Rest is looking to build an internal global equity team of four specialists and tightens its focus on active risk as it continues to fine-tune the investment portfolio
Rest Super is in the process of building an internal global equities capability of four portfolio managers over the coming year. This team will be based in Sydney.
In early November, the fund announced to have hired Richard Mercado as Head of Internal Global Equities and he will develop an active, fundamental stock-picking strategy with a quality growth flavour to it.
Mercado joined from Comgest in Paris, France, where he was a high-conviction portfolio manager specialising in global equities. He also worked for USS Investment Management, the investment arm of UK pension fund Universities Superannuation Scheme.
Rest already manages cash, debt, Australian equities, infrastructure and property in-house, but until now didn’t have an active internal team for global equities.
Andrew Lill, Chief Investment Officer (CIO) at Rest, says the addition of an internal equities team was the result of thinking about how to best drive returns from the risks taken in the portfolio. The opportunity was cemented by the establishment of Rest’s internal trade desk and Mercado’s desire to move back to Australia after 10 years in Europe.
“We don’t have a specific target for internalisation that we try to get to,” Lill said in an exclusive interview with [i3] Insights. “We expect that, for the near future, a range of 15 – 25 per cent of our portfolio managed internally makes sense, but I see the enabler as being the technology upgrades that we’ve done,” he said.
Rest has implemented a new data and investment analytics framework. The fund worked together with State Street and wealth management consulting firm 1886 to implement the portfolio system.
In addition, Rest has established a trade desk for its internal team and these changes combined created the ability to establish an internal global equities capability.
We feel it's important to have the global equity team together in one place. Whether in time, we further utilise our London office, we'll see. The short-term target is to build out a Sydney team of four people with great expertise to run a global equity mandate for us
“As we were building this out, it became clear that we could begin to think about a global equity capability in-house,” Lill says. “And as we looked around the world, we were looking for the right fit. Could we find an individual or individuals that would really fit our investment culture as a member-oriented super fund in Australia?
“And Richard’s experience of having worked for USS in London and for high-profile asset managers, we were really delighted that we could find him at this time. Now, we’re looking to build out that team,” he says.
Although much of Rest’s internal team is based in Melbourne – a legacy of internalising the team of its former fully-owned fund manager Superannuation Investment Management – Mercado and his team will be based in Sydney, alongside a number of the fund’s Investment Strategy and Asset Allocation team.
“We feel it’s important to have the global equity team together in one place. Whether in time, we further utilise our London office, we’ll see. The short-term target is to build out a Sydney team of four people with great expertise to run a global equity mandate for us,” Lill said.
Rest has board approval to expand the size of the assets run internally to 25 per cent of the fund, but Lill said this is not a number he is fixated on.
“As I see it, it is really the mixture of governance, technology, and culture that will determine the pace at which we internalise. We’re not just trying to meet a target, because I do think that the overall value equation is really important. It’s not just cost,” he says.
“Our projections show that our fund will probably be at $100 billion by 2026, and the idea of managing up to $25 billion of assets is a large undertaking and shouldn’t be approached lightly. To do that well requires steady thinking and some patience,” says.
Targeted Risk Exposures
Rest has been overhauling its investment structure in the last few years, moving away from an asset consultant-based model to one where it has a single investment function led by Lill as CIO.
The team has reviewed its asset allocation structure and has sharpened the focus on where it wants to take risk in the portfolio and reduce exposure to areas where it doesn’t feel it is getting appropriately rewarded for risk.
“We’ve spent a lot of time on the areas of a multi-asset portfolio where we have a high conviction that risk is driving benefits in terms of the returns. And where we don’t have a high conviction, we will close down the tracking error,” Lill says.
The team’s analysis has shown that Rest wasn’t getting appropriately rewarded for the active risk it took in certain duration positions in fixed income, small & midcap positions in global equities and active currency management.
“Over time, we have closed down the amount of active risk that we’re allocating to those areas,” Lill says.
We have added enhanced passive mandates since 2020, and ... it's been one of the areas where we've been able to drive both financial returns and also reduce carbon intensity in our equity portfolios
Rest has a strong track record in delivering alpha from Australian small caps and Lill says the fund is in a sweet spot in terms of size of the total fund to be able to continue to harvest small cap alpha in Australian equities going forward.
But it has different views on the case for global small cap equities.
“The evidence from our own allocations and from our external research would suggest that it’s not an area that we have a high conviction of capturing an information ratio,” he says.
“We don’t need to play that game where the hit rate is low and the nature of the returns is episodic, while the active fees can be quite high. I think there are just better places to spend our active risk budget and our fees budget.
“We do allow our global managers to take small cap exposures, but we don’t have a specific small cap mandate anymore,” Lill says.
As Rest has been culling some of these active strategies, it has also added a number of enhanced passive mandates in its equity portfolios.
“We have added enhanced passive mandates since 2020, and the timing has been really good. Factor-based investing has had a really good period in that time. And it’s continued sort of to improve the information ratio of the overall equity portfolio,” he says.
Rest added two large mandates in global equities and one large mandate in Australian equities.
“It’s been one of the areas where we’ve been able to drive both financial returns and also reduce carbon intensity in our equity portfolios,” he says.
“The systematic, quantitative approach has a 30 per cent lower WACI (weighted average carbon intensity) score than the index and that’s part of the mandate. But we are also seeking to ensure that the portfolio continues to drive alpha relative to the broad index and that has been really successful.”
[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.