Very few superannuation funds manage to extract all the benefits of a particular model and will therefore have to deal with and minimize the impact of the potential negative aspects associated with each model.
It is a real challenge to minimise the negatives. There is no template for how it can be done. There are, however, a number of elements that needs to be explicitly considered to enhance the chances of success. These can be summarised as follows:
- The dominant outsourced model has not lived up to expectations. Active managers have not on a consistent basis generated the outperformance net of fees that was expected relative to the relevant passive benchmarks.
- Cost control becomes increasingly important in a low return environment. Given current valuations of both bonds and equities, it is not unreasonable to expect low returns on a forward looking basis.
- As fund assets under management grows it becomes easier to justify the costs of an internal investment team.
- The development and liquidity of the ETF market has made it much easier to tilt a portfolio. Assuming the internal investment team prefers Japanese over US equities, the tilts can be implemented with a couple of key strokes rather than having to buy and sell large baskets of securities.
- ETFs have also made available factor exposures, which were previously the domain of active managers. An internal team can now easily get exposure to factors like Low Volatility, Quality, Value, Growth or interest rate sensitive stocks and use these to configure an asset class.
- The growing use of risk models have enabled funds to better understand the risk exposures embedded in their portfolios. This greater transparency has highlighted that a number of risk factors run across asset classes and therefore cannot be managed by the external investment managers within an asset class. Instead the risks have to be managed from a total portfolio perspective. Generally, only the internal team has that overview.
As the superannuation funds move towards hybrid models consisting of a blend of internal and external management, it may be useful to take a look at the main positives and negatives associated with being either 100 per cent insourced versus 100 per cent outsourced. The hybrid models can then be assessed against both.
Very few superannuation funds manage to extract all the benefits of a particular model and will therefore have to deal with and minimize the impact of the potential negative aspects associated with each model.
It is a real challenge to minimise the negatives. There is no template for how it can be done. There are, however, a number of elements that needs to be explicitly considered to enhance the chances of success. These can be summarised as follows:
- clearly defined objectives;
- a strong governance framework;
- a well- resourced team;
- a culture that empowers the team to achieve the required outcomes;
- remuneration structures that align with the required outcomes;
- diversification of the strategic decisions;
- avoidance of a culture that promotes an “A-Team” and a “B-Team” within the same team;
- ensure the team has market access; and
- constructive use of competition.
The list can be further condensed to three critical elements; People, Culture and Governance. Get those three elements right and the team should be able to succeed irrespective of the model. Ensure all team members are valued and pull together for the greater good of the fund. It is a tough challenge, but it is worth getting it right, because the success ultimately benefits members.
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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.