ART is looking to implement more niche equity allocations through an internally developed completion capability that tightly manages the risk from such allocations.
The Australian Retirement Trust (ART) is using its scale and resources to allocate to more targeted and niche equity strategies in an effort to increase returns and achieve better diversification.
The fund then uses an internally developed completion capability to construct indices around these niche strategies in order to manage the risks of the exposures.
“It is a big change to shift from global mandates in equities to very targeted, specific ones and then ensuring you have all of the portfolio construction infrastructure in place to manage that risk appropriately,” Andrew Fisher, Head of Investment Strategy at ART, says in an interview with [i3] Insights.
It is a big change to shift from global mandates in equities to very targeted, specific ones and then ensuring you have all of the portfolio construction infrastructure in place to manage that risk appropriately
“We now have a really well-developed portfolio completion capability in equities. This comes from a long-standing partnership with our index manager, State Street, and the capacity to, in essence, use our index capacity to build [indices] around any portfolio we like.
“This speaks to some of the benefits of scale and how we’re using our scale to generate returns as we grow.”
In an interview earlier this year, Ian Patrick, Chief Investment Officer at ART, said the fund was researching whether it would benefit from taking active positions in large caps and go passive in the rest of the index.
Fisher explains that this is part of a larger research project into more targeted allocations, but the work is still ongoing.
“It’s a big piece of research; not gonna be something that’s resolved very quickly,” he says.
Completion Capability Originates in QSuper
The completion capability was originally developed by QSuper and following the merger with SunSuper, the broader ART entity is now benefiting from this effort.
Fisher pointed out that it is one of the benefits of scale as it takes up a fair amount of resources to run the capability and put the right governance structure around it to ensure the fund isn’t taking any unintended risks.
“I’m always consistently surprised that whilst you worry about the things you can’t do with scale, it’s amazing the opportunities that scale opens up. And we’ve continued to see better and better outcomes through scale,” he says.
“What scale gives you is a much more meaningful capacity to allocate to smaller, niche-type ideas.”
He says the team often uses the example of reforms in Japan to explain how it would apply a targeted allocation.
Former Japanese Prime Minister Shinzo Abe introduced the so-called “Three Arrows” approach to reform the domestic economy, targeting specific measures through aggressive monetary policy, fiscal consolidation and a growth strategy.
I'm always consistently surprised that whilst you worry about the things you can't do with scale, it's amazing the opportunities that scale opens up. And we've continued to see better and better outcomes through scale
An important part of this strategy has been to introduce corporate governance reforms that are more friendly to shareholders and target growth.
“One way you could try and access that in an active capacity would be an activist type of strategy,” Fisher says.
“We have enough capital to do that in a meaningful way and in a cost-effective way, but also have it have enough impact that it’s worth the investment of time and energy. If you only have a small equity portfolio, is it really worth a person’s time to investigate that?”
The completion strategy can also make use of derivatives to implement ideas, but again will complement any idea with a broader index exposure.
“We have a reasonable passive exposure and that passive exposure can be all in stocks or that passive exposure could be stocks and derivatives,” Fisher says.
“The way we’re using a completion capability is to give us more flexibility on the derivative side, so when we see attractive opportunities to replicate with derivatives over physical [assets] and then we use completion to build the rest of the index around it.
“We’re not using [completion] in a style-adjusting way or anything like that. It’s really just the ability to take out of any piece of the index and then we will basically build the rest around it.”
ART works closely with State Street on the construction of its customised indices and Fisher says the manager has been instrumental in ART’s ability to put the completion capability in place.
But he also indicates that as ART has become more sophisticated, the relationship has changed.
“If you think of a traditional manager, an external partner relationship and [a] passive [approach], then you tell them what the index is and they build to the index,” he says.
“We have moved on. We’ve evolved from that to tell them what portfolio, what stocks we need to buy and they’ll build the portfolio.
“Because if you keep taking things out of the index, you have to keep recreating a new index and that’s incredibly burdensome for the index manager.
“We’ve essentially built the infrastructure internally to construct an index and so we can construct the stock list of the index internally and give it to the passive manager to implement.”
Targeting Duration in Individual Investment Options
On the fixed-income side of the portfolio, ART has also adopted QSuper’s approach to include high-duration bonds and the ability to adopt a specific duration target at the investment option level, rather than at the total portfolio level.
“QSuper would talk about high-duration bonds, but what I didn’t quite appreciate is the implementation focuses on targeting duration at the option level. Thinking about fixed income in that way has revolutionised the way we’ve thought about fixed income across all of our portfolios,” Fisher says.
QSuper would talk about high-duration bonds, but what I didn't quite appreciate is the implementation focuses on targeting duration at the option level. Thinking about fixed income in that way has revolutionised the way we've thought about fixed income across all of our portfolios
“If you look at some of the performance that’s been delivered in the last couple of years, then it doesn’t show up much, but we have had much more resilient portfolios. That will really show up the next time we see a big depression or recessionary-type impact on markets.”
The duration target differs per investment option, since more conservative options will include more fixed-income assets. For example, the fund’s balanced option has a target of approximately a year, which is the result of the fund’s ideas about the level of sovereign bonds such an option should include.
Although the strategic duration targets are relatively static, the team has some degree of flexibility in adjusting duration through dynamic asset allocation and completion strategies.
“It will respond to what the physical portfolio is doing,” Fisher says.
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