Cbus will start to manage more of its Australian large-cap equities in-house. We talk to Deputy CIO Leigh Gavin about what this means for the role of external managers and their place in the hybrid model.
Cbus Super is in the process of expanding its line-up of internal Australian equity strategies with a new fundamental, active ASX Core strategy that has the ability to both address capacity issues and potential biases in the portfolio.
In February, the $100 billion superannuation fund for the construction industry hired Ryan Riedler as Head of ASX Core Strategy, Australian Equities, to manage the new strategy. Riedler joined the fund from Cooper Investors, where he was Deputy Portfolio Manager and then Portfolio Manager of the Cooper Investors’ Endowment Fund.
The Core strategy will look predominantly for opportunities in large-cap companies, mainly the ASX 100 universe, to avoid overlapping too much with its small-cap strategies.
Currently, Cbus has a passive allocation to the ASX 20 to avoid large skews in its portfolio and keep tracking error within desired limits.
“That [ASX 20 allocation] partly addresses some of the systemic tilts that you have in an actively managed Australian equities universe,” Leigh Gavin, Deputy Chief Investment Officer of Cbus, says.
“So, for instance, by having a dedicated allocation of 5 to 10 per cent in small caps, you, by definition, are going to be underweight large caps,” Gavin says in an interview with [i3] Insights.
The challenge we always find there is that the ASX Small Ords [index[ tends to be a better place for alpha, but a worse place for beta. Generally, the alpha that fundamental small cap managers have been able to generate over the last 20 years is pretty healthy in Australian equities
“You also have some systemic biases because there are no banks in the ASX Small Ordinaries Index. So, by definition, you tend to be quite underweight the banks. Broad-cap managers tend to be underweight the ASX 20 as well, so it helps to square up some of those biases in the portfolio.”
Historically, Cbus has had a relatively high allocation to small and mid-sized companies because the investment team believes there is consistent alpha to be found in these sectors. The fund has always taken an active approach to small and mid-caps because the beta in these sectors is poor.
“The challenge we always find there is that the ASX Small Ords [Index] tends to be a better place for alpha, but a worse place for beta. Generally, the alpha that fundamental small-cap managers have been able to generate over the last 20 years is pretty healthy in Australian equities,” Gavin says.
“And it needs to be because the ASX Small Ords has underperformed the ASX 100 by 3.4 per cent per annum over the last 25 years. We have a negative small company risk premium in Australia and it’s not clear to me that the next 25 years are going to be any different from the last 25 years, given the paucity of high-quality reasonably priced IPOs,” he says.
“But our small-cap configuration has generally generated enough outperformance to offset that negative small company risk premium.”
At $100 billion, Cbus is still at a size where it can take meaningful positions in small and mid caps, he says.
“Cbus, at one stage, had 15 to 20 per cent in mid and small caps. As we grow, it’s obviously harder to maintain that size allocation,” he says.
“But I think we’re one of the few funds that is still maintaining a reasonably sized allocation of around 10 per cent to dedicated small-cap managers at present, including our own internal small-cap strategy.”
Sticking with the Hybrid Model
Gavin was appointed as Deputy CIO in February and, in addition to his other responsibilities, which include shaping the fund’s approach to total portfolio management, he remains in charge of the internal strategies.
Cbus has committed to managing half of its assets internally in the next three years, including the assets managed by its fully owned real estate arm, Cbus Property. Today, it manages about 34 per cent of its total assets in-house.
As at June 30, 2024, Cbus managed over $20 billion in Australian equity strategies, including internal and external managers. Externally, it has about a dozen managers, while it runs three strategies internally, in addition to the new core large-cap strategy.
It has been running a small-cap strategy for five years, which now has $850 million in assets under management. It also runs a so-called ‘quantamental strategy’ in-house, which is a relatively concentrated, high tracking error portfolio, but that has natural capacity limits within the total configuration, given its high tracking error nature.
And finally, it has an Australian Corporate Opportunities Fund that takes large stakes in a select few companies in the Australian equities universe and aims to outperform an absolute return target of 9 per cent a year over the long-term. “We recognise it’s predominantly a long-only Australian equities strategy, but it can generate alpha through other means as well, including underwriting and sub-underwriting,” Gavin says.
But despite the expansion of the internal Australian equity strategies, the fund is unlikely to move to a fully internalised Australian equity portfolio, he says. “It’s the sort of portfolio we don’t think will be 100 per cent internal, certainly not in this five-year strategy (which runs until 30 June 2028), and I’m pretty sure not in the five-year strategy after that either,” he says.
“What we talk a lot about in our hybrid approach is having big, scalable strategies that can become core allocations and where you can build a portfolio around.”
[Australian equities] is the sort of portfolio we don't think will be 100 per cent internal, certainly not in this five-year strategy (which runs until 30 June 2028), and I'm pretty sure not in the five-year strategy after that either.
Cbus has been vocal about running a hybrid model where it complements a select number of internal strategies with external fund managers.
“We’re big believers in a hybrid strategy. Whilst the median manager in Australian equities has delivered circa 1 to 1.5 per cent per annum gross of fees over the last 10 and 20 years, there are a number of managers who have delivered 2.5 to 3 per cent alpha over that period,” Gavin says.
“We think there’s always going to be a role for those managers, particularly on the wings [of the portfolio]. For example, deep value or deep growth are the sort of things that we’re unlikely to do internally anytime soon.”
He believes the industry is more likely to see consolidation in large-cap Australian equity strategies as managers have found it hard to add consistent alpha above the fees they have charged in recent years.
“The core has been certainly competitive in the last 10 to 20 years and will continue to be competitive over the next 20. That’s where you may see some consolidation over the next 10 years,” he says.
Besides higher investment returns from niche strategies, he also points to the indirect benefits of having external managers on the roster, including the ability to leverage ideas and specialist knowledge.
“When you are very large, you typically have a much higher proportion of internal funds, which means you can lose a source of IP (intellectual property) from external managers,” he says.
“We think we’re small enough to still have an amazing amount of relationships and access to potential IP from investment managers, investment banks and other asset owners around the world.
“Someone has used the term ‘Goldilocks’ to describe us; at $100 billion now, we are not too big, not too small. And we think we’re likely to stay in that sweet spot for quite some time since our cash flows are good, but they’re not so large that we have to deploy tens of billions every year into every private market asset class just to maintain the allocation.”
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[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.