A key to TelstraSuper’s success has been its ability to react quickly to market dislocations, CIO Graeme Miller says
It has been said Australian superannuation funds all invest in a similar way, and at a high level that statement is true. Most funds have models that offer members options with different asset allocation mixes, ranging from low risk, fixed income heavy portfolios to risky and equity heavy portfolios.
But when looking under the hood of these funds, there are some significant differences in how they identify opportunities and handle delegation to their investment teams.
Graeme Miller, Chief Investment Officer of TelstraSuper, says this is exactly where the fund’s competitive strength comes from. In addition to the usual asset classes,TelstraSuper has a specific sleeve in its portfolio set aside for idiosyncratic opportunities.
This Opportunities Portfolio spans all asset classes and is allowed to grow to 10 per cent of the total portfolio. Right now, it sits at about $825 million or about 3.5 per cent of the fund. The investment team has been given delegation from the investment committee to act quickly on any market dislocations or mispricings, all within strict, pre-agreed boundaries.
“The whole idea behind the Opportunities Portfolio is to allow us to be nimble and make investments that other superannuation funds might find difficult or time consuming to do,” Miller says in an interview with [i3] Insights.
“Many of the investments are probably too small for our much larger competitors to invest the time and resources on, but because of our size, we can make meaningful investments that will move the dial, and make a real difference to our members.
The whole idea behind the opportunities portfolio is to allow us to be nimble and make investments that other superannuation funds might find difficult or time consuming to do. Many of the investments are probably too small for our much larger competitors to invest the time and resources on, but because of our size, we can make meaningful investments that will move the dial, and make a real difference to our members
“In the last five years, the Opportunities Portfolio has grown to about $825 million. It was just short of a billion dollars about a year or so ago, but we did realise some assets in the portfolio.
“We’ve currently got about 15 different investments in that portfolio, so that means that none of them dominate the portfolio. It’s very diverse,” he says.
The current investments span a broad range of sectors and asset classes and are often based on investment themes. For example, TelstraSuper invests in an actively managed carbon credit strategy to play into the decarbonisation and renewable energy theme.
It also owns 5G mobile network-related companies to align with the theme of the Internet of Things, artificial intelligence and the broader digitisation of the global economy.
But not all investments in the Opportunities Portfolio are based on long term themes. Sometimes relatively short-lived market dislocations come up.
“One of the investments that we’ve got is a portfolio of Australian REITs (real estate investment trusts]. Up until a few months ago at least, we’ve seen very significant falls in the prices of Australian, and indeed global, real estate investment trusts. And in many cases, we’ve seen that the prices of many of these REITs have fallen well below the value of the underlying assets in those trusts.
“Now, obviously, the real estate sector has been through some stress and we’ve seen falls in the value of properties. And there are a number of demographic and other factors that have justified those falls, but our thesis has been that the market has overreacted.
“And so one of the investments that we’ve got in the Opportunities Portfolio is a portfolio of Australian REITs. We’re now waiting for the underlying prices to return towards or beyond the underlying value of those properties, at which point we’ll monetise that,” Miller said.
It is a strategy that has worked for the team before. In the aftermath of the coronavirus pandemic, real estate prices were down dramatically and TelstraSuper bought a number of REITs then as well.
“Coming out of COVID, we saw some extraordinary discounts in the pricing and those discounts corrected themselves. We monetised a chunk of that portfolio. But more recently, we’ve identified that those discounts have re-emerged. And so we’ve gone back into it,” he says.
Internalisation
The Opportunities Portfolio is not the only innovation that sets TelstraSuper apart from other super funds. It was also a pioneer in the move to internalise asset management, well before AustralianSuper decided to bring this function in-house.
The fund manages about a third of its Australian equities portfolio in-house and half of its Australian fixed interest and cash portfolios.
Asked if Miller can share any lessons learned from the internalisation journey, he says the key is to go in with clear objectives and realistic expectations relative to the size of your fund.
“As they go through the internal funds management journey, funds need to have realistic expectations around what internal funds management can and cannot do,” he says.
“If your objective is to try to build the strongest, most powerful alpha engine, then it’s unlikely that a superannuation fund, certainly one of TelstraSuper’s size, is able to do that on a sustainable basis. We’d probably be setting ourselves up for failure.
“On the other hand, if we want to get access to the skill set of a group of highly competent people, who will consistently add value over and above a market index in a reliable and predictable fashion, without taking excessive tracking error or risk and with reasonably modest outperformance targets, then I think history shows us that this is exactly the sort of thing that we can realistically achieve from internal management,” he says.
However, Miller believes it is important not to rely solely on the internal capabilities in any asset class. Telstra Super always pairs its internal portfolios with an externally managed portfolio in order to get a high degree of diversification.
“As is the case with all active management approaches, there will be periods where these processes will underperform or fail to deliver, and we want to guard against that,” he says.
As they go through the internal funds management journey, funds need to have realistic expectations around what internal funds management can and cannot do. If your objective is to try to build the strongest, most powerful alpha engine, then it's unlikely that a superannuation fund, certainly one of TelstraSuper's size, is able to do that on a sustainable basis
Miller is also adamant funds should not focus on cost savings as the primary driver of internalisation. Saving costs is an important benefit to members, but it can also draw attention away from performance.
“Internal funds management can be done at a much lower marginal cost, at a much lower unit cost, than external funds management. But I think you need to be very careful about having cost savings as the only driver, or even the predominant driver of why you’re doing internal funds management, because that drives you to a mindset or a culture of cost minimisation rather than value maximisation.
“And so whenever we’ve done internal funds management, we allocate a significant budget to the team, to its processes, to its systems and to its resources to make sure that our internal teams are very well resourced and, therefore, able to deliver the very best value that they can, rather than simply being focused on cost minimisation as the primary driver.”
But when implemented well, internalisation can be a powerful tool to optimise the portfolio and eke out efficiencies. For example, under a fully externalised asset management model, the total portfolio is the sum of a series of independent strategies by managers that don’t talk to each other and don’t try to optimise the end portfolio.
What internal management can do here is help fill in the gaps and avoid redundancy in the total portfolio.
“If you’ve got manager A buying a stock at exactly the same time as manager B is selling the stock, then what you end up with is a market weight, but you’re paying active management fees for that,” he says.
“What we found that internal funds management enables us to do is to correct for those sorts of unintended consequences that we often see from purely externally managed programs. And in our experience, that’s been one of the key benefits of having an internally managed capability.
“We can customise those mandates to recognise what else we’ve got in the portfolio, and to round out the portfolio in exactly the way we want them to,” he says.
Although TelstraSuper manages significant chunks of the Australian equity portfolio in-house, the fund doesn’t manage any international equities internally. The reason for this is largely related to the current size of the fund, Miller says.
“When we ask ourselves the question: ‘Are we likely to have a competitive advantage in running a fundamental, active international equity capability with a smallish team based in Melbourne?’, the answer that we’ve reached to date is that it’s unlikely that we would have a competitive edge in doing that,” he says.
“I’m not saying that we would never consider doing it – and indeed we have looked at it from time to time – but what we found is that it’s much more difficult to access the global opportunity set, because it’s much bigger and we’re quite far removed from that opportunity set.”
Besides, the ability to reduce portfolio redundancy and unintended portfolio biases in an international equity portfolio is much less than in Australian equities.
“We do look at it from time to time, but we’ve not yet found a compelling case to do it.
“I’d suggest to you that if we ever did do it, we’d be far more likely to start off with a quantitative type process, rather than a fundamental bottom-up type process, because it’s more likely that we’d be able to identify a competitive advantage in a quantitative process,” Miller says.
“There are literally tens of thousands of potential stocks that we can own globally, and to do deep, high-quality research on them does require a larger critical mass than would be the case if it’s more of a quantitative-driven strategy,” he says.
How the fund’s investment strategy continues to evolve may be influenced by bigger things, as TelstraSuper recently announced plans to merge, citing benefits of scale for members.
Miller could not comment further on the merger plans, as they are still at a very early stage.
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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.