to run the latter portfolio, which would have been hard to do with external managers.
“That ex-50 portfolio, because we run the whole portfolio ourselves, is about market weight right now. But if we had five external managers in small caps, then we would never get there,” he said.
“Because we can take up the whole capacity of the strategy through a single-manager approach, we can stretch out our capacity envelope to be broad enough to meet most circumstances.”
As AustralianSuper continues to grow, he expects the allocation to small caps to become more difficult, but he said a larger size would bring new opportunities to the fund.
“As things drop off, other things come on to your agenda. In the future, small caps in Australia will be harder to do, but private equity co-investments and co-sponsorships will be much easier to do,” he said.
If Delaney had to choose between small caps and private equity co-investments, he would take the latter, he said.
“I think I’ll take the private equity deal. I think that’s going to make a lot more than small caps in the long run,” he said.
AustralianSuper also runs property investments internally, but Delaney acknowledged this strategy had been more problematic due to overweights to the wrong sectors.
“It has been really disappointing; it was long and short the wrong strategies. We had a strategy of overweighting retail and having more international property than Australian property,” he said.
“Both of them were the wrong decision and with property when you’ve got one which is underperforming, it’s very hard to get out of because you never want to accept how bad it is until it gets really bad.”
Retail properties have been struggling in recent years as online shopping has increased in popularity. The global pandemic has only reinforced this move away from bricks and mortar shops.
The rise of e-commerce has also resulted in an increased demand for warehouses and distribution centres, but AustralianSuper also had a short exposure to industrial real estate.
“That was the worst of all worlds and that’s performed really poorly,” Delaney said.
“We’ve got one good international investment, which is at King’s Cross Estate [in London], but the others haven’t been very good at all.”
Limits to Illiquidity
As the fund continues to grow, AustralianSuper has been allocating more to private markets, which allows the fund to put large amounts of capital to work and produce smooth returns.
But these assets tend to be illiquid in nature and despite the large inflows into the fund every month from contributions, there are restrictions to how much it can allocate to these assets.
For example, in times of market stress, listed assets tend to fall more sharply than unlisted assets, which will cause the strategic asset allocation to get out of whack.
We've got a figure of around 30 per cent (private assets as a percentage of the total portfolio) we think for the balance plans is about max and that's a function of the sources and uses and the willingness and the ability to rebalance the portfolio if equity markets were to halve
“When equity markets halve, as they did in 2007-2008, your illiquid allocation will go up by 40 to 50 per cent. So you need enough liquidity to be able to rebalance your portfolio when the chance to buy stocks is the best,” Delaney said.
“You can’t have two-thirds of your portfolio in illiquid assets unless you say rebalancing the portfolio in listed assets and taking care of cheap prices will not be part of your strategy.
“So we’ve got a figure of around 30 per cent we think for the balance plans is about max and that’s a function of the sources and uses and the willingness and the ability to rebalance the portfolio if equity markets were to halve.”
But he also acknowledged there will be a time when the fund will have a significant portion of members in retirement and this will put additional liquidity pressures on it, making it harder to invest large portions of the portfolio in private markets.
“[When] we get to the retirement phase in the late 2030s and there’s a lot of money going out of the fund, it will be a different world. But I won’t be managing it then,” he said.
During the fireside chat, Delaney also provided an insight into some of the projects he is working on. One in particular focuses on increasing returns by changing the way the fund approaches portfolio construction.
“I’m thinking about [changing] the overall structure of the portfolio to make more money in the long run. Rather than building by asset classes, if I build by investment strategies – high returning, middle returning, low returning – [then] can I find a way of unpicking more value?” he said.
“And so I’m playing around with a spreadsheet and I think I’ve got half an idea, but I have to convince the senior investors that’s going to be a good idea.”
Asked how many basis points the idea might add over the long term, he said he thought it could add 20 to 30 per annum.
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