Cerulli Global Edge: consultants rule in oz

Global Edge, October 2010

In recent years asset consultants have developed an influential role in the more than A$1 trillion Australian superannuation industry. Among other things, it is consultants who are in large part responsible for the shift towards illiquid assets in Australian super funds in recent years – a move which some feel came close to backfiring in the global financial crisis.

The role of asset consultants has become particularly significant ever since the choice of super regime came into effect in Australia in July 2005. This allowed Australian individuals to choose whichever super fund they wanted to save into, and had a number of knock-on effects. In particular, industry funds – not-for-profit funds that had previously served only a particular area of society such as education employees or a state government  – were opened up to far wider usage, and as a consequence, rapidly started to grow in sophistication.

One of the ways they did so was by retaining asset consultants such as Mercer, Jana Investment and Frontier Consulting, and several of them started to do some new and interesting things to Australian superannuation portfolios. Probably the most striking example was Access Economics (whose super advisory business has since been spun off as Access Capital Advisers). Access took the view that alternative assets, and in particular big chunky assets like infrastructure, were particularly well suited to superannuation funds, since trustees, with little danger of unpredictable outflows from members, were able to take the long term view that these assets required.

A typical Access-advised fund would look like this: about half the fund invested in mainstream asset classes, and the other half in something called a target return portfolio, made up mainly of unlisted assets. These unlisted portfolios looked most unlike the Australian share-heavy portfolios that local investors had been used to in their savings vehicles. Consequently, MTAA Super, originally formed by the Motor Trades Association of Australia for employees of Australia’s automotive industry, put members into direct holdings in the UK’s East London Bus Group and a port in Gdansk, Poland, along with numerous domestic airports and other properties and utilities. Another landmark Access client, Westscheme, which was set up to service Western Australian public sector employees, by 2007 had 17.6% of its funds in subordinated debt or infrastructure equity, 8.8% in private equity, 10.3% in direct property and a chunk in timber.

It wasn’t just Access clients who behaved in this way. Sunsuper, a Queensland-based industry fund, took a direct shareholding in the private equity manager Carnegie Wylie in 2005, giving itself the right to be a cornerstone investor, with therefore guaranteed allocation, to any subsequent fund it launched.

Better still, it worked. Throughout the bull market that followed choice of super legislation, industry funds dominated superannuation returns league tables, and Access clients like MTAA and Westscheme typically jousted for the top spot.

But there was a challenge here. How did anyone really know what the performance of one of these super funds was? Who was to say just what a port in Gdansk would be worth on open market from one day to the next? Throughout this period the for-profit funds run by the asset management arms of the big banks would grumble about league tables and performance, questioning whether they really reflected reality.

And then came the global financial crisis, and the whispered grumbling became a much more widely discussed concern. At a time when investors were pulling out of funds the world over, what would happen to these industry funds with half their assets in securities that they couldn’t possibly sell? There was growing alarm that illiquid funds would be unable to meet redemptions.

In fact, while that concern was perfectly valid for many alternative funds, it was actually irrelevant for super funds: Australians can only withdraw from them in specific circumstances (such as reaching the minimum age to do so) and Australian employers are required to put an amount equivalent to 9% of employees’ salary into super funds. The wall of money flowing into superannuation is unstoppable, mandated by law: you couldn’t turn the tide if you wanted to. It’s true that, under choice of super, you can take your funds and put them into another super fund, but people tend to show a stodgy inertia about the effort involved in doing so; no runs on major super funds transpired.

Nevertheless, super fund trustees have tended to take a closer look at their risk profile ever since. In April 2009 the Australian Prudential Regulation Authority wrote to all super trustees to clarify its expectations on the valuation of unlisted assets. “By nature, unlisted investments are more complex than listed investments,” APRA said; it stressed the need for a robust, documented policy framework and made specific mention of external advisers such as asset consultants. APRA’s note was more about accuracy of valuation than any suggestion that funds stay out of unlisted assets, or break with their advisers, but it showed a growing recognition of the issue.

While super trustees have not been encouraged to ditch alternative assets – since there is a strong argument they can provide better long term returns and keep costs low – they have been encouraged to consider whether the liquidity they offer members is consistent with the liquidity of their assets.

Consultants today say that the main impact of the global financial crisis was a renewed understanding of liquidity, and the dangers of a liquidity mismatch. Some report more diversification – or a recognition that what they thought was diversification was actually just a range of correlated asset classes. (As one consultant puts it: “There were funds out there which thought they were diversified but then saw everything go to custard at the same time.”) Some report that, far from a suspicion of illiquid assets, use of alternatives has actually gone up, although scrutiny of how those alternative assets behave has increased too. Others report that suspicion has grown of hedge funds, particularly those that did not add value when traditional asset classes ran into trouble in the financial crisis (and also because fund of fund structures sometimes contributed to a liquidity mismatch).

It’s certainly true to say that those super funds that nailed their colours to the alternative mast have stuck with their convictions. MTAA Super’s balanced option had 59.5% of its money in the target return portfolio as of June 30 2010, compared to a target allocation of 45%. 51.8% of that portfolio was in infrastructure, 26.9% in property and 16.3% in private equity. But it no longer tops the league tables: according to industry research group SuperRatings, it ranked 48^th out of 49 balanced option funds in the year to June 30, and 49^th over three years, though it looks a much healthier 13^th out of 34 over 10 years. As for Westscheme, it has reduced the proportion of the fund taken up by its target return portfolio from 44% to 36.7% between June 30 2009 and June 30 2010 – partly a consequence of decent market performance in that time – but has not been suffering from its unlisted holdings, with revaluations of assets including Brisbane Airport, DCT Gdansk and Etihard Stadium increasing the target return portfolio performance by 2.28%.

One trend that has emerged from all of this is that many super funds have added chief investment officers, taking more direct responsibility for investment rather than outsourcing as much to consultants. Consultants are still employed, but under a slightly different supervisory approach than before. Two funds who have recently added CIOs are Australian Super and the Local Government Superannuation Scheme.

Some feel that the power of the consultant diminished with the financial crisis: that it will be a while before trustees will think it appropriate to outsource so completely their allocation decisions. Others remark that Australia remains one of the most intermediated markets in the world for asset management, with advisers employed at every turn from the individual to the billion-dollar fund; in such an environment, the consultant with smart ideas and an ability to demonstrate they work will still be amply busy.